U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

39–880 PDF 2008

S. HRG. 110–286

SARBANES-OXLEY AND SMALL BUSINESS: ADDRESSING PROPOSED REGULATORY CHANGES

AND THEIR IMPACT ON CAPITAL MARKETS

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS

AND ENTREPRENEURSHIP

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

April 18, 2007

Printed for the use of the Committee on Small Business and Entrepreneurship

(

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

(II)

COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

JOHN F. KERRY, Massachusetts, Chairman

CARL LEVIN, Michigan

TOM HARKIN, Iowa

JOSEPH I. LIEBERMAN, Connecticut

MARY LANDRIEU, Louisiana

MARIA CANTWELL, Washington

EVAN BAYH, Indiana

MARK PRYOR, Arkansas

BENJAMIN L. CARDIN, Maryland

JON TESTER, Montana

OLYMPIA J. SNOWE, Maine

CHRISTOPHER S. BOND, Missouri

NORMAN COLEMAN, Minnesota

DAVID VITTER, Louisiana

ELIZABETH DOLE, North Carolina

JOHN THUNE, South Dakota

BOB CORKER, Tennessee

MICHAEL B. ENZI, Wyoming

JOHNNY ISAKSON, Georgia

NAOMI BAUM, Democratic Staff Director

WALLACE HSUEH, Republican Staff Director

(III)

CONTENTS

Page

OPENING STATEMENTS

Kerry, The Honorable John F., Chairman, Committee on Small Business

and Entrepreneurship, and a United States Senator from Massachusetts .... 1

Coleman, The Honorable Norm, a United States Senator from Minnesota ....... 3

Tester, The Honorable Jon, a United States Senator from Montana .................. 4

Corker, The Honorable Bob, a United States Senator from Tennessee .............. 4

Snowe, The Honorable Olympia J., a United States Senator from Maine ......... 38

WITNESS TESTIMONY

Cox, The Honorable Christopher, Chairman, U.S. Securities and Exchange

Commission ........................................................................................................... 4

Olson, The Honorable Mark W., Chairman, Public Companies Accounting

Oversight Board ................................................................................................... 18

Venables, Thomas, President and Chief Executive Officer, Benjamin Franklin

Bank, on behalf of the American Bankers Association ..................................... 62

Wasielewski, Richard, Vice president and Chief Financial Officer, Nortech

Systems, Inc. ......................................................................................................... 70

Piche, Joseph, Chief Executive Officer and Founder, Eikos, Inc. ........................ 74

ALPHABETICAL LISTING AND APPENDIX MATERIAL SUBMITTED

Coleman, The Honorable

Opening Statement ........................................................................................... 3

Prepared statement .......................................................................................... 49

Corker, The Honorable Bob

Opening Statement ........................................................................................... 4

Cox, The Honorable Christopher

Opening Statement ........................................................................................... 4

Prepared statement .......................................................................................... 9

xlResponses to post-hearing questions from: .................................................

Senator Kerry ............................................................................................ 92

Senator Snowe ........................................................................................... 95

Senator Pryor ............................................................................................. 106

Senator Enzi .............................................................................................. 109

Letter to Senator Kerry ................................................................................... 130

Enzi, The Honorable Michael B.

Prepared statement .......................................................................................... 134

Post-hearing questions posed to:

SEC Chairman Christopher Cox .............................................................. 109

PCAOB Chairman Olson .......................................................................... 121

Kerry, The Honorable John

Opening Statement ........................................................................................... 1

Post-hearing questions posed to:

SEC Chairman Christopher Cox .............................................................. 92

PCAOB Chairman Olson .......................................................................... 113

Letter to Chairmen Cox and Olson ................................................................. 126

Olson, The Honorable Mark W.

Testimony .......................................................................................................... 18

Prepared statement .......................................................................................... 21

xlResponses to post-hearing questions from: .................................................

Chairman Kerry ........................................................................................ 113

Page

IV

—Continued

xlResponses to post-hearing questions from—Continued

Senator Snowe ........................................................................................... 116

Senator Pryor ............................................................................................. 119

Senator Enzi .............................................................................................. 121

Letter to Senator Kerry ................................................................................... 128

Piche, Joseph

Testimony .......................................................................................................... 74

Prepared statement .......................................................................................... 77

Responses to post-hearing questions from Senator Pryor ............................. 124

Pryor, The Honorable Mark L.

Post-hearing questions posed to:

SEC Chairman Cox ................................................................................... 106

PCAOB Chairman Olson .......................................................................... 119

Richard Wasielewski ................................................................................. 124

Joseph Piche .............................................................................................. 124

Snowe, The Honorable Olympia J.

Opening statement ........................................................................................... 38

Prepared statement .......................................................................................... 39

Post-hearing questions posed to:

SEC Chairman Cox ................................................................................... 95

PCAOB Chairman Olson .......................................................................... 116

Letter to Chairmen Cox and Olson ................................................................. 128

Tester, The Honorable Jon

Opening Statement ........................................................................................... 4

Venables, Thomas

Testimony .......................................................................................................... 62

Prepared statement .......................................................................................... 65

Wasielewski, Richard

Testimony .......................................................................................................... 70

Prepared statement .......................................................................................... 72

Responses to post-hearing questions from Senator Pryor ............................. 124

COMMENTS FOR THE RECORD

Enzi, The Honorable Michael B., a U.S. Senator from Wyoming, prepared

statement .............................................................................................................. 134

Sullivan, The Honorable Thomas M., Chief Counsel for Advocacy, U.S. Small

Business Administration, prepared statement .................................................. 137

Leahey, Mark B., Esq., Executive Director, Medical Device Manufacturers

Association, prepared statement ......................................................................... 151

Independent Community Bankers of America, prepared statement ................... 156

(1)

SARBANES-OXLEY AND SMALL BUSINESS:

ADDRESSING PROPOSED REGULATORY

CHANGES AND THEIR IMPACT ON CAPITAL

MARKETS

WEDNESDAY, APRIL 18, 2007

UNITED STATES SENATE, COMMITTEE ON SMALL BUSINESS AND

ENTREPRENEURSHIP, Washington, D.C.

The Committee met, pursuant to notice, at 10:30 a.m., in room

428-A, Russell Senate Office Building, Hon. John F. Kerry, Chairman of the Committee, presiding.

Present: Senators Kerry, Bayh, Pryor, Tester, Snowe, Coleman,

Thune, and Corker.

OPENING STATEMENT OF THE HONORABLE JOHN F. KERRY,

CHAIRMAN, SENATE COMMITTEE ON SMALL BUSINESS AND

ENTREPRENEURSHIP, AND A UNITED STATES SENATOR

FROM MASSACHUSETTS

Chairman KERRY. This hearing will come to order. I apologize to

everybody for the delay, but we had two votes in the Senate, as I

think you know, and we just finished the second one, so people are

hustling over here.

I want to thank SEC Chairman Cox, the PCAOB Chairman

Olson, and all of our witnesses for taking time out of busy schedules to be here to testify at this hearing, in which we will examine

the effects that the Sarbanes-Oxley regulations are having on small

business and how we can help small businesses to comply with the

law.

Let me say up front that we are all proud that our country

boasts the fairest and most transparent and efficient financial marketplace in the world. We have achieved this status by developing

a regulatory approach that ensures investors around the world can

have confidence in our markets. However, between the years 1998

and 2000, there were 464 financial restatements by public companies. That number was higher than the previous 10 years combined, and too often, those public companies were overstating their

income in order to attract investors or hold on to investors.

The trust and confidence of the American people in their financial markets was dangerously eroded by the actions of WorldCom,

Enron, Arthur Andersen and others, and the shocking malfeasance

by these businesses and accounting firms put a strain on the

2

growth of our economy, cost investors billions in assets and hurt

the integrity of financial markets around the world.

By all accounts, the Sarbanes-Oxley Act has brought back accountability to corporate governance and to auditing and to financial reporting for public companies. The audit of internal controls

over financial reporting has produced significant benefits, and public company financial reporting has improved overall. As a result,

investor confidence in our capital markets has been restored and

our Nation’s economic growth continues.

Recent published reports show that accounting restatements on

large companies’ financial results declined by 20 percent last year.

This is important evidence that Sarbanes-Oxley is working. These

improvements, however, have not come without some drawbacks

and complications. Too many small public companies who have

played by the rules are now expected to deal with the time and financial burden required by the Sarbanes-Oxley law. Last year,

businesses with less than $75 million in assets saw the number of

financial restatements increase by 46 percent. This shows that

businesses getting ready to comply with Sarbanes-Oxley are having

trouble. I believe that we will all benefit when small businesses are

prepared for compliance with Sarbanes-Oxley.

However, according to a recent U.S. Government Accountability

Office study requested by Senator Snowe, the cost of compliance

and the time needed for small companies to comply with SarbanesOxley regulations has been disproportionately higher than for large

public companies. Firms with assets of $1 billion or more spend

about 13 cents per $100 in revenue for audit fees, while small businesses are forced to spend more than $1 per $100 in revenue to

comply with the same rules.

As we will hear from witnesses on the second panel today, this

disproportionate burden faced by small public companies may be a

deterrent to other small businesses interested in going public.

These small businesses aren’t resistant to fair and open financial

reporting, but they are hesitant to make this transition because of

the burdensome costs involved with compliance.

Small businesses, we all know, are vital participants in capital

markets. They play a critical role in future economic growth and

high-wage job creation. I have no doubt that small public companies will be able to comply with the Sarbanes-Oxley law just as big

business is doing today. All small public companies know it is in

their best interest to have regulations in place that provide transparency and accountability. These are the qualities that encourage

investor confidence in U.S. markets, giving them access to more investors and increasing the pool of available capital, while keeping

their competitors from manipulating the marketplace through

faulty accounting.

But, and this is an important but, I think each of us on this

Committee, wherever we have gone in the country, when talking

to business people, hear anecdotally that there is sort of an overreach or an excessiveness, that we could, perhaps, accomplish the

goals of Sarbanes-Oxley perhaps with a little less financial and administrative burden. It is important for us to listen to that, to take

it into account, to try to figure out if that is true. I think the real

measure of this hearing is whether we can sustain the goals, the

3

accountability, and the transparency while minimizing the disruptive features and costs so that you maximize your competitive abilities and your growth, and that is the balance we would obviously

like to find.

We need to find a way, I think, to help some of these small businesses, the backbone of the American economy, to make this transition and make it effectively and smoothly. To that extent, I am

very pleased that the Securities and Exchange Commission and the

Public Company Accounting Oversight Board are currently considering final rules and guidance on the implementation of SarbanesOxley that will make it easier for small businesses to comply with

the law.

And while I acknowledge that the intent of the rule changes is

to make it easier and less burdensome for small businesses to comply, we all know that the devil is always in the details. So I look

forward to hearing from Chairmen Cox and Olson on the status of

the rulemaking progress and see how those regulations will take

into consideration the concerns of the small business community.

As we move forward, there are additional steps that could be

taken to assist small businesses, and I want to work with Senator

Snowe and others on this Committee to find, hopefully, a common

ground on how we could do that.

I recently wrote to the SEC and the PCAOB with Senator Snowe

urging the regulators to give small businesses up to an additional

year to comply with the pending changes to Sarbanes-Oxley regulations. I believe this added time will help small businesses adapt to

the changing regulatory structure and make it easier for those who

lack the expertise or the financial resources to be able to comply

with the law. I thank Chairman Cox for his previous support in

providing small public companies with additional time to comply

with Sarbanes-Oxley.

As Chair of the Committee on Small Business and Entrepreneurship, I will continue to closely follow this impact on small firms and

very much look forward to working with Senator Snowe and our

colleagues to try to help small companies be able to abide by the

law while simultaneously allowing them to focus on what they do

best, which is creating jobs and growing our economy by participating in the capital markets.

So we look forward to hearing from our witnesses today. Before

I introduce them, let me turn—Senator Snowe, I know, is on her

way, but let me turn to Senator Coleman. Do you have any opening

statement, Senator?

OPENING STATEMENT OF THE HONORABLE NORM COLEMAN,

A UNITED STATES SENATOR FROM MINNESOTA

Senator COLEMAN. Just very briefly. I want to thank the Chair

for convening this hearing. As I travel around my State and I talk

to small businesses, this and health care are the two single most

common concerns and complaints.

I would just also take a note of personal pride in that both our

witnesses before us, Chairman Cox and Chairman Olson, both have

ties to St. Paul, Minnesota, having been born there or lived there,

so I know they have the right kind of background to be very sensitive to these concerns and are smart enough to handle the conVerDate 11-MAY-2000 14:24 Feb 14, 2008 Jkt 039880 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 C:\SBA\39880.TXT CELINA PsN: CELINA
4

cerns. I look forward to their testimony and the testimony of the

other witnesses.

Again, I want to thank the Chair for his leadership on this very

critical issue.

Chairman KERRY. Thank you. You are not going to claim there

is something in the Mississippi River water, are you?

[Laughter.]

Chairman KERRY. Senator Tester?

