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THE SARBANES-OXLEY ACT 4 YEARS LATER:

WHAT HAVE WE LEARNED?

HEARING

BEFORE THE

SUBCOMMITTEE ON REGULATORY AFFAIRS

OF THE

COMMITTEE ON

GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

APRIL 5, 2006

Serial No. 109–199

Printed for the use of the Committee on Government Reform

(

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

http://www.house.gov/reform

(II)

COMMITTEE ON GOVERNMENT REFORM

TOM DAVIS, Virginia, Chairman

CHRISTOPHER SHAYS, Connecticut

DAN BURTON, Indiana

ILEANA ROS-LEHTINEN, Florida

JOHN M. MCHUGH, New York

JOHN L. MICA, Florida

GIL GUTKNECHT, Minnesota

MARK E. SOUDER, Indiana

STEVEN C. LATOURETTE, Ohio

TODD RUSSELL PLATTS, Pennsylvania

CHRIS CANNON, Utah

JOHN J. DUNCAN, JR., Tennessee

CANDICE S. MILLER, Michigan

MICHAEL R. TURNER, Ohio

DARRELL E. ISSA, California

JON C. PORTER, Nevada

KENNY MARCHANT, Texas

LYNN A. WESTMORELAND, Georgia

PATRICK T. MCHENRY, North Carolina

CHARLES W. DENT, Pennsylvania

VIRGINIA FOXX, North Carolina

JEAN SCMIDT, Ohio

——— ———

HENRY A. WAXMAN, California

TOM LANTOS, California

MAJOR R. OWENS, New York

EDOLPHUS TOWNS, New York

PAUL E. KANJORSKI, Pennsylvania

CAROLYN B. MALONEY, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

DANNY K. DAVIS, Illinois

WM. LACY CLAY, Missouri

DIANE E. WATSON, California

STEPHEN F. LYNCH, Massachusetts

CHRIS VAN HOLLEN, Maryland

LINDA T. SANCHEZ, California

C.A. DUTCH RUPPERSBERGER, Maryland

BRIAN HIGGINS, New York

ELEANOR HOLMES NORTON, District of

Columbia

———

BERNARD SANDERS, Vermont

(Independent)

DAVID MARIN, Staff Director

LAWRENCE HALLORAN, Deputy Staff Director

TERESA AUSTIN, Chief Clerk

PHIL BARNETT, Minority Chief of Staff/Chief Counsel

SUBCOMMITTEE ON REGULATORY AFFAIRS

CANDICE S. MILLER, Michigan, Chairman

CHRIS CANNON, Utah

MICHAEL R. TURNER, Ohio

LYNN A. WESTMORELAND, Georgia

JEAN SCHMIDT, Ohio

STEPHEN F. LYNCH, Massachusetts

WM. LACY CLAY, Missouri

CHRIS VAN HOLLEN, Maryland

EX OFFICIO

TOM DAVIS, Virginia HENRY A. WAXMAN, California

ED SCHROCK, Staff Director

KRISTINE HUSAR, Professional Staff Member

BENJAMIN CHANCE, Clerk

KRISTA BOYD, Minority Counsel

(III)

C O N T E N T S

Page

Hearing held on April 5, 2006 ................................................................................ 1

Statement of:

Feeney, Hon. Tom, a Representative in Congress from the State of Florida; Hon. Mark S. Kirk, a Representative in Congress from the State

of Illinois; and Hon. Gregory W. Meeks, a Representative in Congress

from the State of New York ......................................................................... 9

Feeney, Hon. Tom ..................................................................................... 9

Kirk, Hon. Mark S. .................................................................................... 17

Meeks, Hon. Gregory W. ........................................................................... 29

Hinchman, Grace L., senior vice president, Financial Executives International; Richard A. Hubbell, chief executive officer, RPC & Marine

Products Corp.; Robert P. Dowski, chief financial officer, Allied Defense

Group [ADG]; Alex J. Pollock, resident fellow, American Enterprise

Institute; and Damon A. Silvers, associate general counsel, American

Federation of Labor and Congress of Industrial Organizations ............... 48

Dowski, Robert P. ...................................................................................... 65

Hinchman, Grace L. .................................................................................. 48

Hubbell, Richard A. ................................................................................... 61

Pollock, Alex J. .......................................................................................... 72

Silvers, Damon A. ...................................................................................... 80

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

Dowski, Robert P., chief financial officer, Allied Defense Group [ADG],

prepared statement of ................................................................................... 68

Feeney, Hon. Tom, a Representative in Congress from the State of Florida, prepared statement of ........................................................................... 12

Hinchman, Grace L., senior vice president, Financial Executives International, prepared statement of .................................................................. 51

Hubbell, Richard A., chief executive officer, RPC & Marine Products

Corp., prepared statement of ....................................................................... 63

Kirk, Hon. Mark S., a Representative in Congress from the State of

Illinois, prepared statement of ..................................................................... 20

Meeks, Hon. Gregory W., a Representative in Congress from the State

of New York, prepared statement of ........................................................... 33

Miller, Hon. Candice S., a Representative in Congress from the State

of Michigan, prepared statement of ............................................................. 4

Pollock, Alex J., resident fellow, American Enterprise Institute, prepared

statement of ................................................................................................... 75

Silvers, Damon A., associate general counsel, American Federation of

Labor and Congress of Industrial Organizations, prepared statement

of ..................................................................................................................... 83

(1)

THE SARBANES-OXLEY ACT 4 YEARS LATER:

WHAT HAVE WE LEARNED?

WEDNESDAY, APRIL 5, 2006

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON REGULATORY AFFAIRS,

COMMITTEE ON GOVERNMENT REFORM,

Washington, DC.

The subcommittee met, pursuant to notice, at 10:08 a.m., in room

2154, Rayburn House Office Building, Hon. Candice S. Miller

(chairman of the subcommittee) presiding.

Present: Representatives Miller, Westmoreland, Lynch, and Clay.

Staff present: Ed Schrock, staff director; Rosario Palmieri, deputy staff director; Kristina Husar and Joe Santiago, professional

staff director; Benjamin Chance, clerk; Krista Boyd, minority counsel; and Jean Gosa, minority assistant clerk.

Mrs. MILLER. Good morning. Our third panelist is on his way,

and I know our first panelist has another meeting to go to, and the

ranking member said that was the sound of the ‘‘Big Dig’’ from

Boston, so with that we will start.

I want to welcome everyone this morning, and the Subcommittee

on Regulatory Affairs will come to order.

No one here can forget the turmoil caused by the corporate and

accounting scandals involving Enron, Arthur Andersen, and certainly WorldCom as well. And as a reaction to the shocking behavior of all of these things, Congress acted very swiftly to pass legislation aimed at restoring order and trust in our Nation’s financial

markets, and with very good reason.

After all, financial investment in our public markets and public

companies is good not only for the companies, but for the financial

security of average Americans. The more liquid our financial markets, the less expensive it is for American companies to raise capital, to grow their business, and to provide investors with a healthy

return on their investment. This system encourages small companies to expand and it is also a recipe for dynamic growth in the

job market.

The Sarbanes-Oxley Act tried to restore investor confidence in

the stock market by restricting accounting firms from performing

a number of services for the companies that they audit. The act

also required new disclosures for public companies and for the officers and directors of those companies. Among the other issues affected by the legislation are securities fraud, criminal and civil penalties for violating the security laws, blackouts for inside traders of

pension fund shares, and protections for corporate whistleblowers.

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However, Congress might have acted just a bit too quickly as

many unintended consequences have made the law more costly to

business and to small businesses, in particular, than originally

thought. We are holding this hearing today to examine some of

these consequences and to look at possible solutions.

Oftentimes it is very hard for policymakers to evaluate the cost

and benefits of a regulation or a piece of legislation. In the case of

Sarbanes-Oxley, we now have data which suggests that the cost of

complying with specific provisions of the act is much greater than

the actual benefits.

For example, while the SEC initially estimated the cost to com- ply with Section 404 to be about $91,000 per company or $1.24 billion in the aggregate, multiple studies pegged the actual compliance cost at $35 billion, which is, of course, nearly 30 times the

original estimate.

But let’s put this in perspective: Section 404 is only 168 words long, and if you use the $35 billion figure, that is almost $21 million per word, and that is just the initial startup cost.

As well, Section 404 has hit small and mid-size firms the hardest: as a percentage of revenue, smaller issuers in 2004 spent 11

times more on the Sarbanes-Oxley implementation than did larger

companies. Micro-cap companies, with revenues under $100 million, saw an 84 percent increase in outside audit fees as a result

of the law. Small cap companies with revenues between $100 million and $700 million saw a 92 percent increase in audit fees. And

S&P 500 companies saw an increase of 55 percent in their audit

fees.

Smaller companies have limited resources which are now being

allocated to Section 404 compliance, and there is great concern that

the regulatory burden of Section 404 is currently diminishing their

competitiveness through higher operating costs and management

distraction from business opportunities and other risks.

In addition to these high out-of-pocket costs, there may also be

an opportunity cost that accompanies Section 404. When a company spends over $4 million a year to comply with a single regulation, they are unable to direct those substantial resources into capital formation, employee benefits and salaries, or even stock dividends. Moreover, the largest potential cost of Section 404 has yet

to be quantified; the loss of opportunities for the American public

to invest in small and innovative firms that have either delisted,

gone dark, or declined to go public.

These corporate managers have determined that the cost of being

a public company is no longer outweighed by the benefits the firm

gained through access to the deep liquid markets of the American

Stock Exchanges. Removing a company from the public exchanges

is costly to a firm in terms of lost prestige, decreased liquidity,

higher cost of capital. And it is conceivable that the decision to

delist results in slower growth, poor returns on investment and a

weaker position in the global market; and of course it also results

in less job creation.

This is a tremendous hurdle that the American companies must

overcome that most global competitors do not. Foreign companies

that do not list their shares on American exchanges, do not face the

same fixed cost imposed by Section 404. Accordingly, they are able

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to invest their resources into research and development, customer

discounts and other forms of value creation.

It is no wonder that at every hearing on regulation, witnesses always bring up Section 404 as a key regulation that is hurting

Americans’ ability to compete.

It is certainly clear that the time has come for this Congress to

begin a dialog on this important subject, sort of put our ear to the

ground and hear directly from those who are affected by Section

404.

So we certainly look forward to all the testimony of the witnesses

today, and with that, I would recognize our ranking member, Representative Lynch, for his opening statement.

[The prepared statement of Hon. Candice S. Miller follows:]

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Mr. LYNCH. Thank you Chairman Miller, and I appreciate the

fact the we are holding this hearing. This is one of the most important securities related acts in the history of this country, and I

think it is appropriate at this point to be reviewing its impact on

medium and small-sized businesses.

I am pleased to join, as well, my colleagues, Mr. Feeney and Mr.

Kirk, and I know Mr. Meeks is on his way, to look at this.

I hear a lot about this in my district. I want to associate myself

with the remarks of the Chair. I understand the impetus of this

act, the WorldCom and Enron scandals, and the lack of accountability that we had in our accounting practices, how investor reliability and accuracy had to be improved. But also, I am concerned

with the unanticipated cost of compliance with especially Section

404 of the act, and I think we have to look very closely at that.

There are definitely ways that we can improve the cost side of this

equation, and not relinquish the accountability and the exactitude

with which investors are helped in making their decisions.

I know for a fact that some of my own constituent businesses in

my district have suggested that such a thorough process is done

during those examination years, that it would be possible, perhaps,

to look at biannual, every 2 years, to have the audits conducted

and have a statement of compliance on those alternate years that

would basically reduce the cost by 50 percent, even maintaining the

existing language in place.

So there are ways that I think we can help small and mediumsized businesses in compliance with the act without sacrificing one

bit of the accountability that is provided by the act. There have

been some successes with Sarbanes-Oxley, and we don’t wan to jettison that in our pursuit of reducing costs of simplifying the act.

I look forward to the comments of both our panels, and again, I

appreciate Chairman Miller for convening this hearing.

Thank you.

Mrs. MILLER. Thank you.

Opening statement for Representative Clay?

Mr. CLAY. Thank you, Madam Chairman, for holding today’s

hearing on Sarbanes-Oxley and its impact on our smaller publicly

traded companies. I welcome our witnesses, especially my colleagues and friends, Mr. Meeks, Mr. Feeney and Mr. Kirk.

When Sarbanes-Oxley was enacted in 2002, our capital markets

were suffering from investor anxiety directly relating to major accounting scandals that rivaled the S&L failures of the 1980’s.

While Enron and WorldCom became the public poster children of

corporate fraud, the fact is there were numerous companies who

were forced to restate earnings and future estimates due to fraud

and faulty accounting practices. A complicit public accounting industry made these activities not exceptions, but standard practices

in order to appease their short-term profit-driven clients.

