Sarbanes-Oxley_Effect_on_Non_U.S._Public_Companies_

Sarbanes-Oxley effect on Non U.S. Public Companies' August 30, 2009 Abstract The goal of this paper is to briefly discuss the affect that Sarbanes-Oxley has on Non-U.S. Public Companies. The effects vary depending greatly on the type of business that the Foreign company is engaged in, it’s competition, and it’s desire to attract U.S. investment. As the Sarbanes-Oxley law and rules are relatively new and businesses are still developing tools and practices to best deal with them, this is a subject in constant flux. Reviewed are the hurdles that are in place to go from Private to Public, the push to go from Public back to Private, market expansion opportunities created for Non-U.S. companies, and business growth options related to compliance. Sarbanes-Oxley effect on Non-U.S. Public Companies In 2002, the Public Company Accounting Reform and Investor Protection Act of 2002 Federal law was passed in the United States. This is often known as Sarbanes-Oxley or SOX. The reason for this was due to a number of large accounting scandals with large U.S. Publicly Traded companies and their accounting firms. These scandals caused significant investor concern and required immediate action to maintain investor confidence. The result was this law being developed to help prevent large accounting irregularities from occurring in the future and being allowed to pass audits. Greater responsibility was also placed on the Board and other company officers to be aware of their accounting processes and of company business taking place. One criticism of Sarbanes-Oxley has been that is has made doing business more costly and difficult for U.S. listed businesses and positively affected Non-U.S. companies. We will look at the various effects that Sarbanes-Oxley has had on Non-U.S. Public Companies. Private to Public Hurdles When one looks at Sarbanes-Oxley and its effect on Non-U.S. Public companies, the first thought that comes to mind when someone says that it may be more difficult to be a Public company in the United States is that it then must be easier to be a Public company elsewhere. Recent articles and studies have been done examining the rate of growth of new U.S. Public companies compared to that in other countries that traditionally compete for many of the same types of business. One study showed that the growth or companies in the UK and listing on the London Stock Exchange corresponded closely with the effective start of Sarbanes-Oxley regulations in the United States. (Mainwaring, Investors Chronicle, 2008) Therefore one would argue that Sarbanes-Oxley makes it easier for Non-U.S. Public companies to simply go Public in other countries than it is in the United States. When we look at Sarbanes-Oxley difficulty in this instance, we’re looking at barrier to entry except as it applies to Public trading. Prior to Sarbanes-Oxley, compliance was much easier than Post-Sarbanes-Oxley. With Sarbanes-Oxley, the IT systems required are more costly, the processes more complex and internally staffed, and must exist for your business. Along with IT systems are business processes which must align or be aligned to what is required to be Sarbanes-Oxley compliant. Alignment and systems can have substantial up-front costs for systems as well as change management consultants and contractors to assist in developing and implementing the required processes, practices, and systems. These changes require time, capital, and staff time from existing organizational resources. Previously the internal controls could exist at a fairly rudimentary level making it easier to spring from Private to Public company. This creates a new hurdle or barrier to entry to go from Private to Public. Private to Public Costs Previously we discussed hurdles that Private companies face becoming a Public U.S. company vs. a Non-U.S. Public company. Another area where we can see the effects of Sarbanes-Oxley on U.S. and Non-U.S. Public companies is simply the increase in annual operating costs. In the case of Sarbanes-Oxley compliance, this means additional headcount and systems costs associated with compliance. It also means slightly higher costs to external auditors such as KPMG and Deloitte to do a more thorough audit than was previously performed in the past with staff that is trained in Sarbanes-Oxley compliance. In one small firm example from USA Today (2007), compliance with Section 404 of Sarbanes-Oxley was costing companies as much as 10% of their annual revenue. These are internal costs and don’t represent the additional costs for external independent third party auditors such as KPMG. KPMG and other accounting agencies have shown positive growth that corresponds closely with the implementation of