▶ 0:15:27Good morning. The subcommittee on capital markets will come to order. Without objection, the chair is authorized to declare recess of the committee at any time. This hearing is titled reassessing Sarbain Oxley, the cost of compliance in today's capital markets. Without objection, all members will have five legislative days within which to submit extraneous materials to the chair for inclusion in the record.
▶ 0:15:55I now recognize myself for four minutes for an opening statement. Good morning again and thank you to our witnesses for being here today. Today's hearing is about making our public markets work again for the companies that fuel our economy. small innovative firms that want to grow hire and bring new products to market.
▶ 0:16:17We're here to examine whether parts of the Sarbain Oxley Act, particularly section 404, are doing more to burden those companies than to protect investors. When Zarbain Oxley or SOCKS was passed in 2002, it had a clear purpose to restore trust on in financial reporting after several major corporate scandals.
▶ 0:16:40But more than two decades later, it's time to ask whether its most burdensome provisions are still serving investors or merely discouraging companies from ever going public in the first place. For many small companies, section 404b has become a major obstacle. It requires companies not only to assess their own internal financial controls, but also to pay for an external auditor to effectively repeat that process.
▶ 0:17:10That's why many refer to it as a quote double audit. The cost can exceed $1 million per year and even for pre-revenue biotech firms and small cap innovators. These costs don't scale. Again, they don't scale. Whether a company generates $50 million or $5 billion, the comp uh the compliance checklist is largely the same.
▶ 0:17:38For a large company, that may be manageable, but for a startup, it's often the difference between expanding operations or laying off staff. And compliance costs have not gone down over time. In fact, recent surveys show costs are rising, driving more hours, more documentation, and broader audit scopes. At the end of the day, Main Street investors are footing the bill.
▶ 0:18:05Whether it's through reduced returns, fewer IPOs, or the lost chance to invest early in the next great American company. Meanwhile, the benefits are unclear. Internal control weaknesses remain stubbornly high. Many firms only disclose problems after issuing financial uh restatements. That's not the sign of a healthy system.
▶ 0:18:30We've also heard from companies that structure their growth fundraising and even equity float to avoid triggering That's an indictment of the rules of the rule's realworld impact. Capital formation shouldn't be driven by how to avoid a duplicative audit. A regulatory framework that deters companies from entering the public markets doesn't strengthen investors confidence.
▶ 0:18:58It weakens long-term economic competitiveness. To be clear, this is not about undermining investor protection. It's about ensuring those protections are effective and proportionate.
▶ 0:19:13Congress and the SEC have taken steps to tailor socks obligations for emerging growth companies and smaller reporting companies, but the current framework remains overly complex and poorly suited into uh to today's economy, especially for firms that are asset light, IPdriven, and increasingly global in structure. Today's hearing is an opportunity to hear directly from the people who live these rules every day.
▶ 0:19:42Our job is to ensure that the path to becoming a public company is not paved with unnecessary barriers. Public markets should be open to companies of all sizes, not just those that can afford to navigate an outdated compliance regime. I would now like to recognize my friend, the ranking member of the subcommittee, Mr. Sherman, for four minutes for an opening statement. Thank you. I believe I'm the only one here who was here for so Oh, and Mr.
▶ 0:20:12Lucas was also here for Sarbain Oxley. You were and you were here. Yeah. Damn. I'm not as I'm not as old as I think I am. Uh a few of us were here for Sarbain Oxley. We remember WorldCom. We remember Enron and the need for a PCAOB. We were then here, even more of us were here for uh uh maid off and the need to apply the PCAOB to broker dealers.
▶ 0:20:44Um we then reformed the PCAOB by making sure that China uh and Chinese-based companies would be subject to it. Uh that was my bill along with Senator Kennedy. And then it we accelerated that process with a separate bill.
▶ 0:21:00And then the most recent development was this committee voting to defund the PCAOB, transfer it to the SEC and not give the SEC any funding or ability to charge fees in order to pro uh uh in order to carry out the functions of the PCAOB.
▶ 0:21:20I want to thank uh uh the uh most powerful unknown person in Washington, Elizabeth Mcdo, for uh uh the Senate parliamentarian for striking that provision. Uh we should not defund the police in the streets and we should not defund the police in the streets. That includes the CFPB and includes the PCAO.
▶ 0:21:47Um the bills that we are considering uh include one that would change allow auditing firms not to register with the PCAOB but instead simply meet the standards of the The AICPA was not consulted.
▶ 0:22:11The CPA caucus was not consulted and the st only standards that would apply to auditing firms were those meaning independents not those dealing with uh their competence and breath of experience for the audit that they were attempting to do.
▶ 0:22:31Uh a second bill expand raises the uh floor on which companies would be exempt and not have to uh have reports or as many reports on their internal uh uh controls.
▶ 0:22:49Uh this makes some sense because we haven't adjusted that figure I believe since Sarbain Zoxley and so if the policy was right then the the dollar amount has to be changed now because $250 million then is very different from $250 million now. So I look forward to uh uh these hearings and working on these bills.
▶ 0:23:14As I said, I think the last time we were all in this room, uh the most fascinating issues that really the entire country faces are those dealing with auditing and accounting and uh uh they are also the most uh important issues. So, Sarbain Oxley was passed virtually unanimously. We need internal control.
▶ 0:23:38We need auditors to audit the internal control and we need PCAOB to audit the auditors. And while this process may be expensive, you know what's more expensive? An Enron or a WorldCom or both pretty much at the same time. I think the losses to investors uh were between the two of those were well over $200 billion. But it's not just that.
▶ 0:24:04the in the loss of confidence in our finan in our capital markets cost this country even more than the 200 to $250 billion lost on those two stocks. I yield back. I now recognize the chairman of the full committee, Mr. Hill, for one minute for an opening statement. Well, thank you, Chair Wagner. Appreciate you holding this hearing today. We examine the long-term regulatory impact of Sarbain Oxley Act of 2002.
▶ 0:24:31And while my colleagues may have been here voting for this bill, some of us were in the private sector living under it for the past 20 years and I can tell you our perspectives are quite different even though we share an important uh point of agreement which is we want investors protected and we want managements and public companies held accountable and we want highquality audit standards.
▶ 0:24:53But all that is subject to now looking back 20 years which is why I think chair Wagner has done an excellent job in having uh this uh hearing uh implementation of the law particularly under section 404B is something that's the most expensive feature in our public securities rulebook. Uh reports show these companies are spending over a million dollars a year purely on socks compliance.
▶ 0:25:20So the fact that we want to take a look at these issues and think through them, I commend the chairwoman and I yield back the balance of my time. Gentleman yields back. The chair now recognizes the ranking member of the full committee, Miss Waters, for one minute for an opening statement. Thank you very much, Chairwoman Wagner. Uh I'm pleased uh that we are holding a hearing to commemorate the Sarbain Oxley Act.
▶ 0:25:47However, it would have been uh more meaningful uh if we could have had this uh hearing uh convened uh before uh you know today. Um let me just say that the Sarbain Oxley Act is the crown jewel of the public company accounting oversight board.
▶ 0:26:14Um, and I have to ask, will what you are doing with this legislation, would it enable, you know, paying for um a tax cut for billionaires? And perhaps um I can remind you that if you had held this hearing before beforehand, you would have realized that the PCAOB is the only regulator that has access to auditors and large public companies in China.
▶ 0:26:45And maybe we need to have you think more about uh realizing uh that shutting this regulator down doesn't just hurt US investors, but it helps the Chinese Communist Party. Hopefully, my Republican colleagues are now paying attention. Thank you very much. I yel Gentleoman yields back.
▶ 0:27:15Today we welcome the testimony of Dr. Abigail Allen, associate professor of accounting at the Marriott School of Business at Brigham Young University. And then Mr. Lawrence Cunningham, director of the Weineberg Center for Corporate Governance at the University of Delaware. Mr. Frank Watanabe, president and CEO of um Arcutudis. And then Mr.
▶ 0:27:41John Coats, a professor of law and economics and deputy dean of the Harvard Law School. We thank each of you for your taking the time to be here. Each of you will be recognized for five minutes to give an oral presentation of your testimony and without objection, your written statements will be made part of the record. Dr. Allen, you are now recognized for five minutes for your oral statements.
▶ 0:28:10Thank you, Chairman Wagner, Vice Chairman Garberino, Ranking Member Sherman, and members of the subcommittee. Thank you for the opportunity to be here to testify. As mentioned, I'm an associate professor at Brigham Young University. I hold a CPA and also a doctorate in business administration.
▶ 0:28:27I'm here on behalf of myself as well as my co-authors Melissa Lewis Western and Kristen Valentine to testify about the findings from a recent research study that we conducted examining the costs and benefits of Sarbain Oxley and in particular section 404 which deals with the audit of internal controls.
▶ 0:28:47We appreciate the subcommittee's interest in re-examining socks in today's capital markets as well as recent initiatives like the 2012 jobs act and recent SEC carveouts which acknowledge that the costs of socks are not born equally across all firms. A common thread across regulatory exemptions so far is a size-based litmus test which recognizes that the direct costs associated with compliance may be overly heavy for small issuers.
▶ 0:29:18Our research also speaks to the existence of indirect costs which manifest for firms of both small and large sizes. So our research focuses on a group of firms that we refer to as young life cycle stage firms. These are firms that can be large and high growth but are early in their development as they explore strategic entry into new products or new markets.
▶ 0:29:44They invest heavily in R&D are not yet profitable from a cash flow perspective and play a critical role in driving economic growth through exploratory innovation. Our research suggests that 404b had negative consequences for innovation for these firms. Specifically, we find that socks negatively impacts both the quantity and quality of innovation produced by young life cycle stage firms.
▶ 0:30:11These firms spend less on R&D, produce fewer patents with lower citation counts. We also find that socks has negative consequences for the type of research being conducted. Following socks, young life cycle firms shift their research pursuits towards safer, less groundbreaking innovation. The patents that they produce are narrower in scope and less likely to lead to future technological advances. Why is that?
▶ 0:30:41Our research identifies two mechanisms through which socks can harm innovation. The first is resource diversion. Young firms like small firms are cash constrained. Every dollar or hour spent on compliance is a dollar or hour not spent on innovation. This same logic which applies to small firms is the rationale that motivates current size-based exemptions. The second mechanism is called innovation hindrance.
▶ 0:31:08We believe that socks imposes well we know socks imposes centralized control structures and we believe that sometimes those structures are at odds with the decentralized flexible environments needed for exploratory innovation. This type of mismatch can stifle the type of risk-taking and creativity that drives breakthrough discoveries for young life cycle stage firms.