OPENING STATEMENT OF THE HONORABLE JON TESTER, A

UNITED STATES SENATOR FROM MONTANA

Senator TESTER. I also want to thank the Chairman. I want to

thank Chairman Cox and Chairman Olson for being here. It is a

delicate balance between regulation and what is appropriate and I

look forward to hearing your perspective on Sarbanes-Oxley and

how we can make it better. Thank you.

Chairman KERRY. Thank you very much.

Senator Corker?

OPENING STATEMENT OF THE HONORABLE BOB CORKER, A

UNITED STATES SENATOR FROM TENNESSEE

Senator CORKER. In the interest of time, I just want to thank you

for the hearing and our witnesses and I will associate myself with

Mr. Coleman’s comments. Thank you.

Chairman KERRY. Thanks a lot, Senator.

Senator Bayh?

Senator BAYH. I have no opening statement.

Chairman KERRY. We welcome Chris Cox, the 28th Chairman of

the Securities and Exchange Commission. He was appointed by

President Bush in 2005, and prior to his appointment, he spent 17

years in the House of Representatives.

Our second witness is Mark Olson, Chairman of the Public Company Accounting Oversight Board. He served as a member of the

Federal Reserve Board of Governors, the Federal Local Market

Committee since December of 2001.

Both are highly qualified and we really welcome you here today.

Thanks for taking the time to come.

Mr. Cox?

STATEMENT OF THE HONORABLE CHRISTOPHER COX,

CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION

Mr. COX. Thank you very much, Mr. Chairman, Ranking Member

Snowe when she arrives, and members of the Committee for inviting me to testify on behalf of the Securities and Exchange Commission concerning the application of Section 404 of the SarbanesOxley Act to small business.

Mr. Chairman, you asked in your opening statement whether or

not the United States can achieve the goals of accountability and

transparency that underlie Section 404 of the Sarbanes-Oxley Act

while simultaneously minimizing the costs and the disruption, especially for small business. The answer to that, in the view of the

Securities and Exchange Commission, and I dare say in the view

of the PCAOB, is yes.

5

Your Committee’s charge is a vitally important one concerning

costs of Sarbanes-Oxley to small business in particular, and even

more generally, given the importance of small business to our economy. For our part, the SEC’s charge in the statute includes the

promotion of capital formation upon which small businesses, of

course, depend. So like you, therefore, we are completely committed

to fostering the climate of entrepreneurship that is so essential to

growth and the success of smaller public companies.

For a small business, raising private capital often depends upon

the future prospective possibility of tapping the public market. So

it isn’t just that the companies that are already public or ready to

go public today are affected by how we implement Sarbanes-Oxley.

It is also true that companies of all sizes are similarly affected.

Every start-up, every new business idea, every determined woman

with a dream or a man striking out on his own needs a flourishing

IPO market.

America, as you well know in this Committee, creates far more

new businesses than does Europe, absolutely and on a percentage

basis, and our capital markets have a far higher percentage of individual owners of securities. So it is essential for the vitality of our

economy that we protect both the opportunity for small businesses

to raise the capital that they need to innovate and the savings of

the individuals, the many individuals, who have invested their

money in the securities of smaller companies.

Today, 4 years after the Sarbanes-Oxley Act was signed into law,

over 6,000 public companies still aren’t required to provide the audited internal control reports that are called for by Section 404 of

the Act. As a practical matter, almost every public company with

securities registered by the Commission, if it has $75 million or

less in public equity, falls into this category. They haven’t been required to comply with Section 404, as you noted, Mr. Chairman, because the Commission has been very sensitive to the special concerns of smaller public companies. All other public companies in

the United States already have 3 years of reporting on internal

controls under their belts.

The Commission has delayed Section 404 compliance for smaller

companies because of the disproportionately higher cost that they

face, just as you pointed out. Our experience in the first 3 years

told us that the way that 404 was being implemented was too expensive for everyone; so imposing that system on the smallest companies would impose unacceptably high costs from the standpoint

of the companies’ investors, who, after all, pay the bills.

So the Commission and the Public Company Accounting Oversight Board set out to address the unique concerns of small business. We further delayed the implementation of 404 for smaller

public companies until Chairman Olson and I, working together

with the full Commission and the full Board and our professional

staffs, could replace the current inefficient system of Section 404

implementation with a more streamlined approach that focuses on

the material risks but that still provides for effective and meaningful internal control audits to protect investors.

The focus of this hearing is on the proper implementation of Section 404. Focusing on the implementation of 404 rather than

changing the law is consistent with the SEC’s view that the probVerDate 11-MAY-2000 14:24 Feb 14, 2008 Jkt 039880 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 C:\SBA\39880.TXT CELINA PsN: CELINA
6

lems we have seen with 404 to date can be remedied without

amending the Sarbanes-Oxley Act. And, despite the unduly high

costs of implementing Section 404, I believe that the Act overall,

including Section 404, may be fairly credited with correcting the

most serious problems that beset our capital markets just a few

years ago.

So as the Commission and the PCAOB move forward with our

plans to make the application of Section 404 workable for smaller

companies, it is important to remember that Congress’s focus on internal controls was not a mistake. It was and it remains exactly

the right thing to do.

It is also important to keep in mind that the Congress didn’t invent the internal control provisions of Sarbanes-Oxley out of thin

air. There were clear antecedents for SOX 404 in the Federal Deposit Insurance Corporation Improvement Act, FDICIA, and before

that in the Foreign Corrupt Practices Act. Since the internal control requirements in those Acts hadn’t resulted in unexpected high

costs, it was reasonable for Congress to assume that Section 404

wouldn’t be disruptive, either.

In the case of FDICIA, however, the banking regulators hadn’t

adopted a highly prescriptive standard to implement the statute’s

internal control provisions. But, following the passage of SOX in

2003, the PCAOB and the SEC adopted a very different Auditing

Standard Number 2 to implement Section 404. It was approved for

use by auditors starting with internal control attestations in 2004.

Following the implementation of AS2, many companies increased

the documentation of their controls and formalized the procedures

they use to identify, test, and analyze the effectiveness of those

controls.

The cost of this exercise far outstripped all expectations, including the formal estimate made by the Securities and Exchange Commission when the reporting requirements of 404 implementation

were approved. It is undoubtedly true that some of these higherthan-expected costs reflected long-neglected maintenance of internal control systems, but it is equally true and undeniable that

much of the extra cost was and continues to be the result of excessive, duplicative, and misdirected effort.

That concern is one of the reasons that, even now, smaller companies aren’t yet required to comply with Section 404. In a moment, Chairman Olson will talk about the particulars of the proposed new auditing standard that the PCAOB is working on to replace AS2. But it isn’t just the auditing standard that is being refashioned.

The SEC is simultaneously writing guidance specially directed to

the management of companies to give them a truly scalable approach to designing controls that will work for the particular circumstances in which they find themselves, especially for small

business. And we are coordinating the two proposals by eliminating

from the new auditing standard any language that would create an

expectation that the controls would be designed to fit the audit

rather than the audit being designed to fit the controls.

It is our intention that the new guidance for management will

work together with the PCAOB’s proposed auditing standard to

clearly delineate the auditor’s responsibility for opining on manageVerDate 11-MAY-2000 14:24 Feb 14, 2008 Jkt 039880 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 C:\SBA\39880.TXT CELINA PsN: CELINA
7

ment’s assessment, on the one hand, and the company’s responsibility for the methods and the procedures that it uses in its internal controls evaluation process, on the other hand. In combination,

the Commission’s proposed guidance and the PCAOB’s proposed

auditing standard should result in the management of smaller companies being able to use a top-down, risk-based approach to their

evaluation of the internal controls. And the new approach to 404

implementation should shift discussions between managements

and auditors away from management’s evaluation process and toward what matters most to investors, the risk that material

misstatements in the company’s financials won’t be prevented or

detected in a timely manner.

By the way, managers and auditors should talk to each other,

and not just managements, but audit committees and boards of directors should have a healthy and ongoing dialogue with their

auditors about the company’s internal controls. There is no auditor

independence rule or any other rule or standard that stands in the

way of this kind of useful communication.

The comment periods for both the Commission and the PCAOB

proposals closed on February 26 of this year. The Commission received 205 comment letters from a broad cross-section of investors,

small companies, large companies, accountants, lawyers, regulators, and academics.

In our outreach to small business throughout this process, the

SEC has been aided by the exceptional work of our Office of Small

Business Policy located within the Division of Corporation Finance.

The Office of Small Business Policy and its very able Director

Gerry Laporte are focused on making sure that the unique needs

of small business are reflected in our rules and in the interpretations and guidance that we provide to the public.

The Office of Small Business Policy also served as the secretariat

for the Advisory Committee on Smaller Public Companies, which

issued its report to the SEC in April 2006. That report was the

first to focus on the problems with Section 404 implementation in

a systematic way, and it has informed many of the solutions that

we are now implementing.

Of special significance to this Committee is that the comments

from the small business community that we received on the proposed new 404 procedures were generally consistent with those

that we received from other commentators. Almost three-quarters

of the comment letters from small business interests indicated that

the SEC’s proposed guidance would allow managements to tailor

their evaluation to the facts and circumstances of their particular

companies and help to focus the 404 process on the areas that are

most important to reliable financial reporting.

Sixteen of the 42 comment letters representing small business

also emphasized the need to allow sufficient time for smaller companies to consider the final guidance issued, or to be issued, by the

Commission and the final auditing standard that we expect will be

adopted by the PCAOB before they are required to implement fully

Section 404 of Sarbanes-Oxley. We take all these comments that

we have received very seriously, and we are working hard to address these concerns.

8

Very recently, on April 4, Chairman Olson and I held an open

meeting to review the general nature of the public comments and

the work that remains to be done to address them. At that meeting, the Commission made it clear that we are very pleased with

the progress that we and the PCAOB are making in our collaboration, and we focused on four remaining areas where we believe additional work is necessary.

First, we need to better align the proposed PCAOB audit standard and the Commission’s proposed guidance.

Second, we need to improve the discussion in the proposed auditing standard of how auditors can scale the audit procedures, which

will be of a special benefit for smaller companies.

Third, we need to do further work to ensure that it is crystal

clear that auditors should use their professional judgment in determining audit procedures and testing based on their assessment of

risk.

And fourth, the auditing standard needs to use broader principles rather than prescriptive rules to describe when auditors may

use the work of others. This last will ensure that auditors can rely,

for example, upon work obtained from management’s risk assessments and monitoring activities when those are found to be competent and objective.

As this Committee is aware, the Commission has carefully

phased in application of the 404 reporting requirements. Specifically, smaller companies would file management reports on their

internal controls along with their annual report for their first fiscal

year ending after December 14, 2007. For calendar year-end companies, this would mean March 2008.

We aim to implement Section 404 just as Congress intended, in

the most efficient and effective way to meet our objectives for the

investor protection, well-functioning financial markets, and healthy

capital formation by companies of all sizes. We won’t forget, Mr.

Chairman, the failures that led to the passage of the SarbanesOxley Act in the first place, and we won’t forget that, for small

business to continue to prosper in America, strong investor protection has to go hand-in-hand with healthy capital formation.

The reforms that we are making to the Sarbanes-Oxley 404 process are intended to be of direct benefit to American small businesses and the millions of Americans who work for them, who invest in them, and who benefit from the goods and the services that

they provide. We are reorienting 404 to focus on what truly matters to investors and away from expensive and unproductive makework procedures that waste investors’ money and distract attention

from what is genuinely material. No longer will the 404 process tolerate procedures performed solely so someone can claim that they

considered every conceivable possibility.

Mr. Chairman, these next few weeks are a critical time for small

business as we approach the finish line in our work to rationalize

404. We look forward to working with you and all the members of

this Committee in the days ahead on these issues as well as on the

many other issues that face our Nation’s small businesses.

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

Commission, and of course I will be happy to take your questions.

[The prepared statement of SEC Chairman Cox follows:]

9

10

11

12

13

14

15

16

17

18

Chairman KERRY. Thank you very much, Mr. Cox.

Mr. Olson?

STATEMENT OF THE HONORABLE MARK W. OLSON, CHAIRMAN, PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD

Mr. OLSON. Thank you very much, Chairman Kerry, and members of the Committee, for inviting us to be here. It is a privilege

to be here with Chairman Cox. We have had the opportunity to

work on this important issue and I have been pleased at the

amount of time that he has accorded this issue in order that we

can achieve, as you appropriately pointed out, the retention of

transparency in the U.S. capital markets while at the same time

making the cost consistent with the incremental benefit.

We look at our charge as the overseer of the accounting profession with a very significant small business focus. First of all, from

the standpoint that, as you know, every accounting firm, auditing

firm, that either audits or wishes to audit a company that is publicly traded must register with us. There are over 1,700 firms

around the world that have registered with us, and of that number,

19

just under 1,000 of them are domestic and they come from all over

the country. As a matter of fact, of that number, we have—let me

see, there are, regrettably, zero from South Dakota, but 21 from

Tennessee, 10 from Minnesota, 31 from Massachusetts, 1 from

Montana, 11 from Indiana, and 2 from Arkansas. So as you can

see, they do cover all of America and most of them are very small.

