[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
THE SARBANES-OXLEY ACT 4 YEARS LATER: WHAT HAVE WE LEARNED?
=======================================================================
HEARING
before the
SUBCOMMITTEE ON REGULATORY AFFAIRS
of the
COMMITTEE ON
GOVERNMENT REFORM
HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
APRIL 5, 2006
__________
Serial No. 109-199
__________
Printed for the use of the Committee on Government Reform
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
index.html
http://www.house.gov/reform
______
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COMMITTEE ON GOVERNMENT REFORM
TOM DAVIS, Virginia, Chairman
CHRISTOPHER SHAYS, Connecticut HENRY A. WAXMAN, California
DAN BURTON, Indiana TOM LANTOS, California
ILEANA ROS-LEHTINEN, Florida MAJOR R. OWENS, New York
JOHN M. McHUGH, New York EDOLPHUS TOWNS, New York
JOHN L. MICA, Florida PAUL E. KANJORSKI, Pennsylvania
GIL GUTKNECHT, Minnesota CAROLYN B. MALONEY, New York
MARK E. SOUDER, Indiana ELIJAH E. CUMMINGS, Maryland
STEVEN C. LaTOURETTE, Ohio DENNIS J. KUCINICH, Ohio
TODD RUSSELL PLATTS, Pennsylvania DANNY K. DAVIS, Illinois
CHRIS CANNON, Utah WM. LACY CLAY, Missouri
JOHN J. DUNCAN, Jr., Tennessee DIANE E. WATSON, California
CANDICE S. MILLER, Michigan STEPHEN F. LYNCH, Massachusetts
MICHAEL R. TURNER, Ohio CHRIS VAN HOLLEN, Maryland
DARRELL E. ISSA, California LINDA T. SANCHEZ, California
JON C. PORTER, Nevada C.A. DUTCH RUPPERSBERGER, Maryland
KENNY MARCHANT, Texas BRIAN HIGGINS, New York
LYNN A. WESTMORELAND, Georgia ELEANOR HOLMES NORTON, District of
PATRICK T. McHENRY, North Carolina Columbia
CHARLES W. DENT, Pennsylvania ------
VIRGINIA FOXX, North Carolina BERNARD SANDERS, Vermont
JEAN SCMIDT, Ohio (Independent)
------ ------
David Marin, Staff Director
Lawrence Halloran, Deputy Staff Director
Teresa Austin, Chief Clerk
Phil Barnett, Minority Chief of Staff/Chief Counsel
Subcommittee on Regulatory Affairs
CANDICE S. MILLER, Michigan, Chairman
CHRIS CANNON, Utah STEPHEN F. LYNCH, Massachusetts
MICHAEL R. TURNER, Ohio WM. LACY CLAY, Missouri
LYNN A. WESTMORELAND, Georgia CHRIS VAN HOLLEN, Maryland
JEAN SCHMIDT, Ohio
Ex Officio
TOM DAVIS, Virginia HENRY A. WAXMAN, California
Ed Schrock, Staff Director
Kristine Husar, Professional Staff Member
Benjamin Chance, Clerk
Krista Boyd, Minority Counsel
C O N T E N T S
----------
Page
Hearing held on April 5, 2006.................................... 1
Statement of:
Feeney, Hon. Tom, a Representative in Congress from the State
of Florida; Hon. Mark S. Kirk, a Representative in Congress
from the State of Illinois; and Hon. Gregory W. Meeks, a
Representative in Congress from the State of New York...... 9
Feeney, Hon. Tom......................................... 9
Kirk, Hon. Mark S........................................ 17
Meeks, Hon. Gregory W.................................... 29
Hinchman, Grace L., senior vice president, Financial
Executives International; Richard A. Hubbell, chief
executive officer, RPC & Marine Products Corp.; Robert P.
Dowski, chief financial officer, Allied Defense Group
[ADG]; Alex J. Pollock, resident fellow, American
Enterprise Institute; and Damon A. Silvers, associate
general counsel, American Federation of Labor and Congress
of Industrial Organizations................................ 48
Dowski, Robert P......................................... 65
Hinchman, Grace L........................................ 48
Hubbell, Richard A....................................... 61
Pollock, Alex J.......................................... 72
Silvers, Damon A......................................... 80
Letters, statements, etc., submitted for the record by:
Dowski, Robert P., chief financial officer, Allied Defense
Group [ADG], prepared statement of......................... 68
Feeney, Hon. Tom, a Representative in Congress from the State
of Florida, prepared statement of.......................... 12
Hinchman, Grace L., senior vice president, Financial
Executives International, prepared statement of............ 51
Hubbell, Richard A., chief executive officer, RPC & Marine
Products Corp., prepared statement of...................... 63
Kirk, Hon. Mark S., a Representative in Congress from the
State of Illinois, prepared statement of................... 20
Meeks, Hon. Gregory W., a Representative in Congress from the
State of New York, prepared statement of................... 33
Miller, Hon. Candice S., a Representative in Congress from
the State of Michigan, prepared statement of............... 4
Pollock, Alex J., resident fellow, American Enterprise
Institute, prepared statement of........................... 75
Silvers, Damon A., associate general counsel, American
Federation of Labor and Congress of Industrial
Organizations, prepared statement of....................... 83
THE SARBANES-OXLEY ACT 4 YEARS LATER: WHAT HAVE WE LEARNED?
----------
WEDNESDAY, APRIL 5, 2006
House of Representatives,
Subcommittee on Regulatory Affairs,
Committee on Government Reform,
Washington, DC.
The subcommittee met, pursuant to notice, at 10:08 a.m., in
room 2154, Rayburn House Office Building, Hon. Candice S.
Miller (chairman of the subcommittee) presiding.
Present: Representatives Miller, Westmoreland, Lynch, and
Clay.
Staff present: Ed Schrock, staff director; Rosario
Palmieri, deputy staff director; Kristina Husar and Joe
Santiago, professional staff director; Benjamin Chance, clerk;
Krista Boyd, minority counsel; and Jean Gosa, minority
assistant clerk.
Mrs. Miller. Good morning. Our third panelist is on his
way, and I know our first panelist has another meeting to go
to, and the ranking member said that was the sound of the ``Big
Dig'' from Boston, so with that we will start.
I want to welcome everyone this morning, and the
Subcommittee on Regulatory Affairs will come to order.
No one here can forget the turmoil caused by the corporate
and accounting scandals involving Enron, Arthur Andersen, and
certainly WorldCom as well. And as a reaction to the shocking
behavior of all of these things, Congress acted very swiftly to
pass legislation aimed at restoring order and trust in our
Nation's financial markets, and with very good reason.
After all, financial investment in our public markets and
public companies is good not only for the companies, but for
the financial security of average Americans. The more liquid
our financial markets, the less expensive it is for American
companies to raise capital, to grow their business, and to
provide investors with a healthy return on their investment.
This system encourages small companies to expand and it is also
a recipe for dynamic growth in the job market.
The Sarbanes-Oxley Act tried to restore investor confidence
in the stock market by restricting accounting firms from
performing a number of services for the companies that they
audit. The act also required new disclosures for public
companies and for the officers and directors of those
companies. Among the other issues affected by the legislation
are securities fraud, criminal and civil penalties for
violating the security laws, blackouts for inside traders of
pension fund shares, and protections for corporate
whistleblowers.
However, Congress might have acted just a bit too quickly
as many unintended consequences have made the law more costly
to business and to small businesses, in particular, than
originally thought. We are holding this hearing today to
examine some of these consequences and to look at possible
solutions.
Oftentimes it is very hard for policymakers to evaluate the
cost and benefits of a regulation or a piece of legislation. In
the case of Sarbanes-Oxley, we now have data which suggests
that the cost of complying with specific provisions of the act
is much greater than the actual benefits.
For example, while the SEC initially estimated the cost to
comply with Section 404 to be about $91,000 per company or
$1.24 billion in the aggregate, multiple studies pegged the
actual compliance cost at $35 billion, which is, of course,
nearly 30 times the original estimate.
But let's put this in perspective: Section 404 is only 168
words long, and if you use the $35 billion figure, that is
almost $21 million per word, and that is just the initial
startup cost.
As well, Section 404 has hit small and mid-size firms the
hardest: as a percentage of revenue, smaller issuers in 2004
spent 11 times more on the Sarbanes-Oxley implementation than
did larger companies. Micro-cap companies, with revenues under
$100 million, saw an 84 percent increase in outside audit fees
as a result of the law. Small cap companies with revenues
between $100 million and $700 million saw a 92 percent increase
in audit fees. And S&P 500 companies saw an increase of 55
percent in their audit fees.
Smaller companies have limited resources which are now
being allocated to Section 404 compliance, and there is great
concern that the regulatory burden of Section 404 is currently
diminishing their competitiveness through higher operating
costs and management distraction from business opportunities
and other risks.
In addition to these high out-of-pocket costs, there may
also be an opportunity cost that accompanies Section 404. When
a company spends over $4 million a year to comply with a single
regulation, they are unable to direct those substantial
resources into capital formation, employee benefits and
salaries, or even stock dividends. Moreover, the largest
potential cost of Section 404 has yet to be quantified; the
loss of opportunities for the American public to invest in
small and innovative firms that have either delisted, gone
dark, or declined to go public.
These corporate managers have determined that the cost of
being a public company is no longer outweighed by the benefits
the firm gained through access to the deep liquid markets of
the American Stock Exchanges. Removing a company from the
public exchanges is costly to a firm in terms of lost prestige,
decreased liquidity, higher cost of capital. And it is
conceivable that the decision to delist results in slower
growth, poor returns on investment and a weaker position in the
global market; and of course it also results in less job
creation.
This is a tremendous hurdle that the American companies
must overcome that most global competitors do not. Foreign
companies that do not list their shares on American exchanges,
do not face the same fixed cost imposed by Section 404.
Accordingly, they are able to invest their resources into
research and development, customer discounts and other forms of
value creation.
It is no wonder that at every hearing on regulation,
witnesses always bring up Section 404 as a key regulation that
is hurting Americans' ability to compete.
It is certainly clear that the time has come for this
Congress to begin a dialog on this important subject, sort of
put our ear to the ground and hear directly from those who are
affected by Section 404.
So we certainly look forward to all the testimony of the
witnesses today, and with that, I would recognize our ranking
member, Representative Lynch, for his opening statement.
[The prepared statement of Hon. Candice S. Miller follows:]
[GRAPHIC] [TIFF OMITTED] T0899.001
[GRAPHIC] [TIFF OMITTED] T0899.002
[GRAPHIC] [TIFF OMITTED] T0899.003
Mr. Lynch. Thank you Chairman Miller, and I appreciate the
fact the we are holding this hearing. This is one of the most
important securities related acts in the history of this
country, and I think it is appropriate at this point to be
reviewing its impact on medium and small-sized businesses.
I am pleased to join, as well, my colleagues, Mr. Feeney
and Mr. Kirk, and I know Mr. Meeks is on his way, to look at
this.
I hear a lot about this in my district. I want to associate
myself with the remarks of the Chair. I understand the impetus
of this act, the WorldCom and Enron scandals, and the lack of
accountability that we had in our accounting practices, how
investor reliability and accuracy had to be improved. But also,
I am concerned with the unanticipated cost of compliance with
especially Section 404 of the act, and I think we have to look
very closely at that. There are definitely ways that we can
improve the cost side of this equation, and not relinquish the
accountability and the exactitude with which investors are
helped in making their decisions.
I know for a fact that some of my own constituent
businesses in my district have suggested that such a thorough
process is done during those examination years, that it would
be possible, perhaps, to look at biannual, every 2 years, to
have the audits conducted and have a statement of compliance on
those alternate years that would basically reduce the cost by
50 percent, even maintaining the existing language in place.
So there are ways that I think we can help small and
medium-sized businesses in compliance with the act without
sacrificing one bit of the accountability that is provided by
the act. There have been some successes with Sarbanes-Oxley,
and we don't wan to jettison that in our pursuit of reducing
costs of simplifying the act.
I look forward to the comments of both our panels, and
again, I appreciate Chairman Miller for convening this hearing.
Thank you.
Mrs. Miller. Thank you.
Opening statement for Representative Clay?
Mr. Clay. Thank you, Madam Chairman, for holding today's
hearing on Sarbanes-Oxley and its impact on our smaller
publicly traded companies. I welcome our witnesses, especially
my colleagues and friends, Mr. Meeks, Mr. Feeney and Mr. Kirk.
When Sarbanes-Oxley was enacted in 2002, our capital
markets were suffering from investor anxiety directly relating
to major accounting scandals that rivaled the S&L failures of
the 1980's. While Enron and WorldCom became the public poster
children of corporate fraud, the fact is there were numerous
companies who were forced to restate earnings and future
estimates due to fraud and faulty accounting practices. A
complicit public accounting industry made these activities not
exceptions, but standard practices in order to appease their
short-term profit-driven clients.