In response, Sarbanes-Oxley strengthened regulations over auditing practices, mandated executives to certify their annual financial

statements, and increase penalties for accounting related fraud.

A cornerstone of this legislation was Section 404, which required

publicly traded companies to attest to their internal control for financial reporting and related activities. while Section 404 is a reasonable mandate to ask of companies, some smaller companies find

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compliance to be both cost prohibitive and time consuming. Although I am sympathetic to this claim, I am also wary, wary of returning to a period of lax internal practices and functions that will

enable inadequate stewardship of investor resources.

It is my hope that new SEC regulations, along with recommendations from our witnesses today, can help us achieve a balance that

provides both adequate investor protections and relief for well-managed small businesses.

This concludes my statement, Madam Chairman, and I yield

back.

Mrs. MILLER. Other opening statements? Representative Westmoreland.

Mr. WESTMORELAND. Thank you, Madam Chairman. I appreciate

you having this hearing. We have an advisory committee at home

in the district, and on our banking and finance advisory committee,

the one thing that I have heard is this Section 404 of the SOX.

I have often been told that Congress had two speeds, dead still

and knee-jerk reaction, and I think this comes under the—this particular section of this bill came under the knee-jerk reaction. I don’t

know, out of the response to what happened maybe to Tyco and

Enron and others, but they weren’t prosecuted under this bill, they

were prosecuted under laws that we already had on the books. And

I think that you can see that there were laws there to protect and

to punish those that caused the problem.

So I hope, Mrs. Chairman, that when we look at this, that we

can come up with some type of legislation or suggestion that would

take some of the burden off of the small and middle-size companies

as far as these audit fees.

I had one small banker tell me that it was 10 percent of his bottom line to adhere to Sarbanes-Oxley. That is ridiculous. Audit

fees, since 2003, have gone up anywhere from 75 to 90 percent.

This should have been called the auditors employment act of 2003.

I look forward to hearing from both panels, and I hope, Mrs. Chairman, that we can come up with some type of idea to really reform

this to where not only does it protect the investors in the company,

but brings about some rational thinking.

Thank you.

Mrs. MILLER. Thank you very much.

Our first witness this morning is our distinguished colleague,

Representative Tom Feeney from the 24th Congressional District of

the great State of Florida. Congressman Feeney is in his second

term and serves currently as a Deputy Whip. He has quickly become a leading advocate for exposing and fighting waste, fraud and

abuse in the Federal Government. He serves as well on the House

Financial Services, sits on the House Judiciary and Science Committee, and was a member of the Sarbanes-Oxley ‘‘listening tour.’’

So Representative Feeney, the floor is yours. We look forward to

your testimony, sir.

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STATEMENTS OF HON. TOM FEENEY, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF FLORIDA; HON. MARK S.

KIRK, A REPRESENTATIVE IN CONGRESS FROM THE STATE

OF ILLINOIS; AND HON. GREGORY W. MEEKS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK

STATEMENT OF HON. TOM FEENEY

Mr. FEENEY. Thank you, Madam Chairman, Ranking Member

Lynch, and members of the subcommittee. I don’t think I could say

it any better than the four of you have just said it. Mrs. Miller, I

thought your introduction was very well done. I think Mr. Lynch

put it best, time is at a minimum for Congress to look at where

we are because we have some data in.

I am very grateful to be joined by two colleagues, who, the three

of us, with a couple of other colleagues, have engaged in a national

listening tour to hear about some of the consequences of SarbanesOxley.

Some have called it the most comprehensive and important corporate governance reform since FDR was President. And I was

kind of surprised when I got here—because I was not here when

Sarbanes-Oxley was passed—that businessmen, both small and big,

chief financial officers, CEOs, beat a path to my door to beg for

some relief from current impacts of Sarbanes-Oxley and for small

and mid cap companies that are not yet directly impacted, beg for

prospective relief.

I like to say, as my colleague did, that Congress has two speeds,

zero and over-react, and it may be that in some ways we have overreacted with respect to Sarbanes-Oxley. So I am glad, that on a bipartisan basis, we can look at the advantages and keep them, look

at the disadvantages and reform or eliminate them.

We have heard some important positive things and effects from

Sarbanes-Oxley. I want to make that clear from the beginning. So

far from my portion of the listening tour I have concluded that

there is general agreement that after SOX was passed we have

tighter financial reporting, which is a good thing. Internal controls

have improved across the board, and there is also more transparency in the overall auditing process. All of those things are cited

approximately by Sarbanes-Oxley supporters as a reason that not

all of this bill should be thrown out in its entirety. And as one suggestion, Section 404 is the target of virtually all of the major complaints. There have been some serious negatives in the way we

have imposed and implemented Sarbanes-Oxley.

On January 6th the Wall Street Journal pointed out, for example, that New York loses its edge in snagging foreign listings. In

the year 2000, $9 of every $10 raised by a foreign company in a

public market was raised primarily in New York, and in the United

States of America.

By the year 2005, the reverse was true, $9 of every $10 raised

by a foreign company in a public exchange is now raised in places

like Luxembourg and London exchanges, the biggest spread favoring London. This is a startling number to me, and candidly, I believe that we are slowly and steadily outsourcing America’s world

lead in the capital markets.

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After a recent trip to Hong Kong, which Mr. Kirk was part of as

well, I received very similar feedback regarding Sarbanes-Oxley

from their Chief Financial Officer, Mr. Tung. He practically

thanked me and Mr. Kirk for Sarbanes-Oxley and the competitive

advantage it gave to the Hong Kong markets. The Financial Times

stated in November 2005, ‘‘Over the past few years, as more global

investors have begun to invest in Asia, the New York Stock Exchange appears to have lost its lore for the region’s leading companies. The roots of New York’s recent difficulties in winning Asian

companies’ listing lies in the high burden of regulations and compliance.’’

Many of the participants in the listening tour also noted that 404

compliance ignores the indirect costs, and I think the chairman

pointed to the opportunity costs of Sarbanes-Oxley compliance.

Some of America’s best and brightest leaders on corporate governance boards are spending more time complying with bureaucratic

and accounting regulations than they are building a better mousetrap, a cheaper mousetrap, and then marketing the mousetrap; and

that is really what we want to do in order to get American advantage.

The opportunity cost is huge. A paper by Mr. Butler of Chapman

University and AEI-Brookings Joint Center for Regulatory Studies,

and Larry Ribstein of the University of Illinois School of Law cites

the ‘‘direct compliance costs of SOX are about $6 billion per year,

but this expense—which basically represents payments to accountants—is a small fraction of the total compliance costs for firms. The

indirect costs from having to divert company resources are much

greater and based on a back-of-the-envelope calculation of how SOX

impacted American markets, they can be estimated at about $1.1

trillion.’’ That is with a ‘‘T’’, and by the way, we have only impacted

5 percent of America’s companies on the public markets so far.

Now, as the CEO of Sun Microsystems put it, Scott McNealy,

‘‘What Sarbanes-Oxley has done in some ways is like throwing

buckets of sand into the gears of the market economy.’’

Madam Chairman, you have more of my testimony, but I see I

have run out of time. I would just suggest that it is time that we

take a serious look at the current impacts of Sarbanes-Oxley, the

prospective impacts as mid-size and small companies are thrown

into this briar patch, which is going to be very difficult for them

to comply with, much more difficult than the large companies that

are having such problems.

Finally, I will quote from the regulator. Mr. McDonough, the

former regulator, who just recently retired as chairman of the Public Company Accounting Oversight Board. I quote him in part in

a recent Wall Street Journal interview, because even he acknowledged that in some ways Sarbanes-Oxley implementation has gone

way overboard. On October 12, 2005 he told the Journal, ‘‘In many

cases it’s clear that they [auditors] overdid it. There’s no question

that some auditors got it right on; there are other cases, in fact

probably more, in which the auditors overdid it, and decided we

better check everything under the sun. Why? Because [they’re] also

concerned about being sued—that it is appropriate for the wellbeing of the American people if companies have costs which simply

don’t have any appropriate offsetting benefit.’’

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The bottom line is we have to do what benefits investors. If we

are taking half of the bottom line out of the pockets of companies

and giving it to auditors and to regulators, then financial investors

around America are being hugely disadvantaged, and again, I want

to thank the committee for paying attention to this very important

issue to the American economy.

[The prepared statement of Hon. Tom Feeney follows:]

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Mrs. MILLER. Thank you very much, Representative Feeney.

And our next witness is another one of our distinguished colleagues. This is Representative Mark Kirk from the 10th Congressional District of Illinois. He is currently in his third term. He is

a member of the House Appropriations Committee and also serves

on three of its subcommittees, Foreign Ops, Military Quality of Life

and Veterans Affairs, and Science, State, Justice and Commerce.

He is certainly a strong supporter of legislation that eases Government regulations, and also another member of the Sarbanes-Oxley

listening tour.

The floor is yours Representative Kirk. We look forward to your

testimony, sir.

STATEMENT OF HON. MARK S. KIRK

Mr. KIRK. Thank you, Chairman Miller. I have some testimony

that I would like to with unanimous consent insert for the record.

Mrs. MILLER. Without objection.

Mr. KIRK. And a letter from a wide industry of leading new industries for comments on this subject.

Sarbanes-Oxley addressed some critical weaknesses in public

markets, but to put it simply, I think we all support Section 1

through 403 of Sarbanes-Oxley. It is just Section 404 I think that

we have a bipartisan consensus on the need for reform. You see

here wide agreement between conservatives, moderates and liberals that we need action. American Enterprise Institute, Nancy

Pelosi, Eliot Spitzer, all agreeing that we need reform of Section

404.

I have a presentation here that answers a basic question, which

is: Does 404 add investor value, and would a retiree making decisions about their IRA, ever use 404 data in making a buy or sell

decision on their retirement savings for the cost and benefit of Sarbanes-Oxley? We see that we fit a need, especially in the mismanagement of America’s largest companies. But we have to balance the compliance of the act with the cost of doing that. We see

with small companies that there is a great imbalance.

My colleague from Florida quoted Bill McDonough that said that

it would be inappropriate to spend too much on the compliance

with this if we simply do not have an offsetting benefit, and what

Chairman McDonough was driving toward, was, are we driving investor value? And I think, clearly, with the application of 404 to

small companies, we are not. We see that SOX compliance already

is costing about 50 times more than was estimated in 2002, exceeding about $6 billion so far. And the global position of the United

States has been dramatically weakened in this area.

We have a bipartisan Republican and Democratic consensus that

whatever else we do, American financial markets should lead, and

we clearly see that because of Section 404 compliance costs, American financial markets are rapidly falling behind.

In our look at SOX and its application, we are also seeing a decline in R&D expenditures, and I think that is troubling for the

long-term future.

If you look here at the next chart, you will see that we have a

greatly disproportionate cost of compliance leveled on small businesses in America of publicly traded companies. And I will just

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note, the category that I want to pay most attention to are companies less than $100 million, the great employers of the United

States. The average $100 million employer, by the way, in America,

makes a 6 percent profit, and so Sarbanes-Oxley, by taking away

almost 3 percent of that profit, means that we have reduced the

profitability of the most dynamic small business sector in America

by half with this one section of one law.

We also see a trend of going private. You can see in the next

slide, a well-known company, Vermont Teddy Bear, will not be in

the public markets and will not offer their securities for sale to the

public, citing this as a critical example of why they have turned to

the private market.

Brookstone, SunGard Data Systems, Toys R Us, AMC Entertainment, Loehmann’s, all going private. And remember, one of the

basic points of Sarbanes-Oxley was transparency and accountability. All of that is lost when a public company becomes private, accomplishing just the exact opposite of the core function of the act.

In fact, Foley & Lardner reports, of 147 companies surveyed, 20

percent would like to go private. That is an almost doubling of the

companies wanting to go in that direction.

By the way, that reverses a 400-year trend in capitalism of companies going from private markets, where capital is relatively expensive, to public markets where it is a bit less expensive. That

should be a great concern.

When we look at other companies seeking a public alternative,

we see that there is a great reluctance to go public, and we have

a number of magazine articles and the Wall Street Journal reporting on that.

My colleague from Florida though listed probably the most dramatic effect of Sarbanes-Oxley, and that is almost the disappearance of foreign listings on U.S. markets. Whether you represent

Boston, New York, Chicago, or one of our other financial centers,

you do agree that all of this work should come to the United

States. It doesn’t mean just jobs in the financial sector and for

stockbrokers, it also means jobs for American accountants and

American lawyers. Every single dollar is lost when we don’t have

those foreign listings. And you can see a 90 percent drop in foreign

work coming to the United States.

To conclude, we have been talking about three common sense reforms for Section 404. First of all, for small business relief, to look

at the smallest companies in America. They represent only about

6 percent of the portfolio on the New York Stock Exchange, and to

give them relief from 404, as the Commission and their Small Business Committee has been looking at.

