U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

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

33–393 PDF 2007

A BALANCING ACT: COST, COMPLIANCE, AND

COMPETITIVENESS AFTER SARBANES-OXLEY

HEARING

BEFORE THE

SUBCOMMITTEE ON REGULATORY AFFAIRS

OF THE

COMMITTEE ON

GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

JUNE 19, 2006

Serial No. 109–217

Printed for the use of the Committee on Government Reform

(

Available via the World Wide Web: http://www.gpoaccess.gov/congress/index.html

http://www.house.gov/reform

(II)

COMMITTEE ON GOVERNMENT REFORM

TOM DAVIS, Virginia, Chairman

CHRISTOPHER SHAYS, Connecticut

DAN BURTON, Indiana

ILEANA ROS-LEHTINEN, Florida

JOHN M. MCHUGH, New York

JOHN L. MICA, Florida

GIL GUTKNECHT, Minnesota

MARK E. SOUDER, Indiana

STEVEN C. LATOURETTE, Ohio

TODD RUSSELL PLATTS, Pennsylvania

CHRIS CANNON, Utah

JOHN J. DUNCAN, JR., Tennessee

CANDICE S. MILLER, Michigan

MICHAEL R. TURNER, Ohio

DARRELL E. ISSA, California

JON C. PORTER, Nevada

KENNY MARCHANT, Texas

LYNN A. WESTMORELAND, Georgia

PATRICK T. MCHENRY, North Carolina

CHARLES W. DENT, Pennsylvania

VIRGINIA FOXX, North Carolina

JEAN SCMIDT, Ohio

——— ———

HENRY A. WAXMAN, California

TOM LANTOS, California

MAJOR R. OWENS, New York

EDOLPHUS TOWNS, New York

PAUL E. KANJORSKI, Pennsylvania

CAROLYN B. MALONEY, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

DANNY K. DAVIS, Illinois

WM. LACY CLAY, Missouri

DIANE E. WATSON, California

STEPHEN F. LYNCH, Massachusetts

CHRIS VAN HOLLEN, Maryland

LINDA T. SANCHEZ, California

C.A. DUTCH RUPPERSBERGER, Maryland

BRIAN HIGGINS, New York

ELEANOR HOLMES NORTON, District of

Columbia

———

BERNARD SANDERS, Vermont

(Independent)

DAVID MARIN, Staff Director

LAWRENCE HALLORAN, Deputy Staff Director

TERESA AUSTIN, Chief Clerk

PHIL BARNETT, Minority Chief of Staff/Chief Counsel

SUBCOMMITTEE ON REGULATORY AFFAIRS

CANDICE S. MILLER, Michigan, Chairman

CHRIS CANNON, Utah

MICHAEL R. TURNER, Ohio

LYNN A. WESTMORELAND, Georgia

JEAN SCHMIDT, Ohio

STEPHEN F. LYNCH, Massachusetts

WM. LACY CLAY, Missouri

CHRIS VAN HOLLEN, Maryland

EX OFFICIO

TOM DAVIS, Virginia HENRY A. WAXMAN, California

ED SCHROCK, Staff Director

KRISTINA HUSAR, Professional Staff Member

BENJAMIN CHANCE, Clerk

KRISTA BOYD, Minority Professional Staff Member

(III)

C O N T E N T S

Page

Hearing held on June 19, 2006 ............................................................................... 1

Statement of:

Robotti, Robert, president, Robotti & Co.; William W. Beach, director

for data analysis, the Heritage Foundation; John P. O’Shea, president

and CEO, Westminster Securities Corp.; and David Lawrence, chief

financial officer, Acorda Therapeutics, Inc. ................................................ 48

Beach, William W. ..................................................................................... 58

Lawrence, David ........................................................................................ 73

O’Shea, John P. ......................................................................................... 65

Robotti, Robert ........................................................................................... 48

Wolkoff, Neal, CEO, the American Stock Exchange; R. Cromwell Coulson,

CEO, the Pink Sheets; and Mallory Factor, chairman, Free Enterprise

Fund ............................................................................................................... 8

Coulson, R. Cromwell ................................................................................ 19

Factor, Mallory .......................................................................................... 30

Wolkoff, Neal ............................................................................................. 8

Letters, statements, etc., submitted for the record by:

Beach, William W., director for data analysis, the Heritage Foundation,

prepared statement of ................................................................................... 60

Coulson, R. Cromwell, CEO, the Pink Sheets, prepared statement of ........ 22

Factor, Mallory, chairman, Free Enterprise Fund, prepared statement

of ..................................................................................................................... 32

Lawrence, David, chief financial officer, Acorda Therapeutics, Inc., prepared statement of ........................................................................................ 75

McHenry, Hon. Patrick T., a Representative in Congress from the State

of North Carolina, prepared statement of ................................................... 3

O’Shea, John P., president and CEO, Westminster Securities Corp., prepared statement of ........................................................................................ 68

Robotti, Robert, president, Robotti & Co., prepared statement of ................ 51

Wolkoff, Neal, CEO, the American Stock Exchange, prepared statement

of ..................................................................................................................... 11

(1)

A BALANCING ACT: COST, COMPLIANCE, AND

COMPETITIVENESS AFTER SARBANES-OXLEY

MONDAY, JUNE 19, 2006

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON REGULATORY AFFAIRS,

COMMITTEE ON GOVERNMENT REFORM,

New York, NY.

The subcommittee met, pursuant to notice, at 10 a.m., in the Auditorium of the U.S. Customs House, 1 Bowling Green, New York,

NY, Hon. Patrick T. McHenry (chairman of the subcommittee) presiding.

Present: Representatives McHenry, Dent, and Maloney.

Also present: Representatives Kelly, and Feeney.

Mr. MCHENRY. Come to order. Good morning. I’m Congressman

Patrick McHenry from North Carolina. I am chairing this subcommittee in Candice Miller’s stead. She has been detained in

Michigan due to a family health emergency. She’s OK. She wanted

me to communicate that, but unfortunately she cannot be here

today.

I’m joined this morning by my colleagues from everywhere from

New York to Florida. To my immediate right would be Mrs.

Maloney, who actually represents Manhattan. And to my left, my

good friend and fellow class representative, Charlie Dent from the

15th Congressional District of Pennsylvania, representing the Lehigh Valley. Next to him is Sue Kelly, representing just to the

north of the city, Westchester and the Hudson Valley, representing

New York’s 19th Congressional District. And to her left is Tom

Feeney from Florida, representing the space coast and Florida’s

24th Congressional District. And we are looking forward to this

hearing today on ‘‘A Balancing Act: Cost, Compliance and Competitiveness after Sarbanes-Oxley.’’

Both Tom Feeney, Mrs. Kelly and I are members of the House

Financial Services Committee. I am also a member of the House

Government Reform Committee. And under the auspices of the

House Government Reform Committee, of which Charlie Dent and

I both sit on, we’re having this hearing today.

I am very pleased to be here in this historic setting discussing

an important issue for our financial markets. New York has long

been considered the financial capital of the world, although we in

North Carolina are very pleased about our banking center in Charlotte and I’m pleased to represent a number of folks that work

there. The reason why we’re holding this hearing today is because

of a growing concern that due to certain regulations and regulatory

2

matters and legislation that we’ve passed, America and New York

is losing its lead as a financial capital to foreign exchanges.

To illustrate the point, I would draw your attention to a Wall

Street Journal article of January 26, 2006 that reported: ‘‘In 2000,

nine out of every ten dollars raised by foreign companies through

new stock offerings were done in New York. By 2005, the reverse

was true. Nine out of every ten dollars were raised through new

company listings in London or Luxembourg.’’

Furthermore, on Tuesday, May 30, 2006, the Journal noted that

the world’s top 10 Initial Public Offerings since the passage of Sarbanes-Oxley, only 1 occurred on Wall Street.

Finally, it’s not hard to conclude that the announced merger of

the New York Stock Exchange with Euronext is due in part to their

desire to recapture these lost listings. Indeed, the Wall Street Journal on Friday, June 2nd said this: that one factor pushing the New

York Stock Exchange toward Euronext is the shriveling of initial

public offerings by international companies amid a tougher U.S.

regulatory environment.

Certainly, Sarbanes-Oxley was a reaction to World Com and

Enron-style scandals. But this bill does offer some solid guidance

to businesses. But unfortunately, the implementation, in particular

of Section 404, a section just 168 words long, has resulted in some

unintended consequences that have become a huge handicap for

American businesses.

I’ve met with a number of business and banking leaders about

this subject around the country and in North Carolina and they

agree. Sarbanes-Oxley has made a dramatic and sometimes negative impact on the capital markets. Transparency is very important

in corporate governance. We understand that as public policymakers. However, as a rule, less government regulation translates

to more productivity, economic expansion and job growth. So we

have to balance those competing interests and needs.

Congress did not intend to handicap U.S. businesses with these

huge costs and the original SEC estimates said that annual compliance cost of the average firm would be somewhere around $91,000.

Today, the average firm spends $3.7 million to comply with the requirements of Sarbanes-Oxley. The SEC underestimated the cost

by a factor of 40 and that is after compliance costs have decreased.

In fact, a moderate size community bank in my District spent

$500,000 last year in direct costs associated with compliance of

Sarbanes-Oxley, on top of all the other indirect costs they tally into

many millions. And this is for a small community bank.

So we have to look at competitiveness around the world, if we’re

to draw that capital here to the United States and that’s what this

hearing is about today. I look forward to the distinguished panels

that we have here today and my colleagues’ questions as well.

And with that, I would now like to recognize my colleague, Mr.

Dent, from Pennsylvania.

[The prepared statement of Hon. Patrick T. McHenry follows:]

3

4

5

Mr. DENT. Thank you, Mr. Chairman. I’d also like to thank

Chairman Miller for holding this critical hearing today on Sarbanes-Oxley Act and also thanks to Mr. McHenry for pinch hitting

for her this morning. As a result of the accounting scandals of

Enron and World Com, Congress passed the Sarbanes-Oxley Act of

2002 with the intent to restore public confidence in the financial

market. SOX requires extensive disclosures about internal controls

for public companies. Specifically, Section 302 requires corporate

managers to attest to the accuracy and reliability of financial reports and disclose material witnesses in internal controls.

Section 404 requires that public companies must disclose their

own financial controls as part of their annual report and requires

an outside accounting firm to audit internal controls and the company’s attestment before being considered compliant. While the intent may have been positive, regulatory demands of SOX compliance has become extremely expensive for companies to meet and

become a major obstacle, perhaps prohibiting smaller businesses

from going public.

I have had extensive discussions of this act with several constituents in my District. In fact, my good friend and constituent, Dave

Lobach, is here today or will be here momentarily if he can park

his car. Dave is the CEO of Embassy Bank in the Lehigh Valley.

Dave and Elmer Gates, the chairman of Embassy, have given me

a firsthand perspective as to the obstacles they face as a result of

Sarbanes-Oxley.

Banking is a highly regulated industry in the United States and

as community bankers, they are consistently inundated with various rules and regulations that go well beyond simple regulation

and I believe it’s safe to say well into the realm of debilitating.

Currently, and this bank in particular, Embassy Bank is reviewed

on an annual basis by the state and the FDIC. Furthermore, in addition to conducting its own internal audit process, Embassy also

has a number of external auditors who consistently assess a variety

of different criteria ensuring regulatory compliance on many levels.

I can say with certainty that many of the small businesses in my

District see SOX as an anti-competitive initiative which adds additional process to an already over-regulated industry and adds tremendous cost in a business where the spreads are very thin.

I have concerns that when the financial markets become too duplicative and over-regulated, the cost will be passed on to or absorbed by the consumer. I was shocked when Mr. Lobach informed

me that the costs—he informed me that the costs Embassy Bank

will accrue this year to be SOX compliant will equal the cost of

opening and operating another branch office for a single year.

I’m quite interested in this issue and the effects that the Sarbanes-Oxley Act has on the small businesses and banks in my District. I do not sit on this subcommittee or the Financial Services

Committee, nor was I a Member of Congress when SOX was enacted in 2002. That said, I’m extremely interested in the testimony

of these expert witnesses assembled here today and I’m eager to

hear a bit about it, about their perspective as to the effects of Sarbanes-Oxley and the evaluation to cost and benefits of being SOX

compliant.

Thank you, Mr. Chairman.

6

Mr. MCHENRY. At this point I recognize Congresswoman Kelly

for the purposes of an opening statement.

