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Winners and Losers in Governance Rollbacks

Matt Kelly | March 26, 2012

Well, for better or worse, Congress now seems poised to pass the JOBS Act this week. From here forward, a large swath of companies going public on U.S. capital markets will be classified as “emerging growth companies” and receive a five-year exemption from the corporate governance and investor protections Washington has instituted over the last decade.

My views on the wisdom of this law are no secret. You can see our full coverage of the JOBS Act's implications elsewhere in our newsletter, and I suspect we'll be reporting on many other consequences of the law—good and bad—for a long while to come. For now, let's dissect some of the more immediate winners and losers.

Who Wins

  • Wall Street. Fewer restrictions on initial public offerings means more companies that can file IPOs more quickly, with Wall Street banks eager to help them—for a fee. If anyone wonders why Sen. Charles Schumer, Democrat from New York, supported the rollback legislation so strongly despite its glaring mistakes: He was simply representing his most important constituency.
  • Venture-backed startups. Venture capital firms have only one goal in mind when they fund a company: the exit event. The governance rollback legislation makes those exit events that much easier to achieve, especially for dud startups that larger corporations don't want to acquire.
  • Washington lawmakers. Congress can now give the appearance of bipartisan progress to support small business, even if the rollback actually does little to help the vast majority of small businesses in the United States.
  • Audit firms. Remember that the JOBS Act includes an exemption from any rule the Public Company Accounting Oversight Board might pass that requires companies to rotate audit firms. That will allow audit firms to forge relationships that much longer and closer with their clients, and is probably one reason why the Center for Audit Quality has received some criticism about its stance during this debate. In fairness, the CAQ did co-sign a letter (all three paragraphs of it) with the Council of Institutional Investors complaining that the JOBS Act would harm the independence of standards-setting bodies.

Who Loses

  • Audit firms. Slapping at the PCAOB is nice, but also remember that the JOBS Act now allows emerging growth companies to submit only two years of audited financial statements to investors, not three—so that's one year's worth of business the audit firms won't get. EGCs will also be exempt from the external auditor reviews of their internal controls as required by Section 404(b) of the Sarbanes-Oxley Act; that's another piece of business gone.
  • The SEC. The SEC has long been a punching bag for Congress, and its arguments to preserve investor protection fell on deaf ears. Worse for the agency: as more investors do fall victim to scam artists, that much more work will fall to the already over-stretched Enforcement Division.
  • The PCAOB. Just when the PCAOB started to talk seriously about holding audit firms more accountable, Congress has moved to take that power away. First is the JOBS Act, barring the PCAOB from imposing any requirement for rotating audit firms onto emerging growth companies; now Congress is moving to outlaw any standard for audit firm rotation at all
  • Investors. Not only does the JOBS Act repeal newer investor protections such as the external auditor review of internal control, or shareholder advisory votes on executive pay; it skewers long-held tenets of disclosure and protection such as a public review of a company's registration statement. The legislation is entirely about easing the path for companies to go public, and it does nothing to enhance investor protections in an already risky world.

Who Doesn't Matter

  • Small businesses. Other than VC-backed startups, most small businesses are not public and never do go public. The rollback legislation will have no effect on them.
  • Large businesses. Sorry, Corporate America; you are not emerging growth companies, so SOX and the Dodd-Frank Act are still with you. That group includes the darling of 2012's IPO class, Facebook, whose annual revenue easily exceeds the $1 billion ceiling to qualify as an EGC.