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SARBANES OXLEY SECTION 404: WHAT IS THE

PROPER BALANCE BETWEEN INVESTOR PROTECTION AND CAPITAL FORMATION FOR

SMALLER PUBLIC COMPANIES?

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS 

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

WASHINGTON, DC, MAY 3, 2006

Serial No. 109–51

Printed for the use of the Committee on Small Business

(

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

COMMITTEE ON SMALL BUSINESS 

DONALD A. MANZULLO, Illinois, Chairman 

ROSCOE BARTLETT, Maryland, Vice 

Chairman 

SUE KELLY, New York 

STEVE CHABOT, Ohio 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

BILL SHUSTER, Pennsylvania 

MARILYN MUSGRAVE, Colorado 

JEB BRADLEY, New Hampshire 

STEVE KING, Iowa 

THADDEUS MCCOTTER, Michigan 

RIC KELLER, Florida 

TED POE, Texas 

MICHAEL SODREL, Indiana 

JEFF FORTENBERRY, Nebraska 

MICHAEL FITZPATRICK, Pennsylvania 

LYNN WESTMORELAND, Georgia 

LOUIE GOHMERT, Texas 

NYDIA VELA ́ ZQUEZ, New York 

JUANITA MILLENDER-MCDONALD, 

California 

TOM UDALL, New Mexico 

DANIEL LIPINSKI, Illinois 

ENI FALEOMAVAEGA, American Samoa 

DONNA CHRISTENSEN, Virgin Islands 

DANNY DAVIS, Illinois 

ED CASE, Hawaii 

MADELEINE BORDALLO, Guam 

RAU ́ L GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

LINDA SA ́ NCHEZ, California 

JOHN BARROW, Georgia 

MELISSA BEAN, Illinois 

GWEN MOORE, Wisconsin 

J. MATTHEW SZYMANSKI, Chief of Staff 

PHIL ESKELAND, Deputy Chief of Staff/Policy Director 

MICHAEL DAY, Minority Staff Director

(II) 

C O N T E N T S 

WITNESSES

Page 

Wander, Mr. Herbert S., Chairman, SEC Advisory Committee on Smaller 

Public Companies ................................................................................................. 4

Broderick, Mr. Bill, Chief Financial Officer, Analytical Graphics, Inc. .............. 6

Crandell, Mr. Keith, Managing Director, ARCH Venture Partners .................... 9

Neiss, Mr. Woodie, Chief Financial Officer, FLAVORx, Inc. ............................... 11

Schroeder, Mr. Mark, President/CEO, German American Bancorp .................... 13

Burns, Mr. James, President & CEO, EntreMed, Inc. ......................................... 15

APPENDIX

Opening statements: 

Manzullo, Hon. Donald A. ................................................................................ 27

Velazquez, Hon. Nydia ..................................................................................... 28

Prepared statements: 

Wander, Mr. Herbert S., Chairman, SEC Advisory Committee on Smaller 

Public Companies .......................................................................................... 30

Broderick, Mr. Bill, Chief Financial Officer, Analytical Graphics, Inc. ....... 54

Crandell, Mr. Keith, Managing Director, ARCH Venture Partners ............. 59

Neiss, Mr. Woodie, Chief Financial Officer, FLAVORx, Inc. ........................ 67

Schroeder, Mr. Mark, President/CEO, German American Bancorp ............. 76

Burns, Mr. James, President & CEO, EntreMed, Inc. .................................. 84

(III) 

(1)

SARBANES OXLEY SECTION 404: WHAT IS THE 

PROPER BALANCE BETWEEN INVESTOR 

PROTECTION AND CAPITAL FORMATION 

FOR SMALLER PUBLIC COMPANIES? 

WEDNESDAY, MAY 3, 2006

HOUSE OF REPRESENTATIVES

COMMITTEE ON SMALL BUSINESS

Washington, DC 

The Committee met, pursuant to call, at 2:00 p.m., in Room 2360 

Rayburn House Office Building, Hon. Donald Manzullo [Chairman 

of the Committee] presiding. 

Present: Representatives Manzullo, Bartlett, Kelly, Akin, Velazquez, Davis, Barrow, Moore. 

Chairman MANZULLO. Good afternoon. The hearing today will 

analyze the impact of Sarbanes Oxley on our nation’s smaller public companies. In particular, this hearing will focus on Section 404 

of SOX. Your White Sox, which are causing the most headaches, 

well, Herb is from Chicago. 

Mr. WANDER. And a White Sox fan. 

Chairman MANZULLO. And a White Sox fan. You don’t want to 

wait another 100 years, Herb. 

In particular, the hearing will focus on Section 404 of SOX, 

which is causing the most headaches and expense for our Nation’s 

smaller companies. 

In 2002, Congress passed with my support the Sarbanes Oxley 

Act, or SOX. Ms. Velμzquez and I both serve on the Finance Committee. 

This legislation was a response to corporate scandals at the large 

companies, such as Enron and WorldCom. However, changes made 

by SOX applied equally to all public companies, regardless of size. 

One of these changes was to perform annual testing of internal 

control under SOX Section 404. These tests require company’s 

management to evaluate whether internal controls are adequate 

and require an independent auditor to sign off on management’s 

assessment. 

Shortly after SOX passed, the SEC estimated in regulations that compliance with Section 404 would cost companies around $90,000 

annually. However, the expected costs in reality did not match up. 

In reality, public companies are paying well in excess of $1 million 

annually to comply with this mandate. 

To its credit, the SEC recognizes that strict compliance with Section 404 may not be beneficial for smaller public companies. This 

is why the SEC has delayed implementation of this provision for 

2

companies with market values under $75 million until July of 

2007. 

In addition, in March 2005 the SEC convened the Advisory Committee to Small Public Companies to analyze the effects of this and 

other SOX provisions on small companies. This panel was also 

tasked with making recommendations to the SEC on what should 

be done to help our smaller public companies cope with the burdens of SOX. 

The Advisory Committee released its final report last week. In 

the report, the Committee recommends that companies with market values of less than $128 million be exempt from Section 404 

unless and until corporate auditing standards are established for 

these companies. While, SOX technically applies only to public 

companies, private companies have plenty of reasons to be nervous. 

The ability to gain access to public markets now turns on whether 

they can stomach the huge costs of Section 404. 

As the witnesses will discuss today, many are just rejecting the 

public markets and staying private. Clearly, SOX has an important 

purpose, however the legislation must not be allowed to overly burden our smaller companies. 

Today we will hear testimony on the compliance burdens SOX 

Section 404 has created for our smaller public companies, and explore whether the recommendations of the SEC Advisory Committee will fix these problems. I look forward to hearing the testimony today, and now yield to the Ranking Minority Member, Representative Velμzquez of New York, for her opening comments. 

[Chairman Manzullo’s opening statement may be found in the 

appendix.] 

Ms. VELμZQUEZ. Thank you, Mr. Chairman. 

This hearing to review the recommendations of the SEC’s Advisory Committee has been a long time coming. Small businesses 

continue to face barriers that hinder their ability to remain competitive and strong. 

The sky-rocketing costs of health insurance and start-up capital 

pose many challenges for entrepreneurs. Both soaring regulatory 

and compliance burdens have consistently been one of their number one concerns. 

Almost every single small business owner and association that 

has testified before this Committee has put reducing the regulatory 

burden at the top of their list for legislative package. That is not 

different with the Sarbanes Oxley Act, as Democrats on the Committee have been hearing from small business owners for nearly 

two years now. Unfortunately, the situation does not seem to be 

getting any better. 

The Sarbanes Oxley Act was intended to strengthen the corporate governance practices of the business community. But, what 

we have heard is that this one comes with a cost, and a particularly steep cost at that. 

The auditing standards, disclosure requirements, and corporate 

governance rules of the Act have added significantly to the operating costs of small companies, many who have gotten stuck in the 

fray. 

Democratic members of the Committee held a roundtable back in 

October, so that we could hear directly from the small business 

3

community on the impact of these reforms. A number of small 

firms we spoke with agree that it is difficult not to support the intentions of Sarbanes Oxley, most notably strong corporate governance and shareholder accountability. Yet, for the 14,000 publicly 

traded companies, the majority of which are smaller firms, Section 

404 of the Act poses a great burden to their future economy vitality. Numerous stories and surveys point to the staggering compliance costs of Section 404 as a major burden on small companies. 

In June, 2003, the SEC estimated the cost of implementing Sec- tion 404 on all registrants at almost $1.24 billion or $91,000 per 

registrant. Yet, time has told that the SEC vastly underestimated 

its calculations. Recent surveys show that the small companies are 

paying an average of nearly $1 million to comply with Section 404, 

and this is simply unacceptable. 

