[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]




SARBANES OXLEY SECTION 404: WHAT IS THE PROPER BALANCE BETWEEN INVESTOR 
    PROTECTION AND CAPITAL FORMATION FOR SMALLER PUBLIC COMPANIES?     

=======================================================================




                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                      WASHINGTON, DC, MAY 3, 2006

                               __________

                           Serial No. 109-51

                               __________










         Printed for the use of the Committee on Small Business


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                      COMMITTEE ON SMALL BUSINESS

                 DONALD A. MANZULLO, Illinois, Chairman

ROSCOE BARTLETT, Maryland, Vice      NYDIA VELAZQUEZ, New York
Chairman                             JUANITA MILLENDER-McDONALD,
SUE KELLY, New York                    California
STEVE CHABOT, Ohio                   TOM UDALL, New Mexico
SAM GRAVES, Missouri                 DANIEL LIPINSKI, Illinois
TODD AKIN, Missouri                  ENI FALEOMAVAEGA, American Samoa
BILL SHUSTER, Pennsylvania           DONNA CHRISTENSEN, Virgin Islands
MARILYN MUSGRAVE, Colorado           DANNY DAVIS, Illinois
JEB BRADLEY, New Hampshire           ED CASE, Hawaii
STEVE KING, Iowa                     MADELEINE BORDALLO, Guam
THADDEUS McCOTTER, Michigan          RAUL GRIJALVA, Arizona
RIC KELLER, Florida                  MICHAEL MICHAUD, Maine
TED POE, Texas                       LINDA SANCHEZ, California
MICHAEL SODREL, Indiana              JOHN BARROW, Georgia
JEFF FORTENBERRY, Nebraska           MELISSA BEAN, Illinois
MICHAEL FITZPATRICK, Pennsylvania    GWEN MOORE, Wisconsin
LYNN WESTMORELAND, Georgia
LOUIE GOHMERT, Texas

                  J. Matthew Szymanski, Chief of Staff
          Phil Eskeland, Deputy Chief of Staff/Policy Director
                  Michael Day, Minority Staff Director

                                  (ii)























                            C O N T E N T S

                              ----------                              

                               Witnesses

                                                                   Page
Wander, Mr. Herbert S., Chairman, SEC Advisory Committee on 
  Smaller Public Companies.......................................     4
Broderick, Mr. Bill, Chief Financial Officer, Analytical 
  Graphics, Inc..................................................     6
Crandell, Mr. Keith, Managing Director, ARCH Venture Partners....     9
Neiss, Mr. Woodie, Chief Financial Officer, FLAVORx, Inc.........    11
Schroeder, Mr. Mark, President/CEO, German American Bancorp......    13
Burns, Mr. James, President & CEO, EntreMed, Inc.................    15

                                Appendix

Opening statements:
    Manzullo, Hon. Donald A......................................    27
    Velazquez, Hon. Nydia........................................    28
Prepared statements:
    Wander, Mr. Herbert S., Chairman, SEC Advisory Committee on 
      Smaller Public Companies...................................    30
    Broderick, Mr. Bill, Chief Financial Officer, Analytical 
      Graphics, Inc..............................................    54
    Crandell, Mr. Keith, Managing Director, ARCH Venture Partners    59
    Neiss, Mr. Woodie, Chief Financial Officer, FLAVORx, Inc.....    67
    Schroeder, Mr. Mark, President/CEO, German American Bancorp..    76
    Burns, Mr. James, President & CEO, EntreMed, Inc.............    84

                                 (iii)















 
SARBANES OXLEY SECTION 404: WHAT IS THE PROPER BALANCE BETWEEN INVESTOR 
     PROTECTION AND CAPITAL FORMATION FOR SMALLER PUBLIC COMPANIES?

                              ----------                              


                         WEDNESDAY, MAY 3, 2006

                   House of Representatives
                                Committee on Small Business
                                                     Washington, DC
    The Committee met, pursuant to call, at 2:00 p.m., in Room 
2360 Rayburn House Office Building, Hon. Donald Manzullo 
[Chairman of the Committee] presiding.
    Present: Representatives Manzullo, Bartlett, Kelly, Akin, 
Velazquez, Davis, Barrow, Moore.
    Chairman Manzullo. Good afternoon. The hearing today will 
analyze the impact of Sarbanes Oxley on our nation's smaller 
public companies. In particular, this hearing will focus on 
Section 404 of SOX. Your White Sox, which are causing the most 
headaches, well, Herb is from Chicago.
    Mr. Wander. And a White Sox fan.
    Chairman Manzullo. And a White Sox fan. You don't want to 
wait another 100 years, Herb.
    In particular, the hearing will focus on Section 404 of 
SOX, which is causing the most headaches and expense for our 
Nation's smaller companies.
    In 2002, Congress passed with my support the Sarbanes Oxley 
Act, or SOX. Ms. Vel zquez and I both serve on the Finance 
Committee.
    This legislation was a response to corporate scandals at 
the large companies, such as Enron and WorldCom. However, 
changes made by SOX applied equally to all public companies, 
regardless of size.
    One of these changes was to perform annual testing of 
internal control under SOX Section 404. These tests require 
company's management to evaluate whether internal controls are 
adequate and require an independent auditor to sign off on 
management's assessment.
    Shortly after SOX passed, the SEC estimated in regulations 
that compliance with Section 404 would cost companies around 
$90,000 annually. However, the expected costs in reality did 
not match up. In reality, public companies are paying well in 
excess of $1 million annually to comply with this mandate.
    To its credit, the SEC recognizes that strict compliance 
with Section 404 may not be beneficial for smaller public 
companies. This is why the SEC has delayed implementation of 
this provision for companies with market values under $75 
million until July of 2007.
    In addition, in March 2005 the SEC convened the Advisory 
Committee to Small Public Companies to analyze the effects of 
this and other SOX provisions on small companies. This panel 
was also tasked with making recommendations to the SEC on what 
should be done to help our smaller public companies cope with 
the burdens of SOX.
    The Advisory Committee released its final report last week. 
In the report, the Committee recommends that companies with 
market values of less than $128 million be exempt from Section 
404 unless and until corporate auditing standards are 
established for these companies. While, SOX technically applies 
only to public companies, private companies have plenty of 
reasons to be nervous. The ability to gain access to public 
markets now turns on whether they can stomach the huge costs of 
Section 404.
    As the witnesses will discuss today, many are just 
rejecting the public markets and staying private. Clearly, SOX 
has an important purpose, however the legislation must not be 
allowed to overly burden our smaller companies.
    Today we will hear testimony on the compliance burdens SOX 
Section 404 has created for our smaller public companies, and 
explore whether the recommendations of the SEC Advisory 
Committee will fix these problems. I look forward to hearing 
the testimony today, and now yield to the Ranking Minority 
Member, Representative Vel zquez of New York, for her opening 
comments.
    [Chairman Manzullo's opening statement may be found in the 
appendix.]
    Ms. Vel zquez. Thank you, Mr. Chairman.
    This hearing to review the recommendations of the SEC's 
Advisory Committee has been a long time coming. Small 
businesses continue to face barriers that hinder their ability 
to remain competitive and strong.
    The sky-rocketing costs of health insurance and start-up 
capital pose many challenges for entrepreneurs. Both soaring 
regulatory and compliance burdens have consistently been one of 
their number one concerns.
    Almost every single small business owner and association 
that has testified before this Committee has put reducing the 
regulatory burden at the top of their list for legislative 
package. That is not different with the Sarbanes Oxley Act, as 
Democrats on the Committee have been hearing from small 
business owners for nearly two years now. Unfortunately, the 
situation does not seem to be getting any better.
    The Sarbanes Oxley Act was intended to strengthen the 
corporate governance practices of the business community. But, 
what we have heard is that this one comes with a cost, and a 
particularly steep cost at that.
    The auditing standards, disclosure requirements, and 
corporate governance rules of the Act have added significantly 
to the operating costs of small companies, many who have gotten 
stuck in the fray.
    Democratic members of the Committee held a roundtable back 
in October, so that we could hear directly from the small 
business community on the impact of these reforms. A number of 
small firms we spoke with agree that it is difficult not to 
support the intentions of Sarbanes Oxley, most notably strong 
corporate governance and shareholder accountability. Yet, for 
the 14,000 publicly traded companies, the majority of which are 
smaller firms, Section 404 of the Act poses a great burden to 
their future economy vitality. Numerous stories and surveys 
point to the staggering compliance costs of Section 404 as a 
major burden on small companies.
    In June, 2003, the SEC estimated the cost of implementing 
Section 404 on all registrants at almost $1.24 billion or 
$91,000 per registrant. Yet, time has told that the SEC vastly 
underestimated its calculations. Recent surveys show that the 
small companies are paying an average of nearly $1 million to 
comply with Section 404, and this is simply unacceptable.
    Even though some studies show these costs have declined, 
they are still significant and are bearing a disproportionate 
burden on small firms.
    The complying costs of Section 404 for small companies is 
approaching 3 percent of revenue, while it is less than 1/10th 
of 1 percent for larger companies.
    Adding to concerns this new evidence showing numerous small 
companies suffering under the weight of costly regulations have 
begun to look abroad to go public. There are currently 37 U.S. 
companies listed on the AIM by the London Stock Exchange, 19 
companies alone that have been listed within the last year.
     This so-called Sarbanes Oxley free zones have freed some 
small firms from the strict capital market regulations seen 
here in the U.S. Both Sarbanes Oxley and Section 404 have been 
cited as primary drivers in this development, which are, in 
turn, hurting the American economy.
    Clearly, there is no end in sight to the burden that so 
many of our Nation's small firms are forced to face. My 
Democratic colleagues and I have cited many of these concerns 
in two recent common letters to the SEC. I am pleased, though, 
with the work the SEC Advisory Committee has done toward 
finding a solution that truly eases the burden and provides 
relief for small companies.
    With the recent release of the Committee's recommendations, 
I am hopeful this will become the basis for a real regulatory 
reform proposal. I know that much uncertainty surrounds the 
SEC's review and consideration of the Advisory Committee's 
recommendations. However, this situation is resolved, I urge 
the SEC to address the issue straight on and provide smaller 
companies with definitive relief from Section 404 sooner rather 
than later.
    I look forward to the testimony of the witnesses today.
    Thank you, Mr. Chairman.
    [Ranking Member Velazquez's opening statement may be found 
in the appendix.]
    Chairman Manzullo. And, thank you, Ms. Vel zquez.
    Some of the ground rules, we have a system of lights up 
there. Green is go, yellow is you got a minute to go, and red 
you are supposed to stop. This is not used in case you don't 
stop, okay?
    It's important to tell your own story. The complete written 
statements of the witnesses will be made part of the official 
record, so you don't have to worry that if you miss something 
it won't be included in it. I'm going to keep the record open 
for three weeks for anybody else that wants to submit written 
statements, but they cannot exceed two written pages. No tomes, 
okay? And, the print cannot go below 10 points. So, no footnote 
prints, for anybody else who wants to submit additional 
statements, including obviously members, we'll keep it open for 
that.
    Now, we are expecting votes, and having taken the 
Constitutional Oath to vote. When the bell goes off, we will go 
out and vote. I think there are three votes and that will take 
probably about a half an hour. Votes are anticipated any 
minute. But what we'll do is, we'll start first with Mr. Wander 
and then, what I don't want you to do is to spend so much time 
looking at the clock that you don't concentrate on your 
testimony.
    How many here have not testified before Congress before? 
Oh, my goodness, four out of six. Okay. Well, the other two 
just assure them, you know, that nothing is going to happen, 
and this is a very, very serious subject, and it's unusual to 
get involved in something this esoteric, but sometimes the 
small businesses want to get larger. There are many companies 
that come within the SBA definition of small businesses, that 
is less than 500 employees, and in the aerospace industry less 
than 1,500 employees, that will be in this situation.
    So, Mr. Wander, we will start with you. I look forward to 
your testimony. You might want to pull the mike as close to 
your mouth as you can.
    Thank you.