Another common sense reform: to permit auditors and consultants to actually talk to each other to decide what compliance is.

Right now, we have pushed many small publicly traded companies

into a Bermuda Triangle of having their consultants on SarbanesOxley not being able to discuss any major compliance issues with

their auditors, and so you cannot get an answer of what is compliance.

And finally, to return to the traditional, Generally Accepted Accounting Principle of what a major problem is. We used to think

of a material weakness as something that affected 5 percent of the

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bottom line. We have lost that, and so right now we have a ridiculous situation where almost a box of lost pencils could be regarded

as a material weakness. If every issue in the company is a material

problem, then we have dramatically worsened the ability of anyone

to manage their company, and I think that Sarbanes-Oxley was

sold to the Congress as a way to help people run their companies,

but if every issue is a material weakness, allowing trial lawyers to

jeopardize the entire company, and therefore, the investor value,

and where our retirees have put their funds, then we have actually

worsened the problem, rather than improved it.

So I thank the committee and look forward to your questions.

[The prepared statement of Hon. Mark S. Kirk follows:]

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Mrs. MILLER. Thank you very much.

Next the subcommittee will hear from another one of our distinguished colleagues, Representative Greg Meeks from the 6th District of New York. He is currently serving his fifth term in Congress, and he serves on the House Financial Services Committee,

and also on the House International Relations Committee. He is a

very strong advocate for consumers, and along with the other representatives who testified today, is also a member of the SarbanesOxley listening tour.

So the floor is yours, Representative, and again, we certainly appreciate you joining us today and look forward to your testimony.

STATEMENT OF HON. GREGORY W. MEEKS

Mr. MEEKS. Thank you, Chairwoman Miller and Ranking Member Lynch.

I remember back in 2002 when the Enron scandal began to unfold. Week by week we learned more about the machinations of the

senior executives of Enron that would ultimately lay low the seventh largest company in America, as well as one of the Big Six

audit firms.

Immediately after that, the WorldCom scandal took front and

center. Following the aftermath of numerous hearings, including us

witnessing one senior executive after another plead guilty—or

plead the Fifth—should have plead guilty—it was clear to members

of the Financial Services Committee, as well as the majority of the

rest of the House of Representatives, that Congress needed to act

to maintain investor confidence in America’s capital markets.

The resulting Sarbanes-Oxley legislation was designed to improve corporate governance by holding board of directors more responsible for their oversight of the corporation, hold the CEOs and

CFOs to task if they knowingly signed off on inaccurate statements, strengthening auditor standards, and forcing publicly traded companies to review, and if need be, improve their internal controls that ultimately led to the production of their financial statements.

Let me say, Madam Chairman, that in the 8 years that I have

sat on the Financial Services Committee, Sarbanes-Oxley is one of

the two most significant pieces of legislation we have passed, along

with Gramm-Leach-Bliley, which repealed the Depression Era

Glass-Steagall Act.

In some ways SOX is more significant because it affects all publicly traded companies and not just the financial sector. After Sarbanes-Oxley was passed and the Public Company Accounting Oversight Board was created, the PCAOB opened for public comment on

their proposed rulemaking for Section 404. Even then, comments

that were received by the PCAOB from companies such as Microsoft, addressed concerns that the audit of internal controls where

a public auditor must attend to the soundness of a company’s internal controls system would significantly increase the cost of public

audit.

During this time period, my office began conducting meetings

with small groups of Tier 2 and Tier 3 accounting firms. The purpose of the meetings was to determine if the potential increase in

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tracted to small accounting firms. Under SOX, there is some leeway for the public auditor to ‘‘rely on the work of others’’ in providing their attestation on the soundness of the 404 audit.

Not only did I suggest this to the PCAOB in writing during their

comment period, but my office also arranged a meeting with members of the National Association of Black Accountants and the

PCAOB to discuss these issues. Unfortunately, this option was not

deemed viable by the PCAOB due to potential supervisory constraints between the major auditor and the subcontracted company.

We are now some 4 years from the passing of Sarbanes-Oxley,

and the jury appears to be deadlocked. Without question, SarbanesOxley has achieved its goals in relation to improved corporate governance. As you know, I have joined with my colleagues, Congressman Kirk and Feeney, in a listening tour of companies that have

to deal with Sarbanes-Oxley compliance. Companies listed on

Nasdaq and the New York Stock Exchange, and members of the

Chamber of Commerce, seem to concur on the corporate governance

issues. There is a consensus that the board of directors have taken

their fiduciary responsibilities more seriously, including meeting

more, acting more independently of management, particularly in

relation to the audit, and improving communication with shareholders.

Many companies have expressed how Section 404 has forced

them to review and tighten their internal controls, making them a

more efficient and secure company. This is clearly a part of what

SOX was meant to do. However, some of our intentions have backfired, and we are forced to recognize that phrase that we hate to

hear as legislators, ‘‘unintended consequences.’’ Although there are

several issues related to 404 compliance costs that I could mention,

for the sake of time, I will limit my concerns to two issues.

The first is the effect that the significant cost in financial and

human resources of SOX implementation is having on small cap

companies, particularly biotech. The second is the overall cost to

our capital markets from companies that have either delisted, not

listed, or have listed overseas.

According to a survey conducted by Financial Executives International, member companies spent an average of $4.3 billion for

costs associated with internal control compliance. I have heard of

companies going from approximately $400,000 for audit costs to

over $1 million. According to that same FEI study, companies with

revenues over $25 billion, spent an average of more than $14 million. The reality is that large cap companies can absorb these costs,

but small cap companies simply cannot.

In New York City we have an enclave of biotech firms. They are

small firms whose primary business is research and development

in health care, agriculture, industrial and environmental biotechnology products. In other words, their research leads to quality

of life improvements that include cancer-related and other types of

life-saving products.

For many of these companies, documentation and testing of internal controls is the responsibility of their internal audit departments. Since in most cases there are only a few staffers, many of

whom are part time, these companies now have to hire additional

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ternal control testing. Many of the smaller biotech companies have

had to redirect 10 percent of their full-time employee resources to

comply with SOX. The cost has ranged from $300,000 to $500,000

for increase in internal staff, and $800,000 to $1 million for external consultants.

I will give you one example. A New York biotech company that works on spinal cord injuries has a market capitalization of $99

million. It has 65 employees and survives on capital raised every

round. It has a spending rate of $4 million for clinical trial and research and development for a possible product to cure spinal cord

injuries. If it spends one million on SOX compliance, that equals

25 percent of its budget. That is an opportunity cost of $1 million

that is not being spent on research to benefit humanity.

I know that it was not the intention of the Financial Services

Committee or this Congress as a whole to divert funds from lifealtering research.

My second concern, particularly as a Member from New York, is

the issue of public listings of companies; 68.7 percent of companies

are listed in the New York Stock Exchange, Nasdaq or the American Stock Exchange. This is a major artery in the lifeblood of the

New York economy. According to Citigroup, as of the year 2000, $9

out of every $10 raised by foreign firms through new stock offerings

was done in New York. In 2005, the $9 out of every $10 has moved

to London or Luxembourg. In addition, hundreds of small corporations have already delisted.

Let me just give you this quote as I wrap up. This is from the

March 17, 2006 article in the Houston Business Journal: ‘‘Today,

hundreds of U.S. companies are considering tapping the London

Exchange’s AIM as a promising source of quick capital. Faced with

costly compliance requirements under Sarbanes-Oxley regulations

passed 4 years ago in the United States, a growing number of

small domestic companies suddenly are more open to the idea of

crossing the ocean to use the more lightly regulated AIM. The overseas option is being weighed against U.S. exchanges such as

Nasdaq.’’

Now, as a member of the International Relations Committee, I

am in favor of development of other countries, but not by creating

an unfair advantage against American companies and American

markets.

Let me close again by saying that I am not offering—I am not

going to offer right this second a particular solution to the day, although, I do have remedies in mind. At this point I am still in a

mode of listening to companies, American and foreign, so that I can

offer a solution or support the solutions of my colleagues. I feel

comfortable that we have heard and considered the best options before choosing any to avoid creating a bigger problem.

It is also important for me to hear particularly from more minority firms, who are too often left out and not heard. And I ask all

to join with me so that we can make sure that all their voices are

here, because they are very definitely being affected by the SOX

regulations.

I end by just saying that this is not a Democrat or Republican

issue. This is an American issue, and we have to work with this

in a bipartisan manner to make sure that we don’t continue with

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unintended consequences, and that we resolve this issue fairly for

our businesses.

Thank you, Madam Chair.

[The prepared statement of Hon. Gregory W. Meeks follows:]

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Mrs. MILLER. Thank you so much. I think that was particularly

well-said.

Let me thank all of our witnesses for being here and tell you how

absolutely delighted I was to listen to all of your testimony and the

opening statements of my colleagues here as well. And being still

a relatively new Member of Congress, one of the most distressing

things for me has been the partisan atmosphere around this place.

I think we can look at this in a very bipartisan way. As you say,

before we are Republicans or Democrats, we are all Americans

first, and this is an American problem and something that we need

to address in a bipartisan way. And I think we can do so.

I was a little bit concerned, even initially, calling this hearing.

I wasn’t here when Sarbanes-Oxley originally passed; I don’t sit on

the Financial Services Committee, either and have not been an official member of your listening tour. But I would think that you

could probably go to all 435 Members and enlist any one of them,

because we must all hear the same things in our district.

As I mentioned to our ranking member before we started here,

I am just outside of Detroit, so you can imagine all the auto suppliers and the small and mid-size businesses that I come in contact

with every time I am out in my district, and they know that I am

the chairman of this Subcommittee on Regulatory Affairs. So I will

ask them, what is the biggest problem that you have with onerous

governmental burdens? And they—I mean, if you took SarbanesOxley out of the vocabulary, they would almost have nothing left

to say, because that is the first thing they want to talk about. And

this is every type of business.

So it is something that we need to look at. This is a committee

that has tried to look at various types of onerous governmental

burdens. It was interesting, we were talking about manufacturing

regulations, and here you have the National Manufacturers Association estimating that the structural costs of American-made

goods are 23 to 24 points higher than any of our foreign competitors, and much of it is due to these kinds of things; particularly

Section 404 in Sarbanes-Oxley. And when we do see jobs leaving

our shores for other countries, like China or Mexico or India or

what have you, guess what, those countries did not put this regulatory burden on us. We have done it to ourselves.

So it is a very appropriate thing, I think, for us to take a good

look in the mirror and see where we can go with this.

I guess I would just throw this out to all of you as we—I think

we are all concerned, of course, that we are not viewed as going

soft on corporate governance after the rather horrific experiences

that we went through with the Enrons and Tyco, etc. But if we

were to revisit some of these corporate governance standards, do

you think that some of the companies or even the American public

might think that we are opening up a Pandora’s Box? In other

words, as bad as 404 is, that they are getting used to it? And the

cost of compliance does seem to be coming down a bit as we are

going through the second and third year of this. At least it is a

known quantity.

Mr. KIRK. Let me just briefly answer that, if we look at the mar- kets the way the SEC does and look at companies at $750 million

in capitalization and below, and give some sort of 404 relief to $750

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and below, you still have 94 percent of public markets under full

Sarbanes-Oxley compliance controls. And so I think that we have

protected the main part of investors, especially retirement investors that are largely, 94 percent, invested in the very large companies, but we have also lifted a tremendous burden off the small employers, which employ over half of all Americans. And so I think

the way that the Small Business Advisor Committee of the SEC

and the way the Commission has looked at this dividing line is a

very helpful one for the Congress.

Mr. FEENEY. Well, I think it is a very real concern that investors

are—you know, there is an Enron trial going on as we speak. I

won’t prejudge the outcome of that, but as the chairwoman said,

there are lots of protections for investors out there. No protection

is going to work against bad apples that really want to commit outright fraud. And the bottom line is nothing in 404 is going to protect investors from people that are really evil. And we need to explain to Americans that regulations are appropriate and necessary;

redundancy and red tape that does not add to investor confidence

is disadvantaging Americans.

I think, you know, Madam Chairman, you put it best, is foreign

companies—to take Gregory’s biotech example—is foreign companies are not spending 25 percent or 50 percent of their bottom line

on compliance with redundant regulations and auditing, but instead putting money into finding the next cure for cancer or the

next cure for AIDS. Good for humanity, but bad for the potential

for American employers and American employees, and it puts us at

a huge disadvantage.

So let’s keep what is good. Explain to Americans. I think we are

trying to build the case to keep what is good, review what is bad,

and either reform it or get rid of it.

Mr. MEEKS. Let me just concur. I think that Representative

Westmoreland said, you know, basically what we do sometimes, we

have knee-jerk reactions. And I think that we have to understand

that it sometimes happens. We react to a situation and we act fast.

