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115th Congress } { Report
HOUSE OF REPRESENTATIVES
1st Session } { 115-425
======================================================================
FOSTERING INNOVATION ACT OF 2017
_______
November 28, 2017.--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. 1645]
[Including cost estimate of the Congressional Budget Office]
The Committee on Financial Services, to whom was referred
the bill (H.R. 1645) 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
On March 21, 2017, Representatives Kyrsten Sinema and Trey
Hollingsworth introduced H.R. 1645, the ``Fostering Innovation
Act of 2017'', which amends Section 404(b) of the Sarbanes-
Oxley Act (SOX) to extend the exemption available to emerging
growth companies (EGCs) from the auditor attestation of a
company's internal controls over financial reporting
requirement beyond the five-year period that applies under
current law. Specifically, the bill extends the exemption until
the earlier of ten years after the EGC went public, the end of
the fiscal year in which the EGC's average gross revenues
exceed $50 million, or when the EGC qualifies with the
Securities and Exchange Commission (SEC) as a large accelerated
filer, $700 million public float, which is the number of shares
available to trade freely between investors that are not
controlled by corporate officers or promoters.
Background and Need For Legislation
The goal of H.R. 1645 is to extend the exemption status for
EGCs from SOX 404(b) requirements beyond the initial five year
period under current law. The legislation does not relieve an
EGC from its responsibilities under SOX 404(a), which require
that management establish and maintain an adequate internal
control structure and procedures for financial reporting.
Title I of the Jumpstart Our Business Startups (JOBS) Act
established EGCs as a new category of issuers. These issuers
have less than $1 billion in annual revenues or $700 million in
public float when they register with the SEC and 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
encourages small companies to go public while ensuring that
they move to full compliance with regulatory requirements as
they become large enough to support the legal, accounting, and
compliance infrastructure more typical of mature enterprises.
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 SOX
compliance costs is Section 404(b), which requires a public
company's auditor to attest to, and report on, management's
assessment of the company's internal controls. 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. A 2008 report by the
Heritage Foundation stated that 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. Moreover, these costs impact small
accelerated filers disproportionately when compared with large
accelerated filers. CRA International's survey data indicates
that for a small accelerated filer--which includes companies
with market capitalization between $75 million and $700
million--the total year-one Section 404 implementation cost per
company is $1.5 million, or 0.46 percent of revenue. For a
large accelerated filer--which is a company with market
capitalization above $700 million--the total is $7.3 million,
or 0.09 percent of its revenue.
Similarly, in 2010, the Independent Community Bankers
Association (ICBA) concluded that:
while [Section] 404 auditor costs declined 5.4% from
2006 as the auditor scope of work narrowed, these costs
were offset by a reported [5%] 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 . . .
[and] 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. . . . [T]he 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 [than larger reporting
companies].
A May 2014 survey conducted by compliance and audit
consultant Protiviti similarly found that around 53% of large
organizations currently spend $1 million or more on SOX
compliance, and 30% 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.''
The significant burdens associated with SOX Section 404(b)
compliance disproportionately affect smaller public companies,
divert resources from growth to regulatory costs, and harm the
ability of these firms to compete against larger peers and
foreign competitors. According to Heritage, ``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:
[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 . . . .
[T]he 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. . . . [T]he 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.
In its report on Capital Markets mandated by President
Trump's February 3, 2017 Executive Order, the Department of
Treasury recommended an increase in the length of time a
company may maintain its EGC status for up to 10 years, subject
to a revenue and/or public float threshold, in order to more
appropriately tailor compliance costs associated for a smaller
public company.
Hearings
The Committee on Financial Services and the Subcommittee on
Capital Markets, Securities, and Investment held a hearing
examining matters relating to H.R. 1645 on March 22, 2017,
April 26, 2017, April 28, 2017, and July 18, 2017.
Committee Consideration
The Committee on Financial Services met in open session on
October 11, 2017, October 12, 2017, and ordered H.R. 1645 to be
reported favorably to the House without amendment by a recorded
vote of 48 yeas to 12 nays (Record vote no. FC-91), 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 record votes
on the motion to report legislation and amendments thereto. The
sole recorded vote was on a motion by Chairman Hensarling to
report the bill favorably to the without amendment. The motion
was agreed to by a recorded vote of 48 yeas to 12 nays (Record
vote no. FC-91), a quorum being present.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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. 1645
will reduce regulatory compliance costs for EGCs 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.
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, November 1, 2017.
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. 1645, the
Fostering Innovation Act of 2017.
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,
Director.
Enclosure.
H.R. 1645--Fostering Innovation Act of 2017
Under current law, the Securities and Exchange Commission
(SEC) requires issuers of securities to file assessments of
their internal control structures and procedures for financial
reporting and have those reports be attested to and covered 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 to have an
auditor's attestation as part of their internal control reports
for up to 5 years after their first sale of equity securities.
H.R. 1645 would increase that maximum exemption period to 10
years.
Based on an analysis of information from the SEC, CBO
estimates that implementing H.R. 1645 would have no significant
effect on the agency's costs because the SEC would not have to
update agency rules to implement the bill. Moreover, the SEC is
authorized to collect fees sufficient to offset its annual
appropriation; therefore, assuming appropriation actions
consistent with that authority, CBO estimates that the net
effect on discretionary spending would be negligible.
Enacting H.R. 1645 would not affect direct spending or
revenues; therefore, pay-as-you-go procedures do not apply.
CBO estimates that enacting H.R. 1645 would not increase
net direct spending or on-budget deficits in any of the four
consecutive 10-year periods beginning in 2028.
H.R. 1645 contains no intergovernmental or private-sector
mandates as defined in the Unfunded Mandates Reform Act.