Of the number, only a handful, about 125, audit more than five

publicly-traded companies. The foundation of the statute is that if

you choose to access the capital markets, there is an expectation

for the level of internal controls that you are expected to have, and

the external auditor is expected to opine on that. This is not an unreasonable expectation for accessing the U.S. capital markets and

it is perfectly consistent, I think, with what you said earlier about

maintaining the transparency of the markets while at the same

time maintaining confidence in the markets. Senator Tester called

it a delicate balance and we believe that is exactly the case.

With respect to small businesses and small firms, unquestionably, the factors of scale alone will mean that the burden will fall

disproportionately to the smaller firms if it is not addressed. I

think your 13 cents per hundred for the large businesses and a dollar per hundred for the small businesses is probably pretty accurate in terms of cost if we do not pay specific attention to them.

I would like to focus on the manner in which we have done that

so far and then talk about some of the things that we can continue

to do in the future.

First of all, we have had small business audit forums around the

country for the last several years. We have had 19 forums in 14

cities, and those forums have helped the small firms learn how

they can do audits in the post-Sarbanes-Oxley environment. We

have had 1,400 auditors attend, and in many cases, we have also

had representatives of audit committees attend.

The manner in which we do the supervision, or oversight, of the

small firms is very different from the larger firms. In many of the

cases, we do not need to be intrusive to the point that we need to

be on site. Much of it can be off-site. The manner in which we do

the inspections is consistent with the level of involvement that they

have with publicly-traded companies.

We are in the process now, and I think that this is very key, of

developing guidance for auditors of small public companies. The

guidance we are developing is through the volunteer efforts of 12

practitioners from 12 firms around the country who are looking at

the scalability of the small audits and trying to make sure that we

can define, in a very specific way, how they can be scalable and,

cost effective for the smaller public companies. That is due to be

made public later this year.

Chairman Cox talked about some of the goals for a revised

Standard AS2, which will be replaced by what we expect will be

AS5. We will help address that as well.

AS5 will be focused on controls that really matter. It will be written in understandable language as opposed to audit-speak, and we

think that this will help in the manner in which audit committees

or CFOs work on the engagement with the external auditor. Ultimately, working with the SEC, I am very confident that we will get

the words right.

20

But as you suggested, the devil is in the details. Implementation

is really key; that is going to involve PCAOB and the SEC with our

respective guidance that we are putting out. Very importantly, it

will involve the firms themselves. The issue is for the firms to recognize that there is an expectation for a certain level of internal

controls that hopefully will be respected and appreciated.

Very importantly, the auditing firms need to be involved. They

need to be involved in the sense that they need to scale the manner

in which they are making the audits more efficient. Just today, Mr.

Chairman and members of the Committee, we issued what we call

a 4010 Report where we have summarized some of what we noticed

in the efficiencies of the audits as they were done in 2006, and we

pointed out in a very specific way how the efficiency has been improved and pointed out ways that it can be even more improved.

As Chairman Cox said, this is at least the third time, I think,

that the Congress has mandated an expectation that there will be

a requirement for internal controls over financial reporting,

FDICIA was the next-to-the-last and the Foreign Corrupt Practices

Act was the first.

One final point I would like to make gets to the U.S. competitiveness issue. In the relatively brief period of time that the PCAOB

has been functioning, we have noticed that in almost all the developed countries of the world there has been a PCAOB-like organization started. As capital markets improve around the world, we are

also finding around the world that there is a need for a government-mandated entity that would focus on oversight over the accounting and auditing professions.

Next month, we will be holding a workshop here in the United

States for our peers around the country. It can be a learning experience for all of us. Interestingly, there are people from 44 different

countries who represent organizations like the PCAOB who are

coming here to participate in the workshop.

Mr. Chairman, that concludes my statement. We have a formal

statement that we have submitted for the record. I would be happy

at this point to answer any questions.

[The prepared statement of PCAOB Chairman Olson follows:]

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

Chairman KERRY. Thank you very much, Mr. Olson.

That was very helpful, both testimonies, and we appreciate them

very much.

Senator Snowe is now here. Senator, do you want to wait and

sort of gather for a minute——

OPENING STATEMENT OF THE HONORABLE OLYMPIA J.

SNOWE, A UNITED STATES SENATOR FROM MAINE

Senator SNOWE. Thank you, Mr. Chairman. I appreciate it and

I am going to dispense with my opening statement, but I want to

thank you for holding this hearing today because this is a critical

issue that has an enormous impact on small public companies.

I want to welcome Commissioner Cox, with whom I have had the

privilege of serving in the U.S. House of Representatives. I am delighted that he is continuing his record of standing public service

to the SEC. To Chairman Olson, thank you for your contributions

and charting a new course as Chair of the Public Company Accounting Oversight Board, so we thank you very much.

These are critical issues and I will get into it in my questioning.

We obviously have to address the challenge of harmonizing the regulations and the direction from both the SEC and from the Board

itself. That is one of the issues that I have heard from the small

business community in my State and across this country. It is creating a lot of confusion and the impact of the cost compliance is becoming exorbitant for many small public companies that otherwise

should be channeling their resources in the direction of job creation

and innovation rather than paying the unnecessary expenses associated with regulatory compliance. I have introduced a bill to address the impact of the regulations on small public companies, as

well, because I think that these carts should be assessed along the

way.

But we will get into that in the questions and I thank you both

for being here and the other witnesses, as well. Thank you, Mr.

Chairman.

[The prepared statement of Senator Snowe follows:]

39

40

41

42

Chairman KERRY. Thank you very much, Senator Snowe.

We will try to proceed as quickly as we can, maybe 5-minute

rounds to start with and if we need more time, I am happy to open

it up to do that.

I want to start. I appreciate the testimony of both of you, and

it is helpful. As a starting principle, an awful lot of small businesses that we meet with say to us, ‘‘Senator, I am not a big corporation. I don’t have the same money. I can’t afford all of this. I

am just starting up. I don’t have as much working capital. These

guys can afford all of these accountants,’’ et cetera. You have set

a principle here, which I think is important for us to air as a

threshold principle with which we are dealing, which is essentially:

If you want to get into the marketplace, if you decide to go public,

there is a standard of behavior that you have to adhere to.

Is it fair to say that has to be without regard to cost and therefore, you are loath to draw a distinction between the big companies

and the small companies, so everybody in the marketplace is the

same? Is that a fair statement?

Mr. OLSON. The audit itself, Mr. Chairman, should be very idiosyncratic and it should be based on the size and complexity of the

individual firm. We have heard examples of relatively small companies that have, for instance, a very high degree of complexity if

they are doing a lot of derivative activities. We have also heard of

simple companies that are accelerated filers. In other words, they

have passed the threshold of being very large, but in fact, they are

a very uncomplicated company. And so the audit itself ought to reflect that complexity——

Chairman KERRY. And you are saying it doesn’t today?

Mr. OLSON. No, it can and increasingly can. It was the initial expectation that it could, but that is exactly what we are trying to

do in the rewriting of the AS5. We are in a very specific way describing how it can be more risk-focused and how it can be designed for the particular complexity and size of the company involved.

Chairman KERRY. I see. So in the end, there will be a variation,

but the variation will not be defined by the per se size of the company. It will be defined by sort of what the company is engaged in

and what kind of activities it is involved in. Is it fair to say that

the discretionary audit standard is going to be applied?

I say discretionary because in reading Chairman Cox’s four

areas, the four areas that you say—or the four remaining areas

where we believe additional work is necessary are not inconsequential areas. The one in particular that leapt out at me was that we

need to do further work to ensure it is crystal clear that auditors

should use their professional judgment in determining auditor procedures and testing based on their assessment of risk. That seems

to sort of restore or put back in place a fairly large measure of discretion. I assume that is the purpose of it.

Mr. OLSON. That is the purpose of it. What the starting point——

Chairman KERRY. Is there a danger in that, where you go back

to where we were?

Mr. OLSON. The starting point is the management itself defining

its critical controls, and then the auditor would come in and attest

to management’s assertions as to the adequacy of those controls.

43

What PCAOB does is provide the standard that the external auditor would come in to do in order to make that determination.

What we have now, and they have to be looked at in combination, is the management guidance provided by the SEC which anticipates that the management will have a very clear hands-on understanding of which controls are key. In addition, PCAOB has defined a standard as to how you could do the audit but with an emphasis on how you can identify the key controls and not simply

make a recitation of all the controls.

Chairman KERRY. So what happens, Mr. Chairman, if the auditor and the management disagree on what either risk is?

Mr. OLSON. That could well happen, and that is a negotiated

process in a sense. But also, what the external auditor is doing is

applying the standard——

Chairman KERRY. Why is it a negotiated process? I mean, preSarbanes-Oxley, that was also a negotiated process, correct?

Mr. OLSON. Yes.

Chairman KERRY. But what we discovered——

Mr. OLSON. Well, negotiated in the sense that there could be

agreement—the focus was on the extent to which the control was

a key control and the extent to which they were following appropriate audit standards.

Mr. COX. I would also jump in, if I may, and point out the obvious, which is that, pre-Sarbanes-Oxley, there was no SarbanesOxley Section 404 audit of internal controls.

Chairman KERRY. Correct. There were just the standards of the

industry and the sort of——

Mr. COX. Well, there was a financial statement audit.

Chairman KERRY. Correct. Understood. So the assumption is that

given 404 and its requirements and the level of scrutiny that both

of you will argue here, not to mention the risk in the marketplace

of adverse reporting, you believe that this standard you are looking

for here of professional judgment and testing and assessment of

risk is the balance? That is effectively what you are looking for

now?

Mr. COX. That is correct, Mr. Chairman.

Chairman KERRY. And you think that balance can, in fact, reduce

costs?

Mr. COX. The entire purpose of using judgment is to achieve the

idiosyncratic audit that Chairman Olson is talking about. If an

auditor cannot use his or her judgment, if there is a ‘‘check the

box’’ mentality, then there is absolutely no way to avoid doing

things that everyone knows are wasteful.

Chairman KERRY. What is the check against an overly friendly

relationship building in the assessment process?

Mr. COX. Well, obviously, we have a great deal of emphasis

placed on the independence of the auditor to begin with. Second,

there is still ample direction for both the auditor in auditing what

management has done and for management itself in terms of what

it is that they are trying to achieve with this whole exercise. It is

supposed to be focused on things that can affect the financial statements, and what we are trying to wring out is any make-work that

has nothing to do with something that might be material to the financial statements.

44

Chairman KERRY. So it is your judgment that there has been

that kind of make-work in the process to date?

Mr. COX. That is the testimony that we have had from a number

of commentors at our roundtables, in the report of the Advisory

Committee on Smaller Public Companies, in the letters that we

have received as recently as our latest round of proposals from both

the PCAOB and the SEC. I think everyone is focused on the fact

that investors are doubly injured when their money is wasted on

things that don’t matter, because not only is that money misspent,

but it is also a distraction to the auditors and for the financial

statement integrity away from what truly is material.

Chairman KERRY. Did you find in the process that there was a

distinction between the make-work requirements with respect to

small business and what happens in large business?

Mr. COX. Not necessarily, although I think it is felt more acutely

by smaller businesses for the reason that you described, that proportionately, those costs fall heavier on smaller businesses.

Chairman KERRY. In the fourth paragraph of the items that you

think need more work, you talked about how the auditing standard

needs to use broader principles rather than prescriptive rules. Can

you sort of fill that out a little bit for us?

Mr. COX. Yes. I think that that is a cognate of the point we were

just discussing. The hope is that we can avoid waste and inefficiency in the audit, and both the PCAOB—in its inspection process,

which in part is focused on efficiency—and the SEC—in our provision of guidance to management want to be sure that that aim is

achieved. By coming at this in a principles-based way, we hold people accountable for what truly matters.

In Enron, which gave rise to a great deal of this, there was famously adherence to a lot of technical rules, but when you stepped

away from examination of the bark on the trees and recognized the

forest, there was a massive fraud underway. A principles-based

system holds people accountable even if they have technically complied with all of the small particular requirements, even if they

have with a check-the-box mentality said, ‘‘I complied with these

technical rules.’’ We want to be sure that we have that kind of safeguard built into the system.

Chairman KERRY. A final question. On the consumer side, they

have also weighed in with you. You have received a lot of letters

from everybody on both sides. But they have suggested that the

Commission is more concerned with reducing cost to business than

with ensuring that the audit is effective. Can you speak to that?

Mr. COX. Our No. 1 concern is investor protection. We want to

make sure that we have financial statements upon which investors

can rely, and we want to make sure that the investors’ money is

being appropriately spent to achieve that objective. As I mentioned

a moment ago, if the investors’ money is being wasted on things

that don’t affect the reliability of the financial statements or their

integrity, then they are being doubly injured because all resources

are scarce, including the auditors’ time. And, if the auditors are

chasing things down rabbit holes that don’t matter, they are probably missing other things that are truly important.

Chairman KERRY. Thank you, Mr. Chairman.

Senator Snowe?

45

Senator SNOWE. Thank you, Mr. Chairman.

