Tuesday, November 12, 2002
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Small, local firms scrambling to reshape boards of directors
By TIM COFFEY
Tuesday, November 12, 2002
In a little more than two months, the most comprehensive package of business regulations since the 1930s go into effect, forever changing management teams and director boardrooms across the United States.
The Sarbanes-Oxley Act, the federally mandated standard of corporate governance, will require significant adjustments for corporate America, from financial accounting training for senior management to the mandatory inclusion of directors with minimal ownership stakes in the company. Corporate governance experts believe Sarbanes-Oxley will, at the very least, put a premium on CPA-trained executives and discourage directors that solely serve as rubber stamps to management.
Yet in San Diego, changing the makeup of local companies, specifically the small firms, could be more problematic than expected. What constitutes an outside director and how would independent directors mesh with management directors?
"It's not the provisions in Sarbanes-Oxley, it's not the content that's the problem," said Craig Dunn, executive director of the Corporate Governance Institute at San Diego State University. "It's the implementation, especially within the smaller public companies, that's challenging."
Sarbanes-Oxley was signed into law in late July, during the dark days of Wall Street's corporate accounting scandals. Through more than 60 pages, the act calls for a more concrete system of checks and balances in U.S. public corporations.
Among other things, the legislation says CEOs and CFOs should certify the truthfulness of financial statements and that an audit committee comprised of independent, outside directors should choose the company's auditors.
Most of the rules in Sarbanes-Oxley were scheduled to go into effect 180 or 270 days after the act was signed. In other words, the rules would apply starting in January or April, at the latest.
The impending new rules mean the small, publicly traded firms in San Diego are rushing to redraw their boards of directors.
"I doubt the really big Fortune 500 company boards are going to be affected as much as the smaller startup companies that have gone public," Dunn said.
Dunn said local companies must define what constitutes an outside director and how to attract the directors since they could be held personally liable for management's deceit.
"It's a Catch-22," he said. "The people that would be best educated about Sarbanes-Oxley would likely be the people that had the greatest reservations about joining a board."
Small firms must also determine how much money to set aside to pay the new directors and the multiple accounting firms needed to conduct internal audits, prepare financial statements and other bills of clean health.
Such a situation will tax the limited resources of small technology and biotechnology firms in San Diego, said Knox Bell, a corporate lawyer with Gray Cary Ware & Freidenrich and the chair of the corporate governance committee for the San Diego-based Corporate Directors Forum.
Sarbanes-Oxley "could cause them to use their limited cash resources on an expense item instead of on research and development or growing revenue," he said.
"That being said, a lot of good things will come out of this. Just because they're difficult doesn't mean they won't be helpful," Bell added.
Corporate lawyer Doug Gordon, a business law attorney with Klinedinst, Fliehman & McKillop PC and a director at large of the Corporate Directors Forum, said the act would create a demand for financial accounting, trained executives and experienced directors.
"It will put a premium on CPAs, it will put a premium on CFOs and it will put a premium on what I call professional directors -- those that take their jobs as directors seriously," he said.
The downside of not selecting an experienced director, Gordon said, could be as devastating to the company as it was to Washington, D.C.-based U.S. Technologies when that firm named William Webster to the audit committee.
The appointment of Webster, the one-time head of the FBI and the CIA, was designed to bring recognition and clout to the firm. Instead, Webster gave management the opportunity to defraud investors of millions of dollars when his committee fired the company's auditors.
Webster's indiscretion was primarily the product of little business experience, Gordon said.
"Whether there was a rule or not at the time that said he needed the financial expertise is not the point," he said. "Do you want a guy like that on your board in a skilled position that is totally clueless?"
Webster and U.S. Technologies -- which was subsequently sued by investors -- went largely unnoticed until Webster was named chairman of the accounting oversight board, the keystone of Sarbanes-Oxley.
He resigned the position Tuesday, one week after Securities and Exchange Commissioner Harvey Pitt resigned because of the flap created by Webster's appointment.