▶ 0:31:32Importantly, while we document these negative consequences for innovation, we are unable to detect any evidence that the costs are offset by the intended benefits of socks for these young life cycle stage firms. While we do see improvements in financial reporting quality for mature firms, consistent with prior literature, we find no evidence that socks improves financial reporting quality for this subset of young life cycle stage firms.
▶ 0:31:58No reductions in restatements, no improvements in acrruel quality, no gains in future performance. We theorize that these intended benefits do not materialize for young life cycle stage firms because their limited free cash flow and more concentrated ownership structures lessen the type of agency concerns that financial reporting oversight is intended to mitigate.
▶ 0:32:24Putting these findings together, a clear takeaway from our research is that the impacts of socks on financial reporting quality and innovation is not uniform. Instead, it varies based on firm specific characteristics that in addition to size may include factors like firm life cycle stage and strategic Accordingly, we advise that any policy solution must involve a complex consideration of both direct
▶ 0:32:54and direct in and indirect costs against the offsetting benefits by firm type. We also advise that the costs and benefits do not always manifest in the same time period. Like insurance, a regulatory approach that leans towards prevention will necessarily impose heavier costs today in exchange for some presumed securities surrounding future financial reporting outcomes.
▶ 0:33:18By contrast, relaxing regulations alleviates current cost burdens while increasing future risk associated with remediation. Our results highlights that the goals of innovation and economic development are not always in contrast, but when they are, policy based, evidence is essential. Thank you for your time. Thank you, Mr. Cunningham. You are now recognized for five minutes for your oral statement.
▶ 0:33:43Chair Wagner, Ranking Member Sherman, committee members, thank you for the opportunity to testify today. It is an honor to be here. I'm Lawrence Cunningham, director of the John L. Weineberg Center for Corporate Governance at the University of Delaware. I've been writing about Sarbain Oxley socks since its inception and ever since carving a niche in the legal academy at the intersection between law and accounting.
▶ 0:34:14Socks was an effective congressional response to several massive frauds. It restored investor confidence at a critical time and helped deter earnings But over time, it became clear that Socks missed its mark in important ways, channeling excessive resources into internal controls at the expense of financial reporting. Let me stress this core insight.
▶ 0:34:45Compliance is not the same as accuracy. A company can have strong internal controls and still misreport its financials or weak controls and report accurately. Yet socks treats internal controls as equivalent to financial reporting as if they are the goal rather than the means.
▶ 0:35:11Over two decades, socks has fostered a sprawling compliance industry where controls proliferate and auditability of controls becomes more important than utility. The system often prizes procedural auditing checklists over substantive accounting judgments.
▶ 0:35:36That's why despite socks, financial restatements persist, including recently at Marquee Companies like CSX, Archer, Daniels, Midland, and Macy's. Last year saw the most reissued financials in many years. And over the past decade, internal control reports flagged fewer than a quarter of the issues in advance. They have become post-mortems, not early warnings.
▶ 0:36:07The costs are real. Socks imposes fixed costs that hit small firms the hardest. The average is $1.5 million per year with a quarter of companies paying more than $2 million. for small firms from biotech companies to regional banks.
▶ 0:36:30That's money not invested in R&D, employee hiring, training, growth, and other important business matters. And the impact on capital markets is pretty clear, too. Socks contributed to a sharp drop in the number of public companies from 6,500 or so back then to around 4,000 today.
▶ 0:37:00Even as the number of large private companies has grown dramatically. Nordstrom and Walgreens are just two of the companies recently indicating they prefer to be private than public, underscoring the costs. Investor perspectives are divided. Many investors believe that the external audit of internal controls adds little or no value.
▶ 0:37:30That's especially true of the long-term focused investors who prefer to do their own analysis. On the other hand, some support the audit of internal control, especially the index fund community that doesn't conduct firm specific analysis. But that division underscores the need for flexibility in this area. Congress has every other major securities law.
▶ 0:37:59Socks deserves the same reassessment and reform. The reform should focus on three things. First, to reinforce the primacy of financial statement reporting over internal control. Second, focus audit standards on judgment and substance, not process and systems. And third, tailor compliance to risk.
▶ 0:38:28Let's reaffirm that the northstar of our capital markets is accurate financial reporting, not welldocumented internal controls. The two pending bills are a good step in that direction. Thank you. I look forward to your questions. Mr. Watonaby, you are now recognized for five minutes for your oral statement. Chair Wagner, uh, Ranking Member Sherman and distinguished members of the subcommittee. Thank you for the opportunity to testify today.
▶ 0:38:57My name is Frank Watanabi and I am the president and CEO of Arcus Biootherrapeutics, a public bioharmaceutical company based in California. I'm also the vice chairman of Bio, which represents over,200 growth stage biotechs that are driving the search for the next generation of breakthrough medicines. Arcutis is a a young biotechnology company that develops innovative treatments for serious skin diseases like psoriasis and eczema. Uh we were founded in 2016 and went public in January of 20.
▶ 0:39:26We received our first FDA approval in July of 22, have since received FDA approval for two additional treatments, and we continue to invest in our portfolio of innovative drug Since inception, we have invested about $1.4 4 billion in developing our products and have grown from three employees to 350 with operations in all 50 states and employees in 39. But we have yet to turn a profit, let alone recoup our massive investments in R&D.
▶ 0:39:55I'd like to share some of the challenges that our cutest faces due to section 44B of the Sarbain Oxley Act. While I fully support regulation, it needs to be smart regulation that accounts for a company's size and the cost of compliance. I believe it is unreasonable and wasteful to impose the same compliance requirements on a 350 person biotech with revenues below $200 million as those for an 80,000 person company with 60 billion in revenues as the law currently requires.
▶ 0:40:26We first experienced the overwhelming burden of 404B in 2021 when although we had not generated any sales and we had just gone public the prior year, we became subject to 404b when our market cap exceeded $700 million.
▶ 0:40:42Two years later, we rolled off of 404B when our public float dipped below 700 million, but we couldn't scale back our costly compliance systems, knowing that we would likely uh need to meet the requirements again, which happened in 2024 when our public float again exceeded the 404b thresholds. To date, we have spent around $11 million on compliance with 404B, and those are costs that are rising inexorably. For example, last year alone, our auditor fees were increased by 24%.
▶ 0:41:13Uh, our switch to 404B roughly doubled our auditor fees. And as a small firm, we had to bring in outside control and compliance resources that cost us about half a million dollars a year. The money we spend on unnecessary compliance is money that we don't have to invest in developing lifealtering drugs. I understand the reason for enhanced controls required by Socks. I'm I'm old enough to remember uh those abuses.
▶ 0:41:37We we all remember, I think, the egregious business abuses that led to the passage of this legislation, but the current thresholds for 404B are too low, and Congress and the SEC should take steps to adjust those thresholds. We're grateful to Congress and the SEC for their previous efforts to reduce the burdens of 404b on small businesses, but there is still more work to be done. Congress can take common sense steps to reduce the burden of 404b on small companies, for example, by adjusting the public float and revenue thresholds as you are considering.
▶ 0:42:07It might also amend the 2020 exemption so that companies are exempt if they qualify as SRC's or report revenues of less than 250 million. These changes would reflect the fact that many companies are still small businesses despite having high market capitalizations. Another smart reform might be to use soft triggers for the public throat float threshold measuring float over an averaging period of say 12 months rather than a single point in time as is now.
▶ 0:42:32I also applaud the proposal that uh that implements a three-year rolling average threshold for revenue instead of a one-year snapshot. Congress should also consider revising the definitions of accelerated and large accelerated filers to better account for low revenue companies with high And you might consider establishing a new intermediate tier of filers, helping to ensure that low revenue innovators like Arcutis are not subject to the same burdensome compliance requirements as mature, highly profitable multinational Revising the
▶ 0:43:02timelines for emerging company growth status, for instance, by extending EGC from 5 to 10 years post IPO and raising the public flo threshold would better account for the long development time timelines typical in the biotech sector and offer immense release to smaller companies. Well, that's not the major focus of the hearing today. I also want to applaud you for your recent hearings on institutional proxy advisory firms. We have suffered uh uh struggles with them and and I think it's it's high time that Congress reform that sector.
▶ 0:43:33Congress has a critical opportunity to support American innovation and competitiveness by modernizing 404b. Small companies like Arcutus are critical to US biotech in the US economy, but we can't thrive if precious capital is consumed by regulatory requirements of little practical benefit. Thank you again for inviting me today and I look forward to the committee's questions. Thank you. U Mr. Coats, you are now recognized for five minutes for your oral statement.
▶ 0:44:00Chair Wagner, uh Ranking Member Sherman, um Ranking Member Waters, Chair Hill, thank you members for the opportunity to speak here. Um the last time I testified before you was during COVID, so I didn't get to be in this nice room. Um good to be here in person. Um, I'm going to quickly go through a few themes that um, I I think provide some counterpoints to what you've heard so far. First, socks, just want to make sure everybody's got this right, is a disclosure law.
▶ 0:44:30It doesn't actually require a company to do anything differently than its management believes is correct for controls. It can report publicly that it disagrees with its auditor as to some of those judgments, and many companies do. And so, um, Frank, you might want to talk to your lawyers if they're telling you you have to follow the auditor's directions about your controls. Even when you think the costs outweigh the benefits, you don't have to. Okay.
▶ 0:44:58Um, the disclosure elements of this law make it a less costly law than some of the alternatives. Other countries in some places actually directly specify the kinds of controls companies have. We don't in this country. We rely on companies in the first instance and then disclosure so that investors whose money is being risked with the control systems in question uh can judge for themselves how and when to price their investments in those companies.
▶ 0:45:26Um the benefits of the law are clear. Um, Professor Allen's study, which I commend as a very good study, and she said this in passing, but I just want to make sure everybody heard it, shows that most companies, most companies subject to 404b benefits, their financial quality is better as a result, and even in the period that she was studying, the costs did not outweigh the benefits.
▶ 0:45:52Now, something that was not mentioned so far is that PCAOB softened 404B in 2007 using its discretion under the law to do so. And I would think the kinds of issues that have been raised where the 404B may not be translated properly for a given company could be addressed by the PCOB or the SEC.
▶ 0:46:15Um, I will note that under Republican administration, nothing happened two two terms ago. Um, the PCOB could have at that point made more modifications. They could have said for an early stage company with 300 employees, we don't want need the auditors to do quite the testing that they do for Goldman Sachs. The PCOB was not under Republican leadership willing to take up that challenge. I you can ask the members who ran it back then why it could be done today.
▶ 0:46:44The SEC is now under Republican administration and could take up this challenge directly. The kinds of things that I heard uh Frank suggesting earlier, they're perfectly appropriate things, I think, for the SEC to consider. But I'm not sure that a federal statute is the right vehicle for doing the kind of fine-tuning that goes to average versus point in time, etc. Because in fact, we're probably not going to know in advance what the right calibration is.
