Sarbanes-Oxley Act impacts privately held companies


2002’s Sarbanes-Oxley Act doesn’t apply to privately held companies, yet many are starting to take up some of its provisions voluntarily.

That’s because of the best practices resulting from the Act’s implementation by publicly held companies, according to Jeff Ott, partner at law firm Warner Norcross & Judd.

SOX was adopted by the U.S. Congress in response to a handful of large-scale accounting frauds that occurred at publicly held companies in the late 1990s and early 2000s, including Enron and WorldCom. Its purpose is to protect outside investors in these companies, which is why nearly all the provisions included within the Act apply only to publicly held companies.

“Essentially, it was an attempt to impose tighter controls on the financial reporting, to try and provide more transparency in financial reporting and to hold people accountable in the financial reporting,” Ott explained.

SOX does contain one provision that directly applies to privately held companies: its provision on whistle blowers.

“They changed the United States criminal code, that basically made it illegal to retaliate against a whistleblower,” Ott said. “So, basically, it says it’s illegal for anybody to retaliate against someone who provides truthful information to any law enforcement officer relating to the commission or possible commission of a federal offense.

“That’s why you see a lot of private companies have adopted whistle-blower policies, and, frankly, a lot of nonprofits and other organizations have adopted whistle-blower policies because of that provision in Sarbanes-Oxley.”

Ott said another provision in the Act could potentially impact privately held companies: the changes to federal sentencing guidelines.

“Basically, it’s tied to the code of ethics,” Ott said. “If you have a code of ethics in place, it can reduce the sentence that a company could receive under the federal sentencing guidelines if there is some sort of financial wrongdoing that is discovered. From that perspective, you will see private companies that adopt codes of ethics for their financial officers.”

Now a decade old, SOX has begun to permeate the walls of privately held companies a little more deeply.

“What public companies do often will become considered to be best practices,” Ott said. “When companies are out there looking at what are best practices for corporate governance, they are going to see all the things that public companies do and, to the extent that these become considered best practices, those will have a trickle-down effect on private companies that are looking to implement best practices.”

Ott pointed to audit standards and the procedures public companies use in terms of internal controls as an example of how SOX might indirectly impact privately held companies.

“The fact of the matter is that private companies will look now and say, ‘Well, all these public companies have their CEO and CFO certify the financials; perhaps we should have our CEO and CFO at least certify the financials to the board so that we have this accountability,’” he said.

Ott believes that larger, privately held companies may very well benefit from some of the best practices that have come out of SOX.

“If you have a really small, privately held company where you’ve got a couple of shareholders and 50 employees, the fact is the people running it are probably going to have a really good pulse on most of the business operations. … By comparison, you can have very large, global, privately held companies where there are business units scattered all over the globe with thousands of employees. In that circumstance, with these larger private companies, it probably does make sense to at least look at some of the best practices that are put in place by SOX and look at whether or not those should also be implemented in the private context.”

Implementing all SOX provisions is costly, though. Privately held companies have the benefit of picking and choosing, where publicly held companies do not. Ott said that there has been an impact from the cost of implementation since 2002, with some public companies opting to go private.

“The cost of compliance with Sarbanes is absolutely a factor that companies now take into consideration in deciding whether or not they should be public or not, and can act as a factor in terms of weighing against being a public company because compliance with Sarbanes is expensive.”

Currently, there is no legislation in the works to create a law similar to SOX for privately held companies.

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