  STATEMENT OF HERB WANDER, SEC ADVISORY COMMITTEE ON SMALLER 
                        PUBLIC COMPANIES

    Mr. Wander. Thank you, Mr. Chairman. It's a delight to be 
here this afternoon, and I thank you for this opportunity to 
provide oral testimony, as well as my written statement.
    Who am I? I'm Herb Wander. I am just recently released from 
my obligations as Co-Chair of the Securities and Exchange 
Commission's Advisory Committee on Smaller Public Companies. We 
were established 13 months ago, have gone through a very 
extensive fact-finding process, and submitted our report to the 
Securities and Exchange Commission last Sunday, April 23rd. I'm 
also a partner with the national law firm of Katten Muchin 
Rosenman LLP.
    In my written statement, so I don't have to repeat it, 
contains information concerning the mission of our Advisory 
Committee, the overarching principles we follow, lists the 
diverse membership, indicates to you all the extensive 
information gathering process that we went through, both in 
hearings and asking written requests, and then there are a 
total list of our recommendations, which, by the way, go beyond 
Section 404. However, this afternoon I will only talk about 
404, dealing with internal controls.
    As both the Chair, and as indicated, the original estimates 
of the cost of Sarbanes Oxley, starting with the Senate Report 
on Sarbanes Oxley, indicated that they thought there would be 
no increase in auditing costs, have been far off the mark. And 
so, I am not going through that, I think that's been well 
documented, I will only add that the latest study that the Big 
Four Accounting Firms produced two or three weeks ago by the 
Charles River Associates indicated that some of the fees are 
coming down, but they still approach $900,000 to a million 
dollars for smaller public companies, which in many cases gets 
to be double digit percentages of their cash flow. So, it is 
truly a big cost, and, indeed, that study also noticed that 
total auditing costs, that's both 404 and regular auditing 
costs were relatively flat, having gone up 200-300 percent over 
the last three or four years, so that the cost burden is 
enormous and that's well documented and I don't think disputed 
by anybody.
    We should not forget the fact that, not only have the costs 
up, but it's the opportunity costs, it's where do you spend 
your money, do you spend your money on research, and my 
colleagues who will testify I think are far more qualified to 
talk to you about loss of opportunity costs and the costs this 
puts on them.
    So, I would like to now concentrate on, essentially, our 
recommendations, because I think there's ample evidence in the 
record, and after our 13 months I think that it's well 
documented. I want to emphasize the following points. Our 
Advisory Committee was not here to repeal 404, but to fix it. 
It is clear that internal controls have been controlled since 
1977. We think they are important, but they have to work 
properly for all companies, particularly for smaller companies.
    Our recommendations which you read are crafted very 
carefully, and you must read them very carefully. We say, 
``Unless and until a framework for assessing the 404 that works 
for assessing internal controls over financial reporting for 
smaller public companies is developed that recognize their 
characteristic needs.'' So, what we are saying is, it's time 
now to get it right, before all those companies that you 
indicated in your opening remarks will become subject to this, 
that they don't have to go through something that everybody in 
today's world admits needs a major overhaul. So, we are not 
saying just totally exempt everything. We have put conditions 
on everything, and we say we would like to fix it.
    I also want to mention that none of the critics, Arthur 
Levitt, Lynn Turner, all of the critics, really do admit that 
there are faults, and serious faults, with 404. So the question 
is, how do we fix it, not whether we let it continue to 
operate, and hope that it gets fixed all of a sudden.
    We also want to emphasize that while we are talking about a 
large number of companies under our recommendations, they 
comprise less than 5 percent of the total U.S. market 
capitalization. People have bandied around, you would exempt 80 
percent of the public companies. Actually, the number is 70 
percent, but the fact is that these are the smallest 
capitalization, under 5 percent of total market capitalization.
    We also believe very strongly that we think AST2, which is 
Accounting Standard No. 2 adopted by the PCAOB needs fixing. 
The PCAOB has done a good job in trying to provide guidance, as 
well as the SEC providing guidance. The guidance has just not 
worked, and we think they ought to go back to the drawing board 
and make changes to the regulation, because those who are 
applying it look at the rule and they look at the guidance 
secondarily or not at all.
    Chairman Manzullo. How are you doing on time?
    Mr. Wander. Well, I'm reminded of the story that the 
Securities Act of-
    Chairman Manzullo. No, on time, you are out of time.
    Mr. Wander. I'm on time, all right. I would just like to 
close that I think my written statement contains all of the 
necessary information concerning our recommendations, which we 
think should be and, in fact, can be adopted by the SEC and the 
PCAOB.
    Thank you very much.
    [Mr. Wander's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you very much.
    Our next witness is Bill Broderick, Chief Financial Officer 
and Treasurer of Analytical Graphics, Incorporated. We look 
forward to your testimony.

     STATEMENT OF BILL BRODERICK, ANALYTICAL GRAPHICS, INC.