In response, Sarbanes-Oxley strengthened regulations over
auditing practices, mandated executives to certify their annual
financial statements, and increase penalties for accounting
related fraud.
A cornerstone of this legislation was Section 404, which
required publicly traded companies to attest to their internal
control for financial reporting and related activities. while
Section 404 is a reasonable mandate to ask of companies, some
smaller companies find compliance to be both cost prohibitive
and time consuming. Although I am sympathetic to this claim, I
am also wary, wary of returning to a period of lax internal
practices and functions that will enable inadequate stewardship
of investor resources.
It is my hope that new SEC regulations, along with
recommendations from our witnesses today, can help us achieve a
balance that provides both adequate investor protections and
relief for well-managed small businesses.
This concludes my statement, Madam Chairman, and I yield
back.
Mrs. Miller. Other opening statements? Representative
Westmoreland.
Mr. Westmoreland. Thank you, Madam Chairman. I appreciate
you having this hearing. We have an advisory committee at home
in the district, and on our banking and finance advisory
committee, the one thing that I have heard is this Section 404
of the SOX.
I have often been told that Congress had two speeds, dead
still and knee-jerk reaction, and I think this comes under
the--this particular section of this bill came under the knee-
jerk reaction. I don't know, out of the response to what
happened maybe to Tyco and Enron and others, but they weren't
prosecuted under this bill, they were prosecuted under laws
that we already had on the books. And I think that you can see
that there were laws there to protect and to punish those that
caused the problem.
So I hope, Mrs. Chairman, that when we look at this, that
we can come up with some type of legislation or suggestion that
would take some of the burden off of the small and middle-size
companies as far as these audit fees.
I had one small banker tell me that it was 10 percent of
his bottom line to adhere to Sarbanes-Oxley. That is
ridiculous. Audit fees, since 2003, have gone up anywhere from
75 to 90 percent. This should have been called the auditors
employment act of 2003. I look forward to hearing from both
panels, and I hope, Mrs. Chairman, that we can come up with
some type of idea to really reform this to where not only does
it protect the investors in the company, but brings about some
rational thinking.
Thank you.
Mrs. Miller. Thank you very much.
Our first witness this morning is our distinguished
colleague, Representative Tom Feeney from the 24th
Congressional District of the great State of Florida.
Congressman Feeney is in his second term and serves currently
as a Deputy Whip. He has quickly become a leading advocate for
exposing and fighting waste, fraud and abuse in the Federal
Government. He serves as well on the House Financial Services,
sits on the House Judiciary and Science Committee, and was a
member of the Sarbanes-Oxley ``listening tour.''
So Representative Feeney, the floor is yours. We look
forward to your testimony, sir.
STATEMENTS OF HON. TOM FEENEY, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF FLORIDA; HON. MARK S. KIRK, A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF ILLINOIS; AND HON. GREGORY W.
MEEKS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK
STATEMENT OF HON. TOM FEENEY
Mr. Feeney. Thank you, Madam Chairman, Ranking Member
Lynch, and members of the subcommittee. I don't think I could
say it any better than the four of you have just said it. Mrs.
Miller, I thought your introduction was very well done. I think
Mr. Lynch put it best, time is at a minimum for Congress to
look at where we are because we have some data in.
I am very grateful to be joined by two colleagues, who, the
three of us, with a couple of other colleagues, have engaged in
a national listening tour to hear about some of the
consequences of Sarbanes-Oxley.
Some have called it the most comprehensive and important
corporate governance reform since FDR was President. And I was
kind of surprised when I got here--because I was not here when
Sarbanes-Oxley was passed--that businessmen, both small and
big, chief financial officers, CEOs, beat a path to my door to
beg for some relief from current impacts of Sarbanes-Oxley and
for small and mid cap companies that are not yet directly
impacted, beg for prospective relief.
I like to say, as my colleague did, that Congress has two
speeds, zero and over-react, and it may be that in some ways we
have overreacted with respect to Sarbanes-Oxley. So I am glad,
that on a bipartisan basis, we can look at the advantages and
keep them, look at the disadvantages and reform or eliminate
them.
We have heard some important positive things and effects
from Sarbanes-Oxley. I want to make that clear from the
beginning. So far from my portion of the listening tour I have
concluded that there is general agreement that after SOX was
passed we have tighter financial reporting, which is a good
thing. Internal controls have improved across the board, and
there is also more transparency in the overall auditing
process. All of those things are cited approximately by
Sarbanes-Oxley supporters as a reason that not all of this bill
should be thrown out in its entirety. And as one suggestion,
Section 404 is the target of virtually all of the major
complaints. There have been some serious negatives in the way
we have imposed and implemented Sarbanes-Oxley.
On January 6th the Wall Street Journal pointed out, for
example, that New York loses its edge in snagging foreign
listings. In the year 2000, $9 of every $10 raised by a foreign
company in a public market was raised primarily in New York,
and in the United States of America.
By the year 2005, the reverse was true, $9 of every $10
raised by a foreign company in a public exchange is now raised
in places like Luxembourg and London exchanges, the biggest
spread favoring London. This is a startling number to me, and
candidly, I believe that we are slowly and steadily outsourcing
America's world lead in the capital markets.
After a recent trip to Hong Kong, which Mr. Kirk was part
of as well, I received very similar feedback regarding
Sarbanes-Oxley from their Chief Financial Officer, Mr. Tung. He
practically thanked me and Mr. Kirk for Sarbanes-Oxley and the
competitive advantage it gave to the Hong Kong markets. The
Financial Times stated in November 2005, ``Over the past few
years, as more global investors have begun to invest in Asia,
the New York Stock Exchange appears to have lost its lore for
the region's leading companies. The roots of New York's recent
difficulties in winning Asian companies' listing lies in the
high burden of regulations and compliance.''
Many of the participants in the listening tour also noted
that 404 compliance ignores the indirect costs, and I think the
chairman pointed to the opportunity costs of Sarbanes-Oxley
compliance. Some of America's best and brightest leaders on
corporate governance boards are spending more time complying
with bureaucratic and accounting regulations than they are
building a better mousetrap, a cheaper mousetrap, and then
marketing the mousetrap; and that is really what we want to do
in order to get American advantage.
The opportunity cost is huge. A paper by Mr. Butler of
Chapman University and AEI-Brookings Joint Center for
Regulatory Studies, and Larry Ribstein of the University of
Illinois School of Law cites the ``direct compliance costs of
SOX are about $6 billion per year, but this expense--which
basically represents payments to accountants--is a small
fraction of the total compliance costs for firms. The indirect
costs from having to divert company resources are much greater
and based on a back-of-the-envelope calculation of how SOX
impacted American markets, they can be estimated at about $1.1
trillion.'' That is with a ``T'', and by the way, we have only
impacted 5 percent of America's companies on the public markets
so far.
Now, as the CEO of Sun Microsystems put it, Scott McNealy,
``What Sarbanes-Oxley has done in some ways is like throwing
buckets of sand into the gears of the market economy.''
Madam Chairman, you have more of my testimony, but I see I
have run out of time. I would just suggest that it is time that
we take a serious look at the current impacts of Sarbanes-
Oxley, the prospective impacts as mid-size and small companies
are thrown into this briar patch, which is going to be very
difficult for them to comply with, much more difficult than the
large companies that are having such problems.
Finally, I will quote from the regulator. Mr. McDonough,
the former regulator, who just recently retired as chairman of
the Public Company Accounting Oversight Board. I quote him in
part in a recent Wall Street Journal interview, because even he
acknowledged that in some ways Sarbanes-Oxley implementation
has gone way overboard. On October 12, 2005 he told the
Journal, ``In many cases it's clear that they [auditors]
overdid it. There's no question that some auditors got it right
on; there are other cases, in fact probably more, in which the
auditors overdid it, and decided we better check everything
under the sun. Why? Because [they're] also concerned about
being sued--that it is appropriate for the well-being of the
American people if companies have costs which simply don't have
any appropriate offsetting benefit.''
The bottom line is we have to do what benefits investors.
If we are taking half of the bottom line out of the pockets of
companies and giving it to auditors and to regulators, then
financial investors around America are being hugely
disadvantaged, and again, I want to thank the committee for
paying attention to this very important issue to the American
economy.
[The prepared statement of Hon. Tom Feeney follows:]
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[GRAPHIC] [TIFF OMITTED] T0899.007
[GRAPHIC] [TIFF OMITTED] T0899.008
Mrs. Miller. Thank you very much, Representative Feeney.
And our next witness is another one of our distinguished
colleagues. This is Representative Mark Kirk from the 10th
Congressional District of Illinois. He is currently in his
third term. He is a member of the House Appropriations
Committee and also serves on three of its subcommittees,
Foreign Ops, Military Quality of Life and Veterans Affairs, and
Science, State, Justice and Commerce. He is certainly a strong
supporter of legislation that eases Government regulations, and
also another member of the Sarbanes-Oxley listening tour.
The floor is yours Representative Kirk. We look forward to
your testimony, sir.
STATEMENT OF HON. MARK S. KIRK
Mr. Kirk. Thank you, Chairman Miller. I have some testimony
that I would like to with unanimous consent insert for the
record.
Mrs. Miller. Without objection.
Mr. Kirk. And a letter from a wide industry of leading new
industries for comments on this subject.
Sarbanes-Oxley addressed some critical weaknesses in public
markets, but to put it simply, I think we all support Section 1
through 403 of Sarbanes-Oxley. It is just Section 404 I think
that we have a bipartisan consensus on the need for reform. You
see here wide agreement between conservatives, moderates and
liberals that we need action. American Enterprise Institute,
Nancy Pelosi, Eliot Spitzer, all agreeing that we need reform
of Section 404.
I have a presentation here that answers a basic question,
which is: Does 404 add investor value, and would a retiree
making decisions about their IRA, ever use 404 data in making a
buy or sell decision on their retirement savings for the cost
and benefit of Sarbanes-Oxley? We see that we fit a need,
especially in the mismanagement of America's largest companies.
But we have to balance the compliance of the act with the cost
of doing that. We see with small companies that there is a
great imbalance.
My colleague from Florida quoted Bill McDonough that said
that it would be inappropriate to spend too much on the
compliance with this if we simply do not have an offsetting
benefit, and what Chairman McDonough was driving toward, was,
are we driving investor value? And I think, clearly, with the
application of 404 to small companies, we are not. We see that
SOX compliance already is costing about 50 times more than was
estimated in 2002, exceeding about $6 billion so far. And the
global position of the United States has been dramatically
weakened in this area.
We have a bipartisan Republican and Democratic consensus
that whatever else we do, American financial markets should
lead, and we clearly see that because of Section 404 compliance
costs, American financial markets are rapidly falling behind.
In our look at SOX and its application, we are also seeing
a decline in R&D expenditures, and I think that is troubling
for the long-term future.
If you look here at the next chart, you will see that we
have a greatly disproportionate cost of compliance leveled on
small businesses in America of publicly traded companies. And I
will just note, the category that I want to pay most attention
to are companies less than $100 million, the great employers of
the United States. The average $100 million employer, by the
way, in America, makes a 6 percent profit, and so Sarbanes-
Oxley, by taking away almost 3 percent of that profit, means
that we have reduced the profitability of the most dynamic
small business sector in America by half with this one section
of one law.
We also see a trend of going private. You can see in the
next slide, a well-known company, Vermont Teddy Bear, will not
be in the public markets and will not offer their securities
for sale to the public, citing this as a critical example of
why they have turned to the private market.
Brookstone, SunGard Data Systems, Toys R Us, AMC
Entertainment, Loehmann's, all going private. And remember, one
of the basic points of Sarbanes-Oxley was transparency and
accountability. All of that is lost when a public company
becomes private, accomplishing just the exact opposite of the
core function of the act.
In fact, Foley & Lardner reports, of 147 companies
surveyed, 20 percent would like to go private. That is an
almost doubling of the companies wanting to go in that
direction.
By the way, that reverses a 400-year trend in capitalism of
companies going from private markets, where capital is
relatively expensive, to public markets where it is a bit less
expensive. That should be a great concern.
When we look at other companies seeking a public
alternative, we see that there is a great reluctance to go
public, and we have a number of magazine articles and the Wall
Street Journal reporting on that.
My colleague from Florida though listed probably the most
dramatic effect of Sarbanes-Oxley, and that is almost the
disappearance of foreign listings on U.S. markets. Whether you
represent Boston, New York, Chicago, or one of our other
financial centers, you do agree that all of this work should
come to the United States. It doesn't mean just jobs in the
financial sector and for stockbrokers, it also means jobs for
American accountants and American lawyers. Every single dollar
is lost when we don't have those foreign listings. And you can
see a 90 percent drop in foreign work coming to the United
States.
