[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
                       FULL COMMITTEE HEARING ON 
                      SARBANES-OXLEY SECTION 404: 
                       NEW EVIDENCE ON THE COSTS 
                          FOR SMALL BUSINESSES 

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

                      COMMITTEE ON SMALL BUSINESS
                 UNITED STATES HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                           DECEMBER 12, 2007

                               __________

                          Serial Number 110-63

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house

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                   HOUSE COMMITTEE ON SMALL BUSINESS

                NYDIA M. VELAZQUEZ, New York, Chairwoman


HEATH SHULER, North Carolina         STEVE CHABOT, Ohio, Ranking Member
CHARLIE GONZALEZ, Texas              ROSCOE BARTLETT, Maryland
RICK LARSEN, Washington              SAM GRAVES, Missouri
RAUL GRIJALVA, Arizona               TODD AKIN, Missouri
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
MELISSA BEAN, Illinois               MARILYN MUSGRAVE, Colorado
HENRY CUELLAR, Texas                 STEVE KING, Iowa
DAN LIPINSKI, Illinois               JEFF FORTENBERRY, Nebraska
GWEN MOORE, Wisconsin                LYNN WESTMORELAND, Georgia
JASON ALTMIRE, Pennsylvania          LOUIE GOHMERT, Texas
BRUCE BRALEY, Iowa                   DEAN HELLER, Nevada
YVETTE CLARKE, New York              DAVID DAVIS, Tennessee
BRAD ELLSWORTH, Indiana              MARY FALLIN, Oklahoma
HANK JOHNSON, Georgia                VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania             JIM JORDAN, Ohio
BRIAN HIGGINS, New York
MAZIE HIRONO, Hawaii

                  Michael Day, Majority Staff Director

                 Adam Minehardt, Deputy Staff Director

                      Tim Slattery, Chief Counsel

               Kevin Fitzpatrick, Minority Staff Director

                                 ______

                         STANDING SUBCOMMITTEES

                    Subcommittee on Finance and Tax

                   MELISSA BEAN, Illinois, Chairwoman


RAUL GRIJALVA, Arizona               DEAN HELLER, Nevada, Ranking
MICHAEL MICHAUD, Maine               BILL SHUSTER, Pennsylvania
BRAD ELLSWORTH, Indiana              STEVE KING, Iowa
HANK JOHNSON, Georgia                VERN BUCHANAN, Florida
JOE SESTAK, Pennsylvania             JIM JORDAN, Ohio

                                 ______

               Subcommittee on Contracting and Technology

                      BRUCE BRALEY, IOWA, Chairman


HENRY CUELLAR, Texas                 DAVID DAVIS, Tennessee, Ranking
GWEN MOORE, Wisconsin                ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York              SAM GRAVES, Missouri
JOE SESTAK, Pennsylvania             TODD AKIN, Missouri
                                     MARY FALLIN, Oklahoma

        .........................................................

                                  (ii)

  


           Subcommittee on Regulations, Health Care and Trade

                   CHARLES GONZALEZ, Texas, Chairman


RICK LARSEN, Washington              LYNN WESTMORELAND, Georgia, 
DAN LIPINSKI, Illinois               Ranking
MELISSA BEAN, Illinois               BILL SHUSTER, Pennsylvania
GWEN MOORE, Wisconsin                STEVE KING, Iowa
JASON ALTMIRE, Pennsylvania          MARILYN MUSGRAVE, Colorado
JOE SESTAK, Pennsylvania             MARY FALLIN, Oklahoma
                                     VERN BUCHANAN, Florida
                                     JIM JORDAN, Ohio

                                 ______

            Subcommittee on Urban and Rural Entrepreneurship

                 HEATH SHULER, North Carolina, Chairman


RICK LARSEN, Washington              JEFF FORTENBERRY, Nebraska, 
MICHAEL MICHAUD, Maine               Ranking
GWEN MOORE, Wisconsin                ROSCOE BARTLETT, Maryland
YVETTE CLARKE, New York              MARILYN MUSGRAVE, Colorado
BRAD ELLSWORTH, Indiana              DEAN HELLER, Nevada
HANK JOHNSON, Georgia                DAVID DAVIS, Tennessee

                                 ______

              Subcommittee on Investigations and Oversight

                 JASON ALTMIRE, PENNSYLVANIA, Chairman


CHARLIE GONZALEZ, Texas              LOUIE GOHMERT, Texas, Ranking
RAUL GRIJALVA, Arizona               LYNN WESTMORELAND, Georgia

                                 (iii)

  

























                            C O N T E N T S

                              ----------                              

                           OPENING STATEMENTS

                                                                   Page

Velazquez, Hon. Nydia M..........................................     1
Chabot, Hon. Steve...............................................     2

                               WITNESSES


PANEL I
Cox, Hon. Christopher, Chairman, Securities and Exchange 
  Commission.....................................................     4


PANEL II
Ryan, Jr., Mitchell, U.S. Chamber of Commerce....................    16
Grossblatt, Harvey, Universal Security Instruments, Inc., AMEX...    18
Loving, Bill, Pendleton Community Bank, Independent Community 
  Bankers Association............................................    20
Brandt, Jr., Thomas, TeleCommunication Systems, Inc., AeA........    21
Greene, Shannon, Tandy Leather Factory, Inc......................    23

                                APPENDIX


Prepared Statements:
Velazquez, Hon. Nydia M..........................................    35
Chabot, Hon. Steve...............................................    37
Cox, Hon. Christopher, Securities and Exchange Commission........    38
Ryan, Jr., Mitchell, U.S. Chamber of Commerce....................    43
Grossblatt, Harvey, Universal Security Instruments, Inc., AMEX...    50
Loving, Bill, Pendleton Community Bank, Independent Community 
  Bankers Association............................................    53
Brandt, Jr., Thomas, TeleCommunication Systems, Inc., AeA........    61
Greene, Shannon, Tandy Leather Factory, Inc......................    67

Statements for the Record:
Biotechnology Industry Organization..............................    72
American Federation of Labor and Congress of Industrial 
  Organizations..................................................    76

                                  (v)

  


                       FULL COMMITTEE HEARING ON
                      SARBANES-OXLEY SECTION 404:
                       NEW EVIDENCE ON THE COSTS
                          FOR SMALL BUSINESSES

                              ----------                              


                      Wednesday, December 12, 2007

                               Committee on Small Business,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 10:00 a.m., in Room 
2360 Rayburn House Office Building, Hon. Nydia Velazquez 
[chairwoman of the Committee] presiding.
    Present: Representatives Velazquez, Gonzalez, Cuellar, 
Altmire, Clarke, Sestak, Hirono, Chabot, Akin, Westmoreland, 
Davis, Fallin, and Buchanan.

           OPENING STATEMENT OF CHAIRWOMAN VELAZQUEZ

    Chairwoman Velazquez. Good morning. I call this hearing to 
order.
    This morning the Committee will continue its oversight of 
the implementation of Section 404 of the Sarbanes-Oxley Act. 
With businesses beginning the process of meeting these 
requirements, now it is an appropriate time to reevaluate the 
burden associated with compliance.
    Since its inception, SOX 404 has presented a unique 
challenge for small firms. While they saw the importance of its 
core goals, many could not afford the high expenses associated 
with compliance. In fact, the cost of implementing it has 
caused many entrepreneurs to reconsider whether the benefit of 
being a public company is worth it at all. The rise of foreign 
stock exchanges in so-called Sarbanes-Oxley free zones has 
started to turn what many considered a myth into reality. 
Section 404, as currently configured, may be undermining the 
competitiveness of American companies.
    I am glad that the SEC recognizes that SOX 404 is a 
substantial burden for small firms. Chairman Cox is to be 
commended for soon undertaking an intensive analysis of 
compliance data and proposing an extension of the compliance 
date for Section 404(b). This will allow all interested parties 
to better understand the impact that this regulation will have 
before it is mandated.
    The recent study by the U.S. Chamber of Commerce, along 
with the American Bankers Association, the American Stock 
Exchange, and the Institute of Management Accountants, has 
provided a foundation for the SEC's subsequent work. The 
Chamber's survey was designed to collect data directly from 
small companies about the actual and expected costs related to 
meeting the requirements of Section 404.
    This constitutes the first and only data concerning SOX 404 
costs that has been released since July when the SEC approved a 
revised auditing standard. When the Committee last examined 
this issue in June, we did not have meaningful data with 
respect to compliance costs. The lack of this information 
limited the Committee's ability to fully assess the deadlines 
that the SEC has established for small firms.
    The survey data confirms what many have suspected--that the 
costs are, in fact, significant, and small companies are 
already incurring steep expenses. More than half of respondents 
indicated that they will spend more than 3 percent of net 
income implementing the requirements of Section 404(a) alone. 
And many small firms are beginning to prepare for 404(b), even 
though it is more than a year away. Sixty-six percent of survey 
respondents have already engaged an auditor as they prepare to 
comply with this requirement.
    The survey data highlights that a postponement, if it is to 
provide meaningful relief for small firms, must be issued as 
soon as possible. It is my hope that the SEC will act on the 
proposed delay immediately. Doing so will allow the Commission 
the time it needs to gather meaningful data before small firms 
are forced to comply with the untested revised rules.
    With Chairman Cox's proposal today, our attention now turns 
to ensuring that the agency's collection and analysis is 
accurate and thorough. This assessment is key in ensuring that 
SOX 404 regulations are right-sized and do not unnecessarily 
burden small companies. I look forward to working with the SEC 
on this evaluation.
    SOX 404, like so many regulations, is very burdensome and 
expensive for small companies. The SEC--and all federal 
agencies for that matter--must do more to ensure that we do the 
up front analysis to limit the impact on such a key segment of 
our economy.
    That is why this Committee will soon be considering 
legislation to expand and strengthen the Regulatory Flexibility 
Act--a key tool that gives small firms a voice in the 
rulemaking process. By doing so, we will be better able to 
preserve the entrepreneurial environment that has made the 
United States a global leader in so many industries.
    I would like to thank in advance Chairman Cox and all of 
the witnesses for their testimony today. And I now recognize 
Mr. Chabot for his opening statement.