    Mr. Broderick. Good afternoon. My name is Bill Broderick. 
I'm the Chief Financial Officer for Analytical Graphics, a 
software company based in Exton, Pennsylvania, serving the 
national security industry. I also serve as a Board Member of 
the Small Business and Technology Council.
    Chairman Manzullo, Congressman Vel zquez, and Members of 
the Committee, I would like to thank you for holding this 
hearing and the opportunity to testify.
    In the short time we have, I hope to provide some 
highlights on my prepared statement in regards to the 
unintended consequences of SOX and small public companies, and 
how it has affected my company, my small private company.
    Since 1989, AGI has grown to a 250-person company, and has 
been named Best Small Company to Work For in America for 2004 
and 2005.
    Chairman Manzullo. Bill, I'm going to restart your clock 
when we get back. How does that sound?
    Mr. Broderick. That's okay, Mr. Chairman.
    Chairman Manzullo. All right? Because I don't want to have 
people walking out in the middle of your testimony. That 
doesn't look too good, does it?
    So, we are going to recess for about a half an hour and 
then we'll be right back.
    Is there anybody here on the panel that has to catch a 
plane later on this afternoon? Okay, then we'll keep this 
order.
    [Recess.]
    Chairman Manzullo. I'm waiting for the alarm clock to reach 
6:00 a.m., and then for somebody to smash the alarm clock and 
to go looking for groundhogs.
    So, Mr. Broderick, if you would like to start all over 
again, and you may have been through this before.
    Mr. Broderick. Yes, I have been, Mr. Chairman.
    Chairman Manzullo. For about 40 seconds, is that correct?
    Mr. Broderick. Yes.
    Chairman Manzullo. So, if I ask you if you've ever 
testified before Congress before you can say yes now. We look 
forward to your testimony.
    Mr. Broderick. I have on the House Armed Services side, Mr. 
Chairman.
    Okay, thank you again for this hearing, Mr. Chairman. I'm 
just going to pick up where I left off with some company 
background.
    Since 1989, AGI has grown to a 250-person company and has 
been named the Best Company to Work in America for 2004 and 
2005. Over our history, we have been able to assemble a 
talented team of 140 engineers and scientists to provide a 
unique and innovative product line, with 12 issued patents to 
our credit. We are proud that the national security community 
relies on the fidelity of our software in many critical areas, 
such as providing battle space situational awareness for 
efforts in Afghanistan and Iraq, as well as the Pentagon for 
top level-
    Chairman Manzullo. Well, just a second, you sound like a 
guy doing a trailer in one of those ads, all right? You can 
slow down a little, all right?
    Mr. Broderick. I'm just -
    Chairman Manzullo. Don't worry about it, all right?
    Mr. Broderick. Okay-as well as top level briefings in the 
Pentagon.
    The key question I pose for today's hearing is, given the 
disproportional cost of Section 404 on SOX, on small public 
companies, are we building a safeguard that costs orders of 
magnitude more than any proven benefit, or simply put, are we 
being penny wise and pound foolish with respect to small 
business compliance with SOX?
    As cited in the April, 2006 final report of the Advisory 
Committee on Smaller Public Companies, the discrepancy between 
the initial Section 404 cost estimate of $91,000 versus the 
actual cost of $900,000 raises the question of cost benefit for 
the shareholders of smaller public companies.
    Given the ongoing cost of compliance with Section 404, the 
valuations of smaller public companies are permanently 
impacted. In my prepared statement, I provided you with a macro 
level calculation on this impact, which resulted in an on 
average loss of approximately $8.1 million in shareholder value 
for each smaller public company, or approximately $60 billion 
in total equity valuation loss would be incurred on a permanent 
basis across all smaller public companies.
    In addition, the above figures do not include the 
opportunity costs and lost productivity of management and other 
personnel related to core business activities. Because the 
regulations lack cost benefit analysis and professional 
judgment, investors lose significant shareholder value.
    We fully concur that regulatory reforms were needed in the 
wake of the financial collapses and malfeasance at Enron and 
other companies. However, there appears to have been a rush to 
enact sweeping reform, without a basic cost benefit analysis to 
assess the impact on smaller public companies.
    As discussed in my prepared statement, we eliminated the 
option of going public to liquidate our venture investor, 
primarily from the significant burdens associated with SOX 
compliance, which would not only reduce our profitability due 
to the cost of SOX, but divert senior management time away from 
core business activities.
    Therefore, we were forced to raise $15 million in bank debt 
and used $13 million of our own cash to liquid out our venture 
investors entire holdings. Accordingly, the result and effects 
of AGI being unable to effectively access the public capital 
markets are as follows;
    1. Our limited capacity to make investments in advanced R&D 
affects our ability to deliver unique capabilities for national 
security needs, which is important, not only to stay 
competitive in a marketplace dominated by large prime 
contractors, but also to keep our Nation's defense technology 
far ahead of our adversaries.
    2. We have foregone growth opportunities and investments in 
business development, marketing and sales to the detriment of 
our long-term sustainability.
    3. Limited cash reserves put a strain on existing business 
operations, preventing scaling up of our infrastructure, which 
includes financial systems, internal controls, and information 
technology.
    Our recommendations to reduce the disproportional impact of 
the Sarbanes Oxley Act on smaller public companies are 
summarized as follows;
    First, AGI strongly supports the Advisory Committee's 
primary recommendations, especially the establishment of a new 
system of scaled or proportional securities regulations for 
smaller public companies.
    Second, I cannot emphasize this enough, the proper tone at 
the top is a critical enabler and force multiplier for 
acceptance of applicable internal controls throughout an 
organization. To this end, AGI recommends mandated executive 
level professional education to establish understanding and 
commitment to the importance of effective internal controls. 
Internal controls are best implemented with the right tone from 
top down.
    Third, in reference to the Advisory Committee 
recommendation III(P)(1), AGI recommends that not only the CEO 
and CFO provide certification for internal controls, but also 
the Chief Operating Officer or equivalent operations executive 
should provide certification as well. This executive is key to 
adoption of an effective internal control system, since he or 
she is more intimately involved in the day-to-day departmental 
operations. This key executive should be held accountable and 
not be disconnected from the internal control certification.
    In closing, if the status quo remains, this will reinforce 
a message to non-public small companies that you must be a 
larger company to access the public capital markets, and many 
smaller public companies, especially in the micro category, may 
be forced to go private.
    I applaud the SEC for establishing an Advisory Committee to 
examine these matters, and commend the Advisory Committee on 
their diligent comprehensive efforts to provide a framework to 
establish common sense, proportional regulations under a cost 
benefit structure.
    I'm grateful to this Committee for holding this hearing on 
topics vital to the health of small business and the 
opportunity to testify.
    I welcome your questions and thank you.
    [Mr. Broderick's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you very much.
    Our next witness is Keith Crandell, Co-Founder and Managing 
Director of ARCH Venture Partners. We look forward to your 
testimony.

