[House Report 114-588]
[From the U.S. Government Publishing Office]


114th Congress    }                                          {  Report
                        HOUSE OF REPRESENTATIVES
 2d Session       }                                          {   114-588

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



 
                    FOSTERING INNOVATION ACT OF 2015

                                _______
                                

  May 23, 2016.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

Mr. Hensarling, from the Committee on Financial Services, submitted the 
                               following

                              R E P O R T

                             together with

                             MINORITY VIEWS

                        [To accompany H.R. 4139]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Financial Services, to whom was referred 
the bill (H.R. 4139) to amend the Sarbanes-Oxley Act of 2002 to 
provide a temporary exemption for low-revenue issuers from 
certain auditor attestation requirements, having considered the 
same, report favorably thereon without amendment and recommend 
that the bill do pass.

                          Purpose and Summary

    Introduced by Representatives Kyrsten Sinema and Michael 
Fitzpatrick on December 1, 2015, H.R. 4139, the Fostering 
Innovation Act of 2015, extends the exemption from Section 
404(b) of the Sarbanes-Oxley Act (SOX) for emerging growth 
companies (EGCs) that would otherwise lose their SOX 404(b) 
exempt status at the end of the five-year EGC period that 
exists under current law. The legislation extends the SOX 
404(b) exemption until the earlier of ten years after the 
company went public, the end of the fiscal year in which the 
EGC's average gross revenues exceed $50 million, or when the 
EGC becomes a large accelerated filer ($700 million public 
float) with the Securities and Exchange Commission (SEC). SOX 
Section 404(b) costs disproportionately burden smaller 
companies and startup enterprises that do not have sufficient 
revenue streams to devote to SOX compliance costs.

                  Background and Need for Legislation

    Title I of the Jumpstart Our Business Startups Act (JOBS) 
(Pub L. 112-106) established EGCs as a new category of issuer 
under the federal securities laws. These EGC issuers have less 
than $1 billion in annual revenues or $700 million in public 
float when they register with the SEC. EGCs are given up to 
five years--known as an ``On Ramp''--to comply with certain 
regulatory requirements, including SOX Section 404(b). By 
granting these issuers temporary ``On Ramp'' status, Title I of 
the JOBS Act encourages small company public offerings and 
ensures that they move to full compliance with regulatory 
requirements as they become large enough to support the legal, 
accounting, and compliance infrastructure typical of mature 
enterprises.

Background on the compliance burden associated with SOX Section 404(b)

    Pursuant to SOX Section 404, the management of a public 
company must assess the effectiveness of the company's internal 
controls over financial reporting. A key driver of the SOX 
Act's compliance costs is Section 404(b), which requires a 
public company's external auditor to attest to, and report on, 
management's assessment of the company's internal controls as 
required by Section 404(a) of SOX. Studies of compliance costs 
overwhelmingly indicate that Section 404 has increased public 
companies' accounting and auditing expenditures, regardless of 
company size.
    In fact, the costs to comply with Section 404(b) have far 
exceeded the SEC's original estimates. According to a 2008 
report by the Heritage Foundation:

          While the SEC initially estimated the cost of 
        complying with Section 404 to be $1.24 billion in the 
        aggregate, multiple studies have projected the actual 
        cost to be $35 billion, almost 30 times that of the 
        original estimate. CRA International's survey data 
        indicates that total year-one Section 404 
        implementation cost per company with market 
        capitalization between $75 million and $700 million, 
        known as a small accelerated filer, is $1.5 million, or 
        0.46 percent of its revenue; and that per company with 
        market capitalization above $700 million, known as a 
        large accelerated filer, is $7.3 million, or 0.09 
        percent of its revenue. A more recent estimate pegged 
        the average cost of direct compliance costs and outside 
        audit fees in 2006 at 2.5 percent of a company's 
        revenue.

    Similarly, in 2010, the Independent Community Bankers 
Association (ICBA) concluded:

