JOHN DVORAK'S SECOND OPINION
Repeal Sarbanes-Oxley
Commentary: Innovative tech companies are choking on the paper work
By John C. Dvorak
Last Update: 11:11 AM ET Jul 16, 2007
BERKELEY, Calif. (MarketWatch) -- I was reading the recent reports in MarketWatch about how some tech companies are participating in the rally and
noticed that all companies cited in the article would be what I would call "industrial" tech companies. You know, the tech equivalent of U.S. Steel in
1956.
See the story here.
When you speak of the big names in tech you are talking about companies that are huge, established, unexciting, and which spend much of their time
trying to absorb newly acquired companies into the corporate gob of goo not dissimilar to the amorphous mass in the movie, "The Blob."
The problem for tech investors who want something a little more interesting than Cisco is that the pickings are rather slim. There are not a lot of
aggressive, new and interesting little fast growth companies out there in which to invest. Not like there were in 1999.
While I'm not advocating a return to the crazed investment fever of 1999, I wouldn't mind seeing something other than mergers and acquisitions. While
M&As were popular back then too they now seem to be the only thing happening in tech.
I blame Sarbanes-Oxley and so does everyone else in the valley.
No CEO can handle going from high-flying and aggressive go-go growth to slamming on the brakes to become the CEO/personal auditor of the
company fretting about ridiculous details.
Most people estimate that it costs any public company a minimum of 4% of bottom line profits to implement and maintain compliance with
Sarbanes-Oxley.
Documenting the figure is not possible. But when I bring it up nobody argues about it except to say, "It might be more than 4-percent."
I tell people that Sarbanes-Oxley should be called by its real name, "The public accountant and auditor's protection act of 2002." The rationale for its
existence stems from the messes created at MCI and Enron among other sketchy companies. Curiously those companies were busted for their
wrong-doing using pre-Sarbanes mechanisms. The system worked so why add a new layer?
Well the fallout from MCI and Enron and other companies showed that the auditors were apparently not doing their jobs well enough to prevent the
mishaps. Sarbanes-Oxley keeps them from getting in trouble by mostly taking them out of the loop they are supposed to monitor.
This has nothing to do with protecting the investors or the public in general. It's to protect the bookkeeping class from getting in trouble for crummy work.
So meanwhile we now treat all CEO's of public companies as pre-criminals who now have to report to the parole board every quarter. So what small
start-up wants to tolerate this sort of abuse and become an American Corporation?
Thus they jump onto the London stock exchange or become Canadian corporations, maybe even Swiss corporations. They'll do anything to pick up the
extra 4% profit not to mention the advantage of avoiding the SOX paperwork and the worries about missteps.
I cannot tell you how much the executive class complains about this, but they always stop short of a revolt. I'm not sure if the reticence to openly carp is
because of their generally inflated salaries that would make them look like whining divas or if it is a simple lack of courage. Probably both.
But this much I do know. The tech scene in particular is suffering in this booming market because companies must stay private. That means their
leverage and influence is minimized.
The only real alternative is to be bought by a big blob company. Either way the public, the economy and the innovating firm all suffer.
This stupid law has to go. Completely.
Hello Regulation, Goodbye American Dream (An Opinion Editorial)
(December 2006)
By: Brad Beckstead, CPA
Managing Partner, Beckstead and Watts, LLP
Now is the time for the Democratic Party to seize a golden opportunity. The Republican-controlled Congress led by President Bush
has managed to decimate the American Dream by passing the Sarbanes-Oxley Act of 2002 (“Sarbox”).
Innovation is key to maintaining our role as leader of the world economy. Without innovation, we become slave to the daily drudgery of
corporate sameness; effectively becoming a Communist-style economy.
China is a prime example of what happens to a country when innovation and entrepreneurship are not rewarded and encouraged.
During a controlled economy, the country attempted to guarantee employment and a risk-free society to the masses through heavy
laws, regulations and “State-Owned Enterprises”, thereby stifling its own innovation and forcing itself to survive as duplicators and
mimics of foreign innovation. As the country has opened itself to a free-market economy, it has enjoyed massive growth and
flourishing hope for the future.
