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

1[House Hearing, 119 Congress]2[From the U.S. Government Publishing Office]34                 REASSESSING SARBANES-OXLEY: THE COST OF5                  COMPLIANCE IN TODAY'S CAPITAL MARKETS67=======================================================================89                                HEARING1011                               BEFORE THE1213                    SUBCOMMITTEE ON CAPITAL MARKETS1415                                 OF THE1617                    COMMITTEE ON FINANCIAL SERVICES1819                     U.S. HOUSE OF REPRESENTATIVES2021                    ONE HUNDRED NINETEENTH CONGRESS2223                             FIRST SESSION2425                               __________2627                             JUNE 25, 20252829                               __________3031                           Serial No. 119-313233       Printed for the use of the Committee on Financial Services3435[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]3637                            www.govinfo.gov3839                                __________4041                   U.S. GOVERNMENT PUBLISHING OFFICE4260-990 PDF                  WASHINGTON : 20254344-----------------------------------------------------------------------------------4546                 HOUSE COMMITTEE ON FINANCIAL SERVICES4748                    FRENCH HILL, Arkansas, Chairman4950BILL HUIZENGA, Michigan, Vice        MAXINE WATERS, California, Ranking51    Chairman                             Member52FRANK D. LUCAS, Oklahoma             SYLVIA R. GARCIA, Texas, Vice53PETE SESSIONS, Texas                     Ranking Member54ANN WAGNER, Missouri                 NYDIA M. VELAZQUEZ, New York55ANDY BARR, Kentucky                  BRAD SHERMAN, California56ROGER WILLIAMS, Texas                GREGORY W. MEEKS, New York57TOM EMMER, Minnesota                 DAVID SCOTT, Georgia58BARRY LOUDERMILK, Georgia            STEPHEN F. LYNCH, Massachusetts59WARREN DAVIDSON, Ohio                AL GREEN, Texas60JOHN W. ROSE, Tennessee              EMANUEL CLEAVER, Missouri61BRYAN STEIL, Wisconsin               JAMES A. HIMES, Connecticut62WILLIAM R. TIMMONS, IV, South        BILL FOSTER, Illinois63    Carolina                         JOYCE BEATTY, Ohio64MARLIN STUTZMAN, Indiana             JUAN VARGAS, California65RALPH NORMAN, South Carolina         JOSH GOTTHEIMER, New Jersey66DANIEL MEUSER, Pennsylvania          VICENTE GONZALEZ, Texas67YOUNG KIM, California                SEAN CASTEN, Illinois68BYRON DONALDS, Florida               AYANNA PRESSLEY, Massachusetts69ANDREW R. GARBARINO, New York        RASHIDA TLAIB, Michigan70SCOTT FITZGERALD, Wisconsin          RITCHIE TORRES, New York71MIKE FLOOD, Nebraska                 NIKEMA WILLIAMS, Georgia72MICHAEL LAWLER, New York             BRITTANY PETTERSEN, Colorado73MONICA DE LA CRUZ, Texas             CLEO FIELDS, Louisiana74ANDREW OGLES, Tennessee              JANELLE BYNUM, Oregon75ZACHARY NUNN, Iowa                   SAM LICCARDO, California76LISA McCLAIN, Michigan77MARIA SALAZAR, Florida78TROY DOWNING, Montana79MIKE HARIDOPOLOS, Florida80TIM MOORE, North Carolina8182                      Ben Johnson, Staff Director8384                                 ------8586                    SUBCOMMITTEE ON CAPITAL MARKETS8788                     ANN WAGNER, Missouri, Chairman8990ANDREW R. GARBARINO, New York,       BRAD SHERMAN, California,91    Vice Chairman                        Ranking Member92FRANK D. LUCAS, Oklahoma             DAVID SCOTT, Georgia93PETE SESSIONS, Texas                 GREGORY W. MEEKS, New York94WARREN DAVIDSON, Ohio                JUAN VARGAS, California95BRYAN STEIL, Wisconsin               JOSH GOTTHEIMER, New Jersey96MARLIN STUTZMAN, Indiana             VICENTE GONZALEZ, Texas97MICHAEL LAWLER, New York             SEAN CASTEN, Illinois98ANDREW OGLES, Tennessee              EMANUEL CLEAVER II, Missouri99ZACHARY NUNN, Iowa                   STEPHEN F. LYNCH, Massachusetts100LISA McCLAIN, Michigan               CLEO FIELDS, Louisiana101MARIA SALAZAR, Florida               JANELLE BYNUM, Oregon102TROY DOWNING, Montana103MIKE HARIDOPOLOS, Florida104105                        C  O  N  T  E  N  T  S106107                              ----------108109                        Wednesday, June 25, 2025110                           OPENING STATEMENTS111112                                                                   Page113Hon. Ann Wagner, Chairwoman of the Subcommittee on Capital114  Markets, a U.S. Representative from Missouri...................     1115Hon. Brad Sherman, Ranking Member of the Subcommittee on Capital116  Markets, a U.S. Representative from California.................     2117118                               STATEMENTS119120Hon. French Hill, Chairman of the Committee on Financial121  Services, a U.S. Representative from Arkansas..................     3122Hon. Maxine Waters, Ranking Member of the Committee on Financial123  Services, a U.S. Representative from California................     4124125                               WITNESSES126127Dr. Abigail Allen, Associate Professor of Accounting, Marriott128  School of Business, Brigham Young University...................     4129    Prepared Statement...........................................     7130Mr. Lawrence Cunningham, Director, Weinberg Center for Corporate131  Governance, University of Delaware.............................    21132    Prepared Statement...........................................    23133Mr. Frank Watanabe, President and Chief Executive Officer,134  Arcutis Biotherapeutics........................................    53135    Prepared Statement...........................................    55136Mr. John Coates, Professor of Law and Economics, and Deputy Dean,137  Harvard Law School.............................................    61138    Prepared Statement...........................................    63139140                                APPENDIX141142              ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD143144Hon. Warren Davidson:145    National Association of Manufactures (NAM)...................   102146Hon. Marlin Stutzman:147    American Securities Association (ASA)........................   108148Hon. Mike Haridopolos:149    Society for Corporated Governance............................   111150151                 RESPONSES TO QUESTIONS FOR THE RECORD152153Written responses to questions for the record from Representative154  Maxine Waters155    Dr. Abigail Allen............................................   119156    Mr. Lawrence Cunningham......................................   122157    Mr. Frank Watanabe...........................................   123158    Mr. John Coates..............................................   124159160                              LEGISLATION161162H.R. ------, a bill to require the Securities and Exchange163  Commission to revise certain thresholds related to smaller164  reporting companies, accelerated filers, and large accelerated165  filers.........................................................   125166H.R. ------, a bill to require auditor independence standards of167  the Public Company Accounting Oversight Board and the168  Securities and Exchange Commission applicable to past audits of169  a company occurring before it was a public company to treat an170  auditor as independent if the auditor meets established171  professional standards.........................................   129172173                      REASSESSING SARBANES-OXLEY:174           THE COST OF COMPLIANCE IN TODAY'S CAPITAL MARKETS175176                              ----------177178                        Wednesday, June 25, 2025179180             U.S. House of Representatives,181                   Subcommittee on Capital Markets,182                           Committee on Financial Services,183                                                    Washington, DC.184185    The subcommittee met, pursuant to notice, at 10:05 a.m., in1862128, Rayburn House Office Building, Hon. Ann Wagner187[chairwoman of the subcommittee] presiding.188    Present: Representatives Wagner, Hill, Lucas, Sessions,189Davidson, Steil, Stutzman, Lawler, Downing, Haridopolos,190Sherman, Waters, Scott, Vargas, Casten, Lynch, Fields, and191Bynum.192    Chairwoman Wagner. Good morning. The Subcommittee on193Capital Markets will come to order.194    Without objection, the chair is authorized to declare a195recess of the committee at any time.196    This hearing is titled, ``Reassessing Sarbanes-Oxley: The197Cost of Compliance in Today's Capital Markets.''198    Without objection, all members will have 5 legislative days199within which to submit extraneous materials to the chair for200inclusion in the record.201    I now recognize myself for 4 minutes for an opening202statement.203204    OPENING STATEMENT OF HON. ANN WAGNER, CHAIRWOMAN OF THE205  SUBCOMMITTEE ON CAPITAL MARKETS, A U.S. REPRESENTATIVE FROM206                            MISSOURI207208    Good morning again and thank you to our witnesses for being209here today. Today's hearing is about making our public markets210work again for the companies that fuel our economy, small,211innovative firms that want to grow higher and bring new212products to market. We are here to examine whether parts of the213Sarbanes-Oxley Act, particularly Section 404, are doing more to214burden those companies than to protect investors.215    When Sarbanes-Oxley, or SOX, was passed in 2002, it had a216clear purpose: to restore trust in financial reporting after217several major corporate scandals, but more than 2 decades218later, it is time to ask whether its most burdensome provisions219are still serving investors or merely discouraging companies220from ever going public in the first place. For many small221companies, Section 404(b) has become a major obstacle. It222requires companies not only to assess their own internal223financial controls, but also to pay for an external auditor to224effectively repeat that process. That is why many refer to it225as a ``double audit.'' The costs can exceed $1 million per226year, and even for pre-revenue biotech firms and small cap227innovators, these costs do not scale. Again, they do not scale.228Whether a company generates $50 million or $5 billion, the229compliance checklist is largely the same. For a large company,230that may be manageable, but for a startup, it is often the231difference between expanding operations or laying off staff.232    Compliance costs have not gone down over time. In fact,233recent surveys show costs are rising, driving more hours, more234documentation, and broader audit scopes. At the end of the day,235Main Street investors are footing the bill, whether it is236through reduced returns, fewer initial public offerings (IPOs),237or the lost chance to invest early in the next great American238company. Meanwhile, the benefits are unclear. Internal control239weaknesses remain stubbornly high. Many firms only disclose240problems after issuing financial restatements. That is not a241sign of a healthy system. We have also heard from companies242that structure their growth, fundraising, and even equity float243to avoid triggering 404(b). That is an indictment of the rule's244real-world impact.245    Capital formation should not be driven by how to avoid a246duplicative audit. A regulatory framework that deters companies247from entering the public markets does not strengthen investors'248confidence. It weakens long-term economic competitiveness. To249be clear, this is not about undermining investor protection. It250is about ensuring those protections are effective and251proportionate. Congress and the Securities Exchange Commission252(SEC) have taken steps to tailor SOX obligations for emerging-253growth companies and smaller reporting companies, but the254current framework remains overly complex and poorly suited to255today's economy, especially for firms that are asset light, IP256driven, and increasingly global in structure. Today's hearing257is an opportunity to hear directly from the people who live258these rules every day. Our job is to ensure that the path to259becoming a public company is not paved with unnecessary260barriers. Public markets should be open to companies of all261sizes, not just those that can afford to navigate an outdated262compliance regime.263    I would now like to recognize my friend, the ranking member264of the subcommittee, Mr. Sherman, for 4 minutes for an opening265statement.266267 OPENING STATEMENT OF HON. BRAD SHERMAN, RANKING MEMBER OF THE268  SUBCOMMITTEE ON CAPITAL MARKETS, A U.S. REPRESENTATIVE FROM269                           CALIFORNIA270271    Mr. Sherman. Thank you. I believe I am the only one here272who is here for----273    Voice. Mr. Lucas.274    Mr. Sherman. Oh, and then Mr. Lucas was also here for275Sarbanes-Oxley.276    Mr. Lucas. I was here.277    Mr. Sherman. And you were here.278    Mr. Lucas. Yes.279    Mr. Sherman. I am not as old as I think I am. A few of us280were here for Sarbanes-Oxley. We remember WorldCom. We remember281Enron and the need for a Public Company Accounting Oversight282Board (PCAOB). Even more of us were here for Madoff and the283need to apply the PCAOB to broker dealers. We then reformed the284PCAOB by making sure that China and Chinese-based companies285would be subject to it. That was my bill along with Senator286Kennedy, and then we accelerated that process with a separate287bill. Then the most recent development was this committee288voting to defund the PCAOB, transfer it to the SEC, and not289give the SEC any funding or ability to charge fees in order to290carry out the functions of the PCAOB. I want to thank the most291powerful unknown person in Washington, Elizabeth MacDonough,292the Senate parliamentarian, for striking that provision. We293should not defund the police in the streets, and we should not294defund the police in the suites. That includes the Consumer295Financial Protection Bureau (CFPB), and it includes the PCAOB.296    The bills that we are considering today include one that297would allow auditing firms not to register with the PCAOB but298instead, simply meet the standards of the Intergrated Council299of Professional Accountants (ICPA). The ICPA was not consulted,300the Certified Public Accountants (CPA) caucus was not301consulted, and the only standards that would apply to auditing302firms were those meeting independence, not those dealing with303their competence and breadth of experience for the audit that304they were attempting to do. A second bill raises the dollar305floor on which companies would be exempt and not have to have306reports or as many reports on their internal controls. This307makes some sense because we have not adjusted that figure, I308believe, since Sarbanes-Oxley. So, if the policy was right309then, the dollar amount has to be changed now because $250310million then is very different from $250 million now.311    So, I look forward to these hearings and working on these312bills. As I said, I think the last time we were