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FULL COMMITTEE HEARING ON

SARBANES-OXLEY SECTION 404:

NEW EVIDENCE ON THE COSTS

FOR SMALL BUSINESSES

COMMITTEE ON SMALL BUSINESS 

UNITED STATES HOUSE OF 

REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

DECEMBER 12, 2007

Serial Number 110-63

Printed for the use of the Committee on Small Business

(

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

HOUSE COMMITTEE ON SMALL BUSINESS 

NYDIA M. VELA ́ ZQUEZ, New York, Chairwoman 

HEATH SHULER, North Carolina 

CHARLIE GONZA ́ LEZ, Texas 

RICK LARSEN, Washington 

RAUL GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

MELISSA BEAN, Illinois 

HENRY CUELLAR, Texas 

DAN LIPINSKI, Illinois 

GWEN MOORE, Wisconsin 

JASON ALTMIRE, Pennsylvania 

BRUCE BRALEY, Iowa 

YVETTE CLARKE, New York 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JOE SESTAK, Pennsylvania 

BRIAN HIGGINS, New York 

MAZIE HIRONO, Hawaii 

STEVE CHABOT, Ohio, Ranking Member 

ROSCOE BARTLETT, Maryland 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

BILL SHUSTER, Pennsylvania 

MARILYN MUSGRAVE, Colorado 

STEVE KING, Iowa 

JEFF FORTENBERRY, Nebraska 

LYNN WESTMORELAND, Georgia 

LOUIE GOHMERT, Texas 

DEAN HELLER, Nevada 

DAVID DAVIS, Tennessee 

MARY FALLIN, Oklahoma 

VERN BUCHANAN, Florida 

JIM JORDAN, Ohio

MICHAEL DAY, Majority Staff Director 

ADAM MINEHARDT, Deputy Staff Director 

TIM SLATTERY, Chief Counsel 

KEVIN FITZPATRICK, Minority Staff Director

STANDING SUBCOMMITTEES 

Subcommittee on Finance and Tax

MELISSA BEAN, Illinois, Chairwoman 

RAUL GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JOE SESTAK, Pennsylvania 

DEAN HELLER, Nevada, Ranking 

BILL SHUSTER, Pennsylvania 

STEVE KING, Iowa 

VERN BUCHANAN, Florida 

JIM JORDAN, Ohio

Subcommittee on Contracting and Technology

BRUCE BRALEY, IOWA, Chairman 

HENRY CUELLAR, Texas 

GWEN MOORE, Wisconsin 

YVETTE CLARKE, New York 

JOE SESTAK, Pennsylvania 

DAVID DAVIS, Tennessee, Ranking 

ROSCOE BARTLETT, Maryland 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

MARY FALLIN, Oklahoma

(II) 

Subcommittee on Regulations, Health Care and Trade

CHARLES GONZA ́ LEZ, Texas, Chairman 

RICK LARSEN, Washington 

DAN LIPINSKI, Illinois 

MELISSA BEAN, Illinois 

GWEN MOORE, Wisconsin 

JASON ALTMIRE, Pennsylvania 

JOE SESTAK, Pennsylvania 

LYNN WESTMORELAND, Georgia, Ranking 

BILL SHUSTER, Pennsylvania 

STEVE KING, Iowa 

MARILYN MUSGRAVE, Colorado 

MARY FALLIN, Oklahoma 

VERN BUCHANAN, Florida 

JIM JORDAN, Ohio

Subcommittee on Urban and Rural Entrepreneurship

HEATH SHULER, North Carolina, Chairman 

RICK LARSEN, Washington 

MICHAEL MICHAUD, Maine 

GWEN MOORE, Wisconsin 

YVETTE CLARKE, New York 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JEFF FORTENBERRY, Nebraska, Ranking 

ROSCOE BARTLETT, Maryland 

MARILYN MUSGRAVE, Colorado 

DEAN HELLER, Nevada 

DAVID DAVIS, Tennessee

Subcommittee on Investigations and Oversight

JASON ALTMIRE, PENNSYLVANIA, Chairman 

CHARLIE GONZA ́ LEZ, Texas 

RAUL GRIJALVA, Arizona 

LOUIE GOHMERT, Texas, Ranking 

LYNN WESTMORELAND, Georgia

(III) 

C O N T E N T S 

OPENING STATEMENTS 

Page

Vela ́zquez, Hon. Nydia M. ....................................................................................... 1

Chabot, Hon. Steve .................................................................................................. 2

WITNESSES

PANEL I 

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

PANEL II 

Ryan, Jr., Mitchell, U.S. Chamber of Commerce .................................................. 16

Grossblatt, Harvey, Universal Security Instruments, Inc., AMEX ..................... 18

Loving, Bill, Pendleton Community Bank, Independent Community Bankers 

Association ............................................................................................................ 20

Brandt, Jr., Thomas, TeleCommunication Systems, Inc., AeA ............................ 21

Greene, Shannon, Tandy Leather Factory, Inc. .................................................... 23

APPENDIX 

Prepared Statements: 

Vela ́zquez, Hon. Nydia M. ....................................................................................... 35

Chabot, Hon. Steve .................................................................................................. 37

Cox, Hon. Christopher, Securities and Exchange Commission ............................ 38

Ryan, Jr., Mitchell, U.S. Chamber of Commerce .................................................. 43

Grossblatt, Harvey, Universal Security Instruments, Inc., AMEX ..................... 50

Loving, Bill, Pendleton Community Bank, Independent Community Bankers 

Association ............................................................................................................ 53

Brandt, Jr., Thomas, TeleCommunication Systems, Inc., AeA ............................ 61

Greene, Shannon, Tandy Leather Factory, Inc. .................................................... 67

Statements for the Record: 

Biotechnology Industry Organization .................................................................... 72

American Federation of Labor and Congress of Industrial Organizations ......... 76

(V) 

(1)

FULL COMMITTEE HEARING ON 

SARBANES-OXLEY SECTION 404: 

NEW EVIDENCE ON THE COSTS 

FOR SMALL BUSINESSES 

Wednesday, December 12, 2007

COMMITTEE ON SMALL BUSINESS, 

Washington, DC. 

The Committee met, pursuant to call, at 10:00 a.m., in Room 

2360 Rayburn House Office Building, Hon. Nydia Vela ́zquez [chairwoman of the Committee] presiding. 

Present: Representatives Vela ́zquez, Gonza ́lez, Cuellar, Altmire, 

Clarke, Sestak, Hirono, Chabot, Akin, Westmoreland, Davis, Fallin, 

and Buchanan. 

OPENING STATEMENT OF CHAIRWOMAN VELA ́ ZQUEZ 

Chairwoman VELA ́ ZQUEZ. Good morning. I call this hearing to 

order. 

This morning the Committee will continue its oversight of the 

implementation of Section 404 of the Sarbanes-Oxley Act. With 

businesses beginning the process of meeting these requirements, 

now it is an appropriate time to reevaluate the burden associated 

with compliance. 

Since its inception, SOX 404 has presented a unique challenge 

for small firms. While they saw the importance of its core goals, 

many could not afford the high expenses associated with compliance. In fact, the cost of implementing it has caused many entrepreneurs to reconsider whether the benefit of being a public company is worth it at all. The rise of foreign stock exchanges in socalled Sarbanes-Oxley free zones has started to turn what many 

considered a myth into reality. Section 404, as currently configured, may be undermining the competitiveness of American companies. 

I am glad that the SEC recognizes that SOX 404 is a substantial 

burden for small firms. Chairman Cox is to be commended for soon 

undertaking an intensive analysis of compliance data and proposing an extension of the compliance date for Section 404(b). This 

will allow all interested parties to better understand the impact 

that this regulation will have before it is mandated. 

The recent study by the U.S. Chamber of Commerce, along with 

the American Bankers Association, the American Stock Exchange, 

and the Institute of Management Accountants, has provided a 

foundation for the SEC’s subsequent work. The Chamber’s survey 

was designed to collect data directly from small companies about 

2

the actual and expected costs related to meeting the requirements 

of Section 404. 

This constitutes the first and only data concerning SOX 404 costs 

that has been released since July when the SEC approved a revised 

auditing standard. When the Committee last examined this issue 

in June, we did not have meaningful data with respect to compliance costs. The lack of this information limited the Committee’s 

ability to fully assess the deadlines that the SEC has established 

for small firms. 

The survey data confirms what many have suspected—that the 

costs are, in fact, significant, and small companies are already incurring steep expenses. More than half of respondents indicated 

that they will spend more than 3 percent of net income implementing the requirements of Section 404(a) alone. And many small 

firms are beginning to prepare for 404(b), even though it is more 

than a year away. Sixty-six percent of survey respondents have already engaged an auditor as they prepare to comply with this requirement. 

The survey data highlights that a postponement, if it is to provide meaningful relief for small firms, must be issued as soon as 

possible. It is my hope that the SEC will act on the proposed delay 

immediately. Doing so will allow the Commission the time it needs 

to gather meaningful data before small firms are forced to comply 

with the untested revised rules. 

With Chairman Cox’s proposal today, our attention now turns to 

ensuring that the agency’s collection and analysis is accurate and 

thorough. This assessment is key in ensuring that SOX 404 regulations are right-sized and do not unnecessarily burden small companies. I look forward to working with the SEC on this evaluation. 

SOX 404, like so many regulations, is very burdensome and expensive for small companies. The SEC—and all federal agencies for 

that matter—must do more to ensure that we do the up front analysis to limit the impact on such a key segment of our economy. 

That is why this Committee will soon be considering legislation 

to expand and strengthen the Regulatory Flexibility Act—a key 

tool that gives small firms a voice in the rulemaking process. By 

doing so, we will be better able to preserve the entrepreneurial environment that has made the United States a global leader in so 

many industries. 

I would like to thank in advance Chairman Cox and all of the 

witnesses for their testimony today. And I now recognize Mr. 

Chabot for his opening statement. 

OPENING STATEMENT OF MR. CHABOT 

Mr. CHABOT. I want to thank the Chairwoman for holding this 

second hearing on the implementation of Section 404 of the Sarbanes-Oxley Act and its impact on small publicly-traded companies. 

And I want to extend a very warm welcome to our former colleague 

from California, Chris Cox, the Chairman of the Securities and Exchange Commission. He was certainly a very valuable member of 

Congress when he was here, one of the top leaders in Congress 

during those years, and he is once again serving his country very 

well in his capacity. So we welcome you here this morning, Mr. 

Chairman. 

3

Of particular concern is whether the financial controls and audit 

standards required for compliance with Section 404 imposes undue 

costs on small companies and impedes their ability to raise capital. 

Like the securities laws of the New Deal, Sarbanes-Oxley, or SOX, 

was a response by Congress to a crisis in confidence about the market for publicly-traded securities. 

Unlike the endemic problems that caused the stock market crash 

back in 1929, and resulted in much tougher securities laws, SOX 

was a response to a few spectacular but isolated instances of extreme corporate greed and criminal behavior on the part of a small 

coterie of corporate executives from companies, including Enron, 

WorldCom, Adelphia, and HealthSouth, for example. 

One of the broad issues that the Committee continues to consider 

is whether SOX, especially Section 404, represents the appropriate 

response to these criminal acts or an overreaction that has unnecessarily burdened small public companies. Today’s hearing will examine some recent data developed by the United States Chamber 

of Commerce concerning the cost that small public companies will 

incur to comply with the requirements of SOX. 