Ms. KELLY. Thank you, Chairman McHenry, for holding this

hearing.

I’d like to welcome Members of the subcommittee to New York

and I really am very pleased to have the honor to have a constituent testify and to participate in a much needed discussion of the

impacts of Sarbanes-Oxley Act on businesses in our country and in

New York.

In 2002, I voted for the original Sarbanes-Oxley Act. At that time

it was a much needed response to the scandals at Enron and World

Com that had already hurt millions of small investors and threatened to destroy confidence in America’s securities markets. As

chairman of oversight and investigations, I held the first Enron

and World Com hearings. Voting for Sarbanes-Oxley then was the

right thing to do.

Four years later, America’s economy is growing strong and consumer confidence is high. For all the success of this law, we do see

some issues that demand attention. Employers in New York’s Hudson Valley and around the Nation have experienced problems meeting the costs imposed by the regulators’ interpretation of the law.

We will hear the experiences of one of my constituents, David Lawrence of Warwick, NY, whose employer has brought numerous jobs

to my District, but is struggling to meet the costs.

When Congress passed Sarbanes-Oxley, it never intended to force

any company to choose between following the law and creating

jobs. Sadly, bureaucratic regulation has chosen to interpret the law

in ways that no longer seem to make sense. Although accounting

costs for audits are declining, businesses with less than $100 million market cap are having to divert precious personnel and resources to comply with a law that was never intended to cover

America’s smaller or startup companies.

Smaller companies are increasingly raising capital outside the

public markets and the IPOs have been delayed and many have

moved off-shore. Given this situation, I think it’s important that

Congress examine how to ensure that our financial system remains

strong, transparent and clean while allowing innovation and

growth to flourish. Even the best laws need continued oversight in

perfecting modifications.

Today’s witnesses from academia and industry will allow us to

explore the best way to comply with the spirit and the substance

of Sarbanes-Oxley in a way that makes sense for this Nation.

I thank you for holding this hearing and I yield back.

Mr. MCHENRY. Thank you, Ms. Kelly. Mr. Feeney.

Mr. FEENEY. Thank you, Mr. Chairman. I’m especially grateful

to you, to Chairman Davis and Chairman Miller for letting Congresswoman Kelly and I kibbutz on your subcommittee’s hearings

because it’s something very important to me. I’ll tell you that there

are a couple of traditional truisms in Congress that Sarbanes-Oxley

has, I think, proven in my view. One is that Congress has typically

two speeds, zero and over-react and the second is that often the

law of unintended, unforeseen consequences means that the adverse consequences of a well-intentioned bill are much greater than

the positive consequences.

7

I have engaged for the last 9, 10 months in a listening tour,

along with Congressman Meeks, Congressman Pete Sessions, Congressman Mark Kirk, and a few others at times and we have visited all three of the major exchanges in Chicago. We’ve been to the

New York Stock Exchange, to the NASDAQ. I look forward to hearing Mr. Wolkoff’s testimony which I’ve read. And I have come to

a conclusion that it is time for a serious review of Sarbanes-Oxley.

We now have enough empirical and anecdotal evidence across the

board to know that the way it has been implemented, especially

404, has been counter productive.

Ultimately, the test is not how many headaches we create for

members of the board of directors, for the CFO or the CEO, ultimately, the test is are we giving net added value to investors? And

I believe the answer is in many cases an overwhelming no and as

we now put small cap companies under the gun, the deadline has

been extended I think until December 16th of this year, but I am

concerned that we are going to have a massive adverse reaction to

imposing these enormously complex requirements on small companies.

The bottom line is we have a conspiracy of two major problems

that have come under the gun here. No. 1 is the way that Sarbanes-Oxley 404 has been implemented is very ambiguous in terms

of what is a de minimis accounting error. There are lots of other

standards that are not clearly set and you combine that with the

fact that everybody involved, from the internal and the external

auditors to the members of the board to the CFO, the CEO is

under the gun for both civil and criminal liability. So over-zealous

regulation is always the result when you have ambiguous rules and

when you have essentially the death sentence for everybody involved.

You talked about the $35 billion estimated direct cost of compliance. I am much more concerned about the indirect cost of compliance with Sarbanes-Oxley. The estimates are as much as $1.1 trillion by two separate sources, which means that effectively this is

an 8 or 9 percent regulatory tax on every transaction that occurs

in the United States of America, and I believe that we are quickly

outsourcing our lead in America’s capital markets which we’ve had

for about 100 years.

With that, Mr. Chairman, I’d like to just note that along with

about 22 co-sponsors, I have filed a bill called the Compete Act. I

would encourage people interested in Sarbanes-Oxley issues to take

a look at that bill. We’ve got eight sponsors and co-sponsors led by

Senator Jim Demint in the U.S. Senate and I’m just again really

thrilled to be here.

Mr. MCHENRY. Thank you, Mr. Feeney. Because the Government

Reform Committee has subpoena power, we always swear in our

witnesses, so if you would all please rise with me, raise your right

hands.

[Witnesses sworn.]

Mr. MCHENRY. Due to time restrictions, we’d ask you to please

limit your opening remarks to 5 minutes. Your time will begin and

be noted by the green light. They’ll signify—when the yellow light

flashes, it will signify you have 1 minute left. And I would ask you

to please abide by that because we’d like to get to questions and

8

we’d like to have a full hearing and the interaction that we have

with the questions between Members of Congress and the panel is

really where we’ll gain the most knowledge.

So with that, I’d like to recognize Mrs. Kelly for the purposes of

introducing Mr. Factor.

Ms. KELLY. It gives me great pleasure to introduce Mr. Neal

Wolkoff, who is chairman and chief executive officer of the American Stock Exchange and was appointed to the post in April 2005,

after serving as an Acting CEO. Previously, he served as chief operating officer and several other senior level executive positions in

the New York Mercantile Exchange, a member of the bar of the

State of New York, and the U.S. District Court, Southern District

of New York. Mr. Wolkoff received a B.A. from the College of Columbia University and a J.D. from Boston University School of

Law.

Next is Mr. R. Cromwell Coulson. Mr. Coulson is the chairman

and chief executive officer for Pink Sheets LLC. In 1997, he led a

group of investors in acquiring Pink Sheets’ predecessor, the National Quotation Bureau, reforming the company into the corporation which now exists. Prior to the acquisition of Pink Sheets, he

was a trader specializing in distressed and value-oriented investments of over-the-counter market maker. He received a BBA from

the Southern Methodist University in Dallas, TX.

Next, we have Mr. Mallory Factor. Mallory Factor is chairman

of the Free Enterprise Fund and president and founder of Mallory

Factor, Inc. He is also the chairman of the New York Public Asset

Fund and Blue Cross Blue Shield Investment Advisory Board. He

serves as a member of the Board of Governors of the New York

State Banking Department. He is a member of the Council on Foreign Relations and served as vice chair of the Council on Foreign

Relations Task Force on Terrorism Financing. He was appointed by

President Ronald Reagan to the Federal Savings and Loan Advisory Council of the Federal Home Loan Bank. He’s a graduate of

Wesleyan University in Connecticut, attended Columbia University

graduate business and law program.

We welcome you all and look forward to your testimony.

Mr. MCHENRY. And we’ll begin with Mr. Wolkoff.

STATEMENTS OF NEAL WOLKOFF, CEO, THE AMERICAN

STOCK EXCHANGE; R. CROMWELL COULSON, CEO, THE PINK

SHEETS; AND MALLORY FACTOR, CHAIRMAN, FREE ENTERPRISE FUND

STATEMENT OF NEAL WOLKOFF

Mr. WOLKOFF. Thank you. Chairman McHenry and members of

the subcommittee, on behalf of the American Stock Exchange, I

would like to thank you for allowing me the opportunity to testify.

As was stated before, I have submitted written testimony which I

would like to become part of the official record.

I would like to briefly summarize the written testimony. The

American Stock Exchange is the only national stock exchange

whose business focus is on listing small and mid-cap companies.

And therefore, we feel that the impact of Sarbanes-Oxley on listed

companies, particularly those companies that are in the small-cap

9

arena are of particular concern to us, among the other national exchanges.

While some of our 600-listed companies are large cap, the vast majority has capitalization between $50 million and $1 billion and

we find that any regulatory system that discourages these companies from participating in the public markets is of vital importance

to our exchange and our listed companies.

Our experience in the 4-years since the law was enacted has

been that regulators have yet to determine how best to address

these corporate governance issues without disadvantaging smaller

companies that lack the same resources as larger companies. Key

problems that confront smaller companies involve Section 404 Sarbanes-Oxley, which requires designing, documenting and ordering

of financial controls. Neither the PCAOB nor the accounting industry have adequately defined what it means or what is necessary to

comply. This lack of clarity has increased costs so that the auditing

firms leave no stone unturned no matter how remote or immaterial

the issue may be. The new regulations make no distinction between a $50 billion large-cap company and a $75 million small-cap company. The law’s

failures to recognize the differences makes it extremely difficult for

smaller companies to compete and to grow in this current regulatory environment.

The lack of differentiation also places AMEX, as well as other

U.S. exchanges, at a steep competitive disadvantage in listing foreign-based companies who instead choose to avoid U.S. capital

markets. The lack of regulatory clarity allows foreign exchanges to

arbitrarily fill in the blanks of Section 404 compliance as they cross

the United States and market their own major benefit which is, of

course, avoidance of Sarbanes-Oxley.

In a recent trip to Tel Aviv, which is a hot bed of entrepreneurship, particularly in health science and technology, I witnessed the

London-based exchange AIM, aggressively marketing its lesser requirements and lower costs of governance contrasted with the

United States. We’re seeing firsthand some of the impacts of Sarbanes-Oxley on smaller companies and our experience to date

raises serious concerns.

Last month, the exchange received a letter from one of our listed

companies advising of its decision to delist its stock from trading

on the AMEX. It went back to the Toronto Stock Exchange, citing

the costs associated with Sarbanes-Oxley as the primary reason.

Another example of the impact of Sarbanes-Oxley occurred in

conjunction with a marketing effort in which I participated several

weeks ago in London. After expressing initial interest in listing on

the AMEX, the chief executive of one of the target companies sent

a message to me, explaining that the Sarbanes-Oxley requirements,

as explained to him by his counsel, prevented any further consideration of the idea and he declined the invitation to attend dinner.

The SEC-appointed Advisory Committee on Smaller Public Companies has issued a report recommending that the SEC exempt

some smaller and small-cap companies that comply with enhanced

corporate governance provisions from Section 404 compliance. We

support the conclusions of the advisory committee, believing that

they represent a sound balancing of interest between regulation

10

and economic growth. However, shortly after our May conference of

SOX implementation issues, the SEC and the PCAOB said that

they did support exemption for smaller companies, though they indicated willingness to work with companies on implementation of

the regulators.

This one size fits all approach is taken without regard to the impact of the cost and regulatory burden on the small, but important

segment of the capital market place that smaller companies represent. In response to growing concerns of small business, Congressman Feeney introduced H.R. 5405, a bill that would modify

Section 404, largely along the lines of the advisory committee recommendations.

We believe that something must be done. Even if the full range

of the advisory committee’s recommendations is not followed either

by the SEC and the PCAOB or if a legislative solution is not enacted.

I’d be happy to answer questions, time permitting later on, as to

a possible middle ground, because the American Stock Exchange is

very interested in this issue.

Thank you.

[The prepared statement of Mr. Wolkoff follows:]

11

12

13

14

15

16

17

18

19

Mr. FEENEY. Mr. Coulson.

STATEMENT OF R. CROMWELL COULSON

Mr. COULSON. I very much appreciate the opportunity to provide

testimony to this subcommittee in connection with its investigation

of the health, liquidity and competitiveness of U.S. equity markets

during the implementation of the Sarbanes-Oxley Act.

Pink Sheets is the leading provider of pricing and financial information for the over-the-counter securities markets and, among

other things, operates an electronic quotation and trade negotiation

service for broker-dealers. While Pink Sheets is well known as the

primary trading venue for the stocks of smaller public companies,

the bulk of Pink Sheets trading by dollar volume takes place in distressed or reorganizing issuers and the securities of large international issuers.

My message today has four parts. First, we will share some of

our thoughts about SOX, based on what we are hearing from smaller public companies; second, some statistics on deregistration;

third, a few general observations about the competitiveness of U.S.

markets; and fourth, we will describe our efforts to encourage costeffective disclosure that protects investors.

