Hearing of the House Small Business Committee - Sarbanes-Oxely Section 404: New Evidence on the Costs for Small Business
Interview
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REP. VELAZQUEZ: Okay. Thank you. Mr. Chairman, I know you don't want to stay to listen for the second panel, and I would like for you later before you leave to identify the staff person that will sit here.
MR. COX: Yes, in fact, I think we'll have more than one.
REP. VELAZQUEZ: Okay, great. But during this morning's second panel, we will here testimony from senior representatives from small companies. The witnesses written statements include clear indication of SOX 404 costs, actual and projected. And I would like to read to you a field of figures they will cite.
Universal Security Instruments, a non-accelerated filer, estimates implementation of SOX 404 as revised will cost the company $150,000 to $200,000. Furthermore, they estimate the company will incur $100,000 in extra fees each year once their company adopts SOX 404. Pendleton Community Bank, a non-accelerated filer, has already spent $70,000 to comply with the revised Section 404, and estimates that coming into full compliance will cost the company a total of $210,000. This is 8.9 percent of anticipated 2007 net income for the bank. Tandy Leather Factor, a non-accelerated filer, preparing for SOX 404 compliance in 2004 spent $155,000 in fees. This amounted to 6 percent of the company's earnings in 2004. Tandy's auditors indicated in 2006 that the work Tandy has done in preparation for SOX 404 compliance was very basic and preliminary.
Mr. Chairman, are these costs in line with your and commission's expectations about reasonable SOX 404 costs for non-accelerated filers?
MR. COX: Well, I think we're going to be very interested in taking a look at what kinds of activity results in these expenses and comparing to over the broadest possible sample that we can will provide you with a rigorous answer to that question. But anecdotal evidence is the sort of thing that I'm sure animates your concerns because those expenses are much higher than what were originally estimated by the commission when the pending rule was adopted and when PCAOB first adopted AS2, the old standard. We expect it to be less expensive than that old standard. These numbers indicate that that is not.
REP. VELAZQUEZ: Are there any other members who wish to make questions at this point? Mr. Buchanan, we are about to end this first panel, do you have any questions for Mr. Cox?
Mr. Chairman, I really want to thank you for your appearance here this morning and your willingness to listen to small companies. And I want to state for the record that I truly personally believe after listening to small companies and holding a hearing, not only here in the Small Business Committee, but also in Financial Services, that Section 404(b) is a huge regulation that will redefine how small companies act in the corporate market. I want to state that I welcome your reevaluation of this issue and that I want to thank you for the decision that you are making regarding delaying the implementation or the compliance of Section 404 because this is going to be meaningful to small companies. And not only to small companies, but to the auditors and to the investors.
Nobody wants to see small companies fail because of an inadvertently burdensome regulation. The delay will also help us, Congress, and the commission assess whether the revised rules and auditing standards appropriately balance the costs and the benefits of SOX 404 for America's smaller companies. And that is our next challenge. But before we tackle that one, however, I would like to express my personal appreciation to you for your leadership on this issue.
MR. COX: Thank you, Madam Chairman. And you also asked that I identify the key staff that are here today to listen to the next panel. They include the deputy chief accountant for audits, Zoe-Vonna Palmrose, and the director of the Office of Small Business at the SEC, Gerry LaPorte.
REP. VELAZQUEZ: And with that, Mr. Chairman, you are excused.
MR. COX: Thank you.
REP. VELAZQUEZ: May I ask now for the second panel to please come forward.
And now we're going to proceed with the second panel. Our first witness is Mr. Michael Ryan, Jr. Mr. Ryan is senior vice president of the U.S. Chamber of Commerce and executive director of the Chamber's Center for Capital Markets Competitiveness. The U.S. Chamber of Commerce is the world's largest business federation, representing 3 million organizations of every size, sector, and region. Welcome, Mr. Ryan, and you will have five minutes to make your presentation.
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REP. VELAZQUEZ: Thank you, Ms. Greene. Mr. Ryan, I would like to address my first question to you. You have heard this morning the SEC is planning to collect data related to sub 404 compliance costs. From your perspective, what are some of the most important data that the commission must collect?
MR. RYAN: Well I, first of all, would suggest that they stratify that data collection. I think it was already suggested by looking at the companies that are already complying -- the smaller companies that are already complying with 404 and seeing how the transition to the new rules plays out in that first year and in particular how the auditors respond to that. And also try to get a sense from companies and auditors, in particular, where the more expensive costs are coming from so that as we drill down into this area and try to solve this problem we know exactly where to target and address as we go forward.
REP. VELAZQUEZ: Any other witness would like to comment on the question? Yes, Mr. Grossblatt.
MR. GROSSBLATT: Yes, in addition, I think the SEC should consider the management, time, and internal corporate resources that have to be spent besides the outside costs.
MR. RYAN (?): It is worth noting that the outside audit fees are an obligatory disclosure in the proxy statements of all of us filers, so there is objective information that's readily collectible for that dimension of the compliance cost.
REP. VELAZQUEZ: Mr. Brandt, your company, as a larger small company, has already implemented sub 404.
MR. BRANDT: Yes.
REP. VELAZQUEZ: And yet without any self-interest associated with the potential delay in the SEC sub 404 compliance deadline, you volunteered to testify this morning.
Can you explain the reasons why you thought it is so important to provide testimony on this issue?
MR. BRANDT: Certainly. Having lived this for four years and having been an auditor before, the marginal benefit of what we've been paying for has been painfully apparent and that is nil, it's negative. The costs we're incurring at $600,000 a year for our small company are grossly disproportionate to the amount of capital at risk in the market that we've had invested in our company. And over the last several years working with the AeA and my peers, and hearing the stories of others who've been through this, the prospect of applying this to still smaller companies is hard to accept.