I think it is particularly relevant to focus on how the Securities 

and Exchange Commission considered costs in the development of 

its most recent interpretations on SOX compliance. The assessment 

of costs is a key component of an agency’s compliance with the Regulatory Flexibility Act, something that the Committee recently assessed in two separate hearings. 

I raise the issue of compliance with the RFA, because a review 

of the Commission’s most recent issuances demonstrates a greater 

need for more accurate cost data to understand the impact that the 

SEC’s rules concerning SOX compliance will have on small public 

companies. I am heartened to read in your testimony that the Commission, under your leadership, will do a full study of the costs 

faced by small companies. 

This data, then, should be used to perform a regulatory flexibility 

analysis, so the Commission can assess appropriate alternative 

methods for compliance with Section 404(b) of SOX. I look forward 

to hearing from our distinguished group of witnesses on these other 

issues concerning the implementation of SOX. 

And I must mention that I, unfortunately, am going to be called 

to another Committee, the Judiciary Committee. We are working 

on the subprime mortgage crisis that has hit the whole country, 

but four states thus far in particular, one being Ohio, my State, the 

others California, Florida, and Michigan especially. And we have 

reached a manager’s amendment in a bipartisan manner, and so I, 

unfortunately, need to be over there. So I apologize to any of the 

witnesses, and I apologize to you, Mr. Chairman. 

However, we are going to have Dave Davis, who is going to fill 

in here for us, to make sure the Democrats don’t get too out of 

hand here on this Committee. 

[Laughter.] 

No. Just kidding. This is one of the committees that really has 

a very excellent relationship, both between the chair and the ranking member and the staff and the members of the Committee. So 

this is one that really does work around here and has been responsible for passing quite a few bills in a bipartisan manner. 

4

So I want to, once again, commend the Chairwoman for her hard 

work in this, and I want to thank Mr. Davis for filling in. And if 

he has to go, I believe Mr. Westmoreland is also going to fill in for 

a while. And I will be back just as soon as I possibly can, and I 

yield back. 

Chairwoman VELA ́ ZQUEZ. For the record, not just some bills, 20 

bills. 

Mr. CHABOT. Twenty bills. 

Chairwoman VELA ́ ZQUEZ. Most productive in the last two decades. 

Mr. CHABOT. Most productive Committee in Congress, right? 

Chairwoman VELA ́ ZQUEZ. That is right. 

Mr. CHABOT. That is right. 

Chairwoman VELA ́ ZQUEZ. So now we will proceed with our first 

panel, and I just want to extend the warmest welcome to our 

former colleague, The Honorable Christopher Cox. Mr. Cox is the 

28th Chairman of the Securities and Exchange Commission. He 

was appointed by President Bush on June 2, 2005, and unanimously confirmed by the Senate on July 29, 2005. 

During his tenure at the SEC, Chairman Cox has brought 

ground-breaking cases against a variety of market abuses, including hedge funds, inside trading, stock options backdating, and securities scams on the Internet. Prior to joining the Securities and Exchange Commission, Chairman Cox served for 17 years in Congress 

where he held a number of positions of leadership in the United 

States House of Representatives. 

Mr. Cox, welcome. 

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

Mr. COX. Thank you very much, Madam Chairman, and members of the Committee. It is a pleasure to be here to testify on behalf of the Securities and Exchange Commission concerning the 

costs and benefits of Sarbanes-Oxley Section 404 for small businesses. 

The Commission, just like this Committee, shares an abiding 

concern for America’s smaller public companies. Since SarbanesOxley became law in 2002, the Securities and Exchange Commission has not applied Section 404 to smaller public companies. In 

addition, we recently issued guidance intended to make the process 

for smaller public companies more economical and more efficient 

for the time when eventually they do come into compliance. 

The Commission’s decision to proceed cautiously in deference to 

smaller public companies and their investors is due in significant 

part to the fact that the cost of regulation, as you all well know, 

falls heaviest on smaller companies, both on a per employee basis 

and as a proportion of revenues. It would be impossible for us at 

the SEC to succeed in our mission if we didn’t focus directly on the 

needs of smaller public companies. For that very reason, the SEC 

has a long history of listening to smaller public companies and assisting them in their efforts to raise capital. 

Just three weeks ago, we adopted new rules designed to make it 

much simpler and easier for smaller public companies to raise capVerDate 0ct 09 2002 12:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39384.TXT LEANN
5

ital. Now any small public company with a public float of up to $75 

million can use these simpler rules, compared to the $25 million 

cap that used to be in place under the old rule. That means another 1,500 public companies will be able to use our simplified disclosure and reporting. 

We also further simplified the rules themselves. We eliminated 

five forms, and we eliminated 36 separate items that used to comprise Regulation S-B. We have also made it more economical for 

smaller companies to sell restricted securities under Rule 144 by 

reducing the holding period from one year to six months, and by 

eliminating many of the other restrictions. 

And non-affiliates won’t have to file forms at all anymore. That 

change will reduce the number of Form 144s filed with the Securities and Exchange Commission by nearly 60 percent. These are all 

ways to cut the cost of capital for smaller public companies and for 

small businesses without sacrificing investor protection. 

We also changed the rules to protect private companies that offer 

stock option plans for their employees. Many small, privately-held 

companies were concerned that they might accidentally be required 

to register as public companies even though they don’t have any 

public shareholders. Our new rule fixes that. 

In taking these steps, we have been responding to several key 

recommendations of the SEC’s Advisory Committee on Smaller 

Public Companies. One of the Advisory Committee’s most important recommendations is the topic that we are focused on this 

morning. Specifically, the Advisory Committee recommended that 

smaller companies should not be made to comply with Section 404’s 

external audit requirement ‘‘unless and until there is a framework 

for assessing internal control over financial reporting for such companies that recognizes their characteristics and needs.’’ 

With that very recommendation in mind, the Commission delayed Section 404 compliance for smaller public companies and set 

to work on providing guidance for those companies that would recognize that their needs are different than those of larger companies. During the last few years, the Commission and the Public 

Company Accounting Oversight Board have worked together to 

completely repeal the old, inefficient system of implementing Section 404. 

The SEC published guidance specifically for management, which 

had not been done before, and both we and the PCAOB approved 

a completely new standard for Section 404, AS-5—that is, topdown, risk-based materiality focused and scalable for companies of 

all sizes. 

Our SEC management guidance, intended for the company’s own 

use, will relieve smaller companies from having to rely on the audit 

standard as their de facto rule book. For smaller public companies, 

the guidance will be in place the very first time that they come into 

compliance, so that they can avoid wasteful and unnecessary compliance efforts that others have had to endure under the old standard. 

When eventually smaller public companies do come into full compliance, as the law requires, the new audit standard will encourage 

the scaling of all audits to reflect each company’s circumstances 

rather than a single checklist for all situations. And to ensure that 

6

this is what actually happens, the SEC will conduct a study, as you 

have all mentioned here this morning, of the costs and benefits of 

404 compliance under the new auditing standard and the new 

management guidance. 

Currently, under the direction of the Office of Economic Analysis, 

the SEC staff is preparing to gather and analyze real-world data. 

The study will seek to identify trends and provide a comparison to 

costs under the old standard. The study will also pay special attention to those small companies that are complying with Section 404 

for the first time. 

This survey of cost and benefits will have two main parts. First, 

there will be a web-based survey of companies that are subject to 

Section 404; and, second, we will conduct in-depth interviews with 

a subset of companies, including those that are just now beginning 

their 404 compliance. This dual approach will allow us to gather 

data from a large cross-section of companies, while providing more 

detailed information about what drives the costs and where companies derive the benefits. 

Because we are intent on using real-world data based on companies’ actual experiences, this survey will be taking place in the 

coming months as companies for the first time use the new auditing standard and the new management guidance. Because we have 

to rely on the actual costs that haven’t been incurred yet, the study 

and analysis of the results can’t be completed before June 2008. 

Under the current schedule, smaller public companies would be 

expected to begin complying with Section 404(b) for fiscal years 

ending after December 15, 2008, so the result is that unless there 

is an additional deferral companies would incur compliance costs 

before the SEC has the benefit of the study and the analysis. As 

a result, I intend to propose to the Commission that we authorize 

a further one-year delay in implementation for small businesses in 

order to base our decision on final implementation of Section 404(b) 

on the best-available cost data. 

Since I last testified before the Committee this summer, the SEC 

and the PCAOB have undertaken comprehensive outreach to help 

the small business community prepare to meet their obligations 

under Section 404(a). This outreach has included a half-dozen forums around the country. To make sure that our guidance is useful 

and understandable for smaller companies, we have also published 

a brochure designed specifically for the management of small businesses. It explains in plain English how to evaluate internal controls and how to determine whether they are effective. 

We have spent a lot of time distilling the key principles of our 

management guidance into this easy-to-read brochure, and we hope 

that all companies, large and small, will read it. It is, of course, 

available on the web at www.sec.gov. 

Madam Chairman, it is the SEC’s intention that our new guidance for management and the PCAOB’s new standard for auditors 

will lower overall compliance costs for companies of all sizes, and 

significantly so compared to the old standard. We expect that compliance costs under Section 404(a) should come down disproportionately for small business, because the new SEC guidance that has 

been developed specifically for management will allow each small 

7

business to exercise significant judgment in designing an evaluation that is tailored to its individual circumstances. 

Unlike external audits, management in a small company tends 

to work with its internal controls on a daily basis. They have a 

great deal of knowledge about how their company works, what goes 

on inside, and how the firms operate. The new guidance allows 

management to make use of that knowledge, which should lead to 

a much more efficient assessment process. 

We state clearly in the brochure for small business that under 

normal circumstances they don’t need to hire extra help to do their 

assessment. They certainly don’t need to engage an outside auditor 

for this purpose. The normal company personnel who are responsible for this work should be able to do it as part of their routine 

duties. The goal of all of these efforts is to implement Section 404 

just as Congress intended—in the most efficient and effective way 

to meet our objectives of investor protection, well functioning financial markets, and healthy capital formation for companies of all 

sizes. 

We won’t forget the failures that led to the passage of the Sarbanes-Oxley Act in the first place, and we won’t forget that for a 

small business to continue to prosper in America both strong investor protection and healthy capital formation must go hand in hand. 

Thank you again for the opportunity to speak on behalf of the 

Commission. I would be happy to answer your questions. 

[The prepared statement of Mr. Cox may be found in the Appendix on page 38.] 

Chairwoman VELA ́ ZQUEZ. Thank you, Mr. Chairman. And I am 

very, very encouraged by your announcement this morning. Mr. 

Chairman, during the Committee’s hearing on June 5, you indicated that you would be willing to consider supporting such a 

delay, if it was warranted. At that time, you also indicated that you 

did not believe that a delay was necessary. You now support a 

delay. What changed your mind? 

Mr. COX. The schedule really requires that if we are going to use 

cost data that we have at least a one-year delay. Otherwise, what 

will happen is that companies will have to incur costs waiting for 

our decision based on the real-world data, and then we might at 

the eleventh hour tell them, ‘‘We are sorry. Never mind. Let us 

wait until we get this right.’’ 

There is a better way to do it, and that is to take all of the realworld data, analyze it, make a decision, and then go forward. 

Chairwoman VELA ́ ZQUEZ. When do you expect that the SEC will 

vote on your proposed delay? 

Mr. COX. Madam Chairman, that is an excellent question. I have 

had the opportunity to talk to all of the Commissioners about this, 

so that while there has not been formal Commission action yet, I 

do have an informal sense of Commissioner support for this proposal. And I hope that reasonably early in 2008 we will be able to 

have an open meeting to do this. 