The CBO staff contact for this estimate is Stephen Rabent.
The estimate was approved by H. Samuel Papenfuss, Deputy
Assistant Director for Budget Analysis.
Federal Mandates Statement
This information is provided in accordance with section 423
of the Unfunded Mandates Reform Act of 1995.
The Committee has determined that the bill does not contain
Federal mandates on the private sector. The Committee has
determined that the bill does not impose a Federal
intergovernmental mandate on State, local, or tribal
governments.
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
With respect to clause 9 of rule XXI of the Rules of the
House of Representatives, the Committee has carefully reviewed
the provisions of the bill and states that the provisions of
the bill do not contain any congressional earmarks, limited tax
benefits, or limited tariff benefits within the meaning of the
rule.
Duplication of Federal Programs
In compliance with clause 3(c)(5) of rule XIII of the Rules
of the House of Representatives, the Committee states that no
provision of the bill establishes or reauthorizes: (1) a
program of the Federal Government known to be duplicative of
another Federal program; (2) a program included in any report
from the Government Accountability Office to Congress pursuant
to section 21 of Public Law 111-139; or (3) a program related
to a program identified in the most recent Catalog of Federal
Domestic Assistance, published pursuant to the Federal Program
Information Act (Pub. L. No. 95-220, as amended by Pub. L. No.
98-169).
Disclosure of Directed Rulemaking
Pursuant to section 3(i) of H. Res. 5, (115th Congress),
the following statement is made concerning directed
rulemakings: The Committee estimates that the bill requires no
directed rulemakings within the meaning of such section.
Section-by-Section Analysis of the Legislation
Section 1. Short title
This Section cites H.R. 1645 as the ``Fostering Innovation
Act of 2017''
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 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--at least $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 (existing law
proposed to be omitted is enclosed in black brackets, new
matter is printed in italic, and existing law in which no
change is proposed is shown in roman):
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. 1645 would amend the Sarbanes-Oxley Act of 2002 (SOX)
to exempt certain companies from Section 404(b) audit
requirements for up to a decade if they have average annual
gross revenues of less than $50 million and a public float of
less than $700 million.
Congress enacted SOX fifteen years ago in the wake of Enron
and several other high-profile corporate and accounting
scandals that collectively cost investors billions of dollars
and undermined confidence in U.S. capital markets. SOX protects
investors from similar misconduct by increasing the accuracy
and transparency of financial reporting by public companies.
Specifically, Section 404(b) requires an external auditor to
attest to and report on management's assessment of the
company's internal controls over financial reporting. H.R. 1645
would create an unnecessary and harmful exemption from these
important requirements.
The Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (P.L. 111-203) already provides a permanent
exemption from Section 404(b) for any company with a public
float of less than $75 million (i.e., companies that are not
classified ``as accelerated filers'' or ``large accelerated
filers''). This exemption currently applies to fully half of
all public companies.
Additionally, the Jumpstart Our Business Startups (JOBS)
Act of 2012 (P.L. 112-106) created a five-year exemption from
Section 404(b) for companies that go public with less than $1
billion in annual revenues, referred to as ``Emerging Growth
Companies'' (EGCs). Since the enactment of the JOBS Act, 85% of
companies that have gone public have done so as EGCs.
The JOBS Act ensures that large companies adhere to the SOX
404(b) auditor requirements by terminating EGC status (and the
associated exemption) after a company has been public for five
years; or when the company has a public float of more than $700
million, annual revenues exceeding $1.07 billion, or debt
issuance exceeding $1.07 billion.
H.R. 1645 would further delay compliance for up to a decade
for companies that no longer qualify as EGCs. This new
exemption is unnecessary in light of existing exemptions and
could prove harmful to the companies that H.R. 1645 purports to
help. In 2013, a Government Accountability Office (GAO) report
found that companies that do not undergo an audit of their
internal controls over financial reporting have a significantly
higher likelihood of restating their financial statements.
Financial restatements are major reporting errors that can
damage a public company's reputation and reduce investor
confidence in the company, its management, and the broader
capital markets.
Removing Section 404(b) requirements can also harm
investors, who rely on corporate financial statements when
making investment decisions. For this reason, academics,
investor advocates, and regulators have opposed expanding SOX
404(b) exemptions. For example, Rick Fleming, the Securities
and Exchange Commission's Investor Advocate, opposed an
identical bill last Congress on the grounds that expanding
404(b) exemptions to a new class of issuers would ``weaken[] an
important investor protection'' and ``further compound[] the
complexity of securities law reporting requirements . . . .''
Professor Robert Brown of the University of Denver, Sturm
College of Law has also advised against expanding exemptions to
SOX 404(b) requirements. During a July 18, 2017, hearing of the
Capital Markets Subcommittee, Professor Brown testified that,
as a matter of ``human nature, if you are inside a company, and
you are responsible for internal controls, if you know somebody
from the outside is going to come and look at them, you are
going to do a better job.'' Investor advocacy groups including
Americans for Financial Reform, Center for American Progress,
Consumer Federation of American, and Public Citizen have also
opposed H.R. 1645 on the basis that increasing exemptions from
SOX 404(b) would endanger investors and diminish the integrity
of U.S. capital markets.
In short, SOX 404(b) auditor requirements provide
substantial benefits to investors and companies. These
requirements promote investor confidence in U.S. capital
markets, strengthen internal controls, and help prevent fraud.
For these reasons, we oppose H.R. 1645.
Maxine Waters.
Keith Ellison.
Michael E. Capuano.
Joyce Beatty.
Emanuel Cleaver.
Wm. Lacy Clay.
Al Green.
Stephen F. Lynch.
[all]