                OPENING STATEMENT OF MR. CHABOT

    Mr. Chabot. I want to thank the Chairwoman for holding this 
second hearing on the implementation of Section 404 of the 
Sarbanes-Oxley Act and its impact on small publicly-traded 
companies. And I want to extend a very warm welcome to our 
former colleague from California, Chris Cox, the Chairman of 
the Securities and Exchange Commission. He was certainly a very 
valuable member of Congress when he was here, one of the top 
leaders in Congress during those years, and he is once again 
serving his country very well in his capacity. So we welcome 
you here this morning, Mr. Chairman.
    Of particular concern is whether the financial controls and 
audit standards required for compliance with Section 404 
imposes undue costs on small companies and impedes their 
ability to raise capital. Like the securities laws of the New 
Deal, Sarbanes-Oxley, or SOX, was a response by Congress to a 
crisis in confidence about the market for publicly-traded 
securities.
    Unlike the endemic problems that caused the stock market 
crash back in 1929, and resulted in much tougher securities 
laws, SOX was a response to a few spectacular but isolated 
instances of extreme corporate greed and criminal behavior on 
the part of a small coterie of corporate executives from 
companies, including Enron, WorldCom, Adelphia, and 
HealthSouth, for example.
    One of the broad issues that the Committee continues to 
consider is whether SOX, especially Section 404, represents the 
appropriate response to these criminal acts or an overreaction 
that has unnecessarily burdened small public companies. Today's 
hearing will examine some recent data developed by the United 
States Chamber of Commerce concerning the cost that small 
public companies will incur to comply with the requirements of 
SOX.
    I think it is particularly relevant to focus on how the 
Securities and Exchange Commission considered costs in the 
development of its most recent interpretations on SOX 
compliance. The assessment of costs is a key component of an 
agency's compliance with the Regulatory Flexibility Act, 
something that the Committee recently assessed in two separate 
hearings.
    I raise the issue of compliance with the RFA, because a 
review of the Commission's most recent issuances demonstrates a 
greater need for more accurate cost data to understand the 
impact that the SEC's rules concerning SOX compliance will have 
on small public companies. I am heartened to read in your 
testimony that the Commission, under your leadership, will do a 
full study of the costs faced by small companies.
    This data, then, should be used to perform a regulatory 
flexibility analysis, so the Commission can assess appropriate 
alternative methods for compliance with Section 404(b) of SOX. 
I look forward to hearing from our distinguished group of 
witnesses on these other issues concerning the implementation 
of SOX.
    And I must mention that I, unfortunately, am going to be 
called to another Committee, the Judiciary Committee. We are 
working on the subprime mortgage crisis that has hit the whole 
country, but four states thus far in particular, one being 
Ohio, my State, the others California, Florida, and Michigan 
especially. And we have reached a manager's amendment in a 
bipartisan manner, and so I, unfortunately, need to be over 
there. So I apologize to any of the witnesses, and I apologize 
to you, Mr. Chairman.
    However, we are going to have Dave Davis, who is going to 
fill in here for us, to make sure the Democrats don't get too 
out of hand here on this Committee.
    [Laughter.]
    No. Just kidding. This is one of the committees that really 
has a very excellent relationship, both between the chair and 
the ranking member and the staff and the members of the 
Committee. So this is one that really does work around here and 
has been responsible for passing quite a few bills in a 
bipartisan manner.
    So I want to, once again, commend the Chairwoman for her 
hard work in this, and I want to thank Mr. Davis for filling 
in. And if he has to go, I believe Mr. Westmoreland is also 
going to fill in for a while. And I will be back just as soon 
as I possibly can, and I yield back.
    Chairwoman Velazquez. For the record, not just some bills, 
20 bills.
    Mr. Chabot. Twenty bills.
    Chairwoman Velazquez. Most productive in the last two 
decades.
    Mr. Chabot. Most productive Committee in Congress, right?
    Chairwoman Velazquez. That is right.
    Mr. Chabot. That is right.
    Chairwoman Velazquez. So now we will proceed with our first 
panel, and I just want to extend the warmest welcome to our 
former colleague, The Honorable Christopher Cox. Mr. Cox is the 
28th Chairman of the Securities and Exchange Commission. He was 
appointed by President Bush on June 2, 2005, and unanimously 
confirmed by the Senate on July 29, 2005.
    During his tenure at the SEC, Chairman Cox has brought 
ground-breaking cases against a variety of market abuses, 
including hedge funds, inside trading, stock options 
backdating, and securities scams on the Internet. Prior to 
joining the Securities and Exchange Commission, Chairman Cox 
served for 17 years in Congress where he held a number of 
positions of leadership in the United States House of 
Representatives.
    Mr. Cox, welcome.

     STATEMENT OF THE HONORABLE CHRISTOPHER COX, CHAIRMAN, 
      SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, D.C.