But we can’t throw the baby out with the bath water. I think that

from the testimony that I have heard from a lot of individuals

around the country, they all agree that a lot of Sarbanes-Oxley is

good. But we are focusing on, and what Representative Kirk just

talked about, I believe that we can have a cap so that we can make

sure that the intention of the Members of Congress is had. And we

can do that without people coming back and talking about the fact

that we are opening up Pandora’s Box. We can do that by saying

that we still have the investors’ confidence that Congressman

Feeney just mentioned, but that we are also making sure that we

are keeping companies public or having the desire to come public

and not go overseas.

Mr. KIRK. Madam Chairman, can I add one more thing?

Mrs. MILLER. Certainly.

Mr. KIRK. Because this really is about investor confidence at its

bottom. If I want to get a credit card tonight, go online at 3 o’clock

in the morning and invest in the futures in pork bellies on the

Shanghai Market, I bet there is a way to do it. And ultimately, investors will find a way around the protections that we think we

have built up around them. If we have added value, they will inVerDate 11-MAY-2000 09:52 Dec 21, 2006 Jkt 000000 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 D:\DOCS\30899.TXT HGOVREF1 PsN: HGOVREF1
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vest their money in American markets. If we have added costs,

they will find their way around it. That is happening with the

major investors as we speak.

Mrs. MILLER. Yes. And I think Representative Kirk made a very

good point when you were saying whether or not individual investors are actually looking at some of this data when they are deciding to invest in an IRA or what have you. So it is an interesting

thing.

My other question would be——

Mr. KIRK. Can I just add——

Mrs. MILLER. Yes.

Mr. KIRK. My staff talked to the Commission yesterday and

asked if they had any report of any investor using a 404 disclosure

to buy or sell securities. And to date, the Commission has not one.

Mr. FEENEY. And neither do the rating services use 404. Moody’s,

Standard & Poors, they could care less about these things. And yet

they are costing Americans—one estimate—$1.1 trillion to our

economy and nobody is using the stuff.

Mrs. MILLER. Well, you know, we are from the Government. We

are here to help them. [Laughter.]

What is your opinion on the lack of direct control, sort of the wiring diagram for this PCAOB, sort of the lack of direct control that

the Congress has on that? Do you think their independence from

congressional oversight is having any impact on their opinions,

their guidance?

Mr. KIRK. The Board, obviously, had some difficulties in starting

up. We went from eight employees to now over 400. So we are finally getting an ability to issue an opinion and to have some common sense in the application of the act. But we have not yet had

the tsunami of full 404 compliance hit the small business sector

yet. And that is the critical issue for the Congress. If we have 100

percent compliance requirements on the small business sector, we

should understand that we are only affecting 6 percent of public

markets but we are dramatically weakening the employers of half

of all Americans. And so that is the concern I have for the PCAOB

and their compliance burden.

Just imagine how many employers and how many public companies will be calling them, flooding their phone lines if a full requirement is imposed on them.

Mr. FEENEY. Madam Chairman, the problem is that everybody in

the system is covering their rear ends. From the chief financial officer to the chief executive officer, they now have to certify total compliance with all of these things even if they had no knowledge. It

is no longer a willful standard or a negligent standard, it is a zeromistake standard. Everybody on the board of directors has to do

that. The inside auditors that are advising the board of directors

has to do that. The outside auditors, who are not allowed to talk

to the inside auditors, they have no incentive whatsoever to use a

reasonableness standard because they are going to be held personally, civilly, and perhaps criminally responsible for any mistake.

Thus the hyperbole about, you know, finding every box of paper

clips for a global company like IBM, or every box of pencils, it really has almost gotten to that point. And also, as you point out, the

Accounting Oversight Board, there is no incentive for them to be

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reasonable. The incentive is to make sure that every single box

that can be checked is checked. Nobody wants to be the guy that

lost that box of paper clips.

Mr. MEEKS. I think that what Representative Feeney just said is

right, because what he is talking about is basically reasonableness.

And there is no incentive to be reasonable as of right now. It is protect yourself at all costs. And so therefore, you know, there is no

room for you to do anything that may be a common-sense approach.

It is if I don’t make sure that I am absolutely 1,000—you know,

even in criminal jurisprudence, you have beyond a reasonable

doubt. This is not—this is zero doubt. So it is a standard that is

so high that I don’t know that it can be met.

Mrs. MILLER. Thank you.

Representative Lynch.

Mr. LYNCH. Thank you. And again, I thank the panel.

Let me ask you—and I understand the standard is a very high

one and may in fact be unrealistic and it may have, as you have

pointed out, negative consequences.

Let’s just take from the existing Section 404. I do want to point

out, though, that Section 404, when people are assessing, you

know, whether to buy a certain stock, whether to invest publicly,

they wouldn’t look at 404. They would look at the numbers, the financial numbers, for the performance of the company itself, the

profit and loss, their value. And what 404 does is it speaks to the

accuracy or reliability of those numbers. You wouldn’t look to Section 404. It is just a given that the companies to which it applies

must comply.

What about the idea, however, that right now Section 404 requires an annual manager’s statement, an annual assessment by

the company supported by an outside auditor, you know, an independent auditor to come in here and say that the internal controls

are in place and that they are reliable. That is a very extensive

process. That is what is driving the costs of this rule.

It would seem to me that thorough of a process does not need to

be repeated every single year, and that if in, you know, 2006 a

company goes through this—and it is a painstaking process and extremely thorough—it would seem that in 2007 it should be sufficient to have those managers and the folks in control at the company certify that last year’s controls and procedures are in effect.

And that should be enough for reliability and what we are talking

about. And then in the next year, 2008, if 2 years have gone by,

obviously, there may be the need to go back to the full-blown, fulltilt assessment again.

But even if we adopted that system, where it is not annual, that

we will trust for 1 year. If a company certifies that their internal

controls and their internal procedures are still in place to the same

degree or substantially to the same degree as they were in the previous year, that should be enough.

In my mind, that would cut everything in half without changing,

you know, a period or a comma in any of this, and it still would

provide that reliability and that accountability that we are looking

for under the bill. Because there has been some improvement on

transparency and other things that have been very good here. And

we are stuck on 404. But it just seems to me that enormous

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amounts of money and labor could be saved, without any measurable drop in quality of the reports and reliability for the investor,

by going to a biannual reporting or biannual manager’s statement

on the reliability of internal controls and procedures.

What are your thoughts?

Mr. KIRK. Congressman, that is a very common-sense reform

that would cut the work level in half. Also, remember what we are

talking about. With a small publicly traded company, the entrepreneur largely sees the entire operation. We are talking about 10

and 20 employees. And so the issue of internal controls is entirely

different than for an extremely large company where you really

have some serious management issues.

But one of the things that we learned on this listening tour is

when you talk to rating agencies, like Moody’s or Standard &

Poors, which for most investors issue the critical buy and sell signal or the data package they use to asses a security, the 404 disclosures are in the 10-Ks that are submitted by the publicly traded

companies. And even the rating agencies say they are not using

this data. It is so turgid, it is so user-unfriendly that it is not driving investor value for a buy or sell signal.

And then we have the issue of the London AIM Market, which

is now marketed directly as a Sarbanes-Oxley-free environment.

And I am worried because, you know, there is an unwritten story

in the 1880’s of how New York gained financial dominance over

London and became the best and least expensive way to access capital markets and the financial center of the world market was

transferred from London to the United States. They are beginning

to gain back that financial leadership.

But that is a critical issue in the rise of China. Congressman

Feeney and I, when we were talking to Chinese entrepreneurs in

the emergence of this $1 trillion economy, said now, because of Sarbanes-Oxley, they would not think ever of listing in the United

States because of these compliance costs. And they are talking

about bringing small, $50, $100, $200 million companies to market

and they do not want to bring this work to the United States,

where 5 years ago all of the work came to the United States.

Mr. FEENEY. Congressman Lynch, you made a very commonsense recommendation. We have actually heard a couple of recommendations and we want to hear more before we make a recommendation of which one I would think would be preferable. One

would be semiannual or every third or every fourth year have the

outside audit; your internal procedures would have to remain the

same. Another way to do it is to allow the exchanges to, for example, have everybody pay in based on a pro rata share of their market capitalization. If they have 1,000 companies and everybody is

the same size, pay in to a little system and then have random testing like we do drug testing in some places. So that everybody has

to stay on their toes, but they do not have to be duplicating and

have this superfluous process where you have redundant mechanisms.

But I would say that doesn’t resolve the whole problem. You still

have the issue of if you place this burden on small and mid-cap size

companies as it remains today, I am afraid you would never get the

next Dell or Microsoft to go public. And American—not only would

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they not grow to the size that they grew, but American investors

would never have the opportunity to invest. I also believe the materiality standard is very important to address.

But if you did those three things, boy, I think you would get to

90 percent of the problem.

Mr. MEEKS. I think your approach is a common-sense approach

and I think that is what the listening tour has helped me with. I

have found that the companies that we have listened to, nobody is

really trying to avoid the scrutiny or anything of that nature. Nobody even—because they all have basically been straightforward

and honest in saying we want to make sure there is transparency,

we want to make sure that our internal controls are in place. It is

just a cost. And we have to figure out and come out with different

ideas of how we reduce the cost.

And they came up themselves, voluntarily, with various ideas,

you know, what Representative Feeney just talked about as far

as—we can even act like a system like the IRS, where there are

random audits. That would help us reduce our costs. We don’t want

to just say that we want to go back to the old way. We accept that

things have changed. But we have to bring down the costs. And I

think that is what the listening tour does. That is what has benefited me, is to hear good commonplace ideas on how we can make

it better so that we don’t have the unintended consequences ruling.

And I think that we can do that.

Mr. LYNCH. OK, thank you.

I yield back.

Mrs. MILLER. Mr. Westmoreland.

Mr. WESTMORELAND. Thank you.

Mr. Kirk, you know, if you look at the total cost of WorldCom, Enron, and Global Crossing, it is about $155 billion. And I believe

the Rochester School of Business just got through putting out the

fact that this is costing $1.4 trillion. Is that a good common-sense

approach to fighting the problem? What is the source, do you think,

of the disparity in the cost that was expected or that the SEC expected this to cost, as compared to what it is costing? And what do

you think made that difference?

Mr. KIRK. A couple of things. First of all, a lack of rationality in

what is material. That is why it is so important to go back to the

old traditional definition of materiality, because if every single lost

pencil box is a material weakness, we are going to continue to have

stories, as we do now, of CEOs spending a vast amount of their

time trying to account for every single asset or liability, you know,

almost on a real-time basis, rather than thinking about new markets and innovation and research and development that we traditionally associate with growing a company.

Another problem is we have four and a half major accounting

firms. And generally, for a small employer, they will, when they

seek to have a public accounting, will find that two or three of the

large accounting firms are conflicted out because they are already

working with competitors. And so the final accounting firm knows

that they have this company in a box and will charge a very high

price for their services.

And remember, in the world of Sarbanes-Oxley, you can’t have

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ing firm to actually certify your books and another one to advise

you as to how to implement 404. And those two firms cannot coordinate their activities to issue you a compliance signal or a noncompliance signal.

So for all those reasons, we have costs that are very high.

Last, let me just say this. And this is what Congressman Lynch

pointed out, that we have—404 is a very short section of law. Enormous discretion is given to the Commission and to the PCAOB.

This hearing is going to help in the process, because if we send a

signal from the Congress that we have broad-based bipartisan support for rationalizing the implementation of these regulations, the

PCAOB and the Commission can take action on their own to dramatically lessen this process.

I think we are in the period here where, this year, this committee and our bipartisan group of members can send that signal. And

my hope is the Board and the Commission will then take action to

relieve this burden. And then, if not, I think the time comes next

year for a listening tour to turn into a legislative tour.

But I hope that the Board and the Commission will see this action by the Congress and take their own authority.

Mrs. MILLER. Yes, Representative Lynch?

Mr. LYNCH. I just want to clarify. I believe I misspoke. I was

talking about biennial, which is every 2 years, not biannual, twice

a year. Biennial, OK? [Laughter.]

I don’t want a riot going on out there.

Mrs. MILLER. We appreciate that clarification.

Representative Clay.

Mr. CLAY. Thank you, Madam Chair, and thank you both for

your testimony.

In terms of the cost and compliance requirements under Section

404, how well is the accounting industry responding to the needs

of industry? Are auditing firms recognizing the limits facing smaller capitalized firms in their evaluations and recommendations for

corporate compliance? Both of you all can tackle it, please.