To conclude, we have been talking about three common sense
reforms for Section 404. First of all, for small business
relief, to look at the smallest companies in America. They
represent only about 6 percent of the portfolio on the New York
Stock Exchange, and to give them relief from 404, as the
Commission and their Small Business Committee has been looking
at.
Another common sense reform: to permit auditors and
consultants to actually talk to each other to decide what
compliance is. Right now, we have pushed many small publicly
traded companies into a Bermuda Triangle of having their
consultants on Sarbanes-Oxley not being able to discuss any
major compliance issues with their auditors, and so you cannot
get an answer of what is compliance.
And finally, to return to the traditional, Generally
Accepted Accounting Principle of what a major problem is. We
used to think of a material weakness as something that affected
5 percent of the bottom line. We have lost that, and so right
now we have a ridiculous situation where almost a box of lost
pencils could be regarded as a material weakness. If every
issue in the company is a material problem, then we have
dramatically worsened the ability of anyone to manage their
company, and I think that Sarbanes-Oxley was sold to the
Congress as a way to help people run their companies, but if
every issue is a material weakness, allowing trial lawyers to
jeopardize the entire company, and therefore, the investor
value, and where our retirees have put their funds, then we
have actually worsened the problem, rather than improved it.
So I thank the committee and look forward to your
questions.
[The prepared statement of Hon. Mark S. Kirk follows:]
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Mrs. Miller. Thank you very much.
Next the subcommittee will hear from another one of our
distinguished colleagues, Representative Greg Meeks from the
6th District of New York. He is currently serving his fifth
term in Congress, and he serves on the House Financial Services
Committee, and also on the House International Relations
Committee. He is a very strong advocate for consumers, and
along with the other representatives who testified today, is
also a member of the Sarbanes-Oxley listening tour.
So the floor is yours, Representative, and again, we
certainly appreciate you joining us today and look forward to
your testimony.
STATEMENT OF HON. GREGORY W. MEEKS
Mr. Meeks. Thank you, Chairwoman Miller and Ranking Member
Lynch.
I remember back in 2002 when the Enron scandal began to
unfold. Week by week we learned more about the machinations of
the senior executives of Enron that would ultimately lay low
the seventh largest company in America, as well as one of the
Big Six audit firms.
Immediately after that, the WorldCom scandal took front and
center. Following the aftermath of numerous hearings, including
us witnessing one senior executive after another plead guilty--
or plead the Fifth--should have plead guilty--it was clear to
members of the Financial Services Committee, as well as the
majority of the rest of the House of Representatives, that
Congress needed to act to maintain investor confidence in
America's capital markets.
The resulting Sarbanes-Oxley legislation was designed to
improve corporate governance by holding board of directors more
responsible for their oversight of the corporation, hold the
CEOs and CFOs to task if they knowingly signed off on
inaccurate statements, strengthening auditor standards, and
forcing publicly traded companies to review, and if need be,
improve their internal controls that ultimately led to the
production of their financial statements.
Let me say, Madam Chairman, that in the 8 years that I have
sat on the Financial Services Committee, Sarbanes-Oxley is one
of the two most significant pieces of legislation we have
passed, along with Gramm-Leach-Bliley, which repealed the
Depression Era Glass-Steagall Act.
In some ways SOX is more significant because it affects all
publicly traded companies and not just the financial sector.
After Sarbanes-Oxley was passed and the Public Company
Accounting Oversight Board was created, the PCAOB opened for
public comment on their proposed rulemaking for Section 404.
Even then, comments that were received by the PCAOB from
companies such as Microsoft, addressed concerns that the audit
of internal controls where a public auditor must attend to the
soundness of a company's internal controls system would
significantly increase the cost of public audit.
During this time period, my office began conducting
meetings with small groups of Tier 2 and Tier 3 accounting
firms. The purpose of the meetings was to determine if the
potential increase in the audit costs could be minimized by
having the 404 work subcontracted to small accounting firms.
Under SOX, there is some leeway for the public auditor to
``rely on the work of others'' in providing their attestation
on the soundness of the 404 audit.
Not only did I suggest this to the PCAOB in writing during
their comment period, but my office also arranged a meeting
with members of the National Association of Black Accountants
and the PCAOB to discuss these issues. Unfortunately, this
option was not deemed viable by the PCAOB due to potential
supervisory constraints between the major auditor and the
subcontracted company.
We are now some 4 years from the passing of Sarbanes-Oxley,
and the jury appears to be deadlocked. Without question,
Sarbanes-Oxley has achieved its goals in relation to improved
corporate governance. As you know, I have joined with my
colleagues, Congressman Kirk and Feeney, in a listening tour of
companies that have to deal with Sarbanes-Oxley compliance.
Companies listed on Nasdaq and the New York Stock Exchange, and
members of the Chamber of Commerce, seem to concur on the
corporate governance issues. There is a consensus that the
board of directors have taken their fiduciary responsibilities
more seriously, including meeting more, acting more
independently of management, particularly in relation to the
audit, and improving communication with shareholders.
Many companies have expressed how Section 404 has forced
them to review and tighten their internal controls, making them
a more efficient and secure company. This is clearly a part of
what SOX was meant to do. However, some of our intentions have
backfired, and we are forced to recognize that phrase that we
hate to hear as legislators, ``unintended consequences.''
Although there are several issues related to 404 compliance
costs that I could mention, for the sake of time, I will limit
my concerns to two issues.
The first is the effect that the significant cost in
financial and human resources of SOX implementation is having
on small cap companies, particularly biotech. The second is the
overall cost to our capital markets from companies that have
either delisted, not listed, or have listed overseas.
According to a survey conducted by Financial Executives
International, member companies spent an average of $4.3
billion for costs associated with internal control compliance.
I have heard of companies going from approximately $400,000 for
audit costs to over $1 million. According to that same FEI
study, companies with revenues over $25 billion, spent an
average of more than $14 million. The reality is that large cap
companies can absorb these costs, but small cap companies
simply cannot.
In New York City we have an enclave of biotech firms. They
are small firms whose primary business is research and
development in health care, agriculture, industrial and
environmental biotechnology products. In other words, their
research leads to quality of life improvements that include
cancer-related and other types of life-saving products.
For many of these companies, documentation and testing of
internal controls is the responsibility of their internal audit
departments. Since in most cases there are only a few staffers,
many of whom are part time, these companies now have to hire
additional personnel or engage outside consultants to perform
the required internal control testing. Many of the smaller
biotech companies have had to redirect 10 percent of their
full-time employee resources to comply with SOX. The cost has
ranged from $300,000 to $500,000 for increase in internal
staff, and $800,000 to $1 million for external consultants.
I will give you one example. A New York biotech company
that works on spinal cord injuries has a market capitalization
of $99 million. It has 65 employees and survives on capital
raised every round. It has a spending rate of $4 million for
clinical trial and research and development for a possible
product to cure spinal cord injuries. If it spends one million
on SOX compliance, that equals 25 percent of its budget. That
is an opportunity cost of $1 million that is not being spent on
research to benefit humanity.
I know that it was not the intention of the Financial
Services Committee or this Congress as a whole to divert funds
from life-altering research.
My second concern, particularly as a Member from New York,
is the issue of public listings of companies; 68.7 percent of
companies are listed in the New York Stock Exchange, Nasdaq or
the American Stock Exchange. This is a major artery in the
lifeblood of the New York economy. According to Citigroup, as
of the year 2000, $9 out of every $10 raised by foreign firms
through new stock offerings was done in New York. In 2005, the
$9 out of every $10 has moved to London or Luxembourg. In
addition, hundreds of small corporations have already delisted.
Let me just give you this quote as I wrap up. This is from
the March 17, 2006 article in the Houston Business Journal:
``Today, hundreds of U.S. companies are considering tapping the
London Exchange's AIM as a promising source of quick capital.
Faced with costly compliance requirements under Sarbanes-Oxley
regulations passed 4 years ago in the United States, a growing
number of small domestic companies suddenly are more open to
the idea of crossing the ocean to use the more lightly
regulated AIM. The overseas option is being weighed against
U.S. exchanges such as Nasdaq.''
Now, as a member of the International Relations Committee,
I am in favor of development of other countries, but not by
creating an unfair advantage against American companies and
American markets.
Let me close again by saying that I am not offering--I am
not going to offer right this second a particular solution to
the day, although, I do have remedies in mind. At this point I
am still in a mode of listening to companies, American and
foreign, so that I can offer a solution or support the
solutions of my colleagues. I feel comfortable that we have
heard and considered the best options before choosing any to
avoid creating a bigger problem.
It is also important for me to hear particularly from more
minority firms, who are too often left out and not heard. And I
ask all to join with me so that we can make sure that all their
voices are here, because they are very definitely being
affected by the SOX regulations.
I end by just saying that this is not a Democrat or
Republican issue. This is an American issue, and we have to
work with this in a bipartisan manner to make sure that we
don't continue with unintended consequences, and that we
resolve this issue fairly for our businesses.
Thank you, Madam Chair.
[The prepared statement of Hon. Gregory W. Meeks follows:]
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Mrs. Miller. Thank you so much. I think that was
particularly well-said.
Let me thank all of our witnesses for being here and tell
you how absolutely delighted I was to listen to all of your
testimony and the opening statements of my colleagues here as
well. And being still a relatively new Member of Congress, one
of the most distressing things for me has been the partisan
atmosphere around this place. I think we can look at this in a
very bipartisan way. As you say, before we are Republicans or
Democrats, we are all Americans first, and this is an American
problem and something that we need to address in a bipartisan
way. And I think we can do so.
I was a little bit concerned, even initially, calling this
hearing. I wasn't here when Sarbanes-Oxley originally passed; I
don't sit on the Financial Services Committee, either and have
not been an official member of your listening tour. But I would
think that you could probably go to all 435 Members and enlist
any one of them, because we must all hear the same things in
our district.
As I mentioned to our ranking member before we started
here, I am just outside of Detroit, so you can imagine all the
auto suppliers and the small and mid-size businesses that I
come in contact with every time I am out in my district, and
they know that I am the chairman of this Subcommittee on
Regulatory Affairs. So I will ask them, what is the biggest
problem that you have with onerous governmental burdens? And
they--I mean, if you took Sarbanes-Oxley out of the vocabulary,
they would almost have nothing left to say, because that is the
first thing they want to talk about. And this is every type of
business.
So it is something that we need to look at. This is a
committee that has tried to look at various types of onerous
governmental burdens. It was interesting, we were talking about
manufacturing regulations, and here you have the National
Manufacturers Association estimating that the structural costs
of American-made goods are 23 to 24 points higher than any of
our foreign competitors, and much of it is due to these kinds
of things; particularly Section 404 in Sarbanes-Oxley. And when
we do see jobs leaving our shores for other countries, like
China or Mexico or India or what have you, guess what, those
countries did not put this regulatory burden on us. We have
done it to ourselves.
So it is a very appropriate thing, I think, for us to take
a good look in the mirror and see where we can go with this.
I guess I would just throw this out to all of you as we--I
think we are all concerned, of course, that we are not viewed
as going soft on corporate governance after the rather horrific
experiences that we went through with the Enrons and Tyco, etc.
But if we were to revisit some of these corporate governance
standards, do you think that some of the companies or even the
American public might think that we are opening up a Pandora's
Box? In other words, as bad as 404 is, that they are getting
used to it? And the cost of compliance does seem to be coming
down a bit as we are going through the second and third year of
this. At least it is a known quantity.
Mr. Kirk. Let me just briefly answer that, if we look at
the markets the way the SEC does and look at companies at $750
million in capitalization and below, and give some sort of 404
relief to $750 and below, you still have 94 percent of public
markets under full Sarbanes-Oxley compliance controls. And so I
think that we have protected the main part of investors,
especially retirement investors that are largely, 94 percent,
invested in the very large companies, but we have also lifted a
tremendous burden off the small employers, which employ over
half of all Americans. And so I think the way that the Small
Business Advisor Committee of the SEC and the way the
Commission has looked at this dividing line is a very helpful
one for the Congress.
Mr. Feeney. Well, I think it is a very real concern that
investors are--you know, there is an Enron trial going on as we
speak. I won't prejudge the outcome of that, but as the
chairwoman said, there are lots of protections for investors
out there. No protection is going to work against bad apples
that really want to commit outright fraud. And the bottom line
is nothing in 404 is going to protect investors from people
that are really evil. And we need to explain to Americans that
regulations are appropriate and necessary; redundancy and red
tape that does not add to investor confidence is disadvantaging
Americans.
I think, you know, Madam Chairman, you put it best, is
foreign companies--to take Gregory's biotech example--is
foreign companies are not spending 25 percent or 50 percent of
their bottom line on compliance with redundant regulations and
auditing, but instead putting money into finding the next cure
for cancer or the next cure for AIDS. Good for humanity, but
bad for the potential for American employers and American
employees, and it puts us at a huge disadvantage.