▶ 0:47:11And it's the kind of thing you would want the agency to be able to fine-tune over time. If you block it into a statute, we all know in this room how hard it is to pass statutes. It's likely to get outdated fairly quickly. I'll note SOCK does not do that. SOCOK delegates to the PCAB and the SEC authority to make changes in how auditors go about their work. And so that could be done under current authority. Um, a few other things.
▶ 0:47:39Um, many companies choose, even though not to comply with 404b today. There are many private companies who have voluntarily done this. There are many companies that float bonds when they could float leverage loans and be able to get out of 404b, but they choose not to. That suggests that the debate over this issue is not nearly as clear-cut as it sometimes is presented. Other countries have followed the US. Most countries now have the equivalent of socks.
▶ 0:48:09So it's not the case that the US is some outlier in this respect. Um, last thing I would say about the proposals, um, is that, um, you really need to think hard about the risk that a statutory change will open the door again to the kinds of
▶ 0:48:40bad reporting that went on leading up to the passage of socks. Um, Chair Hills Emily's bank when it was bought by a public company was bought by a public company bank subject to socks. They paid about a half a million for total audit including 404b in the year of that deal.
▶ 0:48:59I believe the stock that was paid as part of the consideration of that deal was more accurately priced and reliable as a result of Sarbain Oxley and that the deal might have been a little bit more fraught if there had been the kind of accounting that went on in the '9s present at the time of that deal. Thank you. I'll stop there. We'll now turn to member questions and I recognize myself for five minutes for questioning. Mr.
▶ 0:49:26Watanabi experts have argued that the benefits of acquire of requiring an external audit testing to internal patrols under section 404B are outweighed by the annual costs for early stage or biotech companies which can amount to over $800,000. In your case, you cited much higher.
▶ 0:49:46Can you discuss your experience in running Arcutudis Biootherrapeutics, a small public biotech firm, and whether the funds spent on section 404B compliance had to be reallocated from let's say R&D and product development and other things? Yeah, thank you for the question. U Chairwoman, yes um it has been a a significant expense uh for our company.
▶ 0:50:14Um uh our audit fees alone last year were 2.2 million. We still are in the middle of this year. Uh I would estimate will probably be in the range of 2.5 plus this year uh just for our audit fees. Uh in addition to as I mentioned I think before we're spending about $500,000 a year for uh support uh for our compliance program to meet the standards that are imposed on us by our auditors. Uh and and that is money that has to come out of R&D. that's that's the variable cost in a biotech company like ours.
▶ 0:50:45Uh and and so we're not investing that money in developing the next generation of cures. I I would also say that um our audit fees about doubled uh when we went from 404a to 404b just given the complexity of of the audit that that the auditors required. Thank you Dr. Allen. According to your research, young life cycle firms experience a significant decline in innovation uh after becoming subject to socks.
▶ 0:51:12Your findings estimated declines between 9 and 12% in R&D intensity and 6% decline in patent filings for young life cycle firms relative to preox levels. In addition to the decline in the level of innovative activities, your research also found that post socks, young life cycle firms pursue less valuable patents. I found that interesting.
▶ 0:51:39Can you discuss how socks implementation forces young life cycle firms to alter their their innovation Certainly. So I would say that the idea here is that in in addition to diverting direct resources spending on research and development or time spent on research and development, the centralized control, formalization of processes and reduced flexibility that often accompanies the implementation of
▶ 0:52:09internal controls can be at odds or mismatched with the decentralized flexible risk-taking environments in which exploratory innovation thrive. So I'll just put a sub point. There are two types of innovation. Exploratory innovation which is strategically oriented towards new market markets, new products has a high probability of failure and exploitative innovation which actually takes incremental steps using existing processes and knowledge.
▶ 0:52:36While exploitative innovation conducted by more mature firms might actually benefit from more centralized controls processes, the exploratory innovation that young life cycle stage firms are engaging in is often mismatched with the control environment imposed by socks. And that's where we think the difference comes from. Thank you, Mr. Cunningham.
▶ 0:52:56Despite the costs and disruptions to innovation processes due to socks compliance, research suggests that young firms don't experience compensating benefits such as substantial improvements in financial reporting quality to offset these challenges. Can you discuss how the incremental improvement in quality achieved through Zox compliance might not be as significant for smaller issuers compared to complex multinational corporations?
▶ 0:53:26Yes, it it's very important to appreciate that when an auditor conducts an audit of the financial statements, it's required to test the internal controls and assess the control environment. So that's some an activity that's part of the the regular financial audit. And for relatively simple firms, low revenue firms, early stage firms, that's sufficient.
▶ 0:53:49And you're not going to get a big bang, a big incremental gain if you then say the auditor also has to give a a certification, an attestation, a full audit of of the entire control environment. Thank you, Mr. Cunningham. Um, many companies site socks as a factor in their decision to go or remain private, including in the recent cases of Nordstrom, Staples, Twitter, Now X, and Walgreens.
▶ 0:54:16If large established companies with robust resources find stocks compliance burdensome enough to consider privatization, this begs the question, how are smaller public companies opposed to cope? I am out of time. I will let you um uh respond in writing if um if that's uh if that's all right. Yes, mine. Next, the chair will recognize the gentleman from Georgia, Mr.
▶ 0:54:46Scott, for five minutes for questioning. Thank you very much. Uh, you know, 22 years ago when I first was appointed on this committee, I served with one Barney Frank and work closely with Barney on this bill.
▶ 0:55:07And I want to point out at the outset that my Republican friends, if if they gut this agency, my Republican friends are unilaterally disarming the United States against China and cutting our regulators access to audit firms, exposing working families and investors
▶ 0:55:38to greater risk. Th this is so seriously and I urge my Republicans, don't destroy this wonderful mechanism, this bill that gives the American public against China. Uh, Mr. codes.
▶ 0:56:00If foreignbased auditors can operate with no oversight, won't this create an unfair competitive advantage for companies using those Uh yes, sir.
▶ 0:56:19It would and it would return us to the period before this body passed the bill that led the PCOB to negotiate the um memorando with the People's Republic of China during which China companies defrauded US investors with a greater propensity and severity than they're doing today. I'll note too some have suggested the SEC could take over that role that the PSOB has provided. those memoranda are with the PCAOB.
▶ 0:56:50The People's Republic of China would get to walk away from them if the um attempt was made to transfer inspection authority to the SEC uh instead. Yeah. And can you speak a little more about this uneven playing field and the potential for distorting capital allocation and market confidence?
▶ 0:57:17You you you rais a very excellent point that's not come up yet. The principal driver I think for socks was fraud. But the biggest benefit is provided is to improve the allocation of capital to firms like uh Mr. Watnav's. Um the precision with which you can price stock depends on the reliability of the financial statements which include the reliability of controls.
▶ 0:57:46One quick word on controls. Controls are kind of basic. Most companies have them just to be clear. I'm I'm quite sure that your company had controls before it even ran into socks. There may be layers of cost added onto them, but to not have any requirement that anyone check whether the controls are adequately designed for China based companies will tilt the playing field in a way that means that some of the capital that appropriately should be allocated to US companies
▶ 0:58:16will be uh misallocated I believe to China companies. Yeah. Now let me make this point and I think you touched upon it uh but it's very important. Private through securities litigation relies on public disclosures and audit reliability.
▶ 0:58:44So if regulators inspect or investigate audit audits, won't investors have fewer tools to pursue leader remedies for fraud or misleading statements? I I believe you're absolutely right about that too. It was said earlier that restatements have continued and that's true.
▶ 0:59:10Uh many companies still make mistakes today, but the incidents of fraudulent misstatements have not risen anywhere close to the levels that they were at before Sarbain Oxley. And that's partly because the private litigation and the inspections together are a more powerful deterrent to fraud. Now I I want my good Republican friends to understand this major point.
▶ 0:59:40If believe that Chinese or foreign companies are exempt from scrutiny, this will erode trust in our financial statements of all US listed companies with foreign operations or auditors. This is significant. Thank you.
▶ 1:00:10Gentleman yields back. The chair now recognizes a gentleman from Arkansas, Mr. Hill, the chair of our full financial services committee for five minutes for questioning. Thanks, Chair Wagner. Let me thank the panel for great testimony. I appreciate it very much. Uh I want Mr. Cunningham to start with you and maybe reflect on Professor Coat's comment that somehow this is all uh optional that if a company wants to do it they can do it but a company doesn't have to do it.
▶ 1:00:40Could you start out by just giving us your view on that comment? I thought it was a a thoughtful comment. I want to make sure we're clear on the record about that. Yes, thank you very much. I Professor Coat's assertion is that Sarbain Oxley is all about disclosure. It only requires disclosure. doesn't require any substant substantive activity. At a high level of theory, there's there's some truth to that, but there there are some very important practical exceptions. Just to take an example, the audit committee rules are mandatory.
▶ 1:01:09You you've got to have independence, literacy, um oversight, very prescriptive, very substantive, has virtually nothing to do with disclosure. Um the the socks audit, the external audit of internal controls is required by the statute. The auditor has to do that work. The auditor has to comply with the auditing standard number five of the PCAOB. It has to do certain things. It has to ask for certain things. It has to get certain responses.
▶ 1:01:36And if a company if John is advising Frank to just ignore uh what the auditors are saying, I I I think as a practical matter, that's that's highly unlikely. You there there's a cooperative need to get the job done. And so there's enormous pressure from this. So disclosure only is very high level of theory is a practical matter. It's it's a it's a qua mandatory audit a auditing system. Yeah.
▶ 1:02:00I I I I thought that was a good exchange and and I I thought it was helpful to get that in the record because there are many things that there's a bit of discretion in but uh legal liability costs and abundance of caution you know air on the size of of spending all the money and dotting every eye even if it isn't you know totally prescriptively required. Another example of that is accredit the accredited investor rule for a regggd private placement.
▶ 1:02:28you're up you're allowed up to 35 nonacredited investors in a regggd private placement under the SEC rules but I don't know anybody that whose lawyer will facilitate that um you've got strong external auditor improvements in socks you've got strong CFO CEO at theest station in socks uh and now you have internal control requirements that were outlined in socks including the audit you you suggest so we've been doing it for 20 years.
▶ 1:02:58Um, what about the idea for uh a less frequent audit required for even a large filer if they have a good track record and they've been in full compliance? What about the business judgment rule? Where is the audit committee in this? Don't they have some right to uh outline the scope for their audit? What are your thoughts on that? Yes, I think you've identified some very important features of of socks that are often overlooked.