       STATEMENT OF KEITH CRANDELL, ARCH VENTURE PARTNERS

    Mr. Crandell. Thank you very much, Mr. Chairman, and 
Members of the Committee, good afternoon.
    I am Keith Crandell, Co-Founder and Managing Director of 
ARCH, a 20-year old venture capital firm located in Chicago, 
Illinois. We fund primarily seed and early stage companies in 
the technology and life sciences area. My partners and I sit on 
many boards of both public and private companies.
    I'm here today in my capacity as a Board Director for the 
National Venture Capital Association, which represents more 
than 400 venture capital funds in the U.S. U.S. companies 
originally funded with venture capital, such as Genentech, 
Goggle, Archipelago, now represent 10 percent of the annual GEP 
and employment in the United States.
    I want to speak today on behalf of our country's emerging 
growth companies, which are being stifled by the Sarbanes Oxley 
law, specifically, Section 404. This law has drained capital 
and resources from these young companies, distracted management 
from growing businesses, diverted the major members of the 
accounting profession, and threatened the future of the U.S. 
capital market system for growth businesses.
    Profitability is critical on Wall Street, and Sarbanes 
Oxley attacks profitability head on. The cost of complying with 
SOX 404 at small companies approaches a million dollars a year. 
If one assumes a healthy company can achieve 10 percent net 
income, then SOX dictates that such a company would have to 
garner up to $10 million in additional revenue just to support 
the cost of compliance.
    For those who suggest that the cost of 404 compliance will 
eventually fall, I would argue that without dramatic change the 
numbers will not fall enough. A recent CRA international study 
found that even with a 31 percent drop in SOX compliance costs 
last year, small cap companies still on average bear a SOX 
burden of $860,000. It's highly unlikely that SOX costs will 
continue to drop as precipitously in the future, and the costs 
remain excessive.
    Of equal concern is the drain on human resources to achieve 
SOX 404 compliance. These companies are being placed in an 
undesirable position of having to hire additional financial 
staff and forego hiring engineers and sales teams. These hires 
do not foster company growth.
    To exacerbate the situation, SOX has compelled the Big Four 
auditors I'm familiar with to shift their focus from auditing 
companies of all sizes to leveraging lucrative 404 practices at 
large corporations. As a case in point, I served as a Board 
Member on a small cap public company that was informed by their 
Big Four auditor in 2004 that, not only were they too busy with 
their larger clients to complete the company's audit on time, 
but that their audit would cost 16 percent more than the 
previous year. The Big Four auditor provided - suggested that 
the smaller company release its numbers late, which we all 
know, including the auditor, that that would be public market 
suicide.
    Although many have suggested that small companies turn to 
second and third tier accounting firms, this isn't a realistic 
choice for many ventured-backed companies, since most 
investment banks that are willing to take their companies 
public request that the company use a Big Four firm.
    From a macro economic perspective, SOX 404 has contributed 
significantly to a clog in the IPO pipeline in the United 
States. The cost of the legal and accounting work for initial 
public offering processes stands at close to $2 million, up 
from $500,000 a few years ago. These hurdles to go public in 
the U.S. today are driving venture capital-backed companies 
away from our capital market system to other exits and other 
markets.
    In 2005, only 56 venture-backed companies went public on 
U.S. exchanges. The healthy IPO market historically has been at 
least twice that level. Only ten IPOs for ventured-backed 
companies were accomplished in the first quarter of this year, 
so we are on track for another dismal year for IPOs.
    We are seeing pre-IPO companies now embrace two viable 
alternatives to going public in the U.S. First is the 
preference for acquisition route, for many companies the cost 
of going public is too high, and when faced with a cheaper, 
less risky alternative the acquisition wins. Unfortunately, 
consolidation acquisitions is much less conductive or conducive 
to job and technology growth.
    The second strategy is companies choosing to go public on 
foreign exchanges. In 2005, there were 519 IPOs on the London 
AIM. In the first quarter of 2006 we saw for the first time two 
of 12 U.S. venture-backed companies went public on the AIM, and 
decided not to use the NASDAQ.
    Eighteen months ago, if you queried a room of ventured 
capitalists about the London AIM, few would have had the market 
on their radar screen, I think today it's viewed as a viable 
and better understood option for many of VC-backed companies.
    While specific provisions of the original Sarbanes Oxley 
law have improved certain practices at U.S. companies, Section 
404 has done little in the way of advancing fraud. We have 
witnessed the information compiled from a 404 audit to be 
unwieldy, out of date, and of little or no use to investors. 
I'm not aware of any evidence that Section 404 has been a 
critical factor in uncovering fraud, such malfeasance is almost 
always discovered by new employees or auditors joining a firm, 
rather than from compiling documents.
    As a committed investor in small and emerging growth 
companies, I strongly support the recommendation of the SEC 
Advisory Board on the smaller public companies, the 
recommendation for tiered regulations. Size appropriate 
structure already exists in other regulations, and I would 
argue that intelligent small company investors would easily 
exchange a certificate of compliance for the extra million 
dollars in that income that would come from tiered regulatory 
relief.
    Further, I am very supportive of any provision that will 
help stimulate more competition in the accounting profession. 
Our supply of qualified accountants to do work for small 
companies is not meeting the increased SOX demands. We would 
welcome new entrants wholeheartedly.
    Companies that seek to thrive and create value will always 
comply with the highest standards. It's critical for market 
credibility, but the time has come to set the bar accordingly, 
and reduce the unnecessary frictional costs of SOX 404, in the 
best interest of growing companies and growing economy.
    Thank you for the opportunity to weigh in on this vital 
matter.
    [Mr. Crandell's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you.
    Our next witness, I read the press release you put out last 
night.
    Mr. Neiss. You liked it?
    Chairman Manzullo. It was good.
    Mr. Neiss. Right.
    Chairman Manzullo. Yes, you know, if this meeting had been 
cancelled I don't know what you would have done, you know.
    Mr. Neiss. I'd still be here.
    Chairman Manzullo. I appreciate that, it shows your 
enthusiasm for being here, and, Woodie, is it Neiss?
    Mr. Neiss. Neiss, yes.
    Chairman Manzullo. Woodie Neiss is the Co-Founder and Chief 
Financial Officer of FLAVORx, Inc., a company that puts 
flavoring into medicines. We look forward to your testimony.

            STATEMENT OF WOODIE NEISS, FLAVORx, INC.

    Mr. Neiss. Thank you very much.
    Chairman Manzullo, Ranking Member Vel zquez, and Members of 
the Committee, thank you for inviting me here today. My name is 
Woodie Neiss, and I represent what is great about this country, 
the ability to take an idea and turn it into a reality.
    I'm an entrepreneur and a Co-Founder of the company 
FLAVORx. We are an INC500 high growth, young energetic small 
business, helping millions of sick children get better faster 
by being more compliant with their medicines. We believe we are 
saving the U.S. healthcare system over $100 million a year in 
unnecessary medicines, doctor visits, insurance claims, gas, 
time and resources of parents, and the companies they work for.
    I represent a different generation of business owners than 
those of Enron and WorldCom. We respect the rules and morals, 
and believe you can run a business fairly. I believe that 
FLAVORx has what America needs in the form of a public company.
    Over the past several years, we have had steady growth, 
maintained positive cash flow, and consistently grown our 
bottom line. I often get calls from parents asking if we are 
publicly traded. It's for this reason that we've been able to 
attract capital from friends, family and most recently private 
equity, with the hopes of going public.
    Wanting to do it right, we've diligently grown our business 
by implementing ethical business practices along the way. This 
wasn't a product of legislation, that's just what you do to 
grow a business and raise capital.
    Part of our process always includes an audit of our 
financial statements. We feel it is necessary to have an 
independent auditor review our books to verify their accuracy. 
It not only reassures us that what we are doing is right, but 
provides a vote of confidence to our business partners.
    Over time, we've grown our audit relationships, and in 2002 
in anticipation of an IPO we hired Ernst & Young. What we 
didn't realize we faced though were adversarial, theoretical 
debates over revenue recognition procedures, concentration on 
overly detailed reporting systems, time consuming discussions 
over policies and procedures irrelevant to a company of our 
size, and extra costs in the form of consultants and legal 
fees.
    Our $10,000 a year, two-week audit suddenly jumped to a 
$70,000 four month audit. On top of that, these fees 
represented a substantial 14 percent of our net income. There's 
a fundamental difference between a small company with public 
aspirations like ours, and a multi-billion dollar company. We 
do have the deep pockets, unlimited personnel, intricate 
infrastructure, or complexity they do, and hence don't need the 
same resources or structure to explain our simple actions.
    Trying to dig for problems in a company like ours, where 
problems don't exist, is counter productive. Spending money to 
uncover these problems, when I can use it to invest in sales 
and marketing, seems a waste. To hold us accountable to rules 
where the challenges are different or non-existent are an 
unintended result of this legislation that is lining the 
pockets of auditors, consultants and lawyers.
    It was for this reason last year that we decided to drop 
our relationship with E&Y. We also started to second guess our 
desire to go public. I mean, why go public when Sarbanes Oxley 
audits are so expensive and painful? Why put yourself through 
the agony, when in the end there's nothing to uncover?
    When it comes time to audit season, you are guilty until 
proven innocent. It doesn't sound very American, does it?
    I highly doubt FLAVORx is unique when I say we want our 
investors to know the good and the bad, that transparency is a 
part of our lives. However, we, like many small businesses, are 
not complex. Unfortunately, however, Sarbanes Oxley does not 
take this into consideration. There needs to be some middle 
ground. There should be a threshold based on the complexity of 
an organization determined by its revenue to which companies 
should be held accountable to SOX. Until then, we can use these 
funds to better grow our companies, rather than reduce our net 
income.
    Of course, the option always exists that we can pass these 
costs off to the consumers, but I highly doubt this was the 
intention of Congress. We, as business leaders, can change-can 
behave ethically without being forced by legislation. To lose 
confidence in us is to lose confidence in the majority of the 
good companies out there that are trying to succeed in this 
challenging business environment of higher costs and increased 
competition.
    Public markets allow companies like FLAVORx access to 
capital which enables us to grow much faster, hire more people, 
and consume more American products. This grows our economy more 
than if we were just to sell to a larger company. However, 
public markets at the expense of Sarbanes Oxley do not make for 
attractive options.
    I know this Committee represents the interests of small 
businesses, and I hope you can help influence your colleagues 
to understand the repercussions that Section 404 is having on 
us.
    Thank you again, Mr. Chairman, for holding this hearing and 
allowing me to testify. I look forward to your questions and 
our discussion.
    [Mr. Neiss' testimony may be found in the appendix.]
    Chairman Manzullo. Appreciate that. I'm just wondering when 
people call your company and are put on hold, if that song, ``A 
Spoonful of Sugar,'' is there.
    Mr. Neiss. We tried, but Disney got-we got in trouble with 
Disney.
    Chairman Manzullo. You did say that you are law abiding, 
that's great.
    Our next witness is Mark Schroeder, with the Independent 
Community Bankers of America. He's President and Chief 
Executive Officer of German American Bancorp in Jasper. How 
many people live in Jasper?
    Mr. Schroeder. About 15,000.
    Chairman Manzullo. Oh, that's a big city.
    We look forward to your testimony.