Sarbanes-Oxley. (Schooley, Pittsburgh Business Times, 2005) The higher costs of auditors such as KPMG and Deloitte are to do a more thorough audit than was previously performed in the past with staff that is trained in Sarbanes-Oxley compliance. In 2007, the cost for Sarbanes-Oxley compliance for 185 firms averaged $1.7 million. (Marketing Business Weekly, 2008) In a study by the SEC in 2006, they found the actual costs to be 10 times the original estimate or approximately$900,000 annually. When Sarbanes-Oxley was originally conceived and passed, the SEC estimated additional compliance costs of $91,000. This puts a U.S. Public company at a distinct disadvantage compared to that of a Non-U.S. Public company. This disadvantage can be somewhat offset by the advantages the U.S. company has when it comes to currency factors and the accessibility to the large U.S. investment market. This has also been somewhat offset by the enactment of similar laws to Sarbanes-Oxley in other countries. In Europe, individual European nations such as Germany, France, and Italy have enacted similar laws to Sarbanes-Oxley. However the gulf between the new laws and the previous laws in those nations are not as great as those between Sarbanes-Oxley and previous U.S. laws so less overall effort has had to have been expended to bring companies into compliance. In Japan as well as several other nations Sarbanes-Oxley-like laws have also been implemented or are in the process of being implemented. In this case as well, the laws are closer to what previously existed and therefore less of an effort is required than in the U.S. Overall however with regards to operating costs, Sarbanes-Oxley compliance has placed a higher burden on Public U.S. companies than other Non-U.S. Public companies have faced. The net effect of this is that Sarbanes-Oxley has positively affected Non-U.S. Public companies. (Tharp, New York Post, 2007) They are able to be more competitive in the market due to a lower impact to their operating costs with new legislation than U.S. Public companies have felt. In some cases a Private U.S. company when looking to go Public did so in a foreign market and thus many of the jobs, purchased services, and tax revenues that the business provided in the United States were sent abroad. A U.S. division may remain but the core admin and higher headquarters is moved out of the United States. In summary, Non-U.S. Public companies enjoy an advantage over U.S. Public companies when it comes to annual operating costs. Non-U.S. Public companies have exploited this to their advantage since 2003. Auditor Job Creation and the benefits to Non-U.S. Companies With the implementation of Sarbanes-Oxley, a great deal of additional auditing work was added to the base audit that is done periodically for any Publicly traded institution. With the effective elimination of Arthur Anderson Consulting following the Enron collapse and investigation, the big four consulting firms, PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young, and KPMG, moved in to fill the void. This was done at the same time as the Sarbanes-Oxley requirements were produced creating a massive need for auditing. With some auditors companies being based in London and Amstelveen, this ultimately profited foreign entities. The big four showed growth of as much as 17% a year in some years following the passage of Sarbanes-Oxley. Therefore Non-U.S. Public companies have profited from the passage and implementation of Sarbanes-Oxley. (Reilly, Wall Street Journal, Eastern Edition, 2004) Reduced Likelihood of having Publicly traded division in the U.S. Sarbanes-Oxley applies to both U.S. Public companies as well as Non-U.S. Public companies if they are listed on a U.S. Stock Exchange and can be invested in. The purpose of Sarbanes-Oxley was to raise consumer or investor confidence in the firm they were investing in. Therefore anything that can be invested in in the U.S. will likely fall under Sarbanes-Oxley requirements. This has a very strong negative impact upon the U.S. market and Non-U.S. companies since past practice was for many of the large ones to have a Publicly traded U.S. business that could be invested in by U.S. investors. With the passage of Sarbanes-Oxley, less companies and boards are willing to subject themselves to these provisions and the associated costs unless there are very strong reasons for it. (Salman, Int’l Journal of Auditing, pg 127) One strategy some companies have employed is to essentially outsource the work that would have been performed by a Publicly traded U.S. subsidiary to an existing U.S. firm which then has the burden of Sarbanes-Oxley compliance as well as other burdens of doing business in a foreign country. The other option is for the