Mr. Olson, in the conference report of the Sarbanes-Oxley Act

when it passed, it indicated that internal controls should not be the

subject of a separate audit. I just would like to have clarification

from both of you on how you interpret the intent of Congress. Obviously, we want to create an important balance here. There is a

public interest at stake. At the same time, I don’t want to stifle

competitiveness and inhibit job creation and job growth and innovation. In the conference report, in referring to the internal control

evaluation reporting, it indicated that any such attestation shall

not be the subject of a separate engagement.

Mr. OLSON. Senator, a couple of points on that. There was some

confusion, I think, or there was some disagreement as to whether

or not an audit could be done on management’s assertions and then

a separate audit done on the controls themselves, and that is one

of the issues that we addressed in AS5. We determined that it was

not necessary to do two audits but, in fact, if you were to focus on

just the controls themselves, you did not have to have a separate

audit done on the management assertions. And so that has been

addressed in AS5.

Furthermore, I think that the previous guidance, under which

the FDICIA 112 audits had been done, the question was raised

that you could focus on either one or the other but you could do

it with a single audit.

Also, I think it is important to know that what we are trying to

do now is to look—if you can combine the audit of internal controls

and the financial audit themselves, there are a lot of efficiencies to

be gained in that. So we have tried to address that question.

Senator SNOWE. Are you in agreement on the fusion of those two

audits, I mean, on the accounting standards side?

Mr. COX. Senator Snowe, as you may recall, I served on the

House-Senate Conference Committee on Sarbanes-Oxley, and I

think you are exactly right in reading the plain language that you

just quoted. And second, inferring the intent of Congress here, it

was clearly contemplated in Section 404 that we would have an integrated audit, and for many of the good reasons that Chairman

Olson just specified. So the Commission has directed our staff to

work closely with the PCAOB staff as we finish up this work to ensure that there is the best possible integration of the financial

statement audit, which itself includes an assessment of internal

controls, and the internal control audit that is required by the

PCAOB.

Senator SNOWE. In the hearings, in the meetings that you conducted around the country, have you had a chance to get a response from small public companies with respect to this integrated

approach at this point? Small companies won’t be able to review

the new requirements until June when these guidelines are issued?

Mr. COX. We have indeed received many comment letters in the

formal comment process on both the proposed audit standard, and

the SEC’s proposed management guidance and those comments are

generally the same coming from smaller companies as from larger

companies. They think that, in this respect, we are moving in the

right direction.

46

Senator SNOWE. I know I have heard from some of the smaller

public companies in Maine, and I want to thank you again, Chairman Cox, for you and your staff being responsive to a number of

the questions that they have asked of the SEC. But what I have

heard is that with the 6-month period in which they would have

to conform to those regulations, do you think that that is going to

be a sufficient amount of time for them to do so?

Mr. COX. I don’t think it would be a sufficient amount of time

to comply in full with Section 404. There are two parts to 404.

There is what management does without its auditors, and then

there is the 404 audit. And in our experience it is that 404(b) requirement, the 404 audit, that is the basis of most of the complaints, most of the stories about distracting non-essential work

and instinct for the capillary instead of instinct for the jugular that

we are trying to fix. And so we have postponed for a further year

the requirement that smaller public companies would have to apply

with that 404 audit piece.

Senator SNOWE. I see. So on that piece, you are deferring for another year?

Mr. COX. Another year.

Senator SNOWE. I see. OK. Now——

Mr. COX. That would be March 2009 for a calendar year-end

company.

Senator SNOWE. I know one of the other issues that has been

raised by the small business community is that the SEC and the

PCAOB should harmonize their rules, because on one hand, the

SEC’s guidelines have been too vague. On the other hand, the

Board’s have been too specific. Do you think you have been able to

fuse the rules sufficiently so that there is clarity in that regard and

provide specific guidance? There is a tremendous burden that is

placed on these small public companies that obviously face the

costs disproportionately than larger companies. Senator Enzi and

I requested a Government Accountability Office study back in 2004

that basically asserted that fact. I think it was $1.14 it cost small

companies for every dollar required for compliance. This was nine

times greater than it was for large companies to comply with the

regulations.

Mr. OLSON. Senator, the operative word that you use is in ‘‘harmony’’ and I think that that is exactly what we are trying to

achieve, harmony in this respect. The management guidance that

would come from the SEC is the guidance to management that has

the hands-on familiarity, and in our case, what we are doing is

adopting a standard that the auditing firm would use. The management guidance should help in one very important respect: With

that management guidance, our auditing standards should no

longer be the de facto standard against which management would

adopt its standards.

I think that, in addition to being highly prescriptive in the original AS2, there was an overabundance of caution, and the auditing

world, the PCAOB, probably the SEC, and even audit committees,

I think, were absolutely over-prescriptive. They wanted to make

sure there were no mistakes made. Well, we have now lived with

Sarbanes-Oxley and we have learned better how we can make it

much more efficient and effective and I think we will move toward

47

achieving that. The harmonization between the SEC and the

PCAOB is exactly what we are trying to achieve.

Senator SNOWE [presiding]. That is important and I appreciate

that. Thank you.

Senator Tester?

Senator TESTER. A question for Chairman Olson, and Chairman

Cox, if you wish. First of all, I want to thank the Board for flexibility on Sarbanes-Oxley. I guess my question is going to revolve

around what is going on in other countries. What happens when

we have got a situation where you have got investor protection

versus capital formation in other countries? Is there a SarbanesOxley out there for other markets? Of course, there will be a followup on this.

Mr. OLSON. Senator, there is indeed, and I think that is one, for

me at least, of the more interesting components of the environment

that we are dealing with. It is following the growth in capital markets around the world.

If you look at the markets that are growing the fastest right now,

they are in places like India, developed Asia, even a resurgence in

Japan. You see a significant building of capital markets in Europe,

for example, in Eastern Europe, and London has been—has not always been, but in recent years has become a very attractive market. So as you see the capital markets grow and you see more and

more investors in those countries investing in those capital markets, logically and not surprisingly, what you see is a focus on the

quality of the audits being conducted. As a result, that is why we

see PCAOB-like entities around the world.

I just came from a meeting not long ago where I met with my

counterparts from around the world, all of whom are grappling essentially with this same issue, the appropriate way to monitor and

inspect the auditing profession while at the same time not unduly

interfering with a cost burden.

Senator TESTER. So how do they deal with—are they more onerous or less or similar? With Sarbanes-Oxley, are we putting our

businesses in this country at a competitive disadvantage? I guess

that is ultimately the question.

Mr. OLSON. Let me describe the differences, because you have hit

on a very important point and the differences are really important.

What Sarbanes-Oxley did in establishing the PCAOB is that it required an independence of the PCAOB separate from the accounting profession. So, for example, we do not get funding from the accounting profession. Our funding comes directly from corporate

America, from publicly-traded companies.

In many other countries that have established an organization

like ours, they don’t have the same resources we do. They are not

in all cases able to fund the kind of a staff that we have to do our

inspections, and sometimes they don’t have the same degree of

independence. Bulgaria and Romania do not have the same resources that we do, for example, but they have had somewhat that

same focus.

Senator TESTER. From an investor protection standpoint, where

do we rate in the worldwide economy?

Mr. OLSON. We are not participating in a race to the bottom, and

I think that is the most important point. We are maintaining conVerDate 11-MAY-2000 14:24 Feb 14, 2008 Jkt 039880 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 C:\SBA\39880.TXT CELINA PsN: CELINA
48

fidence in the standards we have in the United States while still

being an attractive marketplace. If you look at the impact of Sarbanes-Oxley, you can actually track the fact that there has been a

reduced cost of capital for firms that have gotten a clean bill of

health on their ICFR audit. I don’t know where we rank. I wouldn’t

put a number on it, but I think that confidence in the U.S. markets

has been restored.

If you look at the growth of IPOs, we have not grown as fast as

some, but there has been an increase in the number of U.S. IPOs

every year since 2003. We have an increased number of foreign

companies that are issuing stock either as joint issuance or issuing

in the United States. I think that that bodes well for the confidence

in our markets.

Senator TESTER. Thank you, Madam Chairman. Thank you,

Chairman Olson.

Chairman KERRY [presiding]. Thank you. Senator Coleman?

Senator COLEMAN. Thank you, Mr. Chairman. Again, I want to

thank you. I do have a more extended opening statement that I

would like entered into the record.

Chairman KERRY. Without objection, it will be placed in the

record.

Senator COLEMAN. Thank you.

[The prepared statement of Senator Coleman follows:]

49

50

51

52

53

54

55

56

Senator COLEMAN. I really appreciate the efforts and the sensitivity of both of the Chairmen here who understand the importance

of us being competitive and small business being able to prosper.

Clearly, some progress is being made even at this stage. We will

have another witness here, a small business person from Minnesota, Rich Wasielewski, and my belief is he will talk about some

of the competitive disadvantages that American business faces because of some of the burdens of Sarbanes-Oxley. So clearly, I think

we are still in search of a more perfect balance.

Chairman Olson, you raise the issue about harmonization. Or

you made the comment about harmonization. I am sure you are

both aware that on February 21, 2007, the SBA Office of Advocacy

sent letters to both of you relating to the proposed internal control

on auditing standard rules. That letter raised, at least from what

I saw, significant concerns about the differences, about this effort

at harmonization. I think it went on to say that despite the working relationship, it was clear to me that the rules that you are proposing don’t fully comport. For example, according to the comment

letter, to quote, ‘‘the SEC guidance seeks to provide flexibility and

scalability to small public companies and therefore does not prescribe a particular methodology of identification of risk and controls. In contrast, the PCAOB’s revised accounting standard is very

prescriptive and contains detailed bullet points on how auditors

must evaluate management’s internal control reporting process.’’ In

the end, the letter finally stated that ‘‘small business representatives have stated that by the use of the PCAOB’s revised auditing

standard as their de facto guidance, they are afraid that following

the SEC’s vague and flexible management guidance results in a

negative audit by an auditor using the more detailed and prescriptive revised auditing standard.’’

My question, then, is with these concerns in mind, can you talk

a little bit more about harmonization? Can you more specifically

address this issue so that we don’t have businesses acting in fear

and have a sense that they are dealing with the concerns of both

of you?

Mr. OLSON. I would be happy to lead off on that one, Senator.

To go back to when we first issued AS2, that was a well thoughtthrough, carefully crafted standard that gave a lot of specific guidance as to what auditors might do in auditing the internal controls

of financial reporting. Because of the abundance of caution that I

mentioned, many of those specific examples, then, were determined

to either be mandatory or presumptively mandatory. Some of the

wording and some of the language in there perhaps suggested a

great deal more procedures be done than were necessary. The term

‘‘make work’’ was used before. I don’t associate with that term. I

don’t think it was make work. I think it was just the fact that people were wearing a belt and a pair of suspenders in terms of identifying the number of controls for which they wanted documentation

and they wanted to test them.

And then, immediately following that, in two separate instances,

the PCAOB had issued either questions and answers or additional

guidance as to how you could make the audit more scalable and

less costly and less intrusive. And yet what we discovered was that

the auditing firms were still going back to the original standard.

57

They weren’t fully incorporating the subsequent guidance. That is

why instead of amending AS2, we are replacing AS2. I think that

will address the de facto standard issue. Also, the SEC is providing

its new management guidance relatively simultaneously.

Senator COLEMAN. And my concern, and I turn to Chairman Cox,

is that this guidance is not either conflicting or confusing but, in

fact, is harmonization. What I am looking for, I just want to be assured—I want you to assure this Committee that when you finally

get the kind of rules out there that they are not going to create

confusion, that they are not going to be in conflict, and that the differences will be resolved. Chairman Cox?

Mr. COX. Senator, there are two areas of the four that I mentioned that we are now focused on in the remaining weeks as we

tie up the loose ends on this major project that relate to what you

are describing. One is harmonizing definitions, and that, as you

can imagine, is vitally important. We don’t want to use the same

terms in different ways as part of the same process, so we are

strongly committed to getting that right.

The second area where harmonization is important and where we

are focused, and I believe this goes directly to the comment that

you are relating to us, is that, to the extent that the SEC’s management guidance is more principles-based than the current

version of the PCAOB proposed audit standard, we are trying to

get further in harmony there, as well. Because if one is check-thebox and the other is principles-based, and I don’t mean to use that

characterization because I don’t think that that is where we are at

all, I think we are really down to the short strokes here. But just

to use that as two extremes, if one were check-the-box and the

other were principles-based, then you would almost certainly have

a very serious problem of the check-the-box approach being the de

facto standard. That is what happened last time around, and that

is the very problem we are trying to fix.

Senator TESTER. Thank you. I just again hope that you work together on this so that those differences are resolved. Thank you,

Mr. Chairman.

Chairman KERRY. Thanks, Senator. I appreciate it.

Senator Bayh?

Senator BAYH. Thank you, Mr. Chairman. Gentlemen, thank you

for your service and your time today.

Mr. Olson, I would like to start with you. The chart that is up

behind us here about the differences in the cost of compliance, is

there any evidence that as we have gone through this cycle now a

couple of times the disparity is shrinking sort of as people get their

feet under them, even in the absence of any additional action by

you and the—I see you are looking at the chart. It just visualizes

what has been orally said about the added cost of compliance for

small business.

[The referenced chart was not available at press time.]

