Sarbanes-Oxley Costs Hurting New Tech Industries, IPOs

Published March 1, 2009

The Sarbanes-Oxley Act—passed in 2002 to bring about more transparent corporate accounting rules—has proven excessively burdensome on business and is hurting new technology companies in particular.

Some experts say the law should be fixed to help facilitate tech sector start-ups to fuel a resurgence of America’s economic engine. Many, however, fear the prospects of changing “SOX” are grim in the current legislative climate.

Burden on Small Business

David John, a senior research fellow at The Heritage Foundation in Washington, DC says SOX creates a greater burden on smaller tech firms, which has stunted their growth.

“Congress did not focus on the cost of compliance,” John said. “In many cases we have companies that have reached the size where in the past they would have been expected to go public, but have decided not to have an initial public offering [IPO] because of SOX reporting requirements.”

William Niskanen, a senior economist at the Washington, DC-based Cato Institute, says a big problem is SOX has changed the approach to IPOs in the United States but not among competitors overseas.

“The number of IPOs has gone way down, and the drop-off was clearly because of SOX,” Niskanen said. “Fewer corporations are filing IPOs in the United States, with some actually withdrawing their IPO filing to go public elsewhere, such as London. That actually reduces transparency rather than increasing it.”

“Going public is a cheap way to raise money, and a continual way for a company to raise money as it can issue more stock when it needs more investors,” John added. “But because of costs made higher by SOX, companies have decided to raise private capital rather than going public.”

Improving SOX

John suggests one area for improvement is in Section 404 of the law, which applies to management certification of financial results.

“The way it was written made it very expensive to comply with the law, and is partly redundant,” John said. “If Congress had been more careful, it could have made a much better law.

“But Congress was in a hurry,” John said, referring to Washington’s quick action in the wake of the Enron scandal and other high-profile incidents of accounting fraud. “They were going to do something, something quick, something strict.

“They wanted to show that they understood that there was a crisis. This is one way Congress has learned to show its concern,” John said. “But when you do something quickly for a complex subject, you are almost certain to make mistakes, and that is what happened here.

“It’s fair to say that technology companies have been especially affected, but all new companies are likely to experience a bigger impact,” John said.

Calculating SOX’s Cost

John added, “There is no way to tell precisely how much Sarbanes-Oxley has cost the overall economy.” But the costs are significant, he believes.

“Congress wildly underestimated the cost when it was considering the bill,” John said. “No one knows for sure, but the cost to business is very real.”

Niskanen agrees.

“Any number of firms have reported substantial cost,” Niskanen said. “It is possible that compliance costs are greater in the first year or two. But not being a member of a stock exchange raises the cost of raising money. The fact that SOX causes companies to remain private increases their costs even when they don’t have to comply with [SOX] directly.”

Prospects for Change

Altering or repealing SOX would not easy, even if Congress were inclined to reform the law. Regulators may be reluctant to scuttle a keystone of SOX—corporations employing outside auditors—so a big chunk of the compliance costs would remain.

“A company’s staff is usually already overworked,” said Susan Hinrichs, a visiting lecturer in computer security at the University of Illinois at Urbana-Champaign. “So in many cases, the organization brings in one set of consultants to get ready for the audit and another set of consultants to perform the audits.”

Loren Heal ([email protected]) writes from Neoga, Illinois.