Firms Pondering IPOs Must be Wary of SOX

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It may be another two years before stock in Home Bancshares Inc. of Conway begins to trade publicly, but its shareholders are already feeling the pinch of new federal accounting regulations.

Chief Financial Officer Randy Mayor estimates that adopting the internal controls, outside auditing and independent director requirements of the Sarbanes-Oxley Act of 2002 could cost the bank holding company nearly half a million dollars a year.

And that’s the good news.

The corporate parent of First State Bank of Conway, Twin City Bank of North Little Rock and Community Bank of Cabot had been warned by its outside auditors and lawyers that implementing Sarbanes-Oxley could cost as much as $750,000 a year.

“I’m thinking more around the $400,000 figure, and probably it will fall somewhere between the two,” Mayor said.

The accountants are calling

the new law SOX, but it is anything but warm and fuzzy. Designed specifically to respond to the type of accounting abuses that made the names of Enron and WorldCom infamous and spelled the end of the Arthur Andersen accounting firm, SOX has had the perverse effect of forcing public companies to pay for more accounting services than ever.

Yes and No

Home Bancshares will be going public in the next two years because its growth-by-acquisition strategy has resulted in a pool of more than 500 shareholders, the magic threshold at which the Securities & Exchange Commission requires private companies to start filing the same disclosures as a public company. And there’s no point in taking on the expense — $300,000 or more per year — without going ahead and giving investors the liquidity of a ready market for their stock.

Safe Foods Corp. is a North Little Rock company whose management has expressed a desire to eventually go public. It is also working to implement SOX, according to CFO Terry Elliott.

“That is the direction we are heading, to go public, because that will give our investors the greatest possible liquidity for their investment,” Elliott said. “But the cost factor is it is very expensive to do everything that Sarbanes-Oxley requires over and above what is already required.”

Equity Broadcasting Corp. of Little Rock, another company with aspirations of trading publicly someday, has also looked at the cost factor and came to a different conclusion.

“We are not required to meet those standards at this point,” said Doug Krile, spokesman for Equity. “Obviously, if we went public we would. We’ve had some discussions, we’re well aware of them, but we just haven’t moved in that direction yet because obviously it’s a very expensive proposition if you don’t have to do it.”

In Triplicate

“Internal controls” are buzzwords in any discussion of Sarbanes-Oxley, but both Mayor and Elliott said the controls are old hat. What SOX has changed is the level of documentation required to prove those controls.

“The internal control they already have if they are running a business right. The documentation is a giant step forward,” Elliott said.

SOX compliance means adopting policies and procedures that will leave no doubt about events that are “material” enough to a company’s finances to require that the SEC — and, therefore, investors and potential investors — be notified.

SOX, Mayor said, requires “documentation of really the whole methodology of how the financial statements are put together — and coming back and auditing and testing to make sure we’re following whatever procedures and policies have been put in place.”

Internal auditing, which traditionally helped upper management identify problems down lower in their organizations, now has to be designed to thwart dishonesty even at the highest levels.

SOX darns almost every hole in corporate governance identified by government investigations of the various accounting scandals for the protection of investors who foolishly assumed that the existing laws protected them. And that kind of reinforcement requires additional hands, even for companies that aren’t yet inviting the public to buy their stock.

“Of course, the first thing is increased staffing in the finance and audit areas because of the additional controls and audits that have to be in place,” Mayor said. “We’re looking at two full-time [employees] for sure. And we’re kind of in the gearing-up phase, so we may not be done.”

These are not minimum-wage jobs. Home is adding two accountants, at least one of them a certified public accountant, to Mayor’s staff.

“They will be involved in auditing controls that we put in place and in helping to prepare the financial information on an ongoing basis,” he said.

Home Bancshares would be putting its accounting staff into high gear by going public even if SOX had not been enacted, and banks are accustomed to making timely reports to the Federal Deposit Insurance Corp. But the extra requirements of SOX mean that the turnaround time after the end of a reporting period has been speeded up. If everything goes as planned, Mayor says his staff will begin producing SOX-compliant month-end financial statements at the end of September.

The amount of outside auditing is also tremendously increased under SOX. Mayor clicked on his calculator and came up with an increase of 50-60 percent in the audit fees Home Bancshares will pay to outside accounting firms.

Declaration of Independence

Another fundamental change required by SOX is the presence of more “independent” directors on the boards of public companies, a change designed to align the interests of the board more closely with those of rank-and-file shareholders. Under Sarbanes-Oxley, only independent directors with significant accounting experience can serve on the audit committees of public companies.

Safe Foods, which is beginning to market a chemical antibacterial treatment that the Food & Drug Administration has approved for use on raw poultry, already has a majority of independent directors, Elliott said.

Home Bancshares isn’t to that point yet, Mayor conceded.

“We’re still working through that,” he said.

The board of directors of a “traditional small bank” is often dominated by significant investors and others with overlapping business interests, Mayor said.

And that’s just the sort of coziness that SOX is trying to eliminate.

Inside directors — executives and/or large shareholders — were often willing and even eager to serve on corporate boards for token fees, especially when their fiduciary roles were less clearly defined by law. But the demand for knowledgeable, independent directors who are willing to take legal responsibility has driven up the price, Mayor said.

“That’s part of the increase in expense, too: You are having to raise those director fees,” he said. “And I can’t blame them. I’m not so sure I’d want to do it with some of the restrictions that are there.”

Mayor, who worked as an inside auditor for First Commercial Corp. of Little Rock before it was sold to Regions Financial Corp. of Birmingham, Ala., said existing accounting regulations should have been adequate to protect investors “if they were followed with the right purpose and attitude.”

But they weren’t.

“I think (SOX) is a result of what happened with the Enrons and the WorldComs. And I think it’s the classic ‘everyone’s getting punished for a couple of extreme abuses.’

“I’m not sure it’s worth every penny we’ll end up spending on it, but we don’t have a lot of choices.”

SOX Unraveled

Adopted in the summer of 2002 in direct response to well-publicized accounting scandals at a number of publicly traded companies, the Sarbanes-Oxley Act includes reforms in corporate governance and the accounting profession intended to:

• Improve corporate financial reporting and internal control;

• Strengthen audit committees;

• Change the relationship between the auditor and client;

• Improve auditor independence;

• Provide additional auditor assurance over internal control; and

• Provide oversight and regulation for auditors of publicly traded companies.

Source: U.S. Government Accountability Office

Home Bancshares Inc.

Board of Directors

Johnny Allison, chairman
Alex Lieblong, vice chairman
Rick Ashley
Dale Bruns
Jack Engelkes
Frank Hickingbotham
Herren Hickingbotham
James Park
Randy Sims
Ron Strother
William Thompson

Source: Home Bancshares Inc.

Safe Foods Corp.

Board of Directors

Carl S. Rosenbaum, Chairman
Curtis Coleman
Anthony Rampley
Fred Smith
John Steuri
Judge Dan Felton III
Dr. Timothy O’Brien

Source: Safe Foods Corp.