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




 
                        SARBANES-OXLEY AT FOUR:
                        PROTECTING INVESTORS AND
                         STRENGTHENING MARKETS

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

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                           SEPTEMBER 19, 2006

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 109-121



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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana          PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio                  MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma             MELVIN L. WATT, North Carolina
ROBERT W. NEY, Ohio                  GARY L. ACKERMAN, New York
SUE W. KELLY, New York, Vice Chair   DARLENE HOOLEY, Oregon
RON PAUL, Texas                      JULIA CARSON, Indiana
PAUL E. GILLMOR, Ohio                BRAD SHERMAN, California
JIM RYUN, Kansas                     GREGORY W. MEEKS, New York
STEVEN C. LaTOURETTE, Ohio           BARBARA LEE, California
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North          MICHAEL E. CAPUANO, Massachusetts
    Carolina                         HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois               RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       JOSEPH CROWLEY, New York
VITO FOSSELLA, New York              WM. LACY CLAY, Missouri
GARY G. MILLER, California           STEVE ISRAEL, New York
PATRICK J. TIBERI, Ohio              CAROLYN McCARTHY, New York
MARK R. KENNEDY, Minnesota           JOE BACA, California
TOM FEENEY, Florida                  JIM MATHESON, Utah
JEB HENSARLING, Texas                STEPHEN F. LYNCH, Massachusetts
SCOTT GARRETT, New Jersey            BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
J. GRESHAM BARRETT, South Carolina   ARTUR DAVIS, Alabama
KATHERINE HARRIS, Florida            AL GREEN, Texas
RICK RENZI, Arizona                  EMANUEL CLEAVER, Missouri
JIM GERLACH, Pennsylvania            MELISSA L. BEAN, Illinois
STEVAN PEARCE, New Mexico            DEBBIE WASSERMAN SCHULTZ, Florida
RANDY NEUGEBAUER, Texas              GWEN MOORE, Wisconsin,
TOM PRICE, Georgia                    
MICHAEL G. FITZPATRICK,              BERNARD SANDERS, Vermont
    Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina
JOHN CAMPBELL, California

                 Robert U. Foster, III, Staff Director


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    September 19, 2006...........................................     1
Appendix:
    September 19, 2006...........................................    43

                               WITNESSES
                      Tuesday, September 19, 2006

Cox, Hon. Christopher, Chairman, U.S. Securities and Exchange 
  Commission.....................................................     5
Olson, Mark W., Chairman, Public Company Accounting Oversight 
  Board..........................................................    11

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    44
    Brown-Waite, Hon. Ginny......................................    46
    Clay, Hon. Wm. Lacy..........................................    47
    Garrett, Hon. Scott..........................................    48
    Gillmor, Hon. Paul E.........................................    51
    Hinojosa, Hon. Ruben.........................................    52
    Kanjorski, Hon. Paul E.......................................    53
    Waters, Hon. Maxine..........................................    54
    Cox, Hon. Christopher........................................    56
    Olson, Mark W................................................    65

              Additional Material Submitted for the Record

Oxley, Hon. Michael:
    Responses to Questions Submitted to Hon. Christopher Cox.....    85
McHenry, Hon. Patrick T.:
    Responses to Questions Submitted to Hon. Christopher Cox.....    89


                        SARBANES-OXLEY AT FOUR:
                        PROTECTING INVESTORS AND
                         STRENGTHENING MARKETS

                              ----------                              


                      Tuesday, September 19, 2006

             U.S. House of Representatives,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 2:10 p.m., in 
room 2128, Rayburn House Office Building, Hon. Michael G. Oxley 
[chairman of the committee] presiding.
    Present: Representatives Oxley, Baker, Bachus, Royce, 
Kelly, Biggert, Fossella, Feeney, Brown-Waite, Neugebauer, 
Price, McHenry, Campbell; Frank, Kanjorski, Maloney, Watt, 
Hinojosa, Scott, Davis of Alabama, and Cleaver.
    The Chairman. The committee will come to order. Consistent 
with the rule 3(f)2 of the rules of the Committee on Financial 
Services for the 109th Congress, the Chair announces that he 
will limit recognition for opening statements to the Chair and 
ranking minority member of the full committee, the Chair and 
ranking minority member of the Subcommittee on Capital Markets, 
Insurance, and Government-Sponsored Enterprises, or to their 
respective designees, for a period not to exceed 16 minutes, 
evenly divided between the majority and minority. Prepared 
statements of all members will be included in the record. The 
Chair now recognizes himself for an opening statement.
    Good afternoon. This will likely be the final time I am 
chairing the Financial Services Committee, and the subject is 
most appropriate: the Sarbanes-Oxley Act. You may have heard of 
that. Although it is named for two chairmen, it is the product 
of our legislative process. Senator Sarbanes and I have 
received both credit and blame in approximately equal doses, 
actually more blame probably. Nevertheless, Sarbanes-Oxley was 
necessary given the substantial damage both to our capital 
markets and to individual investors.
    The day I took office on July 21, 1981, Americans were 
faced with skyrocketing inflation and an Israeli-Lebanese 
conflict. Then-Federal Reserve Chairman Paul Voelker testified 
that day before the House Banking Committee and said, ``Dealing 
with inflation is essential to our future wellbeing as a 
Nation.'' The Dow Jones Industrial Average closed at 934; the 
S&P 500 at 128. At that time, 6.9 million households invested 
in mutual funds. Mutual funds had total assets of $241 billion.
    Since that day, the American investor and our capital 
markets have weathered many events: the insider trading 
scandals and the savings and loan debacle in the mid- and late 
1980's; the deflation of the Internet and telecom bubbles; and 
the 9/11 terrorist attacks; and perhaps the most daunting 
crisis for the American investor, the largest corporate 
scandals in American history in the inaugural years of this 
century.
    Congress's response to these scandals was the Sarbanes-
Oxley Act, signed into law on July 30, 2002. With this 
legislation, Congress set about restoring investor confidence 
in our capital markets by strengthening the financial reporting 
and generally raising the bar in our public companies.
    Nearly every provision in the Act can be tied to improving 
the accuracy and reliability of corporate disclosures, which is 
at the heart of the Federal securities laws. Sarbanes-Oxley 
requires more timely and complete disclosure of material 
information and underscores the duties of the individuals and 
entities monitoring financial reporting from management and 
boards of directors to audit committees and auditors.
    I believe that the Act has been a success. More Americans 
than ever are invested in the market. Over 53 million 
households own mutual funds, a nearly ninefold increase from my 
first day on the job. Americans now have $9.5 trillion invested 
in mutual funds, 35 times as much as in 1981.
    Today the Dow Jones Industrial Average and the S&P 500 are 
near their all time highs, and we have indeed become a Nation 
of investors. The Act, though, is still in its implementation 
stage, particularly for the most criticized of the provisions, 
Section 404, requiring management's report on internal controls 
and an auditor's assessment of this report.
    I must note that Section 404 was not in the original House 
passed bill. So maligned is this provision that some are using 
it to try to impede the New York Stock Exchange/Euronext merger 
or to try to disrupt other potential cross-border exchange 
transactions, claiming that the Act will apply to companies 
listed solely in Europe, a claim that is simply false. 
Sarbanes-Oxley always has applied only to companies listed in 
the United States.
    Ironically, Section 404, surely the most costly provision 
from the company's perspective, may be one of the most 
beneficial to investors. Companies--the board of directors, 
audit committees, and management--are more engaged in ensuring 
a proper system of internal controls over financial reporting. 
In a corporate board member survey, 81 percent of senior 
executives reported Section 404 compliance as a success, and 76 
percent of senior executives believe Section 404 compliance has 
motivated improved internal controls. Stronger financial 
reporting benefits investors, and improved accounting 
transparency fortifies our capital markets.
    That being said, Section 404 has proved costlier than 
originally anticipated. I continue to believe that these costs 
are due not to the text of the Act but to an overzealous 
implementation of these internal control provisions.
    I commend our witnesses today, our former colleague, Chris 
Cox, Chairman, of course, of the SEC, and Mark Olson, Chairman 
of the Public Company Accounting Oversight Board, for leading 
efforts in making this implementation effective and cost-
efficient. I support their bold intentions to revise Auditing 
Standard No. 2 to provide further implementation and guidance 
to public companies and their auditors. I look forward to 
hearing their views on these efforts as well as the impact of 
Sarbanes-Oxley on investor confidence.
    With that, I yield to the gentleman from Massachusetts.
    Mr. Frank. Thank you, Mr. Chairman.
    I think it is appropriate that you be presiding at your 
last hearing on the legislation which bears your name, because 
I think it is an important part of the legacy that is built of 
bipartisanship and of sensible regulation, regulation that is 
market-enhancing rather than interfering with the market. I 
think that ought to be our watch word.
    This is legislation written to help the market work better 
and that, I think, is the role that we should be trying to 
fulfill when it is necessary to do something and possible to do 
it in this way.
    I also support your view that much of the criticism has 
been overborne. I was struck recently by an article, I think, 
in the New York Times, that a number of private companies not 
legally mandated to follow Sarbanes-Oxley are finding it useful 
to adopt some of the procedures, that they find this enhances 
their reputation, that this enhances their ability to deal with 
a whole range of other parties, lenders, customers, potential 
partners and venturers and others.
    I do agree that there is now some need for change, and I 
have to say, if having enacted something this far-reaching--and 
I can't claim a lot of credit for this. I was not the ranking 
member at the time. Former colleague John LaFalce was, and he 
deserves a great deal of credit because he was a leader, as you 
know, Mr. Chairman, in that effort with you. But as I look at 
this, it would be very surprising if we had gotten it 100 
percent right the first time in a somewhat new area. So, 
clearly, there is room for change.
    I do believe that the essential legislative structure is 
sufficiently flexible, so there is no need for legislative 
change. And you and I have had conversations with both of our 
witnesses, and I think there clearly is enough flexibility in 
the statute as written for the SEC and PCAOB to be able to make 
the adjustments that are necessary.
    This can be made less burdensome without in any way 
compromising its core purpose. I look forward to our witnesses 
being able to do that in their respective agencies, and my hope 
is that, early next year at some point or next spring, we will 
see some revisions that they have both put through that will 
make this more flexible; as I said, less of a burden but 
without any serious imposition. I think some of the burdens 
have been exaggerated, but I think, in some cases, more has 
been required of people than we ought to be requiring, but in a 
framework which allows them to cut back on some of the 
excessive rules and regulations without compromising the core.
    So I am glad that we are having this hearing in which we 
can reinforce what I believe is a consensus view in the 
Congress, not unanimous, but representative of a very large 
number of us, and I look forward to their doing it. Thank you.
    The Chairman. I thank the gentleman.
    The chairman of the subcommittee is running late, so we 
will recognize the gentleman from Pennsylvania, Mr. Kanjorski.
    Mr. Kanjorski. Mr. Chairman, just over 4 years ago, after a 
tidal wave of corporate scandals, we adopted the Sarbanes-Oxley 
Act. We are meeting today to review the effects of this 
landmark law on our capital markets. I believe that it has 
strengthened corporate responsibility, improved auditing 
results, and enhanced investor confidence.
    Since the enactment of the Sarbanes-Oxley Act, however, we 
have regularly heard complaints from some parties about the 
cost of complying with the law. In particular, the statute 
provisions regarding internal control audits have become the 
subject of an extensive public debate. I would therefore like 
to focus my comments this afternoon on this area of the law.
    We designed Section 404 to require publicly-traded 
companies and their auditors to assess a firm's policies, 
practices, systems, and procedures to prevent abuse, protect 
against fraud, and ensure proper accounting. This provision 
also requires companies to report any material weaknesses in 
these internal controls--and work to fix those problems--before 
financial reporting failures occur. This mandate helps public 
corporations to decrease their risk of future stockholder 
losses.
    As I noted last year when we reviewed these matters, 
Section 404 has another important benefit: This provision is 
helping executives to better understand the financial reporting 
shortcomings within their companies, allowing them to recognize 
the nature of the problems earlier and adopt reforms and 
accounting procedures expeditiously. This work also is helping 
to provide important assurances to the senior officers of 
public companies who now must sign statements attesting to the 
accuracy of their financial statements under Section 302 of the 
Sarbanes-Oxley Act.
    In May, the Public Company Accounting Oversight Board and 
the Securities Exchange Commission announced the steps that 
they would take to improve the implementation of Section 404, 
particularly for small public companies. Hopefully these 
efforts will result in the establishment of a ``roadmap'' that 
provides smaller companies and their auditors with the tools 
needed to achieve the benefits of strong internal control 
without unnecessary cost.
    In addition to addressing questions about Section 404 
implementation, I hope that our distinguished witnesses will 
examine another budding issue: how the Sarbanes-Oxley Act 
affects listed companies when an American exchange like the New 
York Stock Exchange or NASDAQ purchases or merges with a 
foreign one. I would also like to know the thoughts of our 
expert witnesses about what reforms, if any, we should adopt to 
protect investors in our increasingly interconnected 
international capital markets. Is it, for example, timely to 
consider the creation of an international securities framework?
    In closing, Mr. Chairman, today's hearing is a fitting way 
to end your Congressional career. As the Public Company 
Accounting Oversight Board and the Securities and Exchange 
Commission work to implement the law that bears your name, it 
is appropriate for us to review their progress.
    The Chairman. The gentleman's time has expired.
    We now turn to our distinguished witnesses. Chairman Cox, 
we will begin with you.