    Mr. Cox. Thank you very much, Madam Chairman, and members 
of the Committee. It is a pleasure to be here to testify on 
behalf of the Securities and Exchange Commission concerning the 
costs and benefits of Sarbanes-Oxley Section 404 for small 
businesses.
    The Commission, just like this Committee, shares an abiding 
concern for America's smaller public companies. Since Sarbanes-
Oxley became law in 2002, the Securities and Exchange 
Commission has not applied Section 404 to smaller public 
companies. In addition, we recently issued guidance intended to 
make the process for smaller public companies more economical 
and more efficient for the time when eventually they do come 
into compliance.
    The Commission's decision to proceed cautiously in 
deference to smaller public companies and their investors is 
due in significant part to the fact that the cost of 
regulation, as you all well know, falls heaviest on smaller 
companies, both on a per employee basis and as a proportion of 
revenues. It would be impossible for us at the SEC to succeed 
in our mission if we didn't focus directly on the needs of 
smaller public companies. For that very reason, the SEC has a 
long history of listening to smaller public companies and 
assisting them in their efforts to raise capital.
    Just three weeks ago, we adopted new rules designed to make 
it much simpler and easier for smaller public companies to 
raise capital. Now any small public company with a public float 
of up to $75 million can use these simpler rules, compared to 
the $25 million cap that used to be in place under the old 
rule. That means another 1,500 public companies will be able to 
use our simplified disclosure and reporting.
    We also further simplified the rules themselves. We 
eliminated five forms, and we eliminated 36 separate items that 
used to comprise Regulation S-B. We have also made it more 
economical for smaller companies to sell restricted securities 
under Rule 144 by reducing the holding period from one year to 
six months, and by eliminating many of the other restrictions.
    And non-affiliates won't have to file forms at all anymore. 
That change will reduce the number of Form 144s filed with the 
Securities and Exchange Commission by nearly 60 percent. These 
are all ways to cut the cost of capital for smaller public 
companies and for small businesses without sacrificing investor 
protection.
    We also changed the rules to protect private companies that 
offer stock option plans for their employees. Many small, 
privately-held companies were concerned that they might 
accidentally be required to register as public companies even 
though they don't have any public shareholders. Our new rule 
fixes that.
    In taking these steps, we have been responding to several 
key recommendations of the SEC's Advisory Committee on Smaller 
Public Companies. One of the Advisory Committee's most 
important recommendations is the topic that we are focused on 
this morning. Specifically, the Advisory Committee recommended 
that smaller companies should not be made to comply with 
Section 404's external audit requirement ``unless and until 
there is a framework for assessing internal control over 
financial reporting for such companies that recognizes their 
characteristics and needs.''
    With that very recommendation in mind, the Commission 
delayed Section 404 compliance for smaller public companies and 
set to work on providing guidance for those companies that 
would recognize that their needs are different than those of 
larger companies. During the last few years, the Commission and 
the Public Company Accounting Oversight Board have worked 
together to completely repeal the old, inefficient system of 
implementing Section 404.
    The SEC published guidance specifically for management, 
which had not been done before, and both we and the PCAOB 
approved a completely new standard for Section 404, AS-5--that 
is, top-down, risk-based materiality focused and scalable for 
companies of all sizes.
    Our SEC management guidance, intended for the company's own 
use, will relieve smaller companies from having to rely on the 
audit standard as their de facto rule book. For smaller public 
companies, the guidance will be in place the very first time 
that they come into compliance, so that they can avoid wasteful 
and unnecessary compliance efforts that others have had to 
endure under the old standard.
    When eventually smaller public companies do come into full 
compliance, as the law requires, the new audit standard will 
encourage the scaling of all audits to reflect each company's 
circumstances rather than a single checklist for all 
situations. And to ensure that this is what actually happens, 
the SEC will conduct a study, as you have all mentioned here 
this morning, of the costs and benefits of 404 compliance under 
the new auditing standard and the new management guidance.
    Currently, under the direction of the Office of Economic 
Analysis, the SEC staff is preparing to gather and analyze 
real-world data. The study will seek to identify trends and 
provide a comparison to costs under the old standard. The study 
will also pay special attention to those small companies that 
are complying with Section 404 for the first time.
    This survey of cost and benefits will have two main parts. 
First, there will be a web-based survey of companies that are 
subject to Section 404; and, second, we will conduct in-depth 
interviews with a subset of companies, including those that are 
just now beginning their 404 compliance. This dual approach 
will allow us to gather data from a large cross-section of 
companies, while providing more detailed information about what 
drives the costs and where companies derive the benefits.
    Because we are intent on using real-world data based on 
companies' actual experiences, this survey will be taking place 
in the coming months as companies for the first time use the 
new auditing standard and the new management guidance. Because 
we have to rely on the actual costs that haven't been incurred 
yet, the study and analysis of the results can't be completed 
before June 2008.
    Under the current schedule, smaller public companies would 
be expected to begin complying with Section 404(b) for fiscal 
years ending after December 15, 2008, so the result is that 
unless there is an additional deferral companies would incur 
compliance costs before the SEC has the benefit of the study 
and the analysis. As a result, I intend to propose to the 
Commission that we authorize a further one-year delay in 
implementation for small businesses in order to base our 
decision on final implementation of Section 404(b) on the best-
available cost data.
    Since I last testified before the Committee this summer, 
the SEC and the PCAOB have undertaken comprehensive outreach to 
help the small business community prepare to meet their 
obligations under Section 404(a). This outreach has included a 
half-dozen forums around the country. To make sure that our 
guidance is useful and understandable for smaller companies, we 
have also published a brochure designed specifically for the 
management of small businesses. It explains in plain English 
how to evaluate internal controls and how to determine whether 
they are effective.
    We have spent a lot of time distilling the key principles 
of our management guidance into this easy-to-read brochure, and 
we hope that all companies, large and small, will read it. It 
is, of course, available on the web at www.sec.gov.
    Madam Chairman, it is the SEC's intention that our new 
guidance for management and the PCAOB's new standard for 
auditors will lower overall compliance costs for companies of 
all sizes, and significantly so compared to the old standard. 
We expect that compliance costs under Section 404(a) should 
come down disproportionately for small business, because the 
new SEC guidance that has been developed specifically for 
management will allow each small business to exercise 
significant judgment in designing an evaluation that is 
tailored to its individual circumstances.
    Unlike external audits, management in a small company tends 
to work with its internal controls on a daily basis. They have 
a great deal of knowledge about how their company works, what 
goes on inside, and how the firms operate. The new guidance 
allows management to make use of that knowledge, which should 
lead to a much more efficient assessment process.
    We state clearly in the brochure for small business that 
under normal circumstances they don't need to hire extra help 
to do their assessment. They certainly don't need to engage an 
outside auditor for this purpose. The normal company personnel 
who are responsible for this work should be able to do it as 
part of their routine duties. The goal of all of these efforts 
is to implement Section 404 just as Congress intended--in the 
most efficient and effective way to meet our objectives of 
investor protection, well functioning financial markets, and 
healthy capital formation for companies of all sizes.
    We won't forget the failures that led to the passage of the 
Sarbanes-Oxley Act in the first place, and we won't forget that 
for a small business to continue to prosper in America both 
strong investor protection and healthy capital formation must 
go hand in hand.
    Thank you again for the opportunity to speak on behalf of 
the Commission. I would be happy to answer your questions.
    [The prepared statement of Mr. Cox may be found in the 
Appendix on page 38.]
    Chairwoman Velazquez. Thank you, Mr. Chairman. And I am 
very, very encouraged by your announcement this morning. Mr. 
Chairman, during the Committee's hearing on June 5, you 
indicated that you would be willing to consider supporting such 
a delay, if it was warranted. At that time, you also indicated 
that you did not believe that a delay was necessary. You now 
support a delay. What changed your mind?
    Mr. Cox. The schedule really requires that if we are going 
to use cost data that we have at least a one-year delay. 
Otherwise, what will happen is that companies will have to 
incur costs waiting for our decision based on the real-world 
data, and then we might at the eleventh hour tell them, ``We 
are sorry. Never mind. Let us wait until we get this right.''
    There is a better way to do it, and that is to take all of 
the real-world data, analyze it, make a decision, and then go 
forward.
    Chairwoman Velazquez. When do you expect that the SEC will 
vote on your proposed delay?
    Mr. Cox. Madam Chairman, that is an excellent question. I 
have had the opportunity to talk to all of the Commissioners 
about this, so that while there has not been formal Commission 
action yet, I do have an informal sense of Commissioner support 
for this proposal. And I hope that reasonably early in 2008 we 
will be able to have an open meeting to do this.
    It is also possible, in fact, I will have to consult with 
the General Counsel and with the Division of Corporation 
Finance, that as has been done in the past this could be done 
by staff action without need of a formal Commission open 
meeting, in which case we could do it even more quickly.
    Chairwoman Velazquez. So if there are procedural steps that 
accompany this rule change, when do you expect that an SEC 
decision in favor of a potential delay will be finalized, if 
there are procedural steps that need to go with the delay?
    Mr. Cox. Well, you know, but for the fact that we are just 
now entering on the holiday season, and New Year's Day is less 
than three weeks away, I would say we could do it even this 
year. But I think realistically the earliest we could do this 
would be during the month of January.
    Chairwoman Velazquez. The month of January.
    Mr. Cox. Yes.
    Chairwoman Velazquez. I understand that the SEC will soon 
undertake its own data collection effort with respect to SOX 
404. And the data the Commission collects will undoubtedly be 
very helpful in determining whether SOX 404 compliance 
continues to be burdensome for small firms. Can you provide 
details as to what companies will be surveyed, when it will 
begin, and how the data will be analyzed?
    Mr. Cox. Yes, I can do so in a general way in this hearing, 
and in a more detailed way between the Committee staff and our 
staff, as you might imagine, because the study is being 
designed by the Office of Economic Analysis. There are some 
general descriptors I can use, but there is also a fair amount 
of detail that you might be more comfortable getting from the 
experts.
    As I described in my opening statement, there are two main 
parts to the survey. We are trying to be both broadly 
horizontal and also do a deep dive into some companies' 
experiences in detail to make sure that we are not missing 
anything. The broad-based survey could potentially include 
virtually every company in this category, depending on the 
level of response to a web-based survey and how successful we 
are in eliciting that response.
    The detailed analysis will be based on the experiences of 
companies that are selected because of their typicality, and 
because we think we can infer the most useful information from 
their experiences.
    Chairwoman Velazquez. But let me ask you, my concern is 
if--will small companies and other interested parties will be 
able to contribute their recommendations about how to conduct 
the most effective data collection effort?
    Mr. Cox. Yes. The kind of input that you are talking about 
into the design process is very much a part of what we have in 
mind.
    Chairwoman Velazquez. Once the data has been collected, 
would you be able to share that data publicly?
    Mr. Cox. I would expect so. I think the entirety of this 
needs to be public in order for the public rulemaking process, 
public program of the SEC, and public company compliance all to 
work.
    Chairwoman Velazquez. Mr. Chairman, the SEC's data 
collection effort will be critically important to small 
companies, no doubt about it. It may provide the evidence that 
SOX 404, in particular Section 404(b), needs to be further 
revised for small companies. What sort of results would the SEC 
have to see to significantly revise how 404(b) is implemented?
    Mr. Cox. Well, ultimately, we are constrained by the 
statute itself, and so while there are a great deal of 
accommodations that can be made in terms of implementation such 
as have already been spelled out in our management guidance, 
and in the audit standard, I think that wholesale change in the 
way that 404(b) applies is a matter not for the SEC but for 
Congress.
    Chairwoman Velazquez. Thank you. And now I recognize Mr. 
Davis.
    Mr. Davis. Thank you, Madam Chairman, and thank you, Mr. 
Chairman. Thank you for being with us today. We appreciate your 
leadership.
    You mention in your written testimony that you would 
propose a delay in implementation to the small business in 
order to base your decisions on final implementation of Section 
404(b). Will that decision--will the decision on whether to 
implement a further delay of implementation be based solely on 
the results of the data gathered?
    Mr. Cox. I think that it will be based on the totality of 
information that we possess, but the only new information will 
be the results of the cost study.
    Mr. Davis. And what type of factors will you be looking at 
on the delay? It looks like it is going to happen, the delay 
will be put forth. But what type of factors will you be looking 
for?
    Mr. Cox. Oh, I am sorry. I may have misunderstood your 
question. I thought you were talking about what we might do 
after we got the cost data. But you are asking me about--
    Mr. Davis. What type of factors will go into making that 
decision?
    Mr. Cox. Well, that analysis is actually very simple. It is 
a question of whether or not we believe that it would be 
beneficial for investors, for issuers, and for the markets to 
have the benefits of this cost study and analysis before we 
make a final decision. Speaking for myself as Chairman, I think 
that is the better part of wisdom. That is the most orderly 
process.
    Otherwise, we will find ourselves halfway or three-quarters 
of the way down the road of the first year of compliance for 
smaller companies with 404(b) at a time when we then take a 
look at cost data and say, ``We did not expect this result. We 
are going to reverse course.'' It would be very disruptive for 
companies that are trying to comply in an orderly way.
    Mr. Davis. Okay. What efforts is the SEC doing to ensure 
that auditors do not take advantage of small business filers?
    Mr. Cox. We have been, and the PCAOB has been, engaged very 
directly with auditing firms of all sizes, but particularly 
those who cater to smaller public companies, to make sure that 
they understand when the PCAOB and the SEC repealed AS-2 and 
substituted the new top-down, risk-based materiality-focused, 
scalable AS-5, that we did so with a strong view to gaining 
efficiencies.
    The costs of Section 404 implementation have got to be 
outweighed by the benefits. That is what Congress intended. I 
know this from speaking to all of the members, both the House 
and Senate side, who have been so concerned about this. I know 
this from speaking to companies, issues, and investors at our 
roundtables.
    People want the benefits of Section 404. Nobody is saying 
we shouldn't get those benefits, but they are trying to make 
sure that there is some correlation between the way the thing 
is implemented and the benefits that the market gets. And so we 
are going to keep all of those factors in mind in making these 
decisions.
    Mr. Davis. Thank you for your dialogue with those that fall 
in with members of Congress to make sure that we have that open 
debate. You stated that the SEC will monitor the effectiveness 
of public company accounting oversight boards inspections of 
whether audit firms are implementing the new auditing 
standards. Could you explain how this process will work?
    Mr. Cox. Yes. It works in a number of ways. In the most 
formal way, it is a function of the inspection process being 
carried out first by the Public Company Accounting Oversight 
Board, which is inspecting the audit firms for 404 
efficiencies, and then by our own inspection at the SEC of the 
PCAOB's inspection process with a view to the same 
efficiencies.
    So the firms, the auditing firms, who are being inspected 
by the PCAOB are getting the full force and effect of the SEC 
and PCAOB inspection process aimed at efficiency. They know 