          While 404 auditor costs declined 5.4% from 2006 as 
        the auditor scope of work narrowed, these costs were 
        offset by a reported five percent increase in the 
        average hourly audit rate charged by auditors. 
        [Financial Executives International] also found that 
        auditor attestation fees paid by accelerated filers in 
        2007 constituted 23.7% of the accelerated filer's total 
        annual audit fees and averaged $846,000, representing 
        only a 5.4% decrease from 2006. In September 2009, the 
        SEC's Office of Economic Analysis issued its 140 page 
        report on the costs of complying with SOX 404 after 
        conducting a large web-based survey of publicly held 
        companies over a period from December 2008 to January 
        2009. The Study found that for companies that were 
        already complying with Section 404(b), the mean total 
        Section 404 compliance cost following the issuance of 
        the SEC guidance was still a staggering $2.33 million 
        per year. Section 404(b) audit fees were a significant 
        portion of those total costs, amounting to a mean 
        average of $1,127,325. Even though the overall mean 404 
        compliance costs had dropped 19% from the pre-guidance 
        cost, for smaller reporting companies, the drop was not 
        as significant. In fact, the Study showed that for 
        filers with public float lower than $75 million, the 
        mean SOX 404 compliance cost following the issuance of 
        SEC guidance was very high--$690,000 per year and the 
        mean 404(b) audit cost was $259,004. From its Study, 
        the SEC generally concluded that smaller publicly held 
        companies have higher SOX 404 compliance costs as a 
        fraction of their asset value.

    More recently, a May 2014 survey conducted by compliance 
and audit consultant Protiviti similarly found that 
approximately 53 percent of large organizations currently spend 
$1 million or more each year on SOX compliance, and 30 percent 
spend $2 million or more annually. The Protiviti survey 
concluded that ``SOX compliance costs are rising more sharply 
than in the past,'' partly as a result of recent Public Company 
Accounting Oversight Board (PCAOB) inspections of external 
auditing firms, which indicated that ``external auditors were 
not doing enough work and thus needed to invest more time in 
[SOX Section 404] audits.''
    At a December 2, 2015 Capital Markets and Government 
Sponsored Enterprises Subcommittee hearing to consider the 
Fostering Innovation Act, Mr. Brian Hahn, Chief Financial 
Officer of GlycoMimetics, testified that the SOX 404(b) auditor 
attestation requirement ``provides little-to-no insight into 
the health of an emerging biotech company--but is extremely 
costly for a pre-revenue innovator to comply with.''
    The significant burdens associated with SOX Section 404(b) 
compliance disproportionately affect smaller public companies, 
diverting resources from growth to regulatory costs and harming 
the ability of these firms to compete against larger peers and 
foreign competitors. According to the Heritage study, ``Section 
404 compliance cost constitutes a substantial fixed cost 
component that imposes a disproportionate burden on smaller 
public companies as they are inherently unable to spread the 
cost with the economies of scale.'' Heritage found that ``in 
the first compliance year, the median audit fee as a percentage 
of revenue for companies with a market cap of less than $75 
million and between $75 million and $250 million was 0.75 
percent and 0.48 percent, respectively. In contrast, that for 
companies with a market cap of more than $5 billion was 0.07 
percent.''
    Increased compliance costs also serve as a disincentive for 
smaller companies to become and remain public companies. For 
example, ICBA pointed out that:

          [W]ith more limited resources, fewer internal 
        personnel and less revenue with which to offset the 
        costs of Section 404 compliance, both micro-cap and 
        small-cap companies are disproportionately impacted by 
        the burdens associated with Section 404 compliance . . 
        . the benefits of documenting, testing and certifying 
        the adequacy of internal controls, while of obvious 
        importance for large companies, are of less value for 
        micro-cap and small-cap companies, who rely to a 
        greater degree on `tone at the top' and high-level 
        monitoring controls, to influence accurate financial 
        reporting. Moreover . . . the proportionately larger 
        costs for smaller public companies to comply with 
        Section 404 adversely affect their ability to compete 
        with larger public companies and even with foreign 
        competition. This reduction in the competitiveness of 
        U.S. smaller public companies hurts their capital 
        formation ability and, as a result, hurts the U.S. 
        economy. During this current economic downturn, many 
        publicly held community banks are having a difficult 
        time raising capital and in many cases, have had to 
        postpone or cancel their capital raising plans.

    The Fostering Innovation Act will promote the continued 
growth and financial success of small and innovative companies. 
As indicated previously, the Act relieves a subset of EGCs from 
Section 404(b) compliance for up to ten years, provided that 
their annual revenue is not greater than $50 million and their 
public float is less than $700 million (a company is an EGC if 
its annual revenue does not exceed $1 billion and its public 
float is less than $700 million); the Act is therefore limited 
in its application to those EGCs that are truly small 
companies, in recognition of the fact that small business 
economic life-cycles require a greater time period in which to 
build up to full compliance with public company regulations. 
Thus, as Mr. Hahn from GlycoMimetics concluded at the December 
2nd hearing, ``Legislation like the Fostering Innovation Act 
will ensure that growing companies have the opportunity to be 
successful on the public market without being forced to siphon 
off innovation capital to spend on costly compliance burdens 
that do not inform emerging biotech investors.''

