Only in the rarified world of Washington could lawmakers push legislation dubbed a “jobs bill” to help small business that actually does almost nothing to help small business—and imposes more risks on investors, and throws more money to Wall Street banks, and sets back corporate governance a full 10 years.
Nevertheless, that is exactly what happened last week.
Let's start with the news. The House of Representatives passed HR 3606, the Reopening American Capital Markets to Emerging Growth Companies Act, 390-23. Billed as a measure to help small businesses enter the capital markets, the legislation creates a new category of filer, the “emerging growth company.” EGCs are defined as companies with less than $1 billion in revenue, less than $700 million in market capitalization, and have been public for less than five years.
ECGs will receive numerous exemptions from existing corporate governance laws, including:
- Section 404(b) of the Sarbanes-Oxley Act, which requires external auditors to review the company's internal control over financial reporting;
- Shareholder advisory votes on executive compensation, as now required under the Dodd-Frank Act;
- Any rule to disclose the ratio of CEO pay to median worker pay, assuming the Securities and Exchange Commission ever gets around to adopting one;
- Any rule the Public Company Accounting Oversight Board might adopt to require mandatory rotation of audit firms, as the PCAOB is currently considering, or any new rule requiring an “Auditor Discussion & Analysis” in the auditor's report;
- Any other new standard from the PCAOB “unless the PCAOB determines that the application of such additional requirements… is necessary in the public interest.”
The bill also allows EGCs to submit a confidential preliminary registration statement to the SEC; agency staffers would then conduct a nonpublic review of the statement and return it to the company for further thought.
Next up is a hearing this week by the Senate Banking Committee for its companion legislation, SB 1933, sponsored by Sen. Charles Schumer, D-N.Y. (New York—you know, the state where Wall Street is.) The Obama Administration has also indicated its support for the bill, so assuming it passes the Senate as well, it could become law later this spring.
Those are the facts of the situation at first glance. Now let's plainly state what Congress really wants to do: rescind corporate governance rules so that more companies can go public more quickly, which sends more business to their wealthy benefactors on Wall Street who will reap millions in fees for taking these companies public. What Congress is not doing is protecting investors, nor is it doing much to create jobs—other than for analysts and underwriters at Wall Street firms, that is.
Here are several more facts worth considering:
- Most small businesses are not publicly traded, and never will be publicly traded.
- Most small businesses are not backed by venture capital, and will never take venture capital.
- Non-accelerated filers already exempt from Section 404(b) experience a higher rate of financial restatements than larger filers that do comply with Section 404(b).
- The market in the United States for initial public offerings, while not as brisk as pre-2008, is nowhere near collapse.
Had Congress seriously wanted to help small businesses, it would have addressed that sector's truly pressing needs, such as the rising cost of healthcare insurance, a transportation spending bill, or the shortage of skilled labor. None of that happened, of course. In fact, the transportation spending bill collapsed in Congress just last week, yet another example of House Speaker John Boehner's inability to get anything done. The jobs bill is little more than a diversion to help the Republican party look good in election season, and House Democrats lamely went along with it.
Congress enacted the Sarbanes-Oxley Act in 2002 to achieve one goal: improve the reliability of financial statements. We had seen a whole parade of businesses restating results—many due to simple management competence, but the most egregious due to outright fraud—and the voting public wanted better assurances that scam artists on Wall Street wouldn't tank the market and ruin their 401(k) balances. SOX was the result.
As usually happens with Congress, the result was far from perfect—but it did work. Companies started cracking open their accounting systems in 2004, found all sorts of flaws, restated all sorts results in 2005 and 2006, and then… things got better! Corporate America, particularly those subject to Section 404(b), started reporting fewer financial restatements. Number of restatements from accelerated filers in 2005: 513. Number of restatements from that same group in 2010: 136.
Compliance with SOX 404 is nobody's idea of a good time, but we do live under a capitalist system. Owners of capital—a group often overlooked in Congress, commonly known as “investors”—need an accurate understanding of their risks, including the risk of restatement, if the market is going to set accurate prices for company stock. When you under-estimate that risk (by exempting companies from Section 404(b) of SOX), the investment seems safer, so the price rises. That enriches the company insiders and the Wall Street firms taking a startup public, but should a restatement ever occur, the pain will be that much sharper for the rest of the market.
Consider, for example, Groupon. Had this jobs bill been in effect last year, Groupon could have submitted a confidential registration statement to the SEC for a preliminary review before its IPO last fall—and nobody would have known that the SEC objected to Groupon's cockamamie, self-invented accounting metric to make its growth prospects more promising. That would be no service to the investing public, which is entitled to know when a company going public is run by unimpressive executives. Groupon, by the way, is currently trading at half its offering price.
Do you want to say that financial reporting rules have grown too complex? I agree. But wishing away the need to test controls is not the solution, any more than wishing away the building inspector makes a complex construction project safer to build. We have much need for reform of capital markets in this country—but repealing prudent inspection of companies entering those markets isn't one of them.