Mr. MEEKS. Well, that was just one of my points, where I said

we had to open it up to tier 2 and tier 3 firms, because we were

trying to make sure that there could be more competitiveness and

more firms involved. When you have just the top firms, as Representative Kirk just talked about, they know, you know, two of the

firms are already engaged, they know that they have the companies, and they can charge whatever they want to charge. They virtually have what is called a monopoly. That is driving costs up significantly.

So I, again, suggest that we need to look again at the opportunity

of tier 2 and tier 3 firms being able to be involved as a subcontractor getting involved and I think that would help drive some of the

costs down.

Mr. CLAY. And you also mentioned some significant barriers that

prevent small-cap companies from becoming compliant. Give me an

example.

Mr. MEEKS. What I was talking about, I mean, when you talk

about they can’t compete because they don’t have the wherewithal

to deal with the Big Four firms. And as a result, you know, you

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pete, and thereby are out of business, and cannot have the opportunity to be the next Dell. We want to make sure that they are not

left out of the game. And you have a significant number of minority

accountants who are left out of the game. And this is a way that,

I think, by adding them into the game, by adding tier 2 and tier

3 firms, then you are eliminating even some of the diversity issues

that you may have in the industry by opening it up and giving everyone an opportunity.

Mr. CLAY. Mr. Kirk.

Mr. KIRK. I would certainly agree that Representative Meeks has

pointed out a critical need for either the Commission or the Congress to act that would help out small minority accounting firms

get into this. They don’t have that opportunity now because they

don’t have the brand name and ability to access and advise a client

in this way.

But even more importantly, in the wider market for small-cap

companies to be able to expand and grow their business, you have

to really, really think about becoming a public company now in

America, given the liabilities and uncertainties that you face because of full 404 compliance. I would like it for minority companies

to be able to go public in an easier way, not a more difficult way.

And that is the problem.

Mr. CLAY. Let me shift and share with you both, one of the reasons I believe in Section 404, is that it forces companies to pay attention to their information technology systems that are often susceptible to hacking, information breaches, and other activities that

have dire economic consequences. If Section 404 requirements are

not met, how can a company be certain its information system’s

proprietary data are secure? Have any of you given thought to——

Mr. KIRK. I would just say remember what we are talking about,

the information data system of a small company is probably two or

three PCs in an office. We are talking about a common-sense approach of not going overboard. These are the most dynamic and

largest employers in America, but they come in groups of 12 or 20

employees. So we are not talking about a very difficult control issue

here. You are probably talking about one office suite and a set of

computers that is similar to the set of computers in your own office.

You know, remember the irony here—404 does not imply to congressional offices. Imagine the challenges you would have as a

small employer employing 18 people if you had two large accounting firms unleashed on your operation, and were told that one gasoline receipt that may have been misplaced is now a material

weakness and you could be brought—brought suit against you on

behalf of some trial lawyers.

That is the kind of issues that we are talking about, because I

think every Member of Congress does understand that we employ

18 people, so we are exactly in the same position, management and

control, as many of the companies that we are talking about.

Mr. MEEKS. Just look at my example of the biotech firm. I mean,

this is a real example. This is what I had going—this is a biotech

firm, mostly—a lot of part-time workers, very limited staff. And

now they have to shift resources and shift people to comply, taking

them away from the research and development that their existence

is there for.

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So we have to make more of a common-sense approach to this,

because otherwise the burden of a company being able to survive

as a public company will not continue to exist, and they will stay

private.

Mr. CLAY. I thank you both for the response, and I agree, we

need to find a balance.

Thank you, Madam Chairman.

Mrs. MILLER. Thank you all so very, very much. We certainly appreciate your time. And, you know, this is an oversight committee

so it is appropriate, I think, that we begin a debate and have some

oversight on various issues, certainly this Section 404. And I certainly agree with you all that—I am hoping that the Commission

and the Board are listening to what is happening, as you are doing

your listening tour on this.

Hopefully, this can’t be any secret to them, the problems that are

out there and that in a bipartisan way the Congress does intend

to take some action if they don’t become a little more proactive

themselves and look at some common-sense solutions as well.

So again, we appreciate your time sincerely. We adjourn for the

next panel to be seated.

[Recess.]

Mrs. MILLER. OK. We will call the committee back to order. Since

this is an oversight committee with subpoena authority, although

we did not swear in the last panel, I do hope that you will bear

with us and please rise and raise your right hands. I would like

to swear you in.

[Witnesses sworn.]

Mrs. MILLER. Thank you very much.

Our first witness on the second panel is Grace Hinchman, who

joined the Financial Executives International in 1999 as vice president for government relations. In 2000, she was promoted to senior

vice president of public affairs. FEI is a professional association for

senior-level corporate financial executives and is dedicated to advancing ethical and responsible financial management.

The floor is yours, Ms. Hinchman. We certainly appreciate you

joining with us today.

STATEMENTS OF GRACE L. HINCHMAN, SENIOR VICE PRESIDENT, FINANCIAL EXECUTIVES INTERNATIONAL; RICHARD

A. HUBBELL, CHIEF EXECUTIVE OFFICER, RPC & MARINE

PRODUCTS CORP.; ROBERT P. DOWSKI, CHIEF FINANCIAL

OFFICER, ALLIED DEFENSE GROUP [ADG]; ALEX J. POLLOCK, RESIDENT FELLOW, AMERICAN ENTERPRISE INSTITUTE; AND DAMON A. SILVERS, ASSOCIATE GENERAL COUNSEL, AMERICAN FEDERATION OF LABOR AND CONGRESS OF

INDUSTRIAL ORGANIZATIONS

STATEMENT OF GRACE L. HINCHMAN

Ms. HINCHMAN. Thank you, Madam Chairman Miller, Ranking

Member Lynch, and members of the subcommittee, for this opportunity to appear before you today. My name is Grace Hinchman,

and I am senior vice president of FEI. It is the leading organization

of 15,000 members, including CFOs, treasurers, controllers, and

other financial executives.

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FEI members represent the preparer community; that is, the financial executives responsible for the preparation of financial

statements. Importantly, we are also users of financial statements,

relying on financial reports of other companies in our investment

and credit decisions. In both roles as a preparer and as a user, we

welcome today’s hearing.

FEI strongly supports the goals of Sarbanes-Oxley. Overall, the

SEC and the PCAOB have done an impressive job in striking a balance between efficiency and cost-effectiveness, while maintaining

the intent of the statute. However, the rules and standards related

to the implementation of Section 404 require significant attention.

Although the SEC maintains final authority over the rules and

standards to implement the requirements of 404, much of the rulemaking and standard setting has come from the PCAOB’s Auditing

Standard No. 2 [AS2].

Since the SEC’s approval of AS2 in June 2004, the PCAOB and

the SEC have released additional guidance to supplement AS2

through policy statements, detailed staff Q&As and roundtable discussions. FEI recognizes that this additional guidance has been

helpful to both preparers and auditors alike, but they have fallen

short in providing a completely effective and efficient implementation process.

FEI firmly believes that Section 404 is workable and does not require congressional action. Both the SEC and the PCAOB have the

authority today to right-size AS2 and Section 404 so they meet the

capabilities of all public companies, large and small.

I would be remiss if I did not mention the overall cost/benefit of

Sarbanes-Oxley. As recently as last month, FEI surveyed 274 public company members with average revenues of nearly $6 billion to

gauge Section 404 compliance costs, and this survey is the fourth

survey that we have done over the last several years, and Congressman Meeks had made reference to one in his testimony.

The survey that we just did in March, last month, showed that

in total companies audit attestation fees represent 44 percent of

their total annual audit costs. The average company, which is a

company of $6 billion in annual revenues, expended approximately

$1 million in internal costs, or approximately 21,000 internal people hours. For year two filers, this average was only a 12-percent

decrease from their first year of implementation. External costs for

non-auditor-related consultants and vendors were $2.3 million.

This was a decrease of approximately 22 percent for year two filers.

Finally, audit fees were approximately $1.4 million, or a decrease

of 13 percent for year two filers.

What this survey shows is that while companies have experienced some reduction in their cost of compliance, primarily their

external costs, they are less than we had anticipated. As a result,

the costs of Section 404 remain high and continue to be disproportionate to the requirements of annual compliance.

In conclusion, FEI is confident that the SEC and the PCAOB are

up to the task of right-sizing compliance requirements of Section

404 of Sarbanes-Oxley and they possess the authority to meet this

challenge. We believe that a more balanced approach will be

achieved and that this right-sizing will further reduce the costs of

Sarbanes-Oxley.

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That concludes my remarks, and I would like to thank Madam

Chairwoman and the members of the subcommittee for inviting

FEI to participate in today’s hearing.

[The prepared statement of Ms. Hinchman follows:]

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Mrs. MILLER. Thank you so much.

Our next witness is Richard Hubbell. He is the president and

chief executive officer of RPC, Inc., which is a position he has held

since 2003. He is also the president and chief operating officer of

Marine Products Corp., a position that he has held since February

2001. Prior to this, he was president and chief operating officer of

RPC, Inc., and also was an executive vice president of Rollins Communications, which he joined in February 1970.

Mr. Hubbell, we appreciate you joining with us today, and we

look forward to your testimony, sir.

STATEMENT OF RICHARD A. HUBBELL

Mr. HUBBELL. Well, thank you very much. As mentioned, I am

the chief executive officer of RPC, which is a small oilfield service

company providing services and equipment to producers of oil and

gas in the petroleum-producing regions of the United States and a

few international markets. RPC has approximately 1,600 employees, the majority of which are in the domestic United States. In

order to deal with the cyclical nature of our business and provide

the best possible return to our shareholders, we acquired a pleasure boat manufacturer in 1986. A few years ago, we decided that

it was in the best interests of our shareholders to form a separate

company and spin that pleasure boat manufacturer off. So that is

why I am president and CEO of two New York Stock Exchange

companies.

Marine Products Corp. is the third largest manufacturer of

sterndriven pleasure boats in the United States. We have two domestic manufacturing facilities and approximately 1,100 domestic

employees. Our strategies have provided good long-term returns to

our shareholders. Today, the combined market capitalization of the

two companies is approximately $1.7 billion.

As a result of the spin-off transaction I just outlined, I manage

a small corporate headquarters staff that handles the common corporate functions of these two public companies. We believe that it

is in the best interests of our shareholders to have this common

headquarters structure, because it allows us to spread the costs

and leverage the knowledge of our staff over such functions as accounting, public company reporting and compliance, and financial

management. It also allows us to work more effectively with outside constituents such as our public accounting firm and our shareholders.

We managed the implementation of the Sarbanes-Oxley Act of

2002 in the same manner. For these companies, which are relatively small, this implementation created a large and ongoing

structure which is expensive for our shareholders and time-consuming for our corporate and field employees. For example, during

the last year prior to the implementation of Sarbanes-Oxley, our

public company compliance costs for each company were approximately $70,000. After the implementation of Sarbanes-Oxley, our

ongoing annual costs increased to $1 million per company. So I

have heard quotes of costs increasing 100 percent. Ours is way,

way more than that.

I acknowledge the loss of confidence in the integrity of the business community that shook our society a few years ago, and I agree

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that decisive measures had to be taken in order to restore public

confidence. I believe that my companies have benefited in certain

ways from the documentation of internal controls, tightening of

policies and procedures, and enhanced transparency in our operations and financial reporting that have resulted from our compliance with Sarbanes-Oxley.

However, I also believe that my companies and our shareholders

have not benefited in proportion to the expenses we have incurred.

In addition, I believe that we have suffered certain opportunity

costs since we are now spending more time to comply with and document policies and procedures than we had in the past. This means

that we can devote less time to the analysis of our financial and

operational results, management of the operations of our businesses, and the intangible aspects of company management that relate to experience and judgment. Sarbanes-Oxley has made many

companies consider going private and has, I believe, prevented others from becoming public. This limits access to the capital markets

for U.S. companies and, in the long run, damages American competitiveness in the global marketplace.

In addition, I have serious concerns about the approach to the

implementation of Section 404. The text of the provision itself is

brief and ambiguous, and it provides a great deal of leeway to a

company’s public accounting firm as to what the accounting firm

believes to be effective internal controls. In the case of my companies, we are a ‘‘controlled corporation,’’ both of them ‘‘controlled corporations,’’ with high insider ownership, and common sense dictates that a different level of testing and documentation than for

public companies with a larger shareholder base. I believe that in

the current environment, public accounting firms have been overzealous in their interpretation of 404, and in many cases have

abandoned basic concepts of materiality and common sense. To

allow public accounting firms to have this level of control ignores

several conflicts of interest, because there is an inherent economic

incentive to spend more time and conduct more testing on internal

controls. As a result of the implementation of Section 404, the work

required by public companies to comply with 404 has been overly

burdensome and without a proportionate benefit to the financial

community or investing public.

Thank you very much.

[The prepared statement of Mr. Hubbell follows:]

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Mrs. MILLER. Thank you.