Mr. OLSON. The bar on the left indicates small companies, $75

million and over, and Sarbanes-Oxley does not yet apply to them.

I am assuming that what is shown is an estimate. Section 404 does

not yet apply to them. So I would think that it would not fully take

into consideration——

58

Senator BAYH. Well, let me ask, then, for companies above the

bar where it goes into place——

Mr. OLSON. Yes.

Senator BAYH [continuing]. As the auditors and the companies

begin to go through this process, are natural efficiencies due to familiarity beginning to take place anyway?

Mr. OLSON. Very much so, and I think a couple of things——

Senator BAYH. Is that just anecdotal or is there any analysis that

quantifies that?

Mr. OLSON. Let me tell you why it is difficult to come up with

a real careful quantification. If the external auditor is auditing

both—in other words, doing a consolidated audit of financials and

internal controls, it is tough to break out which of the costs are for

the internal controls as opposed to the financial audit. Anecdotally,

what we are hearing is that firms that have accelerated filers have

their methodology in place, and have their approach to the controls.

In fact, I very recently heard an example of an accelerated filer

that used the occasion of Sarbanes-Oxley to catch up on some of

the internal controls that already needed attention; they used this

as an opportunity.

What I think we are hearing increasingly from the accelerated

filers, and I hear this again and again and again, that they are a

better company today because of Sarbanes-Oxley, but that the incremental cost still exceeds the incremental value and that is what

we are trying to bring into line. We still have a ways to go. I

wouldn’t claim that we have achieved all of that at this point.

Senator BAYH. So some progress, but progress yet to make?

Mr. OLSON. I think that is a fair statement.

Senator BAYH. Chairman Cox, for you, one of the things I have

been interested in since the beginning of this whole thing, and I

know you were there at the inception, as well, I would be interested to know if anybody in your shop has any data about sort of

the aggregate cost of compliance across the economy versus the aggregate amount of fraud that we have been preventing or that had

been taking place because of this. One of the things that has been

on my mind, it would be ironic if in the name of protecting the

shareholders we actually were imposing more costs on the shareholders than the harm we were preventing. Is there any data out

there about this?

Mr. COX. It is a mismatch because there is much harder data on

what we spend to prevent fraud and much softer data on the fraud

that doesn’t occur. Economists make a real and heroic effort to

measure the latter, but as you might imagine——

Senator BAYH. How about the fraud we were actually catching?

Mr. COX [continuing]. Measuring what didn’t happen is very,

very difficult.

Senator BAYH. Pre-Sarbanes-Oxley, there is some data on the

amount of fraud that was actually detected——

Mr. COX. Well, we do know—our economists will now probably

want to restrain me because I am going to——

Senator BAYH. You need a one-armed economist.

[Laughter.]

Mr. COX. I am going to practice amateur economics here, but if

one is willing to do reasonably rough justice about this, it is a fact

59

that our markets are healthy now. They were not before. They

were stressed. They were in great difficulty. Investor confidence

was shaken. There were significant problems that were uncovered.

We are, at least right now, at a time when we do not have problems of that magnitude coming to the fore. We at the SEC look for

them every day.

Senator BAYH. Well, how about the hard data that we do have

on the additional costs of compliance? Are there figures out there

on that?

Mr. COX. Yes, of course.

Senator BAYH. What would those be?

Mr. COX. Now, you mentioned specifically that you are looking

for a figure in aggregate for the whole country?

Senator BAYH. I think you know what I am driving at, the appropriate additional cost to promote transparency. I am just trying to

do a cost-benefit analysis of what we are spending and the benefit

we are deriving from that.

Mr. COX. What I would like to do, we have, of course, an Office

of Economic Analysis and it is staffed by top-flight professionals at

the SEC. What I would like to do is get you the very best data that

we have on this rather than trying to wing it. But I assure you,

having looked at this very carefully, that the numbers are going to

be much more reliable on the cost side than they are on the benefits side.

Still, I want to go back to a question Senator Tester put a moment ago. I think that the fact that so much of the world, and

Chairman Olson mentioned this in his response, is emulating Sarbanes-Oxley, and there is a lot of competitive marketing going on

in other countries, attacking the brand name of Sarbanes-Oxley

and so on. But if you take a look at the securities regulations that

are being propounded in these other countries, including in the

United Kingdom and many of the leading markets in the world,

they are emulating the major parts of Sarbanes-Oxley, including

internal controls assessments by management. The one respect in

which they have not emulated 404 is the audit piece.

But across the board, I think that, if one is talking about Sarbanes-Oxley in general and the recent improvements that are being

made to investor protection in the United States of America, the

emulation by other countries and around the world tells us, first,

we are not putting ourselves at a competitive disadvantage because

that is what is going on in these other markets, and second, we

probably did something right.

Senator BAYH. Thank you, gentlemen.

Chairman KERRY. Thank you very much, Senator. I appreciate it.

We have one more Senator and then we do have another panel.

I don’t know, gentlemen, do you have folks here with you who may

be able to stay and hear them, because I find sometimes the regulatory folks who come up first would sometimes benefit by hearing

what the other folks have to say.

Mr. OLSON. We have people who will stay, yes.

Chairman KERRY. Thanks. That is great.

Senator Corker?

Senator CORKER. Thank you, Mr. Chairman, and I thank both of

you for your service.

60

I want to follow up a little bit on Senator Bayh and Senator Tester’s comments. Before I do that, I do want to thank you for working

together to try to create some harmony. I think ‘‘harmony’’ is the

word that has been used here today, to make sure that companies

don’t feel bifurcated, if you will, in their efforts to satisfy each of

you and end up doing a lot of work that is make-work. I will just

add to Norm Coleman’s comments, as far as what you hear back

in the State of Tennessee from small companies, SOX is a huge

issue and one that they continue to be concerned about.

But I want to take it more to the macro level. I know we are

talking about small business today, but I know that Senator Bayh

was asking more quantitative kinds of questions, and I know it is

hard to come up with those and sometimes even ever find out what

is a true answer to those questions. If you step back and just look

at the macro level in our country and look at the way we are competing with other countries, the tremendous resurgence of private

equity here—I know a lot of that is due to the low cost of debt

today, but tremendous attribution to the regulations it takes to be

in public markets today, we see a tremendous resurgence in London and Europe and other countries.

Could you all just give us some editorial comments as to where

you see us as a country relating to public markets over the next

5 or 10 years and just some other editorial comments, because both

of you addressed this, as to what we might ought to look at as a

country to make ourselves more attractive in those ways.

Mr. COX. Senator, the globalization of markets, which has been

a fact of life ever since we have had public companies, for hundreds

of years, is accelerating in the time in which we live and markedly

so. And so for the Securities and Exchange Commission, focusing

on how we work with our fellow regulators around the world has

been a very, very big part of my job, and to a certain extent, given

the SEC’s history, a surprisingly large part.

As you know, the New York Stock Exchange and Euronext have

combined. The NASDAQ took a 25 percent stake in the LSE. There

are alliances being formed among markets and exchanges around

the world. Increasingly, investors have the opportunity, either directly or indirectly, to require foreign securities to subject themselves to the regulation therefore not of the United States but of

other countries. You mentioned the phenomenon of very large private pools of capital, including private equity hedge funds and so

on, all of these changes. And added to that, the development of

large liquidity pools in other countries that are competitive with

the United States that didn’t formally exist and not to that extent

have made the environment a very challenging one for the United

States generally and for regulators specifically.

But here is, if we take a snapshot, where we find ourselves. We

are the largest, deepest, most liquid market in the world by far.

Our exchanges are the largest, deepest, and most liquid by far. We

continue to attract the lion’s share of the world’s investment offerings and there is no other market that comes particularly close to

us. We have no birthright to that, and so we have to constantly

sharpen our competitive edge.

In my view, one of our comparative advantages is that one puts

its, his, or her money into the United States, there is a rule of law

61

here and a sense of safety and security that is unparalleled and exists nowhere else in the world. We want to maintain that competitive and comparative advantage. We also want to make sure that

our regulations, because we have to now work more closely with

other regulators, fit this new increasingly global world in which investors are living, and that means not so much that we have to diminish in any way the ultimate level of protection, but rather that

in order to achieve constantly that same high level of protection,

we have got to keep pace. We have got constantly to change for

that reason.

Mr. OLSON. Senator, let me just follow up. First of all, I associate

myself with Chairman Cox’s remarks. Having come to the PCAOB

from another regulator and having been in a highly regulated environment all of my life, there is one fundamental premise that we

in the United States have that most of the rest of the world does

not have, and it is this: The markets in the United States are presumed to work until such time as there is evidence that there

needs to be some intrusion to correct a market irregularity.

If you look at most of the regulatory burden that exists in the

United States, almost all of it came out of a specific crisis in the

past. All of the agencies that were created—like the Federal Reserve Board, the Comptroller of the Currency, the FTC, the SEC,

for example, were designed around addressing specific previous crises.

So, with much of the rest of the world, what you see is not a very

permissive, very free market; but rather you instead have entities

that are allowed to do only what they are specifically prescribed to

do by law.

I think that we continue to have a free and open marketplace

and it is only when there are events like an Enron or a WorldCom

that create a Sarbanes-Oxley, or a new body of law. I think that

what we need to do is to make sure that we have retained respect

for the fact that markets do work and that we still do not want to

be an environment where individuals, who are investors, cannot

have confidence in the markets.

Fifty-percent-plus now of all U.S. households are investors in one

way or another. That fact, I think, has been an important consideration for assuring that we have a body of law that addresses consumer concerns at the equity investment level. We can do that in

a way that is still cost effective. Things are still out of line, but we

are working very hard to bring them back into alignment.

Chairman KERRY. Thanks, Senator, very, very much.

Just one parting question, if I can, as sort of a summary of this.

We hear from some venture capital folks around the country that

Sarbanes-Oxley is sort of a barrier to start-up here. Is there any

evidence of companies actually making a decision to move to Europe or elsewhere as a consequence of these rules? It is a derivative

of the question asked earlier by Senator Tester, but it is something

that I have heard lately from some very thoughtful and significant

D.C. types.

Mr. COX. Senator, I, of course, hear the same thing from the venture capital community, from their formal association and from individuals in the industry, so I think at least in some sense, there

is a reality to this. It is the firm conviction of people in that comVerDate 11-MAY-2000 14:24 Feb 14, 2008 Jkt 039880 PO 00000 Frm 00065 Fmt 6633 Sfmt 6633 C:\SBA\39880.TXT CELINA PsN: CELINA
62

munity that there are serious problems and problems that affect

their decision making. Whether or not upon the completion of our

work that will remain their opinion is something else. But I think

we all know——

Chairman KERRY. But you are consciously, in the four areas you

talked about and in your approach to these rules that you are refining, you are consciously taking that into account? Is that part

of what you are factoring into this, or not?

Mr. COX. Yes. We are open to the possibility that many might

persist in their antipathy towards Sarbanes-Oxley, notwithstanding

the reality, and I think the other part of your question might challenge us to provide data and I think the answer to that question

might be very different. I would be happy, by the way, to follow up

if you would permit with some hard data on that topic——

Chairman KERRY. We would like to follow up——

Mr. COX [continuing]. Because I think we have some.

Chairman KERRY. I will leave the record open for 2 weeks here

to deal with the follow-up with you in writing on a couple questions

because we are pressed for time now, but I think it would be important to try to determine some of those things, if we can.

We are very, very appreciative. Thank you so much, both of you.

Thank you for the work you are doing. You can tell there is a lot

of serious interest here on this and we will follow it very closely

and we thank you.

Mr. COX. Thank you, Senator.

Mr. OLSON. Thank you.

Chairman KERRY. Could I ask the members of the second panel

to come right forward and we will try to continue seriatim here.

First, Tom Venables, the president and chief executive officer of

the Benjamin Franklin Bank in Franklin, Massachusetts, and he

is testifying on behalf of the American Bankers Association, but I

also want to thank Dan Forte and the Massachusetts Bankers for

their efforts on behalf of the financial services industry and particularly addressing these concerns.

We also have Joseph Piche, the CEO and founder of Eikos, a

high technology company located in Massachusetts.

And third, we will hear from Richard Wasielewski, the vice president and chief financial officer of Nortech Systems in Wayzata,

Minnesota, a full-service electronics manufacturer. I might also

note, if my memory serves me correctly, Wayzata is a good feeder

for hockey players in America.

Mr. Venables, please lead off. Go ahead.

STATEMENT OF THOMAS VENABLES, PRESIDENT AND CHIEF

EXECUTIVE OFFICER, BENJAMIN FRANKLIN BANK, ON BEHALF OF THE AMERICAN BANKERS ASSOCIATION

Mr. VENABLES. Thank you. Mr. Chairman, I am pleased to represent the American Bankers Association’s views regarding the impact of the Sarbanes-Oxley Act of 2002 on small businesses. Chairman Kerry and Ranking Member Snowe, before I go further, I

would like to thank you both on behalf of the ABA for your efforts

on this issue and specifically the letter that you wrote requesting

an additional extension of the Section 404 compliance date for nonaccelerated filers.

