[House Report 115-425]
[From the U.S. Government Publishing Office]


115th Congress    }                                    {       Report
                        HOUSE OF REPRESENTATIVES
 1st Session      }                                    {      115-425

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



 
                    FOSTERING INNOVATION ACT OF 2017

                                _______
                                

 November 28, 2017.--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. 1645]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Financial Services, to whom was referred 
the bill (H.R. 1645) 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

    On March 21, 2017, Representatives Kyrsten Sinema and Trey 
Hollingsworth introduced H.R. 1645, the ``Fostering Innovation 
Act of 2017'', which amends Section 404(b) of the Sarbanes-
Oxley Act (SOX) to extend the exemption available to emerging 
growth companies (EGCs) from the auditor attestation of a 
company's internal controls over financial reporting 
requirement beyond the five-year period that applies under 
current law. Specifically, the bill extends the exemption until 
the earlier of ten years after the EGC went public, the end of 
the fiscal year in which the EGC's average gross revenues 
exceed $50 million, or when the EGC qualifies with the 
Securities and Exchange Commission (SEC) as a large accelerated 
filer, $700 million public float, which is the number of shares 
available to trade freely between investors that are not 
controlled by corporate officers or promoters.

                  Background and Need For Legislation

    The goal of H.R. 1645 is to extend the exemption status for 
EGCs from SOX 404(b) requirements beyond the initial five year 
period under current law. The legislation does not relieve an 
EGC from its responsibilities under SOX 404(a), which require 
that management establish and maintain an adequate internal 
control structure and procedures for financial reporting.
    Title I of the Jumpstart Our Business Startups (JOBS) Act 
established EGCs as a new category of issuers. These issuers 
have less than $1 billion in annual revenues or $700 million in 
public float when they register with the SEC and 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 
encourages small companies to go public while ensuring that 
they move to full compliance with regulatory requirements as 
they become large enough to support the legal, accounting, and 
compliance infrastructure more typical of mature enterprises.
    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 SOX 
compliance costs is Section 404(b), which requires a public 
company's auditor to attest to, and report on, management's 
assessment of the company's internal controls. 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. A 2008 report by the 
Heritage Foundation stated that 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. Moreover, these costs impact small 
accelerated filers disproportionately when compared with large 
accelerated filers. CRA International's survey data indicates 
that for a small accelerated filer--which includes companies 
with market capitalization between $75 million and $700 
million--the total year-one Section 404 implementation cost per 
company is $1.5 million, or 0.46 percent of revenue. For a 
large accelerated filer--which is a company with market 
capitalization above $700 million--the total is $7.3 million, 
or 0.09 percent of its revenue.
    Similarly, in 2010, the Independent Community Bankers 
Association (ICBA) concluded that:

        while [Section] 404 auditor costs declined 5.4% from 
        2006 as the auditor scope of work narrowed, these costs 
        were offset by a reported [5%] 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 . . . 
        [and] 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. . . . [T]he 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 [than larger reporting 
        companies].

    A May 2014 survey conducted by compliance and audit 
consultant Protiviti similarly found that around 53% of large 
organizations currently spend $1 million or more on SOX 
compliance, and 30% 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.''
    The significant burdens associated with SOX Section 404(b) 
compliance disproportionately affect smaller public companies, 
divert resources from growth to regulatory costs, and harm the 
ability of these firms to compete against larger peers and 
foreign competitors. According to Heritage, ``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:

        [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 . . . . 
        [T]he 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. . . . [T]he 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.

    In its report on Capital Markets mandated by President 
Trump's February 3, 2017 Executive Order, the Department of 
Treasury recommended an increase in the length of time a 
company may maintain its EGC status for up to 10 years, subject 
to a revenue and/or public float threshold, in order to more 
appropriately tailor compliance costs associated for a smaller 
public company.

                                Hearings

    The Committee on Financial Services and the Subcommittee on 
Capital Markets, Securities, and Investment held a hearing 
examining matters relating to H.R. 1645 on March 22, 2017, 
April 26, 2017, April 28, 2017, and July 18, 2017.