So let's keep what is good. Explain to Americans. I think
we are trying to build the case to keep what is good, review
what is bad, and either reform it or get rid of it.
Mr. Meeks. Let me just concur. I think that Representative
Westmoreland said, you know, basically what we do sometimes, we
have knee-jerk reactions. And I think that we have to
understand that it sometimes happens. We react to a situation
and we act fast. But we can't throw the baby out with the bath
water. I think that from the testimony that I have heard from a
lot of individuals around the country, they all agree that a
lot of Sarbanes-Oxley is good. But we are focusing on, and what
Representative Kirk just talked about, I believe that we can
have a cap so that we can make sure that the intention of the
Members of Congress is had. And we can do that without people
coming back and talking about the fact that we are opening up
Pandora's Box. We can do that by saying that we still have the
investors' confidence that Congressman Feeney just mentioned,
but that we are also making sure that we are keeping companies
public or having the desire to come public and not go overseas.
Mr. Kirk. Madam Chairman, can I add one more thing?
Mrs. Miller. Certainly.
Mr. Kirk. Because this really is about investor confidence
at its bottom. If I want to get a credit card tonight, go
online at 3 o'clock in the morning and invest in the futures in
pork bellies on the Shanghai Market, I bet there is a way to do
it. And ultimately, investors will find a way around the
protections that we think we have built up around them. If we
have added value, they will invest their money in American
markets. If we have added costs, they will find their way
around it. That is happening with the major investors as we
speak.
Mrs. Miller. Yes. And I think Representative Kirk made a
very good point when you were saying whether or not individual
investors are actually looking at some of this data when they
are deciding to invest in an IRA or what have you. So it is an
interesting thing.
My other question would be----
Mr. Kirk. Can I just add----
Mrs. Miller. Yes.
Mr. Kirk. My staff talked to the Commission yesterday and
asked if they had any report of any investor using a 404
disclosure to buy or sell securities. And to date, the
Commission has not one.
Mr. Feeney. And neither do the rating services use 404.
Moody's, Standard & Poors, they could care less about these
things. And yet they are costing Americans--one estimate--$1.1
trillion to our economy and nobody is using the stuff.
Mrs. Miller. Well, you know, we are from the Government. We
are here to help them. [Laughter.]
What is your opinion on the lack of direct control, sort of
the wiring diagram for this PCAOB, sort of the lack of direct
control that the Congress has on that? Do you think their
independence from congressional oversight is having any impact
on their opinions, their guidance?
Mr. Kirk. The Board, obviously, had some difficulties in
starting up. We went from eight employees to now over 400. So
we are finally getting an ability to issue an opinion and to
have some common sense in the application of the act. But we
have not yet had the tsunami of full 404 compliance hit the
small business sector yet. And that is the critical issue for
the Congress. If we have 100 percent compliance requirements on
the small business sector, we should understand that we are
only affecting 6 percent of public markets but we are
dramatically weakening the employers of half of all Americans.
And so that is the concern I have for the PCAOB and their
compliance burden.
Just imagine how many employers and how many public
companies will be calling them, flooding their phone lines if a
full requirement is imposed on them.
Mr. Feeney. Madam Chairman, the problem is that everybody
in the system is covering their rear ends. From the chief
financial officer to the chief executive officer, they now have
to certify total compliance with all of these things even if
they had no knowledge. It is no longer a willful standard or a
negligent standard, it is a zero-mistake standard. Everybody on
the board of directors has to do that. The inside auditors that
are advising the board of directors has to do that. The outside
auditors, who are not allowed to talk to the inside auditors,
they have no incentive whatsoever to use a reasonableness
standard because they are going to be held personally, civilly,
and perhaps criminally responsible for any mistake.
Thus the hyperbole about, you know, finding every box of
paper clips for a global company like IBM, or every box of
pencils, it really has almost gotten to that point. And also,
as you point out, the Accounting Oversight Board, there is no
incentive for them to be reasonable. The incentive is to make
sure that every single box that can be checked is checked.
Nobody wants to be the guy that lost that box of paper clips.
Mr. Meeks. I think that what Representative Feeney just
said is right, because what he is talking about is basically
reasonableness. And there is no incentive to be reasonable as
of right now. It is protect yourself at all costs. And so
therefore, you know, there is no room for you to do anything
that may be a common-sense approach. It is if I don't make sure
that I am absolutely 1,000--you know, even in criminal
jurisprudence, you have beyond a reasonable doubt. This is
not--this is zero doubt. So it is a standard that is so high
that I don't know that it can be met.
Mrs. Miller. Thank you.
Representative Lynch.
Mr. Lynch. Thank you. And again, I thank the panel.
Let me ask you--and I understand the standard is a very
high one and may in fact be unrealistic and it may have, as you
have pointed out, negative consequences.
Let's just take from the existing Section 404. I do want to
point out, though, that Section 404, when people are assessing,
you know, whether to buy a certain stock, whether to invest
publicly, they wouldn't look at 404. They would look at the
numbers, the financial numbers, for the performance of the
company itself, the profit and loss, their value. And what 404
does is it speaks to the accuracy or reliability of those
numbers. You wouldn't look to Section 404. It is just a given
that the companies to which it applies must comply.
What about the idea, however, that right now Section 404
requires an annual manager's statement, an annual assessment by
the company supported by an outside auditor, you know, an
independent auditor to come in here and say that the internal
controls are in place and that they are reliable. That is a
very extensive process. That is what is driving the costs of
this rule.
It would seem to me that thorough of a process does not
need to be repeated every single year, and that if in, you
know, 2006 a company goes through this--and it is a painstaking
process and extremely thorough--it would seem that in 2007 it
should be sufficient to have those managers and the folks in
control at the company certify that last year's controls and
procedures are in effect. And that should be enough for
reliability and what we are talking about. And then in the next
year, 2008, if 2 years have gone by, obviously, there may be
the need to go back to the full-blown, full-tilt assessment
again.
But even if we adopted that system, where it is not annual,
that we will trust for 1 year. If a company certifies that
their internal controls and their internal procedures are still
in place to the same degree or substantially to the same degree
as they were in the previous year, that should be enough.
In my mind, that would cut everything in half without
changing, you know, a period or a comma in any of this, and it
still would provide that reliability and that accountability
that we are looking for under the bill. Because there has been
some improvement on transparency and other things that have
been very good here. And we are stuck on 404. But it just seems
to me that enormous amounts of money and labor could be saved,
without any measurable drop in quality of the reports and
reliability for the investor, by going to a biannual reporting
or biannual manager's statement on the reliability of internal
controls and procedures.
What are your thoughts?
Mr. Kirk. Congressman, that is a very common-sense reform
that would cut the work level in half. Also, remember what we
are talking about. With a small publicly traded company, the
entrepreneur largely sees the entire operation. We are talking
about 10 and 20 employees. And so the issue of internal
controls is entirely different than for an extremely large
company where you really have some serious management issues.
But one of the things that we learned on this listening
tour is when you talk to rating agencies, like Moody's or
Standard & Poors, which for most investors issue the critical
buy and sell signal or the data package they use to asses a
security, the 404 disclosures are in the 10-Ks that are
submitted by the publicly traded companies. And even the rating
agencies say they are not using this data. It is so turgid, it
is so user-unfriendly that it is not driving investor value for
a buy or sell signal.
And then we have the issue of the London AIM Market, which
is now marketed directly as a Sarbanes-Oxley-free environment.
And I am worried because, you know, there is an unwritten story
in the 1880's of how New York gained financial dominance over
London and became the best and least expensive way to access
capital markets and the financial center of the world market
was transferred from London to the United States. They are
beginning to gain back that financial leadership.
But that is a critical issue in the rise of China.
Congressman Feeney and I, when we were talking to Chinese
entrepreneurs in the emergence of this $1 trillion economy,
said now, because of Sarbanes-Oxley, they would not think ever
of listing in the United States because of these compliance
costs. And they are talking about bringing small, $50, $100,
$200 million companies to market and they do not want to bring
this work to the United States, where 5 years ago all of the
work came to the United States.
Mr. Feeney. Congressman Lynch, you made a very common-sense
recommendation. We have actually heard a couple of
recommendations and we want to hear more before we make a
recommendation of which one I would think would be preferable.
One would be semiannual or every third or every fourth year
have the outside audit; your internal procedures would have to
remain the same. Another way to do it is to allow the exchanges
to, for example, have everybody pay in based on a pro rata
share of their market capitalization. If they have 1,000
companies and everybody is the same size, pay in to a little
system and then have random testing like we do drug testing in
some places. So that everybody has to stay on their toes, but
they do not have to be duplicating and have this superfluous
process where you have redundant mechanisms.
But I would say that doesn't resolve the whole problem. You
still have the issue of if you place this burden on small and
mid-cap size companies as it remains today, I am afraid you
would never get the next Dell or Microsoft to go public. And
American--not only would they not grow to the size that they
grew, but American investors would never have the opportunity
to invest. I also believe the materiality standard is very
important to address.
But if you did those three things, boy, I think you would
get to 90 percent of the problem.
Mr. Meeks. I think your approach is a common-sense approach
and I think that is what the listening tour has helped me with.
I have found that the companies that we have listened to,
nobody is really trying to avoid the scrutiny or anything of
that nature. Nobody even--because they all have basically been
straightforward and honest in saying we want to make sure there
is transparency, we want to make sure that our internal
controls are in place. It is just a cost. And we have to figure
out and come out with different ideas of how we reduce the
cost.
And they came up themselves, voluntarily, with various
ideas, you know, what Representative Feeney just talked about
as far as--we can even act like a system like the IRS, where
there are random audits. That would help us reduce our costs.
We don't want to just say that we want to go back to the old
way. We accept that things have changed. But we have to bring
down the costs. And I think that is what the listening tour
does. That is what has benefited me, is to hear good
commonplace ideas on how we can make it better so that we don't
have the unintended consequences ruling. And I think that we
can do that.
Mr. Lynch. OK, thank you.
I yield back.
Mrs. Miller. Mr. Westmoreland.
Mr. Westmoreland. Thank you.
Mr. Kirk, you know, if you look at the total cost of
WorldCom, Enron, and Global Crossing, it is about $155 billion.
And I believe the Rochester School of Business just got through
putting out the fact that this is costing $1.4 trillion. Is
that a good common-sense approach to fighting the problem? What
is the source, do you think, of the disparity in the cost that
was expected or that the SEC expected this to cost, as compared
to what it is costing? And what do you think made that
difference?
Mr. Kirk. A couple of things. First of all, a lack of
rationality in what is material. That is why it is so important
to go back to the old traditional definition of materiality,
because if every single lost pencil box is a material weakness,
we are going to continue to have stories, as we do now, of CEOs
spending a vast amount of their time trying to account for
every single asset or liability, you know, almost on a real-
time basis, rather than thinking about new markets and
innovation and research and development that we traditionally
associate with growing a company.
Another problem is we have four and a half major accounting
firms. And generally, for a small employer, they will, when
they seek to have a public accounting, will find that two or
three of the large accounting firms are conflicted out because
they are already working with competitors. And so the final
accounting firm knows that they have this company in a box and
will charge a very high price for their services.
And remember, in the world of Sarbanes-Oxley, you can't
have one accounting firm. You have to have two. You have one
accounting firm to actually certify your books and another one
to advise you as to how to implement 404. And those two firms
cannot coordinate their activities to issue you a compliance
signal or a noncompliance signal.
So for all those reasons, we have costs that are very high.
Last, let me just say this. And this is what Congressman
Lynch pointed out, that we have--404 is a very short section of
law. Enormous discretion is given to the Commission and to the
PCAOB. This hearing is going to help in the process, because if
we send a signal from the Congress that we have broad-based
bipartisan support for rationalizing the implementation of
these regulations, the PCAOB and the Commission can take action
on their own to dramatically lessen this process.
I think we are in the period here where, this year, this
committee and our bipartisan group of members can send that
signal. And my hope is the Board and the Commission will then
take action to relieve this burden. And then, if not, I think
the time comes next year for a listening tour to turn into a
legislative tour.
But I hope that the Board and the Commission will see this
action by the Congress and take their own authority.
Mrs. Miller. Yes, Representative Lynch?
Mr. Lynch. I just want to clarify. I believe I misspoke. I
was talking about biennial, which is every 2 years, not
biannual, twice a year. Biennial, OK? [Laughter.]
I don't want a riot going on out there.
Mrs. Miller. We appreciate that clarification.
Representative Clay.
Mr. Clay. Thank you, Madam Chair, and thank you both for
your testimony.
In terms of the cost and compliance requirements under
Section 404, how well is the accounting industry responding to
the needs of industry? Are auditing firms recognizing the
limits facing smaller capitalized firms in their evaluations
and recommendations for corporate compliance? Both of you all
can tackle it, please.