      STATEMENT OF MARK SCHROEDER, GERMAN AMERICAN BANCORP

    Mr. Schroeder. Thank you.
    Thank you for the opportunity to testify today, good 
afternoon. My name is Mark Schroeder, and as the Chairman said 
I am President and Chief Executive Officer of German American 
bancorp. We are located in Jasper, Indiana, and we are a 
community bank holding company, with approximately $1 billion 
in assets.
    It is my pleasure to speak today on behalf of both my 
company and the Independent Community Bankers of America, which 
represents approximately 5,000 community banks in the United 
States, many of whom are publicly held, and speak on the costs 
of Section 404 of Sarbanes Oxley, and on the recommendations 
included in the final report of the SEC Advisory Committee on 
Smaller Public Companies.
    Let me give you a little background on German American. 
German American bancorp was formed in 1983, and we were formed 
with the express purpose of providing a vehicle for small 
community banks to come together to achieve economies of scale 
and to obtain the liquidity of a publicly-held community 
banking company.
    Since 1983, nine community banks, the majority of which 
have served their communities in southern Indiana for over a 
century, have joined our company, allowing their shareholders 
the opportunity to continue holding an investment in their 
locally-owned community bank.
    German American is listed on NASDAQ. We have approximately 
3,500 registered shareholders, and we have a market 
capitalization of $144 million.
    I think I bring a unique perspective among the witnesses 
today, because German American bancorp is an accelerated filer 
with the SEC, and we have, therefore, been subject to SOX 404 
compliance for the last two years.
    For 2004, our direct costs as a company, just for SOX 404 
compliance, amounted to nearly $600,000, with an additional 
estimated $250,000 of internal indirect costs, for total 
compliance costs of $850,000, which equates to .08 cents per 
share for our shareholders.
    For 2005, our costs declined, but even these declined 
costs, the direct costs were $350,000, and our indirect costs 
were $150,000, for a total cost of $500,000, or approximately 
.05 cents a share.
    Now, these costs are extremely high, but these costs fail 
to consider and take into account the internal operating 
inefficiencies that have been created because of the 
duplicative internal controls that we have had to put in place 
since the implementation of 404.
    In an effort to be conservative, and to avoid being 
questioned by the PCAOB, accounting firms, ours included, are 
requiring layer, upon layer, of checks and balances, beyond 
that which can be justified on any kind of risk cost basis 
beyond that needed for proper segregation of duties, and beyond 
anything that's ever been required by the banking regulators.
    In particular, the cost of duplicate checks and balances, 
coupled with the requirement for layer, upon layer of 
documentation of these duplicative processes, have added 
additional operating inefficiencies through every area of our 
company.
    The cost of this inefficiency is impossible to measure, but 
it is significant, and at a minimum we believe it is equal to 
or in excess of the measurable indirect costs.
    For many publicly-held community banks and holding 
companies, the immediate response to the high costs of SOX has 
been to go private, and cease being registered as SEC filers. 
Since the beginning of 2003, 75, over 75 community banks have 
filed to go private. The reasons cited in these filings 
uniformly include increased legal and auditing hard costs, and 
management staff time soft costs, associated with the Exchange 
Act, but unquestionably 404 compliance is the biggest concern.
    Unless something is done to ease the burden of 404, we 
would predict that as the micro cap companies, those below $75 
million of market cap, are looking at facing this, you will see 
a flood of public banks, small public banks, choosing to go 
private.
    The SEC Advisory Committee on Smaller Public Companies 
should be commended for its fine work in preparing and drafting 
the final report, and including more than 30 recommendations 
for scaled or proportional securities regulation for smaller 
public companies. Among the Advisory Committee's primary 
recommendations, ICBA strongly endorses exempting micro caps 
from the internal control attestation requirements of Section 
404, and unless and until a framework for assessing internal 
controls over financial reporting for such companies is put in 
place for the small cap companies, exempting those small cap 
companies from the external audit requirements of 404.
    We agree strongly with the Advisory Committee that with 
more limited resources, fewer internal personnel, and less 
revenue with which to offset the costs of 404 compliance, both 
micro cap and small cap companies have been disproportionately 
impacted by the burdens of Section 404 compliance.
    We also agree that the benefits of documenting, testing, 
certifying the adequacies of internal controls, while of 
obvious importance to large companies are of less value for 
micro cap and small cap companies who rely to a greater degree 
on tone at the top and high-level monitoring controls to 
influence accurate financial reporting.
    There has been little attempt by either the SEC-
    Chairman Manzullo. How are you doing on time there?
    Mr. Schroeder. -okay, I'll wrap up here, Chairman.
    There has been little attempt by either the SEC or the 
PCAOB to tailor or scale regulations to address the 
disproportionate costs and burdens.
    On behalf of the nearly 5,000 members of the Independent 
Community Bankers of America, we urge the members of the 
Committee on Small Business to support the Advisory Committee's 
recommendations, and urge the Securities Exchange Commission to 
adopt them.
    Thank you.
    [Mr. Schroeder's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you.
    Our next witness is James Burns. Mr. Burns is President and 
CEO of EntreMed, Inc., speaking on his behalf, and also on 
behalf of his trade organization, the Biotech Industry 
Organization or BIO. We look forward to your testimony.

            STATEMENT OF JAMES BURNS, ENTREMED, INC.