 STATEMENT OF HON. CHRISTOPHER COX, CHAIRMAN, U.S. SECURITIES 
                    AND EXCHANGE COMMISSION

    Mr. Cox. Thank you very much, Mr. Chairman, Ranking Member 
Frank, and members of the committee. I very much appreciate 
being invited to testify on behalf of the Securities and 
Exchange Commission concerning the impact of the Sarbanes-Oxley 
Act of 2002. As you know, I have submitted formal written 
testimony that has been approved by the entire Commission. With 
your permission, I would like at this moment to summarize that 
testimony and also to add a few of my own thoughts.
    The Chairman. Without objection.
    Mr. Cox. As I mentioned, I am especially pleased to be 
here, but particularly so because I am sitting next to Chairman 
Mark Olson of the Public Company Accounting Oversight Board. We 
are working together very closely to implement the Sarbanes-
Oxley Act.
    On this fourth anniversary, I would like to begin by 
recognizing the leadership of this committee under Chairman 
Oxley, Ranking Member Frank, and Ranking Member LaFalce. When 
President Bush issued his 10-point plan to improve corporate 
responsibility and to protect America's shareholders on March 
7, 2002, in the wake of the collapse of Enron, this committee 
put forward a blueprint that contained many of those elements. 
Most of the essential provisions of this committee's 
legislation were included in the conference report in the final 
Sarbanes-Oxley Act.
    As a member of this committee, at the time, I well remember 
the significant work that preceded the drafting of the 
legislation, including extensive hearings and the considerable 
effort that you led to shepherd the bill through the 
legislative process. I particularly remember the House-Senate 
conference and the immediately evident significance of the 
eventual product, the most sweeping modernization of our system 
of securities regulation since the initial enactment of the 
Federal securities laws more than 70 years ago.
    Even though it has only been 4 years since the passage of 
Sarbanes-Oxley, the law has done already what few other 
Congressional enactments can claim: It has entered the popular 
culture. It has its own acronyms, its own nicknames, SOX and 
Sarbox. It has its own devoted Web sites, including an advice 
column titled, Dear Ms. Sarbox.
    But most impressive by far is that, in addition to having 
spawned an entire industry of books and seminars, SOX now has 
its own dummies book: Sarbanes-Oxley for Dummies. Mr. Chairman, 
the SEC and the PCAOB have been working hard to make 404 
compliance easier and less expensive, but it would seem that 
the marketplace has once again innovated more quickly than the 
government and delivered the desired result for a mere $14.95, 
and unlike the Commission's guidance, this has cartoons.
    But surely this is a welcome sign not only that SOX has 
achieved iconic status but also that its precepts have entered 
the popular culture. With this publication, it has joined the 
ranks of many other enjoyable and popular pastimes, as 
evidenced by such titles as Wine for Dummies, Poker for Dummies 
and Formula One Racing for Dummies. Those are real titles.
    The thrust is that, for many good reasons, the legislation 
we are meeting here today to discuss has had a very positive 
effect on corporate governance and on accounting transparency 
in America. We have come a long way since 2002. Investor 
confidence has recovered. There is greater corporate 
accountability. Financial reporting is more reliable and 
transparent. Auditor oversight is significantly improved.
    The legislation that this committee produced 4 years ago 
under your leadership, Mr. Chairman, has helped make that 
happen. The Act is not perfect in every respect, but the vast 
majority of its provisions are net contributors to the Nation's 
economic health. Those parts of Sarbanes-Oxley that aren't 
working as well as they should, notably Section 404, could be 
made to work better through better implementation. Chairman 
Olson and I are hard at work on that.
    But before providing an update on the Commission's efforts 
to provide better implementation of the Sarbanes-Oxley Act, I 
would like to highlight a little-noticed fact. While 
competitors in other countries are using Sarbanes-Oxley as a 
reason for foreign companies to list in their jurisdictions, 
many of those same countries are adopting provisions of the Act 
as part of their own regulatory regimes.
    As we consider the effect of Sarbanes-Oxley on U.S. 
competitiveness, it is important to keep in mind how broadly 
many of its provisions have been taken up overseas. It would 
appear, 4 years later, that America's approach is not unique; 
we have just been early adopters. Of course, each country has 
implemented these reforms in slightly different ways, depending 
on their national legal system, on their market conditions and 
on other factors. But it is remarkable how similar so many of 
their reforms are to those passed by the Congress 4 years ago.
    Let me give you just some of the examples. Governments in 
major markets around the world have established independent 
auditor oversight bodies like the PCAOB. For example, the 
European Union recently adopted a directive requiring all EU 
member states to create an auditor oversight body. There is now 
widespread agreement that to improve audit quality, the auditor 
oversight body should be independent of the industry they 
oversee.
    Other major capital markets have also recognized the 
conflict of interest that some non-audit services create and 
the need to place restrictions on these services to improve 
audit quality. The European Union, United Kingdom, France, Hong 
Kong, China, Japan, Australia, Canada, and Mexico have all 
passed reforms requiring mandatory audit partner rotation, 
although they vary regarding the details about how this 
rotation works.
    Audit committee independence is another increasingly common 
theme around the world. United Kingdom, Hong Kong, Australia, 
Canada, and Mexico have all introduced reforms since 2002 
requiring all members of the audit committee to be independent 
of management. A number of countries have even adopted 
requirements similar to the first half of the controversial 
Section 404 of Sarbanes-Oxley which requires management to do 
its own assessment of the company's internal controls over 
financial reporting. Several countries, including the United 
Kingdom, Australia, and Hong Kong have adopted a comply-or-
explain approach to a management assessment.
    Japan, France, and Canada all now have legislation or 
regulation requiring a management assessment of internal 
controls. Still others, such as Mexico, have corporate 
governance codes that recommend having a management assessment 
of internal controls.
    The problems that we have experienced implementing Section 
404 arise from the regulatory interpretation of the second half 
of this provision, the part that requires an auditor 
attestation to management's assessment, and just as in America, 
that aspect has proven more controversial abroad than the 
assessment itself.
    Despite the controversy, however, several other 
jurisdictions have adopted some variant of this requirement. 
For example, the United Kingdom requires auditors to report on 
a comply-or-explain basis if they believe management's 
assessment is unsupported. In China, France, and Japan, there 
are now rules requiring an auditor's evaluation of management's 
report on a company's internal controls but with some 
differences in the manner in which the evaluation is to be 
conducted that make it far less costly.
    Some countries, including Brazil and Australia, require an 
evaluation but don't require that the evaluation be made 
public. Instead, they require the auditor to report the 
evaluation to the board.
    Another trend is for corporate governance codes to include 
a non-binding recommendation for auditor evaluation. That is 
done in Germany and in Mexico. Still other jurisdictions, such 
as Canada, are taking a wait-and-see approach to determine the 
impact of the auditor attestation requirement here in the 
United States.
    Not only with respect to Section 404, but with the entirety 
of Sarbanes-Oxley, the SEC will continue to work with other 
regulators around the world to encourage effective regulatory 
standards that promote capital formation, job creation and 
economic growth while at the same time offering a high degree 
of investor protection.
    As the Congress full well appreciated when it passed 
Sarbanes-Oxley, these aren't inconsistent goals, but rather, 
they are highly complementary ones. Since President Bush signed 
the Sarbanes-Oxley Act in 2002, the Commission has completed 
nearly 20 rulemakings and studies that were mandated by the 
Act. And since 2004, the legislation has resulted in the 
largest public companies representing over 95 percent of the 
total U.S. market capitalization becoming subject to all of 
these new rules mandated by Sarbanes-Oxley.
    The Section 404 requirements, as I have said, have gotten 
by far the most attention, but I would like to mention some of 
the specific improvements that have profoundly and positively 
affected corporate America, public investors and the important 
work done every day by the Commission throughout the rest of 
the Act. One of the principal objectives of the Act was to 
improve executive responsibility and the tone at the top in 
America's public companies. We can credit two sections of the 
Act in particular for helping to achieve that objective, 
Sections 302 and 906. A fraudulent Section 302 certification is 
subject to civil enforcement by the Securities and Exchange 
Commission, and a fraudulent Section 906 certification is 
subject to criminal enforcement by the Department of Justice. 
These dual certification requirements are designed to ensure 
that the company's top leaders are personally involved in the 
disclosure process.
    It is one of the hallmark accomplishments of Sarbanes-Oxley 
that we now have the corporate equivalent of President Truman's 
oft cited aphorism: ``The buck stops here.'' Thanks to SOX, the 
responsibility for the truthfulness of public company corporate 
reporting and disclosure stops on the desks of our corporate 
leaders.
    Another very significant improvement was made by Section 
301 of Sarbanes-Oxley. This section embodies the Congress's 
view that audit committees play a vital oversight role in the 
financial reporting process. The SEC's rules under Section 301 
require that the audit committees of all listed companies be 
independent. They alone are responsible for the appointment, 
compensation, retention and oversight of a company's outside 
auditor, and the auditor must report directly to the audit 
committee.
    The audit committee also must establish the level of 
funding necessary to fulfill its duties including, if 
necessary, the retention of independent counsel and other 
advisors. That is a very significant change. We have long held 
that independent auditors ought to be independent, but their 
independence rested in large part in the past on their ability 
to deal with the sometimes conflicting demands from the same 
executives who selected them and who determine their fees. 
Today's independent audit committees, thanks to Sarbanes-Oxley, 
can retain their own counsel and advisors. They now have the 
resources and the protection that they need to carry out truly 
independent evaluations.
    Beyond the independence of audit committees, Sarbanes-Oxley 
has strengthened auditor independence. The entirety of Title 2 
of the Act is devoted to that topic. The intense focus on 
auditor independence reflects Congress's appreciation that the 
audit process is most effective when investors are assured that 
audits are performed by objective and unbiased professionals. 
The Act bans auditors from providing the kind of non-audit 
services to audit clients that could give rise to financial 
conflicts of interest. It emphasizes the role of audit 
committees in approving other services by auditors, and it 
requires audit partner rotation. All of this is more protection 
for investors and less incentive for the auditors to do 
anything that detracts from their core mission.
    In January 2003, the Commission amended its auditor 
independence rules to conform to the Act. As with all of our 
rules, we are continually monitoring the implementation of 
these rules as we respond to requests from companies and 
accounting firms for interpretive guidance.
    Our current enforcement efforts focused on the backdating 
of stock options demonstrate the importance of these changes in 
Sarbanes-Oxley when it comes to real-time reporting. It was a 
significant improvement brought about by Sarbanes-Oxley that 
now there is real-time disclosure of material information by 
companies and insiders.
    Thanks to changes mandated by the Act, investors are 
entitled to review reports of insider transactions, including 
the receipt of option grants, within 2 business days after the 
transaction occurs. And all of these reports are now required 
to be filed on EDGAR, the SEC's Web-based disclosure system. 
The real-time reporting of grants has eliminated much of the 
opportunity for backdating that existed before the law took 
effect.
    One of the most significant changes made by the Sarbanes-
Oxley Act was the creation of the Public Company Accounting 
Oversight Board. Investors have been blessed with an 
exceptionally high caliber of leadership at the PCAOB. Since I 
became Chairman of the SEC, it has been my privilege to work 
first with Chairman Bill McDonough, then acting Chairman Bill 
Gradison and, most recently, Chairman Mark Olson, who took the 
helm this year. Chairman Olson is familiar to most of you on 
this committee, having served with distinction as a Governor of 
the Federal Reserve Board of Governors, among other notable 
positions.
    Chairman Olson is now working closely with the Commission's 
new Chief Accountant, Conrad Hewitt, who is a distinguished 
leader of the accounting profession and the former chief 
financial regulator for the State of California, as we continue 
our joint efforts to improve investor confidence in the 
reliability of audit reports.
    As I conclude, I would like to turn now to the one notable 
exception to the largely positive record of change wrought by 
the Sarbanes-Oxley Act. The Section 404 internal control 
reporting requirements as they have been implemented to date 
have met with a variety of criticisms, particularly from 
smaller companies. What we have learned from our Section 404 
compliance efforts to date is that the problems issuers have 
experienced thus far are not inherent in the language of the 
statute but stem rather from the method of its implementation.
    We have also become convinced that there are no irreparable 
problems with Section 404 implementation, although fixing the 
problems that we have identified will be challenging. We are 
working with the PCAOB to ensure this provision of the law is 
implemented efficiently and effectively.
    Larger domestic companies with a public float of $75 
million or more have now been fully subject to Section 404 
requirements for two full reporting seasons. We have been 
carefully monitoring compliance efforts each step of the way. 
On the basis of this experience, we can report that, while 
implementation efforts thus far have resulted in significantly 
greater than anticipated costs, compliance with Section 404 
nonetheless produces significant benefits. Chief among these 
benefits is a heightened focus on internal controls at the top 
level of public companies.
    While a portion of the first-year compliance expense 
undoubtedly reflected start-up costs and, in many cases, long 
neglected maintenance of internal control systems and 
procedures, it is undeniable that some of the costs were 
attributable to excessive, duplicative or misdirected efforts 
on the part of companies and their registered public accounting 
firms.
    In response to concerns about these unnecessary costs, the 
Commission directed the staff to issue additional guidance. The 
guidance emphasizes that it is management's responsibility to 
determine the form and level of internal controls appropriate 
for each company and to determine the scope of its assessment 
and testing.
    The guidance emphasized that the registered public 
accounting firms must recognize a range of reasonable choices 
by companies acceptable in the implementation of the Section 
404 requirements. The PCAOB issued complementary guidance in 
May and November of 2005 regarding the application of its 
Auditing Standard No. 2, and then, in May of this year, the SEC 
announced a plan to rebalance Section 404 compliance by all of 
the companies that fall under our jurisdiction, large and 
small, foreign and domestic.
    On May 17, 2006, the Commission issued a road map laying 
out the specific steps we plan to take to make Section 404 
compliance more efficient and cost effective. One of the 
significant steps on that road map was the publication on July 
11th of a concept release as a prelude to the issuance of SEC 
guidance for management on how to assess the effectiveness of a 
company's internal controls. The public comment period on the 
concept release just closed yesterday.
    In addition, last month, the Commission proposed to grant 
further relief from the Section 404 reporting requirements to 
smaller public companies. The initial compliance date for these 
companies would be extended until fiscal years ending on or 
after December 15, 2007. The Commission also proposed to extend 
the date by which smaller companies, so called non-accelerated 
filers, must begin to comply with the section 404(b) 
requirement to have an auditor's attestation as part of their 
404 compliance. This deadline would be moved to the first 
fiscal year ending on or after December 15, 2008.
    As a separate action, in August, the Commission granted 
relief from section 404(b) compliance for certain foreign 
private issuers that are accelerated filers, and that, 
according to Commission data, about 23 percent of the 
approximately 1,200 foreign private issuers will receive the 
one-year extension.
    As this brief summary makes clear, Mr. Chairman, much has 
been accomplished to strengthen and restore integrity to the 
U.S. capital markets since the enactment of Sarbanes-Oxley 4 
years ago. In a time of crisis, you, then Chairman Sarbanes, 
this committee, and your colleagues in the Senate stepped 
forward to champion these significant reforms to our regulatory 
framework. Your vision and responsible judgment, Mr. Chairman, 
along with Ranking Member Frank, Ranking Member LaFalce, and 
the other leaders of this committee, has been absolutely 
essential in maintaining the standards in our securities market 
as the best in the world and in giving America's investors the 
strongest protection in the world and in providing them with a 
higher level of confidence than they can have anywhere else on 
earth.
    In the months and years ahead, we will continue to work to 
implement the critical reforms affected by the Sarbanes-Oxley 
Act in the best way possible to meet our objectives of investor 
protection, well-functioning markets and healthy capital 
formation. We won't forget the failures that plagued our 
markets at the dawn of this millennium and the crisis of 
investor confidence that ensued. We will do our best to honor 
your legacy by ensuring that Sarbanes-Oxley works for every 
stakeholder; for investors, for issuers, for our economy, and 
for our country.
    I appreciate the opportunity to appear before this 
committee on behalf of the Commission, and I look forward to 
answering your questions.
    [The prepared statement of Chairman Cox can be found on 
page 56 of the appendix.]
    The Chairman. Thank you, Chairman Cox, and thank you for 
your very comprehensive testimony.
    We are pleased now to have the relatively new Chairman of 
the Public Company Accounting Oversight Board, Mark Olson.
    Welcome back.