that we are quite serious about making sure that AS-5 is 
implemented as intended.
    Second, the PCAOB and the SEC are routinely engaged with 
the firms in discussions of these issues. Our Office of the 
Chief Accountant, for example, on a daily basis discusses these 
topics with the auditing firms. And, thirdly, I and the other 
Commissioners and the staff of the SEC have a number of 
informal opportunities, some of them slightly more formal--for 
example, at our roundtables and others, a part of our 
interaction through meetings and our officers and around the 
country, as I have described in my testimony, to focus 
attention on these matters.
    But changing the way that people operate is very much what 
the PCAOB and the SEC had in mind by repealing AS-2 and 
substituting AS-5.
    Mr. Davis. You stated earlier this year that Congress never 
intended the 404 process to become inflexible, burdensome, and 
wasteful. Do you still hold those views? And what is your 
response?
    Mr. Cox. I do. And because I was a member of the House 
Senate Conference Committee that wrote Sarbanes-Oxley, and 
because I was there on the floor when we were all speaking 
about it, I know that not a single member from any state got up 
and said, ``I want a process that is inefficient, costly, and 
burdensome, that destroys American competitiveness.'' Nobody 
said that. Nobody thinks that that is what this law is all 
about.
    What people wanted was a law that gave investors greater 
confidence that the numbers that they were relying on to make 
their financial choices were solid and good, that the 
pathologies that we saw manifested in the cases that 
Congressman Chabot listed--Enron, Worldcom, Adelphia, and so 
on--that all of those things would be dealt with in the most 
serious fashion by our law enforcement system, that reliability 
would be the touch-tone of our financial reporting in the 
United States. That is what this was all about. And there is a 
way to do all of that without crushing the whole enterprise in 
the process.
    Mr. Davis. One final question. A moment ago you talked 
about collecting data. Once you have that data, what will SEC's 
decision process be dealing with Sarbanes-Oxley compliance?
    Mr. Cox. Yes. I apologize for beginning to answer that 
question earlier, because I thought that was your earlier 
question. At that point, we will take the cost data and put it 
together with the totality of information that we have acquired 
through extensive examination of 404 implementation over the 
last several years, and then make a decision about what to do 
next.
    This is the same kind of decision that we have already 
taken with respect to small business on multiple occasions with 
respect to foreign private issuers, with respect to accelerated 
filers, and large accelerated filers in the United States.
    Mr. Davis. Thank you. and thank you, Madam Chairman. I 
yield back.
    Chairwoman Velazquez. Mr. Gonzalez?
    Mr. Gonzalez. Thank you very much, Madam Chairwoman. And 
welcome, Chairman Cox. Good to see you again. And I am glad you 
alluded to the fact that we were all there in 2002 when 
Sarbanes-Oxley was adopted. As a matter of fact, the 
Chairwoman, you, and yours truly were members of the Financial 
Services Committee that probably were the focus of all of the 
hearings, and it was exciting times for all of the wrong 
reasons.
    The witnesses were very, very interesting. Most of those 
witnesses are today in prison, and some of those--and most--
    [Laughter.]
    --of the companies are no longer in existence. And I guess, 
you know, and I don't mean to be flippant about it, but do you 
recall--during all of the hearings that were conducted, and, 
you know, we had Bernie Ebbers there, we had everybody from 
Enron, we had Arthur Andersen, we had everybody there, and it 
was, like I said, exciting times. But do you recall any 
witnesses that were summonsed and testified that represented 
small business public trading companies?
    Mr. Cox. I think the answer to your question is no, and I 
believe--I imagine you don't recall it either, because that 
seemed not to be the focus at the time--and so we can infer 
from the answer to your question--is that this part of the 
analysis is a very important auxiliary.
    Mr. Gonzalez. Yes. And I guess I am just making the point 
that that really wasn't the problem. It wasn't the small 
business publicly-traded companies that created the situation 
that called for Congress to act, which I think was the 
appropriate thing to do. But like in most instances, obviously, 
you know, we cast a wide net many times, and we bring many 
people into it, but it doesn't mean that we can't review what 
we did in 2002 and tweak it, maybe not a wholesale revision, 
and so on.
    I know that former Chairman Oxley was not receptive to the 
idea of visiting Sarbanes-Oxley. That was my understanding a 
year ago. Now we have Chairman Frank. I really don't know his 
position and how flexible he might be in entertaining maybe 
some revisions, again some tweaking to see if we can make it a 
little easier in its application.
    Still provide the public the safeguards that are really the 
essence of the legislation that were a result of certain 
misconduct at a certain level that truly impacted our economy, 
investor confidence, and so on. I think that is the appropriate 
thing.
    And see if I am reading you right in your testimony. There 
is only so much the SEC can do in the implementation to take 
care of the cost, the inconvenience, and of course I think 
there is diminishing return as to the objectives of Sarbanes-
Oxley at the end of this thing. But, really, it probably is up 
to the United States Congress to look at it and to see if 
anything can be done legislatively. Would you agree with that?
    Mr. Cox. Well, I always have a great respect, which I have 
built up over my time serving in this institution, for the role 
of the legislative process and the choices that policymakers 
have before them. That is not our job at the SEC. Our job is to 
make the laws that we did pass work in the best way possible. I 
am of the view, having had--going to my third year experience 
as a regulator looking at this, that it should be able to work 
without legislative change, and that is what we are trying to 
do.
    I say that because while we didn't have small businesses up 
at those hearings focused on Enron and the rest, we all well 
know that financial fraud exists also in smaller public 
companies. And, in fact, in many cases some of the pathologies 
are even worse because the lack of internal controls in some 
small companies are more egregious than could possibly exist in 
a larger company with more routinized processes.
    So the focus on internal controls is not misplaced. It is 
something that small public companies need just like large 
public companies. But what happened, because we had all of our 
focus on enormous firms, is that the system that was designed 
to implement it just didn't fit. We once in a while allude to 
the mythology tale of Procrustes who used to stretch his 
victims onto Procrustean beds, so that eventually they would 
fit. That is a little bit of what we saw going on with small 
business and 404 compliance.
    Lastly, I would just say that while there is enormous 
concern in the small business community about the potential 
effects of SOX 404(b), the small business sector is the one 
group that has never done it. And there is now a new system in 
place which we fully intend will be vastly different than the 
one that they observed other companies having so much trouble 
with.
    So I think the first opportunity we should take is to get 
it right, the way Congress wrote the law, and only failing that 
would policymakers have to come in and do something else.
    Mr. Gonzalez. All right. Well, I appreciate your service, 
and, of course, your testimony today. I yield back.
    Chairwoman Velazquez. Time has expired. Ms. Fallin?
    Ms. Fallin. Thank you, Madam Chairman. Appreciate you 
coming today and talking about a very important issue to our 
business community and the United States. I had a couple of 
questions. Are you going to survey companies that are private, 
but might want to go public?
    Mr. Cox. It is an excellent question. The cost study that 
we are talking about is literally focused on the costs of 
complying with the new management guidance, and the new audit 
standard. And so it would be impossible to derive that 
information from companies that aren't complying and are 
incurring those costs. But survey data of companies that are 
thinking about going public would be enormously useful for 
other purposes.
    Ms. Fallin. Okay. And once the Commission has collected the 
data, what types of action could it take to reduce Sarbanes-
Oxley compliance for the smaller companies?
    Mr. Cox. I think we are going to have to stay with this. I 
have thought all along that writing a new audit standard, and 
writing management guidance that is directed to small business 
and takes into account their special concerns, is only half the 
job. After that, you know, starting with user-friendly things, 
like a brochure for small business that explains in plain 
English what modest steps people can take to get started on 
this, and extending to talking to the audit firms and making 
sure that they are focused on efficiencies and they are not 
taking advantage of their clients, all of these things are 
going to require constant vigilance and maintenance by the SEC.
    Ms. Fallin. Thank you, Madam Chairman. Thank you.
    Chairwoman Velazquez. Ms. Hirono?
     Ms. Hirono. Thank you, Madam Chair. Mr. Cox, I note in 
your testimony that you state clearly in your brochure as to 
the small companies that under normal circumstances they would 
not need to hire an outside auditor to do this assessment as 
required. Now, the reality might be, however, that because 
there are penalties involved in not complying, wouldn't it be 
the case that for most companies that they would want to have 
an outside auditor do this?
    Mr. Cox. I don't think so.
    Ms. Hirono. An auditor do this assessment?
    Mr. Cox. I think the external audit piece clearly 
contemplated as the 404(b), and what we have been careful to do 
is parse that for small businesses as we phase in their 
compliance. So at this point what smaller public companies are 
going to be expected to do is their own assessment.
    Of course, they all have auditors to do their financial 
statements, and the statute itself, you know, contemplates that 
this is something of an integrated process. So there is no rule 
against talking to your auditor and having a good healthy 
dialogue at all times and asking your question about what they 
think.
    But the idea that it is the auditor's job either to design 
the self-assessment or to attest to it as part of this 404(a) 
process I think is very misplaced. And we have been trying to 
focus everyone on that, in the brochure talk about what special 
expertise companies have about this. Companies know how they 
work best of all. They know the risks of their business. They 
know sometimes at a very detailed level what checks might be in 
place--for example, a clerk taking money out of the cash 
register or whatever are the special risks of their business.
    Ms. Hirono. If I could just focus--
    Mr. Cox. Getting an auditor involved in that kind of level 
of detail I think is one of the big problems that we had under 
the old standard.
    Ms. Hirono. I understand what you are saying. It is 
laudable that you would want to say to the small companies, 
``You don't need to go out and spend money and have an outside 
auditor.'' However, because of the penalties that would be 
involved, and you also noted that for small companies there may 
be more concern about in-house kinds of assessments and--
    Mr. Cox. I should just add that the penalties that attach 
are the penalties that have always attached to having something 
wrong with your financial statements. In the phase-in that--as 
we have laid it out for smaller business, the 404(a) process 
results in a management's assessment that is furnished and not 
filed with the SEC. That means there is no different penalty 
that attaches.
    The only penalties are the ones that they have always had 
and have right now, and that is for filing financial statements 
with something wrong with them. But nothing different about the 
internal controls assessment.
    Ms. Hirono. Well, that is also reassuring. So your feeling 
is that once you are able to, through a brochure like this, and 
your efforts to meet with the small business community, and to 
reassure them that they do not have to spend all kinds of money 
to be able to comply with 404(b), that in fact the new rules 
that you have adopted will not have such an adverse impact on 
small business companies' ability to comply.
    Mr. Cox. Yes. In fact, I--
    Ms. Hirono. What is your expectation?
    Mr. Cox. --would go so far as to say that if we get this 
right, ultimately the greater investor confidence that would 
result from this process could reduce the cost of capital for 
smaller businesses. Not to say they won't have an outlay to do 
the compliance, but if cost of capital is a function of 
investor conference or concern at some level, and appreciation 
of risk, there is I think a way for--
    Ms. Hirono. I think that is a good point.
    Mr. Cox. --us all to win at this.
    Ms. Hirono. Thank you. Thank you, Madam Chair.
    Chairwoman Velazquez. Mr. Westmoreland?
    Mr. Westmoreland. I don't really have any questions or 
comments. Good to see you again, and appreciate you all taking 
a good look at this. And hopefully you will come up with a 
decision to maybe put it off another year, but I do appreciate 
your being here and coming to testify.
    Chairwoman Velazquez. Okay. Thank you. Mr. Chairman, I know 
you don't want to stay for the--to listen for the second panel. 
And I would like for you later, before you leave, to identify 
the staff person that will stay here.
    Mr. Cox. Yes. In fact, I think we will have more than one.
    Chairwoman Velazquez. Okay. Great.
    Mr. Cox. But during this morning's second panel, we will 
hear testimony from senior representatives from small 
companies. The witnesses' written statements include clear 
indication of SOX 404 costs, actual and projected, and I would 
like to read to you a few of the figures they will cite.
    University Security Instruments, a non-accelerated filer, 
estimates implementation of SOX 404 as revised will cost the 
company $150,000 to $200,000. Furthermore, they estimate the 
company will incur $100,000 in extra fees each year once their 
company adopts SOX 404. Pendleton Community Bank, a non-
accelerated filer, has already spent $70,000 to comply with the 
revised Section 404 and estimates that coming into full 
compliance will cost the company a total of $218,000. This is 
8.9 percent of anticipated 2007 net income for the bank.
    Tandy Leather Factory, a non-accelerated filer preparing 
for SOX 404 compliance in 2004, spent $157,000 in fees. This 
amounted to 6 percent of the company's earnings in 2004. 
Tandy's auditors indicated in 2006 that the work Tandy has done 
in preparation for SOX 404 compliance was very basic and 
preliminary.
    Mr. Chairman, are these costs in line with your and 
Commission's expectations about reasonable SOX 404 costs for 
non-accelerated filers?
    Mr. Cox. Well, I think we are going to be very interested 
in taking a look at what kinds of activity results in these 
expenses, and comparing it to over the broadest possible sample 
that we can, to provide you with a rigorous answer to that 
question. But that anecdotal evidence is the sort of thing that 
I am sure animates your concerns, because those expenses are 
much higher than what were originally estimated by the 
Commission when the impending rule was adopted and when PCAOB 
first adopted AS-2, the old standard.
    We expect it to be less expensive than that old standard. 
These numbers indicate that that is not so.
    Chairwoman Velazquez. Are there any other members who wish 
to make questions at this point?
    [No response.]
    Mr. Buchanan, we are about to end this first panel. Do you 
have any questions for Mr. Cox?
    Mr. Buchanan. No, thank you.
     Chairwoman Velazquez. Mr. Chairman, I really want to thank 
you for your appearance here this morning, and your willingness 
to listen to small companies. And I want to state for the 
record that I truly personally believe after listening to small 
companies, and holding a hearing not only here in the Small 
Business Committee but also on Financial Services.
    That Section 404(b) is a huge regulation that will redefine 
how small companies access the public market. And I want to 
state that I welcome your reevaluation of this issue, and that 
I want to thank you for the decision that you are making 
regarding delaying the implementation or the compliance of 
Section 404, because this is going to be meaningful to small 
companies. And not only to small companies, but to the auditors 
and to their investors.
    Nobody wants to see small companies fail because of an 
inadvertently burdensome regulation. The delay will also help 
us--Congress and the Commission--assess whether the revised 
rules and auditing standards appropriately balance the costs 
and the benefits of SOX 404 for America's smaller companies. 
And that is our next challenge.
    But before we tackle that one, however, I would like to 
express my personal appreciation to you for your leadership on 
this issue.
    Mr. Cox. Thank you, Madam Chairman. And you also asked that 
I identify the key staff that are here today to listen to the 
next panel. They include the Deputy Chief Accountant for Audit, 
Zoe-Vonna Palmrose, and the Director of the Office of Small 
Business at the SEC, Gerry Laporte.
    Chairwoman Velazquez. And with that, Mr. Chairman, you are 
excused.
    Mr. Cox. Thank you.
    Chairwoman Velazquez. May I ask for the second panel to 
please come forward?
    And now we are going to proceed with the second panel. Our 
first witness is Mr. Michael Ryan, Jr. Mr. Ryan is Senior Vice 
President of the U.S. Chamber of Commerce, and Executive 
Director of the Chamber's Center for Capital Markets 
Competitiveness. The U.S. Chamber of Commerce is the world's 
largest business federation representing three million 
organizations of every size, sector, and region.
    Welcome, Mr. Ryan, and you will have five minutes to make 
your presentation.

