[House Report 114-588]
[From the U.S. Government Publishing Office]
114th Congress } { Report
HOUSE OF REPRESENTATIVES
2d Session } { 114-588
======================================================================
FOSTERING INNOVATION ACT OF 2015
_______
May 23, 2016.--Committed to the Committee of the Whole House on the
State of the Union and ordered to be printed
_______
Mr. Hensarling, from the Committee on Financial Services, submitted the
following
R E P O R T
together with
MINORITY VIEWS
[To accompany H.R. 4139]
[Including cost estimate of the Congressional Budget Office]
The Committee on Financial Services, to whom was referred
the bill (H.R. 4139) to amend the Sarbanes-Oxley Act of 2002 to
provide a temporary exemption for low-revenue issuers from
certain auditor attestation requirements, having considered the
same, report favorably thereon without amendment and recommend
that the bill do pass.
Purpose and Summary
Introduced by Representatives Kyrsten Sinema and Michael
Fitzpatrick on December 1, 2015, H.R. 4139, the Fostering
Innovation Act of 2015, extends the exemption from Section
404(b) of the Sarbanes-Oxley Act (SOX) for emerging growth
companies (EGCs) that would otherwise lose their SOX 404(b)
exempt status at the end of the five-year EGC period that
exists under current law. The legislation extends the SOX
404(b) exemption until the earlier of ten years after the
company went public, the end of the fiscal year in which the
EGC's average gross revenues exceed $50 million, or when the
EGC becomes a large accelerated filer ($700 million public
float) with the Securities and Exchange Commission (SEC). SOX
Section 404(b) costs disproportionately burden smaller
companies and startup enterprises that do not have sufficient
revenue streams to devote to SOX compliance costs.
Background and Need for Legislation
Title I of the Jumpstart Our Business Startups Act (JOBS)
(Pub L. 112-106) established EGCs as a new category of issuer
under the federal securities laws. These EGC issuers have less
than $1 billion in annual revenues or $700 million in public
float when they register with the SEC. EGCs are given up to
five years--known as an ``On Ramp''--to comply with certain
regulatory requirements, including SOX Section 404(b). By
granting these issuers temporary ``On Ramp'' status, Title I of
the JOBS Act encourages small company public offerings and
ensures that they move to full compliance with regulatory
requirements as they become large enough to support the legal,
accounting, and compliance infrastructure typical of mature
enterprises.
Background on the compliance burden associated with SOX Section 404(b)
Pursuant to SOX Section 404, the management of a public
company must assess the effectiveness of the company's internal
controls over financial reporting. A key driver of the SOX
Act's compliance costs is Section 404(b), which requires a
public company's external auditor to attest to, and report on,
management's assessment of the company's internal controls as
required by Section 404(a) of SOX. Studies of compliance costs
overwhelmingly indicate that Section 404 has increased public
companies' accounting and auditing expenditures, regardless of
company size.
In fact, the costs to comply with Section 404(b) have far
exceeded the SEC's original estimates. According to a 2008
report by the Heritage Foundation:
While the SEC initially estimated the cost of
complying with Section 404 to be $1.24 billion in the
aggregate, multiple studies have projected the actual
cost to be $35 billion, almost 30 times that of the
original estimate. CRA International's survey data
indicates that total year-one Section 404
implementation cost per company with market
capitalization between $75 million and $700 million,
known as a small accelerated filer, is $1.5 million, or
0.46 percent of its revenue; and that per company with
market capitalization above $700 million, known as a
large accelerated filer, is $7.3 million, or 0.09
percent of its revenue. A more recent estimate pegged
the average cost of direct compliance costs and outside
audit fees in 2006 at 2.5 percent of a company's
revenue.
Similarly, in 2010, the Independent Community Bankers
Association (ICBA) concluded:
While 404 auditor costs declined 5.4% from 2006 as
the auditor scope of work narrowed, these costs were
offset by a reported five percent increase in the
average hourly audit rate charged by auditors.