▶ 1:03:25Um the the the main culprit behind Enron was a very cooperative auditing firm in Arthur Anderson. All of those frauds were audited by that same firm. That same firm went out of business, went bankrupt, is gone and isn't part of the auditing culture today. Uh so Arbane Oxy prohibited public auditing companies from providing non- audit services to their public audit clients. That was a huge change and it's probably more important than any of these other things.
▶ 1:03:52And so and I don't have any notion that that's going to be changed. I think that's a very important change. Um the audit committee rules are extremely important. Uh I think audit committees are much more effective, much more energetic, much more leaning in and probably can be relied upon more uh these days. And so uh I think the the excessive investment of resources into that internal control audit is is really something that you all ought to uh focus on. And it's a it's a I think the highest priority.
▶ 1:04:22It's it's created a a culture of excess and um and the primary beneficiaries are those same auditing firms who are no longer allowed to do non Yeah, there's no doubt this has been a nice revenue opportunity for that. But I think if you have the high standards of the of the seauite officers and the audit committee independence and the rotation of the public accounting firm and that discipline that's put in in socks, then why couldn't an audit committee say we're going to do the audit of internal controls every three years instead
▶ 1:04:52of annually when it's such a box checking exercise. And I agree with I agree with you. I think audit committees are substantially improved than when they were in in 2002 2003. Quoting your pal Warren Buffett, I mean he was always arguing that the compensation committee ought to have a saber-tooth tiger as the chair, not a pussycat. And I think that's true for auditing firms and auditing committees. And I think that's been a a positive result from Sarbain.
▶ 1:05:22But I think the compliance costs need to be reviewed. I yield back to the chair. Gentleman yields back. The chair now recognizes the gentleoman from California, Miss Waters, who is also the ranking member of our full financial services committee. You're recognized for five minutes for questions. Ma'am, thank you very much, Chair Wagner.
▶ 1:05:40Professor Coats, as you know, Republican so-called big beautiful bill has a provision that would dismantle the PCAO and move its functions under the SEC. The PCAOB is the crown jewel of the Sarbain Oxley Act of 2002, which was passed by Congress in response to a number of major accounting scandals in the early 2000s.
▶ 1:06:08The Republicans have done nothing to increase the SEC's budget, which seems to be the only way the commission could continue the important work. The PCAOB is currently budget neutral as it funds itself by fees on public companies and broker dealers. So, the provision would not save taxpayers any money whatsoever.
▶ 1:06:34Furthermore, both the SEC and the PCAOB have confirmed to my staff in writing that the SEC is not a party to the agreements the PCAOB has enreached with foreign governments to inspect companies and auditors based in their jurisdictions.
▶ 1:06:54Again, if we are shutting down the PCAOB, the SEC cannot inspect auditors in China or in many other foreign jurisdictions. Can you talk more about the potential disaster dismantling the PCAOB would be for investors and our broader financial markets? Yes. Thank you, Chair uh Ranking Member um Waters.
▶ 1:07:20Um the uh I'm glad to hear in this hearing so far no one on either side proposing to abolish the PCOB even though that is what the budget bill would have done but for the Senate parliamentarian. I I assume that's because of a recognition of the point you're asking me about that abolishing the PCAOB would save no money.
▶ 1:07:48In fact, I think it would actually increase the the burden on the taxpayer because the transfer to the SEC would be an unplanned, unfunded, disastrous overnight transfer. The SEC, where I worked, I know in Washington, it's actually a small agency, but it it's quite big and it has a lot of things to do.
▶ 1:08:09And for it to suddenly and overnight take on the role of the PCOB would be quite expensive as a matter of transition and certainly even more expensive without any planning. It would fail and the result would be a return to basically a lack of inspections with any kind of meaningful backbone. Um the AICPA which is a perfectly excellent organization. My uncle was a CPA. CPAs are great.
▶ 1:08:37AICPA is a good organization, but it is not up to, nor was it in the 90s up to the task of checking the audit standards of the biggest audit firms for most public companies. If you abolished the PA PCAOB, I believe, or transferred significant authority to states or to self-regulation, you would see a resumption of bad audit practices.
▶ 1:09:03They would look the other way, not simply at controls, but at the basic financial statements that Professor Cunningham has emphasized so much, and you would again find a resurgence of restatements and ultimately of fraud. That, by the way, would affect companies that are not fraudulent themselves.
▶ 1:09:20An important research finding that's been repeated several times is that when a company in an industry like biotech commits fraud, not only does it lose enormously when the fraud's revealed, but other companies in the same industry do as Furthermore, as I previously mentioned, the Sarbain Oxley Act, that is SOCKS, was enacted in 2002 in response to a series of high-profile corporate accounting scandals like
▶ 1:09:50Enron and Worldcom, which collectively cost investors billions of dollars and eroded public confidence in financial markets. Those scandals exposed systemic issues like fraudulent accounting practices, conflicts of interest, and inadequate oversight. Socks passed with overwhelming bipartisan support. Support support 423-3 in the House and 99 to zero in the Senate.
▶ 1:10:16Nevertheless, Republicans looking to fund a tax cut for billionaires have decided to eliminate this agency without convening a single hearing and may be looking to weaken the rest of the law it authorized that authorized it. Professor Coats, we don't have time. I would like you to talk through some of the key tenants of Sarbane Oxley and why they have been so beneficial for investors in US economies overall.
▶ 1:10:43Since we don't have time, we certainly hope that they will hold a hearing uh so that you could be able to talk more about why it is so important for us to have an independent PCAOB. With that, I yield back the balance of my time. Thank you. Thank you. The gentle lady yields back. The chair now recognizes the gentleman from Oklahoma, Mr. Lucas, who's also the chair of the task force on monetary policy, Treasury market resilience, and economic prosperity.
▶ 1:11:12You're recognized, sir, for five minutes for questioning. Thank you, Madam Chairman, and thank you to our witnesses for testifying today. We benefit from the deepest, most liquid capital markets in the world, and that's why it's important for us to always look at how we can improve access for everyone in the economy. so our markets stay strong, resilient, and attractive.
▶ 1:11:34One of the challenges we face today is the prohibitive cost to going public, overreaching compliance requirements, and reporting regulations that discourage companies from entering public markets. Dr. Allen, can you talk more about some of the disincentives that we should address as so our public markets remain a viable option for companies to raise capital? Thank you.
▶ 1:11:59Uh, chairman Congressman Lucas, I I think it's important to recognize that in any discussion of the cost and benefits to being public, our research highlights that those costs and benefits are not uniform across firms.
▶ 1:12:13And so what I take away from this hearing today and and the bills that were proposed is a desire which I commend of the committee to uh investigate and think about carefully where the benefits are most likely to manifest for what type of firm and to avoid uh prescribing costly regulation in places where those benefits are less likely to manifest and the costs are supposed to be higher.
▶ 1:12:38In terms of the academic research to your question on how firms enter and perhaps exit public markets, I'm aware of an excellent academic study by unans and co-authors that was conducted last year where they try to quantify the costs of being a public firm. They estimate that as a consequence of the jobs act, for example, which provided regulatory relief, roughly 28 more firms per year will go public. So there's something certainly to be said for that careful analysis.
▶ 1:13:07The flip of that of course is if we there is also academic research that suggests as professor coats has testified that there are benefits to investor confidence in the market that may lead to more investment. So I think careful consideration of those complex cost and benefits is warranted. Mr.
▶ 1:13:28One, can you speak uh continue to speak to your own experience about what challenges uh did you face as your company was growing and how can we ensure that our compliance and reporting regimes are appropriately tailored to the size of business they regulate? Can you expand on that some more please? Yeah, certainly. And and I think you know to Dr. Brown's point, um the the the the jobs act and and the the lower thresholds for for newer companies to go public were was key to our decision to go public in 2020.
▶ 1:13:58Uh and certainly enable it it facilitated that process. It's still a costly and cumbersome process, but it it's a lot less costly and cumbersome thanks to the Job Act. Uh and and and you know, even if we when we weren't uh when we first went public, we weren't subject to 404b, right? We were uh and and there were considerable uh requirements on us as a 404A company as well.
▶ 1:14:21When we tripped into 404B the following year because of our market cap, as I mentioned before, there was a very significant cost increase associated with that. doubling in roughly in our audit fees and the additional cost of having compliance resources come in to design the internal control systems that were required for us to to meet the standards of our auditors and and that was money that you know I had to take out of the bank effectively to take my investors money to spend on the auditors and the compliance resources and it was money that I didn't
▶ 1:14:51then have to invest in Mr. Cunningham, you've studied the effects on business when federal regulations aren't well suited for present challenges. In your view, how can we modernize Sarbain Oxlay in a way that maintains robust financial integrity while making our public markets more attractive to firms? Can we still protect investors while competing on the global stage?
▶ 1:15:12And I would note I was here for and voted for the passage of Sarbain Oxley, but even the United States Constitution has required occasional adjustments to reflect the times. could you touch on that? Yes, thank you very much. I I think um investor protection and capital formation are the two objectives and um this hearing I I hope will focus and is focusing on investor protection.
▶ 1:15:36I think several of the immediate steps that Frank has outlined would be very useful and that appear in one of the bills. So um raising the 404b exemption and even chairman sh ranking member chairman Sherman has said we we need to adjust those things for for inflation. So that seems obvious. Um averaging it over several periods would be a good idea.
▶ 1:15:58Perhaps extending the um emerging growth company period from five to seven or nine years and but overall to refocus on the primacy of financial reporting. That's the information that investors need. The integrity of internal controls is a means to that end and I think we have lost sight of that. So if we can guide or you can guide the PCO AOB or the SEC to recalibrate, I think that would be extremely helpful. Thank you, Madam Chair. My time has expired. Gentleman yields back.
▶ 1:16:28The chair now recognizes the gentleman from California, Mr. Vargas, for five minutes for questioning. Thank you very much, Madam Chair. I appreciate very much the opportunity and also the ranking member and all the witnesses here today. I don't uh I don't often quote uh President George uh W. Bush other than for his maliprobism for strategery. I did enjoy that one. But I I do want to quote him when he signed the Sarbain Oxley bill in 2002.
▶ 1:16:58As the ranking member noted, it passed 423-3 in the House and 99 to0 in the Senate. He said this quote, "America's system of free enterprise with its all its risks and all its rewards is a strength of our country and a model for the world. Yet free markets are not a jungle in which only the unscrupulous survive or a financially free-for-all guided only by greed. The fundamentals of a free market, buying and selling, saving, and investing require clear rules and confidence in the basic fairness.