STATEMENT OF MARK W. OLSON, CHAIRMAN, PUBLIC COMPANY ACCOUNTING 
                        OVERSIGHT BOARD

    Mr. Olson. Thank you very much, Mr. Chairman, Ranking 
Member Frank, and members of the committee. I join with the 
others, Mr. Chairman, to thank you for the work that you have 
done not only on this effort but on many others over the years 
and the times that I have had a chance to work with you from my 
various roles in the past; we all thank you.
    I have, as you know, submitted an extensive statement which 
I would like to submit for the record, and I would like in my 
opening statement just to include a summary of some of the 
issues, particularly those that have not yet been covered.
    The Chairman. Without objection.
    Mr. Olson. I also would like to indicate how much I 
appreciate the opportunity to make this presentation in 
conjunction with Chairman Cox, whom I have already enjoyed 
working with in this combined effort.
    Many of you talked about the environment that we were in 4 
years ago when Sarbanes-Oxley was passed and some of the 
immediate repercussions of that environment. I won't repeat 
some of the things that have been said, but let me elaborate on 
some of the points from my perspective.
    Immediately prior to joining the Federal Reserve Board, I 
served as the staff director of the Securities Subcommittee of 
the Senate, and some of you may know, we held extensive 
hearings that year on accounting issues. And it is instructive, 
I think, to remember that, at this time immediately following 
the tech boom and then bust, there was a significant focus on 
the inadequacy of GAAP accounting to capture value in corporate 
America. GAAP accounting in the United States had been 
constructed in significant part to capture value in a bricks-
and-mortar era, and increasingly, corporate value was in 
intellectual property, in human capital, ideas and the like.
    However, throughout that entire discussion, there was an 
underlying presumption that the accounting that was there was 
good, could be in fact relied upon, and then the accounting 
scandals of Enron, WorldCom, Global Crossing, and the like came 
and shook that underlying confidence.
    By that time, I was on the Federal Reserve Board, and we 
could measure in a sense what happened in the U.S. economy as a 
result of that lack of confidence. There is an old longstanding 
economic principle that you can measure risk, but you cannot 
measure uncertainty. And in an environment of uncertainty, 
there was a very significant element of risk-aversion. We saw 
it in corporate America. We saw it in the contraction of, in a 
significant way, the U.S. economy. Frankly, we saw it in the 
accounting profession that, at that time, were readjusting some 
business models, and I think the resulting implementation of 
Sarbanes-Oxley, I think, reflected some of that same 
uncertainty.
    The passage of Sarbanes-Oxley, which created title 1, which 
created the PCAOB, essentially did two things: It replaced the 
accounting industry's self-regulatory organization, which 
frankly had failed it during this time; and it replaced it with 
an independent agency, and as Chairman Cox indicated, that 
model to a greater or lesser extent is being adopted throughout 
the world.
    Also, it required that we inspect the accounting firms and 
the manner in which they are doing their audits from the 
perspective of the interests of investors. That is what we have 
been doing.
    During the time that we have had in place the registration 
process, there are now 1,600 accounting firms that have been 
registered. Congressman Kanjorski talked a little bit about the 
international implications, and Chairman Cox made the same 
point. Of those 1,600, roughly 700 are foreign firms that 
either contribute in a significant way or partially in audits 
of firms that are registered in the United States. So there is, 
as all of you know, there is a significant--an increasingly 
global economy. We are finding the global interaction is very 
important, and we are gearing up to meet that.
    We inspect now all registered firms by statute. All firms 
that perform more than 100 issuer audits, we inspect annually; 
and everybody else, every 3 years. Our inspection is quite 
different from the manner in which the SRO did in that it is 
much more risk-based, much more focused not simply on the 
extent to which the audit is done consistent with standards, 
but it looks at the overall auditing environment as well.
    Chairman Cox and several others of you have commented also 
on Section 404. Let me just make some comments on 404 as well. 
As it was approved by the SEC, AS 2, the implementation of our 
AS 2 in June of 2004, the initial reaction was it was too 
burdensome, that the value did not equal the cost. And we fully 
agree that was the case. I think it was a combined over-
reaction of the accounting industry, perhaps the SEC in the 
initiation of 404 and, in our case, in the implementation of AS 
2. We responded quickly and continue to respond in order to 
help bring that cost-value paradigm into balance.
    We issued interpretive guidance relatively quickly. In May 
of 2005, we issued a policy statement on how the audits could 
be made more effective. In November of that year, we evaluated 
the environment in which it was undertaken and acknowledged 
that there needed to be greater efficiency, and we are now in 
the process of making changes to AS 2, amending AS 2 in 
conjunction, as Chairman Cox indicated, with their concept 
release on 404.
    I would like to mention that small companies are being 
significantly taken into consideration in this effort. Our 
guidance will emphasize the scalability. We have undertaken, 
and will continue to undertake, a series of training for 
auditors of small companies. These training sessions include 
the issuers that they audit.
    There have been some studies done on the implication of 
Sarbanes-Oxley in the marketplace, and as Chairman Cox pointed 
out, in particular when he talked about the audit committees 
and independence, in many instances, what Sarbanes-Oxley did 
was codify best practices. However, the boards of directors in 
particular have reassessed the roles of audit committees, and 
what we have found significantly--and since I have been in this 
role I have had many representatives of audit committees talk 
to me about the value of the internal controls and the value 
that they have realized in that independence. Congressman Frank 
mentioned, and it is clearly our experience also, that firms 
and not-for-profits that are not specifically covered under 
Sarbanes-Oxley are volunteering to increase the standards that 
they expect, and in order for some of those businesses or those 
not-for-profits to attract boards of directors, they are 
finding that there has to be a significantly heightened level 
of internal controls on their financial reporting in order to 
attract the people that they want.
    The cost benefit, we would submit, needs to be evaluated 
over time, especially because the implementation will go out, 
as the chairman said, out to 2009. We won't fully know the cost 
benefit until that time, but there are some indications that 
the cost benefit is being realized. The U.S. capital markets 
are by far the largest and the deepest in the world. Foreign 
issuers that are issuing now in U.S. markets are increasing as 
a percent of the total number of the IPO's, and the listings on 
U.S. firms command evaluation premium vis-a-vis the issuers in 
other markets, so we are already starting to be able to measure 
some of the value that we see of Sarbanes-Oxley. And, Mr. 
Chairman and members of the committee, I would submit that is 
the type of grade and that is the type of evaluation that we 
are prepared to live with, the extent to which U.S. markets 
continue to be strong and the value of Sarbanes-Oxley at least 
equals their additional cost.
    I might say in closing, however, that there has been one 
significant failure. The order of the letters in the name does 
not lend it self to an acronym that roles easily off the 
tongue, and if there is a way that that can be changed without 
opening up the statute, Mr. Chairman and members of the 
committee, we would much appreciate that. Thank you. I look 
forward to answering your questions.
    [The prepared statement of Mr. Olson can be found on page 
65 of the appendix.]
    The Chairman. You mean peekaboo doesn't work?
    Mr. Olson. That is not our favorite.
    The Chairman. Let me first of all thank both chairmen for 
an excellent presentation and an excellent overview of where we 
are have been. Since I have been living with this now for over 
4 years--and I get a lot of free advice as I am sure you do as 
well--and most of the criticism, of course, centers around 404, 
though I have another favorite that I want to bring up a little 
bit later.
    I think sometimes memories are short about the atmosphere 
that we were legislating in. The gentleman from California 
remembers well, and, as I say many times publicly, it was the 
atmosphere towards corporations in general, and CEO's in 
particular, during those difficult times that was kind of 
summed up by what I would hear at home which was pretty much, 
let's give them a fair trial and then hang them.
    I say this because I think in, clearly, my 25 years in 
Congress, never has the Congress legislated in such a 
superheated atmosphere. And it was unique. And given the 
response, given the facts before us, I think overall we 
responded pretty effectively despite the fact that nothing is 
perfect, and time allows us to perhaps take a look at some of 
the changes that we could do.
    To that end, let me ask both of you, in the area of 404, 
clearly, the implementation has proven more costly than had 
been anticipated. What, in both of your judgments, caused that 
specifically? And secondly, are you considering regulatory 
changes that would move more towards a risk-based approach to 
implementation of 404?
    I guess, Chairman Cox, we will begin with you.
    Mr. Cox. I would start in answering the first part of your 
question about what specifically caused the excessive cost in 
early implementation of 404 with the divergence from the plan 
in the statute. Section 404 is not very long. You can read it 
in under a minute. It has two parts: The first part requires 
the company to self-assess, to take a look at its own internal 
controls and determine whether or not they are effective. Part 
two requires the auditor, in the context of doing the overall 
audit of the company, to attest to whether or not management 
did that.
    What has happened in practice or what happened in the early 
going was that part A was completely subsumed in part B, and 
the entirety of the exercise was an auditor-driven exercise. 
The bulk of, in fact, the only real guidance provided by the 
government was in the form of an auditing standard, and the 
auditing standard was about 400 pages long. That occupied the 
field.
    And so the fact that this was not a management-driven 
exercise, that management had no guidance in how to make it 
such, resulted in a lot of audit-type approaches to the 
management's assessment of itself.
    The basis for the statute, as everyone on this committee 
full well knows and remembers, was existing Federal law. 
Section 404, nearly word for word, was borrowed from the FDIC 
Improvement Act, and, in the FDICIA context, we had no 
experience with the kind of outcry we had seen following 
implementation of Section 404, so there was really no way for 
Congress to predict based on our experience, based on the 
legislative history, what actually happened.
    We now know, on the basis not only of that early experience 
but very deliberate efforts, roundtables of the SEC where we 
call in issuers, practitioners, auditors and so on and discuss 
this in the manner of a Congressional hearing, how to make this 
problem abate and how to get more bang for our buck.
    The main point here is not that 404 implementation didn't 
work; everybody seemed to think it provided benefits. The only 
question is, how much did those benefits cost the investor, and 
were they worth it, because we are spending the investor's 
money? So the process that we are embarked upon now is designed 
to squeeze out all the excessive costs and in particular any 
part of this effort that is unrelated ultimately to making 
those financial statements good and solid. If it doesn't affect 
the financial statements, if it is not material, then a risk-
based approach is going to spend resources elsewhere. And we 
think we can do that.
    So that gets to the second half of your question, will we 
be moving to a risk-based approach, and that is one of the 
touchstones of what the SEC and the PCAOB are doing with this 
now.
    The Chairman. Thank you.
    Chairman Olson.
    Mr. Olson. Just to supplement some of the things that 
Chairman Cox has said, it was the symbiotic over-reaction, I 
think, of the accounting industry, the PCAOB, probably the SEC 
and maybe others, I think, in not only the manner in which we 
provided the initial guidance--I think we provided it with some 
specificity and with some complexity that may have contributed 
in some ways to an over-reaction or a sense that the 
accounting, that the auditors would need to do more procedures 
than, for example, what was the case either in the previous 
standards or FDICIA 112.
    We did put out some subsequent guidance reminding the 
accounting profession that the intention is that it be a risk-
based approach. In fact, the manner in which we now inspect the 
accounting firms for the manner in which they do their audits 
of the internal controls for financial reporting focuses--
anticipates it will be done in a very risk-based approach.
    So what we are doing now prospectively is to make sure that 
the language is less technical, more specific, can be more 
readily, I think, understood, interpreted, that where there is 
some confusion on terms, we have tried to clarify those and at 
the same time focus on what is the fundamental expectation with 
respect to AS 2, is that issues of materiality can be focused 
on and identified prior to the time that it would require a 
restatement, and that is really the fundamental purpose.
    The Chairman. AS 2 was what, some 300 pages; right?
    Mr. Olson. About 180, I believe.
    The Chairman. And we would expect that the changes made 
should hopefully be shorter and more concise?
    Mr. Olson. Exactly.
    The Chairman. One of the issues that I have not heard a 
whole lot about and yet it bothered me when initially it was 
added in the Senate is the whole issue of the corporate loans. 
It was clearly because of the $400-million-plus loan that 
Bernie Ebbers got from apparently one board member's approval 
at WorldCom that triggered the amendment offered by Senator 
Schumer. Have you, have either of you taken a look at that 
particular provision and have any comment in that regard?
    Mr. Cox. Mr. Chairman, you and I have had the opportunity 
to discuss this, and I am certainly full well aware of the 
problem. The Act does not give the SEC, as we interpret it, the 
power to change it, and we do not have a rule right now 
implementing the provision.
    The Chairman. Thank you. Did you have a comment?
    Mr. Olson. I do not.
    The Chairman. Finally, and this is a bit off the subject, 
but in some sense, it really kind of puts a finer point on what 
was going through the body politic at the time. I get this 
question all the time. What was the biggest mistake that 
anybody made in this whole process? Obviously, you would try to 
avoid self-implication, so I usually say--and I will be 
interested in your response--my response is that the biggest 
mistake I felt in this whole process was essentially the death 
penalty for Arthur Andersen, where we in a relatively short 
time went from the Big 8 accounting firms to the Final Four, 
and that the lack of competition in the accounting profession, 
at least to some extent, has driven costs up. I just would be 
curious as to your responses.
    Mr. Cox. Mr. Chairman, I would like to answer that question 
in two parts, and the first part, what got us to that juncture, 
and then, second, how we reacted to it. But if one is looking 
for mistakes made, it is a big mistake to overlook what was 
going on inside Enron, inside Arthur Andersen, inside WorldCom. 
The scandals were real, and they were big, and they were major. 
And in this committee, we all sat through extensive hearings, 
and we had these people before the Congress and heard from 
them, and we looked at what went on inside Arthur Andersen.
    Were it not for the egregious conduct that occurred in the 
marketplace, then whatever excessive response, if someone wants 
to call it that, that occurred later wouldn't have happened. So 
while I am happy to critique the fine points of the 
