Disclosure Abuses

In 2002, Congress became very concerned about financial disclosure abuses by public companies as new scandals seemed to be emerging almost daily on Wall Street. Michael Oxley, a conservative Republican, and Paul Sarbanes, a liberal Democrat, proposed a new law which was soon passed by Congress and became known as the Sarbanes-Oxley Act. This bill has significantly increased the cost and criteria for publicly-held companies to meet financial disclosure requirements. For some corporations, financial reporting has become one of the largest expenses of being a public company.

Sarbanes-Oxley requires that companies invest in expensive and time-consuming documentation of financial records. Additionally, companies must devote substantial manpower to monitoring and evaluating the effectiveness of their internal financial controls. The company must also hire outside auditors to test these controls and issue a report on their effectiveness. Today, compliance to these rules costs some companies up to 10% of their annual profit. (Not exactly what you dreamed of when you first opened your business, huh?)

But wait! There’s more. A couple of particularly excruciating parts of Sarbanes-Oxley have to do with the CEO and the Board of Directors.

• The CEO is now required to sign off on the company’s financial statements. This means the CEO is legally liable if there are errors in the statements.
• The Board of Directors is now required to be more independent. That is, they should not serve as a rubber stamp for management decisions. Those directors who violate these guidelines can be legally liable.

As you might imagine, it has become more difficult to get people to serve on the Board of Directors of public companies. In fact, most companies now have to provide liability insurance for their directors because of the Sarbanes-Oxley Act.