63

The ABA is very concerned about the huge time and cost burdens

experienced in complying with the Act as well as business opportunity costs. The banking industry has significant experience with

management reporting on internal controls because of the FDIC

Improvement Act of 1991, or FDICIA, which has long required

management reports and auditor attestations. Although the Act

used FDICIA as its model, the rules followed for FDICIA were rewritten for Section 404 purposes, resulting in excessive work and

cost. The burdens of Section 404 are also having an impact on nonregistrants as the AICPA and the PCAOB work to make the auditing standards for FDICIA and Sarbanes-Oxley 404 the same.

For illustrative purposes, my own company, the Benjamin Franklin Bank Corp. in Franklin, Massachusetts, a community bank

with $913 million in total assets, employing 186 people, incurred

costs of approximately $420,000 and over 2,200 internal man hours

during 2006 to comply with Section 404. This represents 6 percent

of our normalized 2006 earnings.

My experience is not unusual. Most community banks have similar scenarios. This expenditure of time and money has not improved our ability to manage the bank.

Given my experience with Section 404, I would like to raise three

areas of concern: The revised and reformed rules, which need to be

finalized with utmost speed; the implementation of the rules, which

needs to focus on cost reductions; and the application of Section

404, which needs to be delayed for non-accelerated filers to give

them time to adjust to the updated rules.

First, the rules related to Section 404 appear to be improving.

The SEC and the PCAOB proposals have the potential to reduce

the cost of compliance for all filers while retaining the strong investor protections. The proposed guidance and auditing standards

need to be finalized, though, with utmost speed.

Another set of rules, those related to shareholder thresholds for

SEC registration, must be updated. Under the Securities Exchange

Act, companies are required to register if they have total assets exceeding $10 million and 500 or more record shareholders. Because

nearly all banks exceed the $10 million threshold, the only criterion of importance is the record shareholder threshold. The

shareholder level has remained at the same level since it was first

set in 1964. Accordingly, the ABA strongly recommends updating

the Exchange Act registration shareholder threshold to between

1,500 and 3,000 record shareholders. The threshold for de-registration should also be brought in line to between 900 and 1,800 record

shareholders.

Second, the implementation of the rules need to focus on cost reductions which will only be realized if the auditing firms apply

them as intended by the rule makers. The SEC and the PCAOB

have achieved the proper balance with their proposals, but monitoring the results will be extremely important in determining the

successes of these changes.

Finally, concerning the application of Section 404, non-accelerated filers need a delay of the compliance date. It is imperative

that the rules are successfully implemented and tested before requiring non-accelerated filers to comply. It is also necessary to provide non-accelerated filers with adequate notice, a minimum of one

64

full year in the case of calendar-year companies, in advance of the

required compliance. This prevents the smaller companies from

wasting valuable resources on and overpaying for unnecessary internal control work.

We are concerned that during the recent Section 404 meeting of

the SEC, there was no mention of a specific delay of the compliance

date for non-accelerated filers. It is urgent that the SEC provide relief to these small businesses in a timely fashion. Non-accelerated

filers are required to produce reports this year on internal controls.

In order to comply, they must decide now whether to follow the old

rules or follow the recently proposed rules. Placing such a significant time constraint on these smaller companies is unreasonable.

The clock is ticking for these non-accelerated filers and the alarms

are ringing.

In conclusion, thank you for holding this hearing and allowing us

the opportunity to provide our observations to you.

[The prepared statement of Mr. Venables follows:]

65

66

67

68

69

70

Chairman KERRY. Thank you very much, Mr. Venables. That was

very helpful.

Mr. Wasielewski?

STATEMENT OF RICHARD WASIELEWSKI, VICE PRESIDENT

AND CHIEF FINANCIAL OFFICER, NORTECH SYSTEMS, INC.

Mr. WASIELEWSKI. Good afternoon. I would like to thank Chairman Kerry, Ranking Member Snowe, and the other Committee

members for this opportunity to share our company’s experience

and insights into the benefits and costs of complying with the Sarbanes-Oxley Act of 2002 and the increased SEC regulations. I am

also honored to participate in this hearing with Chairman Cox and

Chairman Olson.

My name is Richard Wasielewski and I am the Vice President

and Chief Financial Officer for Nortech Systems, Incorporated. To

provide some background on Nortech, we are a publicly traded

Minnesota corporation organized in 1990. We file annual and quarterly reports, proxy statements, and other documents with the

SEC. We are an electronic manufacturing services company with

facilities in Minnesota, Wisconsin, Iowa, and Monterrey, Mexico.

We have over 1,100 employees who manufacture wire harness and

cable assemblies, electric sub-assemblies, and printed circuit board

assemblies for a variety of original equipment manufacturers. Approximately 950 of these employees are U.S. employees and 150 are

supporting our Monterrey operations. The primary markets we

serve are industrial equipment, medical equipment, military/defense, and transportation. Our 2006 revenue was just over $105 million, with a net profit of $1.3 million, or 1.25 percent. Our industry is highly competitive.

We are battling against global competitors with significant greater

resources. We have assets totaling $42 million and a current market capitalization of just over $20 million.

Over the last 5 years, our compliance costs have increased almost

21⁄2 times, from $376,000 in 2002 to $933,000 in 2006. We estimate

that approximately 50 percent of this increase is the result of the

cost incurred from the Sarbanes-Oxley compliance and internal

control initiatives while the other 50 percent is cost incurred on expanded SEC and Financial Accounting Standards Board reporting

requirements.

Despite these high costs, Nortech’s board of directors, CEO, CFO,

and officers fully support the goals and objectives of the SarbanesOxley Act of 2002 and believe in the U.S. capital markets. The

major benefits to date of this Act is the assurance and continuous

confidence our investors have in our company reporting of financial

and management performance, along with the additional governance from a stronger internal control of our financial processes.

Our internal control policy and procedures are benefiting from a

solid structure of clearly defined roles and responsibilities, risk assessment, monitoring, and corrective actions for continued improvement.

However, these benefits come at a significant cost to Nortech

from large administrative costs and fees necessary to meet regulations. Our company faces a competitive disadvantage against large

public companies with great economies of scale, as well as private

71

and foreign companies that do not have to comply. Our relatively

small finance department spends a disproportionate amount of

time on regulatory compliance activities rather than supporting the

business and operations.

Every dollar spent on increased regulatory requirements is one

dollar less we are able to spend on growth opportunities, capital investment, and our ability to attract new investors to our company.

Every hour spent by me and my staff on regulatory requirements

is one hour less that can be devoted to overseeing the critical financial performance metrics essential for day-to-day operating decision

as well as short- and long-term financial planning.

We know that the SEC and the PCAOB teams are working hard

to understand the impacts increased regulations and oversight

have on small business companies such as Nortech. We look forward to the new guidance on Section 404 for small companies to

help us reduce costs and save time in order to keep us competitive

in our global marketplace and provide our shareholders a fair return on their investment.

We support the Committee on Small Business and Entrepreneurship and their request that the implementation date of 404 for

small companies be delayed from the current effectivity date. This

delay will allow us to continue to build upon our current internal

control processes without the time and cost pressures the current

deadlines have and also allow us to field test the new guidance for

small businesses.

In conclusion, we believe the great opportunity and major benefits of 404 are already in place. Investors’ confidence has been restored in U.S. capital markets and improved control processes helping companies like Nortech better manage internal control systems

are in place. For the competitive health of smaller U.S. companies

like Nortech Systems, it is vital that our future compliance burden

be scalable.

Thank you again for the opportunity to participate in today’s

hearings and for the Committee’s interest in this critical issue to

Nortech and small businesses.

[The prepared statement of Mr. Wasielewski follows:]

72

73

74

Chairman KERRY. Thank you very much, Mr. Wasielewski.

Mr. Piche?

STATEMENT OF JOSEPH PICHE, CHIEF EXECUTIVE OFFICER

AND FOUNDER, EIKOS, INC.

Mr. PICHE. Chairman Kerry, Ranking Member Snowe, and members of the Committee, it is an honor to testify this morning regarding the impact of Sarbanes-Oxley on small businesses. My

name is Joe Piche and I am the founder and CEO of Eikos, Inc.,

in Franklin, Massachusetts. We are a small nanotechnology company that makes flexible, transparent, conductive films and coatings, and Eikos last year won the Wall Street Journal’s Technical

Innovation Award globally for the most innovative material in the

world.

We started in 1996 and we have grown to 16 very talented peo- ple. In 2006, we had approximately $3.5 million in sales and our

products have applications around the world. We have one licensee

in Japan. As much of our commercial sales are in Japan and Asia,

we contribute in a small way to reduce America’s trade deficit.

I am pleased with what my team has accomplished, but we have

reached a point where we need to access capital markets in order

to expand. We have explored various options and concluded the

best venue for raising the required capital for expansion might lie

in the public markets. As such, we have explored the options within the United States and concluded that the atmosphere for doing

so here is less favorable than utilizing other public markets, such

as the AIM in London.

I am not an economist nor an accountant nor an expert in the

details regarding issues of the regulation of public companies. I am

a chemist by training, and from my perspective as an entrepreneur,

the atmosphere for raising capital in the United States has taken

a turn for the worse, specifically with regards to going public and

the costs associated with compliance for a small public company in

the United States.

At Eikos, we believe that some aspects of Sarbanes-Oxley have

contributed to the current change in the financial climate in the

U.S. capital markets. While Sarbanes-Oxley has had positive impacts, it has made it more difficult for me, a private company, and

has dramatically increased our costs of doing business.

Let me say from the outset, I believe Sarbanes-Oxley, for the

most part, is very good legislation. Entrepreneurs like me depend

75

on our capital markets, and our capital markets depend on trust.

Sarbanes-Oxley and the PCAOB have helped to restore the trust

that corporate accounting scandals have helped to destroy. But

over time, it has become clear that some of the secondary impacts

of Sarbanes-Oxley have made it more difficult for companies like

mine to do business.

Regarding increased costs, as I have mentioned, Eikos needs to

raise capital through private equity markets. However, due to increased regulations, the costs for our company to obtain this equity

is extraordinarily high. The accounting costs specifically associated

with taking a company public are now so large they threaten to

wipe out the funding that a company like Eikos would receive in

its IPO. So what is the incentive to take the company public when

the company will not gain any capital as a result?

The increased cost of accounting has far broader effect on a small

company than just the question of whether or not to go public. Sarbanes-Oxley has increased the price of accounting services. I have

witnessed a dramatic increase in the costs at Eikos. This cost is

small relative to the huge resource expenditure that public companies are now required to make as part of Sarbanes-Oxley. For example, I see other nanotechnology companies that have gone public

or are public and they are now spending more per employee on

Sarbanes-Oxley compliance than they are spending on health care.

This should not be.

With regards to liability, the increased liability imposed by Sarbanes-Oxley makes it simply not worth the risk to serve on the

board without good D&O insurance. Before Sarbanes-Oxley, I could

buy insurance for approximately $8,000 a year. Immediately after,

the price shot up to approximately $40,000 to $50,000, a substantial increase. And it is not the same policy. The deductible went up

and the coverage is much less comprehensive.

At Eikos, we offer the best available health insurance. This is

something I refuse to compromise because I do not want my employees to ever worry about their health or the health of a family

member. But the high cost of D&O insurance forced me to make

a decision between maintaining this high standard of health insurance versus maintaining D&O insurance. Hence, I have lost board

members because of the lack of our D&O insurance.

Driving investment overseas, it is our transparency and accountability that inspire the global investment community’s confidence

in American markets, and that attracts investments from around

the world to the United States. Sarbanes-Oxley was designed specifically to strengthen the world’s confidence in our markets and

thus attract even more foreign investment. This was a noble goal

and in many ways has succeeded well. But in some ways, it has

gone too far. Some of the very requirements of Sarbanes-Oxley that

were designed to restore global confidence in the American markets

by creating tremendous financial incentives for private companies

to go public not in the United States, but in other countries. By increasing the costs of going public in the United States, SarbanesOxley is giving foreign capital markets a competitive advantage

over American markets.

Eikos has considered carefully going public on the London AIM

exchange. We estimate the cost in the United States to be approxiVerDate 11-MAY-2000 14:24 Feb 14, 2008 Jkt 039880 PO 00000 Frm 00079 Fmt 6633 Sfmt 6633 C:\SBA\39880.TXT CELINA PsN: CELINA
76

mately $2 million, but only $500,000 to $600,000 on the AIM. We

are by no means alone. In foreign markets, the percentage here has

increased in the last several years whereas the United States has

held relatively stagnant or decreased.

In conclusion, I would like to thank you, Senator Kerry, for your

leadership in sponsoring legislation to help make it easier for small

businesses to comply with Sarbanes-Oxley. I would also like to

thank the members of the Committee for your ongoing commitment

to support small businesses like Eikos. America’s small businesses

are the engines of innovation and employment and they are absolutely essential to our continued competitiveness in this century.

[The prepared statement of Mr. Piche follows:]

77

78

79

80

81

Chairman KERRY. Thank you very much, Mr. Piche.

Let me just pick up with you, since you testified last. So what

would you do? What is the balance here?

