"Critics See Some Good From Sarbanes-Oxley"
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 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. • Theory & Practice is a weekly look at people and ideas influencing managers. Send comments to firstname.lastname@example.org. For an archive of past columns, visit CareerJournal.com/Columnists. Write to Joann S. Lublin at email@example.com and Kara Scannell at firstname.lastname@example.org