company to simply be a privately held subsidiary in the U.S. which tends to limit its size and strength and ultimately the number of employees, purchased services, and tax revenue that would come from it. Since Sarbanes-Oxley went into effect, there has been a significant decrease in new foreign U.S. listings and a commensurate increase in the number of foreign delistings and domestic going Private conversions. (Karmin, Wall Street Journal, 2006) Increased ability to grow through purchase of U.S. companies Another possible effect on Non-U.S. Public companies is that they could grow rapidly through the acquisition of Private U.S. based companies. These Private U.S. based companies may require large amounts of capital to grow but don’t wish to go Public or can’t afford to go Public and therefore make easy targets for foreign purchase. As previously mentioned, prior to Sarbanes-Oxley, it was fairly easy for companies to go Public and launch IPO’s as was seen during the “dot-com” era of the mid to late 1990’s. With Sarbanes-Oxley, this is more costly and complex. Another aspect relates to the Board and other Directors of the company. There are less competent Directors in the market that are willing to assume the risks that Sarbanes-Oxley either carries or implies. With the combined factors of it being complex, costly, and possibly lacking in Board leadership, it’s easy to see how these companies can be “easy pickings” for a Non-U.S. Public company. A Non-U.S. Public company can easily raise cash through the sale of stocks and bonds and purchase U.S. based companies that have sound business models, plans, products, or patents that would otherwise have helped out U.S. investors and citizens. Therefore another effect of Sarbanes-Oxley on Non-U.S. Publicly traded companies is to make Private U.S. company acquisition easier and more likely instead of that company going Public and growing as they would have pre-Sarbanes-Oxley. Conclusion We have looked at several different effects that Sarbanes-Oxley can have on Non-U.S. Publicly traded companies. The discussed effects may not all effect Non-U.S. Public companies however it seems likely that at least several of the effects may play a role with any given Non-U.S. Public company that is looking to do or currently does business in the U.S. Overall Sarbanes-Oxley has cost the U.S. market greatly with some estimates being around $200 billion which has gone to Non-U.S. companies both Public and Private. There are numerous studies out that make recommendations on changes that would help out the U.S. investment market as well as U.S. companies themselves. Some of these are focused primarily on the small to medium sized business area which many argue has been most affected by Sarbanes-Oxley. Other studies focus on large cap businesses with recommendations to assist them in reducing overhead costs and resource utilization and be able to focus and grow on their core business instead. At the moment, the focus of the Executive and Legislative branches of the U.S. Government is on the current economy and other world events and crisis. Sarbanes-Oxley itself has not had too much press and did not prevent the global banking crisis and sub-prime mortgage event that has affected the world over. No one can say however if Sarbanes-Oxley actually helped prevent it from being worse than it was. Given the types of financial accounting practices that were being practiced in 2001 & 2002, one could say that those would possibly still be occurring in the absence of Sarbanes-Oxley and have further exacerbated the worldwide economic downturn that has occurred. Many of the recommendations that have been made to improve Sarbanes-Oxley legislation and assist small and mid-cap businesses have merit and should be considered. However this is not likely to occur until the number and scope of the current crisis subsides to some degree. References Ferrell, G. (2007, July 30). Sarbanes-Oxley law has been a pretty clean sweep. USA Today. Anonymous. (2008, May 12). Financial Executives International; FEI Survey: Average 2007 SOX Compliance Cost $1.7 Million. Marketing Business Weekly, pg. 369. Mainwaring, J. (2008, January 29). Over here and doing well. Investors Chronicle. Schooley, T. (2005, October 7). Accounting for Growth. Pittsburgh Business Times. Tharp, P. (2007, January 27). Not Well St. New York Post. Reilly, D. (2004, November 2). Sarbanes-Oxley Aids Overseas Accountants; U.S. Law Has Global Reach And Fuels Revenue Growth At Some Firms in the U.K. Wall Street Journal (Eastern Edition.) Salman, F., Carson, E. (2009, July) The Impact of the Sarbanes-Oxley Act on the Audit Fees of Australian Listed Firms. International Journal of Auditing. 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