Corporate Governance — It’s Not Just for the Big Guys
By Ken Leslie & Yvonne McNulty
Assurance Services
Universal Advisor , 2004 Issue No. 2


Corporate governance issues are big news these days. Traditionally, governance topics fell into the “important, but not urgent” category, and issues weren’t addressed unless a problem arose. However, highly visible corporate failures, financial reporting problems at well-known companies and, of course, the enactment of Sarbanes-Oxley and various regulatory changes have lead many organizations to examine their current practices. While the Sarbanes-Oxley Act requires public companies to implement significant changes to improve governance, effective governance is recognized as a critical issue for other organizations, too.

The Sarbanes-Oxley governance framework focuses on the role of an organization’s board of directors, effective internal controls, and accountability for honest and ethical conduct. In evaluating its governance practices, a nonpublic company might look to the following practices.

Role of the Board of Directors

Sarbanes-Oxley expands the scope and importance of the Board of Director’s role in public company governance; moreover, it stresses that these boards should be independent from management and have significant authority to function effectively and objectively in their oversight role as the elected representatives of the stockholders.

The oversight needs of privately owned companies are very different. In most cases, the company’s owners are also active in significant management roles. If the organization is incorporated, the Board often consists of the company’s owners and managers. In these cases, although there’s a legal requirement to have a Board of Directors, their role may be more a matter of legal formality than independent oversight.

Potential benefits from an independent Board of Directors include:

• Independent, objective input on business issues and decisions.
• Additional skills or experience that may not be present in the management team.
• Strategic connections to other organizations.
• Additional expertise in important technical disciplines.
• Periodic review, counsel, and support for management.

How can private business owners take advantage of these benefits? The following methods are frequently used in closely held companies:

1. Elect or appoint an appropriate number of independent Directors to your Board. If you choose to add to your Board of Directors, you’ll want to be very careful and particular about selecting candidates, since a great deal of authority is formally vested in the Board. It’s important to check with legal counsel to discuss the ramifications of adding new Board members, both with respect to procedural and ongoing operating issues.

2. Consider appointing a Board of Advisors. Also known as an Advisory Board, this group can provide all or most of the benefits of a Board of Directors and assume many of the same functions, but without a formal legal role in the organization’s governance. The Advisory Board structure may make sense for a company that wants the independent, objective input that independent directors can provide without relinquishing or assigning any formal authority to the advisors. Typically, any formal authority that resides in an Advisory Board has been intentionally delegated by management.

As with a formal Board of Directors, choosing Advisory Board members carefully is an important exercise, since these individuals are usually recruited to provide key management input and assistance in important areas.

3. Use independent advisors on an “as needed” basis. Another way to solicit needed input is to retain independent experts to help with specific business needs. These experts are often professional service providers or consultants. In this age of increased specialization, privately owned entities may lack the size or depth to employ specialists in every area of business need, so they team up with appropriate subject matter specialists. Typical examples of the kinds of advisors retained in this manner include CPAs, attorneys, financial advisors, quality consultants, architects, and employee benefits advisors. These kinds of professionals are often retained to assist with specific projects or needs but may also serve key ongoing advisory roles.

Regardless of which approach you choose, it’s critical to find the right advisors for you and your organization. Should you choose to look for candidates for your Board of Directors or appoint a Board of Advisors, some important factors to consider in your selection process are included in the table below.

Internal Controls

Among the most recognizable provisions of Sarbanes- Oxley is Section 404, which requires that management certify the adequacy and effectiveness of the company’s internal controls in its annual report filed with the SEC. Depending on its size, each company registered with the SEC must comply with Section 404 for its 2004 or 2005 fiscal year. As such, SEC registrants have been conducting very thorough reviews of their internal control structures, using guidelines that have been established by regulators.

While the provisions of Sarbanes-Oxley only apply to companies that are registered with the SEC, all organizations can benefit from regular and thorough reviews of their internal control environments. Privately owned businesses often operate with less formalized control systems and structures in place compared to public companies, probably because they’re not specifically regulated and tend to be smaller organizations compared to the average public company.

Properly designed and conducted internal control reviews will help determine if a company’s control systems are appropriately designed and documented and will test to see that they’re operating effectively and according to plan. These reviews should include all significant financial processes, both manual and electronic. With many businesses replacing or revising significant technology applications every few years, surrounding control processes should be reviewed and possibly revamped as well. Finally, internal control reviews can help identify significant risk areas in a business’s financial operation and identify control measures to help eliminate or reduce those risks.

Code of Ethics

Like their public counterparts, privately owned companies can benefit by adopting an appropriate Code of Ethics. This can help define and describe an organization’s culture and values from a “top down” perspective. A company that has established a culture that values and reinforces high ethics will want to communicate its values throughout the entity and ensure that they’re well understood and embraced by employees. A Code of Ethics can send a very open and visible message to both employees and outsiders that describes how the company conducts its business. At the same time, it provides the ethical framework for expectations for individual employees’ behavior.

An effective Code of Ethics outlines the standards for honest and ethical conduct, including guidance concerning:

• Handling conflicts of interest.
• Full and accurate disclosure of financial information to management and other interested parties.
• Compliance with applicable laws, rules, and regulations.
• Prompt internal reporting of violations of the Code of Ethics.
• Accountability for compliance with the Code of Ethics.

The Benefits are Far-Reaching

Although Sarbanes-Oxley only requires public companies to abide by its rules, effective governance is critical for all organizations. If you’d like more information about how the provisions of Sarbanes-Oxley can affect your organization, contact Ken Leslie at 248.223.3612 or Yvonne McNulty at 419.842.6149.