  STATEMENTS OF MICHAEL J. RYAN, JR., U.S. CHAMBER OF COMMERCE

    Mr. Ryan. Thank you very much. Good morning, Madam 
Chairman, and members of the Committee. As the Chairwoman said, 
my name is Michael Ryan. I am Executive Director and Senior 
Vice President of the U.S. Chamber of Commerce's Center for 
Capital Markets Competitiveness.
    On behalf of the Chamber, and our small business members, I 
want to thank you for holding this hearing and focusing 
attention on this very important issue. On June 5th, this 
Committee held a similar hearing concerning the 
disproportionate and unnecessary burden that immediate 
application of SOX 404 would have on small companies. Since 
then, the Committee has asked questions of and received answers 
from the SEC concerning its cost-benefit analysis in connection 
with SOX 404 implementation for small public companies.
    More recently, the U.S. Chamber, working with others, 
released the results of a survey conducted to quantify the 
expected cost to small businesses of immediate application of 
Section 404(a) and the application of Section 404(b) beginning 
a year from now, which is the current timeline for these two 
provisions.
    As I begin my testimony, I would like to make several basic 
points. First, small businesses are critical to the long-term 
health and vibrancy of the U.S. economy. They are the source of 
millions of jobs and the incubator of many of the next 
generation of innovative products and services. Second, the 
U.S. Chamber supports the purposes of the Sarbanes-Oxley Act, 
including the application of Section 404 internal control 
provisions to small companies.
    Third, while the recent changes to Section 404 
implementation are positive steps forward, these changes are 
complex and will necessarily be more costly to implement during 
the first year than in future years. Fourth, almost all 
regulation disproportionately burdens small businesses, and 
this will undoubtedly be the case with Section 404, even when 
we get it right.
    Fifth, a one-year delay for small public companies while 
the kinks are worked out would significantly reduce the 
disproportionate burden. And, finally, to realize the maximum 
benefit from a delay, we need that delay to be announced 
immediately. Our survey shows that companies are already 
spending money, and each day that passes undermines the benefit 
a delay would provide.
    Since this Committee's hearing this past summer, new data 
have been collected that sheds light on some small companies' 
cost of compliance with 404. On November 8th, we released a 
study showing that, despite recent reforms, Section 404 will 
disproportionately burden small businesses. Unless the SEC or 
Congress takes action, the current timeline will require small 
public companies with a calendar year end to begin complying 
with 404(a) in early 2008 and 404(b) in early 2009.
    While the SEC has predicted that non-accelerated filers 
would not engage their auditors for SOX 404 compliance until 
the first half of 2008, more than 83 percent of the respondents 
have already done so with respect to 404(a) and 58--more than 
58 percent have done so with respect to 404(b). The study also 
shows that more than half of the companies responding with less 
than $75 million in market value will spend more than 3 percent 
on net income--of net income on Section 404(a). Sixty-three 
percent anticipate a cost increase in the next year due to 
compliance with 404(a) and (b). Finally, more than 58 percent 
of the respondents believe that 404 will not help detect and 
prevent fraud.
    Our study shows why small companies complying for the first 
time should not be guinea pigs for the improved rules adopted 
by the SEC and the PCAOB. We continue to support strong 
internal controls and believe that the improved rules, if 
implemented as intended, will address many of the challenges 
companies face in complying with Sarbanes-Oxley.
    We once again applaud the initiatives made by the SEC and 
the PCAOB to fix the implementation process for Section 404 to 
better reflect the intent of Congress and the needs of 
investors and companies. We view the PCAOB's new auditing 
standard, as well as the SEC's management guidance for 
companies, as a significant step forward. And we commend 
Chairman Cox and Chairman Olson and their respective agencies 
for their leadership, time, and energy to bring balance back to 
the system.
    In the end, we are hopeful that these changes will restore 
the balance we believe Congress intended all along and will 
bring costs more in line with the benefits. Further, we 
recognize and strongly support the efforts the SEC and the 
PCAOB have put forth since May to ensure that auditors and 
public companies alike fully understand the new rule and 
guidance and implement them in as cost effective a manner as 
possible.
    These efforts have taken many forms, including hosting town 
hall meetings around the country and issuing detailed guidance. 
We believe, however, that the need for these efforts--and we 
agree they were needed--only goes to support our argument for 
further delay for small businesses. That is, the changes put in 
place in May by the SEC and the PCAOB are complex, not easily 
understood, and will require a great deal of time and energy to 
work out the details.
    Therefore, implementation in 2007 and 2008 will necessarily 
be more costly than will be the case in future years when much 
of the transition pain will be behind us. In the meantime, U.S. 
small businesses should not have to shoulder the 
disproportionate regulatory burden.
    With a further delay for small businesses we will be better 
able to leverage the experiences of large companies, the 
auditing profession, and regulators to ensure that 
implementation costs are minimized. Failure to do so--failure 
to do this could significantly undermine the cost-cutting 
objectives of the new standards.
    We also need to remain prepared to make additional changes 
if the new rules don't work as intended. At least two of the 
five SEC Commissioners, Commissioners Atkins and Casey, have 
publicly indicated a willingness to consider such a delay. And 
based on the testimony we heard from Chairman Cox just a few 
moments ago, I would add him to that list.
    The Senate Committee on Small Business and 
Entrepreneurship, led by Chairman Kerry and Ranking Member 
Snowe, held a hearing this past April, and these Senators have 
publicly called for further delay. The Office of Advocacy at 
the Small Business Administration has also just--has also 
joined in and asked the SEC to revisit the compliance 
deadlines.
    And just this past week Representative Spencer Bachus, 
ranking member of the House Financial Services Committee, sent 
a letter to Chairman Cox asking for a one-year delay in 
implementation of 404(b). In summary, we believe that we will 
only know if the efforts of the SEC and the PCAOB have been 
successful until after we have experience with the 
implementation.
    Therefore, we are again calling for the immediate 
announcement for a one-year delay for smaller public companies 
before they must comply with Section 404, and we urge this 
Committee to support this call for delay.
    Thank you for the opportunity to be here today.
    [The prepared statement of Mr. Ryan may be found in the 
Appendix on page 43.]
    Chairwoman Velazquez. Thank you, Mr. Ryan.
    Our next witness is Mr. Harvey Grossblatt. He is the CEO of 
Universal Security Instruments based in Owings Mill, Maryland. 
Universal is the manufacturer and distributor of residential 
fire and smoke alarms. Universal has been a public company 
since 1973 and was included in Fortune Small Business 
Magazine's top 100 fastest growing small companies in 2006 and 
2007. Universal Security Instruments is listed on the American 
Stock Exchange.
    Each one of the witnesses will have five minutes. When the 
light is green, you will start. When the light is yellow, it 
means that the five minutes is about to expire.

STATEMENT OF HARVEY GROSSBLATT, UNIVERSAL SECURITY INSTRUMENTS, 
                     INC. ON BEHALF OF AMEX

    Mr. Grossblatt. Madam Chairman and members of the 
Committee, I am Harvey Grossblatt, and I would like to thank 
you for the opportunity to comment on the Sarbanes-Oxley Act, 
Section 404, about which I feel quite strongly.
    I will attempt to summarize my written testimony.
    Although I fully agree with the need for the legislation to 
protect our investor confidence in capital markets, it is the 
method used to protect the last six percent of the total market 
capitalization not covered by Section 404 with which I 
disagree.
    My company has been a public company since 1973, and it is 
a non-accelerated filer. Before I became CEO, I was the CFO, 
and I would prepare our 10(q) in one day and our 10(k) in two 
to three days. Now, without Section 404, it takes us three days 
for the preparation of the 10(q) and almost two weeks to 
prepare our 10(k).
    Additionally, our auditors and lawyers spend 50 percent 
more time reviewing the documents.
    When Sarbanes-Oxley passed, I did not realize our legal and 
accounting fees would increase 50 percent immediately as I 
mistakenly thought that most of the cost would be 404 and 
believed small companies would eventually be exempt.
    I now realize how wrong I was. The implementation of 
Section 404 will cost approximately $200,000, plus an 
additional $100,000 covering the 50 percent increase in our 
legal and audit fees. In a small company like mine, the 
management will have to divert valuable time from growing the 
business to make sure that we comply with these rules, spending 
considerable money without any return on our investment.
    I wish I could have understood how this benefits our 
shareholders. When investors buy stock in small public 
companies, they are buying the management, and I believe they 
would rather have us grow their business instead of spending 
profits without any return. I do not understand how the 
Congress can expect a small corporation with 20 employees to 
have the same accounting and control systems that multi-billion 
dollar companies have.
    I realize that Congress tried to help with the 
implementation of these regulations, but it is still a one size 
fits all approach without regard to the impact of the cost of 
compliance.
    These costs may be spread over two years, but they do not 
go away. It seems to me the only beneficiaries of these rules 
will be the consultants, lawyers, and auditors and not the 
shareholders whom this law was implemented to protect.
    And before I end, I would like to make two comments on 
Commissioner Cox's statement. The first, one question was about 
Commissioner Cox brought out that most companies could do this 
themselves. I do not believe this will happen as all public 
companies have an independent audit committee made up of 
independent directors who take fiduciary responsibilities very 
seriously, and I cannot believe anyone will let the company's 
management review itself without having independent consultants 
come in.
    Secondly, the more important point, if this Committee could 
follow up with Commissioner Cox, the biggest problem with all 
of these new recommendations at PCAOB and the SEC that come 
out, it is not clear enough to the auditors. If I told you how 
many times we have to argue with our auditors and they say, 
``Well, we do not have a clear direction,'' so they go from one 
extreme to the other extreme.
    That is the biggest problem that we experience. The 
management side is fine. We understand what we have to do for 
404, but we need clear guidance for our accountants.
    And I would like to end by thanking you for the opportunity 
to provide my personal experience and input to this important 
issue, and I will be happy to answer any questions you may 
have.
    [The prepared statement of Mr. Grossblatt may be found in 
the Appendix on page 50.]

    Chairwoman Velazquez. Thank you, Mr. Grossblatt.
    Our next witness is Mr. Bill Loving. Mr. Loving is CEO of 
Pendleton Community Bank based in Franklin, West Virginia. 
Pendleton Community Bank serves six counties in West Virginia 
and Virginia. Pendleton Community Bank has four branches, 66 
employees, 710 registered shareholders.
    Mr. Loving is testifying on behalf of the Independent 
Community Bankers Association. ICBA represents 5,000 community 
banks of all sizes and charter types throughout the United 
States.
    Welcome, sir.