It is also possible, in fact, I will have to consult with the General 

Counsel and with the Division of Corporation Finance, that as has 

been done in the past this could be done by staff action without 

need of a formal Commission open meeting, in which case we could 

do it even more quickly. 

8

Chairwoman VELA ́ ZQUEZ. So if there are procedural steps that 

accompany this rule change, when do you expect that an SEC decision in favor of a potential delay will be finalized, if there are procedural steps that need to go with the delay? 

Mr. COX. Well, you know, but for the fact that we are just now 

entering on the holiday season, and New Year’s Day is less than 

three weeks away, I would say we could do it even this year. But 

I think realistically the earliest we could do this would be during 

the month of January. 

Chairwoman VELA ́ ZQUEZ. The month of January. 

Mr. COX. Yes. 

Chairwoman VELA ́ ZQUEZ. I understand that the SEC will soon 

undertake its own data collection effort with respect to SOX 404. 

And the data the Commission collects will undoubtedly be very 

helpful in determining whether SOX 404 compliance continues to 

be burdensome for small firms. Can you provide details as to what 

companies will be surveyed, when it will begin, and how the data 

will be analyzed? 

Mr. COX. Yes, I can do so in a general way in this hearing, and 

in a more detailed way between the Committee staff and our staff, 

as you might imagine, because the study is being designed by the 

Office of Economic Analysis. There are some general descriptors I 

can use, but there is also a fair amount of detail that you might 

be more comfortable getting from the experts. 

As I described in my opening statement, there are two main 

parts to the survey. We are trying to be both broadly horizontal 

and also do a deep dive into some companies’ experiences in detail 

to make sure that we are not missing anything. The broad-based 

survey could potentially include virtually every company in this 

category, depending on the level of response to a web-based survey 

and how successful we are in eliciting that response. 

The detailed analysis will be based on the experiences of companies that are selected because of their typicality, and because we 

think we can infer the most useful information from their experiences. 

Chairwoman VELA ́ ZQUEZ. But let me ask you, my concern is if—

will small companies and other interested parties will be able to 

contribute their recommendations about how to conduct the most 

effective data collection effort? 

Mr. COX. Yes. The kind of input that you are talking about into 

the design process is very much a part of what we have in mind. 

Chairwoman VELA ́ ZQUEZ. Once the data has been collected, 

would you be able to share that data publicly? 

Mr. COX. I would expect so. I think the entirety of this needs to 

be public in order for the public rulemaking process, public program of the SEC, and public company compliance all to work. 

Chairwoman VELA ́ ZQUEZ. Mr. Chairman, the SEC’s data collection effort will be critically important to small companies, no doubt 

about it. It may provide the evidence that SOX 404, in particular 

Section 404(b), needs to be further revised for small companies. 

What sort of results would the SEC have to see to significantly revise how 404(b) is implemented? 

Mr. COX. Well, ultimately, we are constrained by the statute 

itself, and so while there are a great deal of accommodations that 

9

can be made in terms of implementation such as have already been 

spelled out in our management guidance, and in the audit standard, I think that wholesale change in the way that 404(b) applies 

is a matter not for the SEC but for Congress. 

Chairwoman VELA ́ ZQUEZ. Thank you. And now I recognize Mr. 

Davis. 

Mr. DAVIS. Thank you, Madam Chairman, and thank you, Mr. 

Chairman. Thank you for being with us today. We appreciate your 

leadership. 

You mention in your written testimony that you would propose 

a delay in implementation to the small business in order to base 

your decisions on final implementation of Section 404(b). Will that 

decision—will the decision on whether to implement a further 

delay of implementation be based solely on the results of the data 

gathered? 

Mr. COX. I think that it will be based on the totality of information that we possess, but the only new information will be the results of the cost study. 

Mr. DAVIS. And what type of factors will you be looking at on the 

delay? It looks like it is going to happen, the delay will be put 

forth. But what type of factors will you be looking for? 

Mr. COX. Oh, I am sorry. I may have misunderstood your question. I thought you were talking about what we might do after we 

got the cost data. But you are asking me about— 

Mr. DAVIS. What type of factors will go into making that decision? 

Mr. COX. Well, that analysis is actually very simple. It is a question of whether or not we believe that it would be beneficial for investors, for issuers, and for the markets to have the benefits of this 

cost study and analysis before we make a final decision. Speaking 

for myself as Chairman, I think that is the better part of wisdom. 

That is the most orderly process. 

Otherwise, we will find ourselves halfway or three-quarters of 

the way down the road of the first year of compliance for smaller 

companies with 404(b) at a time when we then take a look at cost 

data and say, ‘‘We did not expect this result. We are going to reverse course.’’ It would be very disruptive for companies that are 

trying to comply in an orderly way. 

Mr. DAVIS. Okay. What efforts is the SEC doing to ensure that 

auditors do not take advantage of small business filers? 

Mr. COX. We have been, and the PCAOB has been, engaged very 

directly with auditing firms of all sizes, but particularly those who 

cater to smaller public companies, to make sure that they understand when the PCAOB and the SEC repealed AS-2 and substituted the new top-down, risk-based materiality-focused, scalable 

AS-5, that we did so with a strong view to gaining efficiencies. 

The costs of Section 404 implementation have got to be outweighed by the benefits. That is what Congress intended. I know 

this from speaking to all of the members, both the House and Senate side, who have been so concerned about this. I know this from 

speaking to companies, issues, and investors at our roundtables. 

People want the benefits of Section 404. Nobody is saying we 

shouldn’t get those benefits, but they are trying to make sure that 

there is some correlation between the way the thing is impleVerDate 0ct 09 2002 12:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39384.TXT LEANN
10

mented and the benefits that the market gets. And so we are going 

to keep all of those factors in mind in making these decisions. 

Mr. DAVIS. Thank you for your dialogue with those that fall in 

with members of Congress to make sure that we have that open 

debate. You stated that the SEC will monitor the effectiveness of 

public company accounting oversight boards inspections of whether 

audit firms are implementing the new auditing standards. Could 

you explain how this process will work? 

Mr. COX. Yes. It works in a number of ways. In the most formal 

way, it is a function of the inspection process being carried out first 

by the Public Company Accounting Oversight Board, which is inspecting the audit firms for 404 efficiencies, and then by our own 

inspection at the SEC of the PCAOB’s inspection process with a 

view to the same efficiencies. 

So the firms, the auditing firms, who are being inspected by the 

PCAOB are getting the full force and effect of the SEC and PCAOB 

inspection process aimed at efficiency. They know that we are quite 

serious about making sure that AS-5 is implemented as intended. 

Second, the PCAOB and the SEC are routinely engaged with the 

firms in discussions of these issues. Our Office of the Chief Accountant, for example, on a daily basis discusses these topics with 

the auditing firms. And, thirdly, I and the other Commissioners 

and the staff of the SEC have a number of informal opportunities, 

some of them slightly more formal—for example, at our 

roundtables and others, a part of our interaction through meetings 

and our officers and around the country, as I have described in my 

testimony, to focus attention on these matters. 

But changing the way that people operate is very much what the 

PCAOB and the SEC had in mind by repealing AS-2 and substituting AS-5. 

Mr. DAVIS. You stated earlier this year that Congress never intended the 404 process to become inflexible, burdensome, and 

wasteful. Do you still hold those views? And what is your response? 

Mr. COX. I do. And because I was a member of the House Senate 

Conference Committee that wrote Sarbanes-Oxley, and because I 

was there on the floor when we were all speaking about it, I know 

that not a single member from any state got up and said, ‘‘I want 

a process that is inefficient, costly, and burdensome, that destroys 

American competitiveness.’’ Nobody said that. Nobody thinks that 

that is what this law is all about. 

What people wanted was a law that gave investors greater confidence that the numbers that they were relying on to make their 

financial choices were solid and good, that the pathologies that we 

saw manifested in the cases that Congressman Chabot listed—

Enron, Worldcom, Adelphia, and so on—that all of those things 

would be dealt with in the most serious fashion by our law enforcement system, that reliability would be the touch-tone of our financial reporting in the United States. That is what this was all about. 

And there is a way to do all of that without crushing the whole enterprise in the process. 

Mr. DAVIS. One final question. A moment ago you talked about 

collecting data. Once you have that data, what will SEC’s decision 

process be dealing with Sarbanes-Oxley compliance? 

11

Mr. COX. Yes. I apologize for beginning to answer that question 

earlier, because I thought that was your earlier question. At that 

point, we will take the cost data and put it together with the totality of information that we have acquired through extensive examination of 404 implementation over the last several years, and then 

make a decision about what to do next. 

This is the same kind of decision that we have already taken 

with respect to small business on multiple occasions with respect 

to foreign private issuers, with respect to accelerated filers, and 

large accelerated filers in the United States. 

Mr. DAVIS. Thank you. and thank you, Madam Chairman. I yield 

back. 

Chairwoman VELA ́ ZQUEZ. Mr. Gonza ́lez? 

Mr. GONZA ́LEZ. Thank you very much, Madam Chairwoman. And 

welcome, Chairman Cox. Good to see you again. And I am glad you 

alluded to the fact that we were all there in 2002 when SarbanesOxley was adopted. As a matter of fact, the Chairwoman, you, and 

yours truly were members of the Financial Services Committee 

that probably were the focus of all of the hearings, and it was exciting times for all of the wrong reasons. 

The witnesses were very, very interesting. Most of those witnesses are today in prison, and some of those—and most— 

[Laughter.] 

—of the companies are no longer in existence. And I guess, you 

know, and I don’t mean to be flippant about it, but do you recall—

during all of the hearings that were conducted, and, you know, we 

had Bernie Ebbers there, we had everybody from Enron, we had 

Arthur Andersen, we had everybody there, and it was, like I said, 

exciting times. But do you recall any witnesses that were 

summonsed and testified that represented small business public 

trading companies? 

Mr. COX. I think the answer to your question is no, and I believe—I imagine you don’t recall it either, because that seemed not 

to be the focus at the time—and so we can infer from the answer 

to your question—is that this part of the analysis is a very important auxiliary. 

Mr. GONZA ́LEZ. Yes. And I guess I am just making the point that 

that really wasn’t the problem. It wasn’t the small business publicly-traded companies that created the situation that called for 

Congress to act, which I think was the appropriate thing to do. But 

like in most instances, obviously, you know, we cast a wide net 

many times, and we bring many people into it, but it doesn’t mean 

that we can’t review what we did in 2002 and tweak it, maybe not 

a wholesale revision, and so on. 

I know that former Chairman Oxley was not receptive to the idea 

of visiting Sarbanes-Oxley. That was my understanding a year ago. 

Now we have Chairman Frank. I really don’t know his position and 

how flexible he might be in entertaining maybe some revisions, 

again some tweaking to see if we can make it a little easier in its 

application. 

Still provide the public the safeguards that are really the essence 

of the legislation that were a result of certain misconduct at a certain level that truly impacted our economy, investor confidence, 

and so on. I think that is the appropriate thing. 

12

And see if I am reading you right in your testimony. There is 

only so much the SEC can do in the implementation to take care 

of the cost, the inconvenience, and of course I think there is diminishing return as to the objectives of Sarbanes-Oxley at the end of 

this thing. But, really, it probably is up to the United States Congress to look at it and to see if anything can be done legislatively. 

Would you agree with that? 

Mr. COX. Well, I always have a great respect, which I have built 

up over my time serving in this institution, for the role of the legislative process and the choices that policymakers have before them. 