                        Committee Consideration

    The Committee on Financial Services met in open session on 
October 11, 2017, October 12, 2017, and ordered H.R. 1645 to be 
reported favorably to the House without amendment by a recorded 
vote of 48 yeas to 12 nays (Record vote no. FC-91), 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 record votes 
on the motion to report legislation and amendments thereto. The 
sole recorded vote was on a motion by Chairman Hensarling to 
report the bill favorably to the without amendment. The motion 
was agreed to by a recorded vote of 48 yeas to 12 nays (Record 
vote no. FC-91), a quorum being present.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                      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. 1645 
will reduce regulatory compliance costs for EGCs 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.

                 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, November 1, 2017.
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. 1645, the 
Fostering Innovation Act of 2017.
    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,
                                                          Director.
    Enclosure.

H.R. 1645--Fostering Innovation Act of 2017

    Under current law, the Securities and Exchange Commission 
(SEC) requires issuers of securities to file assessments of 
their internal control structures and procedures for financial 
reporting and have those reports be attested to and covered 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 to have an 
auditor's attestation as part of their internal control reports 
for up to 5 years after their first sale of equity securities. 
H.R. 1645 would increase that maximum exemption period to 10 
years.
    Based on an analysis of information from the SEC, CBO 
estimates that implementing H.R. 1645 would have no significant 
effect on the agency's costs because the SEC would not have to 
update agency rules to implement the bill. Moreover, the SEC is 
authorized to collect fees sufficient to offset its annual 
appropriation; therefore, assuming appropriation actions 
consistent with that authority, CBO estimates that the net 
effect on discretionary spending would be negligible.
    Enacting H.R. 1645 would not affect direct spending or 
revenues; therefore, pay-as-you-go procedures do not apply.
    CBO estimates that enacting H.R. 1645 would not increase 
net direct spending or on-budget deficits in any of the four 
consecutive 10-year periods beginning in 2028.
    H.R. 1645 contains no intergovernmental or private-sector 
mandates as defined in the Unfunded Mandates Reform Act.
    The CBO staff contact for this estimate is Stephen Rabent. 
The estimate was approved by H. Samuel Papenfuss, Deputy 
Assistant Director for Budget Analysis.

                       Federal Mandates Statement

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995.
    The Committee has determined that the bill does not contain 
Federal mandates on the private sector. The Committee has 
determined that the bill does not impose a Federal 
intergovernmental mandate on State, local, or tribal 
governments.

                      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

    With respect to clause 9 of rule XXI of the Rules of the 
House of Representatives, the Committee has carefully reviewed 
the provisions of the bill and states that the provisions of 
the bill do not contain any congressional earmarks, limited tax 
benefits, or limited tariff benefits within the meaning of the 
rule.

                    Duplication of Federal Programs

    In compliance with clause 3(c)(5) of rule XIII of the Rules 
of the House of Representatives, the Committee states that no 
provision of the bill establishes or reauthorizes: (1) a 
program of the Federal Government known to be duplicative of 
another Federal program; (2) a program included in any report 
from the Government Accountability Office to Congress pursuant 
to section 21 of Public Law 111-139; or (3) a program related 
to a program identified in the most recent Catalog of Federal 
Domestic Assistance, published pursuant to the Federal Program 
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No. 
98-169).

                   Disclosure of Directed Rulemaking

    Pursuant to section 3(i) of H. Res. 5, (115th Congress), 
the following statement is made concerning directed 
rulemakings: The Committee estimates that the bill requires no 
directed rulemakings within the meaning of such section.