We agree with everything about SOX, except for its costs. SOX

has rightfully forced management to be responsible for their company’s disclosure and accountants to stand behind their audits. Unfortunately, by removing the vendor-client tension from the audit

process, accounting costs are no longer within the audit client’s

control. Regulators have given no guidance so the client can push

back. We sincerely hope that the SEC’s recent initiative to repair

Section 404 audit process will rebalance the client-vendor relationship and rein in the cost burden for all issuers, large and small.

Approximately 500 issuers that have gone dark are currently

trading in the Pink Sheets system. While the number of issuers

going dark may seem high, from 2000 to 2005, over 5,000 issuers

filed Form S–1s or SBTs to register securities in the public markets

for the first time. Already this year over 500 issuers have filed with

the SEC to be registered. So while there’s been an increase in

deregistration activity, it is simply not true that issuers have been

exiting the registration system en masse.

It is true that many small issuers are still watching and if the

costs become too burdensome, those numbers may change.

But this brings us to our third topic, the competitiveness of our

equity capital markets for small companies. There’s been much discussion lately suggesting that due to SOX 404, smaller U.S. companies are flocking to the LSE’s alternative investment market. We

don’t really buy the argument that the success of the AIM is due

to SOX 404. We see substantially more Canadian and Australian

companies listing on the AIM than American companies and neither of those countries has adopted SOX or requires a Section 404

audit.

If you look at the Toronto Stock Exchange, who has a very successful tier for smaller issuers, most of their marketing materials

now are saying why we’re better than the AIM. And so that said,

we think that much can be learned from other markets. In studying the AIM and other successful markets for small companies, we

20

are very impressed by the fact that capital raising is perceived as

an integral part of the listing process. The London Stock Exchange

publicized extensively the capital raised for its listed issuers to an

extent that seems odd when compared to U.S. exchanges.

The AIM was designed to provide a successful opportunity for

smaller U.K. companies to raise capital. That has created a community of advisors and capital providers for smaller U.K. companies. It is not surprising that by offering attractive capital-raising

opportunities for smaller companies, the AIM is now finding a

worldwide audience.

We have learned much from the AIM. I would respectfully suggest that the subcommittee’s work would be enhanced by a thorough study of the AIM and what ideas can be brought to America.

Fourth, disclosure requirements must be effectively tailored for

smaller companies. The challenge is to encourage disclosure that

will protect investors from questionable issuers without giving—

without driving good companies away. The AIM has an excellent

solution. Smaller companies are required to appoint a professional

gatekeeper which they call the NOMAD who works with the issuer

and performs due diligence so that material information is disclosed to investors.

Our new OTCQX listing concept has been borrowed, in large

measure, from the AIM process. Companies listing on the Pink

Sheets OTCQX premium tiers, are required to appoint and pay for

an attorney or broker dealer to review their disclosure. We believe

that this review of an issuer’s disclosure will benefit investors because much of the disclosure necessary to make good investment

decisions is not contained in a company’s GAAP financial statements or 404 controls.

Investment decisions for smaller issuers are usually based on the

company’s prospects. In contrast, the focus of a U.S. GAAP audit

is on the disclosure of historical numbers. This has been lost in a

lot of what the value of SOX brings. We all know historical performance is no guarantee of future results, as even truer of the

smaller issuer working on a cure for cancer or some new technology

that has no revenues. These plans and prospects must therefore be

clearly described in the nonfinancial portions of an issuer’s disclosure.

We think that the OTCQX disclosure review process will play

such a valuable role for smaller issuers that we are agnostic of

OTCQX issuers are SEC registered or just have audited GAAP finances. While we expect to attract companies that deregister with

our more intelligent disclosure process, we believe that almost all

of the OTCQX issuers who are interested in raising capital will still

be registered with the SEC. That is because the most attractive

U.S. capital pools for small issuers demand registration rights.

Even with registered issuers, we think the OTCQX review will

serve the useful function of helping the issuer to get it right which

should inspire greater investor confidence in OTCQX issuer disclosure. At Pink Sheets, we see great opportunities to create a vibrant

and successful secondary market for small companies. A study commissioned by the AIM, states that a vibrant market for small to

medium enterprises can add as much as 1 percent to the GDP

21

growth of a country’s economy. We hope OTCQX becomes a part of

that. Thank you.

[The prepared statement of Mr. Coulson follows:]

22

23

24

25

26

27

28

29

30

Mr. MCHENRY. Thank you, Mr. Coulson.

Mr. Factor.

STATEMENT OF MALLORY FACTOR

Mr. FACTOR. Chairman McHenry, distinguished members of the

subcommittee, I’m honored to testify here today about my views on

Sarbanes-Oxley legislation. My remarks are based on the work that

I’ve undertaken as chairman of the Free Enterprise Fund and Free

Enterprise Institute.

Recently, you may know the Free Enterprise Institute has joined

with a small Nevada accounting firm to launch a legal challenge

to the constitutionality of the Public Company Accounting Oversight Board [PCAOB].

Today, I’ll focus on the economic concerns about Sarbanes-Oxley

in four main areas: its cost to our public companies, its discouragement of American entrepreneurship, its disproportionate burdens

on small businesses, and finally, its adverse effects on the global

competitiveness of our capital markets.

In my written testimony I also discuss the unintended beneficiaries of Sarbanes-Oxley and the unconstitutional Public Company Accounting Oversight Board. I welcome the opportunity to

discuss any of these issues in response to your questions.

First, Sarbanes-Oxley has imposed enormous costs both direct

and indirect on our public companies. The passage of SarbanesOxley coincided with the loss of $1.4 trillion of shareholders’

wealth. No more than $400 billion of that loss could be explained

by other factors. In other words, Sarbanes-Oxley had a $1 trillion

negative impact on the U.S. economy, a $1 trillion decrease in

shareholder value is just the opposite of the growth to increased investor confidence that supporters of the legislation predicted would

result in the passage of Sarbanes-Oxley.

Estimates from the American Electronics Association showed

that U.S. companies are spending an aggregate of $35 billion a

year just on Section 404 compliance, almost 3,000 percent more

than the SEC’s projected cost of $1.2 billion in June 2003.

The cost of being a public company in the United States has increased dramatically. The average cost of being a U.S. public company has increased by $1.8 million, a stunning 174 percent increase. This cannot be what Congress intended. These costs must

be reduced for the sake of America’s economic health.

Second, Sarbanes-Oxley is discouraging entrepreneurship. Inaccessible public capital markets have ripple effects that touch even

the earliest stage investments. With fewer liquidity events on the

horizon for most startups, fewer early stage investments are economical. Many of the startups that do get funded will have difficulty raising enough capital to succeed as they begin to grow out

of their development phase. The capital that is available, often

takes the form of expensive equity, private equity of mezzanine financing.

In addition, the criminal provisions put a further chill on entrepreneurship. CEOs and CFOs are required to certify corporate reports without traditional good-faith protections. They can also be

held criminally liable for honest mistakes in those reports.

31

The Nobel Prize winning economist, Milton Friedman said, ‘‘it’s

costing the country a great deal. Sarbanes-Oxley says to every entrepreneur for God’s sakes don’t innovate, don’t take chances because down will come the hatchet. We’re going to knock your head

off.’’

Third, Sarbanes-Oxley has a disproportionate negative effect on

small business. Compliance costs are not coming down. Last week

a study showed audit fees for small cap companies jumped over 20

percent in 2005 alone. From 2003 to 2005, audit fees have increased a startling 141 percent for small-cap companies. This increase is significantly higher than the still costly increase of 104

percent for medium size companies and 62 percent for large capitalization companies over the same period. For companies with less than $1 billion in yearly revenues, average Sarbanes-Oxley compliance costs have increased 174 percent

overall since inception. I believe that relief for small and mediumsized companies is the most urgent aspect of reform which Congress should address immediately.

Fourth and finally, Sarbanes-Oxley hinders America’s standing

in the global economy. Last year, the London Stock Exchange had

a record year for foreign listings. In a survey of these new listings,

they discovered that 90 percent of the companies that considered

listing in the United States said London’s Exchange was more attractive because the companies listing there did not have to comply

with Sarbanes-Oxley. In 2005, 23 of 24 companies that raised over $1 billion in capital

chose not to register on U.S. exchanges, according to the New York

Stock Exchange. In 2000, prior to Sarbanes-Oxley, 9 out of 10 of

the largest IPOs in the world involved the U.S. public markets. In

sharp contrast, last year 9 out of 10 of the top IPOs avoided the

U.S. markets all together.

If Sarbanes-Oxley is good for investors, they should be willing to

be paid for the benefits, but a study by Professor Kate Latvic of the

University of Texas School of Law shows that investors, in fact, do

not prefer such regulated companies. Her study found that investors preferred companies not subject to Sarbanes-Oxley.

In conclusion, I believe that the common interest of businesses,

investors and all Americans require a thoughtful revision of Sarbanes-Oxley. Such reform to reduce the counter-productive and unintended ill-effects of Sarbanes-Oxley will enable our entrepreneurs, our investors and our workers to have confidence that

America will continue to lead the world in competitiveness, productivity and economic abundance.

I look forward to your questions and I also wish quick recovery

for Chairman Miller’s husband and I thank her for putting this together.

[The prepared statement of Ms. Factor follows:]

32

33

34

35

36

37

38

39

Mr. MCHENRY. Thank you. Thank you, Mr. Factor. I’ll start off

the questions and we’ll put the 5-minutes on the clock which we’ll

try to stick to.

I enjoyed your testimony. I think you all have three unique perspectives and that’s why it’s wonderful to have you on the same

panel.

Mr. Coulson, have you seen an uptick in your business with Pink

Sheets well, since the passage of Sarbanes-Oxley?

Mr. COULSON. Since Sarbanes-Oxley, we’ve seen tradings and uptick in trading in our business, but it’s not—the companies that are

deregistered are not currently actively trading securities for the

most part because they fall into—from that side, if you look at the

500 companies that are in the Pink Sheets, about half of their

stock trade is below 50 percent, so I’d say they’re economically distressed and they were having trouble any way and they may not

have remained public companies. And other ones are the quiet, the

guys who have deregistered, their companies are not accessing capital markets and they’re not seeing the value portion of other companies controlled by a large shareholder who says it’s not worth it

to them.

But there hasn’t yet been a windfall from SOX and what we’re

building with OTCQX, we’re really building it to fit to either side

because we look at the regulatory environment today and don’t

hope that it will change either way.

Mr. MCHENRY. Mr. Wolkoff, have you seen activity in terms of,

or a slackening in activity, in terms of IPOs new listings on your

exchange? Or, have you seen companies going dark or delisting

from your exchange since Sarbanes-Oxley?

Mr. WOLKOFF. It’s not a simple answer because I think that up

until about 2 years ago the AMEX was not being an effective competitor as far as attracting new listings. And over the last 2 or 3

years, we’ve seen an uptick because we’ve increased our efforts, our

spending and so we have been actually taking quite a few companies both from IPOs or who have left the NASDAQ. Those seem to

be the two.

We have seen some companies that have chosen to go private.

One can always ask whether it might have been a more appropriate decision for that company in the first place and we have

seen certainly a difficulty in attracting companies from outside the

U.S. jurisdiction. Particularly for us, we have about 20 percent of

our market in natural resources, exploration and production. Canada is a natural marketing place for us. And we’ve found that it’s

difficult, although we’ve had success, it is difficult success. It’s challenging success.

Mr. MCHENRY. Someone put forth the idea that in essence small

cap companies have a disproportionate share of their profit being

spent on compliance costs. So the idea would be a larger entity

could purchase them and roll in their compliance costs and thereby

increase shareholder value.

Have you seen mergers and acquisitions driven in that direction?

Mr. WOLKOFF. I’ve seen mergers and acquisitions. I could not say

that’s the cause or that should even be a desirable cause. The fact

that entrepreneurial companies get absorbed into conglomerates or

into companies that are simply larger, may not be the best growth

40

engine for the economy. We’ve always seen small companies being

bought. In the pharmaceutical industry, a company, just to name

one like a Pfizer, rather than spending 10 years developing a new

pharmaceutical in-house, may simply choose to buy a company that

has promise——

Mr. MCHENRY. I have a quick question. I’ll get back to you.