Even though some studies show these costs have declined, they 

are still significant and are bearing a disproportionate burden on 

small firms. 

The complying costs of Section 404 for small companies is approaching 3 percent of revenue, while it is less than 1/10th of 1 

percent for larger companies. 

Adding to concerns this new evidence showing numerous small 

companies suffering under the weight of costly regulations have 

begun to look abroad to go public. There are currently 37 U.S. companies listed on the AIM by the London Stock Exchange, 19 companies alone that have been listed within the last year. 

This so-called Sarbanes Oxley free zones have freed some small 

firms from the strict capital market regulations seen here in the 

U.S. Both Sarbanes Oxley and Section 404 have been cited as primary drivers in this development, which are, in turn, hurting the 

American economy. 

Clearly, there is no end in sight to the burden that so many of 

our Nation’s small firms are forced to face. My Democratic colleagues and I have cited many of these concerns in two recent common letters to the SEC. I am pleased, though, with the work the 

SEC Advisory Committee has done toward finding a solution that 

truly eases the burden and provides relief for small companies. 

With the recent release of the Committee’s recommendations, I 

am hopeful this will become the basis for a real regulatory reform 

proposal. I know that much uncertainty surrounds the SEC’s review and consideration of the Advisory Committee’s recommendations. However, this situation is resolved, I urge the SEC to address the issue straight on and provide smaller companies with definitive relief from Section 404 sooner rather than later. 

I look forward to the testimony of the witnesses today. 

Thank you, Mr. Chairman. 

[Ranking Member Velazquez’s opening statement may be found 

in the appendix.] 

Chairman MANZULLO. And, thank you, Ms. Velμzquez. 

Some of the ground rules, we have a system of lights up there. 

Green is go, yellow is you got a minute to go, and red you are supposed to stop. This is not used in case you don’t stop, okay? 

It’s important to tell your own story. The complete written statements of the witnesses will be made part of the official record, so 

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4

cluded in it. I’m going to keep the record open for three weeks for 

anybody else that wants to submit written statements, but they 

cannot exceed two written pages. No tomes, okay? And, the print 

cannot go below 10 points. So, no footnote prints, for anybody else 

who wants to submit additional statements, including obviously 

members, we’ll keep it open for that. 

Now, we are expecting votes, and having taken the Constitutional Oath to vote. When the bell goes off, we will go out and vote. 

I think there are three votes and that will take probably about a 

half an hour. Votes are anticipated any minute. But what we’ll do 

is, we’ll start first with Mr. Wander and then, what I don’t want 

you to do is to spend so much time looking at the clock that you 

don’t concentrate on your testimony. 

How many here have not testified before Congress before? Oh, 

my goodness, four out of six. Okay. Well, the other two just assure 

them, you know, that nothing is going to happen, and this is a 

very, very serious subject, and it’s unusual to get involved in something this esoteric, but sometimes the small businesses want to get 

larger. There are many companies that come within the SBA definition of small businesses, that is less than 500 employees, and in 

the aerospace industry less than 1,500 employees, that will be in 

this situation. 

So, Mr. Wander, we will start with you. I look forward to your 

testimony. You might want to pull the mike as close to your mouth 

as you can. 

Thank you. 

STATEMENT OF HERB WANDER, SEC ADVISORY COMMITTEE 

ON SMALLER PUBLIC COMPANIES 

Mr. WANDER. Thank you, Mr. Chairman. It’s a delight to be here 

this afternoon, and I thank you for this opportunity to provide oral 

testimony, as well as my written statement. 

Who am I? I’m Herb Wander. I am just recently released from 

my obligations as Co-Chair of the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies. We 

were established 13 months ago, have gone through a very extensive fact-finding process, and submitted our report to the Securities 

and Exchange Commission last Sunday, April 23rd. I’m also a partner with the national law firm of Katten Muchin Rosenman LLP. 

In my written statement, so I don’t have to repeat it, contains 

information concerning the mission of our Advisory Committee, the 

overarching principles we follow, lists the diverse membership, indicates to you all the extensive information gathering process that 

we went through, both in hearings and asking written requests, 

and then there are a total list of our recommendations, which, by 

the way, go beyond Section 404. However, this afternoon I will only 

talk about 404, dealing with internal controls. 

As both the Chair, and as indicated, the original estimates of the 

cost of Sarbanes Oxley, starting with the Senate Report on Sarbanes Oxley, indicated that they thought there would be no increase in auditing costs, have been far off the mark. And so, I am 

not going through that, I think that’s been well documented, I will 

only add that the latest study that the Big Four Accounting Firms 

produced two or three weeks ago by the Charles River Associates 

5

indicated that some of the fees are coming down, but they still approach $900,000 to a million dollars for smaller public companies, 

which in many cases gets to be double digit percentages of their 

cash flow. So, it is truly a big cost, and, indeed, that study also noticed that total auditing costs, that’s both 404 and regular auditing 

costs were relatively flat, having gone up 200-300 percent over the 

last three or four years, so that the cost burden is enormous and 

that’s well documented and I don’t think disputed by anybody. 

We should not forget the fact that, not only have the costs up, 

but it’s the opportunity costs, it’s where do you spend your money, 

do you spend your money on research, and my colleagues who will 

testify I think are far more qualified to talk to you about loss of 

opportunity costs and the costs this puts on them. 

So, I would like to now concentrate on, essentially, our recommendations, because I think there’s ample evidence in the 

record, and after our 13 months I think that it’s well documented. 

I want to emphasize the following points. Our Advisory Committee 

was not here to repeal 404, but to fix it. It is clear that internal 

controls have been controlled since 1977. We think they are important, but they have to work properly for all companies, particularly 

for smaller companies. 

Our recommendations which you read are crafted very carefully, 

and you must read them very carefully. We say, ‘‘Unless and until 

a framework for assessing the 404 that works for assessing internal controls over financial reporting for smaller public companies 

is developed that recognize their characteristic needs.’’ So, what we 

are saying is, it’s time now to get it right, before all those companies that you indicated in your opening remarks will become subject to this, that they don’t have to go through something that everybody in today’s world admits needs a major overhaul. So, we are 

not saying just totally exempt everything. We have put conditions 

on everything, and we say we would like to fix it. 

I also want to mention that none of the critics, Arthur Levitt, 

Lynn Turner, all of the critics, really do admit that there are 

faults, and serious faults, with 404. So the question is, how do we 

fix it, not whether we let it continue to operate, and hope that it 

gets fixed all of a sudden. 

We also want to emphasize that while we are talking about a 

large number of companies under our recommendations, they comprise less than 5 percent of the total U.S. market capitalization. 

People have bandied around, you would exempt 80 percent of the 

public companies. Actually, the number is 70 percent, but the fact 

is that these are the smallest capitalization, under 5 percent of 

total market capitalization. 

We also believe very strongly that we think AST2, which is Accounting Standard No. 2 adopted by the PCAOB needs fixing. The 

PCAOB has done a good job in trying to provide guidance, as well 

as the SEC providing guidance. The guidance has just not worked, 

and we think they ought to go back to the drawing board and make 

changes to the regulation, because those who are applying it look 

at the rule and they look at the guidance secondarily or not at all. 

Chairman MANZULLO. How are you doing on time? 

Mr. WANDER. Well, I’m reminded of the story that the Securities 

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Chairman MANZULLO. No, on time, you are out of time. 

Mr. WANDER. I’m on time, all right. I would just like to close that 

I think my written statement contains all of the necessary information concerning our recommendations, which we think should be 

and, in fact, can be adopted by the SEC and the PCAOB. 

Thank you very much. 

[Mr. Wander’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you very much. 

Our next witness is Bill Broderick, Chief Financial Officer and 

Treasurer of Analytical Graphics, Incorporated. We look forward to 

your testimony. 

STATEMENT OF BILL BRODERICK, ANALYTICAL GRAPHICS, 

INC. 

Mr. BRODERICK. Good afternoon. My name is Bill Broderick. I’m 

the Chief Financial Officer for Analytical Graphics, a software company based in Exton, Pennsylvania, serving the national security 

industry. I also serve as a Board Member of the Small Business 

and Technology Council. 

Chairman Manzullo, Congressman Velμzquez, and Members of 

the Committee, I would like to thank you for holding this hearing 

and the opportunity to testify. 

In the short time we have, I hope to provide some highlights on 

my prepared statement in regards to the unintended consequences 

of SOX and small public companies, and how it has affected my 

company, my small private company. 

Since 1989, AGI has grown to a 250-person company, and has 

been named Best Small Company to Work For in America for 2004 

and 2005. 