congressional response and the administrative response, I don't 
think we should for a moment fail to recall what got us to that 
juncture in the first place. And I think everyone on this 
committee could do a good job extemporaneously citing all those 
good reasons that brought us there.
    I think that if there is a mistake or a fault in all of 
this, and I am not sure I am prepared to call it exactly that, 
it is the magnitude of the change that was wrought all at once. 
That is not normally the way securities regulation has 
proceeded over most of its history, with the exception of the 
initial creation of the Securities and Exchange Commission in 
1934 and the passage of the 1933 Act, which really was a big 
change and a big shock to the system. But one of the things 
that has been a hallmark of securities regulation and which I 
always appreciated as a private practitioner is the care and 
the patience that the agency takes in putting things out for 
comment and listening to the marketplace and in making, 
wherever possible, incremental change rather than broad 
sweeping changes, because we are dealing with a big marketplace 
in the United States and around the world, and so we don't want 
to do experiments on a live patient.
    So I think that the breadth of change, the magnitude of the 
changes that were undertaken all at once inevitably produced, 
as Congressman Frank mentioned, some anomalies that have to be 
addressed, and, in the case of 404, it is an expensive anomaly.
    The Chairman. Chairman Olson.
    Mr. Olson. Mr. Chairman, I would like to address the 
question from a slightly different perspective. The combination 
of events that brought about the demise of Andersen were a 
sequence of legal actions which should appropriately be 
addressed to the Justice Department and the SEC. What I would 
like to do is talk to you about what may be some of the 
unintended consequences of the succession of events that led to 
that.
    With Arthur Andersen, as we all know, there were some rogue 
actors at Andersen that helped bring about that demise, but 
from our perspective, Andersen had thousands of very talented 
people. And what immediately happened was a significant 
redistribution of that talent to the other firms so you saw all 
of the other firms, including some of the--some that are not 
among the four largest, gaining some additional talent. Some of 
our most capable people at the PCAOB were people who were with 
Andersen up to that point, and they are enormously valuable 
people.
    The Chairman. You are occupying their former offices; is 
that correct?
    Mr. Olson. Yes, I am. That is one of the ultimate ironies. 
I think that one of the things that has happened as a result 
is, when we only have four firms and those firms are not simply 
dominating in the United States, but dominating around the 
world, it has impacted the manner in which the firms can 
compete. And I don't know that we fully appreciate or fully 
realize the significance of that, but I think that there is--
the competition among firms is an issue that is on our minds 
and one that we are very concerned about in watching.
    The Chairman. Thank you. My time has long expired.
    The gentleman from Massachusetts.
    Mr. Frank. There appears to be a lot of agreement that 
there should be some changes, some refinements, more 
flexibility put in. Do you have enough authority under existing 
legislation to do that? That is from what you know now; 
obviously, we haven't completed the process. Is it likely to 
get done what you think ought to be done to get this working 
the way we want it to work, that you have to come back to get 
an amendment to the legislation, or do you have enough 
flexibility within the existing legislation to go ahead?
    Mr. Cox. I believe that we have ample authority 
administratively to apply Section 404 in a manner that is cost-
effective and gets the job done for investors. I don't think 
there is anything inherent in the statute that makes it unduly 
expensive. I am willing to acknowledge that it has been, but I 
don't believe that is a problem with the law.
    Mr. Olson. I have the same answer, Congressman.
    Mr. Frank. Good. I think that is our view, too, and so I 
think we can look forward to some substantial improvement 
without having to reopen this.
    You mentioned, Chairman Cox, FDICIA. I will note 
parenthetically for people who don't remember exactly, that was 
the law that we passed after the thrift bail-out situation to 
try to forestall a crisis or help forestall a crisis in the 
commercial banking area, and it was part of a very successful 
effort.
    I must say, I remember in 1989--1988 into 1989--there was 
some skepticism among some journalists. They were saying, first 
the thrift collapsed and now the commercial banks are going to 
do it, and they just brushed it under the rug for the 1988 
election.
    In the years that follow FDICIA, not obviously entirely, 
maybe not even substantially because of it, but there were, I 
guess, the fewest bank failures in history; none for a while. 
And it did seem to be an example of a successful effort. I had 
not recalled frankly that the language was the pattern.
    But that leads to a question. We have heard from some banks 
who are covered by FDICIA that they think they should be given 
an exemption from 404 on the grounds that they gave at the 
office and are already covered. What is the response to the 
suggestion that it is duplicative for them, that they are 
already under it? It is administered differently. Would that 
mean it is only up to the primary bank regulators, not you? We 
have just begun to hear from some banks who have raised that 
issue, and I would be interested in your response.
    Mr. Cox. Well, the first layer of response I would offer is 
that, with the exception of one-bank holding companies, the 
bank holding companies which have the 404 compliance 
requirement own more than banks typically, and so, with respect 
to a large bank holding company, it would be difficult to 
exempt them from 404 compliance. With respect to small 
community banks that happen to be one-bank holding companies, 
then I suppose that is something that you could entertain as a 
possibility legislatively.
    Mr. Frank. Is there a way to deal--has it been duplicated? 
What happens if you are a bank--I hadn't realized this before--
and you are subject both to FDICIA and Sarbanes-Oxley? How does 
that interact? Is there coordination?
    Mr. Cox. I think the initial decision to interpret Section 
404 of Sarbanes-Oxley differently from FDICIA even though the 
language was the same resulted in two different sets of 
compliance procedures and regiments, and so banks had to adjust 
and do both.
    Mr. Frank. That sounds like a reasonable issue that I would 
hope you would look at, and we ought to be able to--that one I 
guess would take legislation if we decided to make--
    Mr. Olson. Congressman, actually, we have made significant 
progress, the PCAOB has, in dealing with the bank regulators. 
As Chairman Cox pointed out, the most fundamental difference 
between the two is that FDICIA 112 applies only to the insured 
depository, and in some institutions, the insured depository 
constitutes virtually all of the assets of the holding company. 
In some, it does not. Now, what we have done in conjunction 
with the bank regulators is to give the bank holding company 
the option of either doing them separately or doing them in an 
audit that would include both. So because of the fact that 
there is that significant overlap, we have found ways to remove 
that element of overlap. In addition, the one other significant 
difference is that not only is it 404 that applies in that 
instance, but it is also a SOX 103 that requires certain things 
to be included in the report, and so that there is--they are 
not--they are not--they are not identical. But because of the 
significant overlap, we have been able to work with the bank 
regulators to eliminate a lot of the duplications.
    Mr. Frank. So this is another case where you think within 
the existing statute there is enough flexibility to accommodate 
that?
    Mr. Olson. I would say so.
    Mr. Frank. It just occurred to me that anybody who is not 
regularly employed either on the staff of this committee or one 
of your agencies who would understand immediately what someone 
meant if we talked about the PCAOB interpretation of FDICIA has 
a seriously deficient life.
    Mr. Olson. That hurts. I spent years and years in FDICIA 
112, and now I hope to spend years and years on AS 2.
    Mr. Frank. Next question just is really retrospective about 
this, and that is, you know, the Congress I think talked 
sensibly about posing the counterfactual when you were trying 
to analyze things. I thought it was useful to do this. We 
talked about the history. In your--well, just factually, I 
would think that is perfect, but in the post-Sarbanes-Oxley 
world, it is my impression that there have been fewer of the 
massive major company collapses of the Enron WorldCom sort. Is 
it reasonable to conclude that Sarbanes-Oxley has been 
successful in diminishing the problem that it sought to fix? 
Has the world been less troubled, the corporate world, since, 
Mr. Cox?
    Mr. Cox. Well, it is undeniable that we are 4 years later 
in a much better place in our public markets, in our capital 
markets and in terms of investor confidence than where we were 
when this law was adopted. For social scientists let alone for 
Federal agencies, it is always a challenge to parse out 
correlation and causation. I can't prove that the status quo is 
the necessary result caused by the legislation, but it is 
certainly the case that we are at a better place today.
    Mr. Olson. The question will be if, 10 years from now, the 
lessons that were learned as a result of Enron, WorldCom need 
to be relearned by a new generation of management and 
accountants and supervisors; that, to me, as having lived 
through many cycles in the banking industry, it does seem to me 
that we need to relearn the same lessons over and over again. 
But I think what we have in place now is an element of 
discipline that wasn't there before. So I am encouraged that we 
can in a significant way, get out--recognize the potential 
weaknesses that we would see in the audit component and be able 
to address those.
    Mr. Frank. Well, I thank you. Obviously, it would be wrong 
to think that you make progress simply by making a new set of 
rules and hitting people if they don't follow the rules. They 
hopefully have some impact in reshaping the culture in which 
people operate. It does seem to me that that has been one of 
the successes. Certainly I had never paid much attention to 
corporate boards of directors before becoming the ranking 
member of the committee. I didn't hang out with that many, and 
I just didn't follow them that closely. And my first impression 
of corporate boards of directors as I began to get involved in 
all this was not a very high one. Actually, I quoted previously 
the comment I first heard from Murray Kempton about editorial 
writers, that their function was to come down from the hill 
after the battle was over and shoot the wounded. It seemed to 
me that is what the corporate directors did. It does seem to me 
from what I read and the conversations I have had that 
corporate directors on the whole taking their responsibilities 
more serious than they used to, that there is less passivity 
that you more often hear of and read of corporate directors 
getting involved, and I think that is one of the advantages of 
this whole new regime. So I am feeling--I mean to say, in 
closing, Mr. Chairman, I am encouraged to have both of these 
men tell us that they have the authority under existing law to 
make those changes which most people would think would be a 
good idea to make it more flexible and less burdensome without 
compromising the mission, and I am encouraged by that. Thank 
you.
    The Chairman. The gentleman's time has expired.
    The gentleman from Louisiana, Mr. Baker.
    Mr. Baker. Thank you, Mr. Chairman. I appreciate your 
leadership in calling the hearing.
    Chairman Cox, you made a couple of points in your opening 
statement. I just want to echo the significance of them in my 
opinion. One was with regard to the fact that regulatory costs 
don't come out of the executive's pocket; they ultimately come 
from the investor. And secondly, that the scope of or magnitude 
of the securities regulatory changes brought about by Sarbanes-
Oxley was perhaps the largest change in structure since the 33, 
34 Acts. Because of those two observations, I think we have an 
obligation to continue an ongoing oversight and examination. I 
don't know it to be the case, but I can maybe say it that, 
among those from the business community who have expressed 404-
type language to me, it has not always been complimentary 
language in private conversation. It may be we need to have one 
of these hearings where we can get people to sit down and tell 
us what they think, but there is considerable angst even today 
about the expected ongoing implementation cost, not that I 
don't think that the Act itself is not justified in light of 
the circumstance when we consider. However, there are measures 
that might be taken I believe more aggressively to help with 
implementation costs, one of which is to encourage the 
utilization of regional or specialist accounting firms to come 
into compliance with 404 requirements. I believe that many in 
the marketplace feel that, unless they are dealing with one of 
the big firms, that is automatically going to be some sort of 
internal red flag when the audit committee does its work. 
However, within that context of the circumstance we faced at 
the time, the unfolding numerous accounting irregularities and 
corporate mismanagement, I feel that the Act was appropriate 
but that we are rounding a corner.
    Again, Chairman Cox, I know you have been a strong advocate 
of promotion of data tagging or XBRL. It would seem to me that 
implementation of that standard of reporting for the public 
operating companies over some period of time would enable us to 
eliminate some of the duplicative difficulty as Mr. Frank was 
just making reference to FDICIA, and banks having to conform in 
perhaps conflict with 404 with the implementation of XBRL, the 
data can be provided once to all regulators in whatever format 
they choose and move away from the paper-based system to a more 
realtime material fact of disclosure. Secondly, the current 
system as modified by Sarbanes-Oxley is a retrospective rules-
based system which I think coupled with the quarterly earnings 
pressures were the tools and the forces that brought about the 
Enrons and the WorldComs; that in order for sophisticated 
managers to be discreet every 90 days, they took that rule book 
and turned it on its edge. I believe I am correct in 
attributing to a number of FASB the view that we ought to 
consider moving more towards a principle-based accounting 
methodology as opposed to rules-based. If we were to do so in 
concert with the elimination of quarterly earnings reports 
together with technological reporting methodologies such as 
XBRL, I think we could take the next step in corporate 
accountability in that appropriate investor protections are not 
mutually exclusive of professional business management. And I 
believe that we can enable having more transparent disclosure 
than we have now, not diminishing the responsibilities of 
management to disclose but do it in a fashion which actually 
results in a lower implementation cost for the industry that is 
now seeming to--well, not all together happy with the cost of 
compliance as it is now structured. I would just simply make 
that statement since I had the time to do it.
    But my question is on another course, and that is with 
regard to the Fair Fund, another one of the significant 
elements I believe in Sarbanes-Oxley, which I believe today--
and I don't have the recent information. I am sure that you 
would have better data than I, but I believe some $7 billion or 
thereabouts had been identified as potentially available for 
recovery. About $5 billion has been recovered to date, and by 
year end, I believe the actual amount returned to investors 
would be approaching $3 billion. Are there any structural 
elements that you have concerns about the operation of the Fair 
Fund? And can you verify for me if those numbers are in the 
appropriate range of value at this point?
    Mr. Cox. You are correct on the numbers, I just wanted to 
check and make sure. In terms of distributions as opposed to 
what has been identified and made available for distribution, 
approximately $770 million in Fair Funds has been distributed 
since the Sarbanes-Oxley Act gave the SEC that authority. This 
is new authority for us, and so we are learning how best to use 