▶ 1:17:28The only risk, the only fair risks are based on honest information. And I think that end of quote. And I think that that's what Sarbain's oxy did and I think what the rules here are. Now earlier professor quote some words were put in your mouth that you said that this was optional. Is that what you said? No. And and to be clear um it's not a matter of theory that companies can choose to not do everything their auditors recommend.
▶ 1:17:5810 to 20% of all public companies report material weaknesses in their control systems. Some of them report them year after year. So this isn't just theory. This is actually borne out in practice. It's not to be clear my advice that you just ignore the auditors. That was not what I was saying.
▶ 1:18:17but rather that if they ask you to do something that you in your judgment can explain is too costly for the benefit, you have the ability to do that as long as you explain that to your investors. Now, if you can't explain it to your investors, then okay, then I can see why you might want to then do it anyway. But then you have to ask yourself if it can't be explained, why exactly are you resisting?
▶ 1:18:41So I it's not optional in a general sense, but it absolutely provides companies currently with the flexibility to resist pressures by auditors when they think it's a bad idea. Well, talking about flexibility, then let's let's stay on that issue for a second. You know, one of the the best arguments I think that they make about um some of these rules is disclosure rules and and the rest is, you know, there's a big company, there's a small company, the costs, they don't scale.
▶ 1:19:07you know, if you're a little company, you know, you have to pay a million bucks if you know, if you're a big company, you can absorb that easily. You, however, in 2007 when you were evaluating socks, you said this. Perhaps the most important component of the Sarbain Oxley was precisely to delegate power to the PCAOB so that it could customize rules and respond to feedback much more rapidly than Congress could do on its own. So, could it do that? Absolutely. And I I just want to emphasize I think the the ideas that Mr.
▶ 1:19:37Wanami sketched in his opening remarks are absolutely worthy of serious consideration. Some of them may be better than what we have right now. But to do it through a statute as opposed to doing it at the level of the PCAOB or if necessary at the level of the SEC who can move more quickly to allow companies uh to respond to their auditors when they feel they're being pressured to do things they shouldn't first.
▶ 1:20:02And then second to carve out different kinds of companies from some of the requirements or to stretch them out. Use averages or three years. If it's a 200 person employee company, it doesn't need I those I think are all fairly taken, but they're things that can be done without changing the statute. All you need is a hearing where you bring people from the SEC and PCO over and say, "What about these ideas, guys? Let's let's do do these at the regulatory level." Okay. And lastly, I do want to ask you about this because the world has changed.
▶ 1:20:32And we do have now other regulations in other parts of the world. And you said that, you know, there's similar regulations in other parts of the world. We're not the only ones here. We're not an outlier. Did you comment? It's completely right. Um following Sarbain Oxley, virtually every major um economy uh uh political system adopted similar requirements.
▶ 1:20:52um there is no observable regulatory arbitrage opportunity to move to say um the Cayman Islands or Bermuda or France or England and raise capital there. In fact, the British these days are very unhappy about the fact that the biggest British companies are listing in the US rather than in England because the combination of a strong regulatory system and deep capital markets reinforce one another and help capital raising. Thank you.
▶ 1:21:21And lastly, I just like to say this, a point of pride. I see that you're at Harvard. Thank God for Harvard. There's a number of us that went to school there, and we can proudly say it now. I hope you guys stick to your guns. Thank you. You're the most popular we've ever been. It's amazing. Yes, I know. Gentleman yields back. The chair now recognizes the gentleman from Ohio, Mr. Davidson, who's also the chair of the subcommittee on national security, illicit finance, and international financial institution. and you're recognized, sir, for five minutes for questioning.
▶ 1:21:51Uh, thank you, Madam Chairwoman. Sarbain Oxley was born out of the good intention in the wake of Enron's collapse. But let's be clear, this statute is not sacred scripture, which is not supposed to be added to or taken from. Even the constitution, which might be uh, you know, the closest thing we have to something sacred in our own country, uh, has been amended quite a lot. So the idea that oh how dare you amend the statute I think it merits at least some consideration and that's the point of this hearing.
▶ 1:22:19So thank you for convening it. Uh it's clear that the burdensome compliance costs have crushed businesses especially smaller ones that don't have the deep pockets to navigate its red tape. Frankly some of the bigger companies view this as an opportunity. It creates deal flow uh because it creates regulatory barriers that just to get to the next phase uh might say it's easier just to go ahead and exit and sell.
▶ 1:22:42As someone who ran manufacted and operated manufacturing businesses in Ohio, I know firsthand the struggle of juggling tight margins and deadlines and and and regulation. Uh I empathize with smaller public companies facing duplicative audits mandated by section 404. These regulations can choke innovation and slow growth for companies that are the backbone of our economy. With that, I have a letter from the National Association of Manufacturers that I request to submit for record with it. So ordered.
▶ 1:23:13Um, thank you, Chairwoman. Um, in this letter, NAM, who represents 13 million people in the manufacturing industry, takes aim at section 404B, which requires companies to hire an outside auditor to publicly attest to management's assessment of the effectiveness of the company's internal controls and financial reporting. This, in addition to normal audits, NAM's findings conclude that the costs far exceed the SEC's rosy estimates, hitting smaller public companies the hardest.
▶ 1:23:41After two decades of this regulatory overreach, it's time for Congress to act and free smaller firms from uh this unnecessary burden. It also supports why I back today's notice legislation to raise the revenue and public float thresholds for smaller reporting companies and adjust their filing filer category transa transitions. This is a common sense step to let businesses focus on creating jobs, not feeding Um Mr.
▶ 1:24:07Cunningham, you've highlighted how SOCK 404B disproportionately hits smaller companies. Can you unpack the real world impact of these um regulations and how can we scale it You've heard a lot of test Thank you very much.
▶ 1:24:21You've heard a lot of testimony today about the the extraordinary hard hit that small companies take from this because the costs don't scale and the costs are substantially duplicative because an audit of financial statements requires an examination of the controls and a testing of of the controls. So I think the cost benefit is is quite out of out of whack. And I think Congress is right that it it's Congress's responsibility to update and review its statutes, not just to delegate to agencies. Yeah.
▶ 1:24:51that it was in fact the the finally hard-fought win in the Chevron deference case in the Supreme Court. So in the wake of that, it creates an even bigger burden for Congress to act. So thank you for that. Dr. Allen, you know, I agree with your statement that for early life cycle firms, diversion of resources and innovation uh hindrance are notable effects uh maybe not the intent but certainly the effects of Sarb Sarbain Oxley's regulatory uh regime, you know, the impact on cash flow and everything else.
▶ 1:25:17Could you just discuss uh from a entrepreneurial perspective what modernization of socks could do uh for Yes. So so thank you. It's important that our research acknowledges that this isn't just a small firm effect. It's very similar from the standpoint of the costs and benefits manifesting differentially, but it's a different type of group.
▶ 1:25:40When we think about these highly innovative companies, the challenge is that although one set of controls is not mandated as professor coats has articulated very well, there's often a compliance mindset that is very rigid in form. I worked at Mattel when they were in the early stages of implementing their socks 404 and essentially they hired out another audit firm to help them design what would be the appropriate controls which then would pass for another audit company.
▶ 1:26:09uh as was very standard practice to have consulting consultants help and while a firm can disclose an internal controls weakness my understanding is that recently the SEC has communicated with firms that it's inappropriate to just let those sit over time that the objective of controls is uh to move forward to remediate those controls to ensure financial reporting quality so overall what happens to firms I think as the audit comes in is that it imposes a mindset or a structure that again has pushed
▶ 1:26:40more towards centralization, formalization of processes that is deconstructive or devaluative to the exploratory innovation process for this particular firm subset. Yeah, thank you for that. And uh I'll just close by saying I appreciate your nod to the late Thomas Soul in your written testimony. So with that, I yield back. The gentleman yields back. The chair now recognizes gentleman from Illinois, Mr. Casten, for five minutes for questioning. Thank you, Madam Chair. Um, thanks witnesses.
▶ 1:27:09So, not for the first time this term, I feel like we're we're we're sort of here in like a a British bakeoff competition and our contestant has served up a giant horsemen cake and we have brought you into a pine on the quality of the flower. Um, you know, we've got a markup here. One of the bills we're marking up is look looking at auditor independent standards of the PCAOB even as we have a budget that would eliminate the PCAOB.
▶ 1:27:38Uh we're sitting here talking about the nuances of audit standards even as this committee has voted to exempt entire industries from any kind of a disclosure-based regulatory regime. And I I say that not to criticize any of your expertise as grain millers, but I'd like to talk about the dung cake. Um I'm pushing that metaphor as hard as I can, but bear with me. I'm at least making a smile. Um, Mr. Watnabi, I I read an interview with you in 2021 where you talked about your process taking your company public.
▶ 1:28:06You said that one of the benefits of the IPO process is that law firms, accountants, investors do an excruciating amount of due diligence in the company. Everybody knows what they're investing in. Transparency and integrity are important when money is involved. I hope you still agree with those statements. Yes. Um um in that context, would you agree that audited financial statements are critical to make sure that we have public confidence in markets and so that people know are efficiently allocating their capital? Um I certainly agree to that.
▶ 1:28:36Um but I would also point out that I I had to have audited financial statements when I was subject to section 404A as well. No, no, understand and and again like I'm I'm not criticizing like that there are different qualities of flower. I'm just saying we're talking about audit because the Congress right now is drafting stable coin legislation. The idea that you could buy some piece of computer code that is neither stable nor a coin, but you could buy this piece of computer code and in exchange for buying that code, it's redeemable for a dollar.
▶ 1:29:05And yet the Senate just passed a bill that said that unless you have $50 billion in assets or more, you are not required to have an audit. You just have an attestation. So, you could shuffle money in on the 29th day of the month, shuffle it out on the 30th, take a snapshot, and that qualifies. Um, I don't know, you could It's like running a casino and having your dad buy 3.4 million of tokens and using that to disguise whether or not you had a solvency problem. Um, the Mr. codes.
▶ 1:29:33Considering that stable coins are sold to retail participants, used for investors, if if my Republican colleagues are right, are going to be tightly integrated into our financial system, do you think they should be subject to audit standards like banks are, like public companies are, or is an attestation sufficient? Um, I would have thought that we as a country and as an economy learned that lesson in 1934, not um recently.
▶ 1:30:01Um, audits are foundational for financial investment. My mother-in-law, bless her heart, doesn't understand that and has one occasion fallen for illegal unregistered securities offerings by people who don't get audits and has lost money.
▶ 1:30:19um the stable coin product as framed by the so-called genius act would extend the capacity of let's call them entrepreneurs for politeness to take that and make it perfectly legal. And so so let me I think it's a terrible Let me stay and look I have you're generous saying 1930s.