                                Hearings

    The Committee on Financial Services' Subcommittee on 
Capital Markets and Government Enterprises held a hearing 
examining matters relating to H.R. 4139 on December 2, 2015.

                        Committee Consideration

    The Committee on Financial Services met in open session on 
March 2, 2016, and ordered H.R. 4139 to be reported favorably 
to the House without amendment by a recorded vote of 42 yeas to 
15 nays (recorded vote no. FC-98), a quorum being present.

                            Committee Votes

    Clause 3(b) of rule XIII of the Rules of the House of 
Representatives requires the Committee to list the recorded 
votes on the motion to report legislation and amendments 
thereto. The sole recorded vote in committee was a motion by 
Chairman Hensarling to report the bill favorably to the House 
without amendment. That motion was agreed to by a recorded vote 
of 42 yeas to 15 nays (Record vote no. FC-98), a quorum being 
present.


                      Committee Oversight Findings

    Pursuant to clause 3(c)(1) of rule XIII of the Rules of the 
House of Representatives, the findings and recommendations of 
the Committee based on oversight activities under clause 
2(b)(1) of rule X of the Rules of the House of Representatives, 
are incorporated in the descriptive portions of this report.

                    Performance Goals and Objectives

    Pursuant to clause 3(c)(4) of rule XIII of the Rules of the 
House of Representatives, the Committee states that H.R. 4139 
will reduce regulatory compliance costs for Emerging Growth 
Companies by extending the exemption to comply with Section 
404(b) of the Sarbanes-Oxley-Act.

   New Budget Authority, Entitlement Authority, and Tax Expenditures

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee adopts as its 
own the estimate of new budget authority, entitlement 
authority, or tax expenditures or revenues contained in the 
cost estimate prepared by the Director of the Congressional 
Budget Office pursuant to section 402 of the Congressional 
Budget Act of 1974.

                        Committee Cost Estimate

    The Committee adopts as its own the cost estimate prepared 
by the Director of the Congressional Budget Office pursuant to 
section 402 of the Congressional Budget Act of 1974.

                 Congressional Budget Office Estimates

    Pursuant to clause 3(c)(3) of rule XIII of the Rules of the 
House of Representatives, the following is the cost estimate 
provided by the Congressional Budget Office pursuant to section 
402 of the Congressional Budget Act of 1974:

                                     U.S. Congress,
                               Congressional Budget Office,
                                    Washington, DC, April 18, 2016.
Hon. Jeb Hensarling,
Chairman, Committee on Financial Services,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 4139, the 
Fostering Innovation Act of 2015.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Stephen 
Rabent.
            Sincerely,
                                                        Keith Hall.
    Enclosure.

H.R. 4139--Fostering Innovation Act of 2015

    H.R. 4139 would extend the exemption period for some 
emerging growth companies from having an auditor attest to and 
report on internal control reports.
    Securities and Exchange Commission (SEC) rules require the 
issuers of securities to file assessments of their internal 
control structures and procedures for financial reporting and 
to have those reports be attested to and reported on in an 
audit report. The Jumpstart Our Business Startups Act of 2012 
exempted companies with annual revenue and debt issuance under 
specified thresholds from the requirement of an auditor's 
attestation of their internal control report for up to five 
years after their first sale of equity securities. H.R. 4139 
would extend the maximum exemption period to 10 years.
    Based on information from the SEC, CBO estimates that 
implementing H.R. 4139 would cost less than $500,000 for 
personnel and administrative costs to revise SEC rules. 
However, the SEC is authorized to collect fees sufficient to 
offset its annual appropriation; therefore, CBO estimates that 
the net effect on discretionary spending would be negligible, 
assuming appropriation actions consistent with that authority.
    Enacting H.R. 4139 would not affect direct spending or 
revenues; therefore, pay-as-you-go procedures do not apply. CBO 
estimates that enacting H.R. 4139 would not increase net direct 
spending or on-budget deficits in any of the four consecutive 
10-year periods beginning in 2027.
    H.R. 4139 contains no intergovernmental mandates as defined 
in the Unfunded Mandates Reform Act (UMRA) and would not affect 
the budgets of state, local, or tribal governments.
    If the SEC increases fees to offset the costs of 
implementing the bill, H.R. 4139 would increase the cost of an 
existing mandate on private entities required to pay those 
fees. Based on information from the SEC, CBO estimates that the 
aggregate cost would be minimal and would fall well below the 
annual threshold for private-sector mandates established in 
UMRA ($154 million in 2016, adjusted annually for inflation).
    The CBO staff contacts for this estimate are Stephen Rabent 
(for federal costs) and Logan Smith (for private-sector 
mandates). The estimate was approved by H. Samuel Papenfuss, 
Deputy Assistant Director of Budget Analysis.

