The Sarbanes-Oxley Act, signed into law in 2002 in response to a wave of corporate scandals, has stirred considerable public debate. Many in the business community argue that the new requirements on publicly traded companies are too onerous, time-consuming and expensive.
In fact, according to a 2004 PricewaterhouseCoopers survey, 49% of chief financial officers and managing directors of U.S.-based multinational firms indicated that compliance with Sarbanes-Oxley was a major challenge.
The Sarbanes-Oxley requirement that firms review the effectiveness of their internal controls may only apply to publicly traded firms, but the need to ensure the adequacy of financial controls is fast becoming a competitive necessity for companies that provide services to public companies. Real estate service providers are confronted with this new reality.
Comply or face the consequences
Many publicly traded companies spend considerable sums of time, money and resources to meet the new requirements of SOX. Section 302, for example, requires that CEOs and CFOs personally attest to the accuracy of financial statements, under penalty of criminal sanction.
Meanwhile, Section 404 requires that a company's management establish, maintain and evaluate its internal controls over financial reporting. Additionally, Section 404 mandates that an independent auditor annually certify and report on management's evaluation of these internal controls.
These are but a few of the many requirements publicly traded companies are now facing. Consequently, several public companies are asking their real estate service providers to meet the same requirements. In some instances, public companies are even asking real estate service providers that are not meeting the requirements to pay for the additional auditing costs of compliance.
But how can a company ensure that its real estate service provider has effective financial controls in place? It can start by asking the provider to conduct more stringent assessments of its internal controls that will satisfy Sarbanes-Oxley Section 404. Specifically, this section requires management of publicly traded firms to issue an annual evaluation of the effectiveness of their internal controls over financial reporting. It also requires that an independent auditor issue a report attesting to management's evaluation.
Why Type 2 Reports Matter
The Securities and Exchange Commission has indicated that in order to satisfy Section 404, companies can rely on what is known as a Type 2 SAS 70 report from their service providers that measures internal controls. This report tests the effectiveness of a service provider's internal controls and evaluates basic accounting functions such as invoice processing and rent collection.
In addition to these functions, the audit also evaluates IT controls on access to the accounting systems, back-up procedures, change management and disaster recovery.
But Type 2 reporting does come at a substantial cost to service providers. CB Richard Ellis, for example, spent nearly $250,000 in 2004 conducting Type 2 reporting for its clients. Going forward, expect more publicly traded companies to demand this type of reporting as they file their Section 404 reports.
Reliable information is paramount
Today, much of the real estate-related information in a company's financial statements comes from outside service providers, who administer leases and ensure that payments are made on time. Service providers also manage buildings, handle property accounting, and oversee construction and renovation projects. This information flows directly into a corporation's financial system and becomes part of its financial statements.
Accurate information flowing into and out of a company is critically important. Companies faced with real estate decisions place a high value on the ability to obtain reliable comparative data on leasing, acquisitions, dispositions and more. Clients increasingly are demanding that service providers have the best information at their fingertips.
Not only does quality information help a space user or commercial real estate owner make the smartest business decisions, it also provides an extra level of protection when it comes to Sarbanes-Oxley compliance.
While the pendulum of financial accounting in the business world has swung wide to the side of intense scrutiny, we expect it to swing closer to the center sometime in the future. Companies and their auditors will eventually determine which controls really add value and which ones don't. Until then, service providers need to either adapt or be prepared to face the tough consequences.
Ann Weinstein, a senior managing director with CB Richard Ellis, is based in Newport Beach, Calif. In her accounting management role, she supports approximately 400 million sq. ft. of properties.