Chairman MANZULLO. Bill, I’m going to restart your clock when 

we get back. How does that sound? 

Mr. BRODERICK. That’s okay, Mr. Chairman. 

Chairman MANZULLO. All right? Because I don’t want to have 

people walking out in the middle of your testimony. That doesn’t 

look too good, does it? 

So, we are going to recess for about a half an hour and then we’ll 

be right back. 

Is there anybody here on the panel that has to catch a plane 

later on this afternoon? Okay, then we’ll keep this order. 

[Recess.] 

Chairman MANZULLO. I’m waiting for the alarm clock to reach 

6:00 a.m., and then for somebody to smash the alarm clock and to 

go looking for groundhogs. 

So, Mr. Broderick, if you would like to start all over again, and 

you may have been through this before. 

Mr. BRODERICK. Yes, I have been, Mr. Chairman. 

Chairman MANZULLO. For about 40 seconds, is that correct? 

Mr. BRODERICK. Yes. 

Chairman MANZULLO. So, if I ask you if you’ve ever testified before Congress before you can say yes now. We look forward to your 

testimony. 

Mr. BRODERICK. I have on the House Armed Services side, Mr. 

Chairman. 

7

Okay, thank you again for this hearing, Mr. Chairman. I’m just 

going to pick up where I left off with some company background. 

Since 1989, AGI has grown to a 250-person company and has 

been named the Best Company to Work in America for 2004 and 

2005. Over our history, we have been able to assemble a talented 

team of 140 engineers and scientists to provide a unique and innovative product line, with 12 issued patents to our credit. We are 

proud that the national security community relies on the fidelity of 

our software in many critical areas, such as providing battle space 

situational awareness for efforts in Afghanistan and Iraq, as well 

as the Pentagon for top levelChairman MANZULLO. Well, just a second, you sound like a guy 

doing a trailer in one of those ads, all right? You can slow down 

a little, all right? 

Mr. BRODERICK. I’m just - 

Chairman MANZULLO. Don’t worry about it, all right? 

Mr. BRODERICK. Okay-as well as top level briefings in the Pentagon. 

The key question I pose for today’s hearing is, given the disproportional cost of Section 404 on SOX, on small public companies, 

are we building a safeguard that costs orders of magnitude more 

than any proven benefit, or simply put, are we being penny wise 

and pound foolish with respect to small business compliance with 

SOX? 

As cited in the April, 2006 final report of the Advisory Committee on Smaller Public Companies, the discrepancy between the 

initial Section 404 cost estimate of $91,000 versus the actual cost 

of $900,000 raises the question of cost benefit for the shareholders 

of smaller public companies. 

Given the ongoing cost of compliance with Section 404, the valuations of smaller public companies are permanently impacted. In 

my prepared statement, I provided you with a macro level calculation on this impact, which resulted in an on average loss of approximately $8.1 million in shareholder value for each smaller public company, or approximately $60 billion in total equity valuation 

loss would be incurred on a permanent basis across all smaller 

public companies. 

In addition, the above figures do not include the opportunity 

costs and lost productivity of management and other personnel related to core business activities. Because the regulations lack cost 

benefit analysis and professional judgment, investors lose significant shareholder value. 

We fully concur that regulatory reforms were needed in the wake 

of the financial collapses and malfeasance at Enron and other companies. However, there appears to have been a rush to enact 

sweeping reform, without a basic cost benefit analysis to assess the 

impact on smaller public companies. 

As discussed in my prepared statement, we eliminated the option 

of going public to liquidate our venture investor, primarily from the 

significant burdens associated with SOX compliance, which would 

not only reduce our profitability due to the cost of SOX, but divert 

senior management time away from core business activities. 

Therefore, we were forced to raise $15 million in bank debt and 

used $13 million of our own cash to liquid out our venture invesVerDate 0ct 09 2002 14:12 Nov 15, 2006 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 G:\HEARINGS\28601.TXT MIKE
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tors entire holdings. Accordingly, the result and effects of AGI 

being unable to effectively access the public capital markets are as 

follows; 

1. Our limited capacity to make investments in advanced R&D 

affects our ability to deliver unique capabilities for national security needs, which is important, not only to stay competitive in a 

marketplace dominated by large prime contractors, but also to keep 

our Nation’s defense technology far ahead of our adversaries. 

2. We have foregone growth opportunities and investments in 

business development, marketing and sales to the detriment of our 

long-term sustainability. 

3. Limited cash reserves put a strain on existing business operations, preventing scaling up of our infrastructure, which includes 

financial systems, internal controls, and information technology. 

Our recommendations to reduce the disproportional impact of the 

Sarbanes Oxley Act on smaller public companies are summarized 

as follows; 

First, AGI strongly supports the Advisory Committee’s primary 

recommendations, especially the establishment of a new system of 

scaled or proportional securities regulations for smaller public companies. 

Second, I cannot emphasize this enough, the proper tone at the 

top is a critical enabler and force multiplier for acceptance of applicable internal controls throughout an organization. To this end, 

AGI recommends mandated executive level professional education 

to establish understanding and commitment to the importance of 

effective internal controls. Internal controls are best implemented 

with the right tone from top down. 

Third, in reference to the Advisory Committee recommendation 

III(P)(1), AGI recommends that not only the CEO and CFO provide 

certification for internal controls, but also the Chief Operating Officer or equivalent operations executive should provide certification 

as well. This executive is key to adoption of an effective internal 

control system, since he or she is more intimately involved in the 

day-to-day departmental operations. This key executive should be 

held accountable and not be disconnected from the internal control 

certification. 

In closing, if the status quo remains, this will reinforce a message to non-public small companies that you must be a larger company to access the public capital markets, and many smaller public 

companies, especially in the micro category, may be forced to go 

private. 

I applaud the SEC for establishing an Advisory Committee to examine these matters, and commend the Advisory Committee on 

their diligent comprehensive efforts to provide a framework to establish common sense, proportional regulations under a cost benefit 

structure. 

I’m grateful to this Committee for holding this hearing on topics 

vital to the health of small business and the opportunity to testify. 

I welcome your questions and thank you. 

[Mr. Broderick’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you very much. 

9

Our next witness is Keith Crandell, Co-Founder and Managing 

Director of ARCH Venture Partners. We look forward to your testimony. 

STATEMENT OF KEITH CRANDELL, ARCH VENTURE 

PARTNERS 

Mr. CRANDELL. Thank you very much, Mr. Chairman, and Members of the Committee, good afternoon. 

I am Keith Crandell, Co-Founder and Managing Director of 

ARCH, a 20-year old venture capital firm located in Chicago, Illinois. We fund primarily seed and early stage companies in the 

technology and life sciences area. My partners and I sit on many 

boards of both public and private companies. 

I’m here today in my capacity as a Board Director for the National Venture Capital Association, which represents more than 

400 venture capital funds in the U.S. U.S. companies originally 

funded with venture capital, such as Genentech, Goggle, Archipelago, now represent 10 percent of the annual GEP and employment in the United States. 

I want to speak today on behalf of our country’s emerging growth 

companies, which are being stifled by the Sarbanes Oxley law, specifically, Section 404. This law has drained capital and resources 

from these young companies, distracted management from growing 

businesses, diverted the major members of the accounting profession, and threatened the future of the U.S. capital market system 

for growth businesses. 

Profitability is critical on Wall Street, and Sarbanes Oxley attacks profitability head on. The cost of complying with SOX 404 at 

small companies approaches a million dollars a year. If one assumes a healthy company can achieve 10 percent net income, then 

SOX dictates that such a company would have to garner up to $10 

million in additional revenue just to support the cost of compliance. 

For those who suggest that the cost of 404 compliance will eventually fall, I would argue that without dramatic change the numbers will not fall enough. A recent CRA international study found 

that even with a 31 percent drop in SOX compliance costs last 

year, small cap companies still on average bear a SOX burden of 

$860,000. It’s highly unlikely that SOX costs will continue to drop 

as precipitously in the future, and the costs remain excessive. 

Of equal concern is the drain on human resources to achieve 

SOX 404 compliance. These companies are being placed in an undesirable position of having to hire additional financial staff and forego hiring engineers and sales teams. These hires do not foster company growth. 

To exacerbate the situation, SOX has compelled the Big Four 

auditors I’m familiar with to shift their focus from auditing companies of all sizes to leveraging lucrative 404 practices at large corporations. As a case in point, I served as a Board Member on a 

small cap public company that was informed by their Big Four 

auditor in 2004 that, not only were they too busy with their larger 

clients to complete the company’s audit on time, but that their 

audit would cost 16 percent more than the previous year. The Big 

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lease its numbers late, which we all know, including the auditor, 

that that would be public market suicide. 

