SOX 404 Compliance

A significant body of academic research and opinion exists regarding the costs and benefits of SOX, with significant differences in conclusions. This is due in part to the difficulty of isolating the impact of SOX from other variables affecting the stock market and corporate earnings.^[5] Conclusions from several of these studies and related criticism are summarized below:

• FEI Survey: Finance Executives International (FEI) provides an annual survey on SOX Section 404 costs. For 200 companies with average revenues of $6.8 billion, the average compliance costs were $2.9 million, down 23% from 2005. Cost for decentralized companies (i.e., those with multiple segments or large divisions) were more than twice those of centralized companies. Auditor costs did not decline. When asked whether the benefits of compliance with Section 404 have exceeded their costs, 22 percent, on average, agreed, with 78 percent saying instead that the costs have exceeded the benefits. 34 percent agreed that compliance with Section 404 has helped prevent or detect fraud.^[6]

• Butler/Ribstein: Their book proposed a comprehensive overhaul or repeal of SOX and a variety of other reforms. For example, they indicate that investors could diversify their stock investments, efficiently managing the risk of a few catastrophic corporate failures, whether due to fraud or competition. However, if each company is required to spend a significant amount of money and resources on SOX compliance, this cost is borne across all publicly traded companies and therefore cannot be diversified away by the investor.^[7]

• Institute of Internal Auditors (IIA): The research paper indicates that corporations have improved their internal controls and that financial statements are perceived to be more reliable.^[8]

• Skaife/Collins/Kinney/Lefond: This research paper indicates that borrowing costs are lower for companies that improved their internal control, by between 50 and 150 basis points (.5 to 1.5 percentage points).^[9]

• Zhang: This research paper estimated SOX compliance costs as high as $1.4 trillion, by measuring changes in market value around key SOX legislative “events.” This number is based on the assumption that SOX was the cause of related short-duration market value changes.^[10] However, the S&P 500 index, a broad measure of U.S. stock value, increased 6% the day the law passed in Congress on July 24, 2002, and 1% the day after it was signed into law by President Bush on July 30. It then declined 7% in three trading days thereafter, regaining pre-signature levels by August 8.^[11] Measuring short-term fluctuations in market value is an acknowledged drawback in this study. One could have easily argued a $1.4 trillion benefit, using the 7% increase leading up to the day after signature, rather than the following 3-day decline.

• Iliev: This research paper indicated that SOX 404 indeed led to conservative reported earnings, but also reduced — rightly or wrongly — stock valuations of small firms.^[12] Lower earnings often cause the share price to decrease.

• The Lord & Benoit Report: Do the Benefits Exceed the Cost? It included a population of nearly 2,500 companies, which represented ALL of the calendar year accelerated filers. Lord & Benoit’s SOX research showed that companies with no material weaknesses in their internal controls, or companies who were able to identify and correct material weaknesses in a timely manner, experienced much greater increases in share prices than companies that did not.^{[13] [14]}, The report indicated that the benefits to a compliant company in share price (10% above Russell 3000 index) were greater than their SOX Section 404 costs. Lord & Benoit, a SOX compliance company, issued the report on May 8, 2006. It was also published by the Wall Street Journal.