Sarbanes-Oxley

Implications for Privately Held Companies

April, 2005

by:  Thomas G. Schober

The collapse of dozens of major U.S. Corporations over the past decade has resulted in a significant federal response to satisfy shareholders and the public that investments in such companies would not be lost through fraud.  The most major piece of legislation is the Sarbanes-Oxley Act (SOX), which provides new regulation and even criminal sanctions.  While aimed at major companies, some of the SOX provisions apply to privately held companies as well.

Those provisions primarily applicable to privately held companies include:

1. Whistleblower Protection - Persons providing information about the commission of a federal offense are protected.  Those who retaliate against such whistleblowers are subject to fines and may even get up to 10 years in prison.
2. Document Destruction - If any company is being investigated by a federal agency, including the IRS, anyone destroying documents faces fines, plus up to 20 years in prison.
3. Securities Fraud - The time to make claims is extended to 5 years from the date of fraud or 2 years after it is discovered.
4. Bankruptcy Implications - Security Law violations are no longer dischargeable in bankruptcy.

Why should companies consider complying with SOX, even if not required by federal law?  If a company plans to grow, such that it may become the target for a takeover by a SOX compliance-required company, it would make the takeover go more quickly and at a lower cost.  Securing money from lenders may be easier.  States are likely to enact similar legislation that will apply to a broader group of companies, so compliance may be necessary anyway.

So what should the prudent, privately held company do?  It is probably best to:

1. Become aware of SOX;
2. Set up systems and controls so that compliance can be met in certain key areas; and
3. Consider full compliance if going public or a larger merger is contemplated.

What things make sense, in any event, whether you want to comply with SOX or not?

1. Avoid "conflicts of interest".
2. Consider some independent directors.
3. Create a whistleblower policy to protect such persons.
4. Establish good internal controls.
5. Evaluate risks and insure properly.
6. Adopt an ethics policy or a code of behavior.
7. Be sure the relationship to the company's accountants is at arm's length.
8. Consider a committee to evaluate executive compensation.

If you are interested in implementing such a plan, we can be of assistance to you.