Although many have suggested that small companies turn to second and third tier accounting firms, this isn’t a realistic choice for 

many ventured-backed companies, since most investment banks 

that are willing to take their companies public request that the 

company use a Big Four firm. 

From a macro economic perspective, SOX 404 has contributed 

significantly to a clog in the IPO pipeline in the United States. The 

cost of the legal and accounting work for initial public offering 

processes stands at close to $2 million, up from $500,000 a few 

years ago. These hurdles to go public in the U.S. today are driving 

venture capital-backed companies away from our capital market 

system to other exits and other markets. 

In 2005, only 56 venture-backed companies went public on U.S. 

exchanges. The healthy IPO market historically has been at least 

twice that level. Only ten IPOs for ventured-backed companies 

were accomplished in the first quarter of this year, so we are on 

track for another dismal year for IPOs. 

We are seeing pre-IPO companies now embrace two viable alternatives to going public in the U.S. First is the preference for acquisition route, for many companies the cost of going public is too 

high, and when faced with a cheaper, less risky alternative the acquisition wins. Unfortunately, consolidation acquisitions is much 

less conductive or conducive to job and technology growth. 

The second strategy is companies choosing to go public on foreign 

exchanges. In 2005, there were 519 IPOs on the London AIM. In 

the first quarter of 2006 we saw for the first time two of 12 U.S. 

venture-backed companies went public on the AIM, and decided not 

to use the NASDAQ. 

Eighteen months ago, if you queried a room of ventured capitalists about the London AIM, few would have had the market on 

their radar screen, I think today it’s viewed as a viable and better 

understood option for many of VC-backed companies. 

While specific provisions of the original Sarbanes Oxley law have 

improved certain practices at U.S. companies, Section 404 has done 

little in the way of advancing fraud. We have witnessed the information compiled from a 404 audit to be unwieldy, out of date, and 

of little or no use to investors. I’m not aware of any evidence that 

Section 404 has been a critical factor in uncovering fraud, such 

malfeasance is almost always discovered by new employees or auditors joining a firm, rather than from compiling documents. 

As a committed investor in small and emerging growth companies, I strongly support the recommendation of the SEC Advisory 

Board on the smaller public companies, the recommendation for 

tiered regulations. Size appropriate structure already exists in 

other regulations, and I would argue that intelligent small company investors would easily exchange a certificate of compliance for 

the extra million dollars in that income that would come from 

tiered regulatory relief. 

Further, I am very supportive of any provision that will help 

stimulate more competition in the accounting profession. Our supply of qualified accountants to do work for small companies is not 

11

meeting the increased SOX demands. We would welcome new entrants wholeheartedly. 

Companies that seek to thrive and create value will always comply with the highest standards. It’s critical for market credibility, 

but the time has come to set the bar accordingly, and reduce the 

unnecessary frictional costs of SOX 404, in the best interest of 

growing companies and growing economy. 

Thank you for the opportunity to weigh in on this vital matter. 

[Mr. Crandell’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you. 

Our next witness, I read the press release you put out last night. 

Mr. NEISS. You liked it? 

Chairman MANZULLO. It was good. 

Mr. NEISS. Right. 

Chairman MANZULLO. Yes, you know, if this meeting had been 

cancelled I don’t know what you would have done, you know. 

Mr. NEISS. I’d still be here. 

Chairman MANZULLO. I appreciate that, it shows your enthusiasm for being here, and, Woodie, is it Neiss? 

Mr. NEISS. Neiss, yes. 

Chairman MANZULLO. Woodie Neiss is the Co-Founder and Chief 

Financial Officer of FLAVORx, Inc., a company that puts flavoring 

into medicines. We look forward to your testimony. 

STATEMENT OF WOODIE NEISS, FLAVORx, INC. 

Mr. NEISS. Thank you very much. 

Chairman Manzullo, Ranking Member Velμzquez, and Members 

of the Committee, thank you for inviting me here today. My name 

is Woodie Neiss, and I represent what is great about this country, 

the ability to take an idea and turn it into a reality. 

I’m an entrepreneur and a Co-Founder of the company 

FLAVORx. We are an INC500 high growth, young energetic small 

business, helping millions of sick children get better faster by being 

more compliant with their medicines. We believe we are saving the 

U.S. healthcare system over $100 million a year in unnecessary 

medicines, doctor visits, insurance claims, gas, time and resources 

of parents, and the companies they work for. 

I represent a different generation of business owners than those 

of Enron and WorldCom. We respect the rules and morals, and believe you can run a business fairly. I believe that FLAVORx has 

what America needs in the form of a public company. 

Over the past several years, we have had steady growth, maintained positive cash flow, and consistently grown our bottom line. 

I often get calls from parents asking if we are publicly traded. It’s 

for this reason that we’ve been able to attract capital from friends, 

family and most recently private equity, with the hopes of going 

public. 

Wanting to do it right, we’ve diligently grown our business by 

implementing ethical business practices along the way. This wasn’t 

a product of legislation, that’s just what you do to grow a business 

and raise capital. 

Part of our process always includes an audit of our financial 

statements. We feel it is necessary to have an independent auditor 

review our books to verify their accuracy. It not only reassures us 

12

that what we are doing is right, but provides a vote of confidence 

to our business partners. 

Over time, we’ve grown our audit relationships, and in 2002 in 

anticipation of an IPO we hired Ernst & Young. What we didn’t realize we faced though were adversarial, theoretical debates over 

revenue recognition procedures, concentration on overly detailed reporting systems, time consuming discussions over policies and procedures irrelevant to a company of our size, and extra costs in the 

form of consultants and legal fees. 

Our $10,000 a year, two-week audit suddenly jumped to a 

$70,000 four month audit. On top of that, these fees represented 

a substantial 14 percent of our net income. There’s a fundamental 

difference between a small company with public aspirations like 

ours, and a multi-billion dollar company. We do have the deep 

pockets, unlimited personnel, intricate infrastructure, or complexity 

they do, and hence don’t need the same resources or structure to 

explain our simple actions. 

Trying to dig for problems in a company like ours, where problems don’t exist, is counter productive. Spending money to uncover 

these problems, when I can use it to invest in sales and marketing, 

seems a waste. To hold us accountable to rules where the challenges are different or non-existent are an unintended result of this 

legislation that is lining the pockets of auditors, consultants and 

lawyers. 

It was for this reason last year that we decided to drop our relationship with E&Y. We also started to second guess our desire to 

go public. I mean, why go public when Sarbanes Oxley audits are 

so expensive and painful? Why put yourself through the agony, 

when in the end there’s nothing to uncover? 

When it comes time to audit season, you are guilty until proven 

innocent. It doesn’t sound very American, does it? 

I highly doubt FLAVORx is unique when I say we want our investors to know the good and the bad, that transparency is a part 

of our lives. However, we, like many small businesses, are not complex. Unfortunately, however, Sarbanes Oxley does not take this 

into consideration. There needs to be some middle ground. There 

should be a threshold based on the complexity of an organization 

determined by its revenue to which companies should be held accountable to SOX. Until then, we can use these funds to better 

grow our companies, rather than reduce our net income. 

Of course, the option always exists that we can pass these costs 

off to the consumers, but I highly doubt this was the intention of 

Congress. We, as business leaders, can change-can behave ethically 

without being forced by legislation. To lose confidence in us is to 

lose confidence in the majority of the good companies out there that 

are trying to succeed in this challenging business environment of 

higher costs and increased competition. 

Public markets allow companies like FLAVORx access to capital 

which enables us to grow much faster, hire more people, and consume more American products. This grows our economy more than 

if we were just to sell to a larger company. However, public markets at the expense of Sarbanes Oxley do not make for attractive 

options. 

13

I know this Committee represents the interests of small businesses, and I hope you can help influence your colleagues to understand the repercussions that Section 404 is having on us. 

Thank you again, Mr. Chairman, for holding this hearing and allowing me to testify. I look forward to your questions and our discussion. 

[Mr. Neiss’ testimony may be found in the appendix.] 

Chairman MANZULLO. Appreciate that. I’m just wondering when 

people call your company and are put on hold, if that song, ‘‘A 

Spoonful of Sugar,’’ is there. 

Mr. NEISS. We tried, but Disney got-we got in trouble with Disney. 

Chairman MANZULLO. You did say that you are law abiding, 

that’s great. 

Our next witness is Mark Schroeder, with the Independent Community Bankers of America. He’s President and Chief Executive 

Officer of German American Bancorp in Jasper. How many people 

live in Jasper? 