Mr. Factor, in about 30 seconds, what do you advocate in terms

of public policy? I mean short of repealing Sarbanes-Oxley which

from your testimony I think would be a desirable thing, what

would you say?

Mr. FACTOR. I think the most immediate need is to grossly exempt small and medium-size companies from Sarbanes-Oxley, No.

1. No. 2, I think you have to create PCAOB in a constitutional way.

We believe it’s totally unconstitutional under Section 2, Article 2 of

the Constitution.

Mr. MCHENRY. OK, Mr. Wolkoff, in conclusion here, what can we

do short of passing legislation to amend Sarbanes-Oxley right now,

what would you advocate?

Mr. WOLKOFF. Yes, I think that some relatively straight-forward

actions could be taken. No. 1, define Section 404 and what it might

mean for companies of different revenues and of different market

capitalizations, perhaps even in different lines of business. Require

the accounting companies to put specificity within audit programs

as to what the goals of a 404 audit would be. With respect to 404,

depending upon the capitalization and revenues of the company, I

would highly recommend that once a company complies with 404,

that the certification be done not on an annual, but a biannual or

a triennial basis, hence improving the cost factor.

And last, as to those smaller companies and I think there are

quibbles about the actual market capitalization, but there should

be a level of company that provided they have independent audit

committee and other ethical-promoting corporate governance factors within the company should be permitted to choose and disclose

that they’re exempt from Section 404 and that the investor on the

basis of that disclosure can choose to buy or not buy the particular

stock.

Mr. MCHENRY. Thank you, Mr. Wolkoff.

Mr. Dent.

Mr. DENT. Thank you, Mr. Chairman. Thank you all for being

here today.

As someone who represents a district where we have a lot of

Main Streets as opposed to a Wall Street, I mentioned in my remarks about a lot of the small banks, in particular, have been very,

very concerned about this law and the cost of compliance and it’s

been outrageous.

The question I have and it’s probably directed to Mr. Factor,

some of the supporters of Section 404 say that these compliance

costs will dramatically decrease as businesses get streamline control processes. It would seem to me that regardless of the level of

cost down the line, that the initial compliance costs associated with

going public are a large enough deterrent to listing on U.S. exchanges. So how do you answer those——

41

Mr. FACTOR. I would say there are a number of people who say

that, in particular, the accountants whose profitability has soared

since Section 404 compliance has been made necessary by this.

I also believe that a number of the larger firms feel that Section

404 compliance should be kept because it’s become a barrier to

entry for small companies that really are the engine of America.

Section 404 is a disaster. I consider it my theory of holes. Section

404 came about because of the problems that occurred with Enron

and World Com and we knew at that point that we were in a hole

because of that. And what frequently is done and I quote Mr. Oxley

‘‘in a hothouse atmosphere excessive regulation comes about.’’ And

those are his words, ‘‘excessive’’ and ‘‘hothouse atmosphere.’’

What they did to get out of the hole, you just dug it deeper.

Mr. DENT. Well, thank you for that answer. And on the issue of

mezzanine financing, can you explain what you mean by that term,

one, and two, how does this distort the public capital markets?

Mr. FACTOR. The most efficient markets are the capital, are the

public capital markets. They’re extraordinarily efficient. They bring

the cost of capital down. When you use private equity firms, the

costs go up. There are not as many people involved.

Liquid markets bring the cost of capital down. Mezzanine financing firms are firms that are supplying equity, debt, sort of middle

of the road instruments that capital markets and public capital

markets, had supplied. But because of Sarbanes-Oxley, and the

compliance costs, people have been avoiding it.

Remember, in an AEA study, companies under $100 million in

revenues, 2.5 percent of revenues were spent on Sarbanes-Oxley

compliance. That takes companies from profitability to

unprofitability.

Mr. DENT. Thank you for that answer and I guess there’s a question for all of you. I’ll start with Mr. Wolkoff. You’ve all indicated

there’s a growing trend of smaller companies to list overseas. Basically, if the trend continues, what is this going to mean for Wall

Street?

Mr. WOLKOFF. It’s a loss of influence. It’s a loss of jobs. Certainly, it’s a lack of opportunity for us to grow. I think that the fact

that Canadian companies and Australian companies choose to list

on the AIM Market rather than their home markets is not really

a positive about Sarbanes-Oxley. It simply means that their home

markets are very small as far as access to capital and they need

access to a larger market. The point being, they don’t consider us.

When I was in Tel Aviv and London, recently, I could tell that

my compatriots at the other national exchanges hadn’t been there.

They basically, I think, have thrown in the towel because the message is that it’s too difficult to list in the United States. We haven’t

thrown in the towel, but what we’re looking for is some ability to

market U.S. capital markets and that means some modification in

the requirement.

Mr. DENT. Are your foreign competitors aggressively marketing

Sarbanes-Oxley against us?

Mr. WOLKOFF. Very aggressively. It’s—in fact, for the AIM market, it is the major selling point. It is Sarbanes-Oxley on page 1,

Sarbanes-Oxley on page 5 and Sarbanes-Oxley on the concluding

page. And in fact, one of the reasons that we have a chance is that

42

Sarbanes-Oxley alone is not enough to overcome some of the problems with liquidity that these foreign exchanges have.

There’s a quest to be in the United States. Companies want to

be here if we show even a small amount of good faith in modifying

some of the heavy-handedness of some of the rules. I’m not saying

do away with it. I’m saying modify it and make it more sensible.

Give us some tools to market to these foreign companies.

Mr. DENT. Thank you and I see my time is up. I yield back.

Mr. MCHENRY. Thank you, Mr. Dent. Ms. Kelly.

Ms. KELLY. Mr. Coulson, you mentioned in your testimony that

a liquid market for the micro cap stocks can boost the GDP of our

country by as much as 1 percent.

Do you think that the current SOX regulatory regime is really

retarding growth in the Pink Sheet companies?

Mr. COULSON. There’s two sides. The Pink Sheet companies

has—a lot of Pink Sheet companies that are raising capital, there

are issues where there should be more criminal and civil charges

against the fraudsters which is needed more. And that’s—there’s

an issue where there’s a subset of smaller companies that just

should be run out of town by the sheriff. And then there’s another

side on legitimate smaller companies that they don’t understand

the costs of what it will be to be public. They are not sophisticated.

They don’t have access to reams of law firms who can research a

question. They need to be treated much more like the IRS treats

a taxpayer, an individual taxpayer by the SEC, rather than how

the IRS treats a corporation. And they need to be educated and

they need to be brought into the system.

And that really doesn’t happen from the SEC’s viewpoint because

they don’t get phone calls when someone successfully invests in a

smaller company that grows. They get a phone call when someone

loses money in a smaller company. So their viewpoint is quite different and it’s very enforcement based. And I wished there was

more enforcement. There’s more enforcement, but they also work to

help companies engage in capital formation and that’s really what

they’ve done a great job with at the AIM. They have built a market

for capital formation and the London capital—the capital of London

has really directed itself at smaller companies. And that’s what

brings in entrepreneurship and GDP growth and all the good

things.

Ms. KELLY. I’d like to go to Mr. Factor. You talked about the

smaller companies having very high opportunity costs because of

SOX 404.

I’d like you to elaborate a little bit on some of what the opportunity costs are and what—how much of an impact do you think

that this is going to have on—not only the further growth in the

industry sector, but also I’d be interested in your thoughts about

what the impact of Sarbanes-Oxley is on New York State.

Mr. FACTOR. Well, I think New York State financial services industry has had preeminence around the world. And has been

known—I think it’s putting a very, very big dent in it. If you look

at the major firms that are here, and they’re also around the world

as well, and they can move their people personnel and their transactions almost anywhere. We have seen a book by Tom Friedman

called the World is Flat, how the world is flattening out and how

43

we have to be more competitive because things are becoming more

equal. But what Sarbanes-Oxley does is tilt the world to other

countries. We are really hurting our opportunities to create jobs, to

create infrastructure and to grow and be productive.

Ms. KELLY. Do you think that this Section 404 has a strong impact on the smaller companies to the extent that it’s going to really

harm the market here?

Mr. FACTOR. It is harming it already. We’ve seen IPOs going

overseas. We’ve seen the growth of private equity which is not as

efficient from a cost point of view. We’ve seen companies choosing

to go private. We’ve seen companies not choosing to go public. It

means they don’t have access to capital in order to grow. That’s

how we create jobs. That’s how this country is built.

Ms. KELLY. That takes me right to Mr. Wolkoff who having been

on—going on the American Exchange, I was very impressed with

the active role that investors have in the smaller companies. And

I’d like very much to have you elaborate a bit, if you would, on the

burden that 404 places on the family controlled public companies

where you have these very active investors.

Mr. WOLKOFF. I think there’s a couple of categories. For the U.S.

company, I think by and large, companies are internalizing the

costs and continuing to list somewhere, if they’re able to list. I

think that the costs are significant. If one did a cost benefit analysis, I have no doubt that the cost benefit analysis would be much

more heavily weighted toward costs than toward benefits. That

being said, I can’t say that Sarbanes-Oxley doesn’t have certain

good aspects to it or isn’t appropriate in some cases, but for many

companies, particularly science companies, like a company forming

a new drug, they have a patent. They have no revenue, they have

Sarbanes-Oxley costs that they have to incur and that just requires

them to divert resources from the other things that they’re doing.

Ms. KELLY. Thank you. My time is up.

Mr. WOLKOFF. May I just make one quick comment?

Ms. KELLY. Yes.

Mr. WOLKOFF. It will be under 15 seconds. You’re talking about $35 billion that’s being spent on Sarbanes-Oxley compliance under

404 that could be used for infrastructure, that could be used for innovation, that could be used to help us grow our economy and create jobs instead of being used for a full employment program for

accountants.

Mr. MCHENRY. Thank you, Ms. Kelly. Mr. Feeney.

Mr. FEENEY. Yes, Mr. Wolkoff, I wanted to followup on some

questions that Ms. Kelly had for Mr. Factor and I’m like Representative Dent. I don’t have any exchanges in central Florida. Nothing

is more liquid that I know of other than air and water than cash.

And as investors can increasingly go on the Internet and invest

their money in investments all over the world, I spoke to the chief

financial officer in Hong Kong, Mr. Tong, I believe it is, and asked

him whether or not a Hong Kong entrepreneur would think about

listing on one of the New York exchanges and he laughed at me.

But why should an investor care? I mean the bottom line is as

I have more opportunities to invest in Luxembourg or London, you

know, 100 years ago, America took the lead, companies, houses like

J.P. Morgan moved their central locations from London to the

44

United States, why should my constituents worry if more money is

going to be raised through private equity firms. Mr. Coulson is developing a private regulatory network that doesn’t have some of the

absurd consequences. If Congress, the PCAOB and the SEC, deliberately or unintentionally, decide just to totally outsource liquid

capital markets, other than the fact that folks on your exchange

will lose jobs and Ms. Kelly may be hurt, why will this hurt investors in central Florida?

Mr. WOLKOFF. I’ll admit, it wouldn’t be a good thing for the

American Stock Exchange, but we have to look at this in the context of two fairly discrete components, one being the companies

themselves that seek to raise capital and the other being the investors. As far as companies that seek to raise capital, the more regulatory costs that are imposed on the company, the more expensive

the cost of capital becomes the more likely it is that company will

look to source capital either in some other jurisdiction or privately.

Mr. FEENEY. If I can interrupt, do you have an opinion on whether or not under Sarbanes-Oxley, as currently implemented, an

Apple, a Dell or a Microsoft would have had an easy a time going

for $50 or $75 million in capitalization to where they ended up?

Mr. WOLKOFF. I recently was on a panel with the CFO of Dell

and I made the point and he didn’t reject it entirely that the next

Dell very well might be in the dorm room of a university located

in Hong Kong or in Mumbai, but probably not in Texas, given the

difficulty of companies to startup.

To the other part of your question, as to why investors would

care, people have over-emphasized or over-stated, I think, the ease

with which American investors can access foreign markets. It is expensive. There is a lack of transparency. There is a lack of access

to regulatory assistance, regulatory certainty and there are currency issues that keep it from being as easily accessible as one

might want. I think that is not an issue that would be resolved

with Sarbanes-Oxley unless some modification began to get companies to do a list and bring their listings into the United States and

accept U.S. jurisdiction and I believe that there is a great hunger

in the rest of the world to access American capital markets, but

that they’re being deterred from doing so.