Mr. PICHE. What would I do today? I would use the London AIM

because I utilize the concept of Ockham’s razor. When you have

two different alternatives, I take the simpler and the more cost effective for the company, because as the CEO, it is my duty to do

that which provides the most benefit to the stockholders and the

employees, many of which are stockholders.

Chairman KERRY. How do you do that and maintain the integrity

that everybody has fought for? There are a lot of folks who believe

that the London standard, in fact, has no minimum size requirements, no minimum public float, no minimum share value, no government review of company disclosure documents, and so, in effect,

they are exempting people from the full code of corporate governance. I mean, the so-called ‘‘attraction’’ is to go back to the Wild

West.

Mr. PICHE. I understand what you are saying. I am not an expert

in this area. However, as a CEO, I am focused on the growth of

the corporation and, therefore, our perspective is we care very

much about corporate governance and we are not in a position to

make decisions regarding how the law should be changed or modified in any way. However, we would like to run Eikos in a right,

good, and proper way. When we talk to the people that come to our

company, knocking on our doors as representatives of the AIM,

often unsolicited, we——

Chairman KERRY. Is that what is happening? They are coming

over here and come to our market because we are——

Mr. PICHE. That is correct, yes. It has happened to us at Eikos,

so——

Chairman KERRY. Well, I wish—again, this is the problem you

have when you have the order of testimony, and we tend to do this

on all our committees here, the regulatory folks first and then they

are gone. It would be good to get the interaction, actually. I think

in the future, I am going to try to see if we can’t set it up that way

a little better.

Obviously, the testimony of Chairmen Cox and Olson is that they

are moving in Europe to adopt a similar standard here. Now, the

AIM actually contradicts that, and in fact, there was a pretty dramatic example recently of a company that placed a convertible loan

stock on the market. It knew its financial performance was going

to fall short, and when they prepared a news release to that effect,

the investment banker advised them to withhold it until after the

offering was complete, and they did, and then, of course, the news

came out and it lost 75 percent of its value in 2 days and it got

a tiny slap on the wrist. I mean, it was like nothing had happened.

So again, that is clearly not the standard that we want to go back

to.

Mr. PICHE. Correct.

Chairman KERRY. We would like to see people move rapidly to

here. I assume we may be losing a few folks who want to go out

into that kind of an atmosphere, but I am sure that investors

broadly, as they look at the movement of capital and the safety of

that capital, are going to ultimately have some problems with that.

82

Mr. PICHE. Possibly. However, the way we look at it at Eikos, if

I may say so——

Chairman KERRY. Yes.

Mr. PICHE [continuing]. Is that our example is if we are going to

put an addition on a home and we needed to borrow $250,000 for

an addition for new bedrooms for children or such and we have the

opportunity to get it from bank one at a certain rate, but we can

get it at bank two at half the rate, we will get it at bank two at

half the rate, end of discussion. We go in the direction of——

Chairman KERRY. So the bottom line——

Mr. PICHE [continuing]. What is best for the——

Chairman KERRY [continuing]. Will drive it no matter what? Mr.

Wasielewski, you are nodding your head in assent there. Do you

want to add on?

Mr. WASIELEWSKI. Yes. It gets back to the cost versus the benefit. Is it worth it?

Chairman KERRY. I am struck. You are on a pretty tight profit

margin.

Mr. WASIELEWSKI. Yes, we are, and——

Chairman KERRY. With that kind of revenue, that surprised me.

Mr. WASIELEWSKI. We need the different markets to raise capital. We believe in the U.S. markets. It is our next area to raise

capital and cash to fund our growth, but we also have to balance

that against venture capital and even going private. So we do that

on a constant basis and it is reviewed on an annual basis, sometimes more often.

Chairman KERRY. And your net view of Sarbanes-Oxley is—I

mean, you seem to support in your testimony the notion of having

this kind of accountability, but you have a ‘‘but’’ there, right?

Mr. WASIELEWSKI. Yes, absolutely. It is getting to where it is

working—it was encouraging to hear the discussion earlier that

they are working towards it, that they are taking our scale into

consideration. I am concerned that when these 6,000 other filers

hit the marketplace, what it is going to do to the cost again to the

accountants and auditors and services that are going to be needed.

Is that going to do another bump in our costs that you have on the

board? Are they going to go higher? Are they going to be 26 cents

and $2? That is a real concern of ours. So they really have to keep

that cost-benefit under control.

Chairman KERRY. Mr. Venables, you all heard the testimony of

the folks who preceded you. I know I have heard this from bankers

previously about the FDIC experience and so forth and that the

404 seems to go beyond that and you felt that it was adequate, and

there is every indication that it was adequate, as a matter of fact.

Were you satisfied that what they said is going to sufficiently take

into account the concerns you all have expressed?

Mr. VENABLES. Only partially, Mr. Chairman. If I can give you

a little example from our own company, in 2002 when I became

CEO of Benjamin Franklin Bank, the bank had run amuck of some

regulatory matters and there was a requirement for a new CEO to

come in and I was part of that change. At the time, the bank was

$450 million in size. It was not required to be FDICIA registered

in any way, but I made the decision as a new CEO that I wanted

83

to make sure I understood the controls. I wanted to make sure we

had a proper framework for risk.

And so we did an early adoption of FDICIA and voluntarily implemented those controls and I had a very powerful management

tool out of the FDICIA exercise to enable me to understand exactly

how this company was running and what changes needed to be

made. We emerged from the excess regulatory oversight almost immediately and enjoy a very, very high rating in all of our areas, especially in our compliance areas.

Now, in 2005, we did an initial public offering. Obviously, we become affected by Sarbanes-Oxley. In 2006, we became an accelerated filer and needed to go through that whole exercise as I outlined. That whole exercise resulted in these tremendous costs as we

have outlined, and yet I did not pick up any additional ability to

better manage our company. I think that is the big frustration.

When I hear the PCAOB and the SEC talk about reforms, I am

greatly encouraged. We think that is definitely heading in the right

direction. But there are a couple caveats. The first is the devil will

be in the details, and unfortunately, as a new Accounting Standard

5 is being evolved, there are decisions that need to be made today

by managements of companies who are non-accelerated filers with

respect to how they need to implement these controls and to which

standards are they needing to adhere. I think ABA is very troubled

by the fact that until those standards are actually in place, it is

unfair to set deadlines for compliance and we really feel that there

should be a full year after the final rules are generated before

smaller companies——

Chairman KERRY. Sure. Well, I see the folks who are here taking

some notes on that. I think that is an important thing for us to

convey and to have some dialogue with the folks who testified previously.

Senator Snowe and some of my colleagues will draw this out a

little more, so let me cede my time here.

Senator SNOWE. Yes. To follow up on that delay, were you suggesting a year delay from——

Mr. VENABLES. We are suggesting a year delay from when the

final rules have been put in place and tested. Our concern is that

it is changing rapidly. My own experience as a company, I know

that the Chairmen feel that implementation sometime in June

would be adequate for the controls that are necessary for the yearend financial statements. I assure you they are not. There are two

things happening at once.

One, there is a tremendous resource drain, and by that, I mean

not only the internal small business staffers who need to put all

this in place, but also the outside experts. They all will have this

crush of companies that need to comply and the meter runs very

high in those types of scenarios.

Secondly, the way the rules work and the proper framework is

that you build the framework and then you test. You may find as

a result of the test that you have a deficiency. If you find you have

a deficiency, then you need to fix that and then retest. Every one

of those cycles is a 3-month—is a quarterly cycle, so that if you do

have control issues that need addressing, you may not have an opportunity to address them and have them implemented by the time

84

of your annual statements at the end of the year, and that could

have serious repercussions.

Senator SNOWE. I see. So when you are talking about non-accelerated filers, they haven’t done any testing on those standards, or

audited those standards, because they haven’t been put in place?

Mr. VENABLES. That is correct.

Senator SNOWE. So when they were talking about the various

dates, March 2009, the date companies need to have the auditors

review their company’s internal controls, does that apply to non-accelerated filters?

Mr. VENABLES. I think that is what they are addressing, yes.

Senator SNOWE. But that is not sufficient because companies

need to furnish their assessment of those controls in March of

2008.

Mr. VENABLES. Senator, if the rules were in effect today, that

could very well be sufficient.

Senator SNOWE. OK. So it is just a matter of time, that is the

big question.

You mentioned the fact of increasing the number of shareholders—the current is 500 to 1,500 or 3,000. Can you explain how

that would benefit community banks, for example?

Mr. VENABLES. Certainly.

Senator SNOWE. What would be the benefit of that?

Mr. VENABLES. It is one of these issues that existed, and then

with the advent of Sarbanes-Oxley and all of this talk it became

a much more critical issue. Today, the threshold for non-filers is

the 500 record shareholders and the $10 million in assets. Well, in

banks, we all have more than $10 million in assets, so it is the 500

shareholders. The standard was set in 1964.

Over the course of the years, in these small, rural in many times,

banks, there may be generations that are inheriting the stock, and

where you might have had one holder, now you have three children

and then you might have five grandchildren, and over time, the

number of shareholders has crept larger. The statute has not

changed at all to keep up with the number of investors.

ABA did some research and determined that, and you can pick

any standard, but one that they found was a reasonable approach

was let us look at the number of shareholders there are out there

in the investing public back in 1964 and let us look at the number

today, and if we apply that same rate of growth, the 500 threshold

limit of 1964 would be more like the 1,500 to 3,000, depending on

how you interpret the data, of today. So it is merely trying to have

that change sort of indexed for the fact that there are many more

investors and there are small companies that have a tough choice,

because if they go over 500, they become registrants. They can’t

necessarily—there is still an investment opportunity——

Chairman KERRY. It is still small income.

Mr. VENABLES. Yes.

Senator SNOWE. I know that some of the banks that I have heard

from in Maine are having to both comply with the banking regulations as well as Sarbanes-Oxley. Is there no way to consolidate any

of these requirements?

Mr. VENABLES. Well, I don’t think there is a way to consolidate

all of it, but I think a lot of the auditing standards can be made

85

similar so that we are not doing a completely different controls

framework by one set of standards and then also maintaining

FDICIA. I will tell you in the case of my own company, you may

know that the FDICIA standard has now gone to $1 billion. Well,

we are a $913 million company and we have decided to continue

with FDICIA controls because we can discontinue perhaps this

year, but with any growth, we will be facing them again. So we are

maintaining two sets of intense risk management frameworks and

I don’t think that is necessary.

Senator SNOWE. Thank you. Mr. Wasielewski and Mr. Piche,

could you tell me, was there anything that you heard from both

Chairman Cox and Mr. Olson with respect to the issues that they

addressed in harmonizing the audits, any of the issues that made

it more positive?

Mr. WASIELEWSKI. Let me take that. The integration audit is

really important because that could help us greatly on costs. You

are working with the same audit team. I think that comment has

probably got the biggest benefit that would be the biggest step that

could be taken. The fear is to have a different audit team in there

and have to reeducate them just like you do on your financial statements. These folks know our business. They know our processes already. That could be a definite benefit, so that is an encouragement.

Senator SNOWE. And you mentioned scalability. Do you think

that it addresses that in that sense, that it avoids the one-size-fitsall?

Mr. WASIELEWSKI. I don’t know.

Senator SNOWE. Yes.

Mr. WASIELEWSKI. Based on what he said, I have a feeling that

is the tough nut in how they go about trying to get that equal on

that slide behind you in the future.

Senator SNOWE. Right.

Mr. WASIELEWSKI. We just get the higher price of audit and auditors and accountants by supply and demand, I think, is the biggest

issue that we are going to face.

Senator SNOWE. That is why we need to get an updated assess- ment of the costs, you know, for every $100 revenue, it is $1.14 in

audit costs.

Mr. WASIELEWSKI. Remember, there are only a couple thousand

that file today and, 6,000 that haven’t filed yet. That work hasn’t

been done on our side and the impact isn’t on theirs either. We

have done a lot. We have improved the internal control. We feel it

is a lot better. I know our investors do. It is just that it would be

nice to field test what they are proposing right now, so we could

understand the impact or it might even be more.

Senator SNOWE. Mr. Piche?

Mr. PICHE. Regarding that specific question?

Senator SNOWE. Yes, that is right. Yes. Was there anything that

you heard that was more positive that might affect the bottom line?

Mr. PICHE. My concern is that I didn’t necessarily hear a clear

pathway that I understand, but again, I am not a professional accountant or regulator, I am a chemist by training and an entrepreneur, and my fear is that it sounds slightly more complex, because then there is now another level of making determinations

86

and definitions as to, well, what should be audited and where do

the limits begin and end. So there might be another layer of requirements on top of the ones that already exist.

Senator SNOWE. And in your particular situation, would you wait

to see how, this all shakes out in the process?

Mr. PICHE. We cannot.

Senator SNOWE. No, you cannot.

Mr. PICHE. No. I think no small company can. It is a global economy. My competition is everywhere.

Senator SNOWE. Right. It is interesting because the GAO did a

study of IPOs in the period between 1999 and 2004 and showed a

decrease of IPOs, from 70 percent to 46 percent. So it would be interesting to know exactly where that stands today. I think that is

true, because the initial capitalization is extremely important for

any small company, small public company. This is a real issue, because you are really the essence of job creation in many ways.