Mr. SCHROEDER. About 15,000. 

Chairman MANZULLO. Oh, that’s a big city. 

We look forward to your testimony. 

STATEMENT OF MARK SCHROEDER, GERMAN AMERICAN 

BANCORP 

Mr. SCHROEDER. Thank you. 

Thank you for the opportunity to testify today, good afternoon. 

My name is Mark Schroeder, and as the Chairman said I am President and Chief Executive Officer of German American bancorp. We 

are located in Jasper, Indiana, and we are a community bank holding company, with approximately $1 billion in assets. 

It is my pleasure to speak today on behalf of both my company 

and the Independent Community Bankers of America, which represents approximately 5,000 community banks in the United 

States, many of whom are publicly held, and speak on the costs of 

Section 404 of Sarbanes Oxley, and on the recommendations included in the final report of the SEC Advisory Committee on Smaller Public Companies. 

Let me give you a little background on German American. German American bancorp was formed in 1983, and we were formed 

with the express purpose of providing a vehicle for small community banks to come together to achieve economies of scale and to 

obtain the liquidity of a publicly-held community banking company. 

Since 1983, nine community banks, the majority of which have 

served their communities in southern Indiana for over a century, 

have joined our company, allowing their shareholders the opportunity to continue holding an investment in their locally-owned 

community bank. 

German American is listed on NASDAQ. We have approximately 

3,500 registered shareholders, and we have a market capitalization 

of $144 million. 

I think I bring a unique perspective among the witnesses today, 

because German American bancorp is an accelerated filer with the 

SEC, and we have, therefore, been subject to SOX 404 compliance 

for the last two years. 

14

For 2004, our direct costs as a company, just for SOX 404 compliance, amounted to nearly $600,000, with an additional estimated 

$250,000 of internal indirect costs, for total compliance costs of 

$850,000, which equates to .08 cents per share for our shareholders. 

For 2005, our costs declined, but even these declined costs, the 

direct costs were $350,000, and our indirect costs were $150,000, 

for a total cost of $500,000, or approximately .05 cents a share. 

Now, these costs are extremely high, but these costs fail to consider and take into account the internal operating inefficiencies 

that have been created because of the duplicative internal controls 

that we have had to put in place since the implementation of 404. 

In an effort to be conservative, and to avoid being questioned by 

the PCAOB, accounting firms, ours included, are requiring layer, 

upon layer, of checks and balances, beyond that which can be justified on any kind of risk cost basis beyond that needed for proper 

segregation of duties, and beyond anything that’s ever been required by the banking regulators. 

In particular, the cost of duplicate checks and balances, coupled 

with the requirement for layer, upon layer of documentation of 

these duplicative processes, have added additional operating inefficiencies through every area of our company. 

The cost of this inefficiency is impossible to measure, but it is 

significant, and at a minimum we believe it is equal to or in excess 

of the measurable indirect costs. 

For many publicly-held community banks and holding companies, the immediate response to the high costs of SOX has been to 

go private, and cease being registered as SEC filers. Since the beginning of 2003, 75, over 75 community banks have filed to go private. The reasons cited in these filings uniformly include increased 

legal and auditing hard costs, and management staff time soft 

costs, associated with the Exchange Act, but unquestionably 404 

compliance is the biggest concern. 

Unless something is done to ease the burden of 404, we would 

predict that as the micro cap companies, those below $75 million 

of market cap, are looking at facing this, you will see a flood of 

public banks, small public banks, choosing to go private. 

The SEC Advisory Committee on Smaller Public Companies 

should be commended for its fine work in preparing and drafting 

the final report, and including more than 30 recommendations for 

scaled or proportional securities regulation for smaller public companies. Among the Advisory Committee’s primary recommendations, ICBA strongly endorses exempting micro caps from the internal control attestation requirements of Section 404, and unless and 

until a framework for assessing internal controls over financial reporting for such companies is put in place for the small cap companies, exempting those small cap companies from the external audit 

requirements of 404. 

We agree strongly with the Advisory Committee that with more 

limited resources, fewer internal personnel, and less revenue with 

which to offset the costs of 404 compliance, both micro cap and 

small cap companies have been disproportionately impacted by the 

burdens of Section 404 compliance. 

15

We also agree that the benefits of documenting, testing, certifying the adequacies of internal controls, while of obvious importance to large companies are of less value for micro cap and small 

cap companies who rely to a greater degree on tone at the top and 

high-level monitoring controls to influence accurate financial reporting. 

There has been little attempt by either the SECChairman MANZULLO. How are you doing on time there? 

Mr. SCHROEDER. -okay, I’ll wrap up here, Chairman. 

There has been little attempt by either the SEC or the PCAOB 

to tailor or scale regulations to address the disproportionate costs 

and burdens. 

On behalf of the nearly 5,000 members of the Independent Community Bankers of America, we urge the members of the Committee on Small Business to support the Advisory Committee’s recommendations, and urge the Securities Exchange Commission to 

adopt them. 

Thank you. 

[Mr. Schroeder’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you. 

Our next witness is James Burns. Mr. Burns is President and 

CEO of EntreMed, Inc., speaking on his behalf, and also on behalf 

of his trade organization, the Biotech Industry Organization or 

BIO. We look forward to your testimony. 

STATEMENT OF JAMES BURNS, ENTREMED, INC. 

Mr. BURNS. Thank you, Mr. Chairman. 

Chairman MANZULLO. Could you pull the mike a little bit closer, 

sir? 

Mr. BURNS. Sure. 

Thank you, Mr. Chairman, Ranking Member Velμzquez, and 

Members of the Committee. As a native Illinoisan I’m glad to be 

here, and also to be here to talk about the issues involved in Sarbanes Oxley Section 404. 

I am the President and CEO of EntreMed, a public biotechnology 

company in Maryland. I have been involved in leading the development of biotechnology companies and products for over 20 years. 

Founded in 1991, EntreMed is a clinical stage pharmaceutical company, focusing on the development of next generation anti-cancer 

and anti-inflammatory drugs that target disease cells directly in 

the blood vessels that nourish them. Our focus is on the development of drugs that are safe and convenient, providing the potential 

for improved patient outcomes. 

Our company currently has three drug candidates in clinical 

trials for cancer, as well as others in pre-clinical development for 

oncology and non-oncology indications. Our company has no product sales, and will depend on continued investment capital for the 

foreseeable future to maintain our clinical development programs. 

I’m here today to testify on behalf of the Biotechnology Industry 

Organization or Bio, an organization representing more than 1,100 

biotechnology companies, academic institutions, state biotechnology 

centers, and related organizations in 50 states and 31 nations. Our 

members are involved in the research and development of health 

care, agricultural, industrial and environmental biotechnology 

16

products. The majority of our member companies are small research and development oriented companies, pursuing innovations 

that have the potential to improve human health, expand our food 

supply, and provide new sources of energy. 

My company has a profile that is typical of the high risk capitalintensive, long lead time regulated business environment of the 

biotech industry. As a representative of one of the most innovative 

high growth sectors of our Nation’s economy, one in which the 

United States maintains a global leadership position, my testimony 

is tailored to the issues faced currently or that will be faced by 

emerging companies in the biotech sector, the micro cap and small 

cap companies who are among the driving forces of our country’s 

innovative leadership and competitiveness in global marketplace. 

Let me, basically, say we appreciate and agree with the congressional intent behind 404, ensuring that companies will have the effective policies, procedures and controls to protect against material 

mis-statements end product and protect it against fraud. Where 

Section 404 has gone awry, however, is in the implementation. 

The reason for increase cost burden is the imposition of an inflexible Section 404, and companies with fewer personnel, little or 

no revenues, and minimal resources. Simply put, if the current 404 

implementation continues to be imposed, micro cap and small cap 

companies in our industries will be forced to endure internal processes and organizational changes that are completely contrary to 

the rapidly changing and highly competitive markets in which we 

operate. 

Let me put 404 into real company context by providing some examples, if you would. One of BIO’s member companies has five employees working on Section 404 compliance, at a cost of approximately $1 million per year. This company estimated that its Controller spent approximately 35 percent of his time on 404, while the 

CFO spent approximately 20 percent of the time, to complete the 

mandated internal control processes and the checklists dictated by 

AS2 the company had to increase its accounting staff by 40 percent. 

Another member’s experience shows the impact of 404 with respect to opportunity cost. This company not only spent approximately $500,000 on its external attestation of internal controls, but 

also had to endure additional costs in terms of (1) the reassignment 

of laboratory research personnel to perform internal control work 

dictated by AS2; (2) the postponement of hiring of five or more additional researchers, the delay of promising R&D programs. 