    Mr. Burns. Thank you, Mr. Chairman.
    Chairman Manzullo. Could you pull the mike a little bit 
closer, sir?
    Mr. Burns. Sure.
    Thank you, Mr. Chairman, Ranking Member Vel zquez, and 
Members of the Committee. As a native Illinoisan I'm glad to be 
here, and also to be here to talk about the issues involved in 
Sarbanes Oxley Section 404.
    I am the President and CEO of EntreMed, a public 
biotechnology company in Maryland. I have been involved in 
leading the development of biotechnology companies and products 
for over 20 years. Founded in 1991, EntreMed is a clinical 
stage pharmaceutical company, focusing on the development of 
next generation anti-cancer and anti-inflammatory drugs that 
target disease cells directly in the blood vessels that nourish 
them. Our focus is on the development of drugs that are safe 
and convenient, providing the potential for improved patient 
outcomes.
    Our company currently has three drug candidates in clinical 
trials for cancer, as well as others in pre-clinical 
development for oncology and non-oncology indications. Our 
company has no product sales, and will depend on continued 
investment capital for the foreseeable future to maintain our 
clinical development programs.
    I'm here today to testify on behalf of the Biotechnology 
Industry Organization or Bio, an organization representing more 
than 1,100 biotechnology companies, academic institutions, 
state biotechnology centers, and related organizations in 50 
states and 31 nations. Our members are involved in the research 
and development of health care, agricultural, industrial and 
environmental biotechnology products. The majority of our 
member companies are small research and development oriented 
companies, pursuing innovations that have the potential to 
improve human health, expand our food supply, and provide new 
sources of energy.
    My company has a profile that is typical of the high risk 
capital-intensive, long lead time regulated business 
environment of the biotech industry. As a representative of one 
of the most innovative high growth sectors of our Nation's 
economy, one in which the United States maintains a global 
leadership position, my testimony is tailored to the issues 
faced currently or that will be faced by emerging companies in 
the biotech sector, the micro cap and small cap companies who 
are among the driving forces of our country's innovative 
leadership and competitiveness in global marketplace.
    Let me, basically, say we appreciate and agree with the 
congressional intent behind 404, ensuring that companies will 
have the effective policies, procedures and controls to protect 
against material mis-statements end product and protect it 
against fraud. Where Section 404 has gone awry, however, is in 
the implementation.
    The reason for increase cost burden is the imposition of an 
inflexible Section 404, and companies with fewer personnel, 
little or no revenues, and minimal resources. Simply put, if 
the current 404 implementation continues to be imposed, micro 
cap and small cap companies in our industries will be forced to 
endure internal processes and organizational changes that are 
completely contrary to the rapidly changing and highly 
competitive markets in which we operate.
    Let me put 404 into real company context by providing some 
examples, if you would. One of BIO's member companies has five 
employees working on Section 404 compliance, at a cost of 
approximately $1 million per year. This company estimated that 
its Controller spent approximately 35 percent of his time on 
404, while the CFO spent approximately 20 percent of the time, 
to complete the mandated internal control processes and the 
checklists dictated by AS2 the company had to increase its 
accounting staff by 40 percent.
    Another member's experience shows the impact of 404 with 
respect to opportunity cost. This company not only spent 
approximately $500,000 on its external attestation of internal 
controls, but also had to endure additional costs in terms of 
(1) the reassignment of laboratory research personnel to 
perform internal control work dictated by AS2; (2) the 
postponement of hiring of five or more additional researchers, 
the delay of promising R&D programs.
    Other issues that this company was trying to deal with was 
whether they would have had to file additional patents. There's 
100 patents in this company right now, and whether and where to 
file additional patents.
    This company could also purchase an entire amount of active 
pharmaceutical ingredient for one of its clinical product 
candidates for the same cost associated with complying with SOX 
404. To say the least, this is clearly an unintended and 
unfortunate consequence of Section 404.
    The risks in our business are patient safety, FDA 
compliance, and the uncertainty of research outcomes. SOX 404 
does not reduce these risks.
    For investors, their confidence and trust in public 
companies may have increased as a result of the passage of SOX 
as whole, in spite of Section 404, not necessarily because of 
it.
    We view CEO and CFO certification under Section 302 as 
beneficial and a requirement that we are not contesting. As we 
saw in the first and second years of 404 implementation, 
investors were less concerned when a company reported a 
material weakness in internal controls than how much a small 
company was paying to meet Section 404 requirements for much 
more complicated businesses.
    Chairman Manzullo. How are you doing on time?
    Mr. Burns. I'm just going to wrap up shortly.
    Chairman Manzullo. Okay.
    Mr. Burns. Biotechnology start-up companies early in their 
histories often have very limited or no product revenues 
compared to their market capitalization. So, for these reasons 
BIO has urged the Securities and Exchange Commission to-and the 
Public Accounting Oversight Board, as expeditiously as 
possible, to take the necessary steps to adopt a reform 
framework recommended by the Advisory Committee's final 
recommendations.
    That concludes my testimony. Thank you.
    [Mr. Burns' testimony may be found in the appendix.]
    Chairman Manzullo. Okay, Mrs. Kelly.
    Mrs. Kelly. Thank you.
    I apologize, I have a very busy schedule and I have to 
leave.
    As one of the people who helped to write SOX, and helped to 
write Section 404, you have to put that into context of what 
was happening at the time that we wrote it. It was certainly 
not intended by Congress to put a chill factor on businesses. 
And, I am concerned, I think we do need to take a look at it.
    With that in mind, I'd like to talk to you, Mr. Wander, 
about a question I had, rather than divide companies by market 
capitalization, would it have made more of an impact to look at 
companies that need relief from the cost of compliance in terms 
of take a look at small businesses that nearly have their 
profits erased by the cost of the compliance, looking at it 
that way rather than-in other words, the percentage that it's 
costing them out of their bottom line. And, is there some 
reason why you didn't do that?
    Mr. Wander. Yes, one of our mantras was to keep it simple. 
We think that one of the just general problems, in terms of 
both legislation and regulation, is that things get so 
complicated that it's very difficult to comply with it, it 
takes away the use of professional judgment.
    So, we tried to figure out all sorts of metrics that would 
apply to scaling the regulation for public companies.
    Most of the people that commented felt that market cap was 
best. The second was, essentially, frankly, number of employees 
or revenue, and we discarded that. And, we considered scaling 
based on what your profitability was, but again, most of the 
comments we had felt that that would be no good because, you 
know, very large companies went into bankruptcy who still, for 
example, had no income whatsoever and needed-were large 
organizations, United Airlines being one of those, that still 
needed to have a robust internal controls over financial 
reporting.
    Mrs. Kelly. Mr. Wander, did you look at the idea that you 
could maybe look at the mandates relative to the percent of 
resources that a company needs to devote to compliance, rather 
than their profitability or numbers of employees and all of 
that that you just mentioned, did you look at what it cost the 
company for compliance and think about a sliding scale of 
percentages in terms of applying 404?
    Mr. Wander. We didn't look exactly at that level. We are 
out of business, so I can't say we'll go back and look at that, 
but it sort of gets difficult in my first reaction to sort of 
figure out, well, if I have revenues of, let's say, $50 
million, and I want to spend up to half a million dollars, 1 
percent of that, how do you cut that off?
    And, the accounting firms were very adamantly against 
establishing a standard where you would say, okay, for a $50 
million company you would have to do a $500,000 internal audit.
    On that issue, we ran into, frankly, a total road block by 
the accounting firms.
    Mrs. Kelly. I can understand that, if you have-with a 
$500,000 audit, however, we do know, and you know because you 
reported the cost of audits is going down, we have to remember 
that this was put in place to protect the American investor, 
and while I am absolutely concerned about small and mid cap 
companies and their compliance, this was not meant to be a 
chill factor on business in the United States. But, we still 
need to have transparency so that people understand what that 
investment is going to be.
    Part of the thing that concerns me in transparency, also 
with regard to small and mid cap companies, concerns naked 
short selling, which I was hoping that we-I brought up in a 
hearing this morning, because that is affecting our small and 
mid cap companies, and I was kind of hoping that maybe you all 
might have taken a look at that at the same time that you were 
doing this.
    Mr. Wander. It was one of the items on our agenda, and, 
frankly, we concluded that we are a limited life group with 
some sort of resource constraints, time restraints, and while I 
agree with you wholeheartedly that that's a very important 
aspect, it wasn't-we just didn't put it as high on our agenda, 
because we frankly think the SEC and NASDAQ are addressing that 
issue.
    Mrs. Kelly. I have just one other comment, this to Mr. 
Crandell.
    Mr. Crandell, you were talking about, you represent the 
venture capitalists, I'm quite concerned that we in government 
are putting grants out to help people develop ideas and bring 
everything up to a certain point, where at the point where they 
are needing to go from a granted position into production, into 
a prototype model of what they are doing, there's an area that 
is talked about in the agencies of government called the 
``valley of death,'' because the venture capitalists, you can't 
blame them, won't go in.
    It would be very good if we could somehow develop a way to 
bridge that gap. It may be a public/private partnership or 
something, because I've been working on that for ten years, and 
I can't seem to figure out how we can force the agencies of 
government to bridge that gap, so that the venture caps can 
come in. I can't blame them, they are out there on the edge of 
the risk anyway.
    Maybe you wouldn't mind engaging in a dialogue. I don't 
know if you want to talk about it now, but certainly you can 
find me and I'd be interested in talking with you, maybe we can 
bridge a gap to help our companies make that jump, so they 
become viable and help us grow the economy.
    Mr. Crandell. Yes, Congressman Kelly, I'd welcome the 