             Section-by-Section Analysis of the Legislation


Section 1. Short title

    This Section cites H.R. 1645 as the ``Fostering Innovation 
Act of 2017''

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 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--at least $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 (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italic, and existing law in which no 
change is proposed is shown in roman):

         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. 1645 would amend the Sarbanes-Oxley Act of 2002 (SOX) 
to exempt certain companies from Section 404(b) audit 
requirements for up to a decade if they have average annual 
gross revenues of less than $50 million and a public float of 
less than $700 million.
    Congress enacted SOX fifteen years ago in the wake of Enron 
and several other high-profile corporate and accounting 
scandals that collectively cost investors billions of dollars 
and undermined confidence in U.S. capital markets. SOX protects 
investors from similar misconduct by increasing the accuracy 
and transparency of financial reporting by public companies. 
Specifically, Section 404(b) requires an external auditor to 
attest to and report on management's assessment of the 
company's internal controls over financial reporting. H.R. 1645 
would create an unnecessary and harmful exemption from these 
important requirements.
    The Dodd-Frank Wall Street Reform and Consumer Protection 
Act of 2010 (P.L. 111-203) already provides a permanent 
exemption from Section 404(b) for any company with a public 
float of less than $75 million (i.e., companies that are not 
classified ``as accelerated filers'' or ``large accelerated 
filers''). This exemption currently applies to fully half of 
all public companies.
    Additionally, the Jumpstart Our Business Startups (JOBS) 
Act of 2012 (P.L. 112-106) created a five-year exemption from 
Section 404(b) for companies that go public with less than $1 
billion in annual revenues, referred to as ``Emerging Growth 
Companies'' (EGCs). Since the enactment of the JOBS Act, 85% of 
companies that have gone public have done so as EGCs.
    The JOBS Act ensures that large companies adhere to the SOX 
404(b) auditor requirements by terminating EGC status (and the 
associated exemption) after a company has been public for five 
years; or when the company has a public float of more than $700 
million, annual revenues exceeding $1.07 billion, or debt 
issuance exceeding $1.07 billion.
    H.R. 1645 would further delay compliance for up to a decade 
for companies that no longer qualify as EGCs. This new 
exemption is unnecessary in light of existing exemptions and 
could prove harmful to the companies that H.R. 1645 purports to 
help. In 2013, a Government Accountability Office (GAO) report 
found that companies that do not undergo an audit of their 
internal controls over financial reporting have a significantly 
higher likelihood of restating their financial statements. 
Financial restatements are major reporting errors that can 
damage a public company's reputation and reduce investor 
confidence in the company, its management, and the broader 
capital markets.
    Removing Section 404(b) requirements can also harm 
investors, who rely on corporate financial statements when 
making investment decisions. For this reason, academics, 
investor advocates, and regulators have opposed expanding SOX 
404(b) exemptions. For example, Rick Fleming, the Securities 
and Exchange Commission's Investor Advocate, opposed an 
identical bill last Congress on the grounds that expanding 
404(b) exemptions to a new class of issuers would ``weaken[] an 
important investor protection'' and ``further compound[] the 
complexity of securities law reporting requirements . . . .'' 
Professor Robert Brown of the University of Denver, Sturm 
College of Law has also advised against expanding exemptions to 
SOX 404(b) requirements. During a July 18, 2017, hearing of the 
Capital Markets Subcommittee, Professor Brown testified that, 
as a matter of ``human nature, if you are inside a company, and 
you are responsible for internal controls, if you know somebody 
from the outside is going to come and look at them, you are 
going to do a better job.'' Investor advocacy groups including 
Americans for Financial Reform, Center for American Progress, 
Consumer Federation of American, and Public Citizen have also 
opposed H.R. 1645 on the basis that increasing exemptions from 
SOX 404(b) would endanger investors and diminish the integrity 
of U.S. capital markets.
    In short, SOX 404(b) auditor requirements provide 
substantial benefits to investors and companies. These 
requirements promote investor confidence in U.S. capital 
markets, strengthen internal controls, and help prevent fraud. 
For these reasons, we oppose H.R. 1645.

                                   Maxine Waters.
                                   Keith Ellison.
                                   Michael E. Capuano.
                                   Joyce Beatty.
                                   Emanuel Cleaver.
                                   Wm. Lacy Clay.
                                   Al Green.
                                   Stephen F. Lynch.

                                  [all]