Mr. Meeks. Well, that was just one of my points, where I
said we had to open it up to tier 2 and tier 3 firms, because
we were trying to make sure that there could be more
competitiveness and more firms involved. When you have just the
top firms, as Representative Kirk just talked about, they know,
you know, two of the firms are already engaged, they know that
they have the companies, and they can charge whatever they want
to charge. They virtually have what is called a monopoly. That
is driving costs up significantly.
So I, again, suggest that we need to look again at the
opportunity of tier 2 and tier 3 firms being able to be
involved as a subcontractor getting involved and I think that
would help drive some of the costs down.
Mr. Clay. And you also mentioned some significant barriers
that prevent small-cap companies from becoming compliant. Give
me an example.
Mr. Meeks. What I was talking about, I mean, when you talk
about they can't compete because they don't have the
wherewithal to deal with the Big Four firms. And as a result,
you know, you find that many minority firms are directly
affected, cannot compete, and thereby are out of business, and
cannot have the opportunity to be the next Dell. We want to
make sure that they are not left out of the game. And you have
a significant number of minority accountants who are left out
of the game. And this is a way that, I think, by adding them
into the game, by adding tier 2 and tier 3 firms, then you are
eliminating even some of the diversity issues that you may have
in the industry by opening it up and giving everyone an
opportunity.
Mr. Clay. Mr. Kirk.
Mr. Kirk. I would certainly agree that Representative Meeks
has pointed out a critical need for either the Commission or
the Congress to act that would help out small minority
accounting firms get into this. They don't have that
opportunity now because they don't have the brand name and
ability to access and advise a client in this way.
But even more importantly, in the wider market for small-
cap companies to be able to expand and grow their business, you
have to really, really think about becoming a public company
now in America, given the liabilities and uncertainties that
you face because of full 404 compliance. I would like it for
minority companies to be able to go public in an easier way,
not a more difficult way. And that is the problem.
Mr. Clay. Let me shift and share with you both, one of the
reasons I believe in Section 404, is that it forces companies
to pay attention to their information technology systems that
are often susceptible to hacking, information breaches, and
other activities that have dire economic consequences. If
Section 404 requirements are not met, how can a company be
certain its information system's proprietary data are secure?
Have any of you given thought to----
Mr. Kirk. I would just say remember what we are talking
about, the information data system of a small company is
probably two or three PCs in an office. We are talking about a
common-sense approach of not going overboard. These are the
most dynamic and largest employers in America, but they come in
groups of 12 or 20 employees. So we are not talking about a
very difficult control issue here. You are probably talking
about one office suite and a set of computers that is similar
to the set of computers in your own office.
You know, remember the irony here--404 does not imply to
congressional offices. Imagine the challenges you would have as
a small employer employing 18 people if you had two large
accounting firms unleashed on your operation, and were told
that one gasoline receipt that may have been misplaced is now a
material weakness and you could be brought--brought suit
against you on behalf of some trial lawyers.
That is the kind of issues that we are talking about,
because I think every Member of Congress does understand that
we employ 18 people, so we are exactly in the same position,
management and control, as many of the companies that we are
talking about.
Mr. Meeks. Just look at my example of the biotech firm. I
mean, this is a real example. This is what I had going--this is
a biotech firm, mostly--a lot of part-time workers, very
limited staff. And now they have to shift resources and shift
people to comply, taking them away from the research and
development that their existence is there for.
So we have to make more of a common-sense approach to this,
because otherwise the burden of a company being able to survive
as a public company will not continue to exist, and they will
stay private.
Mr. Clay. I thank you both for the response, and I agree,
we need to find a balance.
Thank you, Madam Chairman.
Mrs. Miller. Thank you all so very, very much. We certainly
appreciate your time. And, you know, this is an oversight
committee so it is appropriate, I think, that we begin a debate
and have some oversight on various issues, certainly this
Section 404. And I certainly agree with you all that--I am
hoping that the Commission and the Board are listening to what
is happening, as you are doing your listening tour on this.
Hopefully, this can't be any secret to them, the problems
that are out there and that in a bipartisan way the Congress
does intend to take some action if they don't become a little
more proactive themselves and look at some common-sense
solutions as well.
So again, we appreciate your time sincerely. We adjourn for
the next panel to be seated.
[Recess.]
Mrs. Miller. OK. We will call the committee back to order.
Since this is an oversight committee with subpoena authority,
although we did not swear in the last panel, I do hope that you
will bear with us and please rise and raise your right hands. I
would like to swear you in.
[Witnesses sworn.]
Mrs. Miller. Thank you very much.
Our first witness on the second panel is Grace Hinchman,
who joined the Financial Executives International in 1999 as
vice president for government relations. In 2000, she was
promoted to senior vice president of public affairs. FEI is a
professional association for senior-level corporate financial
executives and is dedicated to advancing ethical and
responsible financial management.
The floor is yours, Ms. Hinchman. We certainly appreciate
you joining with us today.
STATEMENTS OF GRACE L. HINCHMAN, SENIOR VICE PRESIDENT,
FINANCIAL EXECUTIVES INTERNATIONAL; RICHARD A. HUBBELL, CHIEF
EXECUTIVE OFFICER, RPC & MARINE PRODUCTS CORP.; ROBERT P.
DOWSKI, CHIEF FINANCIAL OFFICER, ALLIED DEFENSE GROUP [ADG];
ALEX J. POLLOCK, RESIDENT FELLOW, AMERICAN ENTERPRISE
INSTITUTE; AND DAMON A. SILVERS, ASSOCIATE GENERAL COUNSEL,
AMERICAN FEDERATION OF LABOR AND CONGRESS OF INDUSTRIAL
ORGANIZATIONS
STATEMENT OF GRACE L. HINCHMAN
Ms. Hinchman. Thank you, Madam Chairman Miller, Ranking
Member Lynch, and members of the subcommittee, for this
opportunity to appear before you today. My name is Grace
Hinchman, and I am senior vice president of FEI. It is the
leading organization of 15,000 members, including CFOs,
treasurers, controllers, and other financial executives.
FEI members represent the preparer community; that is, the
financial executives responsible for the preparation of
financial statements. Importantly, we are also users of
financial statements, relying on financial reports of other
companies in our investment and credit decisions. In both roles
as a preparer and as a user, we welcome today's hearing.
FEI strongly supports the goals of Sarbanes-Oxley. Overall,
the SEC and the PCAOB have done an impressive job in striking a
balance between efficiency and cost-effectiveness, while
maintaining the intent of the statute. However, the rules and
standards related to the implementation of Section 404 require
significant attention.
Although the SEC maintains final authority over the rules
and standards to implement the requirements of 404, much of the
rulemaking and standard setting has come from the PCAOB's
Auditing Standard No. 2 [AS2].
Since the SEC's approval of AS2 in June 2004, the PCAOB and
the SEC have released additional guidance to supplement AS2
through policy statements, detailed staff Q&As and roundtable
discussions. FEI recognizes that this additional guidance has
been helpful to both preparers and auditors alike, but they
have fallen short in providing a completely effective and
efficient implementation process.
FEI firmly believes that Section 404 is workable and does
not require congressional action. Both the SEC and the PCAOB
have the authority today to right-size AS2 and Section 404 so
they meet the capabilities of all public companies, large and
small.
I would be remiss if I did not mention the overall cost/
benefit of Sarbanes-Oxley. As recently as last month, FEI
surveyed 274 public company members with average revenues of
nearly $6 billion to gauge Section 404 compliance costs, and
this survey is the fourth survey that we have done over the
last several years, and Congressman Meeks had made reference to
one in his testimony.
The survey that we just did in March, last month, showed
that in total companies audit attestation fees represent 44
percent of their total annual audit costs. The average company,
which is a company of $6 billion in annual revenues, expended
approximately $1 million in internal costs, or approximately
21,000 internal people hours. For year two filers, this average
was only a 12-percent decrease from their first year of
implementation. External costs for non-auditor-related
consultants and vendors were $2.3 million. This was a decrease
of approximately 22 percent for year two filers. Finally, audit
fees were approximately $1.4 million, or a decrease of 13
percent for year two filers.
What this survey shows is that while companies have
experienced some reduction in their cost of compliance,
primarily their external costs, they are less than we had
anticipated. As a result, the costs of Section 404 remain high
and continue to be disproportionate to the requirements of
annual compliance.
In conclusion, FEI is confident that the SEC and the PCAOB
are up to the task of right-sizing compliance requirements of
Section 404 of Sarbanes-Oxley and they possess the authority to
meet this challenge. We believe that a more balanced approach
will be achieved and that this right-sizing will further reduce
the costs of Sarbanes-Oxley.
That concludes my remarks, and I would like to thank Madam
Chairwoman and the members of the subcommittee for inviting FEI
to participate in today's hearing.
[The prepared statement of Ms. Hinchman follows:]
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Mrs. Miller. Thank you so much.
Our next witness is Richard Hubbell. He is the president
and chief executive officer of RPC, Inc., which is a position
he has held since 2003. He is also the president and chief
operating officer of Marine Products Corp., a position that he
has held since February 2001. Prior to this, he was president
and chief operating officer of RPC, Inc., and also was an
executive vice president of Rollins Communications, which he
joined in February 1970.
Mr. Hubbell, we appreciate you joining with us today, and
we look forward to your testimony, sir.
STATEMENT OF RICHARD A. HUBBELL
Mr. Hubbell. Well, thank you very much. As mentioned, I am
the chief executive officer of RPC, which is a small oilfield
service company providing services and equipment to producers
of oil and gas in the petroleum-producing regions of the United
States and a few international markets. RPC has approximately
1,600 employees, the majority of which are in the domestic
United States. In order to deal with the cyclical nature of our
business and provide the best possible return to our
shareholders, we acquired a pleasure boat manufacturer in 1986.
A few years ago, we decided that it was in the best interests
of our shareholders to form a separate company and spin that
pleasure boat manufacturer off. So that is why I am president
and CEO of two New York Stock Exchange companies.
Marine Products Corp. is the third largest manufacturer of
sterndriven pleasure boats in the United States. We have two
domestic manufacturing facilities and approximately 1,100
domestic employees. Our strategies have provided good long-term
returns to our shareholders. Today, the combined market
capitalization of the two companies is approximately $1.7
billion.
As a result of the spin-off transaction I just outlined, I
manage a small corporate headquarters staff that handles the
common corporate functions of these two public companies. We
believe that it is in the best interests of our shareholders to
have this common headquarters structure, because it allows us
to spread the costs and leverage the knowledge of our staff
over such functions as accounting, public company reporting and
compliance, and financial management. It also allows us to work
more effectively with outside constituents such as our public
accounting firm and our shareholders.
We managed the implementation of the Sarbanes-Oxley Act of
2002 in the same manner. For these companies, which are
relatively small, this implementation created a large and
ongoing structure which is expensive for our shareholders and
time-consuming for our corporate and field employees. For
example, during the last year prior to the implementation of
Sarbanes-Oxley, our public company compliance costs for each
company were approximately $70,000. After the implementation of
Sarbanes-Oxley, our ongoing annual costs increased to $1
million per company. So I have heard quotes of costs increasing
100 percent. Ours is way, way more than that.
I acknowledge the loss of confidence in the integrity of
the business community that shook our society a few years ago,
and I agree that decisive measures had to be taken in order to
restore public confidence. I believe that my companies have
benefited in certain ways from the documentation of internal
controls, tightening of policies and procedures, and enhanced
transparency in our operations and financial reporting that
have resulted from our compliance with Sarbanes-Oxley.
However, I also believe that my companies and our
shareholders have not benefited in proportion to the expenses
we have incurred. In addition, I believe that we have suffered
certain opportunity costs since we are now spending more time
to comply with and document policies and procedures than we had
in the past. This means that we can devote less time to the
analysis of our financial and operational results, management
of the operations of our businesses, and the intangible aspects
of company management that relate to experience and judgment.
Sarbanes-Oxley has made many companies consider going private
and has, I believe, prevented others from becoming public. This
limits access to the capital markets for U.S. companies and, in
the long run, damages American competitiveness in the global
marketplace.
In addition, I have serious concerns about the approach to
the implementation of Section 404. The text of the provision
itself is brief and ambiguous, and it provides a great deal of
leeway to a company's public accounting firm as to what the
accounting firm believes to be effective internal controls. In
the case of my companies, we are a ``controlled corporation,''
both of them ``controlled corporations,'' with high insider
ownership, and common sense dictates that a different level of
testing and documentation than for public companies with a
larger shareholder base. I believe that in the current
environment, public accounting firms have been overzealous in
their interpretation of 404, and in many cases have abandoned
basic concepts of materiality and common sense. To allow public
accounting firms to have this level of control ignores several
conflicts of interest, because there is an inherent economic
incentive to spend more time and conduct more testing on
internal controls. As a result of the implementation of Section
404, the work required by public companies to comply with 404
has been overly burdensome and without a proportionate benefit
to the financial community or investing public.