[Financial Executives International] also found that
auditor attestation fees paid by accelerated filers in
2007 constituted 23.7% of the accelerated filer's total
annual audit fees and averaged $846,000, representing
only a 5.4% decrease from 2006. In September 2009, the
SEC's Office of Economic Analysis issued its 140 page
report on the costs of complying with SOX 404 after
conducting a large web-based survey of publicly held
companies over a period from December 2008 to January
2009. The Study found that for companies that were
already complying with Section 404(b), the mean total
Section 404 compliance cost following the issuance of
the SEC guidance was still a staggering $2.33 million
per year. Section 404(b) audit fees were a significant
portion of those total costs, amounting to a mean
average of $1,127,325. Even though the overall mean 404
compliance costs had dropped 19% from the pre-guidance
cost, for smaller reporting companies, the drop was not
as significant. In fact, the Study showed that for
filers with public float lower than $75 million, the
mean SOX 404 compliance cost following the issuance of
SEC guidance was very high--$690,000 per year and the
mean 404(b) audit cost was $259,004. From its Study,
the SEC generally concluded that smaller publicly held
companies have higher SOX 404 compliance costs as a
fraction of their asset value.
More recently, a May 2014 survey conducted by compliance
and audit consultant Protiviti similarly found that
approximately 53 percent of large organizations currently spend
$1 million or more each year on SOX compliance, and 30 percent
spend $2 million or more annually. The Protiviti survey
concluded that ``SOX compliance costs are rising more sharply
than in the past,'' partly as a result of recent Public Company
Accounting Oversight Board (PCAOB) inspections of external
auditing firms, which indicated that ``external auditors were
not doing enough work and thus needed to invest more time in
[SOX Section 404] audits.''
At a December 2, 2015 Capital Markets and Government
Sponsored Enterprises Subcommittee hearing to consider the
Fostering Innovation Act, Mr. Brian Hahn, Chief Financial
Officer of GlycoMimetics, testified that the SOX 404(b) auditor
attestation requirement ``provides little-to-no insight into
the health of an emerging biotech company--but is extremely
costly for a pre-revenue innovator to comply with.''
The significant burdens associated with SOX Section 404(b)
compliance disproportionately affect smaller public companies,
diverting resources from growth to regulatory costs and harming
the ability of these firms to compete against larger peers and
foreign competitors. According to the Heritage study, ``Section
404 compliance cost constitutes a substantial fixed cost
component that imposes a disproportionate burden on smaller
public companies as they are inherently unable to spread the
cost with the economies of scale.'' Heritage found that ``in
the first compliance year, the median audit fee as a percentage
of revenue for companies with a market cap of less than $75
million and between $75 million and $250 million was 0.75
percent and 0.48 percent, respectively. In contrast, that for
companies with a market cap of more than $5 billion was 0.07
percent.''
Increased compliance costs also serve as a disincentive for
smaller companies to become and remain public companies. For
example, ICBA pointed out that:
[W]ith more limited resources, fewer internal
personnel and less revenue with which to offset the
costs of Section 404 compliance, both micro-cap and
small-cap companies are disproportionately impacted by
the burdens associated with Section 404 compliance . .
. the benefits of documenting, testing and certifying
the adequacy of internal controls, while of obvious
importance for large companies, are of less value for
micro-cap and small-cap companies, who rely to a
greater degree on `tone at the top' and high-level
monitoring controls, to influence accurate financial
reporting. Moreover . . . the proportionately larger
costs for smaller public companies to comply with
Section 404 adversely affect their ability to compete
with larger public companies and even with foreign
competition. This reduction in the competitiveness of
U.S. smaller public companies hurts their capital
formation ability and, as a result, hurts the U.S.
economy. During this current economic downturn, many
publicly held community banks are having a difficult
time raising capital and in many cases, have had to
postpone or cancel their capital raising plans.
The Fostering Innovation Act will promote the continued
growth and financial success of small and innovative companies.
As indicated previously, the Act relieves a subset of EGCs from
Section 404(b) compliance for up to ten years, provided that
their annual revenue is not greater than $50 million and their
public float is less than $700 million (a company is an EGC if
its annual revenue does not exceed $1 billion and its public
float is less than $700 million); the Act is therefore limited
in its application to those EGCs that are truly small
companies, in recognition of the fact that small business
economic life-cycles require a greater time period in which to
build up to full compliance with public company regulations.
Thus, as Mr. Hahn from GlycoMimetics concluded at the December
2nd hearing, ``Legislation like the Fostering Innovation Act
will ensure that growing companies have the opportunity to be
successful on the public market without being forced to siphon
off innovation capital to spend on costly compliance burdens
that do not inform emerging biotech investors.''
Hearings
The Committee on Financial Services' Subcommittee on
Capital Markets and Government Enterprises held a hearing
examining matters relating to H.R. 4139 on December 2, 2015.