it. The Commissioners, the five of us, all agreed that we want 
to do this as efficiently as possible because we spend a fair 
amount of time looking at the legislative intent, at, what your 
purpose was in authoring this provision.
    Mr. Baker. Any particular problems that need addressing?
    Mr. Cox. If you are asking if there are legislative 
problems, I don't think so. If you are asking whether there are 
problems that need addressing, the answer is yes. Not big 
problems, administrative problems, but our objective is to get 
this money out consistent with the statutory purpose much 
faster than would otherwise be possible. The whole point of the 
Fair Fund's authority is to wash out the litigation cost, to 
eliminate the rate cost that goes to private counsel and return 
all that money directly to injured investors with alacrity. So 
coming up with administrative procedures that permit us to do 
that rather than simply to replicate what private litigants 
would do anyway by following the same procedures or in some 
cases just piggybacking on their distributions in class actions 
is the challenge that is before us right now.
    Mr. Baker. Thank you. I yield back.
    The Chairman. The gentleman yields back.
    The gentleman from Pennsylvania, Mr. Kanjorski.
    Mr. Kanjorski. I would like to talk about the future a 
little bit. One of the complaints I often hear on the Street is 
that 19 of the largest 20 IPO's in the last year were 
undertaken in markets other than the American exchanges. This 
complaint seems to envelop into some of the questions as to 
whether or not the Sarbanes-Oxley Act disadvantages the 
American market from foreign markets for some international 
companies. With that idea in mind, from both of you, I would 
just like to know whether it is time that this committee, the 
American Government, and you as regulators, start to consider 
the creation of an international securities framework. Is it 
time that we recognize that the global market is here to stay 
and that perhaps we need to find some kind of methodology to 
allow money to flow freer with adequate protection to investors 
and transparency? Should we think about initiating some of 
these talks for international securities protection?
    Mr. Cox. The answer to that question is an unqualified yes. 
Indeed, I already commenced that process virtually a year ago 
when I first became Chairman. Events would have certainly 
driven the SEC to that even if we weren't clever enough to 
think of it on our own. There is no question, as you point out, 
that this exchange consolidation is underway. Beyond the LSE 
and your own acts, there may be other markets. It certainly 
stands to reason that, at some point in the future, people 
might want to offer as a competitive market advantage 24/7 
trading which might imply 6 hours a day in four spots around 
the earth. Getting ahead of this potential business development 
by talking with our counterpart regulators in foreign 
countries, not just in Europe but around the world, is what the 
SEC is very busy doing right now. I have spent far more time 
talking to our counterpart regulators than probably past 
Chairmen have thought necessary for this reason. I have spent a 
lot of quality time with the FSA in the United Kingdom. I am 
going to be in Portugal next week to talk to the Euronext 
regulators. This is a top priority for the Commission.
    Mr. Olson. Congressman, a couple of reactions. First of 
all, let me go back to the IPO number that you talked about. 
Undoubtedly there was a point in time where that number was 
correct. As we have tried to look at the IPO market to try to 
measure the impact of Sarbanes-Oxley on the attractiveness of 
this market versus others, the most significant adjustment in 
the IPO market--for example, the United States versus the 
European market--occurred in the time from 1995 to 1999. That 
was a time when IPO issuance in the United States dropped 
significantly, while, in Europe, it increased significantly for 
reasons that I can't fully explain to you.
    During the period immediately following the dot-com bust, 
there was a similarity in the movement of IPO issuance around 
the world with the exception of Northern Asia. In other words, 
markets tend to move in sequence, and there was a--and the 
movement there was quite similar. In the last few years, what 
has happened is that there has been an increase, the IPO market 
has increased to a greater extent in Europe than it has in the 
United States, but it has grown in the United States. So we--
coming back to a point I made earlier, I think that it is 
important to evaluate over a longer timeframe what is happening 
in the markets and the impact of recent legislation. But let 
me--let me say in parallel to what Chairman Cox indicated, and 
coming back to the point that Congressman Baker made, among the 
other things that we see happening is a focus on international 
accounting standards, some of which is directed toward a more 
principle-based accounting. What we need to do as regulators is 
to assure that our manner of regulating and our manner of 
inspecting accommodates whatever changes take place in 
prudential accounting.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The 
gentleman from New Jersey, Mr. Garrett.
    Mr. Garrett. Thank you, Mr. Chairman. Before I begin, let 
me just make a comment with regard to the ranking member's 
opening comments about some of the positive sides of what has 
occurred so far is that certain companies who are not under the 
auspices of what is being required are looking to see--
implementing some of the same requirements under SOX which I 
guess just points to the fact that, in a free market situation, 
investors will go to those markets who are implementing 
transparency and the like. The flip side of that argument of 
course is that, in a free market economy, that without SOX in 
place, companies would go in that direction anyway and may be 
an indication that the free market would tend us to go in a 
direction of legislation that is pending. I think Congressman 
Flake has it that SOX should be totally voluntary, and the 
investor class is smart enough to decide where they want to 
invest their dollars. That really goes to the second point that 
the chairman made is that Congress acted, obviously, in the 
heat of the moment of what was going on after Enron and 
WorldCom came about and was responding to much of the political 
pressures that we were experiencing at the time. But I think we 
have to remember one thing back at that time is that the 
officials of both Enron and WorldCom broke laws that were in 
fact on the books at that time, and they were successfully 
prosecuted under those laws as well. And an indication of 
consumer or I should say investor confidence that can be seen 
in what happened with the Dow Jones after that. The Dow Jones 
Industrial Average actually rose after the disclosure of the 
Enron problems. I think that belies the notion that there was a 
breakdown in the investor confidence. On the other hand, I 
think it shows the investors were smart enough to react to the 
circumstances.
    I would like to thank Chairman Olson for being here and 
just ask you a couple questions. I am concerned, as are outside 
organizations, with the constitutionality of the PCAOB and 
would appreciate your thoughts on whether or not Congress 
should be or could be exerting more control over the PCAOB, 
bring it under a control with regard to annual appropriation 
process, congressional oversight in addition to what we are 
doing here as far as the normal appointment process. The PCAOB 
is basically a de facto regulatory agency and therefore should 
be in line with all other constitutional principles. So, in 
your opinion, should members of the board be Presidential 
appointments with Senate confirmation just like any other 
regulatory board? And since PCAOB can and does collect fees, 
should they be treated for appropriation purposes the same way 
that the SEC occurs?
    And finally, second portion of that, I would turn to 
Chairman Cox. One of the outside organizations that has filed 
suit is the Free Enterprise Fund challenging constitutionality 
on various points that I have raised here. The FCC apparently 
has joined with that suit, and the response that the FCC had 
is, in spite of filing a joint brief, is that they have broad 
and pervasive oversight with regard to PCAOB.
    My question to Chairman Cox is, has there been any 
instances--and perhaps you can give them to us today, where you 
have used that broad and pervasive oversight where the PCAOB 
has decided to take some sort of action and the FCC has used 
that oversight to stop them?
    Mr. Olson. You asked me the first part of the question, 
Congressman. That portion of the statute, title one, PCAOB is 
very carefully crafted. As I remember, the discussion at the 
time, the issue facing the Congress in creating an agency, an 
independent agency which would replace the self-regulatory 
agency was to create one that would attract the talent 
necessary to achieve the objective in a timeframe necessary for 
it to get up to speed for the purpose of achieving the 
congressional mandate, and I will submit that I have difficulty 
envisioning how it could have been done with any other type of 
a construct or any other type of an organization. And so I 
think it was carefully constructed as it was, and--but I will 
say also that one of the other elements that the Congress did 
add was that it provided for very significant--in fact the term 
we use is ``pervasive oversight'' by the SEC. And so there is 
this very significant element of oversight responsibility that 
the SEC has in fulfilling our mission, and you ask again also 
about the lawsuit and the constitutionality. Our internal 
counsel and our external counsel are very confident that the 
constitutionality of PCAOB will be upheld, but I will also turn 
it over to the chairman to answer further if he would choose.
    Mr. Garrett. Thank you.
    Mr. Cox. You asked me to address specifically the extent to 
which the SEC has exercised its oversight authority over the 
PCAOB, and I will just give a handful of examples in my 
experience in 1 year. First, as you might expect, given the 
range of PCAOB responsibilities, in order for that oversight to 
work, there has to be very close communication and coordination 
between the PCAOB and the SEC, and that starts at the chairman 
level. With Chairman McDonough, with acting Chairman Gradison 
and now with Chairman Olson, I have had a very close working 
relationship and an opportunity to discuss things in 
development so, before it is too late, before the SEC would 
have to take formal action after the fact to try and influence 
or adjust or reverse some action, these things are well 
understood and worked out to start with. Second, very formally 
we adopted a rule governing PCAOB budgets. The rule was crafted 
with the assistance of then acting Chairman Gradison, who had 
an awful lot of useful experience as ranking member of the 
Budget Committee here and member of the Ways and Means 
Committee for many years. He understands how the agency budget 
process works, and so the budget process that has now been 
adopted just a few months ago for the PCAOB is virtually the 
same that the SEC has, reporting to OMB and of course to the 
Congress. And we follow very similar deadlines so there is that 
passback process and so on. Before that rule was adopted, 
before the SEC exerted that oversight authority and exercised 
that responsibility, I would say that, from the SEC's 
standpoint and therefore from the public's standpoint, it was 
not a transparent process. With respect to 404 in particular, 
we have had concern about how AS 2 works. Every PCAOB auditing 
standard has to be approved by the SEC. And so what we are 
doing with AS 2 is anticipating the necessity of SEC approval 
for any rewrite of AS 2, and we are just rolling up our sleeves 
and joining in this effort to make sure we get it right. We are 
inspecting, through the use of the SEC inspection process, the 
PCAOB inspectors this year to make sure that they are doing 
what we think they are doing, and that is trying to make the AS 
2 implementation process more cost-effective. The PCAOB put out 
guidance in this area and we are trying to encourage that 
result. They are now in the process of inspecting the auditing 
firms to see whether they are implementing that guidance. As I 
noted, the SEC inspectors are going to inspect the PCAOB 
inspectors and that inspection process to make sure that is all 
working. In all of these ways, and I can provide other 
examples, I think, that the process that Congress asked us to 
follow is being utilized extensively.
    The Chairman. The gentleman's time has expired. The 
gentlelady from New York, Mrs. Maloney.
    Mrs. Maloney. Thank you, Mr. Chairman, and welcome. I would 
like to follow up with the line of questioning of Mr. Frank, 
and I was glad to hear, Chairman Cox, hear you say to him that 
you thought the law gives you the ability to adjust Section 
404. I must say, I hear practically every day from small 
companies in my district, and they really feel that the law is 
burdensome, costly and unfair to them, and they want an 
adjustment as soon as possible. As you know, there are several 
legislative ideas and legislation is before Congress now. So my 
question is, what is your timeframe for implementing this 
change? And what should we think of as your deadline? I am sure 
that will be the first question I am asked tomorrow by 
companies in my district.
    Mr. Cox. In addition to the extensions that we have 
repeatedly provided for smaller public company compliance so 
that, to date, no smaller public company, properly defined, is 
required to comply with the 404, the roadmap that we announced 
in May of this year has as its major component a process that 
will enable the SEC to put out guidance for management that 
will be especially useful for smaller public companies. So they 
will have a framework in which to apply 404, and there will be 
a revised auditing standard, too, which heretofore has been 
almost the entirety of 404 guidance, and that, too, should 
address the needs of not just current company compliance but 
also of those smaller public companies which have not had to 
comply with Section 404. All of this is anticipated to be 
accomplished before the expiration of these latest extensions. 
If for any reason our work is not completed before the 
expiration of those extensions, then certainly the Commission 
would want to consider further extending, but our plan is to do 
it within that timetable.
    Mrs. Maloney. Okay. And that timetable is 3 months, 6 
months?
    Mr. Cox. Well, the extensions take us in one case through 
2007 and the other through 2008, and so we expect, in order to 
stay within those respected deadlines, to do this in the first 
half of next year.
    Mrs. Maloney. There is also concern in Europe that 
Sarbanes-Oxley would apply to European companies if the 
European exchange they list on merges with a U.S. exchange. 
Even though you have said this is not the case, they still have 
this concern. And can you clarify it further? Again, I keep 
getting questions on it.
    Mr. Cox. Indeed. In fact, just this morning I got a report 
from our Office of International Affairs that our dialogue with 
European regulators has yielded substantial support for the 
statement that we issued, I believe it was in June, and we will 
continue to take every opportunity to repeat that clear 
message. National regulators will remain responsible for the 
regulation of the capital markets within their jurisdiction. 
And certainly the proposed transactions before us with respect 
to LSE and Euronext don't threaten that regime.
    Mrs. Maloney. Thank you. And I would like to hear your 
response to the claims by some that our markets have become 
less competitive because of Sarbanes-Oxley and, specifically, 
allegations that companies that would list on our exchange are 
now listing abroad. And how can we evaluate the significance of 
IPO's abroad? And should we be surprised that Russian and 
Chinese companies list on their home exchanges? Or is this a 
trend that is troublesome to American business, the fact that 
many companies have literally said, I won't list in America now 
because of this? Your comments.
    Mr. Cox. Well, I think the way you put the question with 
some nuance is very appropriate because oftentimes one hears a 
statistic about how many of the world's largest IPO's are 
taking place in the United States or on foreign markets. It is 
appropriate to take a look at the IPO's in specific, and you 
will then notice that several of them are state-owned companies 
that for a variety of reasons are going to prefer listing in 
their home markets or are going to prefer not to come to the 
United States. And whether or not such listings would meet U.S. 
