Private Company RMs

That simple question, he said, initiated "an unusually fertile discussion about whether private companies could avoid the ramifications of Sarbanes-Oxley," he said last month in Philadelphia during a panel discussion of the law's ramifications at the Risk and Insurance Management Society's annual conference.

"A lot of companies which are private view this as not their concern–that these are publicly-traded standards," he noted.

As exploration of the question continued, he said, "there was a lot of nodding, like people had begun to realize that the ability for a private company to stick its head in the sand and say, 'not me,' isn't realistic."

He added that "everybody is going to be affected by the principles of SOX–be they outside stewardship, be they internal controls, be they conflict of interest with auditors–those are principles in SOX that are going to ripple past public companies into governance at large."

He said that "unless their thoughts are that they will never need to raise money, will never want to be acquired and will never want to go public, unless those three questions are all no, they will have to deal with some or all parts of SOX in some way going forward."

He added that "most private companies have interest in one or more of those three [growth options]."

Recently, Mr. Galban said, "I was talking to one customer who said they have walked away from several applicant companies to be acquired because they didn't have the 404 standards [internal control requirements], but more importantly, they weren't even close."

He noted the practical reality is that "the M&A guys in these bigger companies are looking and comparing because they have to be at fault for compliance."

When considering an acquisition, he continued, "they want to know whether [the company to be acquired] also is up to those standards, so there is no 'indigestion' in the merger."

The consequences to a firm wishing to be acquired that doesn't adhere to some of the Sarbanes-Oxley standards, he said, "are that the company is finding itself less courted."

Although this could potentially affect all types of businesses, he said, "at least a couple of customers I've talked to were in Silicon Valley," a major center of technology company formations over the past decade.

There, he said, "the problem is exacerbated" because the "entrepreneurial spirit there is much more dominant than, say, the control spirit."

"It's fair to say that internal controls are pretty unsexy in the spirit of creative entrepreneurship, so it's more of a leap for some young companies that are into ideas," he said.

Internal controls such as checks and balances, accounting, auditing and backstopping "are probably not high on their list of the most exciting things they could do," he added.

What is his advice to risk managers? Progressive risk managers of privately-held companies need to realize, he said, that "it's absolutely imperative they begin to look at this in the context of their own business."

Even though the SOX compliance process is expensive and tiresome, and they don't legally have to do all of it, "the principles are going to become important in their business going forward," according to Mr. Galban.

He emphasized that taking these steps "doesn't have to mean spending $4 million a year, but they will have to consider getting themselves into that kind of governance mode."

This could mean having more outsiders sitting on the board, better internal controls, and more influence from outside directors, attorneys and accountants in the management of the company than ever before, he suggested.

He added that there is a "definite trend toward more operational management–more operational CEOs, for example, and fewer imperial CEOs."

Another trend, he noted, is that lawyers, accountants and outside board members are getting more influential.

"There is some cost to this and enormous transitional pains, but nobody made a huge case that this is evil stuff," he said. "Everybody I've talked to says it is not the worst thing in the world that we have more collective consensus on the management of these companies."

Should an organization hire an expert to implement SOX-like compliance? That depends on where any deficiencies lie, he said. "As a general principle, you need to look at each section," he explained. "If it's internal controls, you probably need to have somebody double-check the auditors, or double-check your internal controls and auditors will do that."

If the company needs more outsiders on the board, "people will say I don't need to–it's my company," he said. While this may be true, he added, "the trend is that a little wisdom from an outside perspective never hurt. Nobody has gotten up and said diversity of view and outside opinion is evil, or that checks and balances get in the way."

Mr. Galban noted that another important reason for compliance is that a privately-held company might wish to contract with a publicly-traded company, such as a large publicly-traded defense firm.

"That large firm is going to be up to speed [on SOX governance standards]," he said. "My guess is they will turn to their vendors, some of which are private, and say their house has to be in order to trade. So this is one more natural extension of how these rules will become the benchmark overwhelmingly."

Caption For picture:

Less formal privately-held outfits might need to get up to speed on Sarbanes-Oxley governance standards to do business with public companies.

"It's fair to say that internal controls are pretty unsexy in the spirit of creative entrepreneurship, so it's more of a leap for some young companies that are into ideas."

Tony Galban, Senior V.P.

Chubb Corp.

Infographic: (smaller board room shot?) (use numbers instead of bullets)

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Why Should Private Firms Care?

Tony Galban of Chubb Group warns risk managers of privately-held companies that unless their employers keep up with internal governance standards established by the Sarbanes-Oxley Act for public firms, they might run into trouble implementing any one of three key expansion strategies:

o If their firms wish to raise capital from new investors to expand or acquire other firms.

o If they want to be an attractive acquisition candidate for a bigger, publicly-owned firm already complying with SOX.

o If they want to go public themselves and generate money by selling stock on the open market.