That is not our job at the SEC. Our job is to make the laws that 

we did pass work in the best way possible. I am of the view, having 

had—going to my third year experience as a regulator looking at 

this, that it should be able to work without legislative change, and 

that is what we are trying to do. 

I say that because while we didn’t have small businesses up at 

those hearings focused on Enron and the rest, we all well know 

that financial fraud exists also in smaller public companies. And, 

in fact, in many cases some of the pathologies are even worse because the lack of internal controls in some small companies are 

more egregious than could possibly exist in a larger company with 

more routinized processes. 

So the focus on internal controls is not misplaced. It is something 

that small public companies need just like large public companies. 

But what happened, because we had all of our focus on enormous 

firms, is that the system that was designed to implement it just 

didn’t fit. We once in a while allude to the mythology tale of Procrustes who used to stretch his victims onto Procrustean beds, so 

that eventually they would fit. That is a little bit of what we saw 

going on with small business and 404 compliance. 

Lastly, I would just say that while there is enormous concern in 

the small business community about the potential effects of SOX 

404(b), the small business sector is the one group that has never 

done it. And there is now a new system in place which we fully intend will be vastly different than the one that they observed other 

companies having so much trouble with. 

So I think the first opportunity we should take is to get it right, 

the way Congress wrote the law, and only failing that would policymakers have to come in and do something else. 

Mr. GONZA ́LEZ. All right. Well, I appreciate your service, and, of 

course, your testimony today. I yield back. 

Chairwoman VELA ́ ZQUEZ. Time has expired. Ms. Fallin? 

Ms. FALLIN. Thank you, Madam Chairman. Appreciate you coming today and talking about a very important issue to our business 

community and the United States. I had a couple of questions. Are 

you going to survey companies that are private, but might want to 

go public? 

Mr. COX. It is an excellent question. The cost study that we are 

talking about is literally focused on the costs of complying with the 

new management guidance, and the new audit standard. And so it 

would be impossible to derive that information from companies 

that aren’t complying and are incurring those costs. But survey 

data of companies that are thinking about going public would be 

enormously useful for other purposes. 

13

Ms. FALLIN. Okay. And once the Commission has collected the 

data, what types of action could it take to reduce Sarbanes-Oxley 

compliance for the smaller companies? 

Mr. COX. I think we are going to have to stay with this. I have 

thought all along that writing a new audit standard, and writing 

management guidance that is directed to small business and takes 

into account their special concerns, is only half the job. After that, 

you know, starting with user-friendly things, like a brochure for 

small business that explains in plain English what modest steps 

people can take to get started on this, and extending to talking to 

the audit firms and making sure that they are focused on efficiencies and they are not taking advantage of their clients, all of 

these things are going to require constant vigilance and maintenance by the SEC. 

Ms. FALLIN. Thank you, Madam Chairman. Thank you. 

Chairwoman VELA ́ ZQUEZ. Ms. Hirono? 

Ms. HIRONO. Thank you, Madam Chair. Mr. Cox, I note in your 

testimony that you state clearly in your brochure as to the small 

companies that under normal circumstances they would not need 

to hire an outside auditor to do this assessment as required. Now, 

the reality might be, however, that because there are penalties involved in not complying, wouldn’t it be the case that for most companies that they would want to have an outside auditor do this? 

Mr. COX. I don’t think so. 

Ms. HIRONO. An auditor do this assessment? 

Mr. COX. I think the external audit piece clearly contemplated as 

the 404(b), and what we have been careful to do is parse that for 

small businesses as we phase in their compliance. So at this point 

what smaller public companies are going to be expected to do is 

their own assessment. 

Of course, they all have auditors to do their financial statements, 

and the statute itself, you know, contemplates that this is something of an integrated process. So there is no rule against talking 

to your auditor and having a good healthy dialogue at all times and 

asking your question about what they think. 

But the idea that it is the auditor’s job either to design the selfassessment or to attest to it as part of this 404(a) process I think 

is very misplaced. And we have been trying to focus everyone on 

that, in the brochure talk about what special expertise companies 

have about this. Companies know how they work best of all. They 

know the risks of their business. They know sometimes at a very 

detailed level what checks might be in place—for example, a clerk 

taking money out of the cash register or whatever are the special 

risks of their business. 

Ms. HIRONO. If I could just focus— 

Mr. COX. Getting an auditor involved in that kind of level of detail I think is one of the big problems that we had under the old 

standard. 

Ms. HIRONO. I understand what you are saying. It is laudable 

that you would want to say to the small companies, ‘‘You don’t 

need to go out and spend money and have an outside auditor.’’ 

However, because of the penalties that would be involved, and you 

also noted that for small companies there may be more concern 

about in-house kinds of assessments and— 

14

Mr. COX. I should just add that the penalties that attach are the 

penalties that have always attached to having something wrong 

with your financial statements. In the phase-in that—as we have 

laid it out for smaller business, the 404(a) process results in a management’s assessment that is furnished and not filed with the SEC. 

That means there is no different penalty that attaches. 

The only penalties are the ones that they have always had and 

have right now, and that is for filing financial statements with 

something wrong with them. But nothing different about the internal controls assessment. 

Ms. HIRONO. Well, that is also reassuring. So your feeling is that 

once you are able to, through a brochure like this, and your efforts 

to meet with the small business community, and to reassure them 

that they do not have to spend all kinds of money to be able to 

comply with 404(b), that in fact the new rules that you have adopted will not have such an adverse impact on small business companies’ ability to comply. 

Mr. COX. Yes. In fact, I— 

Ms. HIRONO. What is your expectation? 

Mr. COX. —would go so far as to say that if we get this right, 

ultimately the greater investor confidence that would result from 

this process could reduce the cost of capital for smaller businesses. 

Not to say they won’t have an outlay to do the compliance, but if 

cost of capital is a function of investor conference or concern at 

some level, and appreciation of risk, there is I think a way for— 

Ms. HIRONO. I think that is a good point. 

Mr. COX. —us all to win at this. 

Ms. HIRONO. Thank you. Thank you, Madam Chair. 

Chairwoman VELA ́ ZQUEZ. Mr. Westmoreland? 

Mr. WESTMORELAND. I don’t really have any questions or comments. Good to see you again, and appreciate you all taking a good 

look at this. And hopefully you will come up with a decision to 

maybe put it off another year, but I do appreciate your being here 

and coming to testify. 

Chairwoman VELA ́ ZQUEZ. Okay. Thank you. Mr. Chairman, I 

know you don’t want to stay for the—to listen for the second panel. 

And I would like for you later, before you leave, to identify the staff 

person that will stay here. 

Mr. COX. Yes. In fact, I think we will have more than one. 

Chairwoman VELA ́ ZQUEZ. Okay. Great. 

Mr. COX. But during this morning’s second panel, we will hear 

testimony from senior representatives from small companies. The 

witnesses’ written statements include clear indication of SOX 404 

costs, actual and projected, and I would like to read to you a few 

of the figures they will cite. 

University Security Instruments, a non-accelerated filer, estimates implementation of SOX 404 as revised will cost the company 

$150,000 to $200,000. Furthermore, they estimate the company will 

incur $100,000 in extra fees each year once their company adopts 

SOX 404. Pendleton Community Bank, a non-accelerated filer, has 

already spent $70,000 to comply with the revised Section 404 and 

estimates that coming into full compliance will cost the company 

a total of $218,000. This is 8.9 percent of anticipated 2007 net income for the bank. 

15

Tandy Leather Factory, a non-accelerated filer preparing for SOX 404 compliance in 2004, spent $157,000 in fees. This amounted to 

6 percent of the company’s earnings in 2004. Tandy’s auditors indicated in 2006 that the work Tandy has done in preparation for 

SOX 404 compliance was very basic and preliminary. 

Mr. Chairman, are these costs in line with your and Commission’s expectations about reasonable SOX 404 costs for non-accelerated filers? 

Mr. COX. Well, I think we are going to be very interested in taking a look at what kinds of activity results in these expenses, and 

comparing it to over the broadest possible sample that we can, to 

provide you with a rigorous answer to that question. But that anecdotal evidence is the sort of thing that I am sure animates your 

concerns, because those expenses are much higher than what were 

originally estimated by the Commission when the impending rule 

was adopted and when PCAOB first adopted AS-2, the old standard. 

We expect it to be less expensive than that old standard. These 

numbers indicate that that is not so. 

Chairwoman VELA ́ ZQUEZ. Are there any other members who wish 

to make questions at this point? 

[No response.] 

Mr. Buchanan, we are about to end this first panel. Do you have 

any questions for Mr. Cox? 

Mr. BUCHANAN. No, thank you. 

Chairwoman VELA ́ ZQUEZ. Mr. Chairman, I really want to thank 

you for your appearance here this morning, and your willingness 

to listen to small companies. And I want to state for the record that 

I truly personally believe after listening to small companies, and 

holding a hearing not only here in the Small Business Committee 

but also on Financial Services. 

That Section 404(b) is a huge regulation that will redefine how 

small companies access the public market. And I want to state that 

I welcome your reevaluation of this issue, and that I want to thank 

you for the decision that you are making regarding delaying the 

implementation or the compliance of Section 404, because this is 

going to be meaningful to small companies. And not only to small 

companies, but to the auditors and to their investors. 

Nobody wants to see small companies fail because of an inadvertently burdensome regulation. The delay will also help us—Congress and the Commission—assess whether the revised rules and 

auditing standards appropriately balance the costs and the benefits 

of SOX 404 for America’s smaller companies. And that is our next 

challenge. 

But before we tackle that one, however, I would like to express 

my personal appreciation to you for your leadership on this issue. 

Mr. COX. Thank you, Madam Chairman. And you also asked that 

I identify the key staff that are here today to listen to the next 

panel. They include the Deputy Chief Accountant for Audit, ZoeVonna Palmrose, and the Director of the Office of Small Business 

at the SEC, Gerry Laporte. 

Chairwoman VELA ́ ZQUEZ. And with that, Mr. Chairman, you are 

excused. 

Mr. COX. Thank you. 

16

Chairwoman VELA ́ ZQUEZ. May I ask for the second panel to 

please come forward? 

And now we are going to proceed with the second panel. Our first 

witness is Mr. Michael Ryan, Jr. Mr. Ryan is Senior Vice President 

of the U.S. Chamber of Commerce, and Executive Director of the 

Chamber’s Center for Capital Markets Competitiveness. The U.S. 

Chamber of Commerce is the world’s largest business federation 

representing three million organizations of every size, sector, and 

region. 

Welcome, Mr. Ryan, and you will have five minutes to make your 

presentation. 

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

COMMERCE 

Mr. RYAN. Thank you very much. Good morning, Madam Chairman, and members of the Committee. As the Chairwoman said, my 

name is Michael Ryan. I am Executive Director and Senior Vice 

President of the U.S. Chamber of Commerce’s Center for Capital 

Markets Competitiveness. 

On behalf of the Chamber, and our small business members, I 

want to thank you for holding this hearing and focusing attention 

on this very important issue. On June 5th, this Committee held a 

similar hearing concerning the disproportionate and unnecessary 

burden that immediate application of SOX 404 would have on 

small companies. Since then, the Committee has asked questions 

of and received answers from the SEC concerning its cost-benefit 

analysis in connection with SOX 404 implementation for small public companies. 

More recently, the U.S. Chamber, working with others, released 

the results of a survey conducted to quantify the expected cost to 

small businesses of immediate application of Section 404(a) and the 

application of Section 404(b) beginning a year from now, which is 

the current timeline for these two provisions. 