Mr. FEENEY. Mr. Wolkoff, in your testimony, you talked about,

one of the things we do in the Compete Act is we allow companies

to voluntarily comply or disclose if they’re not going to comply and

let the investors determine what the premium would be to comply

with certain regulations. If the regulations turn out to be absurd,

then the liquid will follow the rational regulatory scheme.

But in addition, two things that we think are important and tell

me how this would play on AMEX, because you do have a few large

cap companies listed.

Mr. WOLKOFF. Yes, we do.

Mr. FEENEY. We require a very strenuous definition of what a de

minimis standard is, so that not every box of paper clips on the

planet is—we have this sort of this race to the absurd in the regulatory scheme because everybody’s threatened with civil and criminal liabilities.

How important would that be?

45

And then second, we suggest that the outside audits which are

totally redundant, I mean they do keep people honest, but those

people already are subject to civil and criminal death penalties. So

they’re redundant.

Supposing we made the external audits random so that the

AMEX could decide, for example, every 10 percent of its companies,

randomly selected, do you think it would have the same chilling effect against fraud that SOX was designed to get at? Can you address those two issues, the de minimis standard and the potential

for random external audits?

Mr. WOLKOFF. Yes, Congressman, I liked your bill. I thought it

was well thought through and considered the important issues——

Mr. FEENEY. Mr. Levitt didn’t think so. He was the author of

SOX or claims. He wasn’t so happy.

Mr. WOLKOFF. Mr. Levitt and I don’t necessarily agree on a number of issues, so that’s not really the standard of whether you’ve

done a good job or not. I think you have done a good job. I think

that one, the need to have definition, the need to provide rationality to what’s required so that how you maintain a box of paper

clips, as you say, really doesn’t come into an overview of your internal controls. I also agree with you as far as the ability to opt out

of regulations so long as that’s disclosed and there are some other

protections.

I think that any effort to provide clarity, to provide lesser scope

of regulation on smaller companies, to allow the investor to make

up his or her own mind based upon appropriate disclosures, I think

those are all good things and I agree with my colleague from the

Pink Sheets, that an increase in enforcement dollars would also go

a long way. I think seeing Mr. Lay and Mr. Skilling convicted has

done more benefit for American capital markets and the trust in

them than all the bills in the history of the U.S. Congress possibly

could have.

Mr. MCHENRY. Any further questions from the panel?

Ms. KELLY. I’d like to throw one out if you don’t mind.

Mr. MCHENRY. Certainly.

Ms. KELLY. We’re trying to look at what will generate a liquid

market that will grow the economy. To do that, it’s very difficult

because we don’t have a statutory—a real statutory definition on

what we should be regulating here. As you’ve all pointed out, the

large companies don’t have a great deal of—it doesn’t have that big

of an impact, but these smaller, these nascent companies that are

coming into the market, things that Mr. Coulson, the entities Mr.

Coulson, and you, Mr. Wolkoff, often deal with, should we look at

a cap on the capitalization of a company? Where would you set the

marker if you were rewriting this bill? And Mr. Feeney’s bill does

the kinds of things that I feel are good. That gets the government,

let industry itself decide. But if we have to rewrite the bill in some

way, would you put a cap on it—on capitalization, on the amount—

certainly not the profitability, but where would you go with trying

to rewrite this so it makes sense?

Mr. WOLKOFF. Are you asking me?

Ms. KELLY. I’m asking all of you.

Mr. WOLKOFF. I think that there should be exemptive authority.

I think that there are some companies that should be able to disVerDate 11-MAY-2000 12:32 Mar 27, 2007 Jkt 000000 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 C:\DOCS\33393.TXT HGOVREF1 PsN: HGOVREF1
46

close that they’re not complying and the reasons why and I think

in the case of say companies that are looking to discover a new

medical device or a new pharmaceutical, and have very little revenues, Sarbanes-Oxley is not the reason people are buying those

stocks and I think that would be completely understandable.

I believe that there’s probably quite a bit that can be done, even

in the absence of legislation, simply by giving definition, by continuing certain exemptions as they exist, by giving a break, really,

to foreign companies, who want to try to access American capital

markets and aren’t going to have half of their shareholders be U.S.

citizens, but some smaller amount. I think that all of these things

are worth trying. I think that there are people with greater knowledge of the application of accounting rules and securities laws than

perhaps I have, but like the panel, I do have concerns that what

we have right now is heavy handed, is excessive, is hurting American capital markets and is hurting American business as well, and

should be rethought in every fundamental way in order that we

can become competitive with the rest of the world without lessening those standards that are most important to investors.

Mr. FACTOR. What I think needs to be done is 404 needs to be

done away with. Mr. Wolkoff talked about two people who got convicted. There were over 700 convictions since Sarbanes-Oxley was

enacted, well over 700 and fines galore, none of them under Sarbanes-Oxley.

What we don’t need is additional legislation and regulation.

What we need is to take the regulation that we have and legislation that we have and use it properly. The fundamental problem

is that once the—once you have in power town D.C., once you have

an Enron and World Com, it’s like that the regulatory dinner bell

ringing and the bureaucrats come rushing to the table with new organizations that just add enormous costs to our society. And it’s

hard to dislodge it. And what we need to do is dislodge them under

404. We need to dislodge them by getting rid of 302 which criminalizes, in many cases, taking risks. We need to really think this

thing—this thing needs to be thought through thoroughly and say

what legislation do we really need to give America the opportunity

to grow and prosper and create jobs.

The only thing I can tell you is we filed a lawsuit to challenge

the constitutionality of the Public Company Oversight Accounting

Board [PCAOB]. On the day we filed it, it was the day that

PUHCA, which is the Public Utilities Holding Company Act of

1935, finally was gotten rid of. It was an overreaction in 1935 to

Sam Ingersoll and in many ways it was a Stalinist act in the way

it was written. It allowed the SEC to bust any multi-state utility

holding company. Sometimes the gross overreaction really hurts

our country and Sarbanes-Oxley does that.

Mr. FEENEY. Mr. Chairman, I wonder if I could ask one more and

with respect to 302, my bill doesn’t touch that, but if you do define

de minimis standards, the criminal penalties become a lot less arbitrary.

Does any of the three panelists have a very quick opinion, the

PCAOB and the SEC appointed a small business advisory committee. I thought their recommendations—I’ve been working on this

47

for 8 or 9 months and I thought their recommendations were prescient since my bill was written, but not quite filed yet.

Does anybody have an opinion why they, for the most part,

nodded and then went about their merry way without adopting the

most important of the advice given by their own advisory committee?

Mr. COULSON. I watched that panel very closely and I think their

report is actually a great report on the state of small company market past 404 and Sarbanes-Oxley. And there’s a lot of other points

they raised that should be followed through on.

They went for the long pass, get rid of it. And it’s much harder

to go through and decide which controls are material to investors

and I think a great process will be if the SEC can do it and the

PCAOB is go through, figure out what the controls are at small

companies and figure out which ones are material to investors and

what’s the cost benefit and say OK, here’s 10 controls you need

when you’re this market cap. Here’s 50. And let’s really, because

SOX 404 is like a rule in Small Town, USA that says every house

has to be painted every year, but the painter decides when he’s

done and you’re paying him by the hour. That can’t work.

You need to be able to cutoff your accountant and say we’re done

on the audit and this is what the regulators say you have to do.

And that hasn’t been done. And that’s the real nightmare and people are running around, the sky is falling. There are SOX consultants who will say pay me hourly and I’ll tell you how the sky is

falling.

There needs to be reined in and while—I agree with many points

of Mr. Factor, and maybe we should get rid of it, but dealing with

going forward, we really need to rein in the cost for the small company and give them some comfort.

Mr. MCHENRY. And with that, thank you so much for testifying

today. Mr. Coulson, I think you had a great line there at the end

about the housepainter. I think it’s very well stated.

Mr. COULSON. Thank you.

Mr. MCHENRY. And thank you so much for taking the time to

testify before us. This information is very important to us, to ensure the strong nature of our financial markets going forward.

With that, we’re going to have a set for 5 minutes for the next

panel, and this panel will stand in recess for 5 minutes.

[Recess.]

Mr. MCHENRY. The committee will come back to order. I welcome

the second panel. Thank you for taking the time to be with us

today. Thank you for waiting your turn.

Because the Government Reform Committee has subpoena

power, we always swear in the witnesses as you heard with the

previous panel, so if you would all please rise and join me. Raise

your right hands.

[Witnesses sworn.]

Mr. MCHENRY. We note in the record that all the witnesses responded in the affirmative. With that, I’d like to recognize my colleague from Pennsylvania, Mr. Dent, for the purposes of three introductions and Ms. Kelly for the fourth.

Mr. DENT. Well, first I’d like to introduce our next witness today

which is Mr. Robert Robotti. Mr. Robotti is the president and manVerDate 11-MAY-2000 12:32 Mar 27, 2007 Jkt 000000 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 C:\DOCS\33393.TXT HGOVREF1 PsN: HGOVREF1
48

aging director of Robotti & Co. He recently served with distinction

on the Securities and Exchange Commission’s Advisory Board on

Smaller Public Companies. He holds a B.S. degree from Bucknell

University, about 100 miles up the road from me and an M.B.A.

in taxation from Pace University. We’re glad to have you with us

here today, Mr. Robotti.

I’d also like to welcome Mr. William Beach, director of the Center

for Data Analysis [CDA], at the Heritage Foundation. Mr. Beach

previously served as president of the Institute of Humane Studies

at George Mason University in Fairfax, VA; previously, unranked

basketball team, by the way, which made it in this year’s Final

Four. He is a graduate of Washburn University and he also holds

an M.A. in history and economics from the University of Missouri,

Columbia. Thank you for being here.

And then we’ll also hear today from Mr. John O’Shea. Mr.

O’Shea is the president and chief executive officer of Westminister

Securities Corp. He is an allied member of the New York Stock Exchange and a member of the New York Board of Trade and Securities Traders Association. He holds both a B.A. and M.A. in economics from the University of Cincinnati. Welcome.

Ms. Kelly.

Ms. KELLY. Thank you. Our final witness today is Mr. David

Lawrence who is the chief financial officer of Acorda Therapeutics,

Incorporated. Mr. Lawrence is a founding member and currently

serves on the Board of Directors as treasurer of the Brian Hearn

Children’s Fund. He is a graduate of Roger Williams College and

received his MBA in Finance from Iona College. And we thank you

all for being here.

Mr. MCHENRY. And with that, we’ll start, just a reminder for this

panel, as you heard before, there’s a 5-minute time limit for opening statements. You’ll see the yellow light come on. We have 1

minute left at that point. I’d wrap up if I were you.

And with that, Mr. Robotti.

STATEMENTS OF ROBERT ROBOTTI, PRESIDENT, ROBOTTI &

CO.; WILLIAM W. BEACH, DIRECTOR FOR DATA ANALYSIS,

THE HERITAGE FOUNDATION; JOHN P. O’SHEA, PRESIDENT

AND CEO, WESTMINSTER SECURITIES CORP.; AND DAVID

LAWRENCE, CHIEF FINANCIAL OFFICER, ACORDA THERAPEUTICS, INC.

STATEMENT OF ROBERT ROBOTTI

Mr. ROBOTTI. Hi. Thank you for the opportunity to testify today.

I was recently a member of the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies and, as

such, served as a member of the Corporate Governance and Disclosure Subcommittee. The SEC, of course, established the Advisory

Committee to examine the impact of Sarbanes-Oxley and other aspects of Federal securities laws on smaller companies.

Professionally, I am both the Founder and Managing member of

an investment partnership, which SEC rules require me not to

name, and the Founder and Portfolio Manager of Robotti & Company Advisors, LLC, an SEC-registered investment advisor. Both of

those entities, I direct the investment of slightly over $300 million,

49

the vast majority of which is invested in small cap and micro cap

companies.

I am also a director of Panhandle Royalty Co., a publicly traded $160 million market cap company. I am a member of Panhandle’s

Audit and Compensation Committees and as such I am familiar

with one company’s travails with Sarbanes-Oxley’s Section 404. I

would point out that, as a board member, it is a logical predisposition to reduce one’s potential personal liability by encouraging a

company to overspend on Section 404 compliance.

