Section 404 of the sarbanes-oxley act requires management to report on ______.

[House Hearing, 110 Congress] [From the U.S. Government Printing 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 U.S. GOVERNMENT PRINTING OFFICE 39-384 PDF WASHINGTON DC: 2007 --------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866)512-1800 DC area (202)512-1800 Fax: (202) 512-2250 Mail Stop SSOP, Washington, DC 20402-0001 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.] [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

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