Thank you very much.
[The prepared statement of Mr. Hubbell follows:]
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Mrs. Miller. Thank you.
Our next witness is Mr. Robert Dowski. He has over 20 years
of domestic and international experience in strategic planning,
corporate financial reporting, and financial accounting
systems. Prior to joining Allied Defense Group, he was a senior
vice president and CFO of New Star, Inc. His financial
management background includes positions with Gillette, GE,
Space Net, Telecorp, PCS, and Hughes Network Systems.
Mr. Dowski, you have the floor. We look forward to your
testimony, sir.
STATEMENT OF ROBERT P. DOWSKI
Mr. Dowski. Thank you very much. I think ADG should be a
poster child for SOX. For those of you who have had a chance to
look us up on the Internet, you know that the company has
suffered through a restatement related to FAS 133. That is an
ongoing process. We have been delayed in filing our 10-K and,
in fact, have been working 80 hours a week with offsetting and
corresponding amount of hours from our auditors trying to get
through our second-year SOX issues. So this is a topic that is
near and dear to my heart. So, with that, let me go through the
testimony.
ADG is a small public company. We are headquartered in
Vienna, VA, and have seven operating units located overseas in
Belgium and here in Texas and California. We design and
manufacture medium caliber ammunition and products for the
security, surveillance, and video transmission markets. We have
approximately 700 employees and in 2005 produced approximately
$110 million in revenues. Our largest operating unit produces
$60 million of revenue and our smallest produces $6 million. We
uncharacteristically lost over $20 million on the bottom line
in 2005. 2005 was also the second year of our SOX
implementation.
I must be honest, Chairwoman Miller, and tell you that not
all of that loss was attributable to our SOX compliance
efforts. But like many other companies in the United States, we
spent a great deal of time and effort trying to meet a set of
one-size-fits-all regulations that did not, as enacted and
thereafter interpreted, adequately differentiate between a
company the size of ADG versus IBM.
I come before the committee as a believer in the primary
goals of the Sarbanes-Oxley legislation: providing more timely,
accurate, and transparent information for investors. ADG
believes that a well-run company should have and maintain good
internal controls. As a company working hand in hand with our
public auditors, we have made significant progress in improving
our internal controls, and we will continue on that journey in
2006 and beyond.
But it has come at a cost. In 2005, we spent over $108
million on external fees for SOX compliance and auditing. We
spent that much and probably more on internal resources on
documentation, testing, and related activities. That $3.6
million in 2005 equates to over 62 cents of negative earnings
for our shareholders, not to mention the unmeasured opportunity
costs of efforts not spent on improving revenue, profit, and
productivity within the company.
Robert Greifeld, president and CEO of Nasdaq, in a recent
Wall Street Journal editorial summarized the situation very
well. He said, ``The burden of compliance is onerous, the cost
is significant, and it falls disproportionately on smaller
companies that are least able to pay.'' Their research has
shown that the burden on small companies, as a percentage of
revenue basis, is 11 times that of large companies.
He went on to say, and we agree, that ``SOX is important,
by and large it works. We have spent 3 years to assess its
strengths and problems. Perhaps 90 percent of all complaints
have their genesis in 20 lines of text in Section 404. The time
has come to address those 404 concerns without diluting the
essential investor protections that are the true legacy of SOX.
Specifically, we should adopt the recommendations of the SEC's
Advisory Committee on Smaller Public Companies, which has
proposed an exemption from 404 for companies with less than
$128 million in market cap and revenues under $125 million.
Companies with up to $787 million in market cap, as long as
they had revenues of less than $250 million, would receive a
partial exemption. The companies exempted account for only 6
percent of the U.S. market cap--which means 404 would still
apply fully to 94 percent of equity market capitalization.''
ADG agrees with these observations and supports his call
for reforms and exemptions.
In their discussion on cost/benefit, the Committee on
Sponsoring Organizations [COSO], states that, ``The challenge
under 404 is to find the right balance. Excessive control is
costly and counterproductive.'' ADG believes that auditors
should not have a one-size-fits-all checklist when auditing
companies of different sizes, and regulators should amend the
current rules to accommodate the special needs and
circumstances faced by smaller companies.
In smaller companies, such as ADG, the simple lack of
people can be a liability. For example, it can be more
difficult to achieve separation of duties that 404 calls for in
many areas because of flatter organizations and smaller staffs.
We have some operating units that have less than 40 people.
Workers and managers in those typically have multiple roles and
responsibilities, so you have a higher dependence on people
doing the right thing. You also typically have a higher degree
of direct and explicit knowledge of day-to-day activities since
managers are much closer to the daily transactions than their
peers at bigger companies. And yet there is no recognition of
that in the standards of the transparency. Managers and
executives should be allowed to place more reliance on
monitoring than on control activities under those
circumstances.
The existing paradigm of documentation and testing creates
huge burdens in small companies. Controls that exist but are
not properly documented and tested internally are not
considered by auditors in their assessments under SOX.
Offsetting informal controls that are ingrained into the
culture of small companies do not receive any credit in the
existing evaluation process. We agree with COSO that internal
control should be a process designed to provide reasonable
assurance regarding the reliability of financial reporting. But
we also agree with the rule of thumb for internal controls that
benefits should outweigh the costs. The current construct of
404 does not meet that criteria. If employees are spending
excessive hours on fine-tuning internal controls, updating
documentation, testing controls, evaluating and re-evaluating
financial reports, and compiling more extensive information for
their board of directors and audit committee, then other more
important activities are not getting done.
ADG agrees that it is time to address the 404 concerns
without diluting the essential investor protections that are
the true legacy of SOX. Proposals for exemptions for smaller
companies should be considered. We should re-examine the
standards for defining and measuring internal controls at
large, medium, and small companies. It makes no sense to have
one set of standards that apply equally to IBM and ADG.
I realize I am out of time. Can I continue?
Mrs. Miller. A few moments.
Mr. Dowski. Let me make one final statement. Personally, I
believe that auditors do not commit fraud. Dishonest people
inside of companies do, and I think we have seen that in the
press. Congress should increase the civil and criminal
penalties on those people who violate the trust of
shareholders. Violators should be forced to forfeit their
assets and spend years in jail. When people who have defrauded
investors and fellow employees out of billions of dollars are
allowed to keep their fancy homes and other offshore assets,
then how on Earth does punishment fit the crime?
People with high ethical standards are the best defense of
the public interest.
Thank you for this opportunity to testify.
[The prepared statement of Mr. Dowski follows:]
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Mrs. Miller. Thank you very much.
Our next witness is Mr. Alex Pollock. He has been a
resident fellow at American Enterprise Institute since 2004,
focusing on financial policy issues, including government-
sponsored enterprises, Social Security reform, accounting
standards, and the issues that have been raised by the
Sarbanes-Oxley Act. Previously he spent 35 years in banking,
including 12 years as a president and chief executive officer
of the Federal Home Loan Bank of Chicago.
We appreciate your testimony here today, Mr. Pollock. The
floor is yours, sir.
STATEMENT OF ALEX J. POLLOCK
Mr. Pollock. Thank you very much, Madam Chairman, Ranking
Member Lynch. I very much thank you for the opportunity to
testify today, and these are my personal views on the issues.
This hearing is very important and most timely. Everybody on
the panels and on the subcommittee has repeated the amazing
evidence from the market, from businesses all over the country,
about the problems with Sarbanes-Oxley implementation. It is a
great right in America of the people to petition their
representatives for redress. I do not think there is any doubt
that the people are petitioning the representatives for redress
of the consequences of Sarbanes-Oxley, which was an act done
with great good intentions, and as you pointed out, Madam
Chairman, in your opening comments, we have had unintended,
very adverse consequences. It is obvious this has been a
tremendously expensive exercise in the creation of paperwork
and bureaucracy, and the total costs of this exercise far
outweigh the benefits which are likely to arise from it. And
the burden of all this is, as many people have said,
disproportionately high for smaller companies.
It is important to remember that when excess costs are
imposed on companies, they are actually imposed on
shareholders, and it does not protect the shareholders to
impose excess costs on them. Moreover, in my opinion, the
historical record is very clear that the mechanical
requirements which characterize the implementation of Sarbanes-
Oxley will not prevent, when the next bubble and boom time
comes, the next set of frauds and scandals, which always appear
during these times, and we will have our future Enrons and
WorldComs, notwithstanding this mass of expensive paperwork.
I want to quote from a typical experience with Sarbanes-
Oxley implementation. This is a letter to the SEC from one
company. They note the ``concentration on minutia . . .
redundant and inefficient operations, creation of an
adversarial relationship with the audit firm . . . form over
function . . . and unrealistic requirements . . .''
The British Confederation of Industry, looking from abroad,
points out, quite correctly, that ``Dealing with risks on the
basis of a remote likelihood,'' which is the Sarbanes-Oxley
implementation standard, not in the act itself but as
implemented, ``other than a remote likelihood,'' that this not
only imposes huge costs but makes the whole thing a nitpicking
process, as we have heard from many people.
And as has been noted, the SEC's Advisory Committee on
Smaller Public Companies says that for the smaller public
companies, relief from 404 is urgently needed.
As has been noted, a highly interesting commentator, Eliot
Spitzer, has described Sarbanes-Oxley implementation as an
``unbelievable burden on small companies.''
And what is apparent is that Congress did not intend all of
this. The SEC did not intend it. Even the PCAOB did not intend
it. This is all a runaway effect basically of fear, the fear on
a lot of people's parts, and especially the fear on the part of
accounting firms that they will be criticized for doing
something wrong. They saw Arthur Andersen be destroyed.
But, on the other hand, for these accounting firms, the
implementation of Sarbanes-Oxley has been a revenue and a
profit bonanza, quite the opposite of what the Senate committee
report on Section 404 stated, namely, ``The Committee does not
intend that the auditor's evaluation be the . . . basis for
increased charges or fees.'' There is a line with great irony
read in retrospect.
I would like to suggest that Congress should act. I don't
think it is wise to wait for the regulatory bureaucracies to do
this. And I would like to highlight three steps I believe
Congress should take. I think you should also do some things to
restructure the PCAOB which are in my written testimony, but I
will not mention them this morning.
First, the best case would be to enact the provisions of
H.R. 1641, a bill introduced last year by Congressman Flake of
Arizona, which would, very simply, and in my view elegantly,
make Section 404 of Sarbanes-Oxley voluntary as opposed to
mandatory. This is an approach well suited to a market economy
and a free society, and I simply point out that if investors
really want the kind of heavy-handed documentation of internal
controls called for by 404, an article of religious faith on
the part of its proponents, then the companies will do it
because the investors will demand it. I think we need to find
out what investors really value, and this voluntary approach
would do it.
At the very minimum, as many other people have said,
Congress should address Section 404 for smaller public
companies, and the best way to do that is make it voluntary for
smaller public companies. I do not actually think that
exemption, which is talked about by the Advisory Committee, is
the best approach. I would like to say voluntary with
explanation and disclosure. So you as management, you decide
how you are going to address internal controls. You disclose
and explain it to the shareholders. They can make up their
minds. We ought to, at a minimum, do that for smaller
companies, best case for everybody.
The second point, Congress should instruct the PCAOB to
change the internal control review standard from this ``other
than a remote likelihood'' to ``a material risk of loss or
fraud.'' This was brought up on the first panel. I think it is
exactly right, and it is the only way to get the accountants
acting right.
Third, Congress should state clearly that it understands
the true nature of accounting, which is that accounting is not
something objective but something full of subjective judgments,
estimates of the future, which is unknowable, debatable
competing accounting theories and complex compromises, art not
science, and, therefore, it is essential to have the
accountants closely advising and counseling their clients on
the application of the ever more complex accounting standards
which the Financial Accounting Standards Board is producing.
And we have lost that, as has also been discussed.
In conclusion, I think it is critical to take a number of
steps, and I think Congress should take them, to bring under
control the unintended effects, intended by nobody, which have
proved so remarkably costly, bureaucratic, and inefficient, and
they have been caused by the way that Sarbanes-Oxley has been
implemented. I hope Congress will take these steps.
Thanks again for the chance to be here.
[The prepared statement of Mr. Pollock follows:]
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Mrs. Miller. Thank you so much.
And our final panelist today is Damon Silvers. He is an
associate general counsel for the AFL-CIO. His responsibilities
include corporate governance, pension, and general business law
issues. He is a member of the Public Company Accounting
Oversight Board Standing Advisory Group. He is also a member of
the Financial Accounting Standards Board User Advisory Council
and a member of the American Bar Association's Subcommittee on
International Corporate Governance.
We welcome you to the committee today, Mr. Silvers, and the
floor is yours, sir.