                       Federal Mandates Statement

    The Committee adopts as its own the estimate of Federal 
mandates prepared by the Director of the Congressional Budget 
Office pursuant to section 423 of the Unfunded Mandates Reform 
Act.

                      Advisory Committee Statement

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                  Applicability to Legislative Branch

    The Committee finds that the legislation does not relate to 
the terms and conditions of employment or access to public 
services or accommodations within the meaning of the section 
102(b)(3) of the Congressional Accountability Act.

                         Earmark Identification

    H.R. 4139 does not contain any congressional earmarks, 
limited tax benefits, or limited tariff benefits as defined in 
clause 9 of rule XXI.

                    Duplication of Federal Programs

    Pursuant to section 3(g) of H. Res. 5, 114th Cong. (2015), 
the Committee states that no provision of H.R. 4139 establishes 
or reauthorizes a program of the Federal Government known to be 
duplicative of another Federal program, a program that was 
included in any report from the Government Accountability 
Office to Congress pursuant to section 21 of Public Law 111-
139, or a program related to a program identified in the most 
recent Catalog of Federal Domestic Assistance.

                   Disclosure of Directed Rulemaking

    Pursuant to section 3(i) of H. Res. 5, 114th Cong. (2015), 
the Committee states that H.R. 4139 contains no directed 
rulemaking.

             Section-by-Section Analysis of the Legislation


Section 1: Short title

    This section cites H.R. 4139 as the ``Fostering Innovation 
Act of 2015.''

Section 2: Temporary exemption for low-revenue issuers

    This section amends Section 404 of the Sarbanes-Oxley Act 
of 2002 to extend the exemption from 404(b) compliance for 
Emerging Growth Companies (EGCs) until the earlier of ten years 
after the company went public, the end of the fiscal year in 
which the EGC's average gross revenues exceed $50 million, or 
when the EGC becomes a large accelerated filer ($700 million 
public float) with the SEC.

         Changes in Existing Law Made by the Bill, as Reported

  In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (new matter is 
printed in italic and existing law in which no change is 
proposed is shown in roman):

                       SARBANES-OXLEY ACT OF 2002




           *       *       *       *       *       *       *
TITLE IV--ENHANCED FINANCIAL DISCLOSURES

           *       *       *       *       *       *       *


SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS.

  (a) Rules Required.--The Commission shall prescribe rules 
requiring each annual report required by section 13(a) or 15(d) 
of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 
78o(d)) to contain an internal control report, which shall--
          (1) state the responsibility of management for 
        establishing and maintaining an adequate internal 
        control structure and procedures for financial 
        reporting; and
          (2) contain an assessment, as of the end of the most 
        recent fiscal year of the issuer, of the effectiveness 
        of the internal control structure and procedures of the 
        issuer for financial reporting.
  (b) Internal Control Evaluation and Reporting.--With respect 
to the internal control assessment required by subsection (a), 
each registered public accounting firm that prepares or issues 
the audit report for the issuer, other than an issuer that is 
an emerging growth company (as defined in section 3 of the 
Securities Exchange Act of 1934), shall attest to, and report 
on, the assessment made by the management of the issuer. An 
attestation made under this subsection shall be made in 
accordance with standards for attestation engagements issued or 
adopted by the Board. Any such attestation shall not be the 
subject of a separate engagement.
  (c) Exemption for Smaller Issuers.--Subsection (b) shall not 
apply with respect to any audit report prepared for an issuer 
that is neither a ``large accelerated filer'' nor an 
``accelerated filer'' as those terms are defined in Rule 12b-2 
of the Commission (17 C.F.R. 240.12b-2).
  (d) Temporary Exemption for Low-Revenue Issuers.--
          (1) Low-revenue exemption.--Subsection (b) shall not 
        apply with respect to an audit report prepared for an 
        issuer that--
                  (A) ceased to be an emerging growth company 
                on the last day of the fiscal year of the 
                issuer following the fifth anniversary of the 
                date of the first sale of common equity 
                securities of the issuer pursuant to an 
                effective registration statement under the 
                Securities Act of 1933;
                  (B) had average annual gross revenues of less 
                than $50,000,000 as of its most recently 
                completed fiscal year; and
                  (C) is not a large accelerated filer.
          (2) Expiration of temporary exemption.--An issuer 
        ceases to be eligible for the exemption described under 
        paragraph (1) at the earliest of--
                  (A) the last day of the fiscal year of the 
                issuer following the tenth anniversary of the 
                date of the first sale of common equity 
                securities of the issuer pursuant to an 
                effective registration statement under the 
                Securities Act of 1933;
                  (B) the last day of the fiscal year of the 
                issuer during which the average annual gross 
                revenues of the issuer exceed $50,000,000; or
                  (C) the date on which the issuer becomes a 
                large accelerated filer.
          (3) Definitions.--For purposes of this subsection:
                  (A) Average annual gross revenues.--The term 
                ``average annual gross revenues'' means the 
                total gross revenues of an issuer over its most 
                recently completed three fiscal years divided 
                by three.
                  (B) Emerging growth company.--The term 
                ``emerging growth company'' has the meaning 
                given such term under section 3 of the 
                Securities Exchange Act of 1934 (15 U.S.C. 
                78c).
                  (C) Large accelerated filer.--The term 
                ``large accelerated filer'' has the meaning 
                given that term under section 240.12b-2 of 
                title 17, Code of Federal Regulations, or any 
                successor thereto.

