As Republican lawmakers seek to reduce compliance burdens for public companies, Section 404(b) of the Sarbanes-Oxley Act of 2002 was once again the main topic of discussion during a House hearing.
The law was enacted to restore trust in financial reporting. “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,” said Rep. Ann Wagner (R-MO), chair of the Capital Markets Subcommittee of the Financial Services Committee, on June 25, 2025.
“For many small companies, Section 404(b) has become a major obstacle,” she said, explaining that the cost can exceed $1 million a year. For large companies, the money spent on 404(b) is manageable but not for a startup–especially one still in the research and development (R&D) phase.
“We’ve also heard from companies that structure their growth fundraising and even equity float to avoid triggering 404(b). That’s an indictment of the rules’ real world impact,” Wagner said.
Business groups—especially the U.S. Chamber of Commerce and, more recently, biotech startups—have been lobbying Congress and the Securities and Exchange Commission (SEC) to exempt more classes of companies from Section 404(b), with some degree of success. This provision requires a public company’s external auditor to attest to management’s evaluation of its internal control over financial reporting (ICFR). The management’s assessment is required by Section 404(a).
Business groups have repeatedly argued that the costs far outweigh the benefits.
Investor advocates, on the other hand, have insisted that the provision is necessary to boost confidence in financial reporting and promotes capital allocation. Congress passed the 2002 law in response to accounting scandals at companies like Enron and WorldCom that cooked their books.
Over the years, however, little by little, either Congress or the SEC exempted more categories of companies—based on their public float or revenues, from Section 404(b).
Now the debate is starting again, and it is likely that a receptive leadership at the SEC will provide Section 404(b) breaks to more companies in line with President Trump’s goal to rollback regulations.
Hearing in 2025
The GOP-led hearing featured four witnesses, with three primarily criticizing the costs of Section 404(b): Abigail Allen, associate professor of accounting, Brigham Young University; Lawrence Cunningham, director, Weinberg Center for Corporate Governance, University of Delaware; and Frank Watanabe, president and chief executive officer, Arcutis Biotherapeutics.
The last witness, John Coates, professor, Harvard Law School and invited to speak by Democrats, was the only one praising the benefits of Sarbanes-Oxley.
Brigham Young’s Allen, who conducted research on Section 404(b), said the provision had a bad effect on innovation.
“We find that SOX negatively impacts both the quantity and quality of innovation produced by young life cycle stage firms,” Allen said. “These firms spend less on R&D, produce fewer patents with lower citation counts.”
University of Delaware’s Cunningham argued that the section over time led companies to channel excessive resources to internal controls at the expense of financial reporting.
“Let me stress this core insight, compliance is not the same as accuracy,” he said. “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 as if they are the goal rather than the means.”
Arcutis, which was founded in 2016 to develop treatments for skin diseases like psoriasis and eczema, has spent $11 million on compliance with 404(b) to date, said CEO Watanabe.
“And those are costs that are rising inexorably,” he said. “For example, last year alone, our auditor fees were increased by 24%. Our switch to 404(b) roughly doubled our auditor fees. And as a small firm, we had to bring in outside control and compliance resources that cost us about half a million dollars a year. The money we spend on unnecessary compliance is money that we don’t have to invest in developing life altering drugs.”
Harvard’s Coates, who briefly served as the SEC’s general counsel when Gary Gensler was chair, provided some counterpoints, emphasizing that the benefits of the law are clear.
He pointed out that Allen’s study “shows that most companies subject to 404(b) benefit; their financial quality is better as a result. And even in the period that she was studying, the costs did not outweigh the benefits.”
He did, however, say that regulators should be the ones to test out what the right threshold should be, not Congress, because they can work faster.
“We’re probably not going to know in advance what the right calibration is, and it’s the kind of thing you would want the agency to be able to fine tune over time,” he said. “If you block it into a statute—we all know in this room how hard it is to pass statutes—it’s likely to get outdated fairly quickly.”
He also noted that Sarbanes-Oxley delegates to the Public Company Accounting Oversight Board (PCAOB) and the SEC to make changes in how auditors go about their work.
The Capital Markets Subcommittee is exploring two draft bills. One draft bill would require the SEC to revise the threshold for smaller reporting companies (SRCs) from $250 million to $500 million in public float, among other things.
This article originally appeared in the June 27, 2025, edition of Accounting & Compliance Alert, available on Checkpoint.
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