My eyes are open to the effects of massive over-regulation on innovation and entrepreneurship. China’s laws are so massive and
restrictive as to force the life-breath from the small business sector. However, they are starting to figure it out. (It is interesting to note
that as they are easing restrictions, the US is adding restrictions and legal burdens.) The consequences of such actions are that their
economy will continue to grow and demand greater world resources as the US economy stagnates under the weight of intense
scrutiny and the heavy burdens of over-regulation.
Innovation and entrepreneurship is an inherently risky business. Success cannot be guaranteed. A risk-free society cannot be
legislated. Innovators and entrepreneurs cannot guarantee positive results or success. Innovation and entrepreneurship are costly
ventures without guarantee of the outcome. Failure is the major option. Investors who choose to put their money behind innovators
and entrepreneurs understand the associated risks. They also understand the associated “upside” of success. They are therefore
willing to continually fund innovation and entrepreneurship on these premises. They embrace the essence of the American Dream.
The Accounting Today trade magazine recently named me to be one of the “Top 100 Most Influential Accountants”. The caption under
my picture, states “Beckstead, who launched a lawsuit questioning the constitutionality of the PCAOB stands as a symbol of the very
vocal opposition to the reform law”. Yet the irony is that my firm faces extinction because of the heavy consequences of Sarbox and the
formation of the PCAOB.
My personal American Dream was to own and run a successful CPA firm serving the needs of small business. I wanted to champion
the American Dream by serving the innovators and entrepreneurs of our fine country. I believe in the American Dream. I
believe in American innovation and entrepreneurship. It has been the backbone of American success since Henry Ford invented the
automobile.
Our firm was forced to join the PCAOB (the “Board”) in order to continue to service the needs of our small business clients. At the time
of registration, our firm serviced the needs of over 60 innovative and entrepreneurial companies. (We were one of the top 10 firms in
the nation measured by the size of a firm’s client base.) We were able to do this because we were cost effective. We were able to
contain costs because we identified the areas of highest risk on the financial statements and addressed those risks adequately in
our audit procedures. We knew that we were not insurers or guarantors of a risk-free investment. We knew that our Audit Report
alerted the investor to the high degree of risk through adequate “Going Concern” disclosure in the body of the Report. We relied upon
the AICPA Audit Standards to guide us in adequately disclosing the risks associated with investment in our clients. We knew that our
clients’ investors placed a very low level of reliance on the financial statements in their decision-making processes because they
knew and accepted the inherent risks associated with their investments. We knew that the risk of failure was at its highest degree
because of the historical performance of innovation and entrepreneurship. Yet we, the entrepreneurs, the investors, and the auditors,
embraced this risk because we collectively believed in the American Dream.
Our American Dream is gone. The Board’s relentless tactics and scrutiny is forcing us out of business. Since registration with the
Board our firm has suffered the following consequences:
- We were inspected by 7 regulators for a period of 14 days with two weeks’ advance notice. Our firm size at the time consisted of 3
people, including myself, in a 1000 square foot office.
- 16 of our audit files were chosen for inspection, serving as one of the highest forms of scrutiny suffered to date by any of the
registered firms. I calculated our time devoted to the inspection process to be in excess of 500 man-hours. Time spent during which
our firm was unable to generate revenue.
- It took a full year for the PCAOB to notify us by draft of the Inspection Report of the outcome and findings of the inspection process.
We were given 30 days to respond or face retribution. It took another 3 months for them to post the Inspection Report with our firm’s
response on their public website.
- In the redacted findings of the Inspection Report, the Board granted us twelve months to address their findings or face “imminent
formal investigation”. Simultaneous to the posting of their Report on their website, they issued a Formal Order of Investigation and
Accounting Board Demand (“ABD”), thereby reneging on the twelve-month restitution period. The ABD demanded that we produce
another 5 audit files from 2003 and 2004 audits within 45 days of the date of the ABD.
- We retained legal counsel to represent our interests against the ABD and spent legal fees in excess of $20,000. There is no legal
precedence, so the law firm was learning the process on our dime. They estimated total defense costs to range from
$200,000-$300,000. Our firm’s annual gross revenues were averaging $750,000 with an average net income of $280,000. We
dismissed our legal counsel prior to entering the depositions to ward off bankruptcy from massive legal fees.
