Reassessing Sarbanes-Oxley: The Cost of Compliance in Today’s Capital Markets

Small Business Administration OversightHouse Financial Services Subcommittee on Capital Markets · June 25, 2025 · 119th Congress
The House Financial Services Subcommittee on Capital Markets held this hearing to examine whether Sarbanes-Oxley's internal control audit requirement, Section 404(b), imposes compliance costs disproportionate to its investor-protection benefits, particularly for small and young public companies. Begins at ▶ 0:15:27
Transcript
Highlights

Title

Reassessing Sarbanes-Oxley Section 404B compliance costs for smaller issuers

Purpose

The House Financial Services Subcommittee on Capital Markets held this hearing to examine whether Sarbanes-Oxley's internal control audit requirement, Section 404(b), imposes compliance costs disproportionate to its investor-protection benefits, particularly for small and young public companies. Four witnesses presented academic research and firsthand corporate experience on 404(b)'s costs and effects on innovation and capital formation, while members also debated a separate proposal to defund the PCAOB and shift its functions to the SEC. Begins at▶ 0:15:27

Who spoke

• Chair Ann Wagner (R-MO)▶ 0:15:27: Opened by arguing 404(b) functions as a "double audit" costing over $1 million a year that doesn't scale with company size▶ 0:17:10, and later questioned Watanabe on reallocated R&D spending▶ 0:49:26 and Allen on innovation declines▶ 0:50:45.

• Rep. Brad Sherman (D-CA), Ranking Member▶ 0:19:58: Recalled his work reforming the PCAOB to cover China-based auditors▶ 0:20:44, criticized the committee's prior vote to defund the PCAOB without giving the SEC funding to replace it▶ 0:21:00, and argued Enron/WorldCom losses of over $200 billion show internal control audits are worth their cost▶ 0:23:38; later asked Coates whether public bondholders, not just equity investors, rely on audited statements▶ 1:59:38.

• Rep. French Hill (R-AR), Chair, Financial Services Committee▶ 0:24:04: Noted 404(b) is the most expensive feature of the securities rulebook, citing over $1 million/year compliance costs▶ 0:24:53; later pressed Cunningham on whether audit frequency could be reduced for large filers with strong compliance track records▶ 1:02:28.

• Rep. Maxine Waters (D-CA), Ranking Member, Financial Services Committee▶ 0:25:20: Called the PCAOB the "crown jewel" of Sarbanes-Oxley▶ 0:25:47 and argued the reconciliation bill's provision to eliminate it would benefit the Chinese Communist Party by cutting off the PCAOB's unique access to Chinese auditors▶ 0:26:14; later had Coates confirm eliminating the PCAOB would save no taxpayer money and could require an unfunded, disastrous transfer to the SEC▶ 1:06:34▶ 1:07:20.

• Dr. Abigail Allen, Brigham Young University▶ 0:28:10: Presented research finding 404(b) reduces both quantity and quality of innovation at young life-cycle firms, with declines of 9–12% in R&D intensity and 6% in patent filings▶ 0:50:45; found no offsetting improvement in financial reporting quality for these firms▶ 0:31:32.

• Mr. Lawrence Cunningham, University of Delaware▶ 0:33:18: Argued SOX conflates compliance with accuracy and has fostered a costly compliance industry▶ 0:34:45, citing average annual costs of $1.5 million and a drop in public companies from 6,500 to about 4,000▶ 0:36:07▶ 0:36:30; later called disclosure-only framing "at a high level of theory" but noted audit committee rules are practically mandatory▶ 1:00:40.

• Mr. Frank Watanabe, Arcutis Biotherapeutics▶ 0:38:28: Said Arcutis has spent about $11 million on 404(b) compliance since first triggering the threshold in 2021, with auditor fees up 24% last year to $2.2 million▶ 0:40:26▶ 0:50:14; proposed raising public float/revenue thresholds and extending emerging-growth-company status from five to ten years▶ 0:42:07▶ 0:43:02.

• Mr. John Coates, Harvard Law School▶ 0:44:00: Countered that SOX is fundamentally a disclosure law and companies can disagree with auditors' judgments if disclosed▶ 0:44:30; noted the PCAOB already has authority to soften 404(b) requirements administratively and did not do so under the prior Republican administration▶ 0:45:26▶ 0:46:15; warned eliminating the PCAOB would return the U.S. to weaker Chinese-company oversight▶ 0:56:19.

• Rep. David Scott (D-GA)▶ 0:54:46: Argued gutting the PCAOB would "unilaterally disarm" U.S. oversight of Chinese auditors and tilt capital allocation toward Chinese firms▶ 0:55:38▶ 0:57:46.

• Rep. Frank Lucas (R-OK)▶ 1:10:43: Asked Allen about disincentives to going public and cited research estimating the JOBS Act enabled roughly 28 more IPOs per year▶ 1:12:38.

• Rep. Juan Vargas (D-CA)▶ 1:16:28: Quoted President Bush's 2002 SOX signing statement on honest information▶ 1:16:58; pressed Coates on whether 20–20% of companies reporting material weaknesses undercuts the "optional" framing▶ 1:17:58.

• Rep. Warren Davidson (R-OH)▶ 1:21:51: Submitted a National Association of Manufacturers letter opposing 404(b)▶ 1:22:42 and asked Cunningham and Allen about real-world impacts on smaller firms▶ 1:23:57.

