AGA Today
Critics See Some Good From
Sarbanes-Oxley
As Law Turns Five, They Say It's
Too Costly, But It Exposes Problems Before They Explode
By JOANN S. LUBLIN and KARA SCANNELL
The Wall Street Journal
July
30, 2007; Page B1
Invitrogen Corp.
spent about $2.5 million and 10,000 hours of employees' time last year
reviewing its inventory-counting procedures, computer-system access and
other "internal controls." The checks, required by the Sarbanes-Oxley
corporate-reform law, found small gaps in documentation but no hint of
accounting fraud.
Officials at the
Carlsbad, Calif., biotechnology company think the costs are excessive.
But they say Sarbanes-Oxley helped to spur other changes that made
Invitrogen a better-run business. Directors meet more often without
executives present. Multiple ombudsmen field employee complaints. Ethics
training is more rigorous. And Chief Executive Greg Lucier requires his
lieutenants to take more responsibility for their results.
"Sarbanes-Oxley
brought a lot more focus to the efforts we were already taking," Mr.
Lucier says. "Invitrogen investors are better protected because
Sarbanes-Oxley regulations have been put in place."
Invitrogen's
experience is instructive as the Sarbanes-Oxley law marks its fifth
anniversary today. The law, passed overwhelmingly by Congress in the
wake of scandals at Enron Corp., WorldCom Inc. and elsewhere, has proved
costlier than executives would have liked. By the end of this year,
public companies in the U.S. will have spent more than $26 billion to
comply, estimates AMR Research, a Boston technology-research firm. That
figure covers everything from staffing to consultant fees and
technology.
But even critics
acknowledge the law has done some good. "There is without question
greater accountability in the boardroom," says Thomas Lehner, an
official of the Business Roundtable, a Washington group representing
big-company CEOs. More boards resolve potential problems "before they
fester and explode," concurs John Olson, a senior partner at Gibson,
Dunn & Crutcher who advises directors at about a dozen concerns.
And institutional
shareholders hurt by the scandals applaud the law's impact.
"Sarbanes-Oxley really has been a critical safeguard in reassuring
investors and restoring confidence in the integrity of companies'
financial statements," says Dan Pedrotty, head of the AFL-CIO's Office
of Investment.
The
Sarbanes-Oxley statute demanded more rigorous internal controls, forced
top executives to certify the accuracy of financial results and created
a watchdog for auditing firms. It also expanded the role of board audit
committees and required companies to take "whistleblower" complaints
more seriously. Related stock-exchange rules bolstered boardroom
independence by requiring regular private sessions of independent
directors, among other changes.
"In the minds of
the investing public, those are important safeguards, and I think in
fact they are," Mr. Lehner says.
Securities and
Exchange Commission Chairman Christopher Cox said last week that the law
helped to restore confidence in U.S. financial markets. He also said
that compliance costs for the law are falling and that the review of
internal controls has "contributed significantly to more reliable
financial reporting."
During the first
years after the law took effect, the heightened focus on internal
controls prompted hundreds of companies to disclose "material
weaknesses" in their accounting and to restate prior financial results.
In 2005, for
example, medical-products maker Baxter International Inc. cited
errors in income-tax accounting and said it would restate financial
results from 2001 through the third quarter of 2004. The restatement
increased the company's previously reported stockholders' equity by
about $108 million for 2001 to 2003 but didn't alter revenue or
earnings. A spokesman says Baxter fixed the errors and declines further
comment.
More recently,
the wave of restatements and weakness disclosures appears to have
crested, as more companies fixed old problems and avoided new ones. In
2005, nearly 11% of companies with annual revenue over $500 million
warned of material weaknesses, reports Corporate Executive Board, a
Washington research firm. Last year, that proportion dropped to 4.3%.
The number of
companies restating financial results nearly tripled, to 1,403 from 513,
between 2003 and 2006, according to proxy advisers Glass, Lewis & Co. In
the first six months of this year, though, the number of companies with
restatements fell to 698 from 786 in the year-earlier half.
Invitrogen
officials say they've always imposed strict ethical and financial
controls. But Sarbanes-Oxley requires extensive reviews to ensure that
financial controls are sound. Last year, that meant that the
4,300-employee company, with annual revenue of nearly $1.2 billion,
monitored about 60 accounting processes and 350 controls, according to
Kelli Richard, vice president of finance.
Three years of
such reviews have uncovered only minor issues involving documentation of
procedures and small variations during the integration of acquisitions,
directors and executives say. "At the core, [controls] were fine," says
Donald Grimm, Invitrogen's lead director and a retired Eli Lilly & Co.
executive. "But sometimes at the edges, they weren't as good as they
should be."
Last year, for
example, a new software system in Europe delayed customer invoices,
swelling accounts receivable. The board's audit committee asked internal
and outside auditors to investigate further and concluded "there was no
accounting or financial-reporting issue," says Raymond Dittamore, a
retired partner of Ernst & Young and an Invitrogen director who is
chairman of that committee.
Chief Financial
Officer David Hoffmeister says the initial scrutiny of internal controls
mandated by Sarbanes-Oxley cost $3 million to $4 million in 2004. Last
year, the tab was $2.5 million because Invitrogen no longer needed
numerous outside consultants. Nonetheless, Mr. Hoffmeister says,
employees "are still spending the same amount of time" on compliance.
He and other
Invitrogen officials say Sarbanes-Oxley has had a big impact in other
ways, too. Messrs. Lucier and Hoffmeister now must swear to the accuracy
and completeness of financial results. So Mr. Lucier requires nearly 20
other executives -- including those overseeing functional groups such as
law and information technology -- to certify their reports to him.
Before Sarbanes-Oxley, top executives reviewed results by talking to
eight financial controllers world-wide.
"You sit across
from your fellow board members and look them in the eye," says Mr.
Lucier, who arrived in 2003. "You know you have to certify results. You
realize that has a lot of consequences."
Mr. Lucier also
beefed up Invitrogen's code of conduct. Each employee must take a
30-minute tutorial about the code annually, then agree in writing to
observe it. The revamped code, dubbed Protocol, is available in 11
languages and contains colorful examples of hypothetical misdeeds, such
as falsified accounting for warehouse shipments in order to achieve
profit targets. In late 2004, Invitrogen assigned ombudsmen to all of
its major sites, where they handle complaints from would-be
whistleblowers.
Complaints
involving accounting or financial results get forwarded immediately to
Mr. Dittamore. "No significant violations have been raised," says John
Skousen, Invitrogen's vice president of compliance.
In 2001, before
Sarbanes-Oxley became law, Invitrogen's outside directors began meeting
among themselves. Now, the audit committee also meets in executive
sessions. The sessions encourage frank discussions, giving directors
more chances to say, "This doesn't smell right. We have to go back and
dig deeper," Mr. Grimm says.
In April, Mr.
Lucier surprised the board by proposing to promote an executive to a
newly created post. During the executive session that followed, the nine
independent directors objected that the official lacked the right
experience. Directors said, " 'We don't think this is going to work,' "
Mr. Grimm recalls. So "we took that back to Greg."
Heeding their protests, Mr. Lucier says
he agreed to phase in his colleague's new duties. That approach
"satisfied everyone's concerns," Mr. Grimm says.