all in this313room, the most fascinating issues that really the entire314country faces are those dealing with auditing and accounting,315and they are also the most important issues. So, Sarbanes-Oxley316was passed virtually unanimously. We need internal control. We317need auditors to audit the internal control, and we need PCAOB318to audit the auditors. While this process may be expensive,319what is more expensive? An Enron or a WorldCom or both, pretty320much at the same time. I think the losses to investors between321the two of those were well over $200 billion, but it is not322just that. The loss of confidence in our capital markets cost323this country even more than the $200 billion to $250 billion324lost on those two stocks. I yield back.325    Chairwoman Wagner. I now recognize the chairman of the full326committee, Mr. Hill, for 1 minute for an opening statement.327328  STATEMENT OF HON. FRENCH HILL, CHAIRMAN OF THE COMMITTEE ON329    FINANCIAL SERVICES, A U.S. REPRESENTATIVE FROM ARKANSAS330331    Mr. Hill. Thank you, Chair Wagner. I appreciate you holding332this hearing. Today we examine the long-term regulatory impact333of Sarbanes-Oxley Act of 2002, and while my colleagues may have334been here voting for this bill, some of us were in the private335sector living under it for the past 20 years. I can tell you336our perspectives are quite different, even though we share an337important point of agreement, which is we want investors338protected, and we want managements and public companies held339accountable, and we want high-quality audit standards, but all340that is subject to now looking back 20 years, which is why I341think Chair Wagner has done an excellent job in having this342hearing.343    Implementation of the law, particularly under Section344404(b), is something that is the most expensive feature in our345public securities rulebook. Reports show these companies are346spending over $1 million a year purely on SOX compliance. So,347the fact that we want to take a look at these issues and think348through them, I commend the chairwoman, and I yield back the349balance of my time.350    Chairwoman Wagner. The gentleman yields back. The chair now351recognizes the ranking member of the full committee, Ms.352Waters, for 1 minute for an opening statement.353354    STATEMENT OF HON. MAXINE WATERS, RANKING MEMBER OF THE355  COMMITTEE ON FINANCIAL SERVICES, A U.S. REPRESENTATIVE FROM356                           CALIFORNIA357358    Ms. Waters. Thank you very much, Chairwoman Wagner. I am359pleased that we are holding a hearing to commemorate the360Sarbanes-Oxley Act. However, it would have been more meaningful361if we could have had this hearing convened before today. Let me362just say that the Sarbanes-Oxley Act is the crown jewel of the363Public Company Accounting Oversight Board. I have to ask, will364what you are doing with this legislation, would it enable365paying for a tax cut for billionaires?366    Perhaps I can remind you that if you had held this hearing367beforehand, you would have realized that the PCAOB is the only368regulator that has access to auditors and large public369companies in China. Maybe we need to have you think more about370realizing that shutting this regulator down does not just hurt371U.S. investors, but it helps the Chinese Communist Party.372Hopefully, my Republican colleagues are now paying attention.373Thank you very much. I yield back.374    Chairwoman Wagner. The gentlewoman yields back. Today we375welcome the testimony of Dr. Abigail Allen, Associate Professor376of Accounting at the Marriott School of Business at Brigham377Young University; and then Mr. Lawrence Cunningham, Director of378the Weinberg Center for Corporate Governance at the University379of Delaware; Mr. Frank Watanabe, President and CEO of Arcutis;380and then Mr. John Coates, a Professor of Law and Economics and381Deputy Dean of the Harvard Law School. We thank each of you for382you taking the time to be here. Each of you will be recognized383for 5 minutes to give an oral presentation of your testimony,384and without objection, your written statements will be made385part of the record. Dr. Allen, you are now recognized for 5386minutes for your oral statements.387388    STATEMENT OF DR. ABIGAIL ALLEN, ASSOCIATE PROFESSOR OF389    ACCOUNTING, MARRIOTT SCHOOL OF BUSINESS, BRIGHAM YOUNG390                           UNIVERSITY391392    Dr. Allen. Thank you. Chairwoman Wagner, Vice Chairman393Garbarino, Ranking Member Sherman, and members of the394subcommittee, thank you for the opportunity to be here to395testify. As mentioned, I am an Associate Professor at Brigham396Young University. I hold a CPA and also a doctorate in business397administration. I am here on behalf of myself as well as my co-398authors, Melissa Lewis-Western and Kristen Valentine, to399testify about the findings from a recent research study that we400conducted examining the costs and benefits of Sarbanes-Oxley,401and, in particular, Section 404, which deals with the audit of402internal controls.403    We appreciate the subcommittee's interest in reexamining404SOX in today's capital markets, as well as recent initiatives405like the 2012 Jumpstart Our Business Startups (JOBS) Act and406recent SEC carveouts, which acknowledge that the costs of SOX407are not borne equally across all firms. A common thread across408regulatory exemptions so far is a size-based litmus test, which409recognizes that the direct costs associated with compliance may410be overly heavy for small issuers. Our research also speaks to411the existence of indirect costs, which manifest for firms of412both small and large sizes, so our research focuses on a group413of firms that we refer to as young lifecycle-stage firms. These414are firms that can be large and high growth but are early in415their development as they explore strategic entry into new416products or new markets. They invest heavily in research and417development (R&D), are not yet profitable from a cash-flow418perspective and play a critical role in driving economic growth419through exploratory innovation.420    Our research suggests that SOX 404(b) had negative421consequences for innovation for these firms. Specifically, we422find that SOX negatively impacts both the quantity and quality423of innovation produced by young lifecycle-stage firms. These424firms spend less on R&D, produce fewer patents with lower425citation counts. We also find that SOX has negative426consequences for the type of research being conducted.427Following SOX, young lifecycle firms shift their research428pursuits toward safer, less groundbreaking innovation. The429patents that they produce are narrower in scope and less likely430to lead to future technological advances. Why is that?431    Our research identifies two mechanisms through which SOX432can harm innovation. The first is resource diversion. Young433firms, like small firms, are cash constrained. Every dollar or434hour spent on compliance is a dollar or hour not spent on435innovation. This same logic, which applies to small firms, is436the rationale that motivates current size-based exemptions. The437second mechanism is called innovation hindrance. We know SOX438imposes centralized control structures, and we believe that439sometimes those structures are at odds with the decentralized,440flexible environments needed for exploratory innovation. This441type of mismatch can stifle the type of risk-taking and442creativity that drives breakthrough discoveries for young443lifecycle-stage firms.444    Importantly, while we document these negative consequences445for innovation, we are unable to detect any evidence that the446costs are offset by the intended benefits of SOX for these447young lifecycle-stage firms. While we do see improvements in448financial reporting quality for mature firms consistent with449prior literature, we find no evidence that SOX improves450financial reporting quality for this subset of young lifecycle-451stage firms, no reductions in restatements, no improvements in452accrual quality, no gains in future performance. Why? We453theorize that these intended benefits do not materialize for454young lifecycle-stage firms because their limited free cash-455flow and more concentrated ownership structures lessen the type456of agency concerns that financial reporting oversight is457intended to mitigate.458    Putting these findings together, a clear takeaway from our459research is that the impacts of SOX on financial reporting460quality and innovation is not uniform. Instead, it varies based461on firm-specific characteristics that, in addition to size, may462include factors like firm lifecycle-stage and strategic463orientation. Accordingly, we advise that any policy solution464must involve a complex consideration of both direct and465indirect costs against the offsetting benefits by firm type. We466also advise that the costs and benefits do not always manifest467in the same time period. Like insurance, a regulatory approach468that leans toward prevention will necessarily impose heavier469costs today in exchange for some presumed security surrounding470future financial reporting outcomes. By contrast, relaxing471regulations alleviate current cost burdens while increasing472future risk associated with remediation.473    Our results highlight that the goals of innovation and474economic development are not always in contrast, but when they475are, policy-based evidence is essential. Thank you for your476time.477478    [The prepared statement of Dr. Allen follows:]479   [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]480481    Chairwoman Wagner. Thank you. Mr. Cunningham, you are now482recognized for 5 minutes for your oral statement.483484STATEMENT OF MR. LAWRENCE CUNNINGHAM, DIRECTOR, WEINBERG CENTER485        FOR CORPORATE GOVERNANCE, UNIVERSITY OF DELAWARE486487    Mr. Cunningham. Chair Wagner, Ranking Member Sherman,488committee members, thank you for the opportunity to testify489today. It is an honor to be here. I am Lawrence Cunningham,490Director of the John L. Weinberg Center for Corporate491Governance at the University of Delaware. I have been writing492about Sarbanes-Oxley--SOX--since its inception and ever since,493carving a niche in the legal academy at the intersection494between law and accounting. SOX was an effective congressional495response to several massive frauds. It restored investor496confidence at a critical time and helped deter earnings497manipulation, but over time, it became clear that SOX missed498its mark in important ways, channeling excessive resources into499internal controls at the expense of financial reporting.500    Let me stress this core insight. Compliance is not the same501as accuracy. A company can have strong internal controls and502still misreport its financials or weak controls and report503accurately. Yet, SOX treats internal controls as equivalent to504financial reporting, as if they are the goal rather than the505means. Over 2 decades, SOX has fostered a sprawling compliance506industry where controls proliferate, and auditability of507controls becomes more important than utility. The system often508prizes procedural auditing checklists over substantive509accounting judgments. That is why, despite SOX, financial510restatements persist, including recently at marquee companies511like CSX, Archer Daniels Midland, and Macy's. Last year saw the512most reissued financials in many years, and over the past513decade, internal control reports flagged fewer than a quarter514of the issues in advance. They have become postmortems, not515early warnings.516    The costs are real. SOX imposes fixed costs that hit small517firms the hardest. The average is $1.5 million per year, with a518quarter of companies paying more than $2 million. For small519firms, from biotech companies to regional banks, that is money520not invested in R&D, employee hiring, training, growth, and521other important business matters, and the impact on capital522markets is pretty clear, too. SOX contributed to a sharp drop523in the number of public companies, from 6,500 or so back then524to around 4,000 today, even as the number of large private525companies has grown dramatically. Nordstrom and Walgreens are526just two of the companies recently indicating they prefer to be527private than public, underscoring the costs. Investor528perspectives are divided. Many investors believe that the529external audit of internal controls adds little or no value.530That is especially true of the long-term focused investors who531prefer to do their own analysis. On the other hand, some532support the audit of internal control, especially the index533fund community that does not conduct firm-specific analysis,534but that division underscores the need for flexibility in this535area.536    Congress has modernized every other major securities law.537SOX deserves the same reassessment and reform. The reform538should focus on three things: first, to reinforce the primacy539of financial statement reporting over internal control; second,540focus audit standards on judgment and substance, not process541and system; and third, tailor compliance to risk. Let us542reaffirm that the North star of our capital markets is accurate543financial reporting, not well-documented internal controls. The544two pending bills are a good step in that direction.545    Thank you. I look forward to your questions.546547    [The prepared statement of Mr. Cunningham follows:]548   [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]549550    Chairwoman Wagner. Mr. Watanabe, you are now recognized for5515 minutes for your oral statement.552553STATEMENT OF MR. FRANK WATANABE, PRESIDENT AND CHIEF EXECUTIVE554                OFFICER, ARCUTIS BIOTHERAPEUTICS555556    Mr. Watanabe. Chair Wagner, Ranking Member Sherman, and557distinguished members of the subcommittee, thank you for the558opportunity to testify today. My name is Frank Watanabe, and I559am the President and CEO of Arcutis Biotherapeutics, a public560biopharmaceutical company based in California. I am also the561Vice Chairman of Bio, which represents over 1,200 growth-stage562biotechs that are driving the search for the next generation of563breakthrough medicines.564    Arcutis is a young biotechnology company that develops565innovative treatments for serious skin diseases like psoriasis566and eczema. We were founded in 2016 and went public in January5672020. We received our first Food and Drug Administration (FDA)568approval in July 2022, have since received FDA approval for two569additional treatments, and we continue to invest in our570portfolio of innovative drug candidates. Since inception, we571have invested about $1.4 billion in developing our products and572have grown from 3 employees to 350, with operations in all 50573States and employees in 39, but we have yet to turn a profit,574let alone recoup our massive investments in R&D.575    I would like to share some of the challenges that Arcutis576faces due to Section 404(b) of the Sarbanes-Oxley Act. While I577fully support regulation, it needs to be smart regulation that578accounts