Committee Consideration
The Committee on Financial Services met in open session on
March 2, 2016, and ordered H.R. 4139 to be reported favorably
to the House without amendment by a recorded vote of 42 yeas to
15 nays (recorded vote no. FC-98), a quorum being present.
Committee Votes
Clause 3(b) of rule XIII of the Rules of the House of
Representatives requires the Committee to list the recorded
votes on the motion to report legislation and amendments
thereto. The sole recorded vote in committee was a motion by
Chairman Hensarling to report the bill favorably to the House
without amendment. That motion was agreed to by a recorded vote
of 42 yeas to 15 nays (Record vote no. FC-98), a quorum being
present.
Committee Oversight Findings
Pursuant to clause 3(c)(1) of rule XIII of the Rules of the
House of Representatives, the findings and recommendations of
the Committee based on oversight activities under clause
2(b)(1) of rule X of the Rules of the House of Representatives,
are incorporated in the descriptive portions of this report.
Performance Goals and Objectives
Pursuant to clause 3(c)(4) of rule XIII of the Rules of the
House of Representatives, the Committee states that H.R. 4139
will reduce regulatory compliance costs for Emerging Growth
Companies by extending the exemption to comply with Section
404(b) of the Sarbanes-Oxley-Act.
New Budget Authority, Entitlement Authority, and Tax Expenditures
In compliance with clause 3(c)(2) of rule XIII of the Rules
of the House of Representatives, the Committee adopts as its
own the estimate of new budget authority, entitlement
authority, or tax expenditures or revenues contained in the
cost estimate prepared by the Director of the Congressional
Budget Office pursuant to section 402 of the Congressional
Budget Act of 1974.
Committee Cost Estimate
The Committee adopts as its own the cost estimate prepared
by the Director of the Congressional Budget Office pursuant to
section 402 of the Congressional Budget Act of 1974.
Congressional Budget Office Estimates
Pursuant to clause 3(c)(3) of rule XIII of the Rules of the
House of Representatives, the following is the cost estimate
provided by the Congressional Budget Office pursuant to section
402 of the Congressional Budget Act of 1974:
U.S. Congress,
Congressional Budget Office,
Washington, DC, April 18, 2016.
Hon. Jeb Hensarling,
Chairman, Committee on Financial Services,
House of Representatives, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office has
prepared the enclosed cost estimate for H.R. 4139, the
Fostering Innovation Act of 2015.
If you wish further details on this estimate, we will be
pleased to provide them. The CBO staff contact is Stephen
Rabent.
Sincerely,
Keith Hall.
Enclosure.
H.R. 4139--Fostering Innovation Act of 2015
H.R. 4139 would extend the exemption period for some
emerging growth companies from having an auditor attest to and
report on internal control reports.
Securities and Exchange Commission (SEC) rules require the
issuers of securities to file assessments of their internal
control structures and procedures for financial reporting and
to have those reports be attested to and reported on in an
audit report. The Jumpstart Our Business Startups Act of 2012
exempted companies with annual revenue and debt issuance under
specified thresholds from the requirement of an auditor's
attestation of their internal control report for up to five
years after their first sale of equity securities. H.R. 4139
would extend the maximum exemption period to 10 years.
Based on information from the SEC, CBO estimates that
implementing H.R. 4139 would cost less than $500,000 for
personnel and administrative costs to revise SEC rules.
However, the SEC is authorized to collect fees sufficient to
offset its annual appropriation; therefore, CBO estimates that
the net effect on discretionary spending would be negligible,
assuming appropriation actions consistent with that authority.
Enacting H.R. 4139 would not affect direct spending or
revenues; therefore, pay-as-you-go procedures do not apply. CBO
estimates that enacting H.R. 4139 would not increase net direct
spending or on-budget deficits in any of the four consecutive
10-year periods beginning in 2027.
H.R. 4139 contains no intergovernmental mandates as defined
in the Unfunded Mandates Reform Act (UMRA) and would not affect
the budgets of state, local, or tribal governments.
If the SEC increases fees to offset the costs of
implementing the bill, H.R. 4139 would increase the cost of an
existing mandate on private entities required to pay those
fees. Based on information from the SEC, CBO estimates that the
aggregate cost would be minimal and would fall well below the
annual threshold for private-sector mandates established in
UMRA ($154 million in 2016, adjusted annually for inflation).