Our next witness is Mr. Robert Dowski. He has over 20 years of

domestic and international experience in strategic planning, corporate financial reporting, and financial accounting systems. Prior

to joining Allied Defense Group, he was a senior vice president and

CFO of New Star, Inc. His financial management background includes positions with Gillette, GE, Space Net, Telecorp, PCS, and

Hughes Network Systems.

Mr. Dowski, you have the floor. We look forward to your testimony, sir.

STATEMENT OF ROBERT P. DOWSKI

Mr. DOWSKI. Thank you very much. I think ADG should be a

poster child for SOX. For those of you who have had a chance to

look us up on the Internet, you know that the company has suffered through a restatement related to FAS 133. That is an ongoing

process. We have been delayed in filing our 10-K and, in fact, have

been working 80 hours a week with offsetting and corresponding

amount of hours from our auditors trying to get through our second-year SOX issues. So this is a topic that is near and dear to my

heart. So, with that, let me go through the testimony.

ADG is a small public company. We are headquartered in Vienna, VA, and have seven operating units located overseas in Belgium and here in Texas and California. We design and manufacture medium caliber ammunition and products for the security,

surveillance, and video transmission markets. We have approximately 700 employees and in 2005 produced approximately $110

million in revenues. Our largest operating unit produces $60 million of revenue and our smallest produces $6 million. We

uncharacteristically lost over $20 million on the bottom line in

2005. 2005 was also the second year of our SOX implementation.

I must be honest, Chairwoman Miller, and tell you that not all

of that loss was attributable to our SOX compliance efforts. But

like many other companies in the United States, we spent a great

deal of time and effort trying to meet a set of one-size-fits-all regulations that did not, as enacted and thereafter interpreted, adequately differentiate between a company the size of ADG versus

IBM.

I come before the committee as a believer in the primary goals

of the Sarbanes-Oxley legislation: providing more timely, accurate,

and transparent information for investors. ADG believes that a

well-run company should have and maintain good internal controls.

As a company working hand in hand with our public auditors, we

have made significant progress in improving our internal controls,

and we will continue on that journey in 2006 and beyond.

But it has come at a cost. In 2005, we spent over $108 million

on external fees for SOX compliance and auditing. We spent that

much and probably more on internal resources on documentation,

testing, and related activities. That $3.6 million in 2005 equates to

over 62 cents of negative earnings for our shareholders, not to mention the unmeasured opportunity costs of efforts not spent on improving revenue, profit, and productivity within the company.

Robert Greifeld, president and CEO of Nasdaq, in a recent Wall

Street Journal editorial summarized the situation very well. He

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said, ‘‘The burden of compliance is onerous, the cost is significant,

and it falls disproportionately on smaller companies that are least

able to pay.’’ Their research has shown that the burden on small

companies, as a percentage of revenue basis, is 11 times that of

large companies.

He went on to say, and we agree, that ‘‘SOX is important, by and

large it works. We have spent 3 years to assess its strengths and

problems. Perhaps 90 percent of all complaints have their genesis

in 20 lines of text in Section 404. The time has come to address

those 404 concerns without diluting the essential investor protections that are the true legacy of SOX. Specifically, we should adopt

the recommendations of the SEC’s Advisory Committee on Smaller

Public Companies, which has proposed an exemption from 404 for

companies with less than $128 million in market cap and revenues

under $125 million. Companies with up to $787 million in market

cap, as long as they had revenues of less than $250 million, would

receive a partial exemption. The companies exempted account for

only 6 percent of the U.S. market cap—which means 404 would

still apply fully to 94 percent of equity market capitalization.’’

ADG agrees with these observations and supports his call for reforms and exemptions.

In their discussion on cost/benefit, the Committee on Sponsoring

Organizations [COSO], states that, ‘‘The challenge under 404 is to

find the right balance. Excessive control is costly and counterproductive.’’ ADG believes that auditors should not have a one-sizefits-all checklist when auditing companies of different sizes, and

regulators should amend the current rules to accommodate the special needs and circumstances faced by smaller companies.

In smaller companies, such as ADG, the simple lack of people

can be a liability. For example, it can be more difficult to achieve

separation of duties that 404 calls for in many areas because of

flatter organizations and smaller staffs. We have some operating

units that have less than 40 people. Workers and managers in

those typically have multiple roles and responsibilities, so you have

a higher dependence on people doing the right thing. You also typically have a higher degree of direct and explicit knowledge of dayto-day activities since managers are much closer to the daily transactions than their peers at bigger companies. And yet there is no

recognition of that in the standards of the transparency. Managers

and executives should be allowed to place more reliance on monitoring than on control activities under those circumstances.

The existing paradigm of documentation and testing creates huge

burdens in small companies. Controls that exist but are not properly documented and tested internally are not considered by auditors in their assessments under SOX. Offsetting informal controls

that are ingrained into the culture of small companies do not receive any credit in the existing evaluation process. We agree with

COSO that internal control should be a process designed to provide

reasonable assurance regarding the reliability of financial reporting. But we also agree with the rule of thumb for internal controls

that benefits should outweigh the costs. The current construct of

404 does not meet that criteria. If employees are spending excessive hours on fine-tuning internal controls, updating documentation, testing controls, evaluating and re-evaluating financial reVerDate 11-MAY-2000 09:52 Dec 21, 2006 Jkt 000000 PO 00000 Frm 00070 Fmt 6633 Sfmt 6633 D:\DOCS\30899.TXT HGOVREF1 PsN: HGOVREF1
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ports, and compiling more extensive information for their board of

directors and audit committee, then other more important activities

are not getting done.

ADG agrees that it is time to address the 404 concerns without

diluting the essential investor protections that are the true legacy

of SOX. Proposals for exemptions for smaller companies should be

considered. We should re-examine the standards for defining and

measuring internal controls at large, medium, and small companies. It makes no sense to have one set of standards that apply

equally to IBM and ADG.

I realize I am out of time. Can I continue?

Mrs. MILLER. A few moments.

Mr. DOWSKI. Let me make one final statement. Personally, I believe that auditors do not commit fraud. Dishonest people inside of

companies do, and I think we have seen that in the press. Congress

should increase the civil and criminal penalties on those people

who violate the trust of shareholders. Violators should be forced to

forfeit their assets and spend years in jail. When people who have

defrauded investors and fellow employees out of billions of dollars

are allowed to keep their fancy homes and other offshore assets,

then how on Earth does punishment fit the crime?

People with high ethical standards are the best defense of the

public interest.

Thank you for this opportunity to testify.

[The prepared statement of Mr. Dowski follows:]

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Mrs. MILLER. Thank you very much.

Our next witness is Mr. Alex Pollock. He has been a resident fellow at American Enterprise Institute since 2004, focusing on financial policy issues, including government-sponsored enterprises, Social Security reform, accounting standards, and the issues that

have been raised by the Sarbanes-Oxley Act. Previously he spent

35 years in banking, including 12 years as a president and chief

executive officer of the Federal Home Loan Bank of Chicago.

We appreciate your testimony here today, Mr. Pollock. The floor

is yours, sir.

STATEMENT OF ALEX J. POLLOCK

Mr. POLLOCK. Thank you very much, Madam Chairman, Ranking

Member Lynch. I very much thank you for the opportunity to testify today, and these are my personal views on the issues. This

hearing is very important and most timely. Everybody on the panels and on the subcommittee has repeated the amazing evidence

from the market, from businesses all over the country, about the

problems with Sarbanes-Oxley implementation. It is a great right

in America of the people to petition their representatives for redress. I do not think there is any doubt that the people are petitioning the representatives for redress of the consequences of Sarbanes-Oxley, which was an act done with great good intentions,

and as you pointed out, Madam Chairman, in your opening comments, we have had unintended, very adverse consequences. It is

obvious this has been a tremendously expensive exercise in the creation of paperwork and bureaucracy, and the total costs of this exercise far outweigh the benefits which are likely to arise from it.

And the burden of all this is, as many people have said, disproportionately high for smaller companies.

It is important to remember that when excess costs are imposed

on companies, they are actually imposed on shareholders, and it

does not protect the shareholders to impose excess costs on them.

Moreover, in my opinion, the historical record is very clear that the

mechanical requirements which characterize the implementation of

Sarbanes-Oxley will not prevent, when the next bubble and boom

time comes, the next set of frauds and scandals, which always appear during these times, and we will have our future Enrons and

WorldComs, notwithstanding this mass of expensive paperwork.

I want to quote from a typical experience with Sarbanes-Oxley

implementation. This is a letter to the SEC from one company.

They note the ‘‘concentration on minutia . . . redundant and inefficient operations, creation of an adversarial relationship with the

audit firm . . . form over function . . . and unrealistic requirements . . .’’

The British Confederation of Industry, looking from abroad,

points out, quite correctly, that ‘‘Dealing with risks on the basis of

a remote likelihood,’’ which is the Sarbanes-Oxley implementation

standard, not in the act itself but as implemented, ‘‘other than a

remote likelihood,’’ that this not only imposes huge costs but makes

the whole thing a nitpicking process, as we have heard from many

people.

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And as has been noted, the SEC’s Advisory Committee on Smaller Public Companies says that for the smaller public companies, relief from 404 is urgently needed.

As has been noted, a highly interesting commentator, Eliot

Spitzer, has described Sarbanes-Oxley implementation as an ‘‘unbelievable burden on small companies.’’

And what is apparent is that Congress did not intend all of this.

The SEC did not intend it. Even the PCAOB did not intend it. This

is all a runaway effect basically of fear, the fear on a lot of people’s

parts, and especially the fear on the part of accounting firms that

they will be criticized for doing something wrong. They saw Arthur

Andersen be destroyed.

But, on the other hand, for these accounting firms, the implementation of Sarbanes-Oxley has been a revenue and a profit bonanza, quite the opposite of what the Senate committee report on

Section 404 stated, namely, ‘‘The Committee does not intend that

the auditor’s evaluation be the . . . basis for increased charges or

fees.’’ There is a line with great irony read in retrospect.

I would like to suggest that Congress should act. I don’t think

it is wise to wait for the regulatory bureaucracies to do this. And

I would like to highlight three steps I believe Congress should take.

I think you should also do some things to restructure the PCAOB

which are in my written testimony, but I will not mention them

this morning.

First, the best case would be to enact the provisions of H.R. 1641,

a bill introduced last year by Congressman Flake of Arizona, which

would, very simply, and in my view elegantly, make Section 404 of

Sarbanes-Oxley voluntary as opposed to mandatory. This is an approach well suited to a market economy and a free society, and I

simply point out that if investors really want the kind of heavyhanded documentation of internal controls called for by 404, an article of religious faith on the part of its proponents, then the companies will do it because the investors will demand it. I think we

need to find out what investors really value, and this voluntary approach would do it.

At the very minimum, as many other people have said, Congress

should address Section 404 for smaller public companies, and the

best way to do that is make it voluntary for smaller public companies. I do not actually think that exemption, which is talked about

by the Advisory Committee, is the best approach. I would like to

say voluntary with explanation and disclosure. So you as management, you decide how you are going to address internal controls.

You disclose and explain it to the shareholders. They can make up

their minds. We ought to, at a minimum, do that for smaller companies, best case for everybody.

The second point, Congress should instruct the PCAOB to change

the internal control review standard from this ‘‘other than a remote

likelihood’’ to ‘‘a material risk of loss or fraud.’’ This was brought

up on the first panel. I think it is exactly right, and it is the only

way to get the accountants acting right.

Third, Congress should state clearly that it understands the true

nature of accounting, which is that accounting is not something objective but something full of subjective judgments, estimates of the

future, which is unknowable, debatable competing accounting theoVerDate 11-MAY-2000 09:52 Dec 21, 2006 Jkt 000000 PO 00000 Frm 00077 Fmt 6633 Sfmt 6633 D:\DOCS\30899.TXT HGOVREF1 PsN: HGOVREF1
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ries and complex compromises, art not science, and, therefore, it is

essential to have the accountants closely advising and counseling

their clients on the application of the ever more complex accounting

standards which the Financial Accounting Standards Board is producing. And we have lost that, as has also been discussed.

In conclusion, I think it is critical to take a number of steps, and

I think Congress should take them, to bring under control the unintended effects, intended by nobody, which have proved so remarkably costly, bureaucratic, and inefficient, and they have been

caused by the way that Sarbanes-Oxley has been implemented. I

hope Congress will take these steps.

Thanks again for the chance to be here.

[The prepared statement of Mr. Pollock follows:]

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Mrs. MILLER. Thank you so much.

And our final panelist today is Damon Silvers. He is an associate

general counsel for the AFL–CIO. His responsibilities include corporate governance, pension, and general business law issues. He is

a member of the Public Company Accounting Oversight Board

Standing Advisory Group. He is also a member of the Financial Accounting Standards Board User Advisory Council and a member of

the American Bar Association’s Subcommittee on International

Corporate Governance.