Other issues that this company was trying to deal with was 

whether they would have had to file additional patents. There’s 100 

patents in this company right now, and whether and where to file 

additional patents. 

This company could also purchase an entire amount of active 

pharmaceutical ingredient for one of its clinical product candidates 

for the same cost associated with complying with SOX 404. To say 

the least, this is clearly an unintended and unfortunate consequence of Section 404. 

The risks in our business are patient safety, FDA compliance, 

and the uncertainty of research outcomes. SOX 404 does not reduce 

these risks. 

17

For investors, their confidence and trust in public companies may 

have increased as a result of the passage of SOX as whole, in spite 

of Section 404, not necessarily because of it. 

We view CEO and CFO certification under Section 302 as beneficial and a requirement that we are not contesting. As we saw in 

the first and second years of 404 implementation, investors were 

less concerned when a company reported a material weakness in 

internal controls than how much a small company was paying to 

meet Section 404 requirements for much more complicated businesses. 

Chairman MANZULLO. How are you doing on time? 

Mr. BURNS. I’m just going to wrap up shortly. 

Chairman MANZULLO. Okay. 

Mr. BURNS. Biotechnology start-up companies early in their histories often have very limited or no product revenues compared to 

their market capitalization. So, for these reasons BIO has urged 

the Securities and Exchange Commission to-and the Public Accounting Oversight Board, as expeditiously as possible, to take the 

necessary steps to adopt a reform framework recommended by the 

Advisory Committee’s final recommendations. 

That concludes my testimony. Thank you. 

[Mr. Burns’ testimony may be found in the appendix.] 

Chairman MANZULLO. Okay, Mrs. Kelly. 

Mrs. KELLY. Thank you. 

I apologize, I have a very busy schedule and I have to leave. 

As one of the people who helped to write SOX, and helped to 

write Section 404, you have to put that into context of what was 

happening at the time that we wrote it. It was certainly not intended by Congress to put a chill factor on businesses. And, I am 

concerned, I think we do need to take a look at it. 

With that in mind, I’d like to talk to you, Mr. Wander, about a 

question I had, rather than divide companies by market capitalization, would it have made more of an impact to look at companies 

that need relief from the cost of compliance in terms of take a look 

at small businesses that nearly have their profits erased by the 

cost of the compliance, looking at it that way rather than-in other 

words, the percentage that it’s costing them out of their bottom 

line. And, is there some reason why you didn’t do that? 

Mr. WANDER. Yes, one of our mantras was to keep it simple. We 

think that one of the just general problems, in terms of both legislation and regulation, is that things get so complicated that it’s 

very difficult to comply with it, it takes away the use of professional judgment. 

So, we tried to figure out all sorts of metrics that would apply 

to scaling the regulation for public companies. 

Most of the people that commented felt that market cap was 

best. The second was, essentially, frankly, number of employees or 

revenue, and we discarded that. And, we considered scaling based 

on what your profitability was, but again, most of the comments we 

had felt that that would be no good because, you know, very large 

companies went into bankruptcy who still, for example, had no income whatsoever and needed-were large organizations, United Airlines being one of those, that still needed to have a robust internal 

controls over financial reporting. 

18

Mrs. KELLY. Mr. Wander, did you look at the idea that you could 

maybe look at the mandates relative to the percent of resources 

that a company needs to devote to compliance, rather than their 

profitability or numbers of employees and all of that that you just 

mentioned, did you look at what it cost the company for compliance 

and think about a sliding scale of percentages in terms of applying 

404? 

Mr. WANDER. We didn’t look exactly at that level. We are out of 

business, so I can’t say we’ll go back and look at that, but it sort 

of gets difficult in my first reaction to sort of figure out, well, if I 

have revenues of, let’s say, $50 million, and I want to spend up to 

half a million dollars, 1 percent of that, how do you cut that off? 

And, the accounting firms were very adamantly against estab- lishing a standard where you would say, okay, for a $50 million 

company you would have to do a $500,000 internal audit. 

On that issue, we ran into, frankly, a total road block by the accounting firms. 

Mrs. KELLY. I can understand that, if you have-with a $500,000 

audit, however, we do know, and you know because you reported 

the cost of audits is going down, we have to remember that this 

was put in place to protect the American investor, and while I am 

absolutely concerned about small and mid cap companies and their 

compliance, this was not meant to be a chill factor on business in 

the United States. But, we still need to have transparency so that 

people understand what that investment is going to be. 

Part of the thing that concerns me in transparency, also with regard to small and mid cap companies, concerns naked short selling, 

which I was hoping that we-I brought up in a hearing this morning, because that is affecting our small and mid cap companies, and 

I was kind of hoping that maybe you all might have taken a look 

at that at the same time that you were doing this. 

Mr. WANDER. It was one of the items on our agenda, and, frankly, we concluded that we are a limited life group with some sort 

of resource constraints, time restraints, and while I agree with you 

wholeheartedly that that’s a very important aspect, it wasn’t-we 

just didn’t put it as high on our agenda, because we frankly think 

the SEC and NASDAQ are addressing that issue. 

Mrs. KELLY. I have just one other comment, this to Mr. Crandell. 

Mr. Crandell, you were talking about, you represent the venture 

capitalists, I’m quite concerned that we in government are putting 

grants out to help people develop ideas and bring everything up to 

a certain point, where at the point where they are needing to go 

from a granted position into production, into a prototype model of 

what they are doing, there’s an area that is talked about in the 

agencies of government called the ‘‘valley of death,’’ because the 

venture capitalists, you can’t blame them, won’t go in. 

It would be very good if we could somehow develop a way to 

bridge that gap. It may be a public/private partnership or something, because I’ve been working on that for ten years, and I can’t 

seem to figure out how we can force the agencies of government to 

bridge that gap, so that the venture caps can come in. I can’t blame 

them, they are out there on the edge of the risk anyway. 

Maybe you wouldn’t mind engaging in a dialogue. I don’t know 

if you want to talk about it now, but certainly you can find me and 

19

I’d be interested in talking with you, maybe we can bridge a gap 

to help our companies make that jump, so they become viable and 

help us grow the economy. 

Mr. CRANDELL. Yes, Congressman Kelly, I’d welcome the opportunity, and I’m happy to do that off line. 

I would say that there are groups of venture capitalists that do 

seed and early-stage investing. We have done 115 companies in the 

last 20 years. We’ve co-founded most of those with technologists, 

scientists and, you know, I think it’s a really important area to 

make sure that the U.S. is very efficient and taking inventions and 

turning them into business’ revenue that employ people. So, I’m 

happy to talk about it. 

Mrs. KELLY. Thank you. 

Mr. CRANDELL. Sure. 

Chairman MANZULLO. I recognize the Ranking Member for her 

questions and comments. 

Ms. VELμZQUEZ. Thank you, Mr. Chairman. 

Mr. Wander, let’s get right to one of the biggest issues facing the 

Advisory Committee’s reform proposal. Critics suggest that if the 

Advisory Committee’s primary recommendations regarding internal 

controls are adopted that investor protections will be undermined. 

What investor protection requirements would still apply to small 

companies that are afforded relief under the Advisory Committee’s 

recommendations? 

Mr. WANDER. Yes, thank you. 

First, all of the companies, whether they be micro caps or small 

companies, would be required to have internal controls over financial reportings. That’s been mandated since 1997. They will still be 

in existence and applicable to all these companies. 

Secondly, these companies will have to provide the certifications 

that are required under Section 302 of Sarbanes Oxley by the Chief 

Executive Officer and the Chief Financial Officer, attesting to the 

compliance with both financial disclosures and other disclosures in 

their narrative portion of their documents. So, those two people 

will be on the line, and I can tell you from my own experience as 

a lawyer representing many of these companies, the executives 

take that role very seriously. It is not something that’s sort of a 

throw away and they sign it. 

Third, they will all go through their regular audits, and we have 

learned, and this is unchallenged by anybody, that for the micro 

cap companies the regular audit is really the audit that catches errors and fraud. You don’t need a separate external audit for those 

companies. So, that would still be in place. 

Ms. VELμZQUEZ. So, you agree that investors will still be sufficiently protected? 

Mr. WANDER. Yes, I believe they will. 

Ms. VELμZQUEZ. Mr. Burns, we have heard that what drives investment in the high-growth setup, biotech and hi-tech sectors, is 

proof of concept, not Section 404, and that some companies are 

spending the equivalent of six months of R&D funding to cover the 

costs associated with Section 404. 

Based on your experience, how much of an impact does Section 

404, as currently implemented, have on increasing investors confidence? 