- We were deposed for 3 days. I was deposed for 2 days, and the firm’s audit manager was deposed for 1 day. Two attorneys and one
accountant represented the Board, we represented ourselves without counsel. The deposition was the equivalent of an oral CPA
exam, only much more technical and intense.
- During the deposition, I asked for a copy of the Formal Order of Investigation. I was told that if I wanted a copy, I would have to sign a
confidentiality agreement which threatened criminal implications if the terms of the agreement were ever disclosed to the outside
world. I declined to sign the confidentiality agreement and therefore never received a copy of the Order. At this date I do not recall what
it said or the justification for the Investigation.
- From the last date of deposition on or about February 3, 2006 until September 6, 2006, there was no communication from the Board’
s Division of Enforcement. Concurrently, our firm continued to make changes to address the findings of the Inspection Report by
adding layers of staff, increasing scrutiny of our audit clients, implementation of additional Quality Control processes, reducing our
client base from over 60 to less than 10, constant contact with our assigned Board administrator, and by changing our Concurring
Review Partner. On September 6, 2006, we received another ABD demanding two more sets of client files. One set represented the
2004 audit of our then-largest client, and the other set represented the 2001, 2002, and 2004 audits of one of our smallest
“development stage” clients. (It is noteworthy to state that the 2001 audit was conducted before Sarbox and the Board were ever
conceived. The files were submitted while thoughts of the Board establishing legal precedence to go back in time indefinitely rang
through our minds.)
- During the entire Inspection Process our firm’s client base has diminished. Revenues have declined. Profitability has decreased by
60% in 2006 compared to 2005. Our ability to attract new clients has been hindered because of the public posting of the Inspection
Report. (The posting of the Inspection Report on the Board’s public website damages a firm’s reputation without the firm having the
ability to make changes or retribution in response to the findings of the Inspection process.)
Some final “food-for-thought”:
- Of the over 100 audits our firm conducted over a 4-year timeframe, our firm has been party to only one class-action lawsuit which
was subsequently dismissed.
- None of our clients have been subject to SEC enforcement action while we were the auditors of record. We resigned as auditor of
record in all cases when we became aware of corporate malfeasance, and complied fully with law enforcement in bringing the
responsible parties to justice. We served as a front-line detector of corporate malfeasance, not an “enabler” as the SEC fondly refers
to auditors and attorneys of corporate bad apples.
- Our audit fees to audit small innovative and entrepreneurial clients have been forced to increase by over 5 times, while our firm’s
internal profitability has decreased by 60% due to the costs of added layers of staff, added work processes and documentation, and
intense regulatory scrutiny.
- The average market value of our over 60 clients’ stock in the public marketplace was less than $10,000,000. The majority of
investors in our firm’s clients had on average $1,000 of personal risk of loss.
- The government’s costs of our inspection and investigation processes have, in my estimation, exceeded $250,000.
- There are over 1,700 firms registered with the PCAOB. To date, a mere 500 have been inspected even though the law mandates that
all firms be inspected within 3 years of the formation of the PCAOB.
- To date, the Board has not requested any of our audit files completed under the terms of our firm’s Quality Control policies adopted
and amended in response to the Inspection Report.
- Every firm is required to have an inspection at least every 3 years.
- Effective 2008, small business issuers will be forced to comply with the terms of SOX 404 by implementing and assessing internal
controls. The costs of compliance have been proven to increase accounting and legal fees by at least 100%.
I understand the cause and effect of Sarbox. I champion its attempt to prevent further Enrons and WorldComs from happening. I
believe the law is working at the level that it should have been intended. This is self-evident as leaders of large corporations analyze
their corporate governance policies and adjust them accordingly, even resigning if necessary, to stand against corruption in their
organizations. However, the cost of Sarbox on the small business sector is overwhelming. The weight of responsibility is too great.
The shackles on the American Dream are too heavy.
Can the Democratic Party release the American Dream from its shackles and lift it to its pre-SOX days of hope? Only time will tell.
Mr. Beckstead is managing partner of Beckstead and Watts, LLP located in Henderson, Nevada.. Beckstead and Watts, LLP is co-
plaintiff with the Free Enterprise Fund in a lawsuit filed against the PCAOB charging it with violating the Appointments Clause of the
Constitution.