The CBO staff contacts for this estimate are Stephen Rabent
(for federal costs) and Logan Smith (for private-sector
mandates). The estimate was approved by H. Samuel Papenfuss,
Deputy Assistant Director of Budget Analysis.
Federal Mandates Statement
The Committee adopts as its own the estimate of Federal
mandates prepared by the Director of the Congressional Budget
Office pursuant to section 423 of the Unfunded Mandates Reform
Act.
Advisory Committee Statement
No advisory committees within the meaning of section 5(b)
of the Federal Advisory Committee Act were created by this
legislation.
Applicability to Legislative Branch
The Committee finds that the legislation does not relate to
the terms and conditions of employment or access to public
services or accommodations within the meaning of the section
102(b)(3) of the Congressional Accountability Act.
Earmark Identification
H.R. 4139 does not contain any congressional earmarks,
limited tax benefits, or limited tariff benefits as defined in
clause 9 of rule XXI.
Duplication of Federal Programs
Pursuant to section 3(g) of H. Res. 5, 114th Cong. (2015),
the Committee states that no provision of H.R. 4139 establishes
or reauthorizes a program of the Federal Government known to be
duplicative of another Federal program, a program that was
included in any report from the Government Accountability
Office to Congress pursuant to section 21 of Public Law 111-
139, or a program related to a program identified in the most
recent Catalog of Federal Domestic Assistance.
Disclosure of Directed Rulemaking
Pursuant to section 3(i) of H. Res. 5, 114th Cong. (2015),
the Committee states that H.R. 4139 contains no directed
rulemaking.
Section-by-Section Analysis of the Legislation
Section 1: Short title
This section cites H.R. 4139 as the ``Fostering Innovation
Act of 2015.''
Section 2: Temporary exemption for low-revenue issuers
This section amends Section 404 of the Sarbanes-Oxley Act
of 2002 to extend the exemption from 404(b) compliance for
Emerging Growth Companies (EGCs) until the earlier of ten years
after the company went public, the end of the fiscal year in
which the EGC's average gross revenues exceed $50 million, or
when the EGC becomes a large accelerated filer ($700 million
public float) with the SEC.
Changes in Existing Law Made by the Bill, as Reported
In compliance with clause 3(e) of rule XIII of the Rules of
the House of Representatives, changes in existing law made by
the bill, as reported, are shown as follows (new matter is
printed in italic and existing law in which no change is
proposed is shown in roman):
SARBANES-OXLEY ACT OF 2002
* * * * * * *
TITLE IV--ENHANCED FINANCIAL DISCLOSURES
* * * * * * *
SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS.
(a) Rules Required.--The Commission shall prescribe rules
requiring each annual report required by section 13(a) or 15(d)
of the Securities Exchange Act of 1934 (15 U.S.C. 78m or
78o(d)) to contain an internal control report, which shall--
(1) state the responsibility of management for
establishing and maintaining an adequate internal
control structure and procedures for financial
reporting; and
(2) contain an assessment, as of the end of the most
recent fiscal year of the issuer, of the effectiveness
of the internal control structure and procedures of the
issuer for financial reporting.
(b) Internal Control Evaluation and Reporting.--With respect
to the internal control assessment required by subsection (a),
each registered public accounting firm that prepares or issues
the audit report for the issuer, other than an issuer that is
an emerging growth company (as defined in section 3 of the
Securities Exchange Act of 1934), shall attest to, and report
on, the assessment made by the management of the issuer. An
attestation made under this subsection shall be made in
accordance with standards for attestation engagements issued or
adopted by the Board. Any such attestation shall not be the
subject of a separate engagement.
(c) Exemption for Smaller Issuers.--Subsection (b) shall not
apply with respect to any audit report prepared for an issuer
that is neither a ``large accelerated filer'' nor an
``accelerated filer'' as those terms are defined in Rule 12b-2
of the Commission (17 C.F.R. 240.12b-2).
(d) Temporary Exemption for Low-Revenue Issuers.--
(1) Low-revenue exemption.--Subsection (b) shall not
apply with respect to an audit report prepared for an
issuer that--
(A) ceased to be an emerging growth company
on the last day of the fiscal year of the
issuer following the fifth anniversary of the
date of the first sale of common equity
securities of the issuer pursuant to an
effective registration statement under the
Securities Act of 1933;
(B) had average annual gross revenues of less
than $50,000,000 as of its most recently
completed fiscal year; and
(C) is not a large accelerated filer.