for a company's size and the cost of compliance. I579believe it is unreasonable and wasteful to impose the same580compliance requirements on a 350-person biotech with revenues581below $200 million as those for an 80,000-person company with582$60 billion in revenues as the law currently requires.583    We first experienced the overwhelming burden of 404(b) in5842021 when, although we had not generated any sales and we had585just gone public the prior year; we became subject to 404(b)586when our market cap exceeded $700 million. Two years later, we587rolled off of 404(b) when our public float dipped below $700588million, but we could not scale back our costly compliance589systems knowing that we would likely need to meet the590requirements again, which happened in 2024 when our public591float, again, exceeded the 404(b) thresholds. To date, we have592spent around $11 million on compliance with 404(b), and those593are costs that are rising inexorably. For example, last year594alone, our auditor fees were increased by 24 percent. Our595switch to 404(b) roughly doubled our auditor fees, and as a596small firm, we had to bring in outside control and compliance597resources that cost us about half a million dollars a year.598    The money we spend on unnecessary compliance is money that599we do not have to invest in developing life-altering drugs. I600understand the reason for enhanced controls required by SOX. I601am old enough to remember those abuses. We all remember, I602think, the egregious business abuses that led to the passage of603this legislation, but the current thresholds for 404(b) are too604low, and Congress and the SEC should take steps to adjust those605thresholds. We are grateful to Congress and the SEC for their606previous efforts to reduce the burdens of 404(b) on small607businesses, but there is still more work to be done.608    Congress can take commonsense steps to reduce the burden of609404(b) on small companies, for example, by adjusting the public610float and revenue thresholds as you are considering. It might611also amend the 2020 exemption so that companies are exempt if612they qualify as SRCs or report revenues of less than $250613million. These changes would reflect the fact that many614companies are still small businesses despite having high market615capitalizations. Another smart reform might be to use soft616triggers for the public float threshold, measuring float over617an averaging period of, say, 12 months rather than a single618point in time, as is now. I also applaud the proposal that619implements a 3-year rolling average threshold for revenue620instead of a 1-year snapshot.621    Congress should also consider revising the definitions of622accelerated and large accelerated filers to better account for623low-revenue companies with high valuations, and you might624consider establishing a new intermediate tier of filers,625helping to ensure that low-revenue innovators like Arcutis are626not subject to the same burdensome compliance requirements as627mature, highly profitable multinational corporations. Revising628the timelines for emerging-company growth status, for instance,629by extending EGC from 5 to 10 years post-IPO and raising the630public float threshold, would better account for the long631development timelines typical in the biotech sector and offer632immense release to smaller companies.633    While it is not the major focus of the hearing today; I634also want to applaud you for your recent hearings on635institutional proxy advisory firms. We have suffered struggles636with them, and I think it is high time that Congress reformed637that sector. Congress has a critical opportunity to support638American innovation and competitiveness by modernizing 404(b).639Small companies, like Arcutis, are critical to U.S. biotech and640the U.S. economy, but we cannot thrive if precious capital is641consumed by regulatory requirements of little practical642benefit.643    Thank you again for inviting me today, and I look forward644to the committee's questions.645646    [The prepared statement of Mr. Watanabe follows:]647    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]648649    Chairwoman Wagner. Thank you. Mr. Coates, you are now650recognized for 5 minutes for your oral statement.651652 STATEMENT OF MR. JOHN COATES, PROFESSOR OF LAW AND ECONOMICS,653              AND DEPUTY DEAN, HARVARD LAW SCHOOL654655    Mr. Coates. Chair Wagner, Ranking Member Sherman, Ranking656Member Waters, Chair Hill, thank you, members, for the657opportunity to speak here. The last time I testified before you658was during coronavirus disease (COVID), so I did not get to be659in this nice room. Good to be here in person.660    I am going to quickly go through a few themes that I think661provide some counterpoints to what you have heard so far.662First, SOX--I just want to make sure everybody has this right--663is a disclosure law. It does not actually require a company to664do anything different than its management believes is correct665or controls. It can report publicly that it disagrees with its666auditor as to some of those judgments, and many companies do.667So, Frank, you might want to talk to your lawyers if they are668telling you you have to follow the auditor's directions about669your controls, even when you think the costs outweigh the670benefits. You do not have to.671    The disclosure elements of this law make it a less costly672law than some of the alternatives. Other countries, in some673places, actually directly specify the kinds of controls674companies have. We do not in this country. We rely on companies675in the first instance and then disclosure so that investors676whose money is being risked with the control systems in677question can judge for themselves how and when to price their678investments in those companies.679    The benefits of the law are clear. Professor Allen's study,680which I commend as a very good study, and she said this in681passing, but I just want to make sure everybody heard it, shows682that most companies--most companies--are subject to 404(b)683benefit. Their financial quality is better as a result, and684even in the period that she was studying, the costs did not685outweigh the benefits. Now, something that was not mentioned so686far is that PCAOB softened 404(b) in 2007, using its discretion687under the law to do so, and I would think the kinds of issues688that have been raised where the 404(b) may not be translated689properly for a given company could be addressed by the PCAOB or690the SEC.691    I will note that under a public administration, nothing692happened 2 terms ago. The PCAOB could have, at that point, made693more modifications. They could have said for an early stage694company with 300 employees, we do not need the auditors to do695quite the testing that they do for Goldman Sachs. The PCAOB was696not, under Republican leadership, willing to take up that697challenge. You can ask the members who ran it back then why. It698could be done today. The SEC is now under Republican699Administration and could take up this challenge directly. The700kinds of things that I heard Frank suggesting earlier, they are701perfectly appropriate things, I think, for the SEC to consider,702but I am not sure that a Federal statute is the right vehicle703for doing the kind of fine-tuning that goes to average versus704point in time, et cetera, because, in fact, we are probably not705going to know in advance what the right calibration is, and it706is the kind of thing you would want the agency to be able to707fine-tune over time. If you block it into a statute--we all708know in this room how hard it is to pass statutes--it is likely709to get outdated fairly quickly. I will note SOX does not do710that. SOX delegates to the PCAOB and the SEC authority to make711changes in how auditors go about their work, and so that could712be done under current authority.713    A few other things. Many companies choose, even though not714required, to comply with 404(b) today. There are many private715companies who have voluntarily done this. There are many716companies that float bonds when they could float leveraged717loans and be able to get out of 404(b), but they choose not to.718That suggests that the debate over this issue is not nearly as719clear-cut as it sometimes is presented. Other countries have720followed the United States. Most countries now have the721equivalent of SOX, so it is not the case that the United States722is some outlier in this respect.723    Last thing I would say about the proposals is that you724really need to think hard about the risk that a statutory725change will open the door again to the kinds of bad reporting726that went on leading up to the passage of SOX. Chair Hill's727family's bank, when it was bought by a public company, was728bought by a public company bank subject to SOX. They paid about729$5 million for a total audit, including 404(b), in the year of730that deal. I believe the stock that was paid as part of the731consideration of that deal was more accurately priced and732reliable as a result of Sarbanes-Oxley and that the deal might733have been a little bit more fraught if there had been the kind734of accounting that went on in the 1990s present at the time of735that deal.736    Thank you. I will stop here.737738    [The prepared statement of Mr. Coates follows:]739   [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]740741    Chairwoman Wagner. Now I will turn to member questions, and742I recognize myself for 5 minutes for questioning.743    Mr. Watanabe, experts have argued that the benefits of744requiring an external audit testing to internal controls under745Section 404(b) are outweighed by the annual costs for early746stage or biotech companies which can amount to over $800,000.747In your case, you cited much higher. Can you discuss your748experience in running Arcutis Biotherapeutics, a small public749biotech firm, and whether the funds spent on Section 404(b)750compliance had to be reallocated from, let us say, R&D and751product development and other things?752    Mr. Watanabe. Yes, thank you for the question, Chairwoman.753Yes, it has been a significant expense for our company. Our754audit fees alone last year were $2.2 million. We still are in755the middle of this year. I would estimate we will probably be756in the range of $2.5 million plus this year just for our audit757fees. In addition to, as I mentioned, I think, before, we are758spending about $500,000 a year for support for our compliance759program to meet the standards that are imposed on us by our760auditors, and that is money that has to come out of R&D. That761is the variable cost in a biotech company like ours, and so we762are not investing that money in developing the next generation763of cures. I would also say that our audit fees about doubled764when we went from 404(a) to 404(b) just given the complexity of765the audit that the auditors required.766    Chairwoman Wagner. Thank you. Dr. Allen, according to your767research, young lifecycle firms experience a significant768decline in innovation after becoming subject to SOX. Your769findings estimated declines between 9 and 12 percent in R&D770intensity and 6 percent decline in patent filings for young771lifecycle firms relative to pre-SOX levels. In addition to the772decline in the level of innovative activities, your research773also found that post-SOX young lifecycle firms pursued less774valuable patents. I found that interesting. Can you discuss how775SOX implementation forces young lifecycle firms to alter their776innovation process?777    Dr. Allen. Certainly. I would say that the idea here is778that in addition to diverting direct resources, spending on779research and development, or time spent on research and780development, the centralized control formalization of781processes, and reduced flexibility that often accompanies the782implementation of internal controls can be at odds or783mismatched with the decentralized flexible risk-taking784environments in which exploratory innovation thrive. So, I will785just put a sub-point there, two types of innovation:786exploratory innovation, which is strategically oriented toward787new markets, new products, has a high probability of failure,788and exploitative innovation, which actually takes incremental789steps using existing processes and knowledge. While790exploitative innovation conducted by more mature firms might791actually benefit from more centralized controls processes, the792exploratory innovation that young lifecycle-stage firms are793engaging in is often mismatched with the control environment794imposed by SOX and that is where we think the difference comes795from.796    Chairwoman Wagner. Thank you. Mr. Cunningham, despite the797costs and disruptions to innovation processes due to SOX798compliance, research suggests that young firms do not799experience compensating benefits, such as substantial800improvements in financial reporting quality, to offset these801challenges. Can you discuss how the incremental improvement in802quality achieved through SOX compliance might not be as803significant for smaller issuers compared to complex,804multinational corporations?805    Mr. Cunningham. Yes. It is very important to appreciate806that when an auditor conducts an audit of the financial807statements, it is required to test the internal controls and808assess the controlled environment. So, that is an activity that809is part of the regular financial audit, and for relatively810simple firms, low-revenue firms, early stage firms, that is811sufficient, and you are not going to get a big bang, a big812incremental gain if you then say the auditor also has to give a813certification and attestation, a full audit of the entire814control environment.815    Chairwoman Wagner. Thank you. Mr. Cunningham, many816companies cite SOX as a factor in their decision to go or817remain private, including in the recent cases of Nordstrom,818Staples, Twitter, now X, and Walgreens. If large, established819companies with robust resources find SOX compliance burdensome820enough to consider privatization, this begs the question, how821are smaller public companies supposed to cope? I am out of822time. I will let you respond in writing if that is all right.823    Mr. Cunningham. Yes, fine.824825    [The information referred to was not submitted prior to826printing.]827828    Chairwoman Wagner. Next, the chair will recognize the829gentleman from Georgia, Mr. Scott, for 5 minutes for830questioning.831    Mr. Scott. Thank you very much. Twenty two years ago, when832I first was appointed to this committee, I served with one833Barney Frank and worked closely with Barney on this bill. I834want to point out at the outset that my Republican friends are835unilaterally disarming the United States against China and836cutting our regulators' access to audit firms, exposing working837families and investors to greater risk. This is so seriously,838and I urge my Republicans, do not destroy this wonderful839mechanism, this bill that gives the American public protection840against