What a Private Manufacturer Should Know about SOX

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by Rex Miller, CPA | Partner, Team Member of Manufacturing and Distribution Services

If you think the Sarbanes-Oxley Act (SOX) doesn’t apply to your closely held manufacturing company, think again. Granted, you’re not required by law to comply with SOX provisions — only publicly traded companies are held to its corporate governance and financial reporting standards. But many privately held companies are adopting some of the act’s provisions because they make good business sense.

Sizing up the benefits

SOX created new standards for corporate accountability as well as new penalties for acts of wrongdoing. It changed how corporate board executives must interact with each other and with corporate auditors. And by holding CEOs and CFOs accountable for the accuracy of financial statements, the act made it virtually impossible for them to make the claim: “I wasn’t aware of any financial issues.”

Despite stringent regulations and the costs associated with compliance (additional paperwork and rigorous audits), the business world acknowledges that SOX represents some best practices, too. In fact, many companies insist that its customers be in compliance if they want to do business with them. For private companies, that may mean adopting some of SOX’s provisions to allay pressure from banks, shareholders and customers to comply.

Some private companies will benefit more from implementing SOX provisions than others. For example, if you’re planning to take your private manufacturing firm public, getting an early start on compliance — at least a year in advance of SOX implementation — can help you avoid post-IPO costs and delays. And if you’re considering a merger or acquisition with a public company, you’re more likely to sell for a premium if you’re SOX-compliant.

Most companies, however, can benefit from the stronger internal controls and fraud prevention policies that result from implementing SOX provisions. This, in turn, helps them attract viable board members and private equity investors and could enable manufacturing businesses like yours to more easily qualify for loans and competitive commercial insurance rates.

Picking and choosing provisions

Unlike public companies, a private company gets to decide which SOX provisions are best for it. Generally, private companies institute whistleblower policies, establish internal financial reporting controls, adopt corporate governance guidelines and require board approval for auditors to provide nonaudit-related services. Here are several other SOX-friendly measures you can implement without paying the high costs of full compliance:

  • Adding independent directors (not owners or managers) to your board,
  • Forming an audit committee,
  • Hiring an accounting firm to recommend audit improvements,
  • Prohibiting or closely monitoring related-party transactions,
  • Appointing a compensation committee to oversee executive compensation,
  • Strengthening accounting procedures and record keeping, and
  • Establishing procedures for employees to anonymously report any financial concerns, as well as the processes that will be used to investigate those reports.

Keep in mind that adopting these measures may not bring your business up to full SOX compliance, but they can strengthen your internal controls, credibility and company image.

Worth the investment

SOX encompasses more than just finance and accounting; it covers any activity that can affect your manufacturing company’s financial well-being. Despite the costs of doing so, putting forth the effort to examine your facilities for potential SOX risks, address operational weaknesses that may affect your bottom line, and implement effective internal controls and independent oversight to protect your business from all forms of fraud can be well worth the investment.