opportunity, and I'm happy to do that off line.
    I would say that there are groups of venture capitalists 
that do seed and early-stage investing. We have done 115 
companies in the last 20 years. We've co-founded most of those 
with technologists, scientists and, you know, I think it's a 
really important area to make sure that the U.S. is very 
efficient and taking inventions and turning them into business' 
revenue that employ people. So, I'm happy to talk about it.
    Mrs. Kelly. Thank you.
    Mr. Crandell. Sure.
    Chairman Manzullo. I recognize the Ranking Member for her 
questions and comments.
    Ms. Vel zquez. Thank you, Mr. Chairman.
    Mr. Wander, let's get right to one of the biggest issues 
facing the Advisory Committee's reform proposal. Critics 
suggest that if the Advisory Committee's primary 
recommendations regarding internal controls are adopted that 
investor protections will be undermined. What investor 
protection requirements would still apply to small companies 
that are afforded relief under the Advisory Committee's 
recommendations?
    Mr. Wander. Yes, thank you.
    First, all of the companies, whether they be micro caps or 
small companies, would be required to have internal controls 
over financial reportings. That's been mandated since 1997. 
They will still be in existence and applicable to all these 
companies.
    Secondly, these companies will have to provide the 
certifications that are required under Section 302 of Sarbanes 
Oxley by the Chief Executive Officer and the Chief Financial 
Officer, attesting to the compliance with both financial 
disclosures and other disclosures in their narrative portion of 
their documents. So, those two people will be on the line, and 
I can tell you from my own experience as a lawyer representing 
many of these companies, the executives take that role very 
seriously. It is not something that's sort of a throw away and 
they sign it.
    Third, they will all go through their regular audits, and 
we have learned, and this is unchallenged by anybody, that for 
the micro cap companies the regular audit is really the audit 
that catches errors and fraud. You don't need a separate 
external audit for those companies. So, that would still be in 
place.
    Ms. Vel zquez. So, you agree that investors will still be 
sufficiently protected?
    Mr. Wander. Yes, I believe they will.
    Ms. Vel zquez. Mr. Burns, we have heard that what drives 
investment in the high-growth setup, biotech and hi-tech 
sectors, is proof of concept, not Section 404, and that some 
companies are spending the equivalent of six months of R&D 
funding to cover the costs associated with Section 404.
    Based on your experience, how much of an impact does 
Section 404, as currently implemented, have on increasing 
investors confidence?
    Mr. Burns. Investor confidence is primarily driven by 
progress to proof of concept. Money goes into, typically, 
companies like ours and it's expensed, it's expensed internally 
and externally, and the progress that's made on R&D, the 
progress that is made in clinical trials, the compliance with 
safety requirements of the FDA and so on are the things that 
investors particularly pay attention to, whether or not their 
investments in the company are being spent efficiently on R&D 
and efficiently on clinical trials, and whether the company is 
making progress toward ultimately getting approval.
    And, they expect that when an audit is completed, and the 
CEO and the CFO certify to the financial, the accuracy of the 
financial statements, that that is what they are certifying to.
    Ms. Vel zquez. Thank you.
    Mr. Wander, last week, and I sit on the Financial Services 
Committee, Marsh Carter, Chairman of the Board of the New York 
Stock Exchange group, testified before the House Financial 
Services Committee on maintaining the international 
competitiveness of the U.S. financial markets.
    In order to keep U.S. markets competitive Mr. Carter 
proposed that the SEC and PCAOB move to a three-year Sarbanes 
Oxley Section 404 review cycle, as a way to reduce regulatory 
burdens. He noted that this could be accomplished without 
having to pass legislation to amend the law.
    Do you think this proposal will help small companies by 
reducing the cost of compliance?
    Mr. Wander. We considered that very seriously in our 
deliberations, and concluded, again, we ran into actually 
opposition from both the issuers and the accounting firms, and 
their arguments were that once you get subject to 404 it's a 
shock, and having it every three years would be worse than 
having it every year. It's like going into an ice cold water.
    And, we thought, and still think, that the better approach 
is to scale the regulations for smaller public companies, so 
that they still have to go through rigorous internal control 
establishment and examination, but that it should be scaled to 
the size of the company, and it should be every year.
    So, but I don't throw out the three-year requirement off 
hand. We did look at it, and thought ours was better.
    Ms. Vel zquez. Thank you.
    My next question is to you, Audit Standard No. 2 implements 
Section 404, AS2, as it is known, is long on guidance for 
accountants, but short on guidance for small companies. COSO 
has attempted to fill this void and provide additional guidance 
for small companies. What is your opinion of COSO guidance in 
this area?
    Mr. Wander. It's still deficient, and they came out, they 
worked very hard to produce some guidance at the request of the 
SEC, and I believe the PCAOB. The exposure draft came out, oh, 
three, four, five months ago. Comments were almost uniformly 
negative. It was a 200 and some page guide, and the problem was 
the guide, by the time you read it you were more confused than 
when you started.
    And, it's unfortunate, because I value COSO and the people 
who work there who are, I think, truly trying to find a 
solution. They are now revising it, I don't know what the 
revision will be, but I think in general it was just too long 
and not pointed enough.
    Ms. Vel zquez. My time is up.
    Mr. Bartlett. Thank you very much.
    I have here a copy of a letter from the Office of Advocacy 
of the Small Business Administration to the Honorable 
Christopher Cox, with whom I had the privilege of serving in 
the House. And, Roman Numeral I says, ``SEC should not impose 
disproportionate burdens on smaller companies by excluding them 
from access to capital markets.''
    I'd first like to apologize for not being here for your 
testimony. I'm also on the Armed Services Committee, and this 
is that one day in the year when we have a mark-up. Ordinarily, 
it lasts til midnight. I think that in the next hour or so it 
will be over, it's going very well today, and so I couldn't be 
here for your testimony.I gather that compliance with these 
regulations is imposing a burden on small business. I would 
like to ask a couple of questions. First of all, is it your 
view that when they wrote these regulations, as a result of our 
law, that they had small business at the table, that they went 
through the requisite hearings, and hearing from small business 
how the implementation of this that might be acceptable to 
large business would be an inappropriate burden on small 
business, do you think that they went through that required 
procedure? Any or all of you.
    Mr. Wander. Well, I will start the answer. I'm sure my 
colleagues here can fill in.
    We think that's one of the very serious problems, is that 
the smaller and mid cap public companies are literally orphans 
in this process. The original COSO recommendations of the early 
`90s had very small chapters in the massive two volume set of 
guidelines dealing with small businesses. And, it sort of said 
they are very different, and you have to scale the regulations 
in order to have smaller companies comply on a reasonable and 
efficient basis.
    When AS2 was first promulgated, the PCAOB, in fact, did 
have an appendix dealing with smaller public companies, which 
was taken out when the final rules were adopted.
    And so, one of the points made by the Advisory Committee is 
that no one has really taken the time or effort to focus on 
what the standards should be for smaller and mid cap companies.
    Mr. Bartlett. Anyone else wish to respond?
    I'm going to violate some rules probably, but they have a 
vote and it's just a couple of floors away. I'll be back very 
quickly, but they are having a roll call vote in Armed Services 
and I'm needed there. I'm going to do what you should never do 
and turn this over to a Minority member.
    Ms. Vel zquez. Well, continue practicing it.
    Mr. Wander, let me continue to ask some questions here. 
Given the effect of Sarbanes Oxley on the public accounting 
industry, there was speculation that some smaller CPA firms 
will drop their public clients.
    There was concern that this would lead to fewer companies 
in an industry already marked by significant consolidation. 
While the General Accounting Office addressed this issue in a 
study two years ago, could you please provide your perspective 
on what role smaller CPA firms are playing in the market for 
Sarbanes Oxley audit services?
    Mr. Wander. I believe that particularly the next five in 
size firms who are actually very active with our Advisory 
Committee, and many of the regional accounting firms, need the 
strong support from the SEC, the PCAOB and Congress. They are 
very talented people. It probably has some limitations, they 
aren't as global as the Big Four, but they certainly are very 
fine professionals for businesses that are, essentially, 
located here in the United States.
    And, I think you will see a trend, I don't think it's fast 
enough, where many smaller public companies will go to the 
smaller accounting firms. I think one of the witnesses talked 
about the fact that unfortunately underwriters and banks 
sometimes insist on a Big Four. In fact, Chairman Cox I think 
has spoken out in saying people should look at smaller 
accounting firms, and I think that that will be one way, 
hopefully, we will have a much more vibrant accounting 
profession, with more opportunities and choices for all 
businesses.
    Ms. Vel zquez. Thank you.
    Mr. Schroeder, how have the compliance costs associated 
with Section 404 affected your bank's ability to invest in the 
local community?
    Mr. Schroeder. Obviously, when you have a cost of a company 
of our size that in the first year was approaching a million 
dollars and now has kind of settled it at a half million 
dollars a year, it impacts our ability to invest in the local 
businesses that we do business with and the local companies, as 
well as the local individuals. From a Community Reinvestment 
Act perspective, it's probably a good place to look at it.
    When we are looking to make an investment from community 
reinvestment, that half million dollars that we are spending on 
404 could be allocated towards CAR type investments, but it 
can't go both places. A half million dollars a year for our 
company is a significant additional cost that will come out 
somewhere in the mix.
    Ms. Vel zquez. Thank you.
    Mr. Wander, none of the top ten initial public offerings 
last year were registered in the U.S., and 23 of the 25 largest 
IPOs occurred in foreign markets. Anecdotal evidence suggests 
that the high costs associated with Section 404 are helping 
drive this trend and causing U.S. companies to raise capital in 
foreign exchanges, such as the London Exchange Alternative 
Investment Market, and some of the witnesses raised this issue, 
too.