           *       *       *       *       *       *       *


                             MINORITY VIEWS

    H.R. 4139 would amend the Sarbanes-Oxley Act of 2002 (SOx) 
to provide a 10 year exemption from the Section 404(b) auditor 
attestation requirements for companies who cease to be Emerging 
Growth Companies (EGCs), provided that they have average annual 
gross revenues of less than $50 million and do not meet the 
Securities and Exchange Commission's (SEC) definition of 
``large accelerated filer'' (i.e., the company has a public 
float less than $700 million).
    Congress passed SOx nearly 15 years ago in the wake of 
several high-profile corporate and accounting scandals, 
including those of Enron, Tyco International, Adelphia and 
WorldCom, which collectively cost investors billions of dollars 
and simultaneously undermined confidence in U.S. capital 
markets. A key component of SOx was Section 404(b), which 
requires that a company's auditor include an assessment of the 
adequacy of the company's internal controls that govern 
financial statements.
    H.R. 4139 would amend SOx to exempt EGCs for up to a decade 
from the Section 404(b) audit if they meet certain revenue and 
public float requirements. This is both unnecessary and 
harmful.
    First, the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 (P.L. 111-203) has already provided 
relief to small issuers, exempting ``non-accelerated filers'' 
(i.e., companies with less than $75 million in public float) 
from the Section 404(b) requirement. In total, approximately 60 
percent of issuers are exempt pursuant to this provision. 
Second, the Jumpstart Our Business Startups Act of 2012 (P.L. 
112-106) expanded upon this relief by providing an exemption 
from Section 404(b) for EGCs, either until five years after the 
EGCs first sale of common equity securities in a public 
offering; the last day of the fiscal year during which the EGC 
had total annual gross revenues of $1 billion (adjusted for 
inflation every five years); the date on which the EGC has, 
during the previous three-year period, issued more than $1 
billion in non-convertible debt; or the date on which it is 
deemed to be a ``large accelerated filer.''
    The additional exemptions provided under H.R. 4139--which 
would further delay compliance for up to a decade for certain 
companies--is not necessary in light of the plentiful 
exemptions already available.
    Additionally, the further exemptions may prove to be 
harmful both to investors and to the very companies H.R. 4139 
purports to help. In a 2013 study, the Government 
Accountability Office (GAO) found that companies that are not 
required to comply with the Section 404(b) audit requirement 
restated their financials more often than those that were 
required to comply. Restatements of financials can have a 
devastating impact on a company's health and potential growth, 
particularly for less established firms.
    Removing Section 404(b) requirements likewise is harmful to 
investors, with 72 percent of institutional investors reporting 
in a 2015 study by the Public Company Accounting Oversight 
Board's Investor Advisory Group that they rely on the Section 
404(b) audits when making investment decisions. Further, Joseph 
Carcello, a CPA and member of the SEC's Investor Advisory 
Committee, testified to the Committee that auditors, rather 
than management, detect approximately 75 percent of the 
internal control deficiencies in these small companies. Mr. 
Carcello also informed the Committee that management tends to 
downplay internal control deficiencies as less severe, and 
auditors must frequently override these classifications.
    In short, auditor reporting on public companies provides 
substantial benefits to investors and to the companies. It 
promotes confidence in U.S. markets, strengthens internal 
controls, and prevents fraud. For these reasons, the Minority 
opposes H.R. 4139.

                                                     Maxine Waters.