In response to the “Enron wave” of corporate scandals, last year Congress passed the Sarbanes-Oxley Act, which imposes major changes in the civil and criminal rules governing public companies. In theory, the act applies only to companies whose stock is publicly traded. But in practice it’s likely to affect private family-owned companies as well—if only because Sarbanes-Oxley affects many providers of services to family companies, like lawyers, accountants, bankers and insurance companies. As these service providers scramble to adopt the “best practices” policies mandated by Sarbanes-Oxley, their dealings with you are likely to change.
Before lending you money, for example, your bank’s loan committee may take a harder look at the strength of your management or your board of directors. Banks may require that your company conduct a fraud audit each year in addition to your financial accounting audit. They may require your CEO and CFO to certify the company’s financials as a condition for extending credit. These precautions will be necessary to strengthen the bank’s loan portfolio and keep regulators at bay.
If your bank’s stock is publicly traded, it may want to reduce its own risk levels in order to avoid shareholder lawsuits or SEC investigations. State and federal banking regulators may adopt Sarbanes-Oxley reforms as oversight procedures.
Accounting firms, vilified for their apparent lapses in the Enron and WorldCom scandals, may require auditors to maintain absolute independence from the companies whose books they audit. State accounting boards may make the Sarbanes-Oxley reforms mandatory for audits of private companies.
Even if that doesn’t happen, new auditing standards for public companies will become the bar against which private company audits are compared: Auditors of private companies will need to demonstrate clearly that the higher standards are not appropriate in a given case—or run the risk that their judgment will be second-guessed later if something goes wrong. Family businesses may find they are required to obtain new audit services, such as “fraud” audits.
One way or another, the increased expectancy of risk associated with audit opinions will drive up the amount of work that goes into an audit and, accordingly, the costs.
Meanwhile, insurance companies are raising their premiums to companies for D&O (directors and officers) liability coverage, even while they’re trying to reduce their risk exposure by excluding more types of claims from coverage. So even non-public family businesses with D&O coverage may face higher rates, greater scrutiny and possibly reduced coverage as a side effect of Sarbanes-Oxley.
Even your customers and vendors may take a harder look at your business in the wake of Sarbanes-Oxley. If they’re public companies, they’ll have to do more to keep their own affairs in order. Or they may simply want to ensure the stability of your business, which ensures the stability of theirs.
To pass muster in this brave new world, you’ll be well advised to bring qualified outside directors into your family business board (if you haven’t done so already). In addition to the objectivity, perspective, professionalism and vision they contribute, the presence of qualified outside board members may go a long way toward assuaging the concerns of your banks, insurers and other outside stakeholders.
The irony, of course, is that just when you most need experienced and independent directors, you may have a hard time finding them. That’s because the risks involved in joining a board are higher now than ever. Prospective directors may tread carefully when considering board seats with a family-run company if your affairs are not transparent, or if the family’s relationships are unduly tangled. And don’t even bother asking an outsider to join your board unless you can provide D&O liability coverage.
What can you do? First, contact your service providers whose industries may be affected by the new Sarbanes-Oxley reforms. Find out if their recent reforms may affect your relationship. For example, ask your auditor to find out if the scope of your audit will change, and whether your fees will rise.
Second, cultivate personal relationships with these service providers. Ultimately, the people representing your providers can best help you negotiate the best possible deal with each provider. Help them better understand your strengths and why certain pervasive business or industry risks may not apply to you.
Third, reduce your risk profile in the eyes of your service providers. Where possible, change or eliminate any business practices that they view unfavorably.
Finally, be prepared to shop. You may find the priorities of certain service providers have changed and they are no longer best positioned to serve you. The ripple effect of Sarbanes-Oxley will reach the family business one way or another. Like all change, Sarbanes-Oxley brings opportunity for those best prepared to meet it.
Matthew K. Donovan, J.D., CPA, is a succession planning consultant for CFG Business Solutions in Phoenix, Ariz. (www.cfgllc.com).