We welcome you to the committee today, Mr. Silvers, and the

floor is yours, sir.

STATEMENT OF DAMON A. SILVERS

Mr. SILVERS. Thank you very much, Chairwoman Miller, Congressman Lynch. On behalf of the AFL–CIO, I express our appreciation for being able to be here today and to discuss this obviously

very important issue.

I will say that before I begin my formal remarks, in very large

part, we very much agree with what Ms. Hinchman said. Not all

my remarks go straight to those points, and I don’t want to associate myself with hers.

Ms. HINCHMAN. And we do not often agree with the AFL–CIO.

Thank you. [Laughter.]

Mr. SILVERS. Right. And as I said to Mr. Parks at the last hearing he and I testified at, it is an unusual experience. But, nonetheless, we do.

Union members participate in benefit plans with over $5 trillion

in assets, and our actual union-sponsored plans have approximately $400 billion in assets. Those workers’ pension funds are

broadly invested in a variety of small-cap and total market index

funds and are sizable shareholders in many small public companies. I have attached to my testimony a letter from one such fund

that provides benefits to our members, the Florida State Board of

Investment, that describes the ways in which that large fund is

deeply invested in small companies.

Union members participate in the capital markets also as individual shareholders and, like other investors, are frequently asked

by brokers to consider investing in small and micro-cap companies.

And I am particularly honored to be, I think, the only investor representative here speaking today.

The integrity of public company financial statements is a prerequisite to the functioning of our capital markets. When investors

lose confidence in financial statement integrity, stock and bond

prices fall, interest rates for businesses rise, and investors seek out

markets in which they have more confidence. With the current account deficit running at a rate in excess of $2 billion a day, the

United States simply cannot afford to undermine the integrity of

its capital markets in whole or in part, and that was the circumstance in which we found ourselves in the summer of 2002, at

the time in which the Sarbanes-Oxley Act was enacted.

However, the Sarbanes-Oxley Act did not create the requirement

that companies maintain adequate internal controls. That requirement has been a matter of law for public companies since 1977. It

has simply been a law that companies have ignored.

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Internal controls are among the most important mechanisms

that ensure that company financial statements are honest and accurate. They range from passwords on key spread sheets to systems for counting inventory. If internal controls are weak, that

weakness casts doubt on the accuracy of company financial statements. In the absence of effective internal controls, company financial statements simply cannot be relied upon.

Weak internal controls are strongly correlated with problems in

company financial statements. Since larger companies—accelerated

filers—began to comply with SOX 404 more than a year ago, according to the corporate governance firm Glass Lewis, most public

company financial restatements have been at companies that have

also had weaknesses in their internal controls.

Small public companies disproportionately are involved in these

restatements and in SEC enforcement actions. According, again, to

Glass Lewis, in 2005 the smallest companies were more than twice

as likely to have to restate their financials as large companies.

Dana Hermanson, a professor of accounting at Kennesaw State

University, has found that smaller public companies ‘‘have accounted for the vast majority of accounting fraud causes brought by

the Securities and Exchange Commission.’’

Consequently, the AFL–CIO opposes any effort to exempt any

public company from its clear obligations under the Sarbanes-Oxley

Act with respect to internal controls. In addition, we strongly oppose any stealth effort to turn the audit of internal controls into

anything other than what the statute requires—an audit sufficiently substantive to support an attestation by the audit firm that

management’s own assessment of its internal controls is correct.

And we are not alone. Contrary to some of what has been said

this morning, there is virtual unanimity in both the institutional

and individual investor community about the importance of protecting the current scope of 404, a consensus which includes institutionally oriented organizations like the Council of Institutional Investors, and organizations oriented toward individual investors like

the American Association of Retired Persons and the Consumer

Federation of America.

In addition, distinguished financial leaders like the former chairman of the Federal Reserve, Paul Volcker, and former SEC Chairman, Arthur Levitt, have opposed weakening 404 and specifically

warn Congress that the effort to do so could rank with other disastrous efforts by Congress to deregulated industries such as the savings and loan industry if it were to move forward.

There are two ways of thinking about the costs versus the benefits of internal control audits. The first way is to try and compare

the costs of complying with SOX 404 with the costs involved, for

example, in the collapse of a large-cap public company. According

to the folks who oppose the application of 404, total costs were approximately $35 billion in 2004. This is approximately a third of a

percent of the market cap of the companies involved, a ratio, for

example, that is comparable to what I pay for fire insurance for my

home. And it is less than half of the cost of any one of the major

corporate collapses that occurred in just one company in 2001 and

2002.

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By the way, other people have very different numbers for what

the costs are here. Audit Analytics, for example, cites the total

audit costs, not 404 but total audit costs, for the Russell 3000 in

2004 as $2.7 billion.

The second way to think about it is to compare the costs with

the benefits that accrue at the individual company level from company management getting a tighter grip on their business and

being able to manage more precisely. There has been some discussion of those benefits here on this panel, and they were described

by Jeffrey Immelt, the CEO of General Electric, when he said, ‘‘I

think SOX 404 is helpful. It takes the control discipline we use in

our factories and applies it to our financial statements.’’

Since 1933, the Federal Government has required companies

that wish to sell their securities to the public to bear a number of

costs related to investor protection. Each of these costs is higher as

a percentage of either assets, revenues, or profits for small companies than for larger companies, and particularly is higher than revenue numbers for small startup-stage companies. Each of these

costs has an effective minimum, regardless of the size of the public

company. Therefore, it is easy to draw charts that look dramatic

but are, in fact, misleading about the impact on small companies

of any kind of investor protection.

The real question is: What are the minimum requirements to access the public markets, to call our members on the phone and try

to sell them your stock?

Now, of course, investors do not have an interest—and this

comes to Ms. Hinchman’s testimony. We do not have an interest in

needlessly expensive internal control audits or audits driven by

conflicts of interest and accounting firms’ desire to recapture consulting revenue they had before, and a variety of other things that

we suspect may be going on. And we do believe that in 2004 the

audit firms did overcharge the public companies and investors were

harmed by that.

However, the appropriate response to that is the regulatory response from the SEC and the PCAOB, and not wholesale exemptions from vital investor protections, and sensible changes in the

guidelines and rules, such as Arthur Levitt’s proposal for reducing

duplicate internal control documentation that is simply inappropriate and a waste of everyone’s time and money.

Ultimately, those who want to weaken Sarbanes-Oxley and exempt wholesale the majority of public companies who seek to sell

their shares and bonds to individual investors, they must answer

the question: Why should Congress allow a company that cannot

attest or receive outside attestation that it has effective internal

controls, why should such a company be allowed to sell shares or

bonds to the investing public? And Congress, furthermore, if it

wishes to go in that direction, will have to explain to the victims

of future accounting fraud why it was that when we had a tough

law that restored investor confidence we weakened it.

Thank you.

[The prepared statement of Mr. Silvers follows:]

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Mrs. MILLER. Thank you all so very much.

Mr. Hubbell, I was interested to hear of your background in the

marina business. My family was from the marina business, and I

remember during the 1980’s when Congress had some unintended

consequences in the marina industry, the boating industry, when

they passed the luxury tax and they wanted to make sure that they

were taxing the rich. And, of course, what they did instead was

drive most of the boat manufacturer companies that employed just

average workers all over our Nation out of business, and the

wealthy ended up buying boats from foreign nations and just documenting those boats offshore and bringing them in. So people do

find a way all around that, and Sarbanes-Oxley, in some ways is,

again, the unintended consequences, I think, of an action by Congress, unfortunately.

Let me just ask generally one question. You know, we have said

that the goal with Sarbanes-Oxley, of course, is full transparency

and internal controls and tightening of financial reporting. How

can we actually bring down the cost? I thought it was interesting

to hear Mr. Dowski talk about the president of Nasdaq, some of the

various recommendations that he had made. And Mr. Pollock mentioned about Representative Flake’s piece of legislation about voluntary compliance. I am not quite sure about all of that, but I

would just pick up a little bit on what Representative Lynch

brought up earlier, which I thought was, again, as was mentioned,

a common-sense approach.

What is your thought about actually, rather than just changing

404, making it—that you would do reporting every other year or,

even as Representative Feeney had mentioned, that you do something similar to what the IRS currently does with all of our tax returns, just a random sampling, which seems to be able to keep the

entire Nation on its toes. Why not utilize that type of an approach

here? I just throw that out to the panel.

Mr. HUBBELL. If I could comment on that, I think all those are

good ideas. I think more importantly there have to be definitions

applied, and somebody mentioned earlier this morning about materiality. Our net profit in both of our companies, after tax, for this

prior year was about $80 million net after tax. And our auditing

firm was using materiality of $100,000. Now, whenever you get to

that small number, if that is their threshold, it took them a lot of

time to try to look for $100,000 things.

So I think if we could apply some definitions—in the case of our

company, we are controlled corporation; insiders own 60 percent, so

it would be hard to argue that anything we do is in violation of the

stockholders’ interest. So it is things like that, I think just some

definitions.

Mrs. MILLER. Yes?

Mr. POLLOCK. Madam Chairman, I think that once every 2 years

would be a distinct improvement on every year. Once every 3 years

would be better. A voluntary standard would be even better.

As I said in my testimony, you do not help shareholders by imposing excessive costs done to standards which are unreasonable,

which the ‘‘other than a remote likelihood’’ standard is, in my judgment, entirely unreasonable. And that is what generates a lot of

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ing firms that any mistake is life-threatening in terms of professional life. When you are operating under fear like that you get unreasonable sorts of responses.

So I think we ought to move in a positive direction, and I would

support anything in a positive direction, but I would take several

other steps besides the ones suggested.

Ms. HINCHMAN. Madam Chairman.

Mrs. MILLER. Mr. Silvers first.

Mr. SILVERS. I think that the question is very well posed. I think

that it is clear that we are in current—while as you can tell from

my testimony we feel very strongly that public companies ought to

have audited assessments of their internal controls and that individual investors particularly will be put at risk by, say, a voluntary

system or an exemption, big institutions will have various ways of

protecting themselves, and individuals I think will not.

Given that those things are—that is our position, we do feel that

it is important to explore the very question you are asking, which

is: How can this be made more cost-effective? How can it be rightsized? And I like Ms. Hinchman’s phrase there very much.

I do not believe that running out—extending the time periods—

I mean, A, I think as Congressman Lynch indicated, doing this

every 2 years would require a change in the statute. I do not believe that is the right approach. I believe it is well intentioned, and

I believe there are more dangerous things than doing that. But I

do not believe it is the right approach, and here is why: because

investors want to have annual financial statements they can rely

upon, and having adequate internal controls at all times is a vital

component of having a financial statement annually that you can

rely upon.

Now, that being said, I think that there is a reasonable basis—

and I am affected by the testimony I have heard about this—that

to look at the issue of whether the standard for materiality is the

right—has been rightly phrased here.

Now, frankly, I don’t think that is Congress’ job to do that. I

think that we in general have an accounting system at every level

where we rely upon independent bodies—FASB, COSO, PCAOB—

to set these standards and to deal with the technical issues. But

I think that this is one area that might be worth looking at.

I also think that there are a variety of ways in which the practice

in this area has become duplicative, and I think the best statement, as I indicated in my testimony, around this issue was the

one by Arthur Levitt, just pointing out places where it appears that

audit firm practice has essentially documented things twice.

Finally, something that a number of commentators have noted

about this situation is that while the PCAOB has given extensive

guidance to audit firms as to what to do, almost no guidance has

been given to issuers, to the folks at this table, as to how they

ought to prepare their assessment. This is a responsibility that lies

with the SEC. I do not want to be critical of the SEC. I think both

under Chairman Cox and Chairman Donaldson that the Commission has been very ably led today and in recent years. But this has

slipped through and needs to be addressed.

The focus here throughout ought to be, again, this concept of

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ference between a 60-person company and a 600,000-person company, and that ought not to be too hard and should not require

weakening fundamental investor protections.

Mrs. MILLER. Ms. Hinchman.

Ms. HINCHMAN. Yes, thank you, chairman. I think that one of the

things that was talked about in the earlier panel—and Mr. Hubbell

had made reference to it as well—is this whole concern about materiality and about how the internal control audits are conducted.

And I think that this is the big challenge, and FEI does believe

that the PCAOB and the SEC has a very important role to help

guide companies through that process. And I had mentioned in my

verbal testimony that there were often Q&As from staff to try and

give further guidance, and there were some tenets and principles

that were articulated by the PCAOB and the SEC over the last 2

years to try and articulate and direct companies and auditors in

particular to take a risk-based approach to their audit, and to effectively not be concerned about, as I like to say, count the pencils in

the supply room, but really look at the challenges that are going

to be a high risk to the entire enterprise or company.

