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

Capital Markets

2025-06-25

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Source: Congress.gov

Summary

This meeting of the subcommittee on capital markets focused on re-evaluating the Sarbanes-Oxley (SOX) Act, particularly Section 404, to address the costs of compliance in modern capital markets and its impact on companies. The discussion aimed to determine if current regulations effectively protect investors without unduly hindering the growth and public market access for small and emerging businesses.

Themes

Cost of SOX Compliance and Impact on Growth and Innovation

The Sarbanes-Oxley Act, especially Section 404B, imposes significant and disproportionate costs on small and emerging companies, often exceeding $1 million annually. These compliance expenses do not scale with company size, making them particularly burdensome for startups and pre-revenue firms. For example, Arcutis Biotherapeutics reported spending $11 million on 404 compliance, with auditor fees more than doubling and increasing by 24% annually. These costs divert crucial resources that could otherwise be invested in research and development, hiring, and business expansion. Research indicates that SOX negatively impacts both the quantity and quality of innovation for young lifecycle firms, leading to reduced R&D spending and a shift towards less groundbreaking research. Such compliance burdens are seen as discouraging companies from going public or even leading existing public companies to consider privatization. Firms are observed managing their public float downward to avoid triggering SOX thresholds, indicating a willingness to sacrifice market valuation to bypass compliance costs.

Effectiveness and Benefits of SOX

While SOX was enacted to restore investor confidence and deter financial manipulation after major corporate scandals, its benefits, particularly those of Section 404B, are debated. Critics argue that compliance does not equate to accuracy, and strong internal controls do not guarantee accurate financial reporting. Financial restatements persist, and internal control reports often serve as post-mortems rather than early warnings, casting doubt on their preventative efficacy. However, some, like Professor Coates, emphasize that SOX, primarily a disclosure law, has significantly improved financial reporting quality and capital allocation. Professor Allen's research, while highlighting the negative impact on young lifecycle firms, also acknowledges that most companies subject to 404B experience improved financial reporting quality.

Role and Future of the PCAOB

The Public Company Accounting Oversight Board (PCAOB) was a direct response to the accounting scandals of the early 2000s, aimed at restoring trust in financial reporting. Concerns were raised about proposals to defund or dismantle the PCAOB, with some arguing that it would "defund the police in the suites" and lead to a resurgence of fraudulent practices. The PCAOB holds unique authority, including access to audit firms in China, which the SEC does not, making its potential abolition or transfer of functions to the SEC problematic for oversight of foreign-based companies. [ 00:27:58 ]

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 While the PCAOB is self-funded, a transfer to the SEC would likely result in an unfunded and disastrous overnight transition, potentially increasing taxpayer burden. [ 01:10:30-01:10:54 ]

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 Both the PCAOB and the SEC possess existing authority to adjust and tailor SOX obligations and audit standards, suggesting that many reforms could be implemented without new legislation.

Proposed Reforms and Modernization

There is broad agreement on the need to modernize SOX to make public markets more attractive and efficient while maintaining robust financial integrity. Proposed reforms include adjusting dollar thresholds for SOX exemptions to reflect current economic realities and inflation. Other suggestions involve using soft triggers or rolling averages for public float and revenue thresholds, and extending Emerging Growth Company (EGC) status from five to 10 years. Experts also recommend refocusing audit standards on judgment and substance rather than rigid processes and systems, and exploring less frequent audits for companies with proven good track records. A key suggestion is for Congress to engage directly with the SEC and PCAOB to explore these proposed adjustments, leveraging their ability to implement changes more quickly and adaptively than new legislation.

Tone of the Meeting

The tone of the meeting was primarily divided and earnest, reflecting contrasting views on the Sarbanes-Oxley Act's effectiveness. While some members and witnesses emphasized SOX's role in providing essential investor protections and market stability, others underscored the excessive compliance costs that burden small and emerging companies, hindering innovation and growth. There was a strong, shared concern regarding the high and disproportionate costs of SOX compliance for smaller entities. Despite these disagreements, there was a general desire for modernization and reassessment of the law to strike a better balance between investor protection and capital formation. The discussion also included political undercurrents, particularly concerning the PCAOB's funding and future. The Chair concluded the meeting by praising the robust participation from all members.

Participants

Transcript

Good morning.  The subcommittee on capital markets will come to order.  Without objection, the chair is authorized to declare recess of the committee at any time.  This hearing is titled, Reassessing Sarbanes-Oxley, the Cost of Compliance in Today's Capital Markets.  Without objection, all members will have five legislative days within which to submit extraneous materials to the chair for inclusion in the record.   I now recognize myself for four minutes for an opening statement.   Good morning again and thank you to our witnesses for being here today.  Today's hearing is about making our public markets work again for the companies that fuel our economy.  Small, innovative firms that want to grow, hire, and bring new products to market.  We're here to examine whether parts of the Sarbanes-Oxley Act, particularly Section 404, are doing more to burden those companies than to protect investors.   When Sarbanes-Oxley or SOX was passed in 2002, it had a clear purpose to restore trust in financial reporting after several major corporate scandals.  But more than two decades later, it's time to ask whether its most burdensome provisions are still serving investors or merely discouraging companies from ever going public in the first place.   For many small companies, Section 404B has become a major obstacle.  It requires companies not only to assess their own internal financial controls, but also to pay for an external auditor to effectively repeat that process.  That's why many refer to it as a, quote, double audit.  The cost can exceed $1 million per year, and even for pre-revenue biotech firms and small cap innovators.   These costs don't scale.  Again, they don't scale.
Whether a company generates $50 million or $5 billion, the compliance checklist is largely the same.  For a large company, that may be manageable.  But for a startup, it's often the difference between expanding operations or laying off staff.   And compliance costs have not gone down over time.  In fact, recent surveys show costs are rising, driving more hours, more documentation, and broader audit scopes.  At the end of the day, Main Street investors are footing the bill.  Whether it's through reduced returns, fewer IPOs, or the lost chance to invest early in the next great American company.  Meanwhile, the benefits are unclear.   Internal control weaknesses remain stubbornly high.  Many firms only disclose problems after issuing financial restatements.  That's not the sign of a healthy system.  We've also heard from companies that structure their growth, fundraising, and even equity float to avoid triggering 404 .  That's an indictment of the rule's real-world impact.   Capital formation shouldn't be driven by how to avoid a duplicative audit.  A regulatory framework that deters companies from entering the public markets doesn't strengthen investors' confidence.  It weakens long-term economic competitiveness.  To be clear, this is not about undermining investor protection.  It's about ensuring those protections are effective and proportionate.   Congress and the SEC have taken steps to tailor SOX obligations for emerging growth companies and smaller reporting companies.  But the current framework remains overly complex and poorly suited to today's economy, especially for firms that are asset-light, IP-driven, and increasingly global in structure.
Today's hearing is an opportunity to hear directly from the people who live these rules every day.  Our job is to ensure that the path to becoming a public company is not paved with unnecessary barriers.  Public markets should be open to companies of all sizes, not just those that can afford to navigate an outdated compliance regime.   I would now like to recognize my friend, the ranking member of the subcommittee, Mr. Sherman, for four minutes for an opening statement.
Thank you.  I believe I'm the only one here who was here for, oh, and then Mr. Lucas was also here for Sarbanes-Oxley.  And you were here.  Yeah.
M
Mr. Lawrence Cunningham
Damn.
I'm not as old as I think I am.  A few of us were here for Sarbanes-Oxley.   We remember WorldCom, we remember Enron, and the need for a PCAOB.

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