    To what extent has the burden associated with the Sarbanes 
Oxley Act deterred private companies from going public in the 
U.S., and to instead list on foreign exchanges, such as AIM?
    Mr. Wander. I think that's a growing phenomenon that you 
will see more and more of. AIM is coming to the United States, 
they almost have full-time representatives.
    And, I would add with that the Toronto Stock Exchange, 
which is really the TSX, which also tries to capture smaller 
businesses with a model somewhat similar to the AIM market. 
They, in fact, presented a program at the Business Law Section 
of the American Bar Association meeting last month in Tampa, 
all foreigners gave the presentation, and they are going around 
to various cities in the United States trying to get listings. 
And, I don't think there's any question that they will gain 
many more companies to go into their system, because for a 
small public company to take so much of their revenue or their 
cash resources to comply with Sarbanes Oxley, particularly, 
404, especially 404, that they will continue to move to foreign 
markets.
    And, I think Sarbanes Oxley is one of the big factors. I 
think as a New York Stock Exchange representative testified, 
litigation is another one.
    Ms. Vel zquez. But, do you believe that the Advisory 
Committee's recommendation will help reverse this trend?
    Mr. Wander. Yes, ma'am.
    Ms. Vel zquez. Okay.
    Mr. Broderick, if the Advisory Committee's recommendations 
are enacted, would you consider your decision to not go public?
    Mr. Broderick. If they were enacted to have a scaling 
proportional regulation, yes, we would then, right now, 
Congresswoman, the way we look at it is, an IPO is not feasible 
right now, but we say into the foreseeable future for a 
technology company that's, you know, three years at best, but 
we look at that we need to get to a certain level of critical 
mass in order to absorb the SOX compliance issues.
    For us, that would be, we are a $50 million company right 
now, the way we look at it we roughly would have to get to $150 
million to give us enough market capitalization, roughly about 
a half a billion dollars or so, to absorb that cost.
    I would say, Congresswoman, just small cap companies, 
especially micro cap companies, in order to get liquidity in 
their stock, and institutional investors and other investors 
awareness to buy their stock, the time commitment and resources 
that the CEO and CFO to put at that is tremendous. When you add 
SOX on top of that, we looked at it and we just, it was a no 
brainer, we said we can't go public because we'll put our 
shareholder value more at risk. For a small cap public company, 
you put estimates out there. We are not like Google, we don't 
have to give guidance. If you don't give some kind of guidance, 
no one will follow you, no one will be interested in your 
stock.
    So, you are out doing your own marketing efforts to get 
that interest, and that's just the general dynamics and the 
burdens on executive management to create liquidity in the 
stock. If you miss an estimate, a quarterly estimate, you know, 
by a penny, your stock can drop 50 percent easily.
    So, when we look at it, the risk of that was so great, and 
the diversion of time and management towards SOX compliance, 
that we said we have a chance to lose 70 percent of our value, 
we might as well just stay private, build the company, and move 
forward with our strategies.
    Ms. Vel zquez. Thank you.
    Thank you, Mr. Chairman.
    Mr. Bartlett. Thank you.
    I'm privileged to serve on three of the least partisan 
committees in the Congress. This is certainly one of them. I 
don't know of anybody here who isn't a small business 
supporter. I serve on Armed Services, and I serve on Science, 
so I had little fear that turning the Chair over to the 
Minority would be abused.
    In another life, I was in business, as a small business 
person, and I learned very quickly that regulations that were 
acceptable to large businesses, if you have 300 people and it 
takes three people to comply with the regulations, that's a 
burden, but not a burden you cannot bear. If you have four 
employees and it takes three to comply with the regulations, 
that's clearly a burden that you can't bear. And so, you need 
to be careful whose business advice you are getting, because 
the strongest competitors for big business is frequently small 
business, and regulations are a way of neutralizing, neutering 
in many cases, a small business. You need to be careful who you 
are asking about whether these are acceptable regulations or 
not, because they may be acceptable to big business because 
it's a burden they can easily bear as a part of their overhead, 
and, furthermore, it now puts their small business competitors 
at a disadvantage. I see a number of you nodding your heads in 
assent, so you've been there and you understand this.
    It's quite clear from your testimony that compliance with 
the regulations resulting from this law is imposing an undue 
burden on small business. The question I need answered is, is 
there a regulatory fix for this, or do we need to have a 
legislative fix for it? Is this something that we can hold the 
bureaucrats responsible for? Can they, within our law, 
promulgate regulations that will be effective and yet 
consistent with the view that small businesses should not be 
unduly disadvantaged by these laws? Can the regulators fix it, 
or do we have to legislatively fix it?
    Mr. Broderick. Congressman, I think if the SEC adopts the 
scaling proportion, it's just common sense, I don't see any 
reason why they wouldn't adopt this and move forward with a 
framework, and then they can tweak that framework as they see 
fit.
    To me, if they don't anything, if they just bury their 
heads in the sand about it, you are going to have small 
companies just, you know, not being able to attract any 
capital, even VC capital. Early-stage companies are going to be 
knocked out of the marketplace, because they see too much risk. 
Now, a VC comes in and he puts a certain level of 
infrastructure into a company, an early-stage company, and 
that's, you know, basic accounting, finance, HR type of 
infrastructure, but now you've got to take that extra layer on 
top of that, and based upon the risk models of VC firms they 
don't know if they are ever going to get to a public 
marketplace.
    So, if those resources are diverted, you are not properly 
growing your company to get adoption of technology products and 
services in the marketplaces that you serve.
    So, as far as - I believe it was a very, very good study 
and report, taking something and boiling it down, as complex as 
it is, and simplifying it, I think it was-I commend the 
Advisory Committee, I think they did a heck of a job with it, 
and I don't-it's just common sense, and we need more common 
sense.
    Mr. Bartlett. Is it your general view that if the 
recommendations of the Advisory Committee were implemented that 
it would largely fix the problem?
    Mr. Schroeder. Speaking as a company that has been an 
accelerated follower, and has been through 404, absolutely. For 
German American bancorp, and for many of the community banks, 
public community banks, that ICBA represents, those 
recommendations would absolutely fix the problem for us, or a 
significant portion of it.
    The portion that we would be left with are good controls, 
they are controls we can live with, they bring value to our 
investors, but it is the 404 compliance and this piling on of 
layers and layers of bureaucracy that it would fix.
    So, for us, absolutely, it would fix it.
    Mr. Bartlett. Yes, sir.
    Mr. Burns. Mr. Chairman, I believe that it would certainly 
help my company, and it would more than likely help most of the 
other companies that are biotechnology companies, and rely on 
the capital to grow their companies.
    And, it's also my understanding that the Commission has the 
authority to implement the recommendations and we fully support 
that. The sooner the better, sir.
    Mr. Bartlett. Do you believe that the recommendations they 
made are consistent with law? Was there any ever discussion, 
any discussion that we might need new legislation to permit 
them to do what seems so reasonable to you?
    Mr. Wander. Perhaps I should at least try to answer that 
question.
    One of our goals, it wasn't in our mission statement, but 
one of our goals since we were an advisory committee to the 
Securities and Exchange Commission, was that we wanted the 
Securities and Exchange Commission to implement our 
recommendations. So, we believe wholeheartedly that the SEC 
does have authority under the various securities laws to 
implement our recommendations.
    I should be totally frank with you, there are people who 
question that, because of a quirk, Section 404 is not part of 
the Securities Exchange Act of 1934, where the SEC has some 
broader authority to adopt regulations. But, we make a case for 
this in our report, and I believe that Congressmen Oxley and 
Baker have, in fact, written to the SEC a letter indicating 
that they believe wholeheartedly that the SEC does have the 
authority to adopt our recommendations.
    On the other hand, Senator Sarbanes is probably on the 
other side on that question.
    Mr. Bartlett. Yes, so often what you see depends on where 
you sit, doesn't it?
    Mr. Wander. Yes.
    Mr. Bartlett. These two people are kind of the extremes of 
the political spectrum, and they are looking at the same law 
and come to different conclusions.
    But, it's my understanding that Chairman Cox would be 
responsible for implementation of this.
    Mr. Wander. He, together with the rest of the 
Commissioners, yes, sir.
    Mr. Bartlett. Is it your understanding that this has come 
to his attention?
    Mr. Wander. Oh, yes, he has commended our report, and said 
that it would be studied quite thoroughly, which I'm sure it 
will. The SEC is a very responsible agency.
    We, as someone just said, hope that they do it on a rapid 
pace, and that they do adopt most of our recommendations, if 
not all of them, but we will see how that pans out. It's only 
been a week since they've gotten the report, although I think 
they knew it was coming and what the recommendations have been 
for probably two to three months.
    Mr. Bartlett. These regulations were promulgated before 
Chairman Cox took over?
    Mr. Wander. Yes.
    Mr. Bartlett. So, this is not his child?
    Mr. Wander. That's correct.
    Mr. Bartlett. Okay.
    I want to ask my Ranking Member if she has any additional 
questions or comments?
    Ms. Vel zquez. No, I don't.
    Thank you, Mr. Chairman.
    Mr. Bartlett. Okay.
    Well, I want to thank you all very much for the 
contribution that you've made. We will wait a reasonable time 
to see if SEC responds responsively. If they do not, why I 
suspect that they will be sitting in your chairs telling us why 
they have not.
    I know Chris Cox very well. He's a genuinely thoughtful 
good guy, and if he doesn't respond promptly it will be because 
there's just a lot of other things on his plate which have kind 
of pushed this aside. We'll make sure that that doesn't happen 
for very long.
    You are in a better position to judge than we as to how 
soon they ought to have responded to this. We would like your 
commitment to get back to us when you think they should have 
responded and they have not, and then we will follow through on 
it.
    I want to thank you all very much for your testimony, and 
our Committee is adjourned.
    [Whereupon, at 4:13 p.m., the Committee was adjourned.]
    

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