What You Don’t Know about Sarbanes-Oxley

Snares, pitfalls, and trapdoors: Sarbanes-Oxley is full of surprises. These five top the list.

Sobin offers a hypothetical: While performing an annual audit of a multinational, auditors find suspicious payments on the books of the company’s Indonesian subsidiary that have all the earmarks of bribes. “The liability becomes very real,” the lawyer says, “and the auditors, under pressure of Sarbanes-Oxley, have to recommend to the corporate client that they undertake a rigorous analysis” of the situation and disclose the results. The disclosure might then lead to heavy fines under the Foreign Corrupt Practices Act (FCPA).

That’s a sea change from the previous way multinationals handled discoveries of baksheesh. Under FCPA and export/import rules, corporate executives don’t have a duty to disclose questionable practices, Sobin says.

Instead, international business disclosure regulators tend to employ a “carrot-and-stick” approach involving incentives for compliance and penalties for transgressions.

That’s spawned a Clintonesque “ask-but-don’t-tell” attitude among corporate officers. “In the past, because there was no requirement to make a disclosure, [executives said,] ‘Let’s just make sure it doesn’t happen again’ ” and leave it at that, the lawyer says.

But leaving it at that is often no longer an option for CFOs, who must now certify the validity of their financials under Sarbox’s Section 302.

That’s because the penalties following such things as an improperly reported import can be a balance-sheet liability. Fines of 100 percent of the value of the goods are not uncommon, Sobin says. If, for instance, a company is illegally importing $50 million of disk drives from a restricted country, that can amount to a decent chunk of change.

The good news is that companies can mitigate — or even eliminate — the fines by fessing up before the customs agents find out. “If you are first in door to report, they will provide you with leniency,” the lawyer adds.

4. Executive mobility just got a whole lot tougher.

Remember the home loans that employers made to company managers, either to relocate an executive or to lure new talent to a different part of the country?

Forget about them for the higher-ups. Under Section 402 of Sarbanes-Oxley, corporations are barred from making personal loans to officers or directors.

That creates a problem for executives who have borrowed from the company to buy a home and must sell it to relocate. Joe Rich, executive vice president at Clark/Bardes Consulting, illustrates the problem: “Let’s say you bought a $4 million ranch home in Palo Alto, and now it’s worth $3 million,” he posits. “The company moves you to Boston. Now you’re upside-down on that loan, and can’t get a new loan [from the company] in Boston.”

Still, the money can come from elsewhere. To help pay for housing, companies could offer new officers heftier signing bonuses and existing ones residence bonuses, according to Rich. Or they might buy executive housing outright and let officers live in it rent-free. Under Sarbanes-Oxley, however, the SEC might consider the free housing a loan, Rich cautions.

The loan prohibition could also create a whole class of embittered officers and directors: the folks who borrowed money to invest in company funds and stock before the equities market went kerflewy. Before Sarbanes-Oxley, a company could adjust the terms of the loan to keep an executive happy.

Post-Sarbox, such adjustments violate the act’s ban on arranging for or renewing loans, Rich notes. Of course, the company could always forgive the loan. Then again, given today’s scandal-ridden environment, maybe not.

5. Private companies aren’t immune to Sarbox.

The Sarbox loan ban also figures into problems that nonpublic companies can encounter under the act. Officer loans are common practice in private companies, particularly in single-owner outfits, notes Parson Consulting’s Rick Fumo.

The owners can continue to bestow largesse as long as they please — provided they don’t want to sell their holdings to a public company or launch an initial public offering. If private company owners do want to go public, they would have to see that the loans are paid back before an initial public offering, Fumo says. That could amount to a pretty penny for some officer/borrowers.

The internal-controls reporting required under Sarbanes-Oxley might also inhibit private owners not used to doing a whole lot of documentation from making a public offering.

Public company finance chiefs and their bosses, for their part, are sure to be probing the governance practices of private merger targets, says Fumo. “The due-diligence process will take on another level of significance and detail because there’s a higher price to pay for a mistake,” the consultant says. That, in turn, could leave finance managers at the acquiring company plenty embarrassed.


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