I will address you today primarily as an investor in small cap

and micro cap companies, i.e., someone to whom the benefits of

Sarbanes-Oxley are directed. Let me start by describing our investment process. We are what is commonly characterized as bottomup equity investors. Our stock selection is predicated on the research and evaluation of fundamental company data. Therefore, we

are primarily interested in an issuer’s annual audited reports as

well as its interim financial statements which companies registered

with SEC are required to publicly disclose. It goes without saying

that the reliability of that data is paramount to our investment decisions. Once we invest, we think and act like owners. This includes continuous evaluation of management and the board’s oversight through assessing their capital allocation decisions.

Again, both audited annual reports and interim financial statements are fundamental tools utilized in this investment process.

Therefore, I am a proponent of expenditures of time and money in

producing such reports which benefit us, the investors and owners,

by providing us with timely financial and other information abut

an issuer.

Let me point out that we know, from many years of investment

in public markets, managements and boards occasionally fail to act

in shareholders’ best interest or even fail to attempt to act in

shareholders’ best interest. The document, the critical evaluation

on our part of managements and boards, I can point to the fact

that I and the entities I direct have been named plaintiffs in numerous lawsuits against companies in which we had invested as a

result of our efforts to protect and we took these efforts to protect

shareholder interests.

So when management of our invested companies states ‘‘the cost

and effort of compliance with Section 404 is disproportionate to its

benefits,’’ I listen with healthy skepticism.

I think it’s important to point out that I strongly support the

vast majority of the investor predictions provided by SarbanesOxley: the independence requirements for the audit committee, the

restrictions on loans to insiders, the whistleblower provisions as

well as other restrictions on services by independent auditors, etc.

The vast majority of the law is a tremendous step forward for

shareholders. There are costs, both hard and subtle, exist, but my

personal investing experience convinces me that the net benefit to

shareholders is significant. Therefore, we support—and the support

of these protections enumerated in SARBOX is documented by our

committee’s work at the SEC also.

But then there is Section 404, where I believe some moderation

with respect to its implementation would be practical. Conceptually, Section 404 compliance requires detailing, documenting and

50

testing data pertinent to the reporting process. Realistically, Section 404 needs to be significantly right-sized. I further believe that

the time and attention now required by top management of small

companies to fully comply misapprpriates shareholder value. This

is subtly more relevant to smaller companies than it is to larger

ones, for large companies the time and effort required by 404 can

be delegated to staff who are not charged with running company.

For smaller companies, senior management spends a substantial

amount of their time on 404 when they could be running the business. Instead, they’re dealing with the compliance of Section 404.

My perspective is based on my years of experience, observations

and evaluations of companies and their managements.

The misallocation of management’s time and attention, as well as

the hard costs paid to outside auditors and consultants are not the

only negatives. The costs associated with complying with Section

404 continue to motivate small companies which do not plan on

raising capital to deregister or go dark. When a company

deregisters or goes dark the company can do this in a relatively

short period of time. It ceases to be required to make annual financial statements and interim reports publicly available. It becomes,

in essence, a private company with public shareholders. Since the

vast majority of the universe of small companies has no plans on

raising capital, the majority of these companies are candidates to

go dark. It is probably in their fiduciary duty actually as directors

and managements to consider this option.

Small companies that have deregistered or that are part of the—

planning to deregister, have to consider the huge costs associated

with Section 404 compliance. And this is one of the unintended consequences. The GAO report itself identifies this as a problem and

identifies that there was a significant increase in the companies

that are deregistering. Out of 5,971 SEC registered companies

today who are non-accelerated filers. I’m going to skip through

since I’ve got plenty more.

We’re concerned also about that impact that it was because a lot

of the discussion really talks about companies raising capital, becoming public. What we’re forgetting about is that there’s a huge

disenfranchised investor base out there who are shareholders in

these companies and potentially are going to be subject to—there

are almost no regulations in terms of what information will be

available to and how they can evaluate these companies. That’s a

significant factor.

Thank you.

[The prepared statement of Mr. Robotti follows:]

51

52

53

54

55

56

57

58

Mr. MCHENRY. Thank you, Mr. Robotti.

Mr. Beach.

STATEMENT OF WILLIAM BEACH

Mr. BEACH. Thank you for the opportunity to testify before you

today, to come all the way from Washington to New York where

it’s even warmer, apparently, than down there.

Policymakers at all levels of government, but particularly at the

Federal level have a number of prime directives that govern their

work: design and run efficient programs, change policy in line with

the changing world in which the policy lives, listen to citizens and

their elected representatives and due no harm.

Within that list, clearly the last ranks highest in my view. At the

risk of using an inappropriate analogy, the cure must not be worse

than the disease. Doubtless, the most profound change in financial

market regulation in the past decade occurred with the passage of

the properly titled Sarbanes-Oxley legislation in 2002. There’s an

adage that I learned in the law and that is hard cases make bad

law.

Today, analysts are acquiring evidence that the reaction of Congress to transitory financial market problems and to the enveloping

recession created law and subsequent regulation that has harmed

markets, the creation of new businesses and consumer well-being,

as well as the general level and quality of U.S. economic activity.

Our own research in the Center for Data Analysis indicates that

Sarbanes-Oxley may have had a negative effect on the volume of

private equity deals independent of the influence of a poorly performing economy that surrounded investment decisions in the first

2 years following the passage of the act.

The key ingredients of a well-functioning dynamic system of financial markets or financial information and entrepreneurship,

there’s no question about that. There are hardly any two factors

more important unless it is the sheer volume of new business ideas

and supporting entrepreneurial activity that produce markets in

the first place. Economic activity can be harmed by government

and these things can be harmed by your acts. While no one denies

that good reporting of financial results is important to market performance, honest 10Ks are preferred over dishonest ones. Markets

can punish crooked companies much faster than you can and more

severely than you can or the courts. In fact, the price system can

move so swiftly against businesses that some stock exchanges actually have rules for stopping trading in a company’s equities when

prices fall by a certain percentage.

Let me describe the research that we have done. There is increasing anecdotal and statistical evidence that Sarbanes-Oxley

has created damaging distortions in the price system. Ladies and

gentlemen, the price system is a natural resource, all right? It isn’t

something that you’ve created or we’ve created. It’s what we

human beings have created and it’s your duty to defend it.

Our own research on this possibility has focused on changes to

venture capital funding after passage of SARBOX. Venture capital

funding reflects all aspects of the problem described here; entrepreneurial activity, it has capital costs, investor decisions, financial

59

reporting requirements and in some cases, it will even have a public-traded moment.

If Sarbanes-Oxley appears now to exercise a deleterious effect on

financial markets, then the venture capital industry should provide

an early indication of that effect, kind of like the canary in the

cave. The staff of the Center for Data Analysis collected monthly

data on venture capital deals from 1995 onwards. Our data came

from Thompson Financial Services Venture Economics Web site.

These data included the volume of deals in their total value, commitments in IPOs. Data were also assembled from other CDA economic models on the U.S. economy. After all, the venture capital

industry was severely affected by the collapse of the dot com bubble

in the fall of 2000 and 2001. The time period also saw the debate

over more financial regulation heating up. So the key problem that

we had to solve was how do you separate the collapse of the venture capital market from the effects of Sarbanes-Oxley? It’s a very

delicate, statistical problem.

The analytical results from running a model of private equity

deals contains ways of tickling out these effects, indicates that the

anecdotal evidence is, in fact, very correct and that Sarbanes-Oxley

actually reduced deals and we are currently updating the model

with new and more recent data and we’ll supply this committee

with that when it becomes available.

We also tested the same model with an appropriate number of

time period lags for two additional measurements: fund commitments and initial public offerings with the same result. Now why

was this result there and I’ll conclude on this and we can do it in

the queries that follow. What happens in Sarbanes-Oxley is that

the regulatory cost and the uncertainty adds to the cost of capital.

It’s the uncertainty factor which is actually the worse part as far

as we can tell from the data. And the uncertainty factor raising the

cost of capital and also raising the possibility of failure in the future has caused the deals to collapse in the way that we saw them.

And we don’t see that as something that’s recovering any time

soon.

Remember, for every one tenth of a point, in capital costs

brought about through government’s own actions, there’s 100,000

or so jobs lost, potential jobs in the economy. So there’s a direct result outside of the deals to the general macro economy.

I’d be happy to answer questions.

[The prepared statement of Mr. Beach follows:]

60

61

62

63

64

65

Mr. MCHENRY. Thank you, sir.

Mr. O’Shea.

STATEMENT OF JOHN P. O’SHEA

Mr. O’SHEA. I would like to first express my appreciation for the

opportunity to speak before the Subcommittee on Regulatory Affairs and share my views with regard to the costs and benefits of

Sarbanes-Oxley. This is an issue of great importance to small businesses in America, as well as the financial community, regulators,

and others who provide services to this vital segment of the American economy.

I’m speaking before the subcommittee from a dual perspective:

first, as president, CEO and owner of a New York Stock Exchange

and NASD member firm and as a small business issuers as clients;

and second, as an individual who has invested personally in many

SBIs and also has acted as an officer and director of SBIs.

I’ve worked with SBIs for over 20 years, and have witnessed numerous changes in regulations that have significantly improved the

transparency of small capital markets, particularly the Over-theCounter Bulletin Board. While some of these regulations placed increased burdens on issuers, they were regulations aimed specifically at smaller issuers for the purpose of enhancing disclosure and

market liquidity for smaller public companies. By contrast, the Sarbanes-Oxley Act has placed a broad-based burden on publicly held

companies of all shapes, sizes and characteristics. While there are

many positive aspects of the act, such as those regarding conduct

and related-party transactions, the audit and review standards are

particularly onerous.

In the case of larger companies, I believe the burden can be absorbed with reasonable impact and the benefits are realized by a

large number of investors. In the case of smaller public companies,

however, I believe the cost, in terms of both financial impact and

management resources, has a disproportionately large effect. These

impacts and expense are not commensurate with the benefit received, resulting in two trends that are having a negative effect on

capital formation for small companies in the United States.

Many issuers are choosing to terminate their registration or go

dark. Additionally, an increasing number of issuers are choosing to

go public in markets outside of the United States. Both of these fall

under the ‘‘law of unintended consequences,’’ having the effect that

this is the exact opposite of what SOX attempts to accomplish.

Rather than increasing disclosure and providing stronger controls

for companies, many issuers are terminating previously available

disclosures, or, by going public elsewhere, not providing them at

all.

According to a study at the University of Maryland, approximately 200 companies petitioned to delist their stock in 2003, with

an estimated similar number in 2004. This compares with just 67

companies in 2002, prior to the implementation of SOX. Their securities are either moved to the pink sheets where they frequently decline in price, or they stop trading altogether. As the investors are

left in the dark, having significantly less knowledge about the actions of management and operational results of the company, they

66

are left with little leverage with which to form the basis of a more

accurate valuation.

The second trend is the growth of competing, non-U.S. marketplaces that cater to small cap companies, particularly the AIM in

London. The number of foreign companies listed on the AIM has

nearly doubled every year since the year 2003 when SOX was first

implemented. With only 60 foreign countries listed on the AIM in

2003, the number jumped to 116 in 2004; 220 in 2005; and 262

through May of this year.

Among it’s listed companies, the AIM includes 37 U.S. companies

up from 17 1 year ago. Some of these abandon their U.S. trading

status in order to join the AIM. Some never pursue U.S. trading

at all. Further, emphasizing this attraction is the fact that newer

markets are being formulated that are emulating the AIM system,

not the NASDAQ. As these alternatives become increasingly available and credible issuers, both United States and international,

will have less incentive to face the complexities and costs of trading

in comparable U.S. markets.

The two trends presented above reflected the general pushback

smaller public companies are having against SOX. While many

smaller public companies are choosing to stay the course and comply with the newer regulations as they become applicable to them,

there is a significant discontent and concern regarding the disproportionately high cost to them. A study by Foley & Lardner

found that in fiscal year 2005, the percentage increase in average

audit fees was significantly higher for small cap companies at 22

percent than mid cap at 6 percent and S&P companies at 4 percent. The year-to-year percentage increases were greatest during

the phase-in of Section 404 requirements, with the largest increases being felt by small cap companies.

In preparation for this testimony, we surveyed smaller companies to get feedback regarding their experience with SOX. In this

informal survey, approximately 70 percent felt that SOX had no effect on communications with shareholders, communications with

analysts or other information useful to management. Sixty-seven

percent of those surveyed also felt the quality of their financial reporting was the same, although 31 percent did feel that it had improved since the implementation of SOX. Seventy-four percent believed that the results obtained were not worth the expense and effort in implementing them.