standards is always a question that needs to be asked. On the 
other hand, fully half of the question has to be, what about 
the rest of these offerings? And should the United States be 
doing anything differently to make sure that we continue to 
attract capital here? We have the deepest, most liquid markets 
as is often repeated. Is that a birth right? Is that something 
that is necessary in nature? Probably not. So we have to have a 
constant focus on it and certainly at the SEC we do.
    Mrs. Maloney. Would these companies, Mr. Chairman, meet the 
tests of transparency and corporate governance that we require 
of American investors? And to what extent are other economic 
factors possibly responsible for this movement? And to what 
extent can we regain our competitive dominance without 
sacrificing our leadership on integrity and security? And 
lastly, if any way or any thoughts you may have on how we could 
evaluate the significance in a clear way of this movement or 
growth of IPO's abroad, and I, again, thank you both for your 
service and for being here today. Thank you. My time is up. But 
any response I would appreciate.
    Mr. Cox. I think, if you put the question in gross, that 
there are undoubtedly many companies that are public companies 
that are listed somewhere else in the world that would not meet 
our standards. There are also undoubtedly many companies listed 
elsewhere in the world not listed here in the United States 
that we would love to have listed here. Companies now have more 
choices of where to list. It is a more competitive capital 
market than it has ever been before, and the fact that there 
are other pools of capital is something that will cause the 
United States, I think, to sharpen its competitive edge. That 
is probably all to the good. There are good reasons, given that 
there are choices that some companies might not choose to come 
to the United States even though they might have a premium for 
listing here, as has been shown in many academic studies. Those 
reasons might include wanting to be closer to their product 
markets which might not be in the United States. So it would 
never be the case that we will have all offerings here, but it 
has long been the case that we have had the lion's share of 
them, and I hope and expect that that will continue to be so. 
At the Securities and Exchange Commission, since a statutory 
mission that Congress has given us is the promotion of capital 
formation, we are doing everything that we can to make sure 
that the United States retains and sharpens its competitive 
edge.
    The Chairman. The gentlelady's time has expired.
    The gentleman from Texas, Mr. Neugebauer.
    Mr. Neugebauer. Thank you, Mr. Chairman. And thank you for 
holding this hearing. I think it is an important part of our 
oversight to continue to monitor legislation that this Congress 
passes and make sure it is working for the purposes intended.
    I appreciate Chairman Cox and Chairman Olson being here. 
The issue that I want to talk about is something that, Chairman 
Cox, that you brought up towards the end of your remarks, and 
that is about the issue that we have been reading in the paper 
about backdating stock options. And I am wondering if the 
correct terminology is, that should we be using, is effective 
dating? I know that a lot of companies today use various 
techniques in order to have meetings and to come to board 
actions. One of them might be to have a teleconference talking 
about when to make options effective and then following that up 
with a unanimous consent agreement that would be signed by all 
of the shareholders. I know that a study was done where over 
200 companies actually used that practice of having a telephone 
conference following up certain board actions with unanimous 
consent agreements. One of the things I think is important is 
that, in this process, you know--and by the way these companies 
have all had audits by some of the major accounting firms, and 
that issue has not been brought up. And now, all of a sudden, 
this backdating issue is coming up, kind of wondering where the 
auditing firms have been in the SEC over the years where now 
this is coming forward, but more importantly, what are we going 
to do to ensure that where those companies that have gone back 
and tried to search and find the lowest share period for that 
and possibly commit a fraudulent act and those companies that 
are in their ordinary course of business or just transacting 
their business, how are we going to make sure that we have a 
way to ensure those companies that have been following the 
advice of their attorneys and other professionals that in fact 
what they have been doing is within the compliance with 
Sarbanes-Oxley and not have to worry about this new veil now 
overhanging people that are signing off on stock transactions? 
So Chairman Cox, could you kind of elaborate on that a little 
bit for me?
    Mr. Cox. Yes. In fact, your question permits me to give a 
very timely answer. Today, the Securities and Exchange 
Commission's Office of the Chief Accountant has published a 
staff interpretation of the accounting literature to provide 
guidance for companies that want to do the right thing, that 
want to stay in compliance and then want to do so quickly. The 
SEC wants to make sure that companies are able to continue to 
put their financial statements out in real time. With the third 
quarter revenues and the September 30 deadline coming up, that 
all of that is timely, and we have a constant flow of good 
information to the marketplace. With respect to companies that 
have some people with black hearts that have cheated, we have 
another tool. That is our enforcement division, and we are 
bringing cases--some of them are now public--to make sure that 
everyone understands that, if your conduct is egregious, such 
as is alleged in these cases, there will be consequences. Now, 
since this is a Sarbanes-Oxley hearing, I can also repeat my 
retroactive congratulations to the Congress for having the 
presence and the foresight to include this real-time reporting 
provision because now the reporting of the grants has to be 
made within 2 business days, whereas before it was up to 45 
days after the end of the fiscal year, so it might be more than 
a year later. The status quo ante Sarbanes-Oxley had that sort 
of attractive nuisance, that moral hazard that gave people the 
opportunity, if they had black hearts, to take advantage. That 
door has been slammed shut thanks to Sarbanes-Oxley.
    Mr. Olson. Congressman, in addition to the window being 
shut, a succession of changes in accounting have also made it 
less likely that there will be backdating. From a period of 
time where you could avoid expensing entirely, if it was an at-
the-money grant or as opposed to an in-the-money grant to 
transition to 123 which allowed for a voluntary expensing to 
123(r) where it is now mandatory. So that window is largely 
closed for the combination of the two reasons. We issued our 
guidance, however, because we just wanted to call attention to 
the existing literature that is out there regarding the audit 
issues that may come up having to do with options dating. But I 
suspect that the issue is largely behind us.
    Mr. Neugebauer. I just want to make sure that, for example, 
say today we got on a conference call and we decided to set the 
effective date for an option, and maybe 2 or 3 days transpire 
afterwards; someone is calling around polling board members for 
that, and then, in 2 weeks, where the UC agreement then begins 
to circulate around and get the last signature. I think we want 
to be clear about that, the fact that maybe the agreement was 
not--the UC agreement was not signed for 2 weeks, but the 
decision was made maybe today in making sure that we don't 
start to perceive that as some kind--some way in backdating 
transactions, and using some commonsense because what I have 
seen--and I know, Chairman Cox, your time in Congress, 
sometimes we spend a lot of time penalizing 99.9 percent of the 
people for the things that one-tenth of 1 percent of the people 
are doing. And I am just hopeful that you will work together 
with Chairman Olson and make sure that we use some commonsense 
as we look at these issues.
    The Chairman. The gentleman's time has expired.
    Mr. Neugebauer. And not create additional problems for, you 
know, compliance with Sarbanes-Oxley.
    The Chairman. The gentleman from North Carolina, Mr. Watt.
    Mr. Watt. Thank you, Mr. Chairman, and thank you for having 
this important hearing.
    And thank you, Mr. Cox and Mr. Olson, for being here. One 
of the things I try to do sometimes at these hearings is, in 
addition to evaluating the impact of legislation that we passed 
and the effectiveness of the regulators at carrying that 
legislation out, is maybe use this as an occasion to evaluate 
ourselves and the way we do things in Congress. My impression 
is that we were a lot less micromanaging in Sarbanes-Oxley, for 
example, than we were in Gramm-Leach-Bliley in the sense that 
we set out some general principles and left it to the 
regulators, SEC and the accounting board to kind of put 
substance there as opposed to kind of legislating a group of 
things that we wanted carried out in Gramm-Leach-Bliley. 
Without implying any criticism of this, I am just trying to put 
this in a framework, what--what is the authority, for example, 
for the SEC under this statute to delay the application of 
Section 404 to smaller companies? I mean, I guess I am trying 
to figure out what the interplay is between the standard that 
Congress wrote, it said, you shall do--provide investors an 
assessment of their internal control. Didn't say when. Where is 
the authority of SEC to delay the implementation of that or the 
application of it to a particular set of business people?
    Mr. Cox. Well, I think you were right to parse the 
distinction between exemptive authority and interpretative 
authority that is being exercised in this case to phase in 
compliance. There is a much more difficult legal question that 
is under debate that I hope to obviate by not taking that 
course. Whether the SEC has exemptive authority that would 
permit it wholesale to exempt a class from compliance from the 
otherwise clear injunction.
    Mr. Watt. Basically, what you are saying is you concede 
that if you were exempting smaller companies completely from 
Section 404, you would have to come back to Congress and get 
that authority, but you can delay the implementation of it 
without coming back for additional authority?
    Mr. Cox. Well, I think all I am prepared to opine on with 
respect to exemptive authority is that--I should say report on, 
because it is a fact--there are legal authorities who sharply 
disagree on both sides of that issue on whether or not the SEC 
has such authority, and indeed, Members of Congress who have 
communicated with us have communicated with us on both sides of 
that issue and thus placed themselves in sharp disagreement. 
The SEC is not going to test that. We are not going to use the 
exemptive authority that we might or might not have, but rather 
we are going to take the view that Section 404 can be made to 
work for issuers of all sizes.
    Mr. Watt. I guess from my own perspective, I am trying to 
evaluate which one of these processes works better. The more 
aggressive legislating that we do, it seems to me that in that 
context, at least some people believe there is a greater need 
for us to go back and revisit some of the provisions of Gramm-
Leach-Bliley, because we were micromanaging, than there is in 
this case to revisit immediately Sarbanes-Oxley because we 
delegated or seemed to give a lot more delegation to the 
regulators, SEC, to set some of these standards. Just comment 
for me a little bit on how you feel like this is operating in 
that general context.
    Mr. Cox. Well, I really enjoy being asked the question even 
though I am having a little difficulty answering it. Because, 
you know, in my congressional mindset, I would like to think 
that Congress is completely competent to write very specific 
legislation that can be prescriptive where necessary, and that 
is probably a healthy way to do things rather than to leave it 
up for grabs and for somebody else to figure out. As a 
regulator now, I am also comfortable in saying that if Congress 
delegates to agencies with specialized expertise the obligation 
to fill in the blanks and the details that the agency can do an 
effective job of that as well. With respect to the very 
specific example you gave, Gramm-Leach-Bliley versus SOX, 
perhaps one of the reasons that you are getting people coming 
up here to the Hill saying, we have got to do something about 
Gramm-Leach-Bliley, is that this many years after the enactment 
of that law, we still haven't got rules. That is our 
responsibility as regulators. So I can tell this committee that 
I am busy working with the banking regulators to try to get 
agreements that we can put out finally, rules under Gramm-
Leach-Bliley. It is, in my view, high time that that be done. 
Then, if there are still concerns, it would be appropriate 
either for the regulators to go back and fix those or for 
Congress to legislate again.
    The Chairman. The gentleman's time has expired.
    The gentleman from North Carolina, Mr. McHenry.
    Mr. McHenry. Thank you, Mr. Chairman.
    I want to start today by referencing the ranking member's 
comments and, Chairman Cox, your to reply to that. FDICIA 1991, 
that largely, you know, that is largely the basis of Sarbanes-
Oxley. When you are talking about banks, their internal 
controls are regulated under FDICIA by the Fed, FTC, ODS, FDIC, 
depending on the institution of course. You mentioned in your 
answer to the ranking member's question that perhaps small 
banks, those that are small bank holding companies perhaps that 
have one single bank within it, those are ones you would like 
to possibly look at relieving some of the burden under 404. Can 
you elaborate on that?
    Mr. Cox. Yes. What I was pointing out is that the Sarbanes-
Oxley requirement in Section 404 applies to the bank holding 
company rather than to the bank, and if the bank holding 
company has anything in it besides one bank, then the rationale 
may not be there any longer to provide the proposed exemption, 
but that if one were talking about a one-bank holding company, 
then that is perhaps--
    Mr. McHenry. Where are you in that process?
    Mr. Cox. To be honest with you, until very recently, I had 
not considered the idea. I have heard it is under consideration 
here in Congress. It is my tentative view, uneducated thus far 
by our general counsel in our operating division, that that 
might require some legislation because I don't know that we 
have the power to exempt bank holding companies from 404 
compliance as a class.
    Mr. McHenry. Could you, after speaking to your general 
counsel in a more substantive way, could you submit to the 
committee an analysis of that, whether or not that would be 
required?
    Mr. Cox. I would be pleased to do that. I would be very 
happy to do that.
    Mr. McHenry. Thank you.
    Chairman Olson, I want to commend you on your choice staff, 
hiring someone from North Carolina and a constituent, her 
father remains a constituent of mine. I want to thank you so 
much for that. And having said that, but there is always a but, 
right? You mention that you saw--in regard to the same question 
that the ranking member--a significant overlap for small banks 
or banks in general and that you had a move within the PCAOB to 
significantly reduce that overlap. I have not seen that nor 
heard that from any of the bankers I have met and discussed 
with, nor have I heard it from the banking industry in general. 
Can you tell me what is happening, because I haven't heard it 
unless this has happened in the last few days?
    Mr. Olson. Well, first of all, the threshold requirement 
for FDICIA 112 is $1 billion in asset size. So if--and the 
threshold requirement for a 404 or AS 2 has only to do with 
whether or not they are a public issuer. So you have a 
difference in the threshold requirement for the applicability. 
If they are a small institution, however, the financial 
reporting internal controls 404(a) and (b) still will not be 
effective as the chairman said, for some period of time. At 
this point in time, that benefit would apply to the accelerated 
filers. In other words, the large institutions, the large 
institution's in North Carolina for example.
    Mr. McHenry. Certainly.
    Mr. Olson. So if you were to hear it to this point, you 
would be more apt to hear it from the largest institutions.
    Mr. McHenry. I would like to say, you know, you both say 
that there perhaps hasn't been a chilling effect--
    Mr. Olson. I am sorry, Congressman. There hasn't been what?