As I begin my testimony, I would like to make several basic 

points. First, small businesses are critical to the long-term health 

and vibrancy of the U.S. economy. They are the source of millions 

of jobs and the incubator of many of the next generation of innovative products and services. Second, the U.S. Chamber supports the 

purposes of the Sarbanes-Oxley Act, including the application of 

Section 404 internal control provisions to small companies. 

Third, while the recent changes to Section 404 implementation 

are positive steps forward, these changes are complex and will necessarily be more costly to implement during the first year than in 

future years. Fourth, almost all regulation disproportionately burdens small businesses, and this will undoubtedly be the case with 

Section 404, even when we get it right. 

Fifth, a one-year delay for small public companies while the 

kinks are worked out would significantly reduce the disproportionate burden. And, finally, to realize the maximum benefit from 

a delay, we need that delay to be announced immediately. Our survey shows that companies are already spending money, and each 

day that passes undermines the benefit a delay would provide. 

Since this Committee’s hearing this past summer, new data have 

been collected that sheds light on some small companies’ cost of 

17

compliance with 404. On November 8th, we released a study showing that, despite recent reforms, Section 404 will disproportionately 

burden small businesses. Unless the SEC or Congress takes action, 

the current timeline will require small public companies with a calendar year end to begin complying with 404(a) in early 2008 and 

404(b) in early 2009. 

While the SEC has predicted that non-accelerated filers would 

not engage their auditors for SOX 404 compliance until the first 

half of 2008, more than 83 percent of the respondents have already 

done so with respect to 404(a) and 58—more than 58 percent have 

done so with respect to 404(b). The study also shows that more 

than half of the companies responding with less than $75 million 

in market value will spend more than 3 percent on net income—

of net income on Section 404(a). Sixty-three percent anticipate a 

cost increase in the next year due to compliance with 404(a) and 

(b). Finally, more than 58 percent of the respondents believe that 

404 will not help detect and prevent fraud. 

Our study shows why small companies complying for the first 

time should not be guinea pigs for the improved rules adopted by 

the SEC and the PCAOB. We continue to support strong internal 

controls and believe that the improved rules, if implemented as intended, will address many of the challenges companies face in complying with Sarbanes-Oxley. 

We once again applaud the initiatives made by the SEC and the 

PCAOB to fix the implementation process for Section 404 to better 

reflect the intent of Congress and the needs of investors and companies. We view the PCAOB’s new auditing standard, as well as 

the SEC’s management guidance for companies, as a significant 

step forward. And we commend Chairman Cox and Chairman 

Olson and their respective agencies for their leadership, time, and 

energy to bring balance back to the system. 

In the end, we are hopeful that these changes will restore the 

balance we believe Congress intended all along and will bring costs 

more in line with the benefits. Further, we recognize and strongly 

support the efforts the SEC and the PCAOB have put forth since 

May to ensure that auditors and public companies alike fully understand the new rule and guidance and implement them in as cost 

effective a manner as possible. 

These efforts have taken many forms, including hosting town 

hall meetings around the country and issuing detailed guidance. 

We believe, however, that the need for these efforts—and we agree 

they were needed—only goes to support our argument for further 

delay for small businesses. That is, the changes put in place in 

May by the SEC and the PCAOB are complex, not easily understood, and will require a great deal of time and energy to work out 

the details. 

Therefore, implementation in 2007 and 2008 will necessarily be 

more costly than will be the case in future years when much of the 

transition pain will be behind us. In the meantime, U.S. small 

businesses should not have to shoulder the disproportionate regulatory burden. 

With a further delay for small businesses we will be better able 

to leverage the experiences of large companies, the auditing profession, and regulators to ensure that implementation costs are miniVerDate 0ct 09 2002 12:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39384.TXT LEANN
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mized. Failure to do so—failure to do this could significantly undermine the cost-cutting objectives of the new standards. 

We also need to remain prepared to make additional changes if 

the new rules don’t work as intended. At least two of the five SEC 

Commissioners, Commissioners Atkins and Casey, have publicly indicated a willingness to consider such a delay. And based on the 

testimony we heard from Chairman Cox just a few moments ago, 

I would add him to that list. 

The Senate Committee on Small Business and Entrepreneurship, 

led by Chairman Kerry and Ranking Member Snowe, held a hearing this past April, and these Senators have publicly called for further delay. The Office of Advocacy at the Small Business Administration has also just—has also joined in and asked the SEC to revisit the compliance deadlines. 

And just this past week Representative Spencer Bachus, ranking 

member of the House Financial Services Committee, sent a letter 

to Chairman Cox asking for a one-year delay in implementation of 

404(b). In summary, we believe that we will only know if the efforts of the SEC and the PCAOB have been successful until after 

we have experience with the implementation. 

Therefore, we are again calling for the immediate announcement 

for a one-year delay for smaller public companies before they must 

comply with Section 404, and we urge this Committee to support 

this call for delay. 

Thank you for the opportunity to be here today. 

[The prepared statement of Mr. Ryan may be found in the Appendix on page 43.] 

Chairwoman VELA ́ ZQUEZ. Thank you, Mr. Ryan. 

Our next witness is Mr. Harvey Grossblatt. He is the CEO of 

Universal Security Instruments based in Owings Mill, Maryland. 

Universal is the manufacturer and distributor of residential fire 

and smoke alarms. Universal has been a public company since 

1973 and was included in Fortune Small Business Magazine’s top 

100 fastest growing small companies in 2006 and 2007. Universal 

Security Instruments is listed on the American Stock Exchange. 

Each one of the witnesses will have five minutes. When the light 

is green, you will start. When the light is yellow, it means that the 

five minutes is about to expire. 

STATEMENT OF HARVEY GROSSBLATT, UNIVERSAL SECURITY 

INSTRUMENTS, INC. ON BEHALF OF AMEX 

Mr. GROSSBLATT. Madam Chairman and members of the Committee, I am Harvey Grossblatt, and I would like to thank you for 

the opportunity to comment on the Sarbanes-Oxley Act, Section 

404, about which I feel quite strongly. 

I will attempt to summarize my written testimony. 

Although I fully agree with the need for the legislation to protect 

our investor confidence in capital markets, it is the method used 

to protect the last six percent of the total market capitalization not 

covered by Section 404 with which I disagree. 

My company has been a public company since 1973, and it is a 

non-accelerated filer. Before I became CEO, I was the CFO, and I 

would prepare our 10(q) in one day and our 10(k) in two to three 

19

days. Now, without Section 404, it takes us three days for the preparation of the 10(q) and almost two weeks to prepare our 10(k). 

Additionally, our auditors and lawyers spend 50 percent more 

time reviewing the documents. 

When Sarbanes-Oxley passed, I did not realize our legal and accounting fees would increase 50 percent immediately as I mistakenly thought that most of the cost would be 404 and believed small 

companies would eventually be exempt. 

I now realize how wrong I was. The implementation of Section 404 will cost approximately $200,000, plus an additional $100,000 

covering the 50 percent increase in our legal and audit fees. In a 

small company like mine, the management will have to divert valuable time from growing the business to make sure that we comply 

with these rules, spending considerable money without any return 

on our investment. 

I wish I could have understood how this benefits our shareholders. When investors buy stock in small public companies, they 

are buying the management, and I believe they would rather have 

us grow their business instead of spending profits without any return. I do not understand how the Congress can expect a small corporation with 20 employees to have the same accounting and control systems that multi-billion dollar companies have. 

I realize that Congress tried to help with the implementation of 

these regulations, but it is still a one size fits all approach without 

regard to the impact of the cost of compliance. 

These costs may be spread over two years, but they do not go 

away. It seems to me the only beneficiaries of these rules will be 

the consultants, lawyers, and auditors and not the shareholders 

whom this law was implemented to protect. 

And before I end, I would like to make two comments on Commissioner Cox’s statement. The first, one question was about Commissioner Cox brought out that most companies could do this themselves. I do not believe this will happen as all public companies 

have an independent audit committee made up of independent directors who take fiduciary responsibilities very seriously, and I cannot believe anyone will let the company’s management review itself 

without having independent consultants come in. 

Secondly, the more important point, if this Committee could follow up with Commissioner Cox, the biggest problem with all of 

these new recommendations at PCAOB and the SEC that come out, 

it is not clear enough to the auditors. If I told you how many times 

we have to argue with our auditors and they say, ‘‘Well, we do not 

have a clear direction,’’ so they go from one extreme to the other 

extreme. 

That is the biggest problem that we experience. The management 

side is fine. We understand what we have to do for 404, but we 

need clear guidance for our accountants. 

And I would like to end by thanking you for the opportunity to 

provide my personal experience and input to this important issue, 

and I will be happy to answer any questions you may have. 

[The prepared statement of Mr. Grossblatt may be found in the 

Appendix on page 50.]

Chairwoman VELA ́ ZQUEZ. Thank you, Mr. Grossblatt. 

20

Our next witness is Mr. Bill Loving. Mr. Loving is CEO of Pendleton Community Bank based in Franklin, West Virginia. Pendleton Community Bank serves six counties in West Virginia and 

Virginia. Pendleton Community Bank has four branches, 66 employees, 710 registered shareholders. 

Mr. Loving is testifying on behalf of the Independent Community 

Bankers Association. ICBA represents 5,000 community banks of 

all sizes and charter types throughout the United States. 

Welcome, sir. 

STATEMENT OF BILL LOVING, PENDLETON COMMUNITY 

BANK, ON BEHALF OF THE INDEPENDENT COMMUNITY 

BANKERS OF AMERICA 

Mr. LOVING. Good morning. My name is Bill Loving, and I am 

the Executive Vice President and Chief Executive Officer of Pendleton Community Bank in Franklin, West Virginia. 

Chairwoman Vela ́zquez and members of the Committee, I appreciate the opportunity to testify on behalf of the Independent Community Bankers of America, ICBA, concerning Section 404 of the 

Sarbanes-Oxley Act of 2002, or SOX, and the results of the Chamber of Commerce cost of SOX 404 survey. 

On November 8th, 2007, the Chamber released the results of a 

survey on the projected 2007 and 2008 cost of SOX Section 404 and 

its impact on small businesses. Since approximately 25 percent of 

the respondents were from the financial service industry and many 

were community banks, ICBA believes the survey’s results are a 

good reflection of the costs that publicly held community banks are 

experiencing with Section 404. 

The Chamber survey indicated that over half of the respondents 

expect internal and external costs to implement SOX 404(a) this 

year to exceed $200,000, while 44 percent of the respondents expect 

next year’s implementation cost of 404(b) to also exceed $200,000. 

For non-accelerated filers, this amounted to more than three percent of net income. These results confirm ICBA’s 2005 SOX 404 

community bank survey which showed that the average community 

bank would be spending more than $200,000, devoting over 2,000 

internal staff hours, and spending approximately three to five percent of their net income to comply with Section 404. 

I can tell you that as CEO of a community bank that is also a 

non-accelerated SEC filer, the Chamber’s survey accurately reflects 

the disproportionate burden that community banks like mine are 

facing to comply with Section 404. This year we have spent about 

$70,000 to comply with 404, which includes cost associated with 

580 man-hours. While the impact on net income for 2007 is approximately three percent, the combined cost to date, if accounted 

for in one calendar year would be $168,640 or 6.88 percent of 

2007’s projected net income. 