▶ 1:30:42We have a White House that seems to have fallen in love with 1890s economic policy but um but but stay on that for a second because it is insane that you know we had an amendment to put audit standards in that was voted down by all the Republicans in this There's recent news that Justin Sun who is one of the many committers of emolements violations has provided a bunch of money to the president of the United States to bail him out of World Liberty Financial.
▶ 1:31:04got to go and have the crypto dinner that he is now trying to do a reverse merger to take his crypto company public in the United States that would allow him to access public IPO markets without having to go through the kind of disclosure that you went through before doing an IPO. Mr. Watnabi, so I guess Mr. Coats, could you talk about some of the concerns that happen through the reverse merger process, particularly with foreign entities of concern that might be able to access public markets with lower disclosure standards? Yes.
▶ 1:31:33Um it it's well established that even when companies that are um subject to full regulation and audit use the reverse merger process, they're more prone to fraud, more prone to misreporting than companies that go through a fully underwritten process.
▶ 1:31:49And as annoying as the underwriters can be during the process, sometimes they really do perform a very valuable service not only to the investors but to the company in its long if it's a long-term um company that has real future to it. So reverse mergers bad sign. Um and the idea of removing regul regulation from the process of doing that even less good idea. Yeah. Well, I I'm out of time. I yield back. I let's just stay focused on the fact that audits are important.
▶ 1:32:20The details of an audit we can talk about later time expired. The chair now recognizes the gentleman from Wisconsin, Mr. Style, who is also the chair of the subcommittee on digital assets, financial technology, and artificial intelligence. Sir, you are now recognized for five minutes for questioning. Thanks, Chair Wagner. Uh thanks for being here. Thanks for the uh the dialogue on an important topic. I want to start with you if I can. Uh Mr. Frank, Mr. Frank Watanabe. Um when it's style, it's steel. Um, but it's good. But thanks for being here.
▶ 1:32:48You you built out a uh a great company, grew a biotech company from a handful of employees uh to a large uh publicly traded company. I want to focus uh in particular on your experience u leading a startup uh through that process. Uh Mr. Licardo and I have legislation to extend uh the EGC, emerging growth company uh on-ramp for certain companies so that they don't age out of EGC status uh before reaching maturity.
▶ 1:33:16And I appreciate uh you expressing support uh in your testimony uh for that today. I just want to ask you to put a little color on that uh to talk about how your business in particular benefited from EGC status uh in the implications that would have occurred if you had lost its status too soon. Yeah. So uh when we went public we were probably about a hundred people uh in the organization. Um and vast majority of those people were involved in researching our products or manufacturing our products.
▶ 1:33:46Um having the emerging growth company status allowed us to to do our IPO given that size because the their requirements are clearly lower uh as as an emerging growth company. uh and and we enjoyed that benefit for a couple of years as well.
▶ 1:34:04I I think if if the the jobs act had not passed and that pathway had not existed, uh the cost for us, the complexity for us to have gone public would have been substantially greater and and we very well may have have re-evaluated our decision to go public. Now, we we lost that status as time went on. So, when you when you lo when you did lose that status, what did you see as an implication on your compliance costs? You know, I I would say um losing EGC status is probably was less of an implication than than 404B.
▶ 1:34:35404B is really the thing that we saw the most significant implication for us in terms of compliance cost. I think I mentioned earlier in my testimony it it has more than doubled the cost of our compliance activities uh at at our and in real world terms that takes it from like 5 to 10 million. Is that what what's the what is what does double mean for as we kind of think about this for companies of your scale? Sure. Sure. So, uh, the year before we triggered 404B, we spent about uh, on our audit, and we didn't have an external compliance, uh, provider.
▶ 1:35:05The year that we, uh, fell into 404B, those, uh, doubled to 1.1 million, uh, in 2021, as I mentioned, last year it was 2.2 million uh, which was up 24% for the prior year. We're expecting something like that this year in terms of an increase as well. So, let me let me hit one additional topic.
▶ 1:35:24Commissioner Pur um said, I think quote, "The process of determining whether a company is smaller is a smaller reporting company and a nonacelerated filer or or or an SRC and an accelerated filer even outside of both categories so complicated that we even that even we at the SEC need diagrams to figure it out." End quote. Um can you just comment on the the complexity of that system?
▶ 1:35:46I one of the challenges and I I suspect that that that quote refers to is is that there are different standards for different things and and so you can be an an SRC and an accelerated filer for example. Uh and and so I think you know to the extent that those uh triggers are harmonized across uh different uh uh regulations or or legislation you know whether it's the SEC or PCAOB or Congress that does it. I think that would be a very positive step because you can I I agree with you. I think we have room to clean that up.
▶ 1:36:15I got about 75 seconds left. And I know you uniquely were impacted uh by proxy advisors. I think this duopoly of ISS and Glass Lewis is atrocious. Uh it's maybe just a step beyond the scale of of the topic of this committee, but hit me with what ISS and Glass Lewis and the Proxy Adviser Duopoly did to you. Well, I think we've struggled with several things.
▶ 1:36:36Um you know, one, there have been factual inaccuracies and our inability to review their reports on us in advance is a problem so that we can't correct So they just put out the information and off people go voting and you don't even have a chance to raise your hand and say that's not true. That that's correct. We have to fix it on the on the back side. Um the other issue is is that they they uh have a a um a set of standards that don't align, for example, with the SEC's own standards for things like independence. And that's been an issue for us.
▶ 1:37:06Uh because they're not fully regulated under the SEC in a manner that that you and I probably think that they should be. Right. They're not really regulated at all. Yeah. Uh and it's the wild west. U in in the ESG area, uh you will they will pay you to tell you how to improve your ESG score. So there's a clear conflict of interest. Conflict of interest. They claim there's a Chinese wall that this side of the the this side of the the entity is going to take the money. This side is going to report, but don't worry, there's no talking between those two. We're out of time. Appreciate your testimony. Big opportunity on Proxy Advisors.
▶ 1:37:37Yield back. Gentleman yields back. The chair recognizes the gentleman from Massachusetts, Mr. Lynch for five minutes of questioning. Thank you, Madam Chair. Thank the witnesses for your your help today. Um it was earlier said that uh Sains Oxley is not uh not sacred text. That that is very very true. But um let's be clear though.
▶ 1:37:59Uh I served on on this committee back in the early uh and witnessed the collapse of Enron and WorldCom and Tao early in the 2000s. These high-profile corporate accounting scandals uh collectively cost investors billions of dollars and eroded eroded public confidence. It it really created a crisis here.
▶ 1:38:25Uh the fall of Enron alone cost about 20,000 jobs was a scandal and more than $2.1 billion in retirement assets. People were talking about bailouts um and as well about $67 billion in losses for for shareholders. So uh the the problem uh the scandal exposed systemic issues in corporate accounting including a lot of fraudulent accounting practices.
▶ 1:38:55uh those those accounting firms were being purchased by their clients to give misleading audits of their companies and uh as a result this committee uh passed the SAS Oxley Act uh and anytime you get 400 votes in the House for a bill that says something and when you get 99 to zero in the Senate that says something uh this was a crisis it sometimes they they say it takes crisis to
▶ 1:39:25get Congress to act, especially in unison in a purposeful way. We had a crisis back then. Um, the bill created the PCAOB, the public company Accounting Oversight Board, whose primary purpose was actually to get at those audits and and to stop the And that's what it what it does today.
▶ 1:39:49But but I want to be clear what this this hearing is not tweaking uh the It it it eliminates it it obliterates to borrow a phrase obliterates the PCAOB. It goes away. The funding for that function of of making sure that the audits are are accurate. The funding for that goes away. And so uh uh Mr. Coats, can you can you talk about that?
▶ 1:40:17So section 50002 or the reconciliation bill basically like I said obliterates um the PCAOB and and the funding stream that supports the auditing function that this notfor-profit corporation the PCAOB uh you know uh performs and what's the what do you think the uh what do you think the result of that is going to be for uh people who rely on on those
▶ 1:40:47it. I firmly believe that the investment community would um with growing speed cease to believe that audited financial statements said actually represented what they purport to represent. It would increase the cost of capital for every small and medium-sized company that wants to raise outside equity capital.
▶ 1:41:16It would harm the American economy. I I have no doubt about that. Yeah. the the one of the other red flags I see is that you know the Trump administration with respect to the SEC which is where I guess some of this responsibility would flow uh the Trump administration also opposes the SEC fiduciary rule which basically says you know financial adviserss have to act in the
▶ 1:41:46best interest of their clients. So I mean there's a direct attack on on financial advisors uh responsibilities to their clients. They want that to go away. And uh I mean there are other firms out there that actually lean into finan fiduciary duty. You got firms out there that are doing really really well that say you know what we are a fiduciary. We accept and we are proud of our responsibility to act in the best interest of our clients.
▶ 1:42:17Yet the Trump administration wants to wants to get rid of that and uh and they want to get rid of the PCAOB. They want to defund uh you know the uh financial protection board. Uh that's been that's been rejected I guess by the parliamentarian over in the Senate. But collectively these aggregate uh attacks on responsible regulation, successful regulation um is really problematic.
▶ 1:42:44But it does show it does reveal the attitude of of the White House in this matter. Thank you. I yield Gentleman yields back. The chair now recognizes the gentleman from Indiana, Mr. Stsman, for five minutes of questioning. Thank you, Madam Chair. And uh I'd like to submit a letter from the American Securities Association to the committee for the record. So ordered. Uh thank you to all of the uh folks here to testify today.
▶ 1:43:11This is a a really important issue especially for um businesses across the country. you know, my previous u career or service outside of public service in the private sector uh dealt with startup companies, uh turnaround companies, but also publicly traded companies.
▶ 1:43:29And um there's a lot of uh companies out there, people that are investing in their local communities, creating jobs that uh want to grow and want to um to to give back to the community, give back to their shareholders, create wealth and new opportunities. And uh and so I think that this uh committee hearing is really critical for the growth of our country.
▶ 1:43:53And um I wanted to um you know while we we know that Sarbain Oxley was intended to prevent fraud over the past 20 years, we've seen the negative impacts of these regulations on growing companies and their access to capital. The cost and regulatory burden of these requirements are excessive as even small companies as I mentioned must pay on average $723,000 a year to comply with his act.
▶ 1:44:20Uh these costs have deterred small companies from going public which I experienced personally. Uh gaining access to capital and propelling economic growth. Uh the median age for a firm seeking an IPO increased from 6.9 years to 2014 in 2014 to 10.7 years. Uh today I had a a business attorney tell me that if you wait uh 10 years you'll become an overnight success. And uh that seems like uh the what's what's happening today because of the regulatory environment. Dr.
