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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Feb 11

Written by: Jack Ciesielski
2/11/2005 10:23 AM 

The Wall Street Journal reports that the high-tech trade group AeA, (formerly the American Electronics Association) has unleashed a report blasting Section 404 of the Sarbanes-Oxley Act. The full report can be found here. Full title: "Sarbanes-Oxley Section 404: The 'Section' of Unintended Consequences and Its Impact on Small Business - A Grassroots Uproar."

I can see it now: Grab the pitchforks! Light the torches! We gonna git them crazy scientists Sarbanes, 'n Oxley, 'n their Section Four-Oh-No-Four monster, dadgummit!

One premise is that the first year of Section 404 reviewing has cost businesses $35 billion - and that it will continue to be a high cost in years two and three. That $35 billion is one big honking number. If companies spent an incremental $35 billion - who's taking in the incremental $35 billion? Was it the Big Four, doing internal control consulting work for non-audit clients? Can't tell, but if you look at this WSJ story on KPMG's US revenues for the year ended September, it seems doubtful. KPMG's revenues in the US were $4.1 billion, up 8% or $300 million. Extrapolate that to the other three Big Four members, and it's nowhere close to $35 billion: it's not even $1.5 billion.

Say for the sake of argument that the Big Four were able to increase their Section 404 non-audit work by maybe $3 billion. Look at the change in 2004 revenues for this pool of firms that have a pretty high degree of favorable exposure to Section 404 work and assume that all of it was driven by 404: Accenture, BearingPoint, Jefferson Wells (part of Manpower*), Navigant Consulting, Resources Connection. Throw in the 2004 revenue change from some other decent-sized firms with potential favorable 404 exposure, but maybe less directly so: Convergys, Hewitt Associates. Lastly, add more "benefit of the doubt:" the whole 2004 revenue change at EDS (a real stretch); the consulting revenues change of IBM; and the like for Unisys. The sum of the revenue changes, plus another maybe $3 billion for the Big Four: about $14 billion, at best.

There's going to be a lot of numbers tossed around in the next few months as the pushback on Section 404 mounts. All will be on the high, hysterical side. And every time you hear them, ask yourself: if it cost this much to whip internal controls in shape, how bad were they in the first place? How badly have firms underinvested in accounting and reporting systems?

To me, the numbers being thrown around make the 404-fighters look worse: they look like they've tried to do everything on the cheap for so long that they've got major infrastructure to rebuild.

*Stock holding of the author and asset management clients of R.G. Associates.