Like many publicly held community banks, Pendleton Community Bank is a good example of a small company that should not 

be subject to the reporting requirements of Section 12 of the Securities Exchange Act of 1934 and to all of the regulatory burdens of 

SOX. With 710 shareholders, we have considered going private to 

avoid these costs, but considering the small community where our 

bank is located, it would be a significant loss both to our commuVerDate 0ct 09 2002 12:48 Dec 20, 2007 Jkt 033615 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 G:\CLERK SB\HEARINGS\TRANSCRIPTS\39384.TXT LEANN
21

nity and to our bank’s reputation if our bank were to go private 

and repurchase most of its stock or participate in a reverse stock 

split, a process that forces out shareholders below a certain level 

of ownership. 

Now that we have reached the end of 2007 and most non-accelerated filers have completed their management internal control reports, ICBA supports Chairwoman Vela ́zquez’s request to the SEC 

to delay the implementation of the auditor attestation requirements required by Section 404(b), which for calendar year filers 

would begin in 2008. The one-year delay would give the SEC and 

the PCAOB an opportunity to evaluate the impact of this new guidance on accelerated and large accelerated filers and would give 

non-accelerated filers that have no experience with Section 404 additional time to understand and apply AS-5. 

We comment Chairman Cox’s decision today to recommend another delay in implementation of Section 404(b) for the non-accelerated filers, an action we applaud and certainly welcome. 

ICBA applauds Chairwoman Vela ́zquez’s effort to obtain hard 

dollar estimates from the SEC on the impact that SOX 404 has on 

smaller public companies. The SEC should have made those estimates prior to adopting AS-5. However, we are pleased that as a 

result of Chairwoman Vela ́zquez’s efforts SEC Chairman Chris Cox 

has committed the Commission to a data collection program beginning next year. 

ICBA believes that the SEC and the PCAOB should establish 

benchmarks or goals for AS-5 that are tied to reduction in overall 

404 costs. For instance, SEC and the PCAOB should state that the 

goal of AS-5 is to reduce average internal control costs by a certain 

percentage, say, 20 percent. 

ICBA supports the community banks serving the Communities 

First Act of 2007 by Chairwoman Vela ́zquez, which would relieve 

community banks with assets of less than one billion from the requirements of 404(b) and raise the threshold under the Exchange 

Act to 1,000 providing relief for hundreds of community banks like 

mine that are struggling. 

We appreciate the opportunity to testify and thank you. 

[The prepared statement of Mr. Loving may be found in the Appendix on page 53.]

Chairwoman VELA ́ ZQUEZ. Thank you, Mr. Loving. 

Our next witness is Mr. Thomas Brandt. He is the CFO, TeleCommunication Systems, Inc., based in Annapolis, Maryland. TCS 

provides mission critical wireless technology solutions to carriers, 

public safety, and government customers. Mr. Brandt serves as 

Chairman of AeA’s Sarbanes-Oxley Committee and is testifying on 

behalf of AeA, a trade association representing roughly 2,500 high 

tech companies. 

Welcome, sir. 

STATEMENT OF THOMAS M. BRANDT, JR., 

TELECOMMUNICATION SYSTEMS, INC., ON BEHALF OF AEA 

Mr. BRANDT. Thank you. 

The AeA, which is the nation’s largest high tech trade association, appreciates this committee’s efforts relating to Section 404 of 

22

the Sarbanes-Oxley Act, and we thank you for holding today’s hearing. 

In addition to serving as the Chairman of AeA’s Sarbanes-Oxley 

Committee, I am the Chief Financial Officer of TeleCommunication 

Systems, Inc., or TCS, based in Annapolis, Maryland. 

TCS was bootstrapped by the founder as an 8(a) company and is now a 500 employee, $150 million accelerated filer under SOX 404. 

I have served as a corporate financial officer for more than 20 

years and started my career as a Price Waterhouse auditor of public companies, where I worked for 12 years. 

When I learned of today’s hearing, I wanted to testify because I 

am convinced that the application of Section 404 to small public 

companies is bad public policy. Based on my experience as both a 

corporate officer and an auditor and as someone who is completing 

the fourth year of Section 404 compliance, it is clear to me that 

Section 404’s cost far outweighs any benefit to investors in small 

cap companies. 

For TCS the incremental Section 404 compliance cost relative to 

the company’s market cap and float continues to be very high. For 

perspective, the average pretext profitability of our business over 

the last three years averaged around two million dollars a year. 

Annual outside audit fees of more than $600,000 represent a big 

bite out of investors’ hides. 

As inefficient as this regulatory impact has been on companies 

like mine, the adverse impact of ever imposing this burden on nonaccelerated filers is alarming. Although we appreciate the SEC’s 

and PCAOB’s efforts to address this issue through the issuance of 

new guidance, I believe that its effect will be minor and that the 

SEC Advisory Committee on smaller public companies’ recommendations to provide tiered exemptions should be revisited. Since TCS’ $135 million market cap is meaningfully comparable to the $75 million cutoff between accelerated and non-accelerated 

filers, ours is a good case study of the burden of Section 404 on 

smaller companies. My written testimony contains more detail to 

illustrate how our fees have increased, but briefly, between 1999, 

just before our IPO, and 2003, we experienced a sevenfold increase, 

from about $50,000 a year to $370,000, in recurring audit costs, 

when revenues only doubled. This cost reflects a lot of outside scrutiny for a small company before layering on Section 404. 

In 2004, the first year of SOX compliance, our audit fees more 

than doubled to $770,000. For 2005, when we were supposed to realize the benefits of a second time through cycle, our fees actually 

increased 13 percent to $871,000. For 2006, our fees were $621,000. 

The PCAOB’s AS-5 and recent related SEC guidance is supposed 

to lower the cost for companies like mine, but for 2007, our Big 

Four audit team told us that we had already taken advantage of 

substantially all the top-down risk-based incremental efficiency 

that AS-5 has reiterated. So we should expect our fees to remain 

around $620,000. 

Over the four-year period, the nature and scope of our company 

operations and financial statements has been sufficiently constant 

to make our numbers a fair small cap example. Based on discussions with my peers, many other companies have been hit much 

harder. While the number of hours to do the recurring extra audit 

23

work since the first years of SOX 404 may have modestly declined, 

the average hourly billing rates for auditors have risen sharply. As 

a former auditor, I am sympathetic that as deep pockets, the Big 

Four firms are compelled to charge more to cover their insurance 

and possible outlays for tort claims, as well as higher salaries and 

partner compensation to attract more people to do Sarbanes-Oxley 

work. 

But that cost burden should not be so disproportionately applied 

to the small companies. For small public companies, which represent a very small portion of the capital traded in the U.S. public 

markets, the bar of audit oversight and compliance was already 

high enough before 404 and expensive enough to reasonably protect 

investors from the risks of bad accounting. 

For the people who are bold and successful enough to grow a 

company that’s a candidate to go public, our country’s small cap 

markets have represented a valuable alternative to being forced to 

sell their companies or slow down their growth and risk losing a 

competitive advantage. 

I believe that entrepreneurs like my company’s founder should 

have fewer, not more obstacles to grow a business and that investors are already sufficiently informed about the risks involved. 

When they can attract the support of public investors, entrepreneurs should have the freedom to pursue their visions rather 

than sell out. 

Excessive, recurring regulatory compliance costs are an unnecessary barrier to investor capital. The SEC Advisory Committee on 

Smaller Public Companies, which included an AeA representative, 

very thoughtfully developed advice as to levels of company size, including some companies larger than the non-accelerated filers, 

which should be exempted from some or all SOX 404 work. 

I believe the recommended tiered relief should be revisited and 

made effective. 

[The prepared statement of Mr. Brandt may be found in the Appendix on page 61.]

Chairwoman VELA ́ ZQUEZ. Thank you, Mr. Brandt. 

Our next witness is Ms. Shannon Greene. Ms. Greene is Chief 

Financial Officer and Treasurer of the Tandy Leather Factory, 

where she has worked since 1996. Based in Fort Worth, Texas, 

Tandy Leather has been the resource for over four generations of 

leather crafters providing quality leather, tools, kits, and teaching 

resources since 1919. 

Ms. Greene was appointed to serve on the board of directors of 

Tandy Leather in January 2001. 

Welcome. 

STATEMENT OF SHANNON L. GREENE, TANDY LEATHER 

FACTORY, INC. 

Ms. GREENE. Good morning, Madam Chairman and members of 

the Committee. My name is Shannon Greene, and I am the Chief 

Financial Officer of Tandy Leather Factory. We are a non-accelerated filer. We are headquartered in Fort Worth, Texas. 

I am also a member of the newly formed Corporate Leadership 

Advisory Council, which is the U.S. Chamber’s voice of mid-market 

24

businesses. The purpose of my being here today is to provide some 

perspective from a small business trying to maintain our position 

as a legitimate public company in today’s market. 

While I would prefer that we were discussing the potential elimination of Section 404, I acknowledge that such a discussion is irrelevant at this time. 

With that said, I applaud the SEC and the PCAOB for recognizing the need to provide scalable rules and guidance to smaller 

companies like ours as it pertains to Section 404. 

I would like to present several points for consideration. First, I 

believe that most small businesses support the concept of a strong 

internal control system. 

Second, non-accelerated filers who have not had to comply with 

Section 404 yet should not be the testing ground for the revised 

rules and guidance. 

Third, if a delay for non-accelerated filers is being considered, the 

decision to delay needs to be made now, as many companies will 

be engaging their auditors soon for 404(b), if they haven’t done so 

already. 

Fourth, the management teams of small businesses wear many 

hats as they generally do not have the financial resources for large 

staffs. The process required to comply with Section 404 further burdens the management that is already stretched thin. It is important that their process of compliance with Section 404 be as efficient and as cost effective as possible. 

Fifth, it has been my experience that investors, whether individuals or institutions, are not as concerned with a company’s internal 

control system as one might think. Many, if not all, of our investors 

would prefer continued growth in company profits rather than formal documentation and an assessment of our internal control system. 

I think we all agree that the 404 process as originally implemented was much more burdensome and costly to all companies 

than Congress intended, and we have already seen that a mere 168 

words, as was the original Section 404, had far reaching, unintended consequences and implications. 

It is important that we get it right this time, and the best companies to make that assessment are those who have already gone 

through the process under the original rules. Small companies in 

their first year of compliance cannot be expected to assess the improvement in the rules as they have no basis for comparison. 

The 404 process needs to be as streamlined as possible for companies so that management teams can focus primarily on growing 

their business. It would be unfortunate to trade dollars spent on 

jobs or product development for inefficient regulatory compliance. 

Small companies should not be the testing ground for the new 

rules, given that 404 tends to have a disproportionate cost impact 

on smaller companies with the first year being the most expensive. 

I would like to know that the revised regulations are going to work 

before we have to apply them to our small company. 

It is important to emphasize that if a delay is being considered 

for non-accelerated filers, the decision needs to be made very soon. 

Four, oh, four (b) applies to us for 2008. We do not have the luxury 

of waiting until the summer or fall to engage our auditors. As a 

25

result, announcing a delay then will significant minimize the benefit of that delay for a company like ours, as we will have already 

incurred sizable costs in the form of additional audit fees during 

the first half of the year. 

We are considered a micro cap in the world of public companies. 

Approximately 35 percent of our outstanding stock is owned by institutions. I meet with a number of these institutions, as well as 

individual stockholders either via telephone or in person numerous 

times a year. Many of our stockholders own our stock because they 

believe in the potential of our company and are comfortable that 

the management team knows how to grow the company and, therefore, increase its value. 