• Rep. Sean Casten (D-IL)▶ 1:26:39: Criticized a Senate stablecoin bill exempting issuers under $50 billion in assets from full audits in favor of mere attestation▶ 1:28:36, and questioned Coates on reverse-merger fraud risk for foreign entities▶ 1:31:04.

• Rep. Bryan Steil (R-WI)▶ 1:32:20: Asked Watanabe about the value of emerging-growth-company status and criticized the "duopoly" of proxy advisors ISS and Glass Lewis for conflicts of interest and unreviewable reports▶ 1:36:15.

• Rep. Stephen Lynch (D-MA)▶ 1:37:37: Recalled Enron's collapse costing 20,000 jobs and $2.1 billion in retirement assets▶ 1:38:25, and warned that defunding the PCAOB would raise the cost of capital for small and mid-sized companies▶ 1:40:17.

• Rep. Victor Stsman [Stutzman?] (R-IN)▶ 1:42:44: Cited a $723,000 average annual compliance cost and rising median IPO age (6.9 to 10.7 years)▶ 1:44:20; asked Allen about firms deliberately managing float below regulatory thresholds▶ 1:44:50.

• Rep. Cleo Fields (D-LA)▶ 1:47:39: Asked Coates about specific SOX failures being addressed and measurable audit-quality improvements since PCAOB oversight began▶ 1:48:10.

• Rep. Troy Downing (R-MT)▶ 1:53:22: A former state securities commissioner, asked Watanabe to rank SOX among compliance costs▶ 1:54:08 and asked Cunningham whether the 2020 SEC exemption expansion had degraded reporting quality (it had not)▶ 1:55:16.

• Rep. Sherman (second round)▶ 1:58:10: Compared audit skepticism to firing a bank guard after 20 years without a robbery▶ 1:58:10, and questioned whether AICPA-standard-only auditors (versus PCAOB registration) risk repeating Madoff-style failures▶ 2:02:26.

• Rep. Gus Bilirakis▶ 2:03:12: Submitted a Society of Corporate Governance letter▶ 2:03:12 and asked Allen for a single "magic wand" fix to SOX▶ 2:05:06.

• Rep. Pete Sessions (R-TX)▶ 2:07:29: Praised the panel's alignment and asked Cunningham and Allen to endorse Coates's proposal of directing SEC/PCAOB regulators to develop calibrated reforms▶ 2:10:18.

Key moments

• Watanabe testified Arcutis's audit fees roughly doubled upon triggering 404(b), reaching $2.2 million last year (up 24%) with an added $500,000/year for compliance staff, all diverted from drug R&D▶ 0:40:26▶ 0:41:13▶ 0:50:14.

• Allen's research found young life-cycle firms cut R&D by 9–12% and patent filings by 6% after 404(b), producing narrower, less-cited patents, with no measurable gain in financial reporting quality for that group▶ 0:29:44▶ 0:31:58▶ 0:51:12.

• Cunningham cited a drop in U.S. public companies from about 6,500 to 4,000 since SOX, alongside firms like Nordstrom and Walgreens choosing to go private, and said internal control reports catch fewer than a quarter of issues before restatements▶ 0:36:30▶ 0:37:00▶ 0:35:36.

• Sharp disagreement between Coates and Watanabe/committee members: Coates argued SOX is a "disclosure law" companies can push back on▶ 0:44:30, while Cunningham countered that as a practical matter auditors' demands are effectively mandatory given liability pressure▶ 1:01:09.

• Waters and Coates established that eliminating the PCAOB (as proposed in the reconciliation bill, before being struck by the Senate parliamentarian) would save no money, since PCAOB is fee-funded, and would strip SEC access to China-based audit inspections because the PCAOB's bilateral agreements with China wouldn't transfer▶ 1:06:34▶ 1:06:54▶ 1:07:48.

• Casten highlighted that a recently passed Senate stablecoin bill exempts issuers with under $50 billion in assets from full audits, requiring only a monthly attestation, which he compared to disguising insolvency with a temporary cash injection▶ 1:28:36▶ 1:29:05.

• Allen cited research (Ewens et al.) finding companies manage float downward to avoid the $75 million and $700 million filer thresholds, sacrificing about $132,000/1.3% of market cap and $900,000/1.2% of market cap respectively by shifting toward debt financing▶ 1:44:50▶ 1:45:19.

• Coates noted 10–20% of public companies report material weaknesses in internal controls, some repeatedly, showing companies do exercise discretion not to follow every auditor recommendation▶ 1:17:58.

• Cunningham said research after the SEC's 2020 expansion of 404(b) exemptions found no decline in reporting quality or control strength among newly exempted firms▶ 1:55:44.

• Sherman noted Sarbanes-Oxley passed 423-3 in the House and 99-0 in the Senate, and estimated Enron and WorldCom losses at over $200 billion, arguing the resulting loss of market confidence cost the country even more▶ 0:23:14▶ 0:24:04.

Metadata

CommitteeHouse Financial Services Subcommittee on Capital Markets
Chamber / CongressHouse · 119th Congress
DateJune 25, 2025
TypeHearing
Witnesses
Dr. Abigail Allen — Associate Professor of Accounting, Marriott School of Business, Brigham Young University
Mr. John Coates — Professor of Law and Economics, and Deputy Dean, Harvard Law School
Mr. Lawrence Cunningham — Director, Weinberg Center for Corporate Governance, University of Delaware
Mr. Frank Watanabe — President and Chief Executive Officer, Arcutis Biotherapeutics
Videoyoutube
Transcript267 caption blocks · 18,349 words · 2:13:47 runtime
EventCongress.gov 118419