The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) is an assortment of reforms designed to protect investors by imposing financial reporting, disclosure and corporate governance requirements on public companies. Sarbanes-Oxley was enacted with Enron and WorldCom – two large public companies – in mind. Yet it also affects private companies, both directly and indirectly.

This Update describes which private companies are most affected by Sarbanes-Oxley, which provisions of Sarbanes-Oxley expressly apply to private companies and how requirements influenced by Sarbanes-Oxley are becoming the new benchmark for financial reporting and corporate governance practices.

Which Private Companies Feel the Most Pain?

Certain provisions of Sarbanes-Oxley expressly apply to all companies, public and private. However, private companies with certain characteristics feel the pressure of Sarbanes-Oxley more acutely than others. Sarbanes-Oxley substantially affects private companies that are:

• Preparing for an IPO. A private company becomes subject to many provisions of Sarbanes-Oxley at the moment it files a registration statement under the Securities Act of 1933, as amended. Therefore, it is critical for a private company preparing for an initial public offering to address Sarbanes-Oxley compliance well in advance of the offering.
• Preparing for a Sale to a Public Company. A public company purchasing a private company becomes responsible for Sarbanes-Oxley compliance with respect to the acquired company (including certification of consolidated financial statements). A private company's financials, sophistication and internal controls may be material issues in a public company's decision about a potential acquisition.
• Issuers of Public Debt. Many provisions of Sarbanes-Oxley expressly apply to private companies that have registered debt securities.

Although Sarbanes-Oxley has the greatest impact on private companies in one or more of the categories described above, all private companies should understand how Sarbanes-Oxley directly and indirectly affects them.

Which Requirements of Sarbanes-Oxley Expressly Apply to Private Companies?

Certain Sarbanes-Oxley provisions broaden the scope of liability or increase penalties for all companies, public and private, for fraud and activities that interfere with enforcement of federal laws and regulations.

• Criminal Liability for Document Destruction. Sarbanes-Oxley provides criminal penalties for anyone who intentionally destroys, alters or falsifies records or documents with the intent to impede or otherwise influence a federal agency investigation (such as an EEOC or IRS matter) or bankruptcy proceeding. Penalties include up to 20 years' imprisonment, fines or both. For further discussion of this topic, please see our April 16, 2003 Update.
• Liability for Retaliation Against Whistleblowers. Sarbanes-Oxley makes it a crime punishable by a fine and up to ten years in prison to knowingly retaliate against any person who provides a law enforcement officer truthful information relating to the commission or possible commission of any federal offense.
• Increased Penalties for White Collar Crime. Sarbanes-Oxley increases the monetary penalties and prison sentence for fraudulent violations of ERISA reporting and disclosure requirements and increases the maximum prison sentence for mail and wire fraud from five to 20 years.
• Securities Law Liabilities Not Dischargeable. Sarbanes-Oxley makes state and federal liabilities for violations of securities laws nondischargeable in bankruptcy. This applies to liabilities for failure to register securities as well as anti-fraud violations.
• Securities Fraud. Sarbanes-Oxley extends the statute of limitations for investors to file a private securities action for securities fraud to two years after discovery of the facts and five years after the occurrence of the alleged violation.
• Blackout Notice Requirements. Department of Labor rules issued under Sarbanes-Oxley require administrators of 401(k) plans to give employees 30 days' advance written or electronic notice of any suspension of trading in an account or access to funds in the account for more than three business days and authorizes civil penalties for failure to provide timely notice of such periods. For further discussion of this topic, please see our February 4, 2003 Update.

The Indirect Impact of Sarbanes-Oxley

Sarbanes-Oxley Is Becoming the New Governance Benchmark. Most of the corporate governance reforms inspired by Sarbanes-Oxley do not expressly apply to private companies. However, these reforms are becoming the benchmark against which financial reporting and corporate governance practices are measured. Thus, private company board members with public company backgrounds are starting to require Sarbanes-Oxley type corporate governance practices. Furthermore, as lenders and insurers encounter more stringent corporate governance practices in public companies, they may start imposing analogous standards on private companies. Private companies interested in adopting "best practices" may consider establishing audit committees, adding or increasing the number of independent directors on their boards of directors, adopting conflict of interest policies and taking other steps to bring them more in line with the corporate governance standards inspired by Sarbanes-Oxley.

Actions to Consider in Response to Sarbanes-Oxley

Sarbanes-Oxley raised the bar for public company corporate governance and may be a sign of things to come for private companies. A number of private companies are adopting corporate governance procedures analogous to those required of public companies, especially those funded by venture capitalists or other institutional investors. Private company directors and officers should consider the extent to which voluntary implementation of the new style corporate governance procedures would be prudent for their companies.

Additional Information

This Update is only intended to be a summary of certain provisions of the Sarbanes-Oxley Act as such provisions may apply to private companies. 

You can find additional information regarding recent developments and recent laws, regulations and rule proposals of interest to private and public companies on our website.