 STATEMENT OF BILL LOVING, PENDLETON COMMUNITY BANK, ON BEHALF 
        OF THE INDEPENDENT COMMUNITY BANKERS OF AMERICA

    Mr. Loving. Good morning. My name is Bill Loving, and I am 
the Executive Vice President and Chief Executive Officer of 
Pendleton Community Bank in Franklin, West Virginia.
    Chairwoman Velazquez and members of the Committee, I 
appreciate the opportunity to testify on behalf of the 
Independent Community Bankers of America, ICBA, concerning 
Section 404 of the Sarbanes-Oxley Act of 2002, or SOX, and the 
results of the Chamber of Commerce cost of SOX 404 survey.
    On November 8th, 2007, the Chamber released the results of 
a survey on the projected 2007 and 2008 cost of SOX Section 404 
and its impact on small businesses. Since approximately 25 
percent of the respondents were from the financial service 
industry and many were community banks, ICBA believes the 
survey's results are a good reflection of the costs that 
publicly held community banks are experiencing with Section 
404.
    The Chamber survey indicated that over half of the 
respondents expect internal and external costs to implement SOX 
404(a) this year to exceed $200,000, while 44 percent of the 
respondents expect next year's implementation cost of 404(b) to 
also exceed $200,000. For non-accelerated filers, this amounted 
to more than three percent of net income. These results confirm 
ICBA's 2005 SOX 404 community bank survey which showed that the 
average community bank would be spending more than $200,000, 
devoting over 2,000 internal staff hours, and spending 
approximately three to five percent of their net income to 
comply with Section 404.
    I can tell you that as CEO of a community bank that is also 
a non-accelerated SEC filer, the Chamber's survey accurately 
reflects the disproportionate burden that community banks like 
mine are facing to comply with Section 404. This year we have 
spent about $70,000 to comply with 404, which includes cost 
associated with 580 man-hours. While the impact on net income 
for 2007 is approximately three percent, the combined cost to 
date, if accounted for in one calendar year would be $168,640 
or 6.88 percent of 2007's projected net income.
    Like many publicly held community banks, Pendleton 
Community Bank is a good example of a small company that should 
not be subject to the reporting requirements of Section 12 of 
the Securities Exchange Act of 1934 and to all of the 
regulatory burdens of SOX. With 710 shareholders, we have 
considered going private to avoid these costs, but considering 
the small community where our bank is located, it would be a 
significant loss both to our community and to our bank's 
reputation if our bank were to go private and repurchase most 
of its stock or participate in a reverse stock split, a process 
that forces out shareholders below a certain level of 
ownership.
    Now that we have reached the end of 2007 and most non-
accelerated filers have completed their management internal 
control reports, ICBA supports Chairwoman Velazquez's request 
to the SEC to delay the implementation of the auditor 
attestation requirements required by Section 404(b), which for 
calendar year filers would begin in 2008. The one-year delay 
would give the SEC and the PCAOB an opportunity to evaluate the 
impact of this new guidance on accelerated and large 
accelerated filers and would give non-accelerated filers that 
have no experience with Section 404 additional time to 
understand and apply AS-5.
    We comment Chairman Cox's decision today to recommend 
another delay in implementation of Section 404(b) for the non-
accelerated filers, an action we applaud and certainly welcome.
    ICBA applauds Chairwoman Velazquez's effort to obtain hard 
dollar estimates from the SEC on the impact that SOX 404 has on 
smaller public companies. The SEC should have made those 
estimates prior to adopting AS-5. However, we are pleased that 
as a result of Chairwoman Velazquez's efforts SEC Chairman 
Chris Cox has committed the Commission to a data collection 
program beginning next year.
    ICBA believes that the SEC and the PCAOB should establish 
benchmarks or goals for AS-5 that are tied to reduction in 
overall 404 costs. For instance, SEC and the PCAOB should state 
that the goal of AS-5 is to reduce average internal control 
costs by a certain percentage, say, 20 percent.
    ICBA supports the community banks serving the Communities 
First Act of 2007 by Chairwoman Velazquez, which would relieve 
community banks with assets of less than one billion from the 
requirements of 404(b) and raise the threshold under the 
Exchange Act to 1,000 providing relief for hundreds of 
community banks like mine that are struggling.
    We appreciate the opportunity to testify and thank you.
    [The prepared statement of Mr. Loving may be found in the 
Appendix on page 53.]

    Chairwoman Velazquez. Thank you, Mr. Loving.
    Our next witness is Mr. Thomas Brandt. He is the CFO, 
TeleCommunication Systems, Inc., based in Annapolis, Maryland. 
TCS provides mission critical wireless technology solutions to 
carriers, public safety, and government customers. Mr. Brandt 
serves as Chairman of AeA's Sarbanes-Oxley Committee and is 
testifying on behalf of AeA, a trade association representing 
roughly 2,500 high tech companies.
    Welcome, sir.

STATEMENT OF THOMAS M. BRANDT, JR., TELECOMMUNICATION SYSTEMS, 
                     INC., ON BEHALF OF AEA

    Mr. Brandt. Thank you.
    The AeA, which is the nation's largest high tech trade 
association, appreciates this committee's efforts relating to 
Section 404 of the Sarbanes-Oxley Act, and we thank you for 
holding today's hearing.
    In addition to serving as the Chairman of AeA's Sarbanes-
Oxley Committee, I am the Chief Financial Officer of 
TeleCommunication Systems, Inc., or TCS, based in Annapolis, 
Maryland.
    TCS was bootstrapped by the founder as an 8(a) company and 
is now a 500 employee, $150 million accelerated filer under SOX 
404. I have served as a corporate financial officer for more 
than 20 years and started my career as a Price Waterhouse 
auditor of public companies, where I worked for 12 years.
    When I learned of today's hearing, I wanted to testify 
because I am convinced that the application of Section 404 to 
small public companies is bad public policy. Based on my 
experience as both a corporate officer and an auditor and as 
someone who is completing the fourth year of Section 404 
compliance, it is clear to me that Section 404's cost far 
outweighs any benefit to investors in small cap companies.
    For TCS the incremental Section 404 compliance cost 
relative to the company's market cap and float continues to be 
very high. For perspective, the average pretext profitability 
of our business over the last three years averaged around two 
million dollars a year. Annual outside audit fees of more than 
$600,000 represent a big bite out of investors' hides.
    As inefficient as this regulatory impact has been on 
companies like mine, the adverse impact of ever imposing this 
burden on non-accelerated filers is alarming. Although we 
appreciate the SEC's and PCAOB's efforts to address this issue 
through the issuance of new guidance, I believe that its effect 
will be minor and that the SEC Advisory Committee on smaller 
public companies' recommendations to provide tiered exemptions 
should be revisited.
    Since TCS' $135 million market cap is meaningfully 
comparable to the $75 million cutoff between accelerated and 
non-accelerated filers, ours is a good case study of the burden 
of Section 404 on smaller companies. My written testimony 
contains more detail to illustrate how our fees have increased, 
but briefly, between 1999, just before our IPO, and 2003, we 
experienced a sevenfold increase, from about $50,000 a year to 
$370,000, in recurring audit costs, when revenues only doubled. 
This cost reflects a lot of outside scrutiny for a small 
company before layering on Section 404.
    In 2004, the first year of SOX compliance, our audit fees 
more than doubled to $770,000. For 2005, when we were supposed 
to realize the benefits of a second time through cycle, our 
fees actually increased 13 percent to $871,000. For 2006, our 
fees were $621,000.
    The PCAOB's AS-5 and recent related SEC guidance is 
supposed to lower the cost for companies like mine, but for 
2007, our Big Four audit team told us that we had already taken 
advantage of substantially all the top-down risk-based 
incremental efficiency that AS-5 has reiterated. So we should 
expect our fees to remain around $620,000.
    Over the four-year period, the nature and scope of our 
company operations and financial statements has been 
sufficiently constant to make our numbers a fair small cap 
example. Based on discussions with my peers, many other 
companies have been hit much harder. While the number of hours 
to do the recurring extra audit work since the first years of 
SOX 404 may have modestly declined, the average hourly billing 
rates for auditors have risen sharply. As a former auditor, I 
am sympathetic that as deep pockets, the Big Four firms are 
compelled to charge more to cover their insurance and possible 
outlays for tort claims, as well as higher salaries and partner 
compensation to attract more people to do Sarbanes-Oxley work.
    But that cost burden should not be so disproportionately 
applied to the small companies. For small public companies, 
which represent a very small portion of the capital traded in 
the U.S. public markets, the bar of audit oversight and 
compliance was already high enough before 404 and expensive 
enough to reasonably protect investors from the risks of bad 
accounting.
    For the people who are bold and successful enough to grow a 
company that's a candidate to go public, our country's small 
cap markets have represented a valuable alternative to being 
forced to sell their companies or slow down their growth and 
risk losing a competitive advantage.
    I believe that entrepreneurs like my company's founder 
should have fewer, not more obstacles to grow a business and 
that investors are already sufficiently informed about the 
risks involved. When they can attract the support of public 
investors, entrepreneurs should have the freedom to pursue 
their visions rather than sell out.
    Excessive, recurring regulatory compliance costs are an 
unnecessary barrier to investor capital. The SEC Advisory 
Committee on Smaller Public Companies, which included an AeA 
representative, very thoughtfully developed advice as to levels 
of company size, including some companies larger than the non-
accelerated filers, which should be exempted from some or all 
SOX 404 work.
    I believe the recommended tiered relief should be revisited 
and made effective.
    [The prepared statement of Mr. Brandt may be found in the 
Appendix on page 61.]

    Chairwoman Velazquez. Thank you, Mr. Brandt.
    Our next witness is Ms. Shannon Greene. Ms. Greene is Chief 
Financial Officer and Treasurer of the Tandy Leather Factory, 
where she has worked since 1996. Based in Fort Worth, Texas, 
Tandy Leather has been the resource for over four generations 
of leather crafters providing quality leather, tools, kits, and 
teaching resources since 1919.
    Ms. Greene was appointed to serve on the board of directors 
of Tandy Leather in January 2001.
    Welcome.

  STATEMENT OF SHANNON L. GREENE, TANDY LEATHER FACTORY, INC.

    Ms. Greene. Good morning, Madam Chairman and members of the 
Committee. My name is Shannon Greene, and I am the Chief 
Financial Officer of Tandy Leather Factory. We are a non-
accelerated filer. We are headquartered in Fort Worth, Texas.
    I am also a member of the newly formed Corporate Leadership 
Advisory Council, which is the U.S. Chamber's voice of mid-
market businesses. The purpose of my being here today is to 
provide some perspective from a small business trying to 
maintain our position as a legitimate public company in today's 
market.
    While I would prefer that we were discussing the potential 
elimination of Section 404, I acknowledge that such a 
discussion is irrelevant at this time.
    With that said, I applaud the SEC and the PCAOB for 
recognizing the need to provide scalable rules and guidance to 
smaller companies like ours as it pertains to Section 404.
    I would like to present several points for consideration. 
First, I believe that most small businesses support the concept 
of a strong internal control system.
    Second, non-accelerated filers who have not had to comply 
with Section 404 yet should not be the testing ground for the 
revised rules and guidance.
    Third, if a delay for non-accelerated filers is being 
considered, the decision to delay needs to be made now, as many 
companies will be engaging their auditors soon for 404(b), if 
they haven't done so already.
    Fourth, the management teams of small businesses wear many 
hats as they generally do not have the financial resources for 
large staffs. The process required to comply with Section 404 
further burdens the management that is already stretched thin. 
It is important that their process of compliance with Section 
404 be as efficient and as cost effective as possible.
    Fifth, it has been my experience that investors, whether 
individuals or institutions, are not as concerned with a 
company's internal control system as one might think. Many, if 
not all, of our investors would prefer continued growth in 
company profits rather than formal documentation and an 
assessment of our internal control system.
    I think we all agree that the 404 process as originally 
implemented was much more burdensome and costly to all 
companies than Congress intended, and we have already seen that 
a mere 168 words, as was the original Section 404, had far 
reaching, unintended consequences and implications.
     It is important that we get it right this time, and the 
best companies to make that assessment are those who have 
already gone through the process under the original rules. 
Small companies in their first year of compliance cannot be 
expected to assess the improvement in the rules as they have no 
basis for comparison.
    The 404 process needs to be as streamlined as possible for 
companies so that management teams can focus primarily on 
growing their business. It would be unfortunate to trade 
dollars spent on jobs or product development for inefficient 
regulatory compliance.
    Small companies should not be the testing ground for the 
new rules, given that 404 tends to have a disproportionate cost 
impact on smaller companies with the first year being the most 
expensive. I would like to know that the revised regulations 
are going to work before we have to apply them to our small 
company.
    It is important to emphasize that if a delay is being 
considered for non-accelerated filers, the decision needs to be 
made very soon. Four, oh, four (b) applies to us for 2008. We 
do not have the luxury of waiting until the summer or fall to 
engage our auditors. As a result, announcing a delay then will 
significant minimize the benefit of that delay for a company 
like ours, as we will have already incurred sizable costs in 
the form of additional audit fees during the first half of the 
year.
    We are considered a micro cap in the world of public 
companies. Approximately 35 percent of our outstanding stock is 
owned by institutions. I meet with a number of these 
institutions, as well as individual stockholders either via 
telephone or in person numerous times a year. Many of our 
stockholders own our stock because they believe in the 
potential of our company and are comfortable that the 
management team knows how to grow the company and, therefore, 
increase its value.
    In all of my discussions with stockholders, I have yet to 
be asked whether we are or expect to be in compliance with 
Section 404. However, I am frequently asked about how much we 
have and will spend trying to comply and how much of a negative 
impact it will have on our earnings.
    While most investors want to invest in ethical companies, I 
do not get the impression that the internal control system is 
what helps those investors make that determination. It is the 
people of the company.
    Due to the immense regulatory burden on public companies 
large and small, I would suggest that we are discouraging 
companies from participating in public markets because it's not 
worth the effort. The objective of 404 is to provide meaningful 
disclosure to investors about the effectiveness of the 
company's internal control system. Said in a different way, 
investors should be able to rely on the information they are 
getting from a public company.
    Rather than penalizing all companies with increased 
regulation, I think stiffer and swifter penalties for offenders 
is a more effective deterrent and would contribute more to the 
goal of a reputable public market. I am not minimizing the 
importance of regulatory compliance. While I do not always 
agree in principle with the rules and regulations set forth, I 
can assure you that my company takes this very seriously. We 
choose to operate our business within the rules, whether we 
agree with them or not, and we will comply with the rules of 
404. I would just like to know that the cost to comply is money 
well spent.
    I appreciate the opportunity to be here today and hope you 
found my thoughts and opinions helpful. In summary, please 
consider my request to delay Section 404 compliance for small 
companies until it has been proven that the rules are achieving 
the intended results.
    Thanks.
    [The prepared statement of Ms. Greene may be found in the 
Appendix on page 67.]