China.841    Mr. Coates, if foreign-based auditors can operate with no842oversight, will this not create an unfair competitive advantage843for companies using those firms?844    Mr. Coates. Yes, sir, it would, and it would return us to845the period before this body passed the bill that led the PCAOB846to negotiate the memorandum with the People's Republic of847China, during which China companies defrauded U.S. investors848with a greater propensity and severity than they are doing849today. I will note, too, some have suggested the SEC could take850over that role that the PCAOB has provided. Those memoranda are851with the PCAOB. The People's Republic of China would get to852walk away from them if the attempt was made to transfer853inspection authority to the SEC instead.854    Mr. Scott. Yes, and can you speak a little more about this855uneven playing field and the potential for distorting capital856allocation and market confidence?857    Mr. Coates. You raised a very excellent point that has not858come up yet. The principal driver, I think, for SOX was fraud,859but the biggest benefit it has provided is to improve the860allocation of capital to firms like Mr. Watanabe's. The861precision with which you can price stock depends on the862reliability of the financial statements, which includes the863reliability of controls. One quick word on controls: controls864are kind of basic. Most companies have them, just to be clear.865I am quite sure that your company had controls before it even866ran into SOX. There may be layers of cost added onto them, but867to not have any requirement that anyone check whether the868controls are adequately designed for China-based companies will869tilt the playing field in a way that means that some of the870capital that appropriately should be allocated to U.S.871companies will be misallocated, I believe, to China companies.872    Mr. Scott. Yes. Now, let me make this point, and I think873you touched upon it, but it is very important. Private874enforcement through securities litigation relies on public875disclosures and audit reliability, so if regulators cannot876inspect or investigate audits, will investors not have fewer877tools to pursue legal remedies for fraud or misleading878statements?879    Mr. Coates. I believe you are absolutely right about that,880too. It was said earlier that restatements have continued, and881that is true. Many companies still make mistakes today, but the882incidence of fraudulent misstatements have not risen anywhere883close to the levels that they were before Sarbanes-Oxley. That884is partly because the private litigation and the inspections885together are a more powerful deterrent to fraud.886    Mr. Scott. Now, I want my good Republican friends to887understand this major point. If investors believe that Chinese888or foreign companies are exempt from scrutiny, this will erode889trust in our financial statements of all U.S.-listed companies890with foreign operations or auditors. This is significant. Thank891you.892    Chairwoman Wagner. The gentleman yields back. The chair now893recognizes the gentleman from Arkansas, Mr. Hill, the Chair of894our full Financial Services Committee, for 5 minutes for895questioning.896    Mr. Hill. Thanks, Chair Wagner. Let me thank the panel for897a great testimony. I appreciate it very much. I want, Mr.898Cunningham, to start with you and maybe reflect on Professor899Coates' comment that somehow this is all optional, that if a900company wants to do it, they can do it, but a company does not901have to do it. Could you start out by just giving us your view902on that comment? I thought it was a thoughtful comment. I want903to make sure we are clear on the record about that.904    Mr. Cunningham. Yes, thank you very much. Professor Coates'905assertion is that Sarbanes-Oxley is all about disclosure. It906only requires disclosure. It does not require any substantive907activity. At a high level of theory, there is some truth to908that, but there are some very important practical exceptions.909Just to take an example, the audit committee rules are910mandatory. You have to have independence. Literacy, oversight,911very prescriptive, very substantive, has virtually nothing to912do with disclosure. The SOX audit, the external audit of913internal controls, is required by the statute. The auditor has914to do that work. The auditor has to comply with Auditing915Standard No. 5 of the PCAOB. It has to do certain things. It916has to ask for certain things. It has to get certain responses.917If a company--if John is advising Frank to just ignore what the918auditors are saying, I think as a practical matter that it is919highly unlikely. There is a cooperative need to get the job920done, and so there is enormous pressure from this, so921disclosure only is a very high level of theory. As a practical922matter, it is a quasi-mandatory auditing system.923    Mr. Hill. Yes. I thought that was a good exchange, and I924thought it was helpful to get that in the record because there925are many things that there is a bit of discretion in, but legal926liability costs and abundance of caution err on the size of927spending all the money and dotting every I, even if it is not928totally prescriptively required. Another example of that is the929accredited investor rule for a Reg D private placement. You are930allowed up to 35 non-accredited investors in a Reg D private931placement under the SEC rules, but I do not know anybody whose932lawyer will facilitate that. You have strong external auditor933improvements in SOX. You have strong CFO/CEO attestation in934SOX, and now you have internal control requirements that were935outlined in SOX, including the audit you suggest. So, we have936been doing it for 20 years.937    What about the idea for a less frequent audit required for938even a large filer if they have a good track record and they939have been in full compliance? What about the business judgment940rule? Where is the audit committee in this? Do they not have941some right to outline the scope for their audit? What are your942thoughts on that?943    Mr. Cunningham. Yes, I think you have identified some very944important features of SOX that are often overlooked. The main945culprit behind Enron was a very cooperative auditing firm in946Arthur Andersen. All of those frauds were audited by that same947firm. That same firm went out of business, went bankrupt, is948gone, and is not part of the auditing culture today. So,949Sarbanes-Oxley prohibited public auditing companies from950providing non-audit services to their public audit clients.951That was a huge change, and it is probably more important than952any of these other things, and I do not have any notion that it953is going to be changed. I think that is a very important954change. The audit committee rules are extremely important. I955think audit committees are much more effective, much more956energetic, much more leaning in, and probably can be relied957upon more these days. So, I think the excessive investment of958resources into that internal control audit is really something959that you all ought to focus on. It is, I think, the highest960priority. It has created a culture of excess, and the primary961beneficiaries are those same auditing firms who are no longer962allowed to do non-audit.963    Mr. Hill. Yes, there is no doubt this has been a nice964revenue opportunity for that, but I think if you have the high965standards of the C-suite officers, and the audit committee966independents, and the rotation of the public accounting firm,967and that discipline is put in SOX, then why could not an audit968committee say we are going to do the audit of internal controls969every 3 years instead of annually when it is such a box-970checking exercise? I agree with you; I think audit committees971are substantially improved than when they were in 2002, 2003.972Quoting your pal, Warren Buffett, I mean, he was always arguing973that the compensation committee ought to have a saber-toothed974tiger as the chair, not a pussycat. I think that is true for975auditing firms and auditing committees, and I think that has976been a positive result from Sarbanes, but I think the977compliance costs need to be reviewed. I yield back to the978chair.979    Chairwoman Wagner. The gentleman yields back. The chair now980recognizes the gentlewoman from California, Ms. Waters, who is981also the Ranking Member of our full Financial Services982Committee. You are recognized for 5 minutes for questions,983ma'am.984    Ms. Waters. Thank you very much, Chair Wagner. Professor985Coates, as you know, Republican's so-called Big Beautiful Bill986has a provision that would dismantle the PCAOB and move its987functions under the SEC. The PCAOB is the crown jewel of the988Sarbanes-Oxley Act of 2002, which was passed by Congress in989response to a number of major accounting scandals in the early9902000s. The Republicans have done nothing to increase the SEC's991budget, which seems to be the only way the Commission could992continue the PCAOB's important work. The PCAOB is currently993budget neutral as it funds itself by fees on public companies994and broker-dealers, so the provision would not save taxpayers995any money whatsoever. Furthermore, both the SEC and the PCAOB996have confirmed to my staff, in writing, that the SEC is not a997party to the agreements the PCAOB has in reach with foreign998governments to inspect companies and auditors based in their999jurisdictions.1000    Again, if we are shutting down the PCAOB, the SEC cannot1001inspect auditors in China or in many other foreign1002jurisdictions. Can you talk more about the potential disaster1003dismantling the PCAOB would be for investors and our broader1004financial markets?1005    Mr. Coates. Yes. Thank you, Ranking Member Waters. I am1006glad to hear in this hearing so far, no one on either side is1007proposing to abolish the PCAOB, even though that is what the1008budget bill would have done but for the Senate parliamentarian.1009I assume that it is because of a recognition of the points you1010are asking me about, that abolishing the PCAOB would save no1011money. In fact, I think it would actually increase the burden1012on the taxpayer because the transfer to the SEC would be an1013unplanned, unfunded, disastrous, overnight transfer. The SEC,1014where I worked, I know in Washington, it is actually a small1015Agency, but it is quite big and it has a lot of things to do,1016and for it to suddenly, overnight, take on the role of the1017PCAOB would be quite expensive as a matter of transition and1018certainly even more expensive without any planning. It would1019fail, and the result would be a return to, basically, lack of1020inspections with any kind of meaningful backbone.1021    The American Institute of Certified Public Accountants1022(AICPA), which is a perfectly excellent organization--my uncle1023was a CPA; CPAs are great--AICPA is a good organization, but it1024is not up to, nor was it in the 1990s, up to the task of1025checking the audit standards of the biggest audit firms for1026most public companies. If you abolished the PCAOB, I believe,1027or transferred significant authority to States or to self-1028regulation, you would see a resumption of bad audit practices.1029They would look the other way, not simply at controls, but at1030the basic financial statements that Professor Cunningham has1031emphasized so much, and you would, again, find a resurgence of1032restatements and, ultimately, of fraud.1033    That, by the way, would affect companies that are not1034fraudulent themselves. An important research finding that has1035been repeated several times is that when a company in an1036industry like biotech commits fraud, not only does it lose1037enormously when the fraud is revealed, but other companies in1038the same industry do as well.1039    Ms. Waters. Wow. Furthermore, as I previously mentioned,1040the Sarbanes-Oxley Act--that is, SOX--was enacted in 2002 in1041response to a series of high-profile corporate accounting1042scandals, like Enron and WorldCom, which collectively cost1043investors billions of dollars and eroded public confidence in1044financial markets. Those scandals exposed systemic issues, like1045fraudulent accounting practices, conflicts of interest, and1046inadequate oversight. SOX passed with overwhelming bipartisan1047support, 423 to 3 in the House and 99 to zero in the Senate.1048Nevertheless, Republicans looking to fund a tax cut for1049billionaires have decided to eliminate this Agency without1050convening a single hearing and maybe looking to weaken the rest1051of the law that authorized it.1052    Professor Coates, you do not have time. I would like you to1053talk through some of the key tenets of Sarbanes-Oxley and why1054they have been so beneficial for investors and U.S. economies1055overall. Since we do not have time, we certainly hope that they1056will hold a hearing so that you could be able to talk more1057about why it is so important for us to have an independent1058PCAOB. With that, I yield back the balance of my time. Thank1059you.1060    Chairwoman Wagner. Thank you. The gentlelady yields back.1061The chair now recognizes the gentleman from Oklahoma, Mr.1062Lucas, who is also the Chair of the Task Force on Monetary1063Policy, Treasury Market Resilience, and Economic Prosperity.1064You are recognized, sir, for 5 minutes for questioning.1065    Mr. Lucas. Thank you, Madam Chairwoman, and thank you to1066our witnesses for testifying today.1067    We benefit from the deepest, most liquid capital markets in1068the world, and that is why it is important for us to always1069look at how we can improve access for everyone in the economy,1070so our markets stay strong, resilient and attractive. One of1071the challenges we face today is the prohibitive cost of going1072public: overreaching compliance requirements and reporting1073regulations that discourage companies from entering public1074markets. Dr. Allen, can you talk more about some of the1075disincentives that we should address so our public markets1076remain a viable option for companies to raise capital?1077    Dr. Allen. Thank you, Congressman Lucas. I think it is1078important to recognize that in any discussion of the cost and1079benefits to being public, our research highlights that those1080costs and benefits are not uniform across firms. So, what I1081take away from this hearing today and the bills that were1082proposed is a desire, which I commend, of the committee to1083investigate and think about carefully where the benefits are1084most likely to manifest for what type of firm, and to avoid1085prescribing costly regulation in places where those benefits1086are less likely to manifest and the costs are supposed to be1087higher.1088    In terms of the academic research, to your question on how1089firms enter and perhaps exit public markets, I am aware of an1090excellent academic study by Ewens and co-authors that was1091conducted last year, where they try to quantify the costs of1092being a public firm. They estimate that as a consequence of the1093JOBS