20

Mr. BURNS. Investor confidence is primarily driven by progress 

to proof of concept. Money goes into, typically, companies like ours 

and it’s expensed, it’s expensed internally and externally, and the 

progress that’s made on R&D, the progress that is made in clinical 

trials, the compliance with safety requirements of the FDA and so 

on are the things that investors particularly pay attention to, 

whether or not their investments in the company are being spent 

efficiently on R&D and efficiently on clinical trials, and whether 

the company is making progress toward ultimately getting approval. 

And, they expect that when an audit is completed, and the CEO 

and the CFO certify to the financial, the accuracy of the financial 

statements, that that is what they are certifying to. 

Ms. VELμZQUEZ. Thank you. 

Mr. Wander, last week, and I sit on the Financial Services Committee, Marsh Carter, Chairman of the Board of the New York 

Stock Exchange group, testified before the House Financial Services Committee on maintaining the international competitiveness of 

the U.S. financial markets. 

In order to keep U.S. markets competitive Mr. Carter proposed 

that the SEC and PCAOB move to a three-year Sarbanes Oxley 

Section 404 review cycle, as a way to reduce regulatory burdens. 

He noted that this could be accomplished without having to pass 

legislation to amend the law. 

Do you think this proposal will help small companies by reducing 

the cost of compliance? 

Mr. WANDER. We considered that very seriously in our deliberations, and concluded, again, we ran into actually opposition from 

both the issuers and the accounting firms, and their arguments 

were that once you get subject to 404 it’s a shock, and having it 

every three years would be worse than having it every year. It’s 

like going into an ice cold water. 

And, we thought, and still think, that the better approach is to 

scale the regulations for smaller public companies, so that they still 

have to go through rigorous internal control establishment and examination, but that it should be scaled to the size of the company, 

and it should be every year. 

So, but I don’t throw out the three-year requirement off hand. 

We did look at it, and thought ours was better. 

Ms. VELμZQUEZ. Thank you. 

My next question is to you, Audit Standard No. 2 implements 

Section 404, AS2, as it is known, is long on guidance for accountants, but short on guidance for small companies. COSO has attempted to fill this void and provide additional guidance for small 

companies. What is your opinion of COSO guidance in this area? 

Mr. WANDER. It’s still deficient, and they came out, they worked 

very hard to produce some guidance at the request of the SEC, and 

I believe the PCAOB. The exposure draft came out, oh, three, four, 

five months ago. Comments were almost uniformly negative. It was 

a 200 and some page guide, and the problem was the guide, by the 

time you read it you were more confused than when you started. 

And, it’s unfortunate, because I value COSO and the people who 

work there who are, I think, truly trying to find a solution. They 

21

are now revising it, I don’t know what the revision will be, but I 

think in general it was just too long and not pointed enough. 

Ms. VELμZQUEZ. My time is up. 

Mr. BARTLETT. Thank you very much. 

I have here a copy of a letter from the Office of Advocacy of the 

Small Business Administration to the Honorable Christopher Cox, 

with whom I had the privilege of serving in the House. And, 

Roman Numeral I says, ‘‘SEC should not impose disproportionate 

burdens on smaller companies by excluding them from access to 

capital markets.’’ 

I’d first like to apologize for not being here for your testimony. 

I’m also on the Armed Services Committee, and this is that one day 

in the year when we have a mark-up. Ordinarily, it lasts til midnight. I think that in the next hour or so it will be over, it’s going 

very well today, and so I couldn’t be here for your testimony.I gather that compliance with these regulations is imposing a burden on 

small business. I would like to ask a couple of questions. First of 

all, is it your view that when they wrote these regulations, as a result of our law, that they had small business at the table, that they 

went through the requisite hearings, and hearing from small business how the implementation of this that might be acceptable to 

large business would be an inappropriate burden on small business, do you think that they went through that required procedure? 

Any or all of you. 

Mr. WANDER. Well, I will start the answer. I’m sure my colleagues here can fill in. 

We think that’s one of the very serious problems, is that the 

smaller and mid cap public companies are literally orphans in this 

process. The original COSO recommendations of the early ‘90s had 

very small chapters in the massive two volume set of guidelines 

dealing with small businesses. And, it sort of said they are very different, and you have to scale the regulations in order to have 

smaller companies comply on a reasonable and efficient basis. 

When AS2 was first promulgated, the PCAOB, in fact, did have 

an appendix dealing with smaller public companies, which was 

taken out when the final rules were adopted. 

And so, one of the points made by the Advisory Committee is 

that no one has really taken the time or effort to focus on what the 

standards should be for smaller and mid cap companies. 

Mr. BARTLETT. Anyone else wish to respond? 

I’m going to violate some rules probably, but they have a vote 

and it’s just a couple of floors away. I’ll be back very quickly, but 

they are having a roll call vote in Armed Services and I’m needed 

there. I’m going to do what you should never do and turn this over 

to a Minority member. 

Ms. VELμZQUEZ. Well, continue practicing it. 

Mr. Wander, let me continue to ask some questions here. Given 

the effect of Sarbanes Oxley on the public accounting industry, 

there was speculation that some smaller CPA firms will drop their 

public clients. 

There was concern that this would lead to fewer companies in an 

industry already marked by significant consolidation. While the 

General Accounting Office addressed this issue in a study two 

years ago, could you please provide your perspective on what role 

22

smaller CPA firms are playing in the market for Sarbanes Oxley 

audit services? 

Mr. WANDER. I believe that particularly the next five in size 

firms who are actually very active with our Advisory Committee, 

and many of the regional accounting firms, need the strong support 

from the SEC, the PCAOB and Congress. They are very talented 

people. It probably has some limitations, they aren’t as global as 

the Big Four, but they certainly are very fine professionals for businesses that are, essentially, located here in the United States. 

And, I think you will see a trend, I don’t think it’s fast enough, 

where many smaller public companies will go to the smaller accounting firms. I think one of the witnesses talked about the fact 

that unfortunately underwriters and banks sometimes insist on a 

Big Four. In fact, Chairman Cox I think has spoken out in saying 

people should look at smaller accounting firms, and I think that 

that will be one way, hopefully, we will have a much more vibrant 

accounting profession, with more opportunities and choices for all 

businesses. 

Ms. VELμZQUEZ. Thank you. 

Mr. Schroeder, how have the compliance costs associated with 

Section 404 affected your bank’s ability to invest in the local community? 

Mr. SCHROEDER. Obviously, when you have a cost of a company 

of our size that in the first year was approaching a million dollars 

and now has kind of settled it at a half million dollars a year, it 

impacts our ability to invest in the local businesses that we do 

business with and the local companies, as well as the local individuals. From a Community Reinvestment Act perspective, it’s probably a good place to look at it. 

When we are looking to make an investment from community reinvestment, that half million dollars that we are spending on 404 

could be allocated towards CAR type investments, but it can’t go 

both places. A half million dollars a year for our company is a significant additional cost that will come out somewhere in the mix. 

Ms. VELμZQUEZ. Thank you. 

Mr. Wander, none of the top ten initial public offerings last year 

were registered in the U.S., and 23 of the 25 largest IPOs occurred 

in foreign markets. Anecdotal evidence suggests that the high costs 

associated with Section 404 are helping drive this trend and causing U.S. companies to raise capital in foreign exchanges, such as 

the London Exchange Alternative Investment Market, and some of 

the witnesses raised this issue, too. 

To what extent has the burden associated with the Sarbanes 

Oxley Act deterred private companies from going public in the U.S., 

and to instead list on foreign exchanges, such as AIM? 

Mr. WANDER. I think that’s a growing phenomenon that you will 

see more and more of. AIM is coming to the United States, they 

almost have full-time representatives. 

And, I would add with that the Toronto Stock Exchange, which 

is really the TSX, which also tries to capture smaller businesses 

with a model somewhat similar to the AIM market. They, in fact, 

presented a program at the Business Law Section of the American 

Bar Association meeting last month in Tampa, all foreigners gave 

the presentation, and they are going around to various cities in the 

23

United States trying to get listings. And, I don’t think there’s any 

question that they will gain many more companies to go into their 

system, because for a small public company to take so much of 

their revenue or their cash resources to comply with Sarbanes 

Oxley, particularly, 404, especially 404, that they will continue to 

move to foreign markets. 

And, I think Sarbanes Oxley is one of the big factors. I think as 

a New York Stock Exchange representative testified, litigation is 

another one. 

Ms. VELμZQUEZ. But, do you believe that the Advisory Committee’s recommendation will help reverse this trend? 

Mr. WANDER. Yes, ma’am. 

Ms. VELμZQUEZ. Okay. 

Mr. Broderick, if the Advisory Committee’s recommendations are 

enacted, would you consider your decision to not go public? 