    Chairwoman Velazquez. Thank you, Ms. Greene.
    Mr. Ryan, I would like to address my first question to you. 
As you have heard this morning, the SEC is planning to collect 
data related to SOX 404 compliance costs. From your 
perspective, what are some of the most important data that the 
Commission must collect?
    Mr. Ryan. Well, I, first of all, would suggest that they 
stratify that data collection. I think it was already suggested 
by looking at the smaller companies that are already complying 
with the 404 and seeing how the transition to the new rules 
plays out in that first year, and in particular, how the 
auditors respond to that, and also try to get a sense from 
companies and auditors, in particular, where the more expensive 
costs are coming from so that as we drill down into this area 
and try to solve this problem we know exactly where to target 
and address as we go forward.
    Chairwoman Velazquez. Any other witness who would like to 
comment on this question? Yes, Mr. Grossblatt.
    Mr. Grossblatt. Yes. In addition, I think the SEC should 
consider the management time and internal corporate resources 
that have to be spent besides the outside cost.
    Mr. Brandt. It is just worth noting that the outside audit 
fees are an obligatory disclosure in the proxy statements of 
all of us filers. So there's objective information that's 
readily collectible for that dimension of the compliance cost.
    Chairwoman Velazquez. Mr. Brandt, your company as a larger 
small company has already implemented SOX 404.
    Mr. Brandt. Yes.
    Chairwoman Velazquez. And yet without any self-interest 
associated with the potential delay in the SEC's SOX 404 
compliance deadline, you volunteered to testify this morning. 
Can you explain the reasons why you thought it is so important 
to provide testimony on this issue?
    Mr. Brandt. Certainly. Having lived this for four years and 
having been an auditor before, the marginal benefit of what 
we've been paying for has been painfully apparent, and it is 
nil; it is negative.
    The costs we are incurring at $600,000 for our small 
company are grossly disproportionate to the amount of capital 
at risk in the market that we have had invested in our company, 
and over the last several years working with the AeA and my 
peers and hearing the stories of others who have been through 
this, the prospect of applying this to still smaller companies 
is hard to accept.
    Chairwoman Velazquez. Ms. Greene, as an accounting 
professional, you recommend a delay in small companies' 
compliance with SOX 404 so that large companies have the 
opportunity to implement and test the new auditing standard 
before small firms are required to comply.
    So you believe a one-year delay in Section 404(b) will 
allow large companies sufficient time to work out any problems?
    Ms. Greene. I think it will certainly help. You know, the 
small business that has not had to comply yet, even though the 
scaled down rules, I think, are going to be helpful for small 
companies. I don't think that we are a good basis of comparison 
because we have not had to do it yet.
    Will one year be enough? I do not know. It depends on how 
well it goes, how the auditors do. A year is better than 
nothing, but I do not think we will know until we get farther 
into it whether that is adequate or not.
    Chairwoman Velazquez. Mr. Loving, in the past this 
Committee has received testimony that some banks are likely to 
consider going private because of the burdens of SOX 404 
compliance. From your perspective, what would it mean for the 
town to have its community bank go private?
    Mr. Loving. Well, from my perspective, I think you have a 
reputation risk to consider if the bank would go private. 
Obviously many of the shareholders are, in fact, customers, and 
they know customers. And so a negative reaction could take 
place because of going private, obviously repurchasing the 
stock against their will, and once that would happen, they 
would potentially look for other options for banking.
    And you know, I am a firm believer that the community bank 
is the life blood of the community, and I think it would be 
very detrimental to many communities if the community banks go 
private.
    Chairwoman Velazquez. Mr. Brandt, again, since you have 
already implemented Section 404, do you have recommendations 
about how SEC can best study the impact of SOX on small 
companies?
    Mr. Brandt. Well, as was suggested, the audit fee data that 
can be collected objectively from our proxy filings could be 
stratified, and the correlations between those outside costs 
and market cap or revenue or profitability could produce some 
useful information.
    Chairwoman Velazquez. Ms. Greene, this morning a lot has 
been made of the date by which a company engages an auditor. 
There seems to be some uncertainty as to what engaging an 
auditor means in terms of financial commitment by the company 
implementing SOX 404. As the person responsible for her 
company's SOX 404 implementation, when your company engaged an 
auditor, was your company committing to pay a certain amount in 
fees?
    Ms. Greene. Auditors have indicated to us that we can 
expect our audit fees to increased by 50 percent when they 
start their assessment work. Our fees have already gone up 
substantially in the last year or so, the premise from the 
auditors being that they are trying to cover insurance costs.
    I think we run a very efficient audit. I think our auditors 
would tell you that, but we have seen substantial increase 
already, and we are not even SOX 404, working on that yet. They 
are telling us to expect a minimum of a 50 percent increase 
when they get ready to start their work on the assessment.
    Chairwoman Velazquez. Thank you.
    Yes, Mr. Brandt.
    Mr. Brandt. If I may add, I think there is sometimes a 
misunderstanding between the audit work and the preparation 
work for Sarbanes-Oxley 404 review by outside auditors. Most 
companies even my size in the first time through have hired 
another outside firm, whether it is a Big Four or now there are 
specialist consulting firms that have sprung up for the purpose 
of helping relatively small businesses write up their processes 
and execute the tests that are required under the law, which 
are all additional costs before the outside audit fees are 
incurred.
    I learned from my AeA peers that many of them spent as much 
on that as they did on their incremental outside audit fee 
cost. Now, that is data that is not captured in proxies, but 
the term ``audit'' has multiple meanings in the context of this 
discussion. That is one of the reasons I wanted to try to be 
here, because of having been on both sides.
    Chairwoman Velazquez. Thank you.
    Yes, Mr. Loving.
    Mr. Loving. If I could mirror that, most of all our costs 
have been from hiring a consultant to help us in preparing to 
comply with Section 404, and only to mention that the external 
audit firm that we used for years chose to remove themselves 
from public company work, and so we had to go through the 
process of filing a new audit firm because of 404.
    And so most of the costs will not be outlined explicitly in 
the financials, but there are costs to comply with 404 before 
you get to compliance with 404(b).
    Chairwoman Velazquez. Thank you.
    Yes, Mr. Grossblatt.
    Mr. Grossblatt. We were told by our auditors if we did use 
an outside firm that the audit fee would be two or three times 
what they will charge to review the independents because it 
becomes an issue about if internal people do it there is an 
independence issue. So you really do not save anything by doing 
it yourself because what you will save on the consultants you 
will pay twice or three times on the audit fee.
    Chairwoman Velazquez. Thank you.
    Mr. Ryan, how important is it that the SEC vote on delaying 
and finalize the announcement of the delays sooner rather than 
later?
    Mr. Ryan. I think that is critical. I think it is 
everything. If the SEC waits to do their study in I believe 
Chairman Cox suggested it was going to be some time this summer 
for the results, we realize many of these companies will have 
already spent the money, made the commitments and, back to the 
testimony of Mr. Grossblatt, management time will have been 
spent on it, which is a very significant cost here.
    So we think that our data shows this, and I think the 
testimony here shows that the companies are getting started 
sooner rather than later, and I think that is particularly true 
for companies that really care about these issues. They are the 
ones being hurt by a delay. So we think that is critical.
    Chairwoman Velazquez. I cannot stress enough to the 
Chairman how important it is for them to make the announcement 
as early as possible, as early as January.
    Mr. Ryan. My sense is he understood that, too.
    Chairwoman Velazquez. Yes. Okay, and now I recognize Mr. 
Westmoreland.
    Mr. Westmoreland. Thank you, Madam Chairman.
    And since I was not here for opening remarks, I do want to 
compliment the Chairwoman on her commitment to small business 
and working to get the Chairman to look at delaying the 
implementation of this for one year. And I certainly support 
you in that.
    Mr. Loving, is your bank audited by state bank regulators?
    Mr. Loving. Yes, sir. It is a very good question. We are 
regulated by state regulators, FDIC regulators. Plus we have to 
comply with SEC regulations, not to mention internal audit, 
external audit, IT audit, compliance audit. I believe that 
mentions most of the audits that we have to comply with or are 
regulated by.
    Mr. Westmoreland. So what you are telling me is that 
basically you already had to jump through a lot of hoops to 
make sure that you were within the laws of the banking 
industry. Is that not true?
    Mr. Loving. Yes, sir, that is correct. We, as senior 
officers of the institution, have to sign a quarterly call 
report that we are testing that the financial information is 
correct. That is publicly available to anyone that goes to the 
FDIC Web site.
    So the overlay of 404 is redundance and duplication of 
effort in many cases for community banks, one we cannot 
eliminate in order to comply with 404.
    Mr. Westmoreland. And is it not true that even though 
community banks are probably hit the hardest on their bottom 
line, it is kind of redundant for any bank that has to go 
through those same audits that you have to go through?
    Mr. Loving. That is correct, sir.
    Mr. Westmoreland. Do you think we will ever pass a law that 
makes people completely honest?
    Mr. Loving. I do not think we will ever pass a law that 
will make people completely honest. I certainly applaud the 
efforts, but I think in the case of 404, the cost is too 
prohibitive.
    Mr. Westmoreland. Thank you.
    Mr. Brandt, you made a couple of comments about CEO 
compensation and officers' compensation, I guess, about trying 
to find people to serve on some of these committees that look 
at some of these audits.
    You know the Big Three. We had Tyco, Enron, WorldCom that 
did some things that were not correct. Those guys are in 
prison, and as I understand it correctly, these CEOs and people 
that are on these different committees have to sign up and have 
really put a lot on the line for what they may be being paid. 
Is that true or would you say that there is more of a risk now 
having to sign some of these affidavits than there was?
    Mr. Brandt. Well, Section 302 of Sarbanes-Oxley provides 
for some representations that we have to make every time we 
submit financial statements, that are very strong 
consciousness-raisers if an officer did not otherwise take 
seriously that responsibility. I have never shown my wife the 
words that I am signing to that put our assets at risk every 
time I fulfill that obligation.
    And I think that attitude is pervasive. It is the rare 
exceptions that do not recognize how serious the responsibility 
is.
    Mr. Westmoreland. Yes, sir, but I mean, you could have been 
put in jail before Sarbanes-Oxley for doing some of the things 
these other people did, right? It is not just signing that 302 
that makes you liable. There were other laws that would have 
made you liable, too. Is that not true?
    Mr. Brandt. That is absolutely right.
    Mr. Westmoreland. So from what you and Mr. Loving say, 
Sarbanes-Oxley in a lot of ways, not just the 404 but other 