Act, for example, which provided regulatory relief,1094roughly 28 more firms per year will go public, so there is1095something certainly to be said for that careful analysis. The1096flip of that, of course, is that there is also academic1097research that suggests, as Professor Coates has testified, that1098there are benefits to investor confidence in the markets that1099may lead to more investment. So, I think careful consideration1100of those complex costs and benefits is warranted.1101    Mr. Lucas. Mr. Watanabe, can continue to speak to your own1102experience about what challenges did you face as your company1103was growing and how can we ensure that our compliance reporting1104regimes are appropriately tailored to the size of business they1105regulate? Can you expand on that some more, please?1106    Mr. Watanabe. Yes, certainly, and I think to Dr. Allen's1107point, the JOBS Act and the lower thresholds for newer1108companies to go public were key to our decision to go public in11092020 and certainly facilitated that process. It is still a1110costly and cumbersome process, but it is a lot less costly and1111cumbersome thanks to the JOBS Act, and, even when we first went1112public, we were not subject to 404(b), right? We were 404(a),1113and there were considerable requirements on us as a 404(a)1114company as well. When we tripped into 404(b) the following year1115because of our market cap, as I mentioned before, there was a1116very significant cost increase associated with that, a doubling1117roughly in our audit fees and the additional cost of having1118compliance resources come in to design the internal control1119systems that were required for us to meet the standards of our1120auditors. That was money that I had to take out of the bank,1121effectively, to take my investors' money to spend on the1122auditors and the compliance resources, and it was money that I1123did not then have to invest in R&D.1124    Mr. Lucas. Mr. Cunningham, you have studied the effects on1125business when Federal regulations are not well suited for1126present challenges. In your view, how can we modernize1127Sarbanes-Oxley in a way that maintains robust financial1128integrity while making our public markets more attractive to1129firms? Can we still protect investors while competing on the1130global stage? I would note I was here for and voted for the1131passage of Sarbanes-Oxley, but even the United States1132Constitution has required occasional adjustments to reflect the1133times. Could you touch on that?1134    Mr. Cunningham. Yes, thank you very much. I think investor1135protection and capital formation are the two objectives, and1136this hearing, I hope, will focus and is focusing on investor1137protection. I think several of the immediate steps that Frank1138has outlined would be very useful and that appear in one of the1139bills. So, raising the 404(b) exemption, and even Ranking1140Member Chairman Sherman has said we need to adjust those things1141for inflation, so that seems obvious. Averaging it over several1142periods would be a good idea, perhaps extending the emerging1143growth company period from 5 to 7 or 9 years, but overall, to1144refocus on the primacy of financial reporting, that is the1145information that investors need. The integrity of internal1146controls is a means to that end, and I think we have lost sight1147of that. So, if you can guide the PCAOB or the SEC to1148recalibrate, I think that would be extremely helpful.1149    Mr. Lucas. Thank you, Madam Chair. My time has expired.1150    Chairwoman Wagner. The gentleman yields back. The chair now1151recognizes the gentleman from California, Mr. Vargas, for 51152minutes for questioning.1153    Mr. Vargas. Thank you very much, Madam Chair. I appreciate1154very much the opportunity and also the ranking member and all1155the witnesses here today. I do not often quote President George1156W. Bush, other than for his malapropism for strategery--I did1157enjoy that one--but I do want to quote him when he signed the1158Sarbanes-Oxley bill in 2002. As the ranking member noted, it1159passed 423 to 3 in the House and 99 to zero in the Senate. He1160said this: ``America's system of free enterprise, with all its1161risks and all its rewards, is a strength of our country and a1162model for the world. Yet free markets are not a jungle in which1163only the unscrupulous survive or a financially free-for-all1164guided only by greed. The fundamentals of a free market1165    --buying and selling, saving and investing--require clear1166rules and confidence in the basic fairness. The only risks--the1167only fair risks--are based on honest information.'' I think1168that is what Sarbanes-Oxley did, and I think what the rules1169here are.1170    Now earlier, Professor Coates, some words were put in your1171mouth that you said that this was optional. Is that what you1172said?1173    Mr. Coates. No, and to be clear, it is not a matter of1174theory that companies can choose not to do everything their1175auditors recommend. Ten to 20 percent of all public companies1176report material weaknesses in their control systems. Some of1177them report them year after year, so this is not just theory,1178this is actually borne out in practice. It is not, to be clear,1179my advice that you just ignore the auditors. That was not what1180I was saying, but, rather, that if they ask you to do something1181that you in your judgment can explain as too costly for the1182benefit, you have the ability to do that as long as you explain1183that to your investors. Now if you cannot explain it to your1184investors, then okay. Then I can see why you might want to then1185do it anyway, but then you have to ask yourself, if it cannot1186be explained, why exactly are you resisting? So, it is not1187optional in a general sense, but it absolutely provides1188companies currently with the flexibility to resist pressures by1189auditors when they think it is a bad idea.1190    Mr. Vargas. Talking about flexibility then, let us stay on1191that issue for a second. You know, one of the best arguments, I1192think, that they make about some of these disclosure rules and1193the rest is there is a big company, there is a small company.1194The costs, they do not scale. You know, if you are a little1195company, you have to pay a million bucks. If you are a big1196company, you can absorb that easily. However, in 2007, when you1197were evaluating SOX, you said this: ``Perhaps the most1198important component of the Sarbanes-Oxley was precisely to1199delegate power to the PCAOB so that it could customize rules1200and respond to feedback much more rapidly than Congress could1201do on its own.'' So, could it do that?1202    Mr. Coates. Absolutely, and I just want to emphasize, I1203think that the ideas that Mr. Watanabe sketched in his opening1204remarks are absolutely worthy of serious consideration. Some of1205them may be better than what we have right now, but to do it1206through a statute as opposed to doing it at the level of the1207PCAOB or, if necessary, at the level of the SEC, who can move1208more quickly to allow companies to respond to their auditors1209when they feel they are being pressured to do things they1210should not first, and then second, to carve out different kinds1211of companies from some of the requirements or to stretch them1212out, use averages, over 3 years. If it is a 200-person employee1213company, those, I think, are all fairly taken, but they are1214things that can be done without changing the statute. All you1215need is a hearing where you bring people from the SEC and PCAOB1216over and say, what about these ideas, guys? Let us do these at1217the regulatory level.1218    Mr. Vargas. Okay. Last, I do want to ask you about this1219because the world has changed, and we do have now other1220regulations in other parts of the world, and you said that1221there are similar regulations in other parts of the world. We1222are not the only ones here. We are not an outlier. Could you1223comment?1224    Mr. Coates. It is completely right. Following Sarbanes-1225Oxley, virtually every major economic political system adopted1226similar requirements. There is no observable regulatory1227arbitrage opportunity to move to, say, the Cayman Islands, or1228Bermuda, or France, or England, and raise capital there. In1229fact, the British, these days, are very unhappy about the fact1230that the biggest British companies are listing in the United1231States rather than in England because the combination of a1232strong regulatory system and deep capital markets reinforce one1233another and help capital raising.1234    Mr. Vargas. Thank you, and last, I would just like to say1235this, a point of pride. I see that you are at Harvard. Thank1236God for Harvard. There are a number of us that went to school1237there, and we can proudly say it now. I hope you guys stick to1238your guns. Thank you.1239    Mr. Coates. We are the most popular we have ever been. It1240is amazing.1241    Mr. Vargas. Yes, I know.1242    Chairwoman Wagner. The gentleman yields back. The chair now1243recognizes the gentleman from Ohio, Mr. Davidson, who is also1244the Chair of the Subcommittee on National Security, Illicit1245Finance, and International Financial Institution. You are1246recognized, sir, for 5 minutes for questioning.1247    Mr. Davidson. Thank you, Madam Chairwoman. Sarbanes-Oxley1248was born out of good intention in the wake of Enron's collapse1249but let us be clear: this statute is not sacred scripture which1250is not supposed to be added to or taken from. Even the1251Constitution, which might be the closest thing we have to1252something sacred in our own country, has been amended quite a1253lot. So the idea that, oh, how dare you amend the statute, I1254think it merits at least some consideration, and that is the1255point of this hearing, so thank you for convening it. It is1256clear that the burdensome compliance costs have crushed1257businesses, especially smaller ones that do not have the deep1258pockets to navigate this red tape. Frankly, some of the bigger1259companies view this as an opportunity. It creates deal flow1260because it creates regulatory barriers that, just to get to the1261next phase, might say it is easier just to go ahead and exit1262and sell.1263    As someone who owned and operated manufacturing businesses1264in Ohio, I know firsthand the struggle of juggling tight1265margins and deadlines and regulation. I empathize with smaller1266public companies facing duplicative audits mandated by Section1267404. These regulations can choke innovation and slow growth for1268companies that are the backbone of our economy. With that, I1269have a letter from the National Association of Manufacturers1270that I request to submit for record with it.1271    Chairwoman Wagner. So ordered.12721273    [The information referred to can be found in the appendix.]12741275    Mr. Davidson. Thank you, Chairwoman. In this letter,1276National Association of Manufactures (NAM), who represents 131277million people in the manufacturing industry, takes aim at1278Section 404(b), which requires companies to hire an outside1279auditor to publicly attest to management's assessment of the1280effectiveness of the company's internal controls and financial1281reporting. This is in addition to normal audits. NAM's findings1282conclude that the costs far exceed the SEC's rosy estimates,1283hitting smaller public companies the hardest. After 2 decades1284of this regulatory overreach, it is time for Congress to act1285and free smaller firms from this unnecessary burden. It also1286supports why I backed today's noticed legislation to raise the1287revenue and public float thresholds for smaller reporting1288companies and adjust their filer category transitions. This is1289a commonsense step to let businesses focus on creating jobs,1290not feeding bureaucracy.1291    Mr. Cunningham, you have highlighted how SOX 404(b)1292disproportionately hit smaller companies. Can you impact the1293real-world impact of these regulations, and how can we scale it1294back?1295    Mr. Cunningham. Thank you very much. You have heard a lot1296of testimony today about the extraordinarily hard hit that1297small companies take from this because the costs do not scale,1298and the costs are substantially duplicative because an audit of1299financial statements requires an examination of the controls1300and a testing of the controls. So, I think the cost benefit is1301quite out of whack, and I think Congress is right: it is1302Congress' responsibility to update and review its statutes, not1303just to delegate to agencies.1304    Mr. Davidson. Yes. That was, in fact, the finally hard-1305fought win in the Chevron deference case in the Supreme Court.1306So, in the wake of that, it creates an even bigger burden for1307Congress to act, so thank you for that. Dr. Allen, I agree with1308your statement that for early lifecycle firms, diversion of1309resources and innovation hindrance are notable effects, maybe1310not the intent, but certainly the effects of Sarbanes-Oxley's1311regulatory regime, the impact on cash-flow and everything else.1312Could you just discuss from an entrepreneurial perspective what1313modernization of SOX could do for industry?1314    Dr. Allen. Yes, so thank you. It is important that our1315research acknowledges that this is not just a small firm1316effect. It is very similar from the standpoint of the costs and1317benefits manifesting differentially, but it is a different type1318of group. When we think about these highly innovative1319companies, the challenge is that although one set of controls1320is not mandated, as Professor Coates has articulated very well,1321there is often a compliance mindset that is very rigid in form.1322I worked at Mattel when they were in the early stages of1323implementing their SOX 404, and essentially, they hired out1324another audit firm to help them design what would be the1325appropriate controls, which then would pass for another audit1326company as it was very standard practice to have consultants1327help. While a firm can disclose an internal controls weakness,1328my understanding is that recently, the SEC has communicated1329with firms that it is inappropriate to just let those sit over1330time, that the objective of controls is to move forward, to1331remediate controls as to ensure financial reporting quality. So1332overall, what happens to firms, I think, as the audit comes in,1333is that it imposes a mindset or a structure that, again, is1334pushed more toward centralization, formalization of processes1335that are deconstructive or devaluative to the exploratory1336innovation process for this particular firm subset.1337    Mr. Davidson. Yes. Thank you for that, and I will just1338close by saying I appreciate your nod to the late Thomas Sowell1339in your written testimony. So with that, I yield back.1340    Chairwoman Wagner. The gentleman yields back. The chair now1341recognizes the gentleman from Illinois, Mr. Casten, for 51342minutes for questioning.1343    Mr. Casten. Thank you, Madam