REP. VELAZQUEZ: Ms. Greene, as an accounting professional, you recommend a delay in small companies compliance with sub 404 so that large companies have the opportunity to implement and test the new auditing standard before small firms are required to comply. Do you believe a one year delay in Section 404(b) will allow large companies sufficient time to work out any problems?
MS. GREENE: I think it will certainly help. You know, as a small business that has not had to comply yet even though the scale down rules, I think, are going to be helpful for small companies, I don't think that we are a good basis of comparison because we haven't had to do it yet. Will one year be enough? I don't know. It depends on how well it goes, how the auditors do. A year is better than nothing, but I don't think we'll know until we get farther into it whether that's adequate or not.
REP. VELAZQUEZ: Mr. Loving, in the past, this committee has received testimony that some banks are likely to consider going private. Because of the burdens of Section 404 compliance, from your perspective, what would it mean for a town to have its community bank go private?
MR. LOVING: Well, from that perspective, I think you have a reputation risk to consider if the bank would go private. Obviously, many of the shareholders are, in fact, customers -- new customers, and so a negative reaction could take place because of going private, obviously repurchasing the stock against their will. And once that would happen, they would potentially look for other options for banking. And, you know, I'm a firm believer that the community bank is the lifeblood of the community, and I think it would be very detrimental to many communities if the community banks go private.
REP. VELAZQUEZ: Mr. Brandt, again. Since you have already implemented Section 404, do you have recommendations about how SEC can best study the impact of (sub ?) for small companies?
MR. BRANDT: Well, as was suggested, the audit fee data that can be collected objectively from our proxy filings, that could be stratified and the correlations between the outside costs and market capital or revenue and profitability could produce some useful information.
REP. VELAZQUEZ: Ms. Greene, this morning a law has been made of the date by which a company engages an auditor. There seems to be some uncertainty as to what engaging an auditor means in terms of financial commitment by the company implementing Section 404. As the person responsible for her company's sub 404 implementation, when your company engage an auditor, was your company committing to pay a certain amount in fees?
MS. GREENE: Our auditors have indicated to us that our audit fees, that we can expect our audit fees to increase by 50 percent when they start their assessment work. Our fees have already gone up substantially in the last year, so the premise from the auditors being that they're trying to cover insurance costs. I think we run a very efficient audit, I think our auditors will tell you that, but we've seen substantial increase already and we're not even SOX 404, working on that yet. They're telling us to expect a minimum of 50 percent increase when they get ready to start their work on the assessment.
REP. VELAZQUEZ: Thank you. Yes, Mr. Brandt.
MR. BRANDT: If I may add, I think there's sometimes a misunderstanding between the audit work and the preparation work for Sarbanes-Oxley 404 review by outside auditors. Most companies, even my size, the first time through have hired another outside firm, whether it's a Big Four or now there are specialist consulting firms that have sprung up for the purpose of helping relatively small businesses write up their processes and execute the tests that are required under the law which are all additional costs before the outside audit fees are incurred.
I learned from my AeA peers that many of them spent as much on that as they did on their incremental, outside audit fee cost. Now that's data that isn't captured in proxies, but the term audit has multiple meanings in the context of this discussion; that's one of the reasons I wanted to try to be here because of having been on both sides.
REP. VELAZQUEZ: Thank you. Yes, Mr. Loving.
MR. LOVING: If I could mirror that, most of our costs have been from hiring a consultant to help us in preparing to comply with Section 404, and not only to mention that the external audit firm that we used for years chose to remove themselves from public company work, and so we had to go through the process of filing a new audit firm because of 404. And so, you know, most of the cost will not be outlined exclusively in the financials, but there are costs to comply with 404 before you get to compliance with 404(b).
REP. VELAZQUEZ: Thank you. Yes, Mr. Grossblatt.
MR. GROSSBLATT: We were told by our auditors that if we did use an outside firm that the audit fee would be two or three times what they will charge to review the independents because it becomes an issue about if internal people do it, there's an independence issue. So you really don't save anything by doing it yourself, because what you save on the consultants, you'll pay twice or three times on your audit fee.
REP. VELAZQUEZ: Thank you. Mr. Ryan, how important is it that the SEC vote on delaying and finalize the announcement of the delay sooner rather than later?
MR. RYAN: I think that's critical. I think that's everything. If the SEC waits to do their study in, I believe Chairman Cox suggested it was going to be sometime this summer for the results, that would be -- we realize many of these companies would have already spent the money, made the commitments. And back to the testimony of Mr. Grossblatt, management time will have been spent on it, which is a very significant cost here.
So we think that our data shows this and I think the testimonies here shows that the companies are getting started sooner rather than later and I think that's particularly true for companies that really care about these issues; they're the ones being hurt by a delay.
REP. VELAZQUEZ: I can't stress enough to the chairman how important it is for them to make the announcement as early as possible.
MR. RYAN: My sense is he understood that too.
REP. VELAZQUEZ: Okay, and now I recognize Mr. Westmoreland.
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REP. VELAZQUEZ: Well I want to take this opportunity again to thank all the witnesses for taking time from your busy schedule and your companies to be here this morning with us. And I'd just like to issue a note of caution here in the sense that I hear some of the witnesses and the members here talking about a legislative fix. But this is the Untied States Congress. It's not going to be that easy.
So I don't want for anyone to think in that mindset. You know, our hope is and we are happy this morning, and grateful that Chairman Cox is taking the lead in doing right on behalf of small companies in this country by doing the cost analysis and collecting data in a scientific manner. And I just hope that they do this in a very close partnership with those companies that would be impacted.
And with that, I ask unanimous consent that members will have five days to submit a statement and supporting materials for the record. Without objection, so ordered, this hearing is now adjourned. (Sounds gavel.)
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