When you grow from a small business to a public company, that

is where the innovation emerges.

So I think this is something we are going to have to examine. At

the same time we must make sure we calibrate the right approach

and preserve the public interest in response to what happened with

Enron and WorldCom.

Thank you. I appreciate your comments here today. Thank you.

Chairman KERRY. Thank you.

Senator Coleman?

Senator COLEMAN. Thank you, Mr. Chairman. I associate myself

with the comments of the Senator from Maine in terms of what we

have to do here. Just two quick questions—and by the way, this

has been a very good hearing, very helpful. We have talked about

or just touched upon various issues—willingness to serve on

boards, what kind of direction and leadership are going to be available to small business if folks find it difficult or impossible to serve

on boards, and the cost of accounting, and then as the system

grows, the pressures of supply and demand is just going to push

up the costs. So we haven’t capped out costs here. If anything, they

are going to rise significantly.

Just two quick questions. Mr. Venables, you made the point

about the need for delay perhaps of 1 year for those non-accelerated filers, but the other point, then, I take it, is that it is urgent

that that decision be made soon. That has got to be one of the factors. Rather than wait for us in Congress to do something, it is my

sense you need to know soon whether there will be delay for that

year?

Mr. VENABLES. Certainly, Senator Coleman, and in conjunction

with that, as well, the work that you heard PCAOB and the SEC

working on together with respect to the new audit standards also

needs to be finished as quickly as possible.

Senator COLEMAN. I hope, again, staff is listening. It goes to the

Chairman’s point about having folks here to hear that.

Mr. Wasielewski, you were actually very positive about some of

the changes but talked about cost. I don’t know if I heard this.

Have you thought about going private? In spite of you being profitable, you have got a really thin line here. You make, what, one

point, you spend about as much on auditing as you make in profit.

87

Mr. WASIELEWSKI. Yes.

Senator COLEMAN. Where are you at on that decision?

Mr. WASIELEWSKI. Well, I think the board and our CEO and I

and the officers review it on an ongoing basis. Again, we do believe

in the U.S. capital markets and that that is a good place for us to

get some cash and invest in our business. So right now, that is the

strategy. As these things grow and these things pan out, you know,

they are always taken into consideration. It is a dynamic decision

point. We do review it, not at every board meeting, but at least one

time a year, that particular situation.

Senator COLEMAN. So it gets to that question of balance and at

certain points the balance tips over and says, we can’t afford to be

in this public market. We just have to go private.

Mr. WASIELEWSKI. And again, it is a balance of benefits and cost.

I think everybody said that. It is definitely, and I think nobody

would disagree that it is definitely weighted now on the costs. The

benefits are in place the last 5 years. Our internal controls are better. Most small companies are better. It is the question of how

much more better do we have to get and at what cost.

Senator COLEMAN. Mr. Chairman, thank you.

Chairman KERRY. Thank you very much.

Yes, Mr. Venables?

Mr. VENABLES. If I may make one follow-up comment on the cost,

we have been concentrating, I think, a lot on the first-year cost,

and I do want to share with you an illustration of subsequent costs

because I think they are important, as well. In 2005, our bank

went public and had an acquisition, so obviously we had substantial audit costs related with those transactions. In 2006, we implemented Sarbanes-Oxley. We had substantially higher audit costs.

Our auditors tell us that our budget for 2007 is less than 2006. The

second-year costs are lower than the first-year costs, but they are

still substantially higher than 2005, the year that we went public

and the year that we made an acquisition. So it is embedded as an

additional layer that that will go on for earnings.

Senator SNOWE. May I?

Chairman KERRY. Yes.

Senator SNOWE. Do you think that there has been an impetus to

shift from public to private companies? I mean, there has been a

lot of shift in that respect. Do you think that this has been an impetus for that?

Mr. VENABLES. From my own experience, I can tell you that in

the banking industry, there are certainly many banks that have delayed going public for this reason.

Senator SNOWE. Because of the costs and because of the complexity of the regulations?

Mr. VENABLES. Exactly.

Mr. WASIELEWSKI. Let me just add to that. It is not only Sarbanes-Oxley and the internal control, it is all the SEC regulations

and compliance stuff that have taken place. Our 10(k) in 2002 was

47 pages long. This year, it is 95 pages plus. It is a substantial

amount of work to meet these requirements and we are not even

at the Sarbanes-Oxley attestation point yet, so it is not only the internal control.

Senator SNOWE. Thank you.

88

Chairman KERRY. This is tough stuff. If I could just ask Mr.

Piche, speaking generally, to come back to the VC question I asked

earlier. Is it, in fact, making it harder to find investors rather than

easier? As the argument is made, because there is an assurance of

the openness and accountability, do investors feel safer or is it

harder?

Mr. PICHE. From the investors’ perspective? Well, from the CEO’s

perspective whose ambition it is to raise money to grow the corporation, from the many CEOs that I know, I think we uniformly

believe that it has become more difficult. I was at a meeting of the

Nano Business Alliance yesterday and I talked with many CEOs

over the course of 2 days in Manhattan. I had the opportunity to

be on the floor of the NASDAQ yesterday at the closing as part of

that and it was fun. But I hear anecdotal stories often, in taxi

lines, from friends of mine that are CEOs of small public companies, and we see the same thing, which is that it is harder to raise

funds privately because of it and it is harder to raise funds publicly

and the costs associated are substantial.

Chairman KERRY. I am particularly struck by the issue on the

banks, and I think that it would be important for the SEC and the

PCAOB to look hard at this issue of the FDIC Improvement Act requirements and what the banks are already jumping through and

this question of harmonization, because I have heard this from

small bankers all over the country. What was it that you said? You

said 6 percent—who said 6 percent? Who said 6 percent of your

profits are——

Mr. VENABLES. Six percent.

Chairman KERRY [continuing]. And that is above what you were

already committed to the FDIC?

Mr. VENABLES. Oh, yes. That was just incremental costs——

Chairman KERRY. That is an incremental cost, an additional 6

percent of profit, on a $406,000——

Mr. VENABLES. Exactly, for the implementation effort.

Chairman KERRY. I think that is something that folks really

need to think about hard, especially when there is a pretty strong

individual regulatory process already in place, whether there is a

harmonization process and whether that is sufficient and, therefore, all that is required. I mean, that is a judgment. You talk

about risk assessment and judgment. The risk assessment ought to

be made with respect to that standard, whether or not it is adequate for the industry, since it is an industry-wide standard.

I served on the Banking Committee for 10 years and I was there

when we did the RTC and went through that horrible period, and

I think that since then, we have already responded to the crisis of

confidence in the marketplace and there is no evidence at this

point, in my judgment, that it is somehow being abused. So again,

there is an example potentially—I am saying potentially—of where

this double requirement may, in fact, really be a drag on our economy and a drag on business.

So there is a lot to look at here and I want to—I am confident

that Senator Snowe wants to join with me, and we will team up

to put some thoughts in front of the Chairmen. I think this has

been very important and very, very helpful today.

Senator Snowe, do you have any additions?

89

Senator SNOWE. No. I thank you. I appreciate it, but I think it

does underscore the serious challenges and impediments that you

face. We just really have to make sure that we reasonably understand the impact and the severity of the burdens of these regulations. On one hand, we have to address the public interest question, and on the other hand, we have to make sure that we develop

and encourage job creation through your leadership. These are not

mutually exclusive endeavors. I am sure that we can try to get this

right, and that is what we will attempt to do through some legislative mechanisms, as well. So I appreciate your thoughtfulness and

your comments here today.

Chairman KERRY. Thank you very, very much. Again, thank you

very much, all of you. We appreciate it.

We stand adjourned.

[Whereupon, at 12:33 p.m., the Committee was adjourned.]

(91)

APPENDIX MATERIAL SUBMITTED

92

93

94

95

96

97

98

99

100

101

RESPONSES BY SEC CHAIRMAN COX TO QUESTIONS FROM SENATOR SNOWE

102

103

104

105

106

107

108

109

110

111

112

113

RESPONSES BY PCAOB CHAIRMAN OLSON TO QUESTIONS FROM CHAIRMAN KERRY

114

115

116

RESPONSES BY PCAOB CHAIRMAN OLSON TO QUESTIONS FROM SENATOR SNOWE

117

118

119

RESPONSES BY PCAOB CHAIRMAN OLSON TO QUESTIONS FROM SENATOR PRYOR

120

121

RESPONSES BY PCAOB CHAIRMAN OLSON TO QUESTIONS FROM SENATOR ENZI

122

123

124

RESPONSES BY RICHARD WASIELEWSKI TO QUESTIONS FROM SENATOR PRYOR

Question 1. You have a copy of the letter sent to SEC Chairman Cox and PCAOB

Chairman Olson from Senators Kerry and Snowe, as well as the SEC and PCAOB

responses in the binder. [The referenced letters appear in Appendix Material Submitted on pages 126–131.] The SEC response notes that four separate extensions

have been given to small businesses regarding compliance with Section 404 of the

Sarbanes-Oxley Act, with the most recent extension granted on December 2006. The

December 2006 extension said that non-accelerated filers (less than $75 million in

market cap) had to comply with Section 404(a) providing management’s assertions

on internal controls for calendar years ending after December 15, 2007, and with

Section 404(b) external auditor’s internal controls audit for calendar years ending

after December 15, 2008.

Given that the SEC granted four extensions in order for small businesses to have

more time to comply with Sarbanes-Oxley Section 404, what have you been doing

during this time to get your own company’s internal controls in order? What challenges have you found? Have you discussed this with your external auditor?

Response. [Submitted in a question and answer format as follows:]

What have you been doing with the extension time?

Our relatively small finance department continues to spend a disproportionate

amount of time on increasing regulatory compliance rather than supporting the

business and operations. When time permits we are implementing internal control

policies and procedures with clearly defined roles and responsibilities, priority management, risk assessment, monitoring, and corrective actions for continued improvement according to generally accepted best practices and the latest guidance. We

have been able to use this time to draft and organize a formal document of our internal control policy and procedures. We are currently working on updating this document and beginning to develop test plans and tracking of our critical and material

control points. The final step will be to formalize the management assessment process.

An additional extension will allow us to continue to build upon our current internal control processes without the time and cost pressures of the current deadlines

and requirements as well as, have a chance to review and incorporate the new SEC

and PCAOB interpretive audit standard guidance for management assessment and

auditor reporting.

What challenges have you found?

Our challenge continues to be the time required to develop and implement a formal and documented internal control process while trying to support our business

and the increased compliance costs of our audit, consulting and GAAP advising fees

due to the increased demand for auditor resources.

Have you discussed this with your external auditor?

We have as part of our audit committee meetings continued to update our auditor

on our progress. They are waiting to see what the new guidance will be and to what

extent we can incorporate into our internal control plans this year given the late

release date.

Thank you again for the opportunity to provide additional input to the committee.

RESPONSES BY JOSEPH PICHE TO QUESTIONS FROM SENATOR PRYOR

Question 1. You have a copy of the letter sent to SEC Chairman Cox and PCAOB

Chairman Olson from Senators Kerry and Snowe, as well as the SEC and PCAOB

responses in the binder. [The referenced letters appear in Appendix Material Submitted on pages 126–131.] The SEC response notes that four separate extensions

have been given to small businesses regarding compliance with Section 404 of the

Sarbanes-Oxley Act, with the most recent extension granted on December 2006. The

December 2006 extension said that non-accelerated filers (less than $75 million in

market cap) had to comply with Section 404(a) providing management’s assertions

on internal controls for calendar years ending after December 15, 2007, and with

Section 404(b) external auditor’s internal controls audit for calendar years ending

after December 15, 2008.

Given that the SEC granted four extensions in order for small businesses to have

more time to comply with Sarbanes-Oxley Section 404, what have you been doing

during this time to get your own company’s internal controls in order? What challenges have you found? Have you discussed this with your external auditor?

125

Response. [Mr. Piche’s response to question 1 was not available at the time the

hearing record was printed.]

Question 2. There are intangible effects of Sarbanes-Oxley that impact corporate

management. The requirements that the CEO and CFO certify their company’s financial statements, coupled with the Act’s implicit notion that the directors are

‘‘gatekeepers’’ capable of preventing fraud, has focused boards of directors on compliance matters instead of corporate strategy; anecdotal evidence suggests that more

time is spent on compliance in today’s boardrooms than on the business of the company. Mr. Piche, in your testimony you mention the increase in the cost of Directors’

and Officers’ (D&O) insurance, an increase of 500 percent since the Act’s enactment,

and that the increased liability imposed by the Act makes it simply not worth the

risk to serve on a board of directors without insurance. Please explain what other

impact the Act has on the board. Is there evidence to suggest that directors spend

more time on compliance issues rather than corporate strategy?

Response. [Mr. Piche’s response to question 2 was not available at the time the

hearing record was printed.]

126

127

128

129

130

131

(133)

COMMENTS FOR THE RECORD

134

135

136

137

138

139

140

141

142

143

144

145

146

147

148

149

150

151

152

153

154

155

156

157

158

159

160

161

162

163

Æ