▶ 1:44:50Allen, I'd like to um ask you in your testimony, you cited research finding that firms tend to manage their public float downward to avoid exceeding the 75 million and $700 million regulatory market cap thresholds for qualifying as accelerated and large accelerated filers, respectively. How much market valuation are firms willing to sacrifice in order to avoid having to comply with socks? Thank you.
▶ 1:45:19So, this is the UN study that I was citing here. They estimated that for firms just below the 75 million threshold, um they're essentially willing to pay 132,000 annually to stay below that threshold or give up about of their market cap. For firms seeking to avoid the 700 million threshold, uh the equivalent is more like 900,000 per year in costs that they're incurring and giving up about 1.2% of their market cap.
▶ 1:45:49The way they stay below this threshold is that they shift their financing towards debt and away from equity. Yeah. No, that's right. So, so is managing float downward a concerning trend to you? And if so, doesn't lower stock float typically lead to higher volatility in the stock's price because it's easier for a smaller number of shares to move the price. So, we do have some evidence of that from outside of US markets.
▶ 1:46:14I don't know that we've tested it specifically in the US, but yes, anytime we see firms incurring real costs to manage their market cap, it suggests that they at least perceive that the net costs are heavier than the net benefits. Yeah, very good. Um, Mr. Cunningham, going back to the compliance barriers. Um, how could you speak to that and and how it's hurting American communities? Um, like I mentioned, those in my district, smaller companies, maybe it's manufacturing, maybe it's tech.
▶ 1:46:44Uh, great ideas. Got a large orthopedic uh sector in northeast or northern Indiana as well. Um, how how does that affect them? Because I know for a fact, I mean, it is hard to go public. it's almost easier just to build the company up and sell it to a publicly traded company or do a spa and just go in backwards um which has its uh you know challenges as well. There are real costs to communities of overregulation and especially this over auditing of of internal controls.
▶ 1:47:14It's it's exceedingly expensive and prohibitive for many companies. Many entrepre every entrepreneur is going to assess the costs and benefits of sourcing capital, deciding whether to stay private or access to public capital markets. And there's no question that there are significant costs, significant barriers. And so, um, businesses in in your district and other communities across America are certainly adversely affected by this. And and so I I commend you and and the committee for focusing attention on it.
▶ 1:47:40Well, I think you know there needs to be a balance, but it seems like this is we're too far to the one side and ultimately, you know, it's money going to the government versus money going to back into building a business or going to shareholders and generating more velocity in the marketplace. So, thank you for your testimony, Madame Chair, I'll yield back. Gentleman yields back. The chair now recognizes gentleman from Louisiana, Mr. Fields, for five minutes of questioning. Thank you, Madam Chairwoman, and let me thank all the witnesses for being here today.
▶ 1:48:10Um, I just have a few questions. Uh, first to um to Mr. Coats. Uh, following the devastating uh Enron war uh come scandal that cost uh investors billions.
▶ 1:48:24Can you walk us through the specific failures that uh SOX uh was designed to uh actually address and what measurable improvements in audit quality and financial reporting reliability we've seen since the uh PCA uh OB began its oversight work. Uh thank you uh M Congressman Phills for that.
▶ 1:48:48Um, so my written testimony refers to scholarship I've published on this and that will give you a much more comprehensive uh answer than what I'm going to summarize. But I'll say a couple of things first to reiterate before Sarbain Oxley there was no PCAOB. If you have no PCAOB then you have audit firms self-regulating whether they do a good job of the basic audit of financial statements.
▶ 1:49:16And in the period leading up to Sarbain O actually they failed over and over with increasing frequency in part because of another thing Sarbain actually changed was they were at the time permitted to engage in significant non- audit work for the same company they were auditing. They were in effect partly auditing themselves and they were being paid lots of money for the overall relationship which meant that they were less inclined to fight hard during the audit.
▶ 1:49:45That led to a dramatic increase in the number of mistakes and of fraud. And you can just see it in the numbers. They were going up and up every year through Sarbain Oxley. Once the PCOB's audit standards kicked in, they began to decline and they've remained at much lower levels over the past 10 years. It they've never gone to zero. Uh it's not the like the PCO is perfect. Sarbines actually is not perfect.
▶ 1:50:13We're never going to get the perfect, but it has significantly improved financial reporting quality as my colleague down the bench here has shown in her work as well. It's not just me. It's um consistently found better reporting quality as a result of audit Thank you. Uh let me um actually doc um Dr.
▶ 1:50:38Allan, uh, from an academic standpoint, what evidence do you see, uh, that the current independent PA uh, PCA OB structure is more or less effective than folding these specialized functions into a broader SEC mandate?
▶ 1:50:55And how would you assess the risk uh of d uh diluting these focus uh expertise across the SEC uh much wider regulatory Thank you for the question. So my own research hasn't looked into the PCOB. I think certainly points that have been raised regarding funding and independence are important questions to assess when thinking about you know who who will perform these functions. uh as Dr.
▶ 1:51:26Coats has mentioned, we do see a drop in restatement rates following the implementation of the PCOB, but it's also correspondent to a time where we saw the independence rules for auditors changing, which was an important shift as well. So research kind of examining the the strength of those two forces would be important to understanding what's going on there. Uh that would be my assessment of current research. Thank you. And my final question is to um uh Mr. Cuttingham.
▶ 1:51:53Uh section 404 internal controls assessments have been criticized u as costly yet they require companies to establish and maintain systems to prevent fraud. In your view, uh what would be the marketwide implications if we signal to investors uh that we're prioritizing compliance uh cost reduction over fundamental fraud prevention uh mechanisms?
▶ 1:52:24I think the signal to markets and to investors of of this review would be to signal that Congress is attentive and concerned about making sure that resources are deployed in ways that protect investors and are not deployed in excessive uh resourcing on on internal controls. Um and I just add on 404B Dr. ground's right that Socks made so many changes.
▶ 1:52:52It was very difficult for a long period of time to determine the effect of particular provisions. You know, we we banned um conflicts of interest and have good audit committees, officer certificates, and these internal controls. But we do have evidence after the SEC increased uh the exemptions under 404B in 2020. We've got empirical research on whether the quality of reporting or intern reporting went down or internal controls. I want to thank you. I'm out of time.
▶ 1:53:22I want to y back to the chair. Thank you, gentlemen. Time's expired and the chair now recognizes the gentleman from Montana, Mr. Downing, for five minutes of questioning. Thank you, Madam Chair, and thank you to the witnesses for being here. Uh, as a recovering regulator, this is a very, uh, interesting topic to me.
▶ 1:53:41Um, I was, uh, formerly the commissioner of securities and insurance for the state of Montana, and I firmly believe that the best way to evaluate any regulations is to determine whether the benefits outweigh the costs. So, I'm happy we're having this hearing on Sarbain Oxley, a law that Congress hasn't changed since 2002. Um, I'm going to start with uh Mr.
▶ 1:54:08You know, you've spoken a lot on the subcommittee about the many barriers that companies have going uh going and staying public. And I think about compliance costs a lot. So, of all the compliance costs that public companies face, where would you rank socks in those costs? Um, I I think that the the thing that I can quantify most clearly is the cost differential between 404A and 404B.
▶ 1:54:34Uh, and you know, I I think I mentioned in my testimony earlier, um, you know, we've spent about $1 million complying with 404B since we started being subject to it. And to quantify that, you know, that that's the cost of me running uh a a phase 2 efficacy trial on a new drug, right? that that's money that I didn't have to spend on developing another new drug to treat another serious disease. Uh you know when we were under 40 or 4A I I still was subject to audit every year.
▶ 1:55:03I still had to sign the attestation every year. I thought about that very care I think about it every quarter very carefully as as I know you did congressman as an entrepreneur. I don't look good in orange. Right. So I I I take that very seriously. So it's it's not that that um you know I'm suggesting a lack of regulation.
▶ 1:55:20I think it's it's really more titrating the regulation uh so that that smaller companies aren't overly burdened with the cost of compliance uh in the same way that a you know a gigantic multi-billion dollar corporation is. Thank you. Uh I'm going to move to Mr. Cunningham. Uh some contend that any serious reforms of socks will lead to more corporate accounting scandals like like Enron.
▶ 1:55:46In 2020, the SEC amended the accelerated filer and large accelerated filer definitions to carve out some smaller issues from the 404B requirements. Have you seen any decline in the quality of financial statements from these companies since this change? Thank you very much for that question. And I I have not and indeed there is empirical research by independent professors demonstrating that there there was no adverse effect in the quality of the reporting or the strength of the controls.
▶ 1:56:16Well, wouldn't you say that proves that Congress can make necessary and targeted reform without jeopardizing audit quality? Yes, sir. Thank you. Uh you know, many public companies see the 404A and the 404B requirements as uh uh duplicative auditing. Is there any way to reform these requirements to reduce this duplicative auditing while maintaining investor confidence? For example, why not just keep the 404A requirements in place?
▶ 1:56:47Yes, I support this this avenue of inquiry and I'm glad Professor Coats agreed that we should consider many of the proposals that Frank has suggested and this this committee has suggested. So I I think it's eminently within the scope of of Congress's jurisdiction to to tackle that and not give it over to the SEC or PCR. I I appreciate that. Are there any essential provisions of socks that you think have worked as intended and do not uh don't need to be reformed?
▶ 1:57:14I I do think that the audit committee regulations I was first quite skeptical of the the very prescriptive and intrusive approach but on reflection over the years I I I think the audit committees are now very leaning in very effective and and so I I I think I'd I'd be satisfied with that. Uh the officer certifications I think have heightened u the attentiveness of of leadership. So, uh, and the ban on on conflicts of interest with the auditors.
▶ 1:57:41I I think that was the the most important and successful accomplishment of the statute. So, there there are quite a few good things, but there are a lot of missteps. Right. Right. I I appreciate that. And and again, just going back in this uh inquiry of of understanding whether the costs, you know, are are worth uh uh the bene the benefits are worth the cost. So, I I I appreciate you all being here. And on that, Madam Chair, I'm going to yield. Gentlemen yields back. The chair now recognizes the gentleman from California, Mr.
▶ 1:58:10Sherman, the ranking member of the subcommittee on capital markets. You're recognized for five minutes for It's hard to know how much to invest in making sure that audits are accurate and that fraud is avoided. Reminds me of a bank that had a bank guard there. They said, "Hey, well, we haven't had a hadn't had a robbery in 20 years. Might as well fire the bank guard." uh you don't know until you find out.
▶ 1:58:37Uh and the harm of Enron and WorldCom uh and I think Mr. Coats has pointed this out is not just to the individual companies and their employers and their stockholders but entire industries and the market overall. And with Enron, I take it very personally because they also destroyed my state for several months by creating an artificial shortage of electricity and artificial blackouts when we had plenty of electric generating capacity. Also destroyed a governor of my state.