    Mr. McHenry. A chilling effect. My apologies. My accent may 
have gotten in the way there. Chilling, cold.
    Mr. Olson. Thanks to my work with your constituent, 
Congressman, I am starting to be able to understand the 
language very well.
    Mr. McHenry. You might even use the word y'all.
    Mr. Olson. Yes.
    Mr. McHenry. There has been--just looking at 2005 IPO's, 24 
out of the 25 largest listed in other exchanges foreign to the 
United States. And you see just with the IPO's, 12 were Chinese 
companies, to your comment earlier, Chairman Cox, 12 were 
Chinese companies that qualified with the New York Stock 
Exchange but chose to list in other markets. The top 10, all of 
which were in foreign markets; I think we do see a chilling 
effect on this. And I would like--you know, I think that is an 
important thing to note in this hearing. So with that, I yield 
back.
    The Chairman. The gentleman's time has expired.
    The gentleman from Georgia.
    Mr. Scott. Yes, thank you, Mr. Chairman.
    Chairman Cox, the New York Stock Exchange and NASDAQ are 
merging or they are buying stakes in international exchanges. 
And some commentators, especially those in Europe, have 
suggested that if the U.S. exchange were to merge with--if they 
were to merge with a foreign exchange, then Sarbanes-Oxley 
would apply only to those companies listed on the foreign 
exchange. Now, this seems to me to be a clear misunderstanding 
of the law, the intention of Congress and the intention of 
Sarbanes-Oxley and the intention of the Securities and Exchange 
Commission. Do you agree that Sarbanes-Oxley would not apply to 
companies that are not listed on a U.S. exchange, even in the 
event of such an international merger?
    Mr. Cox. Yes. Given the transactions that we are aware of 
thus far, that is undoubtedly going to be the case. And, as you 
know, the SEC has very publicly and clearly stated that. And we 
appreciate this opportunity to say it again.
    Mr. Scott. All right.
    Another question I have is, I am concerned about the 
competitive position of the United States in this increasingly 
global financial marketplace. We have all heard of the alarming 
statistic about the flight of global IPO listings to foreign 
markets. Many cite the high cost of compliance to Sarbanes-
Oxley as one of the reasons for this trend. And I believe that 
there are costs that can be significantly reduced through 
regulatory action by you and by Chairman Olson. I am wondering 
if you agree with me on that. And if you do agree, if this is a 
priority with you.
    Mr. Cox. I do agree with you, and it is a priority. I often 
hear, as I am sure that you do, the combined costs of 
regulation and litigation in the United States do not compare 
favorably with competitor countries. To a certain extent, I 
think we want to have the benefits of our regulatory system and 
our civil justice system, so we are unwilling to give them up. 
But we also have to be very keenly aware that, if there are 
excessive costs in those systems, we need to wash them out. I 
am absolutely convinced that, in both the case of regulation 
and litigation, there are excessive costs that can be wrung out 
so that we can be more competitive. At the SEC, of course, we 
are responsible for the regulatory piece, and we are working 
very hard to reduce those unnecessary costs. In the context of 
this Sarbanes-Oxley hearing, certainly 404 is a good example 
where we had that opportunity. I think we will be successful.
    Mr. Scott. Do we have any quantitative data on any loss of 
companies or moving out of it because of the high cost of 
complying with Sarbanes-Oxley?
    Mr. Cox. Well, we certainly have good quantitative data on 
where companies are choosing to list. Their motivations are a 
little harder to button down. Some companies are happy to 
announce what their intentions are. Others are a little bit 
more opaque about it. But I just think we have to be very eyes 
open and recognize that, leaving aside regulation, litigation 
and those costs, the capital markets are, for the betterment of 
our world and mankind, more competitive now than they have ever 
been before. There are more choices, and a lot of that is due 
to U.S. leadership because we have been promoting the concept 
of markets to countries around the world, and they are taking 
us up on it. So as developing countries and Europe and Asia, 
mature economies now, have deeper and more liquid capital 
markets than they used to, we are going to have people with 
choices. Getting back to first principles, if we believe in 
markets and the strength of competition to reduce costs and 
provide higher standards of living, then that is a good thing. 
We just need to compete in order to win, and competing means 
offering a better service, a better product at a lower price.
    Mr. Scott. Let me ask you, going back to what I really 
think is the big elephant in the room of course is section 404. 
Most of the complaints that I get within my constituency and 
the business community is that it is sort of like one size fits 
all. It is costing smaller companies a great amount of money. 
What recommendations would you make to that specific concern 
about the complaint from smaller businesses who feel that 
section 404 was basically written for these larger corporations 
and it is just costing them just an arm and a leg.
    Mr. Cox. I think the evidence on that point is 
overwhelming. The way that section 404 was implemented through 
Auditing Standard No. 2 initially was more expensive than 
anyone expected, and certainly that process would be unduly 
burdensome for smaller public companies, and that is why 
compliance for those companies has been postponed until we can 
get a framework in place that actually makes sense for smaller 
public companies.
    The SEC appointed an advisory committee, as you know, on 
smaller public companies to look into this very carefully over 
a long period of time. They produced an excellent report, and 
they recommended to us an alternative: either exempt smaller 
public companies or postpone compliance until such time as 
there is a framework that is workable for implementation of 
Sarbanes-Oxley section 404 by these smaller entities. We have 
chosen the second prong of that recommendation. That is the 
road map that we laid out in May, and I think the stakes are 
very high. I think we have got to succeed in this effort.
    The Chairman. The gentleman's time has expired. The 
gentleman from Alabama.
    Mr. Bachus. I thank the chairman.
    Chairman Cox, yesterday in Chicago there was a town hall 
meeting by a capital markets commission and actually members of 
your staff and members of Chairman Olson's staff testified and 
what it dealt with was the legal risk facing private sector 
auditing and the resulting risk to the capital markets and to 
investors.
    I will shorten the question to say they actually talked 
about the viability and the effectiveness of independent 
auditing at publicly held companies going forward and the legal 
risk. Could you comment on those legal risks? I know we 
mentioned it a little earlier in your dialogue with the 
gentleman from Georgia. I really see the accounting profession 
at legal risk. Would you comment?
    Mr. Cox. Yes. This is the bookend to the costs that 
companies are complaining of in their implementation of section 
404. The auditing firms are concerned with two things: First, 
getting it right, and second, their own liability if they 
don't. To the extent that that liability system isn't working 
just right, to the extent that it is imposing unnecessary risk, 
then the resulting behavior is that the auditing firm for its 
own protection runs upcosts at investor's expense.
    Mr. Bachus. But you do see the accounting industry at 
substantial legal risk today, don't you?
    Mr. Cox. There is no question. The fact that there are four 
large firms that do essentially all of the multinational work 
means that for purposes of a great deal of litigation they are 
viewed as the insurers of last resort or sometimes first 
resort.
    Mr. Bachus. Let me move on to reg show, naked short 
selling. I know there have been proposals to reign that in and 
you have got two proposed rule changes I think pending. I want 
to talk to you about two other proposed rule changes and urge 
that you take a look at those, and I want to actually introduce 
into the record--we have a company, Movie Gallery, in Alabama 
which has basically been savaged by naked short selling and 
Bloomberg did about an 8-page article on naked short selling 
and they weren't too kind to the SEC in that article. So I want 
to ask you to take a look at that as you leave.
    The Chairman. Without objection.
    Mr. Bachus. The two proposals, and I would like to 
introduce it, many, including the U.S. Chamber of Commerce, are 
calling for the SEC to require that the aggregate amount of 
sales be disclosed daily, and I would like you to take a look 
at the SEC doing that.
    Second, it seems to me that the whole problem of failures 
to deliver that results from naked short selling would go away 
if the SEC goes back to the requirement of a pre-borrow. What 
are your thoughts on those? You may not want to go into that 
too much, but I would I'd like to get your thoughts on those 
two.
    Mr. Cox. I would be, first of all, very happy to look at 
what it is you are going to provide to us. Reg SHO is very much 
on our minds because we just completed a roundtable, the 
Commission's word for what you call a hearing here, last 
Friday, September 15th. It was very successful. It was focused 
on our Reg SHO pilot. It had a number of distinguished academic 
researchers. I participated in it as did other Commissioners, 
and the presentation was focused on how the price test such as 
Exchange Act rule 10(A)(1) and the former NASD rule 3350 affect 
liquidity, volatility and market efficiency.
    The rule itself, as you know, is relatively new. It was 
adopted in June of 2004. We are considering amendments to it, 
and we are particularly concerned with the problem of naked 
short selling. So your proposals are very timely.
    Mr. Bachus. What I will do is I will just submit to you in 
writing maybe--I just want you to know that there is concern. I 
do have an Alabama corporation that has really been damaged by 
it.
    My third question, and Ms. Maloney and others have referred 
to the competitive disadvantages to Sarbanes-Oxley. I think 
they are mainly section 404. I think they are definitely--what 
we are hearing particularly from people in financial services, 
where we are the global leader in providing financial services 
in the world, is that section 404, there are some negative 
implications, particularly when it comes to internal control.
    My question to you is can these negative implications, 
which I think the SEC has acknowledged, can they significantly 
be reduced by regulatory action?
    Mr. Cox. I am of the view that they can, and, furthermore, 
I am spending a great deal of energy and effort to make sure 
that they are in fact reduced, that these costs are reduced. 
Any regulation is going to have some cost, and so, to the 
extent that there is anything called assessment of internal 
controls, there are going to be costs.
    But I think it is possible to do this and, as I mentioned, 
many other countries are doing this. So it is not unique to the 
United States. I think it is possible to do this in a sensible 
way that gives investors a lot of bang for their buck. What we 
don't want is for the whole effort to be focused on the 
tangential and the irrelevant. We need an instinct for the 
jugular rather than the capillary. We want a risk-based 
approach that focuses on what affects the financial statements, 
and we want it to be scalable so that smaller public companies 
have a way to comply without a great deal of question, and so 
they don't get whipsawed by a process built for much larger 
companies.
    Mr. Bachus. I would ask Chairman Olson, too, if he would 
like to comment on how we can address the regs. I am not 
arguing that Sarbanes-Oxley didn't have benefit but I think we 
all acknowledge that there are some concerns about our global--
    Mr. Olson. We acknowledge that there have been legitimate 
concerns and costs that have been--that are probably 
unwarranted. AS 2, which implements section 404from our 
perspective, was passed in 2004. We can see immediately that 
there were procedures that were being done that were in excess 
of what we expected.
    By 2005, my predecessors, who were very quick to try to 
evaluate those changes, were already making adjustments inAS 2 
either by putting out a series of Q and A's or by some other 
issuances that talked about grading accounting firms on the 
efficiency as well as the effectiveness. And the amendments 
that we are proposing now will address exactly the question you 
are raising.
    The Chairman. The gentleman's time has expired.
    The gentleman from Missouri.
    Mr. Cleaver. Thank you, Mr. Chairman.
    Mr. Cox, thank you for being here. In your statement on 
page 3 in the fourth paragraph you said the SEC will continue 
to work with other regulators around the world to encourage 
effective regulatory standards that encourage capital 
formation, job creation and economic growth while at the same 
time offering a high degree of investor protection.
    What is the SEC doing; what are the steps, what is the work 
that is going on that is protecting the investor protection?
    Mr. Cox. The reason that this is a global undertaking is 
that there is global convergence. There is undoubtedly beyond 
even the exchange consolidations increasingly one global pool 
of capital into which all of the participants dip and it is 
very much a competition not just between and among nations but 
between and among firms who operate in all of these different 
countries.
    As that market, that global market, takes shape, it is 
incumbent on us as regulators to talk about harmonizing our 
regulations to the maximum extent possible. So what I am doing, 
what the SEC is doing, is working with our counterpart 
regulators to take a look at the extent to which already their 
rules are somewhat alike in some respects to our rules, and, 
when we find those opportunities, we will see if we can't make 
our rules not just like one another but the same. Then, to the 
extent that we have different approaches but we are indifferent 
about which one to pick, we will try to harmonize in that 
respect.
    Finally, we will have the hardest category, which is those 
that are fundamentally inconsistent. Already in Europe this 
exists. We have one common rule book, and then we have separate 
national rule books. We have to work just as Europe is working 
through all those for the simple purpose of wringing out the 
extra cost of duplication and redundancy. Any time there is a 
rule that accomplishes an objective one way and another rule 
that accomplishes the same objective another way, you have got 
unnecessary cost, and we want to eliminate that.
    Here at home we have an opportunity with the regulation of 
broker dealers and possibly exchanges to eliminate duplication 
as well, and we are focused there.
    Mr. Cleaver. I agree with you about the interconnectedness, 
the global economy, but I would question whether or not that 
does not require something more formal than discussion. When 
you look at what is going on, the current size of U.S. 
investments held by foreign entities is rising and if, for 
example, those companies are listed in the Euronext but find 
themselves exempt from Sarbanes-Oxley, isn't it quite possible 
and in fact somewhat likely that companies can get around 
Sarbanes-Oxley because they are going to interconnect with 
foreign-held companies. And we don't--as you have said in 
comments before, looking at a statement you made at the 
American Securitization Forum in New York where you pretty much 
assured the foreign markets that they are not going to be 
subjected to Sarbanes-Oxley. What protects the investor, what 
allows the investor to know that even though this is a global 
market, I can trust what is being reported even though the 
money is so--there is so much shadow over the money because it 
is going into France, French companies in business with a U.S. 
company?
    Mr. Cox. There are several issues that I think converge 
here in this discussion. One is the issue of regulatory 
arbitrage, which you have alluded to. That is a very real 
issue. Regulatory arbitrage from the standpoint of a regulator 
is a hazard. We don't want to create needless opportunities for 
that to occur, so instead the approach is to work with our 
counterpart regulators to eliminate those.
    Second--
    Mr. Cleaver. When you say you work with, I guess that is 
the little spot of my concern.
    Mr. Cox. The way that we work with them, and this gets into 
the second point, is to focus on our national objectives. Even 
