Will Obama and Congress Slay the Sarbox Job-Killing Monster?
In President Obama's 33-minute-long speech to Congress on job creation, one sentence was worth nearly all the rest of his 4,000 words.
In the middle of trotting out the tired old "solution" of stimulating by taxing, borrowing and even more spending, the president had one brief outline of a potential agenda item that was new and surprising. And if he indeed follows through with the initiative he hinted at, it will probably do more to boost job growth than the entire so-called American Jobs Act he dropped in Congress' lap on Monday.
In the middle of the speech last Thursday, Obama said, "We're also planning to cut away the red tape that prevents too many rapidly growing start-up companies from raising capital and going public." The next day, Bloomberg reported that "the administration will work with the Securities and Exchange Commission to review rules, including those put in place by the Sarbanes-Oxley Act passed in 2002 to impose stricter accounting rules."
It remains to be seen if Obama will do any more than review Sarbanes-Oxley. But if he were looking for burdens to business growth and job creation, he certainly has the right target in his crosshairs.
Mostly through a vague mandate in the law's Section 404 for documenting "internal controls," Sarbox has made companies responsible for documenting the tiniest minutiae of little importance to shareholders. Referred to as the Accountants' Full Employment Act, Sarbox has made the Big 4 accounting firms rich at the expense of growth in nearly every other industry.
Rushed through Congress in the wake of the Enron and WorldCom scandals, Sarbox passed unanimously in the Senate and with only three dissenting votes in the House. (The wise three were former Rep. Mac Collins, R-Ga.; Rep. Jeff Flake, R-Ariz., and current Rep. and GOP presidential candidate Ron Paul, R-Texas).
But soon members of both parties would express some buyer's remorse. By 2006, House Democratic leader Nancy Pelosi would decry Sarbox's "unintended consequences" and proclaim, "I don't think you need the whole package." But because of the misplaced blame for the financial crisis - a financial crisis that Sarbox did nothing to prevent - on deregulation rather than poor regulation, both parties largely abandoned efforts to scale back the law.
Despite fading from the policy spotlight in DC, Sarbox remains a significant burden keeping the U.S. economy from reaching its potential. U.S. initial public offerings dropped off dramatically after Sarbox's passage and have never come back. According to statistics from University of Florida finance professor Jay Ritter, in no year after Sarbox's passage has the number of IPOs reached that of the slow-growth and recession years of 1991 and 1992, let alone the late '90s boom years.
And the law still disproportionately burdens smaller public companies. Much has been made of prominent IPOs this year such as the one for LinkedIn and the forthcoming Groupon, and we should indeed celebrate these American success stories. Overlooked, however, is that much of the internal growth at these firms has already occurred. Most of these companies have already reached large-cap status with market valuations of more than $1 billion.
But smaller companies, which routinely would raise money by going public in the ‘80s and 90s, are caught in a Catch-22 with the Sarbox accounting regs. According to a Securities and Exchange Commission study released this April, for small-cap and micro-cap companies with market valuations between $75 million and $250 million, the cost of first-year compliance with the "internal control" mandates equals an amazing 77 percent of their total assets. Even after four years, this cost only goes down to 41 percent the firms' total assets.
These midsize upstart firms, according to research by the respected Kauffman Foundation, are the ones most likely to be the net job creators. And their sources of funding are limited. If they can't raise equity financing through the stock market, they have to scrounge for funding in an already overcrowded debt market. And that funding is limited, particularly in a slow economy
Politically, if Obama wanted to scale back or repeal a big regulation, this would be an excellent candidate. The law was signed by George W. Bush (though largely drafted by the Democrat-controlled Senate that came after the Jim Jeffords switch, as I explained in National Review in 2005), and Republicans foolishly never took the opportunity to relax or repeal it when they were in power. Thus, Obama does not have to go back on legislation he supported and can even triangulate to the "right" of the Bush administration.
After that, it's hard to see what priorities Obama would be sacrificing through a relaxation or repeal of this law. Sarbox hits start-up companies in politically favored industries such as alternative energy every bit as much as it hits other firms.
At the very least, Obama's speech gets this specific burden to economic recovery back on the policy table. And who knows? Maybe this president will even pull a Jimmy Carter, who deregulated airlines and trucking after decades of rigid price-setting rules.
If repealing or scaling back Sarbox is where President Obama wants to go, Republicans in Congress should certainly help him get there. If not, and he merely wants to "review" the law, they should go there themselves. America's bold entrepreneurs and risk-taking investors deserve nothing less.