▶ 1:59:07Uh there's been discussion of the proxy advisors. Uh I am a concern that they also offer advice on how to get a good score. But as to uh complaining that right before there's going to be a vote, somebody could publish something that affects how people vote and it might be a dilopoly. Well, welcome to my world. The LA Times publishes things right before a vote. They don't let me see in advance.
▶ 1:59:38And maybe it's a duopoly because we also have the Los Angeles Daily News, but it is at most a duopoly. Um we've got to explore the scope of what is required under Sarbain Oxley. What the I I think uh people have mentioned the frequency but I think the quarterly and annual are probably the right frequency and then most of this hearing is focused on who's exempted.
▶ 2:00:03We exempt on the basis of dollar thresholds which tend to focus on the equity that is out there. Um but uh Mr. coats. Don't public bond holders also rely on these financial statements? And is there any reason to exclude uh the publicly held debt when we're also looking at the publicly held stock and in disturbing these thresholds?
▶ 2:00:28So the current exemptions, some of which are built into statutes, are crude. Um as you just noted, equity is not the only source of capital. outside equity investors are not the only ones relying on financial statements. Um they could be more carefully designed. I want to emphasize however that let me let me move in another question. Does the PCOB or the SEC have the authority under current law to make some of the adjustments we're talking about?
▶ 2:00:59Because uh there is an argument that uh these are arcane details that perhaps regulators can deal with better than us or or at least more frequently more frequently more quickly and they can monitor. Do they have the authority under prison statute? They absolutely do. The one exception this is something you guys could consider letting them more carefully design experiments with their regulations. Currently they're constrained to do that.
▶ 2:01:25I think you could consider giving the SEC the authority to test and then quickly one one thing that failed the test was the structure of Arthur Anderson. When I was doing audits, you had the audit partner whose job it was to golf with the CFO and the technical review department and you couldn't issue the opinion without Arthur Anderson had a don't ask don't tell approach with their technical review department.
▶ 2:01:55uh is it I I don't think any accounting firm has replicated that but is it clear that under current uh uh regulations you have to have a technical review department inside the uh the accounting firm sign off whether the audit partner wants it uh wants that or not. Thanks to the PCAOB and its standards and its inspections, audit firms routinely avoid that kind of cabineting of information that helped trigger Enron. Yes.
▶ 2:02:26And then uh one of the proposals and the one I I think I like least is the idea that the uh auditor wouldn't have to uh register with the PCOB but rather just meet the standards of the AICPA. As I pointed out, the ICPA wasn't consulted uh on that uh on that bill.
▶ 2:02:46Um, and I saw with Maid Off that maybe the auditor was in technical compliance with the ICPA standards but was manifestally incapable of doing the audit. They had a couple of CPAs and Maid off had a big empire to uh uh to audit. Uh, are the uh what are the downsides of not having the audit firms be approved by the by the PCOB?
▶ 2:03:12I I don't think we want to return to the Bernie made off scandal. So no, it would not be in my opinion a good idea. Thank you. Gentlemen, time expired. The chair now recognizes a gentleman from Florida, Mr. Heridopoulos, for five minutes of questioning. Thank you, Madam Chair. And I first want to submit a letter from the Society of Corporate Governance regarding scaling disclosure and obligations for the record. So order. And I also want to thank the chair for bringing this issue forth.
▶ 2:03:39As a new member of the committee, it is very helpful to understand the history and and to hear from the experts in the field for a bill that's over 20 years old and and some of the changes that have taken place in our society since. And I think one of the things we've talked a lot about in this committee is the the power of the blockchain and the power of technology in general so that more people could put their eyes on things so that when bad things happen, we can be alerted earlier as opposed to later on so many different subjects. And so one of the issues that um Mr.
▶ 2:04:08Wadonabi, if if you could, you you mentioned this term a couple of times, 24% increases. Are these prices that you're getting from your lawyers and accountants and so forth that going through these records or are these new rules that are being instituted each year in year out that that force you to hire more accountants and lawyers? So, the 20 Thank you for the question. The 24% increase that that I mentioned was year-over-year increase in in the fees charged by our auditors.
▶ 2:04:37Um, you know, it it's um it's not something that I have a lot of negotiating leverage with. My shareholders appoint our auditors annually at our annual general meeting as as I think all public companies do. Um, once our auditors are in place, they they look at the scope of work and they tell me how much it's going to cost me and and it goes up quite a bit every year. Um, it's it's more than doubled just since we went public. Um, uh, or sorry, excuse me, just since we we uh fell into 404B.
▶ 2:05:06So the the costs go up every every year and and the company has really no ability to negotiate those fees. Okay. Thank you. And and Dr. Allen, if I could with your question, if if you had a magic wand, we've we've heard the testimony today. You live this clearly. You understand this better than most. If you had a magic wand and pick one item that could be changed within Sarbain Oxley to still have the oversight that we're all looking for, but also looking at the everyday costs that businesses are trying to make the decision. Do they go public? Do they stay public?
▶ 2:05:36Do they sell to a different public company if they're a private company? All these things in place. If you had a magic wand, you could say, "Here's one change I would make to keep the oversight in place, but reduce some of these costs so the PE companies might go public who are making these difficult decisions." What would you use as that magic wand? Can I give two things? One, I really like the idea of rolling averages because I think it's very hard for companies to come in and out of exemption status.
▶ 2:06:01And two, it would be more granular regulation that allows for thoughtful exemptions based on things like low revenue where we have lower risks or high innovation environments where control environments are more damaging. Mr. Cutting, same to you. Is you agree with me, Dr. Allen? Is there other issues that are out there that you think this is the not the magic bullet, but at least try to reduce some of these 24% costs or or change the way we're doing business from 23 years ago? Agree with Dr. Allen. And so that means I get three.
▶ 2:06:30So, so just I agree with Chair Hill too. His idea of of having instead of an annual uh test uh have it every second year or every third year depending on on risk profiles, complexity of the company, development stage, revenue and so on. I I I think that's a a worthy uh topic. Why don't you do you want to add to that as well? I I I'd agree with all three of those. Mr. Coach, I you uh made some good statements today. I want I want to give you an opportunity too.
▶ 2:06:59Is there something you've obviously seen this law in effect for 20 years? There's got to be some issues where we thought was a great idea in 20 2002, but maybe it's either outlived this usefulness or technology has allowed us to look at things more quickly as opposed to the the paperwork shuffle from 20 odd years I so I think the most important thing that this body could do is bring the PCOB and SEC folks here and push them on the kinds of suggestions that you've just heard about because I do think they can do it more quickly and if they
▶ 2:07:29get it wrong suppose they titrate too far one way or the other uh they can reverse that more quickly than Congress can as a body. So I would have a hearing specifically on some of these these specific ideas that would be the natural next step. Well, Madam Chair, I appreciate the opportunity and I yield back. Gentleman yields back. The chair now recognizes the gentleman from Texas, Mr. Sessions, for five minutes of questioning. Madam Chairman, thank you very much.
▶ 2:07:55Uh, I think you did an awesome job to gather together people that don't compete against each other, but have a same or similar story to tell. And I applaud you for doing this. Uh, Mr. Coats, I'll be quite blunt. I like where you come from and your value added to today is not an answer.
▶ 2:08:18It is giving the regulatory bodies the opportunity to come in and in essence work with companies on some negotiation about what they'll do. Uh this is important because Mr. wannabe's uh testimony. Page three says the compliance costs for emergency emerging growing biotechs on averages of a year.
▶ 2:08:49And then you go on and actually list what that price tag costs you in research and development to bring your clear biotech ideas that may save lives, may fix problems, may be a breakthrough. We're spending time on compliance costs rather than doing those things. I note Mrs. Allen spoke well about this. Mr. Cunningham.
▶ 2:09:19Very impressive. Uh and and I don't think that it says something somewhere and delete something later, but I do find that you have tried to focus the activity off of that compliance costs can have significant effects for firm IPO decisions. And so I'd like to go at that level as opposed to beginning, middle, end, how big they are.
▶ 2:09:48It is causing people who actually are business leaders and entrepreneurs who want to get something to marketplace that are worried about the FDA that are worried about an FDA trial that are worried about something else and they're having to worry about am I saying everything right? Am I getting exactly what my c what it does or not do my biotech company or otherwise?
▶ 2:10:18And I just think if Mr. Cunningham, Mrs. Allen, if you take just a minute, which is all I have left because I spoke too long, what do you think about Mr. coat's idea of us using this tape of this hearing that Congresswoman Wagner has been really good at narrowing down and going to regulators and saying we charge you with trying to come up with a plan not picking winners or losers
▶ 2:10:49but by picking things and they they could strike that balance. Miss Allen, I support the idea that that Professor Coat had put forward of consulting with the SEC, with members of the PCOB to think about the costs and benefits and how they differ across firms. I think also, as he's suggested, some level of experimentation. It's very hard to calibrate standards appropriately on the first go. So, an openness to trying it, examining the data, and revising is is good policymaking.
▶ 2:11:20and then making sure you hold them accountable. But there's a variance that's allowed there. Mr. Cunningham, one of the statements that has been made is time. Time. When I was at Southwestern University taking my business classes, we learned time is money. Well, Mr. Wannabe would also say time is also people's lives delaying things because you're having to shift.
▶ 2:11:48tell us about the ability the flexibility that you should be given uh that these companies should be given by the regulator. Yeah, I think it's an excellent point and um it would be prudent, I think, for this this committee, I don't mean to tell you how to do your job, but but to have the SEC here and have the PCO AOB here and and to give an accounting their perspective what they see the costbenefit matrix uh and and develop strategies
▶ 2:12:18for um right sizing and balancing and I I think that would be very productive thing to help uh address the uh the the lost time uh due to due to red tape, due to excessive uh resourcing into the internal control environment. We care very much as well do you about an investor who could be duped into the wrong thing.
▶ 2:12:43But I think almost anybody that has money to invest, I'd like to think would recognize that getting to the FDA trial is the plus or minus. That's the go or no go for lots of these things. Madam Chairman, this is uh in my opinion the best hearing you've had. I remain confident that we can make a difference that we built a a an argument that's available on a bipartisan basis and you proved it with your uh committee here today.
▶ 2:13:13Thank you very much. I yield back my time. Gentlemen's time's expired and I'd like to thank all my colleagues for their uh robust participation today. Okay, I want to thank our witnesses for their testimony today. And without objection, all members will have five legislative days to submit additional written questions for the witnesses to the chair. The questions will be forwarded to the witnesses for their response. I'd ask the witnesses to please respond no later than July 30th, 2025.
▶ 2:13:43This hearing stands adjourned.