sections, is kind of piling on, so to speak.
    Mr. Brandt. Yes.
    Mr. Westmoreland. Would you agree with that?
    Mr. Brandt. Yes.
    Mr. Westmoreland. I have one question--
    Chairwoman Velazquez. Would the gentleman yield?
    Mr. Westmoreland. Yes.
    Chairwoman Velazquez. I just would like to say that Mr. 
Grossblatt's wife is here today.
    [Laughter.]
    Chairwoman Velazquez. And I hope that this hearing is not 
going to be any trouble to you.
    Mr. Grossblatt. I was just trying to give some 
understanding of what we have to put up with on a regular 
basis.
    Mr. Westmoreland. Hopefully you will not be going off.
    And my last question is for Mr. Grossblatt. So that we will 
not misunderstand anything, you mentioned that your company had 
an extra cost of 200,000 and about another $100,000 increase, I 
think. Who is eventually going to pay that increase that your 
business suffers?
    Mr. Grossblatt. Public shareholders.
    Mr. Westmoreland. Absolutely. Okay. So, I mean, this is 
something that, you know, you just cannot absorb this. I mean, 
the company just cannot absorb this kind of cost, and so 
Congress, and I think the Chairwoman would agree with me, you 
know, we have got a couple of speeds up here, but our main 
speed is knee-jerk, and this was done while some terrible 
things were done to some of the stockholders in some of these 
companies.
    I was not here, but I have seen the knee-jerk speed, and I 
think it was a knee-jerk and that there really was not enough 
attention paid to the end user in what this was actually going 
to cost especially small business and who was going to be the 
people actually paying for this piling on or double and 
tripling and quadrupling some of these things that we already 
had laws to cover.
    But, Madam Chairman, that is all I have and thank you so 
much.
    Chairwoman Velazquez. Thanks.
    Mr. Gonzalez.
    Mr. Gonzalez. Thank you very much, Madam Chairwoman.
    As indicated earlier with the Chairman of the SEC, some of 
us were here in 2002 and we were right in the middle of it and 
voted for it. It was an appropriate response, I think, at that 
time. It was referred to as corporate governance. It was quite 
relevant, and we knew there would be some consequences, some 
intended and others not intended.
    Maybe what we are viewing here are the unintended and what 
we are really going to do. But the question really comes down 
to--and I posed this to the Chairman, Mr. Cox, and he indicated 
that, at least the way I interpreted his response was that we 
probably do not need a real legislative fix or tweaking, 
definitely not a wholesale revision of Sarbanes-Oxley, and that 
much can be done within the regulatory scheme and the 
promulgation of rules and guidelines.
    I do not totally agree with that, but I am not on Financial 
Services. I am not on the other committees, but I am hard 
pressed to believe that universal security instruments in the 
past created special purpose entities, if you recall what those 
things used to be, based on the advice of the same accounting 
firm that was conducting your auditing because they were also 
doing your consulting.
    I do not believe that your enterprise and its officers were 
exercising questionable stock option and sales based on insider 
information. But that is the scenario. That is what we were 
reacting to. And as I said earlier, we cast a very wide net, 
and maybe it is time to review where we are today.
    What was our goal then? What is our goal now, given the 
history and the implementation of the act?
    It is clear and, I think, back in the June hearing and 
today's hearing, that we really do have to do what businesses 
do, and that is maybe look at a cost-benefit analysis. Are we 
really getting the result that we need or require?
    But it does appear to me that Chairman Cox has expressed a 
clear opinion that corporate governance at all levels is 
important, and I think you heard him actually articulate its 
application to the small publicly traded countries in this 
country.
    But I really would like to get a feel from where you all 
are coming from. We may have a year delay. We may tweak this. 
My prediction is we will have the delay; we will have the 
information gathering. The SEC will do everything under its 
power to make it more cost effective and simpler, but we are 
still going to run into the same problem.
    I mean I just really believe that. We do this all the time. 
We do a one-year fix, a two-year fix, and you know, the old 
thing about where I come from we simply say ``manana.`` You 
know, I mean, we will just figure it tomorrow. Not good, not 
good.
    But I'm going to ask Mr. Brandt. You know, you're talking 
about tiered exemptions. How do you accomplish that? Can you do 
it within regulatory guidelines, the Commission, and so on, or 
are we talking about a legislative fix?
    Mr. Brandt. I started coming to Washington to talk about 
Sarbanes-Oxley 404 when the AeA first invited us here in 2004, 
and I observed sort of what I guess you are saying. We would 
talk to regulators and they would say this has to be dealt with 
by Congress, and we would talk to Congress people or their 
staff and they would say this has to be dealt with by 
regulators.
    It happens that Senator Sarbanes is my Senator, was my 
Senator, and I had an opportunity to address him directly, and 
he believed that this was a regulatory matter insofar as the 
impact of 404 on small caps.
    You know, I am here to speak to anybody would will listen 
that I think resources are being misallocated.
    Mr. Gonzalez. So what is the best remedy? How do you see 
it?
    I mean we are going to have the year delay. We are going to 
have the information gathering. We are going to streamline it, 
but it seems from your testimony you are saying you really are 
viewing something that goes beyond what I anticipate is being 
contemplated, and you are talking about some sort of exemption.
    Mr. Brandt. I am, and without repeating that whole Small 
Business Committee report, and I did participate along with our 
other representatives in its preparation, there was a lot of 
thought given to the strata in the capital markets where the 
risk relative to confidence of outsiders in the integrity of 
our regulatory process was immaterial to anybody rationally 
reaching that conclusion.
    So there was a cutoff suggested for self-review and 
reporting on internal control and a lower level where neither 
self-review nor outside auditor review and attestation would be 
necessary. And I believe that was a prudent approach.
    Mr. Gonzalez. And if you did adopt that, could you square 
that with Chairman Cox's concern regarding small publicly 
traded companies and how important it is to have good, solid 
corporate governance at all levels?
    Mr. Brandt. Yes, I can because I believe there are so many 
other regulations and controls and audit processes to which we 
are subject that the risk of misstatement of financial 
statements is already relatively low. If we make a mistake it 
might be on applying an obscure algorithm like FAS-123(r) for 
stock option accounting or some obscure lease rule, but unless 
somebody is very willfully trying to cheat, it is not likely 
our financial statements are going to be bad, and most of us 
have the self-interest when sign our 302 statements or just 
otherwise acknowledge our fiduciary responsibilities to try to 
walk the straight and narrow.
    Mr. Gonzalez. Well, thanks. I want to extend my thanks to 
all the witnesses.
    I yield back.
    Chairwoman Velazquez. Ms. Hirono.
    Ms. Hirono. Thank you, Madam Chair.
    The reason I asked Chairman Cox the question about the 
expenditures of outside auditors is that in spite of his 
testimony, I did think that probably most of the companies 
would do that, and all of your testimony indicates that that 
would, in fact, be the case.
    So then the SEC does their study and the study will show 
that most of the companies will be incurring these kinds of 
additional expenses and so they could say, ``Well, we are not 
telling you that you should do that. In fact, you should be 
able to do it with in-house personnel.''
    So then we are left and again, I agree with my colleague 
back there that we will be here discussing this again with 
having probably obtained a one-year delay. So I think the 
bottom line really is, Mr. Brandt, what you have brought out 
and I have a feeling what the rest of you probably would like 
us to address, is a statutory kind of legislative fix. Is that 
correct?
    Mr. Loving. Yes, ma'am. I believe that it will take a 
statutory fix to complete the revision of 404 and to improve 
the profitability of small public companies. The new study may 
show an opportunity to reduce cost, but I do not believe that 
it will be able to reduce cost to a point that I can eliminate 
eight percent or even six percent of net income to comply with 
404. There is going to be a dollar specific that we will have 
to pay to comply with 404 even under new guidance, and someone 
spoke earlier about the auditors and the simplicity or the 
communication to the auditors. That is the second issue.
    It was mentioned we know what it takes to comply, but 
oftentimes what we are hearing from the auditors is we are not 
sure what the ruling is. So, therefore, you need to do this.
    Well, obviously they are going to err on the side of 
caution, and that usually brings about additional cost. So I do 
think legislative change is necessary.
    Ms. Hirono. Madam Chair, I would just like to say that I 
was not here when SOX was adopted, but I would certainly be 
open to some kind of a legislative addressing as long as I can 
refer to what Mr. Brandt said, that there are plenty of other 
checks on what companies are doing to make sure that their 
processes are as they should be.
    Thank you, Madam Chair.
    Chairwoman Velazquez. Mr. Westmoreland.
    Mr. Westmoreland. Thank you.
    Just one last question for Mr. Brandt.
    You said you worked for Price Waterhouse for several years.
    Mr. Brandt. I did, 12 years, yes.
    Mr. Westmoreland. Twelve years. These audit firms, the Big 
Four, and you mentioned some of the other ones, were they 
involved in the Tyco or Enron or WorldCom, any of the auditing 
firms that are doing your audits now or that do these audits 
now?
    Mr. Brandt. Well, I understand, of course, it is gone, but 
pretty much every other public company of any size is audited 
by a Big Four firm.
    Mr. Westmoreland. Did SOX put any additional requirements 
on these auditing firms?
    Mr. Brandt. Well, the creation of the PCAOB provided a new 
level of regulation on their profession. So that has become, 
you know, an issue with them, that they are not a self-
regulated profession any longer, but they have a new entity 
checking their work papers and determining whether they did 
enough work, which has the impact as I think was said earlier 
that, well, we need to do this extra work now because we want 
to make sure we have enough material in our work papers for 
when the PCAOB looks over our shoulders.
    Mr. Westmoreland. So they are auditing the auditors.
    Mr. Brandt. Yes, they are.
    Mr. Westmoreland. Okay. Thank you.
    No further questions, Madam Chairwoman.
    Chairwoman Velazquez. Well, I want to take this opportunity 
again to thank all of the witnesses for taking time from your 
busy schedule and your companies to be here this morning with 
us.
    And I just would like to issue a note of caution here in 
the sense that I hear some of the witnesses and the members 
here talking about a legislative fix, but this is the United 
States Congress. It is not going to be that easy. So I do not 
want anyone to be in that mindset.
    You know, our hope is and we are happy this morning and 
grateful that Chairman Cox is taking the lead in doing right on 
behalf of small companies in this country by doing the cost 
analysis and collecting data in a scientific manner, and I just 
hope that they do this in a very close partnership with those 
companies that will be impacted.
    And with that I ask unanimous consent that members will 
have five days to submit a statement and supporting materials 
for the record.
    Without objection, so ordered.
    This hearing is now adjourned.
    [Whereupon, at 11:59 a.m., the Committee meeting was 
adjourned.]

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