And I think what Mr. Silvers says is absolutely true, that I think

that the PCAOB and the SEC are up to the task to give the guidance to companies versus a company that has 60 employees versus

2,000 employees. And there is an opportunity to scale the requirements and compliance for these provisions to those different size

companies without an outright exemption.

Mr. POLLOCK. My colleagues have a lot more faith in regulatory

agencies than I do, Madam Chairman.

Mrs. MILLER. Mr. Dowski.

Mr. DOWSKI. Yes, I listen with fascination to people that are not

involved on a day-to-day basis with running companies. I will give

you an example of the current standards of reasonableness in

terms of the implementation of SOX 404. We have a company in

California called MS Microwave. It has 40 employees, does about

$10 million of revenue, surveillance equipment.

Under the current SOX regulations, they have an IT department

that is actually one individual who runs their servers and keeps all

their PCs up. We failed our SOX audit out there for many reasons,

but one of which was we did not have adequate controls under IT.

According to the SOX regulations that are enforced today by the

auditing firms and by the PCAOB, that one individual had to hold

a meeting, had to write out minutes, had to actually invite somebody else to the meeting so that there would be a witness to the

meeting, and had to do that on a quarterly basis and review the

statuses of his IT environment with at least two outside experts.

That was deemed to be efficient and effective IT controls.

It is insane. The way it is being enforced is insane. And I am

not—I think there are a lot of arguments to be said against making

exemptions. The problem is that 404 is all of 20 pages. Simply,

somebody has to sit down and say, look, we cannot apply the same

standard uniformly to a very large company and a very small company. There has to be an interpretation of the definition of reasonableness and materiality that many of the people have talked

about, anecdotally or directly. And that is the thing, when you get

right down to it, that drives small companies, like ADG, which is

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really a collection of seven even smaller companies, it drives you

to drink because the standards are just unreasonable. You have

separation of control duties. Three different people have to handle

the checks. Somebody has to request the check. Somebody else has

to print the check. And the third person has to sign it. In some organizations, we have one person doing the same thing, and yet it

is a material weakness because we do not have those controls in

place. It is just insane. So there has to be a standard of reasonableness applied.

Mrs. MILLER. Thank you.

Representative Lynch.

Mr. LYNCH. Thank you, Madam Chairman.

First of all, I just want to say, just as a matter of disclosure, I

actually am a member of the AFL–CIO. I am an active member.

I pay my dues every month, so I am probably an investor as well.

I do want to say that—you know, and I have concerns from that

end. I participate in a pension fund and a lot of my constituents

do as well. And so I am very interested in the transparency and

the accountability and the security that is provided by certain aspects of Sarbanes-Oxley.

But I also know that these smaller businesses are really an incubator of great innovation in this country and that the burdens here

are disproportionate to the protections they are providing.

I heard Ms. Hinchman and also Mr. Pollock, they both sort of hit

on the material risk standard, if you will, and whether or not moving to that standard would satisfy the concerns that you have

raised. And I just—we have to have some balance here. We have

to have some balance, because right now I think just the costs that

we are talking about.

And so I want anyone who feels equipped to address that issue—

and I also want to talk about the biennial issue here about having

these full, independent audits done every other year, because I

have to say that having sat on a union pension fund, you know, as

a trustee, the fact that a company has to go through this process

in, say, the odd-number year and then they realize that the next

year they are attesting to the internal controls and procedures that

they have in place, it seems very odd that they would leap off that

standard in the even-number years knowing that they are going to

be inspected again on the odd-number year. I just do not see that

divergence occurring under realistic circumstances. So I am less

concerned with the every-other-year situation.

But you may be right. It may not be the ideal solution here.

Maybe it is something along Mr. Pollock’s line of thought where it

is voluntary in a sense, but with, you know, encouragement with

the SEC and PCAOB, I don’t know.

The last—and I know I have given too many questions already,

but Mr. Pollock and Ms. Hinchman also suggested that the SEC

and the PCAOB already have the ability to do this internally, and

you are right, I think they are well equipped to do that. But are

they willing to? That seems to be my question. And do they not

need under the circumstances some—do we need to act here? I get

the sense that we do because nothing is happening. I would love

to see this thing handled by the SEC or PCAOB, but I just do not

know, with everything else they have going there—my goodness,

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we do not even have folks at the SEC to train and to coach the

issuers in these cases how to go about compliance with SarbanesOxley.

So I am a little bit skeptical that they would be able to leap into

the fray here and come up with a regulatory solution.

Ms. HINCHMAN. Mr. Lynch, I think part of the challenge is, particularly with the PCAOB, when AS2 was issued, that they really

did rely very heavily on what is called principle-based accounting.

And they did that intentionally because there was a drive in the

accounting, financial reporting world to go in that direction.

Mr. LYNCH. Principle as opposed to rule-based?

Ms. HINCHMAN. Correct.

Mr. LYNCH. OK.

Ms. HINCHMAN. But our auditing profession is very much reliant

on rules-based accounting, and so it has been a very difficult transaction for the auditors to rely on AS2 and to make the determinations for how to interpret those principles, predominantly because

of liability concerns. And we are sympathetic to that issue. I think

that is a big part of what is driving the procedures and the way

that people are performing these audits these days.

But from year one to year two, I think that you have been able

to see a growing sense of confidence, both on the auditor’s part and

also on management’s part, on how to conduct these internal audits. And I think that would go a long way, if the PCAOB could

give a little more rules-based direction on how to interpret and use

AS2 and get out of some of the examples that Mr. Dowski had

made mention to earlier, and allow them to really focus with confidence on a risk-based assessment on how to conduct the internal

audit.

I also think that the SEC does need to step up to the plate more,

in terms of giving guidance to the issuers, as you said.

Mr. POLLOCK. Congressman, I very much share your skepticism

on whether the SEC and PCAOB would step up to this issue. It is

quite clear that the SEC did not know what its regulation would

entail. These are unintended consequences from their point of view

as well, also for the PCAOB. They did not understand, when they

were regulating, what was going to happen.

Both the SEC and the PCAOB have subsequently quite severely

criticized the accounting firms for what they have done, and as our

colleague suggested here, the accountants, of course, have a rather

serious conflict of interest in that the more burden there is, the

more profitable they become.

But neither the SEC nor the PCAOB accepted any responsibility

for the morass of bureaucracy they caused, and if you think about

the incentives, unlike Congress, which is a balancing body, to balance interests and balance costs and benefits, the incentive structure of any regulatory body is to avoid embarrassment at all costs

and to be quite insensitive to the costs imposed on other people in

order to make sure that you do not get in trouble. And I think we

have that problem with both of these agencies.

If I may just add one other comment, I do think that the status

of the PCAOB needs to be reformed as well. It is clearly functionally a regulatory body. It needs to be brought under congressional

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lator, and I do think that was a mistake in Sarbanes-Oxley which

should be rectified.

Mr. SILVERS. Congressman, let me answer the two questions that

you sort of posed conceptually, and then I want to make a remark

about the regulatory agencies as well.

The question of doing an internal control audit every 2 years as

opposed to every year really raises the question of: Is the internal

control audit an integrated whole with the audit of financial statements? In our view it is. If you are not—and, you know, one could

take the view that we only need an audit of the financial statements every 2 years. But if you are going to represent to investors

on an annual basis that on X date you can rely on these numbers,

you also need to, I think, provide investors an assurance that the

process that produced those numbers has some integrity to it.

I think that we are now sitting at a moment where we have just

been through the startup period against a background in which

public companies had essentially been lax in relation to internal

controls because no one was watching. As I said in my testimony,

there has been a requirement to have adequate internal controls

for public companies for close to 30 years. But when people actually

started, you know, opening up the hood and looking to see what

was there, it turned out that really that was not what was going

on at all.

Now, so I think that is the conceptual issue your proposal raises,

and candidly, I have heard it for the first time today, and my reaction I think would be the reaction of many people in the investor

community, that we want an annual audited financial statement

that we can count on and that integration matters. I mean, I understand what you are trying to achieve and am sympathetic with

your ends, but I am not sure that is the right way to do it.

Now, in relationship to the materiality standard, I do think that

is an area that ought to be looked at, but I want to give you this

warning. A, as I said earlier, I think this is an area—these kinds

of standards are traditionally an area in the accounting area where

Congress has deferred to these independent agencies on the details.

It is very much the kind of oversight process the chairwoman alluded to before.

The warning around materiality is this: If you have too high a

number threshold around internal controls materiality, you run the

risk that auditors will not be looking—that neither the internal financial controls people nor the auditors will be paying much attention to symptoms of larger problems, that very big problems tend

to start small.

I do not pretend to know what the right answer is here, but

when you think about getting to the right answer, it is not just a

question of is that particular control of that particular account likely to blow the company up. It is, are you learning something by

looking at that, the weakness of that control that tells you that

there are larger systemic risks. And we have to build that in somehow into the process.

Now, finally, with respect to the regulatory agencies, the Nation

owes a deep debt of gratitude to the Public Company Accounting

Oversight Board. When it was established in the fall of 2002, we

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cessor, Bill Gradison, who is the Acting Chair, and the very good

people who worked there, the fundamental integrity of the financial

reporting system in the United States is not really in doubt today

in the way it was in September 2002.

I do not believe it is fair to characterize them the way that my

friend Mr. Pollock has. Those people are dedicated servants to the

Nation and we owe them a debt. Can they—and their colleagues

at the SEC, whom I have equal and profound respect for, can they

do the right-sizing that is really needed here? And I think the answer is unquestionably yes. Not only can they, but really no one

else can. This involves a level of detail, expertise, and interaction

with the various components here and attention over time that

only those agencies really have, in conjunction with COSO, I believe. I do not think there is really an alternative, and I think that

they are eminently able to do it.

Mr. DOWSKI. I think that the key issue is whether or not they

are willing to, in the environment that we are in today, take a risk

and step out and interpret those rules in a less than uniform way.

I think that is—you know, I think that is really at the heart of the

debate on 404 if you really sort of break it down and look at why

a lot of companies like ADG are saying that this is just not a workable implementation plan.

You know, I think Ms. Hinchman hit on a good point in that

there has to be a shift from historical rules-based to principle-based

interpretation in a lot of the implementation areas, and that

PCAOB has started down that path, but the auditors in the environment are in with the increased liability and what they saw happen to Arthur Andersen are simply sitting there wants to check the

box. And if they have a schedule that they have to fill out and they

cannot check every box, then they are going to keep working it

until you can get closer to checking those boxes. They will make

that one guy hold a meeting and write up some minutes and document it so they can check that box. And that is the thing that really has to be changed and adjusted. Whether the PCAOB can do it

or the SEC can do it or whether Congress should do it, I mean, I

think we ought to use the organizations we have and put the onus

back on auditors.

The other issue is that auditors have gone from being an advisor

to companies to being an antagonist with companies, and that is

really something that has happened. I have been doing this for 20

years, and since 2002, the biggest thing that has changed is the

rules have gotten more complicated, and you cannot call up your

audit partner and ask, ‘‘Here is what I think about the interpretation of this opinion and here is what we are doing. Do you think

this is the right thing?’’ They will not give you an answer. They

will say, ‘‘Write it up. Send it to us, and we may or may not tell

you that it is an issue.’’ They may or may not tell you that during

the quarter, and then at the end of the year, they will come back

with a whole list of other questions that you did not answer correctly. And that is part of this, I think, environment that has to

change and improve as we move through, you know, the reactions

that we all had to what happened in 2002, and to an environment

where this thing becomes a lot more rational.

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I mean, nobody is going to argue that the shareholders do not—

are not entitled to good internal controls. I think people in the financial profession have been stressing good financial controls because they are the basis on which you make reliable financial

statements. You know, long before this came up, people were focused on controls. The breakage now is because we have now taken

one standard for what is an acceptable internal control and we are

applying it uniformly against the landscape of the American economy, and it just does not make any sense at the practical level.

Mr. LYNCH. Thank you.

Mrs. MILLER. Thank you all so very, very much, sincerely, for

your attendance today. I think this has been really a fascinating

hearing, and again, I think the impetus for the hearing was everybody seeing that something is wrong with the 404 and the way that

it is being implemented, and as many of you mentioned, the Commission and the Board certainly have the ability to be proactive

and to do something short of Congress taking legislative action and

whether or not they have the will. A way that they may have the

will is to see that Congress—there is sort of a growing momentum

here congressionally for some action, and we would like to preclude

that kind of a thing if they would move on something more reasonable. The standard always has to be reasonable.

So we appreciate you all coming and appreciate the ranking

member, and with that the meeting will be adjourned.

[Whereupon, at 12:19 p.m., the subcommittee was adjourned.]

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