Mr. BRODERICK. If they were enacted to have a scaling proportional regulation, yes, we would then, right now, Congresswoman, 

the way we look at it is, an IPO is not feasible right now, but we 

say into the foreseeable future for a technology company that’s, you 

know, three years at best, but we look at that we need to get to 

a certain level of critical mass in order to absorb the SOX compliance issues. 

For us, that would be, we are a $50 million company right now, 

the way we look at it we roughly would have to get to $150 million 

to give us enough market capitalization, roughly about a half a billion dollars or so, to absorb that cost. 

I would say, Congresswoman, just small cap companies, especially micro cap companies, in order to get liquidity in their stock, 

and institutional investors and other investors awareness to buy 

their stock, the time commitment and resources that the CEO and 

CFO to put at that is tremendous. When you add SOX on top of 

that, we looked at it and we just, it was a no brainer, we said we 

can’t go public because we’ll put our shareholder value more at 

risk. For a small cap public company, you put estimates out there. 

We are not like Google, we don’t have to give guidance. If you don’t 

give some kind of guidance, no one will follow you, no one will be 

interested in your stock. 

So, you are out doing your own marketing efforts to get that interest, and that’s just the general dynamics and the burdens on executive management to create liquidity in the stock. If you miss an 

estimate, a quarterly estimate, you know, by a penny, your stock 

can drop 50 percent easily. 

So, when we look at it, the risk of that was so great, and the diversion of time and management towards SOX compliance, that we 

said we have a chance to lose 70 percent of our value, we might 

as well just stay private, build the company, and move forward 

with our strategies. 

Ms. VELμZQUEZ. Thank you. 

Thank you, Mr. Chairman. 

Mr. BARTLETT. Thank you. 

I’m privileged to serve on three of the least partisan committees 

in the Congress. This is certainly one of them. I don’t know of anybody here who isn’t a small business supporter. I serve on Armed 

24

Services, and I serve on Science, so I had little fear that turning 

the Chair over to the Minority would be abused. 

In another life, I was in business, as a small business person, 

and I learned very quickly that regulations that were acceptable to 

large businesses, if you have 300 people and it takes three people 

to comply with the regulations, that’s a burden, but not a burden 

you cannot bear. If you have four employees and it takes three to 

comply with the regulations, that’s clearly a burden that you can’t 

bear. And so, you need to be careful whose business advice you are 

getting, because the strongest competitors for big business is frequently small business, and regulations are a way of neutralizing, 

neutering in many cases, a small business. You need to be careful 

who you are asking about whether these are acceptable regulations 

or not, because they may be acceptable to big business because it’s 

a burden they can easily bear as a part of their overhead, and, furthermore, it now puts their small business competitors at a disadvantage. I see a number of you nodding your heads in assent, so 

you’ve been there and you understand this. 

It’s quite clear from your testimony that compliance with the regulations resulting from this law is imposing an undue burden on 

small business. The question I need answered is, is there a regulatory fix for this, or do we need to have a legislative fix for it? Is 

this something that we can hold the bureaucrats responsible for? 

Can they, within our law, promulgate regulations that will be effective and yet consistent with the view that small businesses should 

not be unduly disadvantaged by these laws? Can the regulators fix 

it, or do we have to legislatively fix it? 

Mr. BRODERICK. Congressman, I think if the SEC adopts the 

scaling proportion, it’s just common sense, I don’t see any reason 

why they wouldn’t adopt this and move forward with a framework, 

and then they can tweak that framework as they see fit. 

To me, if they don’t anything, if they just bury their heads in the 

sand about it, you are going to have small companies just, you 

know, not being able to attract any capital, even VC capital. Earlystage companies are going to be knocked out of the marketplace, 

because they see too much risk. Now, a VC comes in and he puts 

a certain level of infrastructure into a company, an early-stage 

company, and that’s, you know, basic accounting, finance, HR type 

of infrastructure, but now you’ve got to take that extra layer on top 

of that, and based upon the risk models of VC firms they don’t 

know if they are ever going to get to a public marketplace. 

So, if those resources are diverted, you are not properly growing 

your company to get adoption of technology products and services 

in the marketplaces that you serve. 

So, as far as - I believe it was a very, very good study and report, 

taking something and boiling it down, as complex as it is, and simplifying it, I think it was-I commend the Advisory Committee, I 

think they did a heck of a job with it, and I don’t-it’s just common 

sense, and we need more common sense. 

Mr. BARTLETT. Is it your general view that if the recommendations of the Advisory Committee were implemented that it would 

largely fix the problem? 

Mr. SCHROEDER. Speaking as a company that has been an accelerated follower, and has been through 404, absolutely. For German 

25

American bancorp, and for many of the community banks, public 

community banks, that ICBA represents, those recommendations 

would absolutely fix the problem for us, or a significant portion of 

it. 

The portion that we would be left with are good controls, they 

are controls we can live with, they bring value to our investors, but 

it is the 404 compliance and this piling on of layers and layers of 

bureaucracy that it would fix. 

So, for us, absolutely, it would fix it. 

Mr. BARTLETT. Yes, sir. 

Mr. BURNS. Mr. Chairman, I believe that it would certainly help 

my company, and it would more than likely help most of the other 

companies that are biotechnology companies, and rely on the capital to grow their companies. 

And, it’s also my understanding that the Commission has the authority to implement the recommendations and we fully support 

that. The sooner the better, sir. 

Mr. BARTLETT. Do you believe that the recommendations they 

made are consistent with law? Was there any ever discussion, any 

discussion that we might need new legislation to permit them to 

do what seems so reasonable to you? 

Mr. WANDER. Perhaps I should at least try to answer that question. 

One of our goals, it wasn’t in our mission statement, but one of 

our goals since we were an advisory committee to the Securities 

and Exchange Commission, was that we wanted the Securities and 

Exchange Commission to implement our recommendations. So, we 

believe wholeheartedly that the SEC does have authority under the 

various securities laws to implement our recommendations. 

I should be totally frank with you, there are people who question 

that, because of a quirk, Section 404 is not part of the Securities 

Exchange Act of 1934, where the SEC has some broader authority 

to adopt regulations. But, we make a case for this in our report, 

and I believe that Congressmen Oxley and Baker have, in fact, 

written to the SEC a letter indicating that they believe wholeheartedly that the SEC does have the authority to adopt our recommendations. 

On the other hand, Senator Sarbanes is probably on the other 

side on that question. 

Mr. BARTLETT. Yes, so often what you see depends on where you 

sit, doesn’t it? 

Mr. WANDER. Yes. 

Mr. BARTLETT. These two people are kind of the extremes of the 

political spectrum, and they are looking at the same law and come 

to different conclusions. 

But, it’s my understanding that Chairman Cox would be responsible for implementation of this. 

Mr. WANDER. He, together with the rest of the Commissioners, 

yes, sir. 

Mr. BARTLETT. Is it your understanding that this has come to his 

attention? 

Mr. WANDER. Oh, yes, he has commended our report, and said 

that it would be studied quite thoroughly, which I’m sure it will. 

The SEC is a very responsible agency. 

26

We, as someone just said, hope that they do it on a rapid pace, 

and that they do adopt most of our recommendations, if not all of 

them, but we will see how that pans out. It’s only been a week 

since they’ve gotten the report, although I think they knew it was 

coming and what the recommendations have been for probably two 

to three months. 

Mr. BARTLETT. These regulations were promulgated before Chairman Cox took over? 

Mr. WANDER. Yes. 

Mr. BARTLETT. So, this is not his child? 

Mr. WANDER. That’s correct. 

Mr. BARTLETT. Okay. 

I want to ask my Ranking Member if she has any additional 

questions or comments? 

Ms. VELμZQUEZ. No, I don’t. 

Thank you, Mr. Chairman. 

Mr. BARTLETT. Okay. 

Well, I want to thank you all very much for the contribution that 

you’ve made. We will wait a reasonable time to see if SEC responds 

responsively. If they do not, why I suspect that they will be sitting 

in your chairs telling us why they have not. 

I know Chris Cox very well. He’s a genuinely thoughtful good 

guy, and if he doesn’t respond promptly it will be because there’s 

just a lot of other things on his plate which have kind of pushed 

this aside. We’ll make sure that that doesn’t happen for very long. 

You are in a better position to judge than we as to how soon they 

ought to have responded to this. We would like your commitment 

to get back to us when you think they should have responded and 

they have not, and then we will follow through on it. 

I want to thank you all very much for your testimony, and our 

Committee is adjourned. 

[Whereupon, at 4:13 p.m., the Committee was adjourned.]

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