(2) Expiration of temporary exemption.--An issuer
ceases to be eligible for the exemption described under
paragraph (1) at the earliest of--
(A) the last day of the fiscal year of the
issuer following the tenth anniversary of the
date of the first sale of common equity
securities of the issuer pursuant to an
effective registration statement under the
Securities Act of 1933;
(B) the last day of the fiscal year of the
issuer during which the average annual gross
revenues of the issuer exceed $50,000,000; or
(C) the date on which the issuer becomes a
large accelerated filer.
(3) Definitions.--For purposes of this subsection:
(A) Average annual gross revenues.--The term
``average annual gross revenues'' means the
total gross revenues of an issuer over its most
recently completed three fiscal years divided
by three.
(B) Emerging growth company.--The term
``emerging growth company'' has the meaning
given such term under section 3 of the
Securities Exchange Act of 1934 (15 U.S.C.
78c).
(C) Large accelerated filer.--The term
``large accelerated filer'' has the meaning
given that term under section 240.12b-2 of
title 17, Code of Federal Regulations, or any
successor thereto.
* * * * * * *
MINORITY VIEWS
H.R. 4139 would amend the Sarbanes-Oxley Act of 2002 (SOx)
to provide a 10 year exemption from the Section 404(b) auditor
attestation requirements for companies who cease to be Emerging
Growth Companies (EGCs), provided that they have average annual
gross revenues of less than $50 million and do not meet the
Securities and Exchange Commission's (SEC) definition of
``large accelerated filer'' (i.e., the company has a public
float less than $700 million).
Congress passed SOx nearly 15 years ago in the wake of
several high-profile corporate and accounting scandals,
including those of Enron, Tyco International, Adelphia and
WorldCom, which collectively cost investors billions of dollars
and simultaneously undermined confidence in U.S. capital
markets. A key component of SOx was Section 404(b), which
requires that a company's auditor include an assessment of the
adequacy of the company's internal controls that govern
financial statements.
H.R. 4139 would amend SOx to exempt EGCs for up to a decade
from the Section 404(b) audit if they meet certain revenue and
public float requirements. This is both unnecessary and
harmful.
First, the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (P.L. 111-203) has already provided
relief to small issuers, exempting ``non-accelerated filers''
(i.e., companies with less than $75 million in public float)
from the Section 404(b) requirement. In total, approximately 60
percent of issuers are exempt pursuant to this provision.
Second, the Jumpstart Our Business Startups Act of 2012 (P.L.
112-106) expanded upon this relief by providing an exemption
from Section 404(b) for EGCs, either until five years after the
EGCs first sale of common equity securities in a public
offering; the last day of the fiscal year during which the EGC
had total annual gross revenues of $1 billion (adjusted for
inflation every five years); the date on which the EGC has,
during the previous three-year period, issued more than $1
billion in non-convertible debt; or the date on which it is
deemed to be a ``large accelerated filer.''
The additional exemptions provided under H.R. 4139--which
would further delay compliance for up to a decade for certain
companies--is not necessary in light of the plentiful
exemptions already available.
Additionally, the further exemptions may prove to be
harmful both to investors and to the very companies H.R. 4139
purports to help. In a 2013 study, the Government
Accountability Office (GAO) found that companies that are not
required to comply with the Section 404(b) audit requirement
restated their financials more often than those that were
required to comply. Restatements of financials can have a
devastating impact on a company's health and potential growth,
particularly for less established firms.
Removing Section 404(b) requirements likewise is harmful to
investors, with 72 percent of institutional investors reporting
in a 2015 study by the Public Company Accounting Oversight
Board's Investor Advisory Group that they rely on the Section
404(b) audits when making investment decisions. Further, Joseph
Carcello, a CPA and member of the SEC's Investor Advisory
Committee, testified to the Committee that auditors, rather
than management, detect approximately 75 percent of the
internal control deficiencies in these small companies. Mr.
Carcello also informed the Committee that management tends to
downplay internal control deficiencies as less severe, and
auditors must frequently override these classifications.
In short, auditor reporting on public companies provides
substantial benefits to investors and to the companies. It
promotes confidence in U.S. markets, strengthens internal
controls, and prevents fraud. For these reasons, the Minority
opposes H.R. 4139.
Maxine Waters.