In all of my discussions with stockholders, I have yet to be asked 

whether we are or expect to be in compliance with Section 404. 

However, I am frequently asked about how much we have and will 

spend trying to comply and how much of a negative impact it will 

have on our earnings. 

While most investors want to invest in ethical companies, I do 

not get the impression that the internal control system is what 

helps those investors make that determination. It is the people of 

the company. 

Due to the immense regulatory burden on public companies large 

and small, I would suggest that we are discouraging companies 

from participating in public markets because it’s not worth the effort. The objective of 404 is to provide meaningful disclosure to investors about the effectiveness of the company’s internal control 

system. Said in a different way, investors should be able to rely on 

the information they are getting from a public company. 

Rather than penalizing all companies with increased regulation, 

I think stiffer and swifter penalties for offenders is a more effective 

deterrent and would contribute more to the goal of a reputable public market. I am not minimizing the importance of regulatory compliance. While I do not always agree in principle with the rules and 

regulations set forth, I can assure you that my company takes this 

very seriously. We choose to operate our business within the rules, 

whether we agree with them or not, and we will comply with the 

rules of 404. I would just like to know that the cost to comply is 

money well spent. 

I appreciate the opportunity to be here today and hope you found 

my thoughts and opinions helpful. In summary, please consider my 

request to delay Section 404 compliance for small companies until 

it has been proven that the rules are achieving the intended results. 

Thanks. 

[The prepared statement of Ms. Greene may be found in the Appendix on page 67.]

Chairwoman VELA ́ ZQUEZ. Thank you, Ms. Greene. 

Mr. Ryan, I would like to address my first question to you. As 

you have heard this morning, the SEC is planning to collect data 

related to SOX 404 compliance costs. From your perspective, what 

are some of the most important data that the Commission must 

collect? 

26

Mr. RYAN. Well, I, first of all, would suggest that they stratify 

that data collection. I think it was already suggested by looking at 

the smaller companies that are already complying with the 404 and 

seeing how the transition to the new rules plays out in that first 

year, and in particular, how the auditors respond to that, and also 

try to get a sense from companies and auditors, in particular, 

where the more expensive costs are coming from so that as we drill 

down into this area and try to solve this problem we know exactly 

where to target and address as we go forward. 

Chairwoman VELA ́ ZQUEZ. Any other witness who would like to 

comment on this question? Yes, Mr. Grossblatt. 

Mr. GROSSBLATT. Yes. In addition, I think the SEC should consider the management time and internal corporate resources that 

have to be spent besides the outside cost. 

Mr. BRANDT. It is just worth noting that the outside audit fees 

are an obligatory disclosure in the proxy statements of all of us filers. So there’s objective information that’s readily collectible for 

that dimension of the compliance cost. 

Chairwoman VELA ́ ZQUEZ. Mr. Brandt, your company as a larger 

small company has already implemented SOX 404. 

Mr. BRANDT. Yes. 

Chairwoman VELA ́ ZQUEZ. And yet without any self-interest associated with the potential delay in the SEC’s SOX 404 compliance 

deadline, you volunteered to testify this morning. Can you explain 

the reasons why you thought it is so important to provide testimony on this issue? 

Mr. BRANDT. Certainly. Having lived this for four years and having been an auditor before, the marginal benefit of what we’ve been 

paying for has been painfully apparent, and it is nil; it is negative. The costs we are incurring at $600,000 for our small company 

are grossly disproportionate to the amount of capital at risk in the 

market that we have had invested in our company, and over the 

last several years working with the AeA and my peers and hearing 

the stories of others who have been through this, the prospect of 

applying this to still smaller companies is hard to accept. 

Chairwoman VELA ́ ZQUEZ. Ms. Greene, as an accounting professional, you recommend a delay in small companies’ compliance 

with SOX 404 so that large companies have the opportunity to implement and test the new auditing standard before small firms are 

required to comply. 

So you believe a one-year delay in Section 404(b) will allow large 

companies sufficient time to work out any problems? 

Ms. GREENE. I think it will certainly help. You know, the small 

business that has not had to comply yet, even though the scaled 

down rules, I think, are going to be helpful for small companies. 

I don’t think that we are a good basis of comparison because we 

have not had to do it yet. 

Will one year be enough? I do not know. It depends on how well 

it goes, how the auditors do. A year is better than nothing, but I 

do not think we will know until we get farther into it whether that 

is adequate or not. 

Chairwoman VELA ́ ZQUEZ. Mr. Loving, in the past this Committee 

has received testimony that some banks are likely to consider going 

private because of the burdens of SOX 404 compliance. From your 

27

perspective, what would it mean for the town to have its community bank go private? 

Mr. LOVING. Well, from my perspective, I think you have a reputation risk to consider if the bank would go private. Obviously 

many of the shareholders are, in fact, customers, and they know 

customers. And so a negative reaction could take place because of 

going private, obviously repurchasing the stock against their will, 

and once that would happen, they would potentially look for other 

options for banking. 

And you know, I am a firm believer that the community bank is 

the life blood of the community, and I think it would be very detrimental to many communities if the community banks go private. 

Chairwoman VELA ́ ZQUEZ. Mr. Brandt, again, since you have already implemented Section 404, do you have recommendations 

about how SEC can best study the impact of SOX on small companies? 

Mr. BRANDT. Well, as was suggested, the audit fee data that can 

be collected objectively from our proxy filings could be stratified, 

and the correlations between those outside costs and market cap or 

revenue or profitability could produce some useful information. 

Chairwoman VELA ́ ZQUEZ. Ms. Greene, this morning a lot has 

been made of the date by which a company engages an auditor. 

There seems to be some uncertainty as to what engaging an auditor means in terms of financial commitment by the company implementing SOX 404. As the person responsible for her company’s 

SOX 404 implementation, when your company engaged an auditor, 

was your company committing to pay a certain amount in fees? 

Ms. GREENE. Auditors have indicated to us that we can expect 

our audit fees to increased by 50 percent when they start their assessment work. Our fees have already gone up substantially in the 

last year or so, the premise from the auditors being that they are 

trying to cover insurance costs. 

I think we run a very efficient audit. I think our auditors would 

tell you that, but we have seen substantial increase already, and 

we are not even SOX 404, working on that yet. They are telling us 

to expect a minimum of a 50 percent increase when they get ready 

to start their work on the assessment. 

Chairwoman VELA ́ ZQUEZ. Thank you. 

Yes, Mr. Brandt. 

Mr. BRANDT. If I may add, I think there is sometimes a misunderstanding between the audit work and the preparation work 

for Sarbanes-Oxley 404 review by outside auditors. Most companies 

even my size in the first time through have hired another outside 

firm, whether it is a Big Four or now there are specialist consulting 

firms that have sprung up for the purpose of helping relatively 

small businesses write up their processes and execute the tests 

that are required under the law, which are all additional costs before the outside audit fees are incurred. 

I learned from my AeA peers that many of them spent as much 

on that as they did on their incremental outside audit fee cost. 

Now, that is data that is not captured in proxies, but the term 

‘‘audit’’ has multiple meanings in the context of this discussion. 

That is one of the reasons I wanted to try to be here, because of 

having been on both sides. 

28

Chairwoman VELA ́ ZQUEZ. Thank you. 

Yes, Mr. Loving. 

Mr. LOVING. If I could mirror that, most of all our costs have 

been from hiring a consultant to help us in preparing to comply 

with Section 404, and only to mention that the external audit firm 

that we used for years chose to remove themselves from public 

company work, and so we had to go through the process of filing 

a new audit firm because of 404. 

And so most of the costs will not be outlined explicitly in the financials, but there are costs to comply with 404 before you get to 

compliance with 404(b). 

Chairwoman VELA ́ ZQUEZ. Thank you. 

Yes, Mr. Grossblatt. 

Mr. GROSSBLATT. We were told by our auditors if we did use an 

outside firm that the audit fee would be two or three times what 

they will charge to review the independents because it becomes an 

issue about if internal people do it there is an independence issue. 

So you really do not save anything by doing it yourself because 

what you will save on the consultants you will pay twice or three 

times on the audit fee. 

Chairwoman VELA ́ ZQUEZ. Thank you. 

Mr. Ryan, how important is it that the SEC vote on delaying and 

finalize the announcement of the delays sooner rather than later? 

Mr. RYAN. I think that is critical. I think it is everything. If the 

SEC waits to do their study in I believe Chairman Cox suggested 

it was going to be some time this summer for the results, we realize many of these companies will have already spent the money, 

made the commitments and, back to the testimony of Mr. 

Grossblatt, management time will have been spent on it, which is 

a very significant cost here. 

So we think that our data shows this, and I think the testimony 

here shows that the companies are getting started sooner rather 

than later, and I think that is particularly true for companies that 

really care about these issues. They are the ones being hurt by a 

delay. So we think that is critical. 

Chairwoman VELA ́ ZQUEZ. I cannot stress enough to the Chairman how important it is for them to make the announcement as 

early as possible, as early as January. 

Mr. RYAN. My sense is he understood that, too. 

Chairwoman VELA ́ ZQUEZ. Yes. Okay, and now I recognize Mr. 

Westmoreland. 

Mr. WESTMORELAND. Thank you, Madam Chairman. 

And since I was not here for opening remarks, I do want to compliment the Chairwoman on her commitment to small business and 

working to get the Chairman to look at delaying the implementation of this for one year. And I certainly support you in that. 

Mr. Loving, is your bank audited by state bank regulators? 

Mr. LOVING. Yes, sir. It is a very good question. We are regulated 

by state regulators, FDIC regulators. Plus we have to comply with 

SEC regulations, not to mention internal audit, external audit, IT 

audit, compliance audit. I believe that mentions most of the audits 

that we have to comply with or are regulated by. 

29

Mr. WESTMORELAND. So what you are telling me is that basically 

you already had to jump through a lot of hoops to make sure that 

you were within the laws of the banking industry. Is that not true? 

Mr. LOVING. Yes, sir, that is correct. We, as senior officers of the 

institution, have to sign a quarterly call report that we are testing 

that the financial information is correct. That is publicly available 

to anyone that goes to the FDIC Web site. 

So the overlay of 404 is redundance and duplication of effort in 

many cases for community banks, one we cannot eliminate in order 

to comply with 404. 

Mr. WESTMORELAND. And is it not true that even though community banks are probably hit the hardest on their bottom line, it is 

kind of redundant for any bank that has to go through those same 

audits that you have to go through? 

Mr. LOVING. That is correct, sir. 

Mr. WESTMORELAND. Do you think we will ever pass a law that 

makes people completely honest? 

Mr. LOVING. I do not think we will ever pass a law that will 

make people completely honest. I certainly applaud the efforts, but 

I think in the case of 404, the cost is too prohibitive. 

Mr. WESTMORELAND. Thank you. 

Mr. Brandt, you made a couple of comments about CEO compensation and officers’ compensation, I guess, about trying to find 

people to serve on some of these committees that look at some of 

these audits. 

You know the Big Three. We had Tyco, Enron, WorldCom that 

did some things that were not correct. Those guys are in prison, 

and as I understand it correctly, these CEOs and people that are 

on these different committees have to sign up and have really put 

a lot on the line for what they may be being paid. Is that true or 

would you say that there is more of a risk now having to sign some 

of these affidavits than there was? 

Mr. BRANDT. Well, Section 302 of Sarbanes-Oxley provides for 

some representations that we have to make every time we submit 

financial statements, that are very strong consciousness-raisers if 

an officer did not otherwise take seriously that responsibility. I 

have never shown my wife the words that I am signing to that put 

our assets at risk every time I fulfill that obligation. 