Chair. Thanks, witnesses. So1344not for the first time this term, I feel like we are sort of1345here in, like, a British Bake Off competition, and our1346contestant has served up a giant horse manure cake, and we have1347brought you in to opine on the quality of the flour. We have a1348markup here. One of the bills we are marking up is looking at1349auditor independent standards of the PCAOB, even as we have a1350budget that would eliminate the PCAOB. We are sitting here1351talking about the nuances of audit standards, even as this1352committee has voted to exempt entire industries from any kind1353of a disclosure-based regulatory regime. I say that not to1354criticize any of your expertise as grain millers, but I would1355like to talk about the dung cake. I am pushing that metaphor as1356hard as I can, but bear with me. I am at least making a smile.1357    Mr. Watanabe, I read an interview with you in 2021 where1358you talked about your process of taking your company public.1359You said that one of the benefits of the IPO process is that1360law firms, accountants, investors do an excruciating amount of1361due diligence in the company. Everybody knows what they are1362investing in. Transparency and integrity are important when1363money is involved. I hope you still agree with those1364statements.1365    Mr. Watanabe. Yes.1366    Mr. Casten. In that context, would you agree that audited1367financial statements are critical to make sure that we have1368public confidence in markets and so that people know they are1369efficiently allocating their capital?1370    Mr. Watanabe. I certainly agree with that, but I would also1371point out that I had to have audited financial statements when1372I was subject to Section 404(a) as well.1373    Mr. Casten. No, no, understand, and, again, like, I am not1374criticizing like that there are different qualities of flour. I1375am just saying we are talking about audit because the Congress1376right now is drafting stablecoin legislation, the idea that you1377could buy some piece of computer code that is neither stable1378nor a coin, but you could buy this piece of computer code, and1379in exchange for buying that code, it is redeemable for $1, and1380yet, the Senate just passed a bill that said that unless you1381have $50 billion in assets or more, you are not required to1382have an audit. You just have an attestation. So, you could1383shuffle money in on the 29th day of the month, shuffle it out1384on the 30th, take a snapshot, and that qualifies. It is like1385running a casino and having your dad buy $3.4 million of tokens1386and using that to disguise whether or not you had a solvency1387problem.1388    Mr. Coates, considering that stablecoins are sold to retail1389participants, used for investors, if my Republican colleagues1390are right, are going to be tightly integrated into our1391financial system, do you think they should be subject to audit1392standards like banks are, like public companies are, or is an1393attestation sufficient?1394    Mr. Coates. I would have thought that we as a country and1395as an economy learned that lesson in 1934, not recently, audits1396are foundational for financial investment. My mother-in-law,1397bless her heart, does not understand that and has, on occasion,1398fallen for illegal unregistered securities offerings by people1399who do not get audits and have lost money. So a stablecoin1400product, as framed by the so-called Guiding and Establishing1401National Innovation for U.S. Stablecoins (GENIUS) Act, would1402extend the capacity of, let us call them entrepreneurs for1403politeness, to take that and make it perfectly legal.1404    Mr. Casten. Let me----1405    Mr. Coates. I think it is terrible.1406    Mr. Casten. Let me say, and look, you are generous saying14071930s. We have a White House that seems to have fallen in love1408with 1890s economic policy. Stay on that for a second because1409it is insane that we had an amendment to put audit standards in1410that was voted down by all the Republicans in this committee.1411There is recent news that Justin Sun, who is one of the many1412committers of emoluments violations, has provided a bunch of1413money to the President of United States to bail him out of1414World Liberty Financial, got to go and have the crypto dinner,1415that he is now trying to do a reverse merger to take his crypto1416company public in the United States that would allow him to1417access public IPO markets without having to go through the kind1418of disclosure that you went through before doing an IPO, Mr.1419Watanabe. So, I guess, Mr. Coates, could you talk about some of1420the concerns that happen through the reverse merger process,1421particularly with foreign entities of concern that might be1422able to access public markets with lower disclosure standards?1423    Mr. Coates. Yes. It is well established that even when1424companies that are subject to full regulation and audit use the1425reverse merger process, they are more prone to fraud, more1426prone to misreporting than companies that go through a fully1427underwritten process, and as annoying as the underwriters can1428be during the process, sometimes they really do perform a very1429valuable service, not only to the investors, but to the company1430if it is a long-term company that has real future to it. So1431reverse mergers, bad signs, and the idea of removing regulation1432from the process of doing that, even less good idea.1433    Mr. Casten. I am out of time. I yield back but let us just1434stay focused on the fact that audits are important. The details1435of an audit, we can talk about later. I yield back.1436    Chairwoman Wagner. The gentleman's time has expired. The1437chair now recognizes the gentleman from Wisconsin, Mr. Steil,1438who is also the Chair of the Subcommittee on Digital Assets,1439Financial Technology, and Artificial Intelligence. Sir, you are1440now recognized for 5 minutes for questioning.1441    Mr. Steil. Thanks, Chair Wagner. Thanks for being here.1442Thanks for the dialog on an important topic. I want to start1443with you, if I can, Mr. Frank Watanabe when it is ``Style,'' it1444is ``Steel,'' but it is good, but thanks for being here. You1445built out a great company, grew a dermatology biotech company1446from a handful of employees to a large, publicly traded1447company. I want to focus in particular in your experience1448leading a startup through that process. Mr. Liccardo and I have1449legislation to extend the EGC1450    --Emerging Growth Company--onramp for certain companies so1451that they do not age out of EGC status before reaching1452maturity, and I appreciate you expressing support in your1453testimony for that today. I just want to ask you to put a1454little color on that, to talk about how your business, in1455particular, benefited from EGC status and the implications that1456would have occurred if you had lost that status too soon.1457    Mr. Watanabe. Yes. So when we went public, we were probably1458about 100 people in the organization, and vast majority of1459those people were involved in researching our products or1460manufacturing our products. Having the emerging-growth company1461status allowed us to do our IPO given that size because their1462requirements are clearly lower as an emerging-growth company,1463and we enjoyed that benefit for a couple of years as well. I1464think if the JOBS Act had not passed and that pathway had not1465existed, the cost for us, the complexity for us to have gone1466public would have been substantially greater, and we very well1467may have reevaluated our decision to go public. Now, we lost1468that status as time went on.1469    Mr. Steil. When you did lose that status? What did you see1470as an implication on your compliance costs?1471    Mr. Watanabe. I would say losing the EGC status probably1472was less of an implication than 404(b). 404(b) is really the1473thing that we saw the most significant implication for us in1474terms of compliance costs. I think I mentioned earlier my1475testimony, it has more than doubled the cost of our compliance1476activities at our----1477    Mr. Steil. In real-world terms, that takes it from, like,1478$5 million to $10 million. What does double mean as we kind of1479think about this for companies of your scale?1480    Mr. Watanabe. Sure, sure. So, the year before we triggered1481404(b), we spent about $650,000 on our audit, and we did not1482have an external compliance provider. The year that we fell1483into 404(b), those doubled to $1.1 million in 2021. As I1484mentioned, last year, it was $2.2 million, which was up 241485percent the prior year. We are expecting something like that1486this year in terms of an increase as well.1487    Mr. Steil. Let me hit one additional topic. Commissioner1488Peirce said, I think, ``The process of determining whether a1489company is a smaller reporting company (SRC) and a non-1490accelerated filer, or an SRC and an accelerated filer, or even1491outside of both categories, so complicated that even we at the1492SEC need diagrams to figure it out.'' Can you just comment on1493the complexity of that system?1494    Mr. Watanabe. One of the challenges, and I suspect that1495quote refers to, is that there are different standards for1496different things, and so you can be an SRC and an accelerated1497filer, for example. So, I think to the extent that those1498triggers are harmonized across different regulations or1499legislation, whether it is the SEC or PCAOB or Congress that1500does it, I think that would be a very positive step, because1501you can----1502    Mr. Steil. I agree with you. I think we have room to clean1503that up. I have about 75 seconds left, and I know you uniquely1504were impacted by proxy advisors. I think this duopoly of1505Institutional Shareholder Services (ISS) and Glass Lewis is1506atrocious. It is maybe just a step beyond the topic of this1507committee but hit me with what ISS and Glass Lewis and the1508proxy advisor duopoly did to you.1509    Mr. Watanabe. Well, I think we have struggled with several1510things when there have been factual inaccuracies, and our1511inability to review their reports on us in advance is a problem1512so that we cannot correct them.1513    Mr. Steil. So, they just put out the information----1514    Mr. Watanabe. And it is----1515    Mr. Steil [continuing]. and off people go voting, and you1516do not even have a chance to raise your hand and say that is1517not true.1518    Mr. Watanabe. That is correct. We have to fix it on the1519back side. The other issue is that they have a set of standards1520that do not align, for example, with the SEC's own standards1521for things like independence, and that has been an issue for1522us.1523    Mr. Steil. Because they are not fully regulated under the1524SEC in a manner that you and I probably think that they should1525be, right?1526    Mr. Watanabe. They are not really regulated at all, yes,1527and it is the Wild West. In the ESG area, they will pay you to1528tell you how to improve your ESG score, so there is a clear1529conflict of interest.1530    Mr. Steil. The conflict of interest is they claim there is1531a Chinese wall, that this side of the entity is going to take1532the money, this side is going to report, but do not worry,1533there is no talking between those two. We are out of time. I1534appreciate your testimony. Big opportunity on proxy advisors.1535Yield back.1536    Chairwoman Wagner. The gentleman yields back. The chair1537recognizes the gentleman from Massachusetts, Mr. Lynch, for 51538minutes of questioning.1539    Mr. Lynch. Thank you, Madam Chair. I thank the witnesses1540for your help today. It was earlier said that Sarbanes-Oxley is1541not sacred text. Now that is very, very true, but let us be1542clear, though. I served on this committee back in the early15432000s and witnessed the collapse of Enron and WorldCom and Tyco1544early in the 2000s. These high-profile corporate accounting1545scandals collectively cost investors billions of dollars and1546eroded public confidence. It really created a crisis here. The1547fall of Enron alone cost about 20,000 jobs. It was a scandal1548and more than $2.1 billion in retirement assets. People were1549talking about bailouts and, as well, about $67 billion in1550losses for shareholders. So, the scandal-exposed systemic1551issues in corporate accounting, including a lot of fraudulent1552accounting practices, those accounting firms were being1553purchased by their clients to give misleading audits of their1554companies, and as a result, this committee passed the Sarbanes-1555Oxley Act. Any time you get 400 votes in the House for a bill,1556that says something, and when you get 99 to zero in the Senate1557that says something. This was a crisis.1558    Sometimes, they say it takes a crisis to get Congress to1559act, especially in unison, in a purposeful way. We had a crisis1560back then. The bill created the PCAOB, the Public Company1561Accounting Oversight Board, whose primary purpose was actually1562to get at those audits and to stop the fraud, and that is what1563it does today. I want to be clear: this hearing is not tweaking1564the PCAOB. It eliminates it. It obliterates, to borrow a1565phrase, obliterates the PCAOB. It goes away. The funding for1566that function of making sure that the audits are accurate, the1567funding for that goes away. Mr. Coates, can you talk about1568that? So, Section 50002 of the reconciliation bill, basically,1569like I said, obliterates the PCAOB and the funding stream that1570supports the auditing function that this not-for-profit1571corporation, the PCAOB performs, and what do you think the1572result of that is going to be for people who rely on those1573audits?1574    Mr. Coates. I firmly believe that the investment community1575would, with growing speed, cease to believe that audited1576financial statements actually represented what they purport to1577represent. It would increase the cost of capital for every1578small-and medium-sized company that wants to raise outside1579equity capital. It would harm the American economy. I have no1580doubt about that.1581    Mr. Lynch. Yes. One of the other red flags I see is that1582the Trump Administration, with respect to the SEC, which is1583where I guess some of this responsibility would flow, the Trump1584Administration also opposes the SEC fiduciary rule, which1585basically says financial advisors have to act in the best1586interest of their clients, so, I mean, there is a direct attack1587on financial advisors' responsibilities to their clients. They1588want that to go away, and, I mean, there are other firms out1589there that actually lean into fiduciary duty. You got firms out1590there that are doing really, really well, that say, you know1591what? We are a fiduciary. We accept and we are proud of our1592responsibility to act in the best interest of our clients. Yet1593the Trump Administration wants to get rid of that, and they1594want to get rid of the PCAOB. They want to defund the Financial1595Protection Board. That has been rejected, I guess, by the1596parliamentarian