Lawmakers, witnesses debate whether Sarbanes‑Oxley Section 404(b) deters IPOs and curbs innovation

At a House Financial Services subcommittee hearing, members and witnesses debated whether Section 404(b) of the Sarbanes‑Oxley Act imposes disproportionate compliance costs on smaller and early‑stage public companies and whether those costs reduce innovation and deter companies from going public. Testimony came from academics and business leaders who described measurable compliance costs and from governance experts who cautioned against weakening investor protections.

The discussion focused on the external auditor attestation required by Section 404(b), which witnesses said often requires duplicative testing of internal controls. "Section 404(b) had negative consequences for innovation for these firms," said Abigail Allen, associate professor of accounting at Brigham Young University's Marriott School of Business, summarizing research showing that firms she classified as "young life cycle stage" reduced R&D spending and produced fewer, lower‑value patents after becoming subject to 404(b). Allen told the subcommittee her study found declines she estimated at roughly 9–12% in R&D intensity and about a 6% decline in patent filings for that firm subset.

Frank Watanabe, president and CEO of Arcutis Biotherapeutics and vice chairman of BIO, described the costs his firm incurred after tripping into 404(b). "To date, we have spent around $11,000,000 on compliance with 404(b," Watanabe testified, adding that audit fees rose sharply after his company moved from 404(a) to 404(b): "our audit fees alone last year were $2,200,000. We still are in the middle of this year. I would estimate we'll probably be in the range of 2 and a half plus this year, just for our audit fees." He said his company doubled outside auditor fees when it switched to 404(b) and pays roughly $500,000 a year for outside compliance support.

Several witnesses and members urged tailoring or recalibrating the rule for smaller or early‑stage companies rather than wholesale repeal. "Our research suggests the impacts of SOX on financial reporting quality and innovation is not uniform," Allen said, recommending policy solutions that consider firm life‑cycle stage and strategic orientation in addition to size. Lawrence Cunningham, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, urged refocusing audit emphasis on the accuracy of financial statements rather than equating extensive internal control documentation with reporting quality: "Compliance is not the same as accuracy. A company can have strong internal controls and still misreport its financials or weak controls and report accurately. Yet, SOX treats internal controls as equivalent to financial reporting."

Members and witnesses outlined several concrete reforms under consideration: raise the public float and revenue thresholds that trigger 404(b) testing, apply rolling averages rather than point‑in‑time measurements, extend Emerging Growth Company timelines beyond five years, create an intermediate filer tier for low‑revenue/high‑valuation firms, and allow risk‑based or periodic (for example, multi‑year) testing of internal controls for firms with established track records. Watanabe urged averaging public float over 12 months and a three‑year rolling revenue average; Cunningham and others noted the PCAOB and SEC have scope to make regulatory adjustments and encouraged regulatory experimentation prior to statutory changes.

Not all witnesses supported large statutory changes. John C. Coates IV, professor of law and economics and deputy dean at Harvard Law School, emphasized that SOX is primarily a disclosure law and that some flexibility already exists. "If they ask you to do something that you and your judgment can explain is too costly for the benefit, you have the ability to do that as long as you explain that to your investors," Coates said, while also noting that agency and practical pressures often make compliance effectively mandatory.

Members pressed witnesses on tradeoffs between investor protection and capital formation. Ranking Member Brad Sherman (D‑Calif.) and others warned that insufficient oversight can lead to fraud and systemic losses; proponents of recalibration argued the fixed costs of 404(b) fall hardest on small or high‑innovation firms and that targeted adjustments could preserve investor protections while easing burdens that divert resources from R&D and hiring.

The hearing produced no votes or formal actions; members asked the SEC and PCAOB to consider regulatory fixes and suggested further hearings to explore changes. Witnesses agreed on the need to balance investor protection with capital formation, albeit with differing views on whether regulators or Congress should set the details.

The hearing record includes research citations and company‑specific figures introduced by witnesses; members gave the SEC and PCAOB time to respond in follow‑up sessions or written comments to be submitted to the committee.