Like a convict who has exhausted his appeals, and whose only hope for a stay of execution is an order of clemency, publicly traded community banks are faced with finally having to comply with what many consider to be the most burdensome element of the Sarbanes-Oxley Act.
Section 404(b) of the act requires that public companies obtain an outside auditor's approval that their financial statements are accurate, but companies with a market capitalization of less than $75 million have, so far, been exempt from having to comply with the law. Earlier this year, the Securities and Exchange Commission issued what it insisted would be the last in a string of extensions it gave to small companies when it said that they would have to begin complying with the law by June. Executives are embracing the prospect of hiring outside auditors to review their internal controls with all the enthusiasm of a man choosing his last meal.
"To say the impact of SOX 404(b) on community banks is significant would be an understatement," said Mike Menzies, president and chief executive of the $159 million-asset Easton Bank and Trust in Maryland and chairman of the Independent Community Bankers of America.
"It costs them a fortune, diverts their capital, and diverts resources," he says. "There are a lot of community banks and small businesses that are going to be thinking about throwing in the towel if they face more regulatory burden."
Dan Blanton, the president and CEO at $1.3 billion-asset Georgia Bank & Trust in Augusta, is not offering much solace. His bank isn't small enough to qualify for the exemption, and Blanton says that while he has gotten used to the expense and the burden, "I feel like I am spending a ton of money for no real purpose."
As it stands, bankers say they already have to produce accurate financial reports to satisfy their examiners, so they view the auditing requirement as a duplication of accounting. "It means a 38 percent increase in our external audit cost," says William A. "Bill" Loving, president and CEO of Pendleton Community Bank, a subsidiary of the $246 million-asset Allegheny Bancshares Inc. of Franklin, W.Va. "If you look at the overall cost we have incurred to meet SOX, over and above 404 compliance, that's just a huge cost to us."
One big reason for the added cost, says Mike Gillespie, vice president of accounting and financial management at the American Bankers Association, is that in attesting to the quality of a bank's internal controls, auditors are putting themselves at risk for legal action if those controls fail.
"The audit firms are charging a risk premium because of the exposure," he says. "Whatever incremental cost banks had in addressing a specific risk and what they need to control it, they pay about the same amount in audit costs to get the attestation."
There is, however, the faintest glimmer of hope sustaining community bankers as they stare down the barrel of SOX 404(b). It is, somewhat ironically, the Investor Protection Act.
The bill passed the House Financial Services Committee last month with a provision attached that would permanently exempt public companies under $75 million from section 404(b) compliance.
The exemption was added as an amendment, against the wishes of powerful committee chairman Barney Frank (D-Mass.), and also requires the SEC to study ways of reducing the compliance burden associated with 404(b) on companies with a market cap between $75 million and $250 million.
"It probably is a necessary political move and probably makes good fiscal sense at this point given the fact that financial institutions are under a lot of pressure," says James D. Cox, a professor of Corporate and securities law at Duke University Law School. "The cost of compliance has been demonstrated to be pretty high."
Whether the amendment will survive a final House vote is unclear, and the bill's most likely Senate counterpart, a 1,100-plus page overhaul of the financial regulatory system, includes no mention of a 404(b) exemption.
The SEC is on the record opposing an exemption, noting in a letter to Congress that 404(b) compliance has "significantly impacted" investors' confidence in public companies' financial reports.
Lost in the shuffle of debate is the fact that the current standards are actually far less burdensome than they were originally. The Public Company Accounting Oversight Board's first set of compliance rules were widely criticized for their cost, and were significantly altered.
"The bottom line is that they really tried to make it less burdensome and I think they succeeded," said Jim Hamilton, principal securities regulation analyst for CCH, a subsidiary of Wolters Kluwer Financial Services. "But still there are people who want a permanent exemption."