STATEMENT OF DAMON A. SILVERS
Mr. Silvers. Thank you very much, Chairwoman Miller,
Congressman Lynch. On behalf of the AFL-CIO, I express our
appreciation for being able to be here today and to discuss
this obviously very important issue.
I will say that before I begin my formal remarks, in very
large part, we very much agree with what Ms. Hinchman said. Not
all my remarks go straight to those points, and I don't want to
associate myself with hers.
Ms. Hinchman. And we do not often agree with the AFL-CIO.
Thank you. [Laughter.]
Mr. Silvers. Right. And as I said to Mr. Parks at the last
hearing he and I testified at, it is an unusual experience.
But, nonetheless, we do.
Union members participate in benefit plans with over $5
trillion in assets, and our actual union-sponsored plans have
approximately $400 billion in assets. Those workers' pension
funds are broadly invested in a variety of small-cap and total
market index funds and are sizable shareholders in many small
public companies. I have attached to my testimony a letter from
one such fund that provides benefits to our members, the
Florida State Board of Investment, that describes the ways in
which that large fund is deeply invested in small companies.
Union members participate in the capital markets also as
individual shareholders and, like other investors, are
frequently asked by brokers to consider investing in small and
micro-cap companies. And I am particularly honored to be, I
think, the only investor representative here speaking today.
The integrity of public company financial statements is a
prerequisite to the functioning of our capital markets. When
investors lose confidence in financial statement integrity,
stock and bond prices fall, interest rates for businesses rise,
and investors seek out markets in which they have more
confidence. With the current account deficit running at a rate
in excess of $2 billion a day, the United States simply cannot
afford to undermine the integrity of its capital markets in
whole or in part, and that was the circumstance in which we
found ourselves in the summer of 2002, at the time in which the
Sarbanes-Oxley Act was enacted.
However, the Sarbanes-Oxley Act did not create the
requirement that companies maintain adequate internal controls.
That requirement has been a matter of law for public companies
since 1977. It has simply been a law that companies have
ignored.
Internal controls are among the most important mechanisms
that ensure that company financial statements are honest and
accurate. They range from passwords on key spread sheets to
systems for counting inventory. If internal controls are weak,
that weakness casts doubt on the accuracy of company financial
statements. In the absence of effective internal controls,
company financial statements simply cannot be relied upon.
Weak internal controls are strongly correlated with
problems in company financial statements. Since larger
companies--accelerated filers--began to comply with SOX 404
more than a year ago, according to the corporate governance
firm Glass Lewis, most public company financial restatements
have been at companies that have also had weaknesses in their
internal controls.
Small public companies disproportionately are involved in
these restatements and in SEC enforcement actions. According,
again, to Glass Lewis, in 2005 the smallest companies were more
than twice as likely to have to restate their financials as
large companies. Dana Hermanson, a professor of accounting at
Kennesaw State University, has found that smaller public
companies ``have accounted for the vast majority of accounting
fraud causes brought by the Securities and Exchange
Commission.''
Consequently, the AFL-CIO opposes any effort to exempt any
public company from its clear obligations under the Sarbanes-
Oxley Act with respect to internal controls. In addition, we
strongly oppose any stealth effort to turn the audit of
internal controls into anything other than what the statute
requires--an audit sufficiently substantive to support an
attestation by the audit firm that management's own assessment
of its internal controls is correct.
And we are not alone. Contrary to some of what has been
said this morning, there is virtual unanimity in both the
institutional and individual investor community about the
importance of protecting the current scope of 404, a consensus
which includes institutionally oriented organizations like the
Council of Institutional Investors, and organizations oriented
toward individual investors like the American Association of
Retired Persons and the Consumer Federation of America.
In addition, distinguished financial leaders like the
former chairman of the Federal Reserve, Paul Volcker, and
former SEC Chairman, Arthur Levitt, have opposed weakening 404
and specifically warn Congress that the effort to do so could
rank with other disastrous efforts by Congress to deregulated
industries such as the savings and loan industry if it were to
move forward.
There are two ways of thinking about the costs versus the
benefits of internal control audits. The first way is to try
and compare the costs of complying with SOX 404 with the costs
involved, for example, in the collapse of a large-cap public
company. According to the folks who oppose the application of
404, total costs were approximately $35 billion in 2004. This
is approximately a third of a percent of the market cap of the
companies involved, a ratio, for example, that is comparable to
what I pay for fire insurance for my home. And it is less than
half of the cost of any one of the major corporate collapses
that occurred in just one company in 2001 and 2002.
By the way, other people have very different numbers for
what the costs are here. Audit Analytics, for example, cites
the total audit costs, not 404 but total audit costs, for the
Russell 3000 in 2004 as $2.7 billion.
The second way to think about it is to compare the costs
with the benefits that accrue at the individual company level
from company management getting a tighter grip on their
business and being able to manage more precisely. There has
been some discussion of those benefits here on this panel, and
they were described by Jeffrey Immelt, the CEO of General
Electric, when he said, ``I think SOX 404 is helpful. It takes
the control discipline we use in our factories and applies it
to our financial statements.''
Since 1933, the Federal Government has required companies
that wish to sell their securities to the public to bear a
number of costs related to investor protection. Each of these
costs is higher as a percentage of either assets, revenues, or
profits for small companies than for larger companies, and
particularly is higher than revenue numbers for small startup-
stage companies. Each of these costs has an effective minimum,
regardless of the size of the public company. Therefore, it is
easy to draw charts that look dramatic but are, in fact,
misleading about the impact on small companies of any kind of
investor protection.
The real question is: What are the minimum requirements to
access the public markets, to call our members on the phone and
try to sell them your stock?
Now, of course, investors do not have an interest--and this
comes to Ms. Hinchman's testimony. We do not have an interest
in needlessly expensive internal control audits or audits
driven by conflicts of interest and accounting firms' desire to
recapture consulting revenue they had before, and a variety of
other things that we suspect may be going on. And we do believe
that in 2004 the audit firms did overcharge the public
companies and investors were harmed by that.
However, the appropriate response to that is the regulatory
response from the SEC and the PCAOB, and not wholesale
exemptions from vital investor protections, and sensible
changes in the guidelines and rules, such as Arthur Levitt's
proposal for reducing duplicate internal control documentation
that is simply inappropriate and a waste of everyone's time and
money.
Ultimately, those who want to weaken Sarbanes-Oxley and
exempt wholesale the majority of public companies who seek to
sell their shares and bonds to individual investors, they must
answer the question: Why should Congress allow a company that
cannot attest or receive outside attestation that it has
effective internal controls, why should such a company be
allowed to sell shares or bonds to the investing public? And
Congress, furthermore, if it wishes to go in that direction,
will have to explain to the victims of future accounting fraud
why it was that when we had a tough law that restored investor
confidence we weakened it.
Thank you.
[The prepared statement of Mr. Silvers follows:]
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Mrs. Miller. Thank you all so very much.
Mr. Hubbell, I was interested to hear of your background in
the marina business. My family was from the marina business,
and I remember during the 1980's when Congress had some
unintended consequences in the marina industry, the boating
industry, when they passed the luxury tax and they wanted to
make sure that they were taxing the rich. And, of course, what
they did instead was drive most of the boat manufacturer
companies that employed just average workers all over our
Nation out of business, and the wealthy ended up buying boats
from foreign nations and just documenting those boats offshore
and bringing them in. So people do find a way all around that,
and Sarbanes-Oxley, in some ways is, again, the unintended
consequences, I think, of an action by Congress, unfortunately.
Let me just ask generally one question. You know, we have
said that the goal with Sarbanes-Oxley, of course, is full
transparency and internal controls and tightening of financial
reporting. How can we actually bring down the cost? I thought
it was interesting to hear Mr. Dowski talk about the president
of Nasdaq, some of the various recommendations that he had
made. And Mr. Pollock mentioned about Representative Flake's
piece of legislation about voluntary compliance. I am not quite
sure about all of that, but I would just pick up a little bit
on what Representative Lynch brought up earlier, which I
thought was, again, as was mentioned, a common-sense approach.
What is your thought about actually, rather than just
changing 404, making it--that you would do reporting every
other year or, even as Representative Feeney had mentioned,
that you do something similar to what the IRS currently does
with all of our tax returns, just a random sampling, which
seems to be able to keep the entire Nation on its toes. Why not
utilize that type of an approach here? I just throw that out to
the panel.
Mr. Hubbell. If I could comment on that, I think all those
are good ideas. I think more importantly there have to be
definitions applied, and somebody mentioned earlier this
morning about materiality. Our net profit in both of our
companies, after tax, for this prior year was about $80 million
net after tax. And our auditing firm was using materiality of
$100,000. Now, whenever you get to that small number, if that
is their threshold, it took them a lot of time to try to look
for $100,000 things.
So I think if we could apply some definitions--in the case
of our company, we are controlled corporation; insiders own 60
percent, so it would be hard to argue that anything we do is in
violation of the stockholders' interest. So it is things like
that, I think just some definitions.
Mrs. Miller. Yes?
Mr. Pollock. Madam Chairman, I think that once every 2
years would be a distinct improvement on every year. Once every
3 years would be better. A voluntary standard would be even
better.
As I said in my testimony, you do not help shareholders by
imposing excessive costs done to standards which are
unreasonable, which the ``other than a remote likelihood''
standard is, in my judgment, entirely unreasonable. And that is
what generates a lot of the excess paperwork, that plus the
fear on the part of the accounting firms that any mistake is
life-threatening in terms of professional life. When you are
operating under fear like that you get unreasonable sorts of
responses.
So I think we ought to move in a positive direction, and I
would support anything in a positive direction, but I would
take several other steps besides the ones suggested.
Ms. Hinchman. Madam Chairman.
Mrs. Miller. Mr. Silvers first.
Mr. Silvers. I think that the question is very well posed.
I think that it is clear that we are in current--while as you
can tell from my testimony we feel very strongly that public
companies ought to have audited assessments of their internal
controls and that individual investors particularly will be put
at risk by, say, a voluntary system or an exemption, big
institutions will have various ways of protecting themselves,
and individuals I think will not.
Given that those things are--that is our position, we do
feel that it is important to explore the very question you are
asking, which is: How can this be made more cost-effective? How
can it be right-sized? And I like Ms. Hinchman's phrase there
very much.
I do not believe that running out--extending the time
periods--I mean, A, I think as Congressman Lynch indicated,
doing this every 2 years would require a change in the statute.
I do not believe that is the right approach. I believe it is
well intentioned, and I believe there are more dangerous things
than doing that. But I do not believe it is the right approach,
and here is why: because investors want to have annual
financial statements they can rely upon, and having adequate
internal controls at all times is a vital component of having a
financial statement annually that you can rely upon.
Now, that being said, I think that there is a reasonable
basis--and I am affected by the testimony I have heard about
this--that to look at the issue of whether the standard for
materiality is the right--has been rightly phrased here.
Now, frankly, I don't think that is Congress' job to do
that. I think that we in general have an accounting system at
every level where we rely upon independent bodies--FASB, COSO,
PCAOB--to set these standards and to deal with the technical
issues. But I think that this is one area that might be worth
looking at.
I also think that there are a variety of ways in which the
practice in this area has become duplicative, and I think the
best statement, as I indicated in my testimony, around this
issue was the one by Arthur Levitt, just pointing out places
where it appears that audit firm practice has essentially
documented things twice.
Finally, something that a number of commentators have noted
about this situation is that while the PCAOB has given
extensive guidance to audit firms as to what to do, almost no
guidance has been given to issuers, to the folks at this table,
as to how they ought to prepare their assessment. This is a
responsibility that lies with the SEC. I do not want to be
critical of the SEC. I think both under Chairman Cox and
Chairman Donaldson that the Commission has been very ably led
today and in recent years. But this has slipped through and
needs to be addressed.
The focus here throughout ought to be, again, this concept
of right-sizing. We do need to see to it that audit firms know
the difference between a 60-person company and a 600,000-person
company, and that ought not to be too hard and should not
require weakening fundamental investor protections.
Mrs. Miller. Ms. Hinchman.
Ms. Hinchman. Yes, thank you, chairman. I think that one of
the things that was talked about in the earlier panel--and Mr.
Hubbell had made reference to it as well--is this whole concern
about materiality and about how the internal control audits are
conducted. And I think that this is the big challenge, and FEI
does believe that the PCAOB and the SEC has a very important
role to help guide companies through that process. And I had
mentioned in my verbal testimony that there were often Q&As
from staff to try and give further guidance, and there were
some tenets and principles that were articulated by the PCAOB
and the SEC over the last 2 years to try and articulate and
direct companies and auditors in particular to take a risk-
based approach to their audit, and to effectively not be
concerned about, as I like to say, count the pencils in the
supply room, but really look at the challenges that are going
to be a high risk to the entire enterprise or company.