As an additional gauge of the perception of the effects of SOX,

we surveyed investors, including 27 individuals and institutions.

We asked these investors about the effects of SOX on the small and

micro cap companies they invest in or would like to invest in.

While 33 percent of the group believed SOX had the potential to

reduce the risk of management fraud, 56 percent believed it had

no effect. Almost the entire group, 93 percent, felt that SOX had

a negative effective on issuer profitability, and 100 percent believed

SOX has caused small and micro cap companies to be less likely

to go public in the United States. When rating the effect of various

factors on positive share performance, 85 percent felt that earnings

and revenue growth was the most important, while 85 percent felt

that compliance with SOX was least important. This indicates that,

while investors find there are some positive aspects to SOX, those

67

aspects are not as highly valued in the marketplace in light of the

negative impact it has on profitability.

Thank you very much.

[The prepared statement of Mr. O’Shea follows:]

68

69

70

71

72

73

Mr. MCHENRY. Thank you, sir.

Mr. Lawrence.

STATEMENT OF DAVID LAWRENCE

Mr. LAWRENCE. Thank you for providing the opportunity to testify before you today on Sarbanes-Oxley Act, Section 404, and finding the proper balance among cost burdens, investor protection and

U.S. competitiveness.

I currently serve as the chief financial officer of Acorda Therapeutics. We are a public biotechnology company located in Hawthorne, NY. I have been involved with the management of corporate governance and finances in biotech and high tech companies

for over 15 years. Founded in 1995, Acorda is a biotechnology company focusing on the development of next generation therapies that

restore neurological function to people with spinal cord injury, multiple sclerosis and related conditions of the nervous system.

Our company has clinical and pre-clinical drug candidates for

MS, the focus on novel approaches to repairing damaged components of the central nervous system. We are currently a net loss

company with one drug on the market. Our market cap of approximately $76 million as of June of this year is at the bottom 0.5 percent of total U.S. market cap.

We completed our initial public offering in February 2006 and

are currently beginning the process of complying with the Sarbanes-Oxley Act.

Today, I’m here to testify on behalf of the biotechnology industry

organization, an organization representing more than 1,100 biotech

companies, academic institutions, State bio technology centers and

related organizations in 50 U.S. States and 31 nations. The majority of bio member companies are small, research and developmentoriented companies pursuing innovations that have the potential to

improve human health, expand our food supply and provide new

sources of energy.

Acorda Therapeutics has a profile that’s typical of the high-risk,

capital-intensive, long-lead time regulated business environment of

the biotech industry. As a representative of one of the most innovative high growth sectors of our Nation’s economy, one in which the

United States maintains a global leadership position, my testimony

is tailored to the issues faced currently or that will be faced by

emerging companies in the biotech sector.

Let me start by saying that we fully appreciate and agree with

the congressional intent behind Section 404, ensuring that companies have in place effective procedures and controls to enhance investor protection and protect against fraud. Where Section 404 has

gone awry is in the implementation. The current implementation

of Section 404 is not tailored and does not work well for small public companies.

The one size fits all approach of Section 404 is highly burdensome and smaller companies are bearing disproportionate costs on

a relative basis. This has been recognized and documented, not

only by the SEC advisory committee for smaller public companies,

where members voted 18 to 3 in favor of Section 404 reform, but

also by the GAO, where it found that smaller companies at the bottom 6 percent of total U.S. market cap pay up to $1.4 million on

74

external auditors for Section 404 compliance. The GAO also found

that 47 percent of the companies reported significant opportunity

costs related to Section 404, draining resources away from innovation and research.

Even the SEC recognized in its recent statement that Section

404 might need reform based on a top down risk-based and scaled

approach, which would make Section 404 more responsive to the

individual size and complexity of the companies. For most biotech

companies, the cost burdens associated with Section 404 compliance include both internal costs, as well as external auditor costs

and are substantial. Our experience as a newly public, non-accelerated company is very similar to those experienced by BIO members. Due to limited internal resources, we will have to immediately contract with an outside consulting firm in order to comply

with SOX requirements by the 2007 deadline.

For many of the newly public companies, Section 404 costs could

mean having to spend a large portion of their research funding for

a leading drug or therapy on Section 404 compliance, forcing many

of the companies to make reductions in research spending in order

to meet the requirements imposed by Section 404.

For the investors, their confidence and trust in public companies

may have increased as a result of SOX as a whole, but not necessarily due to Section 404. As we saw in the first and second years

of Section 404 implementation, investors were less concerned when

a company reported a material weakness in internal controls under

Section 404, than on how much a small company was paying to

meet Section 404 requirements.

Here, the cost of implementing Section 404, particularly for

smaller public companies, appear to outweigh many of the benefits

that are directly related to Section 404.

As embraced by the Advisory Committee in its final recommendations, it is critical that Section 404 reform framework establishing a risk-based approach that provides scaled reforms

based on a revenue filter condition. This approach recognizes that

level of risk, the level of complexity, and the level of product revenues are clearly interrelated and that product revenue should drive

the level of internal control procedures.

Without Section 404 reform, evidence points to the fact that innovation may be stifled and U.S. competitiveness compromised. With

recent submission of the Advisory Committee’s final recommendations and the SEC’s statement of intent for reform, it appears that

now is the opportune time for the SEC to fully engage and follow

through with reforms consistent with the original principles upon

which SOX was enacted.

Thank you for your time and consideration of BIO’s views. BIO

urges the subcommittee to request expeditious action by the Commission on the reform framework endorsed by the Advisory Committee.

[The prepared statement of Mr. Lawrence follows:]

75

76

77

78

79

80

81

Mr. MCHENRY. Thank you, sir, and I’ll begin the questioning.

We’ll start the clock with 5 minutes.

Mr. Robotti, a question for you. How much do you rely on Section

404, in terms of making decisions about companies? What is your

reliance on Section 404?

Mr. ROBOTTI. Well, one of the points I raised is that I don’t think

the public market really ascribes much value to it because if you

look at the micro cap companies that are not accelerated filers, less

than $75 million of unaffiliated market cap today, there’s no repricing of the securities in those markets. They don’t have a higher

multiple, but you’ve got to pay for those stocks. They don’t sell a

higher multiple, a lower multiple for books. So it doesn’t seem to

me, because part of the portfolio companies that we invest in are

still not 404 compliant and others are. So you know, I, as an investor, look at these companies, have met with managements, look at

the financial reports they have, look at what they’ve done in the

past in terms of restating their financials, and make my own subtle

assessments about the reliability of management and internal controls. And so it’s really not an assessment, because from the outset,

it’s, of course, always difficult to understand exactly the process

that they went through in 404.

The companies that I am familiar with the 404 processes that

they have gone through, you know there are some benefits that do

come from kind of reviewing top down, everything they do, but the

time and effort involved—there’s a lot more detail work that really

is relatively irrelevant. So that’s my opinion. And I clearly have

talked to companies who have said, listen, who have said to me,

the cost of being a public company is not that significant, so I don’t

know why company XYZ who is a competitor of ours did

deregister—this is 2 or 3 years ago—for other reasons. And then

I come back to them a couple of months later and they say gee,

we’ve looked at this 404 and we’re looking at what the time and

effort is going to be involved and the cost of it. I’m considering that

we would really deregister.

So that’s a specific company where I’ve had conversation where

clearly the guy said it’s not significant being a public company and

the costs aren’t that significant to evaluating 404 and saying: ‘‘I

don’t know if I really want to go through that process and incur

all these incremental expenses and I don’t really see the benefit

added.’’ And I could understand, yeah, I own 19 percent of the company and yet I’m not really an insider. I’m not really privy to any

information that any outside investor isn’t, but I understand his

process. And if I were a director, I would think yeah, maybe that

is really relevant for you to not be a reporting company.

Mr. MCHENRY. All right, I think it’s pretty clear we understand

the problems in the marketplace and I appreciate you touching on

that. Now if we could transition, if we all, all four of you could take

just 30 seconds and explain what we should do, what Congress

should do, what action we should take and we’ll begin with you,

Mr. Robotti, but please keep it at 30 seconds. We’ve got to keep to

the time.

Mr. ROBOTTI. 404 is extremely poorly designed and implemented.

The idea that you need additional work done on internal controls

is logical and in the testimony given by an ex-SEC Commissioner

82

who said what you’ve got to do, he said take 1 day for the CFO,

5 days for the order and that’s what he said he designed the law

when he implemented the law and wrote the law and that’s not

what’s happening. So the implementation is vastly off.

Internal controls are good. You need it. 404, way overkill.

Mr. MCHENRY. Mr. Beach.

Mr. BEACH. I’m not on the market, so I won’t give you that kind

of a detailed response, but let me just say that I think you should

commission research on the economic effects of 168 words. I honestly think that Congress needs to have more information and reliable peer-reviewed information about what this has done, so you

can get past the anecdotes which are all very important and into

something that’s more solid than that, something that you can rely

on.

Mr. MCHENRY. Mr. O’Shea.

Mr. O’SHEA. At the very least, I think you should delay implementing some of the more onerous provisions of the act, particularly 404, to do cost benefit studies, to understand the effect and

perhaps consider having some companies, small cap companies or

different industries being exempt from those provisions.

Mr. MCHENRY. Mr. Lawrence.

Mr. LAWRENCE. Similar. It’s the 404 provisions that are especially difficult for small companies such as Acorda and others in

the biotech industry. It really is either—put on hold so it can be

further studied and analyzed or some sort of a leveled approach or

scaled approach based on revenue and market cap.

Mr. MCHENRY. All right, I appreciate your input.

Mr. Dent.

Mr. DENT. Thank you, Mr. Chairman. Mr. Beach, I do appreciate

your comment just a moment ago about the impact of 168 words

on the economy. And I’m always reminded in this business of legislating that we pass laws to stop people, bad people from doing bad

things and the corollary to that is oftentimes it prevents good people from doing good things and I think you drove that point home.

Mr. Lawrence, I represent an area of the country where there’s

a lot of biotech interest and activity. And I’d be curious to know

have you, are you aware of any research that has been foregone or

discoveries that are not being made because of the compliance costs

associated with Section 404?

Mr. LAWRENCE. It’s tough to say what discoveries have not been

made, if the funds haven’t been directed toward them. In our case,

we will probably be similar to other biotech companies where you

could spend upwards of $1 million or more in the implementation

of SOX, so for a small company like us, that’s $1 million that will

not be used to bring in more researchers and license additional

technology or things that could accelerate the development of

breakthrough drug in the future.

Mr. DENT. With respect to these opportunity costs for these small

companies, I mean just elaborate on that. What do these opportunity costs—what opportunities are being missed?

Mr. LAWRENCE. Just the opportunity to—you may have drugs

reaching a certain development stage where additional funding

could take it to the next level. Get it into a clinical trial, bring it

into a Phase 2 clinical trial. Get it out of the laboratory and into

83

human testing. Those are questions that you will ask yourself, if

you’re spending money on things that are not going to the research

and development, primarily what investors have invested in our

company for.

Mr. DENT. Mr. Beach, can you just elaborate too on the impact

on jobs. We’re always talking about jobs around here and what do

you see the impact on jobs because of this statute, Sarbanes-Oxley,

and its implementation, I should say?

Mr. BEACH. Well, our own research is beginning to indicate pretty strongly, Congressman, that Sarbanes-Oxley has, in fact, added

to the cost of capital and we know that in looking at large models

of the U.S. economy, as well as industry specific models, that capital costs are really the big driver in business expansion, in reinvestment and new technology, all of which has immediately two

areas, one, and that is the improvement in salaries and wages. It

makes workers more productive and they’re able to command higher pay and so if capital costs are going up, that will reduce the potential wages and salaries and also in achieving new employment.

And when Congress acts to increase the cost of capital, that is

worse than when any other institution in the United States acts,

for example, just capital market increases because people who are

borrowing now have to also calculate that you will followup this action with other deleterious actions and so we say in our modeling

that at one-tenth of an increase in capital costs that’s due to your

actions results in 100,000 lost potential jobs, not actual jobs, but

potential employment falls by that amount.

Mr. DENT. And what industries do you think, looking forward, will be most impacted by this law, knowing that $9 out of $10

raised for these new companies are being listed elsewhere, outside

of this country?