over in the Senate, but collectively, these1597aggregate attacks on responsible regulation, successful1598regulation is really problematic, but it does show, it does1599reveal the attitude of the White House in this matter. Thank1600you. I yield back.1601    Chairwoman Wagner. The gentleman yields back. The chair now1602recognizes the gentleman from Indiana, Mr. Stutzman, for 51603minutes of questioning.1604    Mr. Stutzman. Thank you, Madam Chair, and I would like to1605submit a letter from the American Securities Association to the1606committee for the record.1607    Chairwoman Wagner. So ordered.16081609    [The information referred to can be found in the appendix.]16101611    Mr. Stutzman. Thank you to all of the folks here for1612testifying today. This is a really important issue, especially1613for businesses across the country. My previous career or1614service outside of public service in the private sector dealt1615with startup companies, turnaround companies, but also publicly1616traded companies, and there are a lot of companies out there,1617people that are investing in their local communities, creating1618jobs that want to grow and want to give back to the community,1619give back to their shareholders, create wealth and new1620opportunities. So, I think that this committee hearing is1621really critical for the growth of our country.1622    While we know that Sarbanes-Oxley was intended to prevent1623fraud, over the past 20 years, we have seen the negative1624impacts of these regulations on growing companies and their1625access to capital. The cost and regulatory burden of these1626requirements are excessive as even small companies, as I1627mentioned, must pay, on average, $723,000 a year to comply with1628this act. These costs have deterred small companies from going1629public, which I experienced personally, gaining access to1630capital and propelling economic growth. The median age for a1631firm seeking an IPO increased from 6.9 years in 2014 to 10.71632years today. I had a business attorney tell me that if you wait163310 years, you will become an overnight success, and that seems1634like what is happening today because of the regulatory1635environment.1636    Dr. Allen, I would like to ask you, in your testimony, you1637cited research finding that firms tend to manage their public1638float downward to avoid exceeding the $75 million and $7001639million regulatory market cap thresholds for qualifying as1640accelerated and large accelerated filers, respectively. How1641much market valuation are firms willing to sacrifice in order1642to avoid having to comply with SOX?1643    Dr. Allen. Thank you, this is the Ewens study that I was1644citing here. They estimated that for firms just below the $751645million threshold, they are essentially willing to pay $132,0001646annually to stay below that threshold, or give up about 1.81647percent of their market cap. For firms seeking to avoid the1648$700 million threshold, the equivalent is more like $900,0001649per year in costs that they are incurring and giving up about16501.2 percent of their market cap. The way they stay below the1651threshold is that they shift their financing toward debt and1652away from equity.1653    Mr. Stutzman. Yes. No, that is right. So, is managing float1654downward a concerning trend for you, and if so, does not lower1655stock float typically lead to higher volatility in the stock's1656price because it is easier for a smaller number of shares to1657move the price?1658    Dr. Allen. We do have some evidence of that from outside of1659U.S. markets. I do not know that we have tested it specifically1660in the United States, but, yes, anytime we see firms incurring1661real cost to manage their market cap, it suggests that they at1662least perceive that the net costs are heavier than the net1663benefits.1664    Mr. Stutzman. Yes, very good. Mr. Cunningham, going back to1665the compliance barriers, could you speak to that and how it is1666hurting American communities, like I mentioned, those in my1667district, smaller companies? Maybe it is manufacturing, maybe1668it is tech, great ideas. We have a large orthopedic sector in1669Northern Indiana as well. How does that affect them because I1670know for a fact, I mean, it is hard to go public. It is almost1671easier just to build the company up and sell it to a publicly1672traded company, or do a Special Purpose Acauistion Company1673(SPAC) and just go in backward, which has its challenges as1674well.1675    Mr. Cunningham. There are real costs to communities of1676overregulation, and especially there is over-auditing of1677internal controls. It is exceedingly expensive and prohibitive1678for many companies. Every entrepreneur is going to assess the1679costs and benefits of sourcing capital, deciding whether to1680stay private or access to public capital markets, and there is1681no question that there are significant costs, significant1682barriers, and so businesses in your district and other1683communities across America are certainly adversely affected by1684this. So, I commend you and the committee for focusing1685attention on it.1686    Mr. Stutzman. Well, there needs to be a balance, but it1687seems like we are too far to the one side, and, ultimately, it1688is money going to the government versus money going back into1689building a business or going to shareholders and generating1690more velocity in the marketplace. Thank you for your testimony.1691Madam Chair, I yield back.1692    Chairwoman Wagner. The gentleman yields back. The chair now1693recognizes the gentleman from Louisiana, Mr. Fields, for 51694minutes of questioning.1695    Mr. Fields. Thank you, Madam Chairwoman, and let me thank1696all the witnesses for being here today. I just have a few1697questions, first, to Mr. Coates. Following the devastating1698Enron/WorldCom scandal that costs investors billions, can you1699walk us through the specific failures that SOX was designed to1700actually address and what measurable improvements and audit1701quality and financial reporting reliability we have seen since1702the PCAOB began its oversight ward?1703    Mr. Coates. Thank you, Congressman Fields, for that. My1704written testimony refers to scholarship. I have published on1705this, and that will give you a much more comprehensive answer1706than what I am going to summarize, but I will say a couple of1707things.1708    First, to reiterate, before Sarbanes-Oxley, there was no1709PCAOB. If you have no PCAOB, then you have audit firms self-1710regulating whether they do a good job of the basic audit of1711financial statements. In the period leading up to Sarbanes-1712Oxley, they failed over and over with increasing frequency, in1713part because of another thing Sarbanes-Oxley changed was they1714were, at the time, permitted to engage in significant non-audit1715work for the same company they were auditing. They were, in1716effect, partly auditing themselves, and they were being paid1717lots of money for the overall relationship, which meant that1718they were less inclined to fight hard during the audit. That1719led to a dramatic increase in the number of mistakes and of1720fraud.1721    You can just see to the numbers they were going up and up1722every year through Sarbanes-Oxley. Once the PCAOB's audit1723standards kicked in, they began to decline, and they have1724remained at much lower levels over the past 10 years. It never1725gone to zero. It is not like the PCAOB is perfect. Sarbanes-1726Oxley is not perfect. We are never going to get to perfect, but1727it has significantly improved financial reporting quality. As1728my colleague down the bench here has shown in her work as well,1729it is not just me, it is consistently found better reporting1730quality as a result of audit standards.1731    Mr. Fields. Thank you. Dr. Allen, from an academic1732standpoint, what evidence do you see that the current1733independent PCAOB structure is more or less effective than1734following these specialized functions into a broader SEC1735mandate, and how would you assess the risk of diluting these1736focus on expertise across the SEC's much wider regulatory1737responsibilities?1738    Dr. Allen. Thank you for the question. My own research has1739not looked into the PCAOB. I think certainly points that have1740been raised regarding funding and independence are important1741questions to assess when thinking about who will perform these1742functions. As Dr. Coates has mentioned, we do see a drop in1743restatement rates following the implementation of the PCAOB,1744but it is also correspondent to a time when we saw the1745independence rules for auditors changing, which was an1746important shift as well. So, research of examining the strength1747of those two forces would be important to understanding what is1748going on there. That would be my assessment of current1749research.1750    Mr. Fields. Thank you, and my final question is to Mr.1751Cunningham. Section 404, internal controls assessments have1752been criticized as costly, yet they require companies to1753establish and maintain systems to prevent fraud. In your view,1754what would be the market-wide implications if we signal to1755investors that we are prioritizing compliance cost reduction1756over fundamental fraud prevention mechanisms?1757    Mr. Cunningham. I think the signal to markets and to1758investors of this review would be to signal that Congress is1759attentive and concerned about making sure that resources are1760deployed in ways that protect investors and are not deployed in1761excessive resourcing on internal controls. I would just add on1762404(b), Dr. Allen is right that SOX made so many changes, it1763was very difficult for a long period of time to determine the1764effect of particular provisions. You know, we banned conflicts1765of interest and have good audit committees, officer1766certificates, and these internal controls. After the SEC1767increased the exemptions under 404(b) in 2020, we have1768empirical research on whether the quality of reporting went1769down or internal controls.1770    Mr. Fields. I want to thank you. I am out of time. I want1771to yield back to the chair. Thank you.1772    Chairwoman Wagner. The gentleman's time has expired, and1773the chair now recognizes the gentleman from Montana, Mr.1774Downing, for 5 minutes of questioning.1775    Mr. Downing. Thank you, Madam Chair, and thank you to the1776witnesses for being here. As a recovering regulator, this is a1777very interesting topic to me. I was formerly the Commissioner1778of Securities and Insurance for the State of Montana, and I1779firmly believe that the best way to evaluate any regulations is1780to determine whether the benefits outweigh the costs. I am1781happy we are having this hearing on Sarbanes-Oxley, a law that1782Congress has not changed since 2002. I am going to start with1783Mr. Watanabe. You have spoken a lot on the subcommittee about1784the many barriers that companies have going and staying public,1785and I think about compliance costs a lot. So, all the1786compliance costs that public companies face, where would you1787rank SOX in those costs?1788    Mr. Watanabe. I think that the thing that I can quantify1789most clearly is the cost differential between 404(a) and1790404(b), and I think I mentioned in my testimony earlier, we1791have spent about $11 million complying with 404(b) since we1792started being subject to it, and to quantify that is the cost1793of me running a phase 2 efficacy trial on a new drug, right?1794That is money that I did not have to spend on developing1795another new drug to treat another serious disease. When we were1796under 404(a), I still was subject to audit every year. I still1797had to sign the attestation every year. I think about it every1798quarter very carefully, as I know you did, Congressman, as an1799entrepreneur. I do not look good in orange, right? So, I take1800that very seriously. So, it is not that I am suggesting a lack1801of regulation. I think it is really more titrating the1802regulation so that smaller companies are not overly burdened1803with the cost of compliance in the same way that a gigantic,1804multibillion dollar corporation is.1805    Mr. Downing. Thank you. I am going to move to Mr.1806Cunningham. Some contend that any serious reforms of SOX will1807lead to more corporate accounting scandals like Enron. In 2020,1808the SEC amended the accelerated filer and large accelerated1809filer definitions to carve out some smaller issues from the1810404(b) requirements. Have you seen any decline in the quality1811of financial statements from these companies since this change?1812    Mr. Cunningham. Thank you very much for that question. I1813have not, and indeed there is empirical research by independent1814professors demonstrating that there was no adverse effect on1815the quality of the reporting or the strength of the controls.1816    Mr. Downing. Well, would you not say that proves that1817Congress can make necessary and targeted reform without1818jeopardizing audit quality?1819    Mr. Cunningham. Yes, sir.1820    Mr. Downing. Thank you. Many public companies see the1821404(a) and the 404(b) requirements as duplicative auditing. Is1822there any way to reform these requirements to reduce this1823duplicative auditing while maintaining investor confidence? For1824example, why not just keep the 404(a) requirements in place?1825    Mr. Cunningham. Yes, I support this avenue of inquiry. I am1826glad Professor Coates agreed that we should consider many of1827the proposals that Frank has suggested and this committee has1828suggested. So, I think it is eminently within the scope of1829Congress' jurisdiction to tackle that and not give it over to1830the SEC or PCAOB.1831    Mr. Downing. I appreciate that. Are there any essential1832provisions of SOX that you think have worked as intended and do1833not need to be reformed?1834    Mr. Cunningham. I do think that the audit committee1835regulations, I was first quite skeptical of the very1836prescriptive and intrusive approach, but on reflection over the1837years, I think the audit committees are now leaning in very1838effectively, and so I think I would be satisfied with that. The1839officer certifications, I think, have heightened the1840attentiveness of leadership, and the ban on conflicts of1841interest with the auditors, I think that was the most important1842and successful accomplishment of the statute. So, there are1843quite a few good things, but there are a lot of missteps.1844    Mr. Downing. Right. Right. I appreciate that, and, again,1845just going back to this inquiry of understanding whether the1846benefits are worth the cost. I appreciate you all being here,1847and on that, Madam Chair, I am going to yield.1848    Chairwoman Wagner. The gentleman yields back. The chair now1849recognizes the gentleman from California, Mr. Sherman, the1850Ranking Member of the Subcommittee on Capital Markets. You are1851recognized for 5 minutes for questioning.1852    Mr. Sherman. It is hard to know how much to invest in1853making sure that audits are accurate