Independent auditors. The first two sections of SOX (Title I, Public Company Accounting Oversight Board; and Title II, Auditor Independence) Of particular concern to companies preparing for an IPO are limitations on the amount of consulting services that auditors may perform for clients; requirements that nonaudit services must be approved by the company’s audit committee; and requirements that the CEO, controller, CFO, chief accounting officer, or any person in an equivalent position cannot have been employed by the auditing firm during the 12 months preceding the audit. Companies considering an IPO must be in compliance with these provisions at least 36 months prior to the IPO.
Corporate governance. The provisions of SOX Title III
... A 2004 study by the Institute of Internal Auditors on the effects of SOX on audit committees of non–publicly traded entities concluded that nonpublic companies could find it more difficult to recruit and retain qualified members to serve on audit committees.
Companies considering an IPO must have appropriate policies in place prior to the IPO. The SEC also is given the power to ban any individual from serving as an officer or director of a publicly traded company.
Corporate fraud and accountability. Titles VIII through XI of SOX deal with corporate fraud and accountability and white-collar crime. Title VIII imposes criminal penalties for destroying, altering, concealing, or falsifying records where the intent is to obstruct a federal investigation or a bankruptcy proceeding; makes debts incurred in violation of securities fraud law nondischargeable through bankruptcy; and extends the statute of limitations for private actions for securities fraud violation to not later than two years after discovery of the fraud or five years after the violation occurred.
[A prospective entrepreneur of a new business considering an Initial Public Offering to create a new publicly traded corporation, while certain that he would at all costs avoid any illegal activities, would realize that if he became the target of a "hot to trot" prosecutor, could well end up in prison and exhausted of personal assets. There is no statute of limitations on criminal "fraud"]
Internal controls. SOX section 404, which covers management assessment of internal controls, has probably received the most negative publicity, due to the additional compliance costs it implies.
In July 2004, Financial Executives International (FEI) surveyed 224 public companies with average revenues of $2.5 billion to determine estimates of the cost to comply with section 404. Results showed that the average total cost of compliance was estimated at $3.14 million per company, or 62% more than the $1.93 million estimate identified in FEI’s January 2004 survey.
... First-year compliance costs for companies with revenues of less than $1 billion were estimated at $1 million or less.
First-year compliance costs for companies with over $5 billion in revenue had increased from an estimated $4.6 million in the January 2004 survey to $8 million in the July 2004 survey. These costs may be viewed as a significant deterrent for a company considering an IPO.
Venture Capital and Technology IPOsAccording to the National Venture Capital Association, the number of venture-backed technology IPOs declined from 245 in 1999 to 28 in 2002. In 2003, the number of deals was up to 29, and in 2004 it climbed to 93.
...The number of technology IPOs took a freefall thereafter, falling to 77 in 2001 [from 900 in 1999 and 713 in 2000] and 71 in 2002. In 2003 they declined even further, to 20. There was a turnaround in 2004, with 88 technology IPOs. According to preliminary data from Venture One, there were 41 technology IPOs in 2005.
Costs and Consequences of SOX; The law firm of Foley & Lardner conducted studies in 2003 and 2004 on the impact of SOX. The survey found that the average annual cost of being a public (registered) company had nearly doubled following the enactment of SOX, from $1.3 million to almost $2.9 million for companies with revenues under $1 billion.
These costs represent continuing annual costs, exclusive of first-year costs to comply with the assessment of internal control systems. A significant portion of the increase was related to insurance for directors and officers (D&O). The study indicated that D&O insurance increased from an average of $329,000 a year pre-SOX to an average of $639,000 a year for 2002 fiscal years, and $850,000 annually for 2003 fiscal years.
As a consequence, there have been reports of companies that have delisted their securities or have elected to delay or cancel their IPOs. Of the 115 public company respondents to Foley & Lardner’s 2004 survey, 21% indicated that they were considering going private, 6% indicated they were considering selling the company, and 7% indicated they were considering merging with another company as a result of SOX requirements.