Mr. BEACH. That’s why I think our research in the venture capital data was so important and revealing, Congressman. And just

very, very quickly, we saw a real movement away from companies

that would have difficult decisionmaking by the private boards. An

unwillingness to take a company public, in other words. High technology companies. Of course, the area of the economy which has

been benefited by Sarbanes-Oxley was made in the previous panel.

We saw an increase, not only in compensation, but in numbers in

the financial services sector, but particularly accountants and those

subsectors. That’s what the research indicates at this particular

point.

Mr. DENT. Thank you, Mr. Chairman. I will yield back.

Mr. MCHENRY. Ms. Kelly.

Ms. KELLY. Thank you. I’d like to ask Mr. Lawrence, biotech

companies have really very low product revenues comparable to

their market capitalization. And it’s not uncommon for a newly

public biotech company to have a market capitalization of $700 million, but have product revenues of less than $1 million.

The SEC Advisory Committee for Smaller Public Companies defines a smaller public company in terms of revenue and market

capitalization. Now I asked the prior panel, is that an appropriate

way to define or should we do it only on market capitalization

alone? Should we—how do we redefine that so that it makes some

sense?

84

Mr. LAWRENCE. The market cap is an important piece. The revenue portion and it is true that when a company begins to have revenue, it does create more complex financial statements. Case in

point, we recently went public and we acquired a product last year

in 2004 and there was a large amount of work that went into revenue recognition on this product and how to report it on the books.

Very detailed, very—intricate accounting policies had to be followed.

So I think that the revenue piece is an important piece because

it does add a sense of complexity to the financial statements and

creates another layer of potential accounting discrepancies.

Ms. KELLY. Let me ask another question. I’ve been sitting here

thinking, listening. Are we holding the companies liable for something that we ought to perhaps because we’re talking in Section

404 about figures that the accountants have? Perhaps we should

talk about where the accountants are being held because when an

accountant goes into a firm, the only way they’re going to get any

information about the firm really is if they’ve been doing it repeatedly and they know the firm very well or whatever the firm tells

them, that’s what they get.

Should we perhaps be looking at accountancy, along with what

we’re talking about with trying to get some—the whole basis for

404 was transparency and the whole idea for transparency was to

get some honesty out there in the marketplace to help an investor

be able to invest with all of the available information. But perhaps

there should be something we should be looking at in terms of accountancy with relationship to what this Section 404 is demanding

of companies. I’m asking this of all of the panel.

I’d like to start with you, Mr. Robotti. Have you thought about

that? And I’d like to hear your thoughts.

Mr. ROBOTTI. Accounts play a key role in the total equation here

and of course, they’re driving—I think that’s one of the problems

with 404 is of course, you know their interpretation of PCAOB

rules are how do you do an internal 404 review is what’s adding

to costs because that’s one of the recommendations, of course, the

committee did make that for small companies, not micro companies, so therefore between $700 million and market cap and over

$128 million, that qualification would move over time because it’s

as small as 1 percent. Those companies would be exempt from the

external auditor opinion on Section 404.

My personal experience with one company where I am director

today and on the audit committee, we just the other day met and

our internal, our external audit was $100,000 incremental the first

year and we paid $100,000 to hire a consultant to work with us to

implement 404 and to put in internal controls and of course, there’s

the time and effort internally.

The second year, the auditors charging us the same $100,000 to

do the audit, no cost savings the second year. There was a 100-hour

reduction from 580 to 480, but they raised the rates. So it’s the

same price. The external consultant went from $100,000 to $30,000

the second year. The external consultant clearly was important

helping the company organize, demonstrate and categorize all of

the internal controls that happen and put in controls that needed

to be done the second year, but became more efficient. The external

85

auditor, I don’t know what they did the first year other than act

as the oversight person to make sure that the internal work was

done. The second year, I don’t know what they’re doing because I

just don’t understand that process. So that’s what I’m saying, the

implementation of 404, I think is a problem. I think auditors are

a key part of the problem.

An extra reason why you don’t need 404 today, the auditors kind

of run the show because if they say listen, we don’t like the data

you gave us, then you know, we’re going to say you’ve got to give

us more data and more information. They control that relationship

today.

Ms. KELLY. Well, should there be some liability there? I don’t

know——

Mr. ROBOTTI. There is liability. They’re concerned about liability.

It’s what’s causing them to over-implement, over-design 404. That’s

what’s driving that.

Mr. BEACH. Congresswoman, I just wanted to say that I think

you’re on to something important there and we’ve noticed it too.

This is not only an intervention into the financial side of private

businesses and publicly traded companies and so forth, but the accounting industry should be in—it should be something that you

should be concerned about because it was an intervention in their

industry.

Good accountancy leads to good information, leads to good pricing of companies, leads to a good allocation of resources in the

economy. So I think accountants are absolutely critical to all of this

and if we have damaged that industry inadvertently, we need to

now pay a lot of attention to the rectification of that industry.

Ms. KELLY. Mr. O’Shea.

Mr. O’SHEA. 404, in my view, has cause for two things to reinforce what Bob said. It could cause for very tough relationships between the auditors and the issuers because the auditors are constantly looking over their shoulder and the costs, both in monetary

and running of the business by the issuers has gone up dramatically.

Additionally, 404 causes the auditors to have to learn a lot more

about the businesses than they’ve ever had to in the past. They

should really be focused on their job which is analyzing the financial statements.

Mr. LAWRENCE. I think that some additional clarity around exactly what the auditing firms need to be doing, separate and apart

from a financial audit is part of the problem. I’m not sure they understand, speaking of liability, where it ends and where they’re off

the hook and where they’re not and what they need to do and what

they don’t need to do. So that’s part of the problem. So basically

what they’re doing is looking at everything.

Ms. KELLY. Thank you.

Mr. MCHENRY. Thank you, Ms. Kelly.

Mr. Feeney.

Mr. FEENEY. Well, thank you, Mr. Chairman, and in fairness,

somebody has to speak up for the accountants here. They’re not

here to defend themselves. To the extent the Big Four were endowed by Congress, intentionally or unintentionally, with control of

the marketplace, Pepsi needs an internal auditor and an external

86

auditor. Assuming they don’t want to hire the same two that Coke

has already signed up, we have created this monopoly rent-seeking

opportunity and I don’t particularly blame the accountants for taking advantage of something that we in the SEC and PCAOB have

endowed them with. I do think that it’s one of the problems we

haven’t talked about here today, but that’s probably best talked

about when we have some folks from the accounting industry, both

big firms and small firms.

Mr. Robotti, you control about $300 million of investment, your

firm does. Do you, as part of your due diligence, when you make

an investment decision, do you go down and pull a 404 report and

pour over the pages 1 through 480 or whatever?

Mr. ROBOTTI. There is no external—404 is just a sentence.

There’s no detail, no information.

Mr. FEENEY. OK, but the compilation of that report by the external, I mean there is a report that the external auditors do, is there

not?

Mr. ROBOTTI. No.

Mr. FEENEY. Well——

Mr. ROBOTTI. There is no outward available public dissemination

of information that is the culmination of the 404 report, other than

the opinion of the auditor.

Mr. FEENEY. OK, Mr. Robotti, you indicated in your testimony

that you think that small companies, given the—they were bumping up against this December 16th date and even some companies

that have complied, I think the way you put it was that they have

a duty to consider going—a duty to their investors, a duty to consider going dark. Does that also include maybe a duty to consider

going offshore with respect to where they list and whether or not

they delist? I mean Mr. Coulson has a proposal he refers to as

DOD that’s sort of a private regulatory proposal.

Mr. ROBOTTI. I think all of those things potentially make sense.

I can see where it is logical for a board of directors to decide to register as a public company to trade in the pink sheets. The problem

with that is that decision is unilaterally in the decisions of the

board of directors, what to do, and then once that’s happened how

does that company act and how does it treat those shareholders

who potentially are disenfranchised because instead of having all

of the disclosures and the protections and of course, that’s what it

is. It’s the disclosure of information that potentially provides investors with the ability to understand that something is going wrong

and if we were to seek some kind of redress whether that’s to

change the board, whether it’s court action, if you don’t have the

information, you can’t do that and that is unilaterally decided by

the management in the board today. That’s the problem with the

process.

Mr. FEENEY. I don’t know whether you’ve read Mr. Coulson’s testimony, but he’s got a private regulatory proposal he thinks takes

care of some of those.

Mr. ROBOTTI. But that’s a voluntary, on the part of the company

process. I, as a shareholder, really have no say in whether that

company—I have a company that just last week announced that

it’s going to deregister with the SEC. IT’s an ex-New York Stock

87

Exchange company. It will do $700 to $800 in revenue and I don’t

know what they’re going to do tomorrow.

Mr. FEENEY. That’s true, that’s a problem. But as an investor

going forward, you have a choice when you’re choosing where to

put your money, company A or B, to determine whether or not the

private regulatory scheme or 404 compliance is a better place.

Mr. ROBOTTI. But I disagree with the fundamental, that concept.

You are forgetting about every shareholder of those companies that

currently had invested, when they were a reporting company, when

they took on that obligation. Now suddenly, they’re not any more.

It’s not my new investment of capital. It’s not the new creation of

company giving capital, that’s a problem, but you’ve forgotten

about the guy who was a shareholder who bought in under a presumption that——

Mr. FEENEY. I couldn’t agree with you more. We don’t have any

argument at all. It’s one of the unintended perverse consequences

of the way we’ve implemented Section 404.

Mr. Beach, you’re not an economist, you’re a data analyst, is that

right?

Mr. BEACH. I am an economist, sir.

Mr. FEENEY. You are an economist.

Mr. BEACH. With due apologies.

Mr. FEENEY. I’ll ask you your opinion on a big question and ask

you whether or not we can ever quantify it because you have some

obvious expertise in the quantification and the scientific approach.

I want to know your opinion whether the cost of SOX compliance

has resulted in the loss of more jobs and the more net value to the

American economy than Enron and World Com combined, and then

I want to know because your methodology, as I understood it, is

you’re going to look at the companies that have basically gone dark

or delisted or are availing themselves of private equity markets

where they would have probably stayed in the public equity markets. Then you’re going to look at the inefficiencies and the cost of

raising capital and you’re going to give us a number.

That method seems to me woefully inadequate to talk about the

total impact on the economy, because Mr. Lawrence just explained

that he’s got his best and brightest scientists, in some cases, spending a good portion of their time instead of finding the next cure for

multiple sclerosis, they’re talking to their internal accountants,

their external accountants, their lawyers and others. So it’s almost

impossible to quantify the loss of opportunity, isn’t it and I’ll let

you answer those questions.

Mr. BEACH. With any precision, it certainly is. What we try to

do in this particular case is go through the following exercise.

We’re taking a lot at what we think is a leading industry in this

whole debate and that is the venture capital industry. That’s just

one of many and we are saying can we isolate the effects of

changes in that industry due to Sarb-Ox on the cost of capital and

several other, Congressman, economic concepts. If we can, then I

can take those results and move them into another model of the

U.S. economy which has been used for a long, long time by economists, a very good detailed model, in fact, I imagine you even used

it.

88

And from there, we can then say this is the effect of Sarb-Ox on

the economy. Same exercise. Look at Enron, World Com, Global

Crossing. Did they have that kind of tangible effect on these key

economic drivers? Move those results into the same model and then

compare the effects of these companies having that increase in cost

of capital as opposed to Sarb-Ox. That is exactly what we’re doing

right now in my unit.

It’s a real good economics question. It’s a real good data analyst

question and we will reach a conclusion contrary to the old saying

that if you lay all economists end to end, they never, in fact, reach

a conclusion. I think we’re very close to being able to advise the

committee that Sarb-Ox has a long-reaching and very deep effect

on the economy.

Mr. MCHENRY. Any further questions from the committee? Well,

hearing none, I want to thank the panel for taking the time to be

here and for sharing information. We’re going to take this back to

Washington and as Mr. Feeney said, he already has legislation that

he has filed. And there’s a lot of interest growing to make needed

reform. So thank you for being here today and this includes our

Government Reform Committee hearing.

Ms. KELLY. Mr. Chairman, I would like to say I do thank the

staff from Washington from this committee that came here and did

all the work to set this up. They did an excellent job.

Mr. MCHENRY. Yes.

[Whereupon, the subcommittee was adjourned.]

[Additional information submitted for the hearing record follows:]

89

90

91

92

93

94

95

96

97

98

99

100

101

102

103

104

105

106

107

108

Æ