And I think what Mr. Silvers says is absolutely true, that
I think that the PCAOB and the SEC are up to the task to give
the guidance to companies versus a company that has 60
employees versus 2,000 employees. And there is an opportunity
to scale the requirements and compliance for these provisions
to those different size companies without an outright
exemption.
Mr. Pollock. My colleagues have a lot more faith in
regulatory agencies than I do, Madam Chairman.
Mrs. Miller. Mr. Dowski.
Mr. Dowski. Yes, I listen with fascination to people that
are not involved on a day-to-day basis with running companies.
I will give you an example of the current standards of
reasonableness in terms of the implementation of SOX 404. We
have a company in California called MS Microwave. It has 40
employees, does about $10 million of revenue, surveillance
equipment.
Under the current SOX regulations, they have an IT
department that is actually one individual who runs their
servers and keeps all their PCs up. We failed our SOX audit out
there for many reasons, but one of which was we did not have
adequate controls under IT. According to the SOX regulations
that are enforced today by the auditing firms and by the PCAOB,
that one individual had to hold a meeting, had to write out
minutes, had to actually invite somebody else to the meeting so
that there would be a witness to the meeting, and had to do
that on a quarterly basis and review the statuses of his IT
environment with at least two outside experts. That was deemed
to be efficient and effective IT controls.
It is insane. The way it is being enforced is insane. And I
am not--I think there are a lot of arguments to be said against
making exemptions. The problem is that 404 is all of 20 pages.
Simply, somebody has to sit down and say, look, we cannot apply
the same standard uniformly to a very large company and a very
small company. There has to be an interpretation of the
definition of reasonableness and materiality that many of the
people have talked about, anecdotally or directly. And that is
the thing, when you get right down to it, that drives small
companies, like ADG, which is really a collection of seven even
smaller companies, it drives you to drink because the standards
are just unreasonable. You have separation of control duties.
Three different people have to handle the checks. Somebody has
to request the check. Somebody else has to print the check. And
the third person has to sign it. In some organizations, we have
one person doing the same thing, and yet it is a material
weakness because we do not have those controls in place. It is
just insane. So there has to be a standard of reasonableness
applied.
Mrs. Miller. Thank you.
Representative Lynch.
Mr. Lynch. Thank you, Madam Chairman.
First of all, I just want to say, just as a matter of
disclosure, I actually am a member of the AFL-CIO. I am an
active member. I pay my dues every month, so I am probably an
investor as well.
I do want to say that--you know, and I have concerns from
that end. I participate in a pension fund and a lot of my
constituents do as well. And so I am very interested in the
transparency and the accountability and the security that is
provided by certain aspects of Sarbanes-Oxley.
But I also know that these smaller businesses are really an
incubator of great innovation in this country and that the
burdens here are disproportionate to the protections they are
providing.
I heard Ms. Hinchman and also Mr. Pollock, they both sort
of hit on the material risk standard, if you will, and whether
or not moving to that standard would satisfy the concerns that
you have raised. And I just--we have to have some balance here.
We have to have some balance, because right now I think just
the costs that we are talking about.
And so I want anyone who feels equipped to address that
issue--and I also want to talk about the biennial issue here
about having these full, independent audits done every other
year, because I have to say that having sat on a union pension
fund, you know, as a trustee, the fact that a company has to go
through this process in, say, the odd-number year and then they
realize that the next year they are attesting to the internal
controls and procedures that they have in place, it seems very
odd that they would leap off that standard in the even-number
years knowing that they are going to be inspected again on the
odd-number year. I just do not see that divergence occurring
under realistic circumstances. So I am less concerned with the
every-other-year situation.
But you may be right. It may not be the ideal solution
here. Maybe it is something along Mr. Pollock's line of thought
where it is voluntary in a sense, but with, you know,
encouragement with the SEC and PCAOB, I don't know.
The last--and I know I have given too many questions
already, but Mr. Pollock and Ms. Hinchman also suggested that
the SEC and the PCAOB already have the ability to do this
internally, and you are right, I think they are well equipped
to do that. But are they willing to? That seems to be my
question. And do they not need under the circumstances some--do
we need to act here? I get the sense that we do because nothing
is happening. I would love to see this thing handled by the SEC
or PCAOB, but I just do not know, with everything else they
have going there--my goodness, we do not even have folks at the
SEC to train and to coach the issuers in these cases how to go
about compliance with Sarbanes-Oxley.
So I am a little bit skeptical that they would be able to
leap into the fray here and come up with a regulatory solution.
Ms. Hinchman. Mr. Lynch, I think part of the challenge is,
particularly with the PCAOB, when AS2 was issued, that they
really did rely very heavily on what is called principle-based
accounting. And they did that intentionally because there was a
drive in the accounting, financial reporting world to go in
that direction.
Mr. Lynch. Principle as opposed to rule-based?
Ms. Hinchman. Correct.
Mr. Lynch. OK.
Ms. Hinchman. But our auditing profession is very much
reliant on rules-based accounting, and so it has been a very
difficult transaction for the auditors to rely on AS2 and to
make the determinations for how to interpret those principles,
predominantly because of liability concerns. And we are
sympathetic to that issue. I think that is a big part of what
is driving the procedures and the way that people are
performing these audits these days.
But from year one to year two, I think that you have been
able to see a growing sense of confidence, both on the
auditor's part and also on management's part, on how to conduct
these internal audits. And I think that would go a long way, if
the PCAOB could give a little more rules-based direction on how
to interpret and use AS2 and get out of some of the examples
that Mr. Dowski had made mention to earlier, and allow them to
really focus with confidence on a risk-based assessment on how
to conduct the internal audit.
I also think that the SEC does need to step up to the plate
more, in terms of giving guidance to the issuers, as you said.
Mr. Pollock. Congressman, I very much share your skepticism
on whether the SEC and PCAOB would step up to this issue. It is
quite clear that the SEC did not know what its regulation would
entail. These are unintended consequences from their point of
view as well, also for the PCAOB. They did not understand, when
they were regulating, what was going to happen.
Both the SEC and the PCAOB have subsequently quite severely
criticized the accounting firms for what they have done, and as
our colleague suggested here, the accountants, of course, have
a rather serious conflict of interest in that the more burden
there is, the more profitable they become.
But neither the SEC nor the PCAOB accepted any
responsibility for the morass of bureaucracy they caused, and
if you think about the incentives, unlike Congress, which is a
balancing body, to balance interests and balance costs and
benefits, the incentive structure of any regulatory body is to
avoid embarrassment at all costs and to be quite insensitive to
the costs imposed on other people in order to make sure that
you do not get in trouble. And I think we have that problem
with both of these agencies.
If I may just add one other comment, I do think that the
status of the PCAOB needs to be reformed as well. It is clearly
functionally a regulatory body. It needs to be brought under
congressional oversight, appropriation, and control, just like
every other regulator, and I do think that was a mistake in
Sarbanes-Oxley which should be rectified.
Mr. Silvers. Congressman, let me answer the two questions
that you sort of posed conceptually, and then I want to make a
remark about the regulatory agencies as well.
The question of doing an internal control audit every 2
years as opposed to every year really raises the question of:
Is the internal control audit an integrated whole with the
audit of financial statements? In our view it is. If you are
not--and, you know, one could take the view that we only need
an audit of the financial statements every 2 years. But if you
are going to represent to investors on an annual basis that on
X date you can rely on these numbers, you also need to, I
think, provide investors an assurance that the process that
produced those numbers has some integrity to it.
I think that we are now sitting at a moment where we have
just been through the startup period against a background in
which public companies had essentially been lax in relation to
internal controls because no one was watching. As I said in my
testimony, there has been a requirement to have adequate
internal controls for public companies for close to 30 years.
But when people actually started, you know, opening up the hood
and looking to see what was there, it turned out that really
that was not what was going on at all.
Now, so I think that is the conceptual issue your proposal
raises, and candidly, I have heard it for the first time today,
and my reaction I think would be the reaction of many people in
the investor community, that we want an annual audited
financial statement that we can count on and that integration
matters. I mean, I understand what you are trying to achieve
and am sympathetic with your ends, but I am not sure that is
the right way to do it.
Now, in relationship to the materiality standard, I do
think that is an area that ought to be looked at, but I want to
give you this warning. A, as I said earlier, I think this is an
area--these kinds of standards are traditionally an area in the
accounting area where Congress has deferred to these
independent agencies on the details. It is very much the kind
of oversight process the chairwoman alluded to before.
The warning around materiality is this: If you have too
high a number threshold around internal controls materiality,
you run the risk that auditors will not be looking--that
neither the internal financial controls people nor the auditors
will be paying much attention to symptoms of larger problems,
that very big problems tend to start small.
I do not pretend to know what the right answer is here, but
when you think about getting to the right answer, it is not
just a question of is that particular control of that
particular account likely to blow the company up. It is, are
you learning something by looking at that, the weakness of that
control that tells you that there are larger systemic risks.
And we have to build that in somehow into the process.
Now, finally, with respect to the regulatory agencies, the
Nation owes a deep debt of gratitude to the Public Company
Accounting Oversight Board. When it was established in the fall
of 2002, we were in a crisis period. Thanks to Bill McDonough
and to his successor, Bill Gradison, who is the Acting Chair,
and the very good people who worked there, the fundamental
integrity of the financial reporting system in the United
States is not really in doubt today in the way it was in
September 2002.
I do not believe it is fair to characterize them the way
that my friend Mr. Pollock has. Those people are dedicated
servants to the Nation and we owe them a debt. Can they--and
their colleagues at the SEC, whom I have equal and profound
respect for, can they do the right-sizing that is really needed
here? And I think the answer is unquestionably yes. Not only
can they, but really no one else can. This involves a level of
detail, expertise, and interaction with the various components
here and attention over time that only those agencies really
have, in conjunction with COSO, I believe. I do not think there
is really an alternative, and I think that they are eminently
able to do it.
Mr. Dowski. I think that the key issue is whether or not
they are willing to, in the environment that we are in today,
take a risk and step out and interpret those rules in a less
than uniform way. I think that is--you know, I think that is
really at the heart of the debate on 404 if you really sort of
break it down and look at why a lot of companies like ADG are
saying that this is just not a workable implementation plan.
You know, I think Ms. Hinchman hit on a good point in that
there has to be a shift from historical rules-based to
principle-based interpretation in a lot of the implementation
areas, and that PCAOB has started down that path, but the
auditors in the environment are in with the increased liability
and what they saw happen to Arthur Andersen are simply sitting
there wants to check the box. And if they have a schedule that
they have to fill out and they cannot check every box, then
they are going to keep working it until you can get closer to
checking those boxes. They will make that one guy hold a
meeting and write up some minutes and document it so they can
check that box. And that is the thing that really has to be
changed and adjusted. Whether the PCAOB can do it or the SEC
can do it or whether Congress should do it, I mean, I think we
ought to use the organizations we have and put the onus back on
auditors.
The other issue is that auditors have gone from being an
advisor to companies to being an antagonist with companies, and
that is really something that has happened. I have been doing
this for 20 years, and since 2002, the biggest thing that has
changed is the rules have gotten more complicated, and you
cannot call up your audit partner and ask, ``Here is what I
think about the interpretation of this opinion and here is what
we are doing. Do you think this is the right thing?'' They will
not give you an answer. They will say, ``Write it up. Send it
to us, and we may or may not tell you that it is an issue.''
They may or may not tell you that during the quarter, and then
at the end of the year, they will come back with a whole list
of other questions that you did not answer correctly. And that
is part of this, I think, environment that has to change and
improve as we move through, you know, the reactions that we all
had to what happened in 2002, and to an environment where this
thing becomes a lot more rational.
I mean, nobody is going to argue that the shareholders do
not--are not entitled to good internal controls. I think people
in the financial profession have been stressing good financial
controls because they are the basis on which you make reliable
financial statements. You know, long before this came up,
people were focused on controls. The breakage now is because we
have now taken one standard for what is an acceptable internal
control and we are applying it uniformly against the landscape
of the American economy, and it just does not make any sense at
the practical level.
Mr. Lynch. Thank you.
Mrs. Miller. Thank you all so very, very much, sincerely,
for your attendance today. I think this has been really a
fascinating hearing, and again, I think the impetus for the
hearing was everybody seeing that something is wrong with the
404 and the way that it is being implemented, and as many of
you mentioned, the Commission and the Board certainly have the
ability to be proactive and to do something short of Congress
taking legislative action and whether or not they have the
will. A way that they may have the will is to see that
Congress--there is sort of a growing momentum here
congressionally for some action, and we would like to preclude
that kind of a thing if they would move on something more
reasonable. The standard always has to be reasonable.
So we appreciate you all coming and appreciate the ranking
member, and with that the meeting will be adjourned.
[Whereupon, at 12:19 p.m., the subcommittee was adjourned.]