For the most part, the reforms of the Sarbanes-Oxley Act of 2002, the broad legislation passed by U.S. Congress to control accounting abuses at public companies, are by their terms applicable only to "public" companies and their audit committees, auditors and attorneys. However, several of these requirements may also apply to private companies, like some community banks.

Why Should My Private Company Consider Compliance?

Insistence by Third Parties. Key business partners, including lenders, insurance companies and potential board members, may require certain aspects of compliance as a precondition to entering or continuing a relationship with the private company on the basis that these requirements represent "best practices."

Investors. Prospective investors in a private placement of securities will increasingly insist on audited financials, assurances of auditor and audit committee independence, controls over and disclosure of "insider transactions," and the inclusion of a Management's Discussion and Analysis section (MD&A) to illuminate financial statements. In addition, investors may be willing to pay a premium to invest in companies with sound corporate governance practices.

Sale to or Merge with a Public Company. Sarbanes-Oxley compliance is compelling when attempting to sell a private company to a public company or merge with a public company. The Act requires that public company CEOs and CFOs include a written certification or statement in each quarterly filing that states they have evaluated the controls and procedures in their companies during the last quarter and concluded they are in place and effective. Therefore, CEOs and CFOs will likely want to ensure that, before bringing an entity into the fold, it is qualified to be part of their public company. So, what if the target private company acquisition is not compliant? Most likely, the deal will not be completed until the company is compliant or it just might fall through because of the delay. Regardless, non-compliance is likely to affect price because the buyer/acquirer will incur costs to "fix things" or because the buyer/acquirer demands to be compensated for time loss/delay in completing the deal.

State Requirements. State securities regulators and attorneys general may adopt requirements similar to those associated with Sarbanes-Oxley that may extend to private companies. For example, states like California have adopted document retention policies that are similar to those adopted by the Public Company Accounting Oversight Board (PCAOB) and the SEC for public companies.

Litigation Avoidance. The fiduciary duties of officers and directors of private companies, the duties of care and loyalty, are the same as those of public companies. To the extent the Act and its related requirements have established higher standards of conduct in matters such as auditor independence, financial statement review, insider transactions and disclosure, those higher standards will likely affect these duties and therefore the potential liabilities of directors and officers of private companies.

Preparation for an IPO. A company must be compliant with some provisions of the Act upon its initial filing of a registration statement and with other provisions upon its registration statement being declared effective.

Underwriters expect that private companies contemplating such a filing have implemented steps to ensure compliance prior to the time the registration statement is filed with the SEC. It is highly unlikely that an underwriter would be willing to proceed if a private company is not compliant with the Act, but thinks it can get things "fixed" while the registration statement is being prepared and marketed. Further, it would be extremely difficult, if not impossible, to do so while simultaneously preparing and marketing a registration statement. Needless to say, advance planning is critical.

GAAP Changes. The Act places the authority to set accounting and auditing standards with the PCAOB. The PCAOB has delegated certain authority to set accounting standards to the Financial Accounting Standards Board (FASB) and allows the FASB to consider accounting issues and evolving business practices and modify generally accepted accounting principles (GAAP) accordingly. Any such changes will also affect private companies' accounting practices.

Auditing Standards. Sarbanes-Oxley establishes the PCAOB to review and set standards relating to the conduct of audits. While these standards technically apply only to public companies, auditors will likely follow the same standards in auditing financial statements of private companies in order to avoid confusion over what constitutes an audit.

Added Value. Although the requirements of Sarbanes-Oxley add cost and some inefficiency to matters of corporate governance and financial oversight, when implemented they can strengthen a company's internal organization and procedures, ultimately adding value to the private company.

Be Aware! There are several provisions of the Act that could impact private companies, including:

• Liability for retaliation against "whistle-blowers"
• Penalties for destroying, covering up or falsifying documents to impede, obstruct or influence a federal investigation
• Requirements for ERISA plan administrators to notify participants and beneficiaries of certain blackout periods
• Document retention policies and procedures
• Extension of the statute of limitations for securities fraud lawsuits
• Prevention of the discharge in bankruptcy of debts from violations of securities laws.
• Increased liability for white collar crimes

Please contact us if you would like more information on Sarbanes-Oxley.