though there is a convergence of markets, there has been no 
similar convergence of national objectives, countries and 
regulators in these countries all have different interests. So 
what we want to do through these discussions when we work with 
our counterparts is to try and construct an understanding that 
we are maintaining high standards. At least among the developed 
countries and the large markets we would like to have a high 
standards world. America is clearly the leading high standard 
country in the world. Not only do we have the largest market 
but the highest standards. I think those things are not 
unrelated because confidence in markets is such an important 
reason for people to invest there. There will always be people 
who have different points of view about what level of 
regulation to maintain and people who take advantage of 
opportunities for regulatory arbitrage. So what we have to 
construct is something that permits us to the maximum extent 
possible to protect U.S. investors and also to compete and to 
have our share of that global capital market.
    The Chairman. The gentleman's time has expired. The 
gentleman from Florida, Mr. Feeney.
    Mr. Feeney. Thank you, Mr. Chairman, and thank you Chairman 
Cox and Chairman Olson. I want to join with the chorus of folks 
that have told you that much of my experience in talking to the 
business community is that Sarbanes-Oxley has had an enormous 
beneficial impact in terms of transparency, in terms of 
clearing up some conflict of issue rules and some corporate 
governance issues. Section 404 is really the heart of the 
matter and we are talking about cost/benefit analysis. And 
Chairman Cox, you just referred to regulatory arbitrage as sort 
of a sinister term, people avoiding legitimate regulations, but 
at some point we have to ask ourselves rather than redundant or 
superfluous regulations that are encouraging capital to flee 
public markets in America is really having all the advantages 
in the cost/benefit analysis.
    I think both of you acknowledged that there was ambiguity 
and some confusion, I think is the word Chairman Olson used in 
the initial implementation, and I agree by the way that most of 
what is wrong with 404 can be fixed from a regulatory 
perspective.
    But between the ambiguity in terms of how to comply with 
404 and the death penalty in terms of civil penalties, criminal 
penalties for internal, external auditors, members of the 
board, CFOs, CEOs, we have sort of had this race to the 
regulatory extreme and it is a huge concern to the companies 
that I talk to. One of the things that I did not get a lot of 
in your testimony that I would be very interested in are some 
more details in terms of quantifying the cost because if we are 
going to do a cost/benefit analysis we need to know what those 
costs are.
    I think in the original testimony in front of the Senate 
the SEC suggested 404 compliance would cost the average 
American company about $92,000, I think was the estimate. In 
fact it has been, according to some estimates, about 30 times 
that.
    I think we ought to talk about what the actual experience 
has been for the companies that have had to comply. I think it 
would be important if you could give us some detailed 
information about the percentage growth in private equity 
markets in America. But these are markets that are less 
transparent, less accessible to small investors like myself 
that have 401Ks or IRAs, and yes, the public exchanges are 
growing but are they growing as fast as the private equity 
markets and what effect does it have on the American capital 
system if we are going to have more capital raised in the 
private equity market as opposed to public markets? It tends to 
be more expensive, less transparent.
    I think the percentage of America's lead in terms of the 
world capital markets has diminished. The last figure I saw 
shows over the last 4 years we have gone from roughly 44, 43 
percent of world capital public market to about 38 share, and 
that has probably continued to decline based on all of the 
evidence that I am hearing.
    Chairman Cox, I don't know whether you will respond to the 
study by Mr. Butler from the Brookings Institute and Mr. 
Ribstein of the University of Illinois where they suggested 
that while the direct costs of Sarbanes-Oxley are much higher 
than anticipated, the indirect costs, and they admit it is a 
back of the envelope calculation, about $1.1 trillion in terms 
of annual regulatory burden on the U.S. economy.
    I would grant if there is a hundred economists that do this 
study we would get a hundred different answers, but if these 
guys are even close, this is having a huge impact on us.
    Finally, the number of restatements have dramatically 
increased. We had something on the order of 1,200 restatements 
last year. How many were really material in terms of affecting 
investor behavior? Are some of these restatements unnecessary 
or redundant and are they adding to the expenses of compliance?
    Finally, and I will end up and let you comment on what I 
have said. I really would be interested in some more 
quantitative analysis of the costs if we are going to do a 
cost/benefit analysis. I would ask you to address a couple 
things. Chairman Oxley alluded to the fact we have created what 
I call a quadropoly. There is really only four big accounting 
firms that are in the business of doing the internal and 
external audits and that has had some significant impact on 
companies trying to comply because they have very few, if any, 
choices.
    The second thing is, as much as Mr. Olson suggests, we are 
trying to clarify 404, we do that almost every year and there 
is still a great deal of mystery in the real world about how to 
comply. What would be wrong with going to a de minimis standard 
of what is a material breach; for example, the old standard of 
5 percent or less of gross sales or revenue for a year? 
Anything under that would be considered a de minimis or an 
error that is not a material impact on the very health of the 
company itself.
    If you would comment on some of those suggestions. Finally, 
the Small Business Advisory Committee, Mr. Cox, did suggest 
that maybe random external audits every third year, fifth year 
might be a way to alleviate some of the costs. If you could 
comment on those suggestions.
    Mr. Cox. That last part you mentioned is with respect to 
404, right?
    Mr. Feeney. That is right.
    Mr. Cox. I hope I made good notes, and I get to most of 
your questions. I will try and go through them as quickly as I 
can. First, with respect to the costs of implementation, there 
is no question that everybody got it wrong. Congress got it 
wrong, the SEC got it wrong. I described some of the reasons I 
think that was so. But the estimates that were provided were 
low-balled substantially, and there are a number of competing 
studies about what the numbers are, and while it is interesting 
to debate which number is most accurate, the remedy in all 
cases is the same.
    To the extent that the regulation and the law are producing 
unnecessarily high costs, we need to get rid of those costs, 
and that is what we have set about doing. The indirect costs, 
such as in one of the studies that you mentioned, typically 
include such things as delayed time to market. A company, it 
might be a venture company, mid-stage growth company, ready to 
go to an IPO, delays its profitability because of extra 
regulatory or litigation costs, and when you add that all up 
for the country it gets you into the trillion dollar plus 
neighborhood.
    I don't think there is much question whether that figure is 
exactly right or not; there are real costs associated with the 
civil justice system and with our system of securities 
regulation, and so the job always is to balance those costs 
against what we are getting for our money, and I think we can 
do better in both areas.
    Our lead vis-a-vis the rest of the world in global capital 
markets is not something we can take for granted, and you are 
right, it is possible to use the term ``regulatory arbitrage'' 
in a nonpejorative way. I was using it a moment ago to describe 
what as regulators we seek to avoid. But it is also the case 
that people have choices, and if any country has burdensome 
regulations that aren't matched with any benefit, then people 
will put their money elsewhere.
    So we need to recognize what it is that makes America's 
market so attractive. It is our rule of law, surely. It is the 
confidence that investors have that their money will be safe 
here, and some of that is attributable to our regulatory 
regime. That doesn't mean every regulation we can think of 
helps us be competitive. So we have got to distinguish between 
one and the other and get rid of all the extra costs because 
investors are paying for that. It is the investors' money, 
nobody else's money.
    The Chairman. The gentleman's time has expired.
    The gentleman from Alabama and our final member, Mr. Davis.
    Mr. Davis of Alabama. Thank you, Mr. Chairman. Gentlemen, 
most of the questions today have obviously, and it has been a 
fairly bipartisan course, most of the questions have been an 
effort to draw you out on the question of whether Sarbanes-
Oxley has had a particularly pernicious anticompetitive affect. 
But what I want to do is spend a little bit of time perhaps 
providing another perspective on this.
    My friend from Florida, Mr. Feeney, mentioned the costs 
from 404 in particular have been estimated at perhaps $92,000 
per American company. As I understand it, the market value of 
public companies in the United States is somewhere around $16 
trillion. As I understand it, over the last--well, just looking 
at 2005, there were 210 initial public offerings in the United 
States and approximately $33 billion in capital raised off of 
those offerings.
    I could go on and on and I have no idea whether you all 
know the average profit margins of companies who trade on our 
stock exchanges but the number 92,000, even if you are 
generous, if you triple it as Mr. Feeney wanted to do, that 
strikes me as for the overwhelming majority of American 
companies a fractional impact. Am I wrong to view it that way?
    Mr. Cox. I think Mr. Feeney's point was not that it was 
triple but that it was in orders of magnitude larger, perhaps. 
I think your point though is a good one. It is the fact that a 
regulation costs money can't be the end of the analysis. It is 
compared to what benefit? And in exchange for what? So it is 
very clear from the fact that section 404 exists in the law 
that Congress anticipated it would cost something. It is also 
very clear Congress wanted the benefit.
    Mr. Davis of Alabama. Let me ask another follow-up that 
flows from that. It seems that the largest dispute that 
Congress has is not whether there have been unfortunate 
regulatory costs during the life of Sarbanes-Oxley but whether 
or not the regulators can be trusted to minimize those costs or 
the congressional oversight or congressional intervention is 
somehow necessary.
    Mr. Cox, you served here for a period of time. In your 
experience was Congress particularly adept or skilled at 
providing clear guidance in terms of regulations and did 
Congress consistently do a better job of providing clarity than 
the regulator involved?
    Mr. Cox. In my experience Congress uniformly did an 
outstanding job.
    Mr. Davis of Alabama. But, serious question, is there any 
particular reason to think that if Congress were to be very 
aggressively involved in reinterpreting or redefining 404 or 
any of the obligations of Sarbanes-Oxley, is there any 
particular empirical reason to think Congress is likely to be 
more efficient or more effective than say you at the SEC.
    Mr. Cox. Taking your question dead seriously, not only is 
it reasonable to expect the regulators to take that ball and 
run with it, I think there is an ample blueprint in 404 to get 
the job done properly. But also with 404 there was a 
legislative antecedent so Congress was not inventing from 
scratch in the case of section 404 and there was every reason 
to think that the regulatory follow-through would bear some 
distinct relation to its antecedent in FDICIA. It has not. I 
think we can do a much better job there, and we are very 
determined to do so.
    Mr. Davis of Alabama. Let me ask another question. Both of 
you gave for lack of a better term nuanced answers about the 
anticompetitive impact of Sarbanes-Oxley. I think, Chairman 
Cox, you pointed out that there are a variety of factors, for 
example, that might explain the surge in European and Asian 
IPO's as compared to American IPO's. You mentioned the state-
based nature of a lot of the new public offerings, you 
mentioned genuine market forces that might have nothing to do 
with regulation, and then in the context of regulation you 
mentioned the overall backdrop of the American economy, the 
fact that way beyond Sarbanes-Oxley we have a variety of tax 
laws and regulatory structures. And finally, you mentioned in 
some instances there is a class of companies who prefer less 
transparency, which is obviously not an American value.
    What is the best empirical case that Sarbanes-Oxley and 
section 404, as we are currently interpreting it, is having an 
anticompetitive impact on our capital markets?
    Mr. Cox. Even though you didn't invite me to do so, I am 
going to answer that question directly. But I want to couple it 
with a restatement of what I mentioned earlier, and that is 
that we have concluded that the SEC, after careful evaluation 
of the first two full reporting cycles, that this compliance 
has benefits. So as I talk about the costs and some of the 
consequences we don't like, I want to underscore that.
    But getting directly to your question of anticompetitive 
effects, the best evidence is probably the least reliable from 
a social science standpoint. It is the testimonial evidence of 
people involved in the markets. It is not quantitative; it is 
subjective; but it is oft repeated and comes not only from 
market participants in this country but from around the world. 
We have had occasion to provide the forum for these comments at 
SEC roundtables. We have also participated in international 
events here and overseas. And of course we have daily 
intercourse with market participants as a result of our 
oversight responsibilities, and in all of these ways it has 
become abundantly clear that market participants are making 
this claim.
    The Chairman. One more?
    Mr. Davis of Alabama. One quick one, Mr. Chairman. The only 
thing that is unusual about that and somewhat troubling to me, 
Mr. Cox, is the collection of all the anecdotal evidence in the 
world is often not powerful for a very simple reason. If there 
were a strong anticompetitive impact, it would seem there 
should be some quantitative evidence that is not capable of 
being sorted out but some direct quantitative evidence that can 
be linked directly to Sarbanes-Oxley. And that is my only 
observation today. I have heard the anecdotes, as you have; I 
have heard the opinions of my colleagues. I am still searching 
somewhere for some specific evidence of anticompetitive impact 
by 404 as we interpret it today, and what I hear today is 
frankly more anecdote than specifics, but that is not your 
fault.
    Mr. Cox. I should add I didn't mean to imply with my 
answer, because I took your question very literally: what is 
the best evidence? I didn't mean to imply that there isn't 
quantitative evidence as well; there is. The quantitative 
evidence most frequently cited today in this hearing was IPO's. 
That is probably datum selected because for seasoned issuers, 
for companies already listed on the exchange, it is a little 
more cumbersome to delist, to go elsewhere and so on. The 
election one makes where to list in the first instance is a 
much more flexible choice. What one makes of those arguments, 
and there are different ways of presenting it, is again a 
subjective thing, however, and that data is susceptible to a 
variety of interpretations. But I think there certainly is some 
quantitative data that would support claims that section 404 
has imposed undesirable costs.
    The Chairman. The gentleman's time has expired.
    The Chair would wish to thank both Chairmen for what I 
think the members agree would be a most instructive and helpful 
final hearing for this committee and to get all of the issues 
out on the table regarding the Act and, more importantly, your 
concerted efforts and positive input in making this Act work 
for our capital markets, and for that we are most grateful.
    The committee is adjourned.
    [Whereupon, at 4:48 p.m., the hearing was adjourned.]


                            A P P E N D I X



                           September 19, 2006


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