and that fraud is avoided.1854Reminds me of a bank that had a bank guard there that said,1855hey, well, we have not had a robbery in 20 years, might as well1856fire the bank guard. You do not know until you find out. The1857harm of Enron and WorldCom, and I think Mr. Coates has pointed1858this out, is not just to the individual companies and their1859employers and their stockholders, but entire industries and the1860market overall. With Enron, I take it very personally because1861they also destroyed my State for several months by creating an1862artificial shortage of electricity and artificial blackouts1863when we had plenty of electric-generating capacity. Also1864destroyed a Governor of my State.1865    There has been discussion of the proxy advisors. I am1866concerned that they also offer advice on how to get a good1867score, but as to complaining that right before there is going1868to be a vote, somebody could publish something that affects how1869people vote, and it might be a duopoly. Well, welcome to my1870world. The LA Times publishes things right before a vote. They1871do not let me see it in advance, and maybe it is a duopoly1872because we also have the Los Angeles Daily News, but it is at1873most a duopoly. We have to explore the scope of what is1874required under Sarbanes-Oxley. I think people have mentioned1875the frequency, but I think the quarterly and annual are1876probably the right frequency, and then most of this hearing is1877focused on who is exempted. We exempt on the basis of dollar1878thresholds, which tend to focus on the equity that is out1879there, but, Mr. Coates, do not public bondholders also rely on1880these financial statements, and is there any reason to exclude1881the publicly held debt when we are also looking at the publicly1882held stock in disturbing these thresholds?1883    Mr. Coates. So the current exemptions, some of which are1884built into statutes, are crude, as you just noted, equity is1885not the only source of capital. Outside equity investors are1886not the only ones relying on financial statements. They could1887be more carefully designed. I want to emphasize, however----1888    Mr. Sherman. Yes. Let me move on to another question. Does1889the PCAOB or the SEC have the authority under current law to1890make some of the adjustments we are talking about, because1891there is an argument that these are arcane details that perhaps1892regulators can deal with better than us or at least more1893frequently.1894    Mr. Coates. More frequently, more quickly, and they can1895monitor----1896    Mr. Sherman. Do they have the authority under present1897statute?1898    Mr. Coates. They absolutely do. The one exception, this is1899something you guys could consider, letting them more carefully1900design experiments with their regulations. Currently, they are1901constrained to do that. I think you could consider giving the1902SEC the authority to test and then quickly change----1903    Mr. Sherman. One thing that failed the test was the1904structure of Arthur Andersen. When I was doing audits, you had1905the audit partner, whose job it was to golf with the CFO, and1906the technical review department. Arthur Andersen had a do not1907ask/do not tell approach with their technical review1908department. I do not think any accounting firm has replicated1909that, but is it clear that under current regulations, you have1910to have a technical review department inside the accounting1911firm sign off whether the audit partner wants that or not?1912    Mr. Coates. Thanks to the PCAOB and its standards and its1913inspections, audit firms routinely avoid that kind of cabining1914of information that helped trigger Enron, yes.1915    Mr. Sherman. Then one of the proposals, and the one I think1916I like least, is the idea that the auditor would not have to1917register with the PCAOB, but, rather, just meet the standards1918of the AICPA. As I pointed out, the AICPA was not consulted on1919that bill. I saw with Madoff that maybe the auditor was in1920technical compliance with the AICPA standards but was1921manifestly incapable of doing the audit. They had a couple of1922CPAs, and Madoff had a big empire to audit. What are the1923downsides of not having the audit firms be approved by the1924PCAOB?1925    Mr. Coates. I do not think we want to return to the Bernie1926Madoff scandal, so, no, it would not be, in my opinion, a good1927idea.1928    Mr. Sherman. Thank you.1929    Chairwoman Wagner. The gentleman's time has expired. The1930chair now recognizes the gentleman from Florida, Mr.1931Haridopolos, for 5 minutes of questioning.1932    Mr. Haridopolos. Thank you, Madam Chair, and I first want1933to submit a letter from the Society of Corporate Governance1934regarding scaling disclosure and obligations for the record.1935    Chairwoman Wagner. So ordered.19361937    [The information referred to can be found in the appendix.]19381939    Mr. Haridopolos. I also want to thank the chair for1940bringing this issue forth. As a new member of the committee, it1941is very helpful to understand the history and hear from the1942experts in the field about a bill that is over 20 years old and1943some of the changes that have taken place in our society since.1944I think one of the things we have talked a lot about in this1945committee is the power of the blockchain and the power of1946technology in general so that more people could put their eyes1947on things, so that when bad things happen, we can be alerted1948earlier as opposed to later on so many different subjects.1949    One of the issues, Mr. Watanabe, if you could, you have1950mentioned this term a couple of times: 24-percent increases.1951Are these prices that you are getting from your lawyers and1952accountants and so forth that are going through these records,1953or are these new rules that are being instituted each year and1954year out that force you to hire more accountants and lawyers?1955    Mr. Watanabe. Thank you for the question. The 24-percent1956increase that I mentioned was a year-over-year increase in the1957fees charged by our auditors. You know, it is not something1958that I have a lot of negotiating leverage with. My shareholders1959appoint our auditors annually at our annual general meeting, as1960I think all public companies do. Once our auditors are in1961place, they look at the scope of work and they tell me how much1962it is going to cost me, and it goes up quite a bit every year.1963It has more than doubled just since we fell into 404(b), so the1964costs go up every year, and the company has really no ability1965to negotiate those fees.1966    Mr. Haridopolos. Thank you, and, Dr. Allen, if I could,1967with your question. We have heard the testimony today. You live1968this. Clearly you understand this better than most. If you had1969a magic wand and pick one item that could be changed within1970Sarbanes-Oxley to still have the oversight that we are all1971looking for, but also looking at the everyday costs that1972businesses are trying to make the decision, do they go public,1973do they stay public, do they sell to a different public company1974if they are a private company, all these things in place. If1975you had a magic wand, you could say, here is one change I would1976make to keep the oversight in place but reduce some of these1977costs so the companies might go public who are making these1978difficult decisions, what would you use as that magic wand?1979    Dr. Allen. Can I give two things?1980    Mr. Haridopolos. Sure.1981    Dr. Allen. One, I really like the idea of rolling averages1982because I think it is very hard for companies to come in and1983out of exemption status, and two, it would be more granular1984regulation that allows for thoughtful exemptions based on1985things like low revenue where we have lower risks or high1986innovation environments where control environments are more1987damaging.1988    Mr. Haridopolos. Mr. Cunningham, same to you. Do you agree1989with Dr. Allen? Are there other issues that are out there that1990you think is not the magic bullet, but at least try to reduce1991some of these 24-percent costs or change the way we are doing1992business from 23 years ago?1993    Ms. Cunningham. I agree with Dr. Allen, and so that means I1994get three. I agree with Chair Hill, too, his idea of having,1995instead of an annual test, have it every second year or every1996third year depending on risk profiles, complexity of the1997company, development stage, revenue, and so on. I think that is1998a worthy topic.1999    Mr. Haridopolos. Mr. Watanabe, do you want to add to that2000as well?2001    Mr. Watanabe. I would agree with all three of those.2002    Mr. Haridopolos. Mr. Coates, you made some good statements2003today. I want to give you an opportunity, too. You have2004obviously seen this law in effect for 20 years. There has got2005to be some issues where we thought it was a great idea in 2002,2006but maybe it has either outlived its usefulness, or technology2007has allowed us to look at things more quickly as opposed to the2008paperwork shuffle from 20-odd years ago.2009    Mr. Coates. I think the most important thing that this body2010could do is bring the PCAOB and SEC folks here and push them on2011the kinds of suggestions that you have just heard about because2012I do think they can do it more quickly. If they get it wrong,2013suppose they titrate too far one way or the other, they can2014reverse that more quickly than Congress can as a body. So, I2015would have a hearing specifically on some of these specific2016ideas. That would be the natural next step.2017    Mr. Haridopolos. Madam Chair, I appreciate the opportunity,2018and I yield back.2019    Chairwoman Wagner. The gentleman yields back. The chair now2020recognizes the gentleman from Texas, Mr. Sessions, for 52021minutes of questioning.2022    Mr. Sessions. Madam Chairwoman, thank you very much. I2023think you did an awesome job to gather together people that do2024not compete against each other but have a same or similar story2025to tell, and I applaud you for doing this.2026    Mr. Coates, I will be quite blunt. I like where you come2027from, and your value-add to today is not an answer. It is2028giving the regulatory bodies the opportunity to come and, in2029essence, work with companies on some negotiation about what2030they will do. This is important because Mr. Watanabe's2031testimony, page 3, says the compliance cost for emerging2032growing biotechs, on average, is $800,000 a year. Then you go2033on and actually list what that price tag costs you in research2034and development to bring your clear biotech ideas that may save2035lives, may fix problems, may be a breakthrough. We are spending2036time on compliance costs rather than doing those things. I note2037Dr. Allen spoke well about this. Mr. Cunningham, very2038impressive, and I do not think that it says something somewhere2039and delete something later, but I do find that you have tried2040to focus the activity, off of, that compliance costs can have2041significant effects for firm IPO decisions, and so I would like2042to go at that level as opposed to beginning, middle, end, how2043big they are.2044    It is causing people who actually are business leaders and2045entrepreneurs, who want to get something to marketplace, that2046are worried about the FDA, that are worried about an FDA trial,2047that are worried about something else, and they are having to2048worry about am I saying everything right? Am I getting exactly2049what it does or not do, my biotech company, or otherwise? I2050just think, Mr. Cunningham, Dr. Allen, if you take just a2051minute, which is all I have left because I spoke too long, what2052do you think about Mr. Coates' idea of us using this tape of2053this hearing that Congresswoman Wagner has been really good at2054narrowing down and going to regulators and saying we charge you2055with trying to come up with a plan, not picking winners or2056losers, but by picking things, and they could strike that2057balance? Dr. Allen?2058    Dr. Allen. I support the idea that Professor Coates had put2059forward of consulting with the SEC, with members of the PCAOB,2060to think about the costs and benefits and how they differ2061across firms. I think, also, as he suggested, some level of2062experimentation. It is very hard to calibrate standards2063appropriately on the first go, so an openness to trying it,2064examining the data, and revising is good policymaking.2065    Mr. Sessions. Then making sure you hold them accountable,2066but there is a variance that is allowed there. Mr. Cunningham,2067one of the statements that has been made is time. When I was at2068Southwestern University taking my business classes, we learned2069time is money. Well, Mr. Watanabe would also say time is also2070people's lives, delaying things because you are having to2071shift. Tell us about the flexibility that you should be given,2072that these companies should be given by the regulator.2073    Mr. Cunningham. I think that is an excellent point, and it2074would be prudent I think for this committee--I do not mean to2075tell you how to do your job--but to have the SEC here, have the2076PCAOB here, and to give an accounting of their perspective,2077what they see the cost-benefit matrix, and develop strategies2078for right-sizing and balancing. I think that it would be a very2079productive thing to help address the lost time due to red tape,2080due to excessive resourcing into the internal control2081environment.2082    Mr. Sessions. We care very much, as well do you, about an2083investor who could be duped into the wrong thing, but I think2084almost anybody that has money to invest, I would like to think,2085would recognize that getting to the FDA trial is the plus or2086minus. That is the go or no-go for lots of these things. Madam2087Chairman, this is, in my opinion, the best hearing you have2088had. I remain confident that we can make a difference, that we2089have built an argument that is available on a bipartisan basis,2090and you have proved it with your committee here today. Thank2091you very much. I yield back my time.2092    Chairwoman Wagner. The gentleman's time has expired, and I2093would like to thank all my colleagues for their robust2094participation today. I want to thank our witnesses for their2095testimony today.2096    Without objection, all members will have 5 legislative days2097to submit additional written questions for the witnesses to the2098chair. The questions will be forwarded to the witnesses for2099their response. I would ask the witnesses to please respond no2100later than July 30, 2025.21012102    [The information referred to can be found in the appendix.]21032104    Chairwoman Wagner. This hearing stands adjourned.21052106    [Whereupon, at 12 p.m., the subcommittee was adjourned.]21072108                               APPENDIX21092110                              ----------21112112                   MATERIALS SUBMITTED FOR THE RECORD2113[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]21142115                                 [all]