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Small Public Firms Get Hit Hard by New Regulations

Small Public Firms Get Hit Hard by New Regulations By SHELLY GARCIA Senior Reporter Being small is little consolation when it comes to complying with the Sarbanes-Oxley Act, or SOX as it’s being called. Although the legislation was passed in response to issues that came to light with larger companies, even the smallest of publicly held firms will have to abide by the regulations and institute the same procedures equally. While the act requires an enormous expenditure of time, money and resources on the part of all companies, it can be especially onerous on small firms. “Smaller companies with limited human capital and cash resources are going to have, relatively speaking, a tougher time with the implementation and readiness,” said Scott Sachs, partner in charge of SOX Section 404 Readiness Consulting Practice at Good Swartz Brown & Berns LLP in Sherman Oaks. Just ask any one of a number of the small cap companies that dot the San Fernando Valley. Most of the CFOs of those firms will tell you they have spent the past six months seeking outside consulting help, adding internal staff and trying to project what the final cost of compliance will be. “Right now we don’t feel it will be under $200,000, but it could balloon well beyond $500,000,” said Dennis Jolicoeur, executive vice president and CFO at Natrol, a maker of nutritional supplements in Chatsworth. “We’re working to keep it as tight as possible. In the long term, compliance has not even been calculated by most companies.” SOX Section 404 requires that companies document all their processes and procedures for everything from accounts receivable to payroll and test the system as documented to be certain it jibes with what’s actually happening. Then the auditors come in and review the whole process. Companies with a market capitalization over $75 million are required to have their procedures in place and tested by the end of this year. Smaller companies get another year to complete the tasks. “We at BioSource, based on the rules and our market cap, will be required to comply beginning December, 2005,” said Alan Edrick, executive vice president and CFO at Camarillo-based BioSource International, “so we have a little bit of time to gain some experience and learn from what’s happening at other firms. That being said, we’ve already initiated our process. Early start Many small cap firms have moved to get an early start on the work ahead because their own internal resources are stretched to the limit as it is, and just as important, there’s a limited pool of outside help available. A lion’s share of accounting and audit capacity out there has already been spoken for by the existing clients of those audit firms. And several area companies reported that they couldn’t even get some accounting firms to take a meeting when they called. “I think it’s a real seller’s market for these services,” said Russell J. Riopelle, CFO at Cherokee Inc. “A couple of consulting firms wouldn’t even give us an hourly quote. Probably half the firms wouldn’t even take a meeting. It’s a good business for mid-level accounting and audit firms.” Van Nuys-based Cherokee, a licensing and marketing firm, has just one location and about 15 or 16 employees, making its task easier than most. The company has hired an outside consultant, but is mostly handling the process in-house. “We didn’t want to spend the money to have them do it all for us,” said Riopelle. “We’ve been able to get by without hiring any more people to do this, but it’s burdening a fair number of our employees.” At many other companies, the operations are just as complex and the work ahead is just as cumbersome as it is at far larger firms, even if the revenue yield is lower by far. Natrol with sales of about $73 million, for example, runs an accounting system that’s comparable to that at Walt Disney Co. with revenues of $73 billion, officials point out. “We can’t amortize it over a gazillion dollars,” said Jolicoeur, “We can only amortize it over our dollars. So proportionately it may be more burdensome for us.” Extra work Officials at Earl Scheib Inc. must contend with an operation that houses more than 100 different locations even though the company’s total revenues are under $50 million. “Right now just for being public, it’s costing us about $750,000 without Sarbanes-Oxley,” said Chris Bement, president and CEO of the Sherman Oaks-based company. “We figure it’s probably going to be $250,000 in extra costs.” That doesn’t include a $1 million point-of-sale system that Earl Scheib is installing. The system will help the company to instantaneously record inventory levels, costs and revenues, which will also assist in complying with SOX, although Bement said the company’s decision to install the system was not related to the new legislation. “I think the financial integrity in our shops is pretty good other than do we get it timely enough, and the POS system will give us instantaneous information,” Bement said. “But we were going to do that anyhow. So we can’t really count it as a cost of Sarbanes-Oxley, although it will help us comply.” Like Cherokee, Earl Scheib plans to handle a lot of the work internally, but the company is also planning to bring an outside firm on board. Although many of the smaller firms plan to use their existing staff to handle much of the workload, these executives point out that their current staff levels are nowhere near those of larger competitors. That may mean other work will be shelved while these new controls are put into place. And for a small company, the additional cost to set up and maintain the new control systems, may likely represent a substantial portion of earnings that would otherwise go to the bottom line. “Some of these 404 projects are costing companies hundreds of thousands of dollars,” said Bob Pearlman, a partner at BDO Seidman. “When you have a $20 million company, it’s literally going to wipe them out. And this is all because of Enron and all the other companies that have nothing to do with these small cap companies.” Indeed, while the executives at these small firms say there is value to instituting the controls required under SOX Section 404, they also are quick to point out that the new workload is a high price to pay for the transgressions of firms that have little to do with their own operations or, for that matter, the majority of businesses. “There’s just a lot of productivity that’s going to be lost in this country, and it’s not going to keep us competitive with the rest of the world,” said Jolicoeur. “The average businessman wants to see the top guys at Enron and Health South in jail with heavy jail time. That’s how you fix this problem. Right now the honest guys are paying the price.”

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