And I think that attitude is pervasive. It is the rare exceptions 

that do not recognize how serious the responsibility is. 

Mr. WESTMORELAND. Yes, sir, but I mean, you could have been 

put in jail before Sarbanes-Oxley for doing some of the things these 

other people did, right? It is not just signing that 302 that makes 

you liable. There were other laws that would have made you liable, 

too. Is that not true? 

Mr. BRANDT. That is absolutely right. 

Mr. WESTMORELAND. So from what you and Mr. Loving say, Sarbanes-Oxley in a lot of ways, not just the 404 but other sections, 

is kind of piling on, so to speak. 

Mr. BRANDT. Yes. 

Mr. WESTMORELAND. Would you agree with that? 

Mr. BRANDT. Yes. 

Mr. WESTMORELAND. I have one question— 

Chairwoman VELA ́ ZQUEZ. Would the gentleman yield? 

30

Mr. WESTMORELAND. Yes. 

Chairwoman VELA ́ ZQUEZ. I just would like to say that Mr. 

Grossblatt’s wife is here today. 

[Laughter.] 

Chairwoman VELA ́ ZQUEZ. And I hope that this hearing is not 

going to be any trouble to you. 

Mr. GROSSBLATT. I was just trying to give some understanding 

of what we have to put up with on a regular basis. 

Mr. WESTMORELAND. Hopefully you will not be going off. 

And my last question is for Mr. Grossblatt. So that we will not 

misunderstand anything, you mentioned that your company had an 

extra cost of 200,000 and about another $100,000 increase, I think. 

Who is eventually going to pay that increase that your business 

suffers? 

Mr. GROSSBLATT. Public shareholders. 

Mr. WESTMORELAND. Absolutely. Okay. So, I mean, this is something that, you know, you just cannot absorb this. I mean, the company just cannot absorb this kind of cost, and so Congress, and I 

think the Chairwoman would agree with me, you know, we have 

got a couple of speeds up here, but our main speed is knee-jerk, 

and this was done while some terrible things were done to some 

of the stockholders in some of these companies. 

I was not here, but I have seen the knee-jerk speed, and I think 

it was a knee-jerk and that there really was not enough attention 

paid to the end user in what this was actually going to cost especially small business and who was going to be the people actually 

paying for this piling on or double and tripling and quadrupling 

some of these things that we already had laws to cover. 

But, Madam Chairman, that is all I have and thank you so 

much. 

Chairwoman VELA ́ ZQUEZ. Thanks. 

Mr. Gonza ́lez. 

Mr. GONZA ́LEZ. Thank you very much, Madam Chairwoman. 

As indicated earlier with the Chairman of the SEC, some of us 

were here in 2002 and we were right in the middle of it and voted 

for it. It was an appropriate response, I think, at that time. It was 

referred to as corporate governance. It was quite relevant, and we 

knew there would be some consequences, some intended and others 

not intended. 

Maybe what we are viewing here are the unintended and what 

we are really going to do. But the question really comes down to—

and I posed this to the Chairman, Mr. Cox, and he indicated that, 

at least the way I interpreted his response was that we probably 

do not need a real legislative fix or tweaking, definitely not a 

wholesale revision of Sarbanes-Oxley, and that much can be done 

within the regulatory scheme and the promulgation of rules and 

guidelines. 

I do not totally agree with that, but I am not on Financial Services. I am not on the other committees, but I am hard pressed to 

believe that universal security instruments in the past created special purpose entities, if you recall what those things used to be, 

based on the advice of the same accounting firm that was conducting your auditing because they were also doing your consulting. 

31

I do not believe that your enterprise and its officers were exercising questionable stock option and sales based on insider information. But that is the scenario. That is what we were reacting to. 

And as I said earlier, we cast a very wide net, and maybe it is time 

to review where we are today. 

What was our goal then? What is our goal now, given the history 

and the implementation of the act? 

It is clear and, I think, back in the June hearing and today’s 

hearing, that we really do have to do what businesses do, and that 

is maybe look at a cost-benefit analysis. Are we really getting the 

result that we need or require? 

But it does appear to me that Chairman Cox has expressed a 

clear opinion that corporate governance at all levels is important, 

and I think you heard him actually articulate its application to the 

small publicly traded countries in this country. 

But I really would like to get a feel from where you all are coming from. We may have a year delay. We may tweak this. My prediction is we will have the delay; we will have the information 

gathering. The SEC will do everything under its power to make it 

more cost effective and simpler, but we are still going to run into 

the same problem. 

I mean I just really believe that. We do this all the time. We do 

a one-year fix, a two-year fix, and you know, the old thing about 

where I come from we simply say ‘‘manana.‘‘ You know, I mean, we 

will just figure it tomorrow. Not good, not good. 

But I’m going to ask Mr. Brandt. You know, you’re talking about 

tiered exemptions. How do you accomplish that? Can you do it 

within regulatory guidelines, the Commission, and so on, or are we 

talking about a legislative fix? 

Mr. BRANDT. I started coming to Washington to talk about Sarbanes-Oxley 404 when the AeA first invited us here in 2004, and 

I observed sort of what I guess you are saying. We would talk to 

regulators and they would say this has to be dealt with by Congress, and we would talk to Congress people or their staff and they 

would say this has to be dealt with by regulators. 

It happens that Senator Sarbanes is my Senator, was my Senator, and I had an opportunity to address him directly, and he believed that this was a regulatory matter insofar as the impact of 

404 on small caps. 

You know, I am here to speak to anybody would will listen that 

I think resources are being misallocated. 

Mr. GONZA ́LEZ. So what is the best remedy? How do you see it? 

I mean we are going to have the year delay. We are going to 

have the information gathering. We are going to streamline it, but 

it seems from your testimony you are saying you really are viewing 

something that goes beyond what I anticipate is being contemplated, and you are talking about some sort of exemption. 

Mr. BRANDT. I am, and without repeating that whole Small Business Committee report, and I did participate along with our other 

representatives in its preparation, there was a lot of thought given 

to the strata in the capital markets where the risk relative to confidence of outsiders in the integrity of our regulatory process was 

immaterial to anybody rationally reaching that conclusion. 

32

So there was a cutoff suggested for self-review and reporting on 

internal control and a lower level where neither self-review nor 

outside auditor review and attestation would be necessary. And I 

believe that was a prudent approach. 

Mr. GONZA ́LEZ. And if you did adopt that, could you square that 

with Chairman Cox’s concern regarding small publicly traded companies and how important it is to have good, solid corporate governance at all levels? 

Mr. BRANDT. Yes, I can because I believe there are so many other 

regulations and controls and audit processes to which we are subject that the risk of misstatement of financial statements is already 

relatively low. If we make a mistake it might be on applying an 

obscure algorithm like FAS-123(r) for stock option accounting or 

some obscure lease rule, but unless somebody is very willfully trying to cheat, it is not likely our financial statements are going to 

be bad, and most of us have the self-interest when sign our 302 

statements or just otherwise acknowledge our fiduciary responsibilities to try to walk the straight and narrow. 

Mr. GONZA ́LEZ. Well, thanks. I want to extend my thanks to all 

the witnesses. 

I yield back. 

Chairwoman VELA ́ ZQUEZ. Ms. Hirono. 

Ms. HIRONO. Thank you, Madam Chair. 

The reason I asked Chairman Cox the question about the expenditures of outside auditors is that in spite of his testimony, I 

did think that probably most of the companies would do that, and 

all of your testimony indicates that that would, in fact, be the case. 

So then the SEC does their study and the study will show that 

most of the companies will be incurring these kinds of additional 

expenses and so they could say, ‘‘Well, we are not telling you that 

you should do that. In fact, you should be able to do it with inhouse personnel.’’ 

So then we are left and again, I agree with my colleague back 

there that we will be here discussing this again with having probably obtained a one-year delay. So I think the bottom line really 

is, Mr. Brandt, what you have brought out and I have a feeling 

what the rest of you probably would like us to address, is a statutory kind of legislative fix. Is that correct? 

Mr. LOVING. Yes, ma’am. I believe that it will take a statutory 

fix to complete the revision of 404 and to improve the profitability 

of small public companies. The new study may show an opportunity 

to reduce cost, but I do not believe that it will be able to reduce 

cost to a point that I can eliminate eight percent or even six percent of net income to comply with 404. There is going to be a dollar 

specific that we will have to pay to comply with 404 even under 

new guidance, and someone spoke earlier about the auditors and 

the simplicity or the communication to the auditors. That is the 

second issue. 

It was mentioned we know what it takes to comply, but oftentimes what we are hearing from the auditors is we are not sure 

what the ruling is. So, therefore, you need to do this. 

Well, obviously they are going to err on the side of caution, and 

that usually brings about additional cost. So I do think legislative 

change is necessary. 

33

Ms. HIRONO. Madam Chair, I would just like to say that I was 

not here when SOX was adopted, but I would certainly be open to 

some kind of a legislative addressing as long as I can refer to what 

Mr. Brandt said, that there are plenty of other checks on what 

companies are doing to make sure that their processes are as they 

should be. 

Thank you, Madam Chair. 

Chairwoman VELA ́ ZQUEZ. Mr. Westmoreland. 

Mr. WESTMORELAND. Thank you. 

Just one last question for Mr. Brandt. 

You said you worked for Price Waterhouse for several years. 

Mr. BRANDT. I did, 12 years, yes. 

Mr. WESTMORELAND. Twelve years. These audit firms, the Big 

Four, and you mentioned some of the other ones, were they involved in the Tyco or Enron or WorldCom, any of the auditing 

firms that are doing your audits now or that do these audits now? 

Mr. BRANDT. Well, I understand, of course, it is gone, but pretty 

much every other public company of any size is audited by a Big 

Four firm. 

Mr. WESTMORELAND. Did SOX put any additional requirements 

on these auditing firms? 

Mr. BRANDT. Well, the creation of the PCAOB provided a new 

level of regulation on their profession. So that has become, you 

know, an issue with them, that they are not a self-regulated profession any longer, but they have a new entity checking their work 

papers and determining whether they did enough work, which has 

the impact as I think was said earlier that, well, we need to do this 

extra work now because we want to make sure we have enough 

material in our work papers for when the PCAOB looks over our 

shoulders. 

Mr. WESTMORELAND. So they are auditing the auditors. 

Mr. BRANDT. Yes, they are. 

Mr. WESTMORELAND. Okay. Thank you. 

No further questions, Madam Chairwoman. 

Chairwoman VELA ́ ZQUEZ. Well, I want to take this opportunity 

again to thank all of the witnesses for taking time from your busy 

schedule and your companies to be here this morning with us. 

And I just would like to issue a note of caution here in the sense 

that I hear some of the witnesses and the members here talking 

about a legislative fix, but this is the United States Congress. It 

is not going to be that easy. So I do not want anyone to be in that 

mindset. 

You know, our hope is and we are happy this morning and grateful that Chairman Cox is taking the lead in doing right on behalf 

of small companies in this country by doing the cost analysis and 

collecting data in a scientific manner, and I just hope that they do 

this in a very close partnership with those companies that will be 

impacted. 

And with that I ask unanimous consent that members will have 

five days to submit a statement and supporting materials for the 

record. 

Without objection, so ordered. 

This hearing is now adjourned. 

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[Whereupon, at 11:59 a.m., the Committee meeting was adjourned.]

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