Going private – The cost of Sarbanes-Oxley

For most of the past few decades, taking a company public was the quintessential sign of having arrived.

Executives who saw their shares start trading in the stock market enjoyed ready access to capital, enhanced prestige and other trappings of success.

Russ Wiles
The Arizona Republic

http://www.azcentral.com/arizonarepublic/business/articles/0724Privatize25.html

But that mind-set is changing for some firms.

They have gone public only to languish, squeezed by rising costs to comply with tougher federal regulations that stem from a spate of corporate scandals.

Ever since Congress passed the Sarbanes-Oxley Act in 2002 to shore up confidence in the stock market and corporate financial statements, public companies have wrestled with the fallout.

The new rules have boosted costs and forced executives to spend more time on regulatory matters. Plenty of senior managers already grumble about the legislation, and yet the strongest dose of it may still be coming.

A provision of Sarbanes-Oxley called Section 404, focused on internal accounting controls, will take effect at the end of 2004.

"I consider the 404 requirement to be more time consuming and costly than the initial (Sarbanes-Oxley) rules," said Stanley Laybourne, chief financial officer at Insight Enterprises Inc. in Tempe.

That’s an opinion shared by Robert Bohannon, chairman, chief executive officer and president of Viad Corp. in Phoenix.

"Given the cost of compliance, some companies will look at other alternatives, such as merging or going private," he said.

That’s already happening with a couple of Valley firms.

Back to private
Senior executives at Phoenix steel-fabricator Schuff International Inc. have launched a bid to take the firm private. Top managers didn’t respond to phone calls for this story but outlined their reasons for exiting the stock market in public documents. They cited Sarbanes-Oxley as a factor.

"New laws and regulations have required increased corporate responsibility and accountability, enhanced financial disclosure and increased audit costs," stated a Schuff report to investors. "It is becoming more expensive for small corporations such as Schuff International to remain publicly held and traded."

Benefits unrealized
Schuff’s woes have been compounded by a low stock price, which makes it hard for the company to raise capital.

"While management has expended substantial time and money to maintain its status quo as a public company, it had been unable to realize the principal benefits," the report said.

Integrated Information Systems Inc. of Tempe filed a share-deregistration statement in December that essentially turned the company private. Sarbanes-Oxley was a factor here, Chief Executive Officer James Garvey said.

He cited auditing fees, liability-insurance costs and attendant expenses, plus other distractions of being public.

"You wind up spending all your time thinking about Sarbanes-Oxley, disclosure issues and staying public, not about your customers or markets," Garvey said.

Grant Thornton International, an accounting/business adviser to midsize firms, reports a steady rise in the number of companies going private after passage of Sarbanes-Oxley. Most are tiny entities, with management buyouts the preferred means of taking these firms private.

Another imposition
Few big corporations have taken such a step; for them, Sarbanes-Oxley is just another imposition. But small firms are more vulnerable because they lack staffing depth and often can’t afford the costs.

The legal, accounting and other costs of being public rose to an estimated average $2.86 million last year for small firms from $2.13 million in 2002, according to a survey by Foley & Lardner LLP.

Large companies paid even more, an average of $7.41 million in 2003, but have greater resources on which to draw.

All that’s in addition to other annoyances routinely faced by public companies. These include the need for top executives to disclose their pay, pressure to meet quarterly profit expectations and pesky inquiries from investors, analysts and the press.

Pressures to improve
"That creates a tendency to focus on short-term results," said Ernie Garcia, chairman and majority owner of DriveTime, a Phoenix auto sales and financing firm. "There are pressures to continually improve on a quarterly basis."

DriveTime was known as Ugly Duckling Corp. before Garcia took it private in August 2002, right around the time Sarbanes-Oxley became law. But he doesn’t blame the legislation for his move.

"It was just a business decision that made sense," Garcia said. "It helped us get our arms around the business to manage it more productively."

Status still strong
Despite the drawbacks, Sarbanes-Oxley doesn’t seem to have diminished the lure of public-company status.

More than 100 corporations have launched initial public offerings so far in 2004, making it the best year for new entrants since 406 firms went public in 2000, said Renaissance Capital Corp. of Greenwich, Conn.

Insight Enterprises went public in 1995, and Laybourne said he would recommend the same move today.

"If you perform well, being a public company gives you so much more access to capital to grow," he said. "And whether Sarbanes-Oxley is there or not, you still need to have good internal controls."

Raising the bar

Yet the tougher regulatory stakes and higher costs raise the bar for public companies, hundreds of which might fare better as private concerns.

For entities on the cusp, Sarbanes-Oxley and the new 404 rules are one more straw that could break the camel’s back.

Reach the reporter at [email protected] or (602) 444-8616.