A Breather From Regulations
‘It’s so meager,” proclaimed House Minority Leader Nancy Pelosi on March 9, the day after the House passage of the Jumpstart Our Business Startups (JOBS) Act, a bill to reduce regulations on businesses that raise capital. Though Pelosi had voted for the bill, as had 157 other Democrats and all the Republicans who were present, she belittled the accomplishment as a “little king” and at most a “jobs bill lite.” A few days later, the bill — which also garnered the support of such staunch liberals as Barney Frank (D., Mass.) and Maxine Waters (D., Calif.), and was supported by the Obama administration — suddenly became “radical.”
“Democrats have belatedly woken up to the act’s radicalism,” stated The Economist. The usual suspects who treat regulation as religion — the AFL-CIO, the New York Times editorial page, etc. — came out in full force against the bill. When the bill came before the Senate, Jack Reed (D., R.I.), Carl Levin (D., Mich.), and Mary Landrieu (D., La.) spearheaded an amendment that would have weakened or gutted every measure of regulatory relief in the House bill. The amendment got the vote of every Senate Democrat and Senator Scott Brown (R., Mass.), but fell short of the 60 votes it needed to move forward. Eventually, 25 Democrats — nearly half of the party’s Senate caucus — joined the unanimous Republicans to pass a bill that contained almost all the provisions of the House version.
In truth, the JOBS Act, which President Obama is set to sign today, is neither meager nor radical. It will reduce some significant regulatory barriers to job creation, most notably the accounting mandates of the Sarbanes-Oxley Act of 2002. The IPO Task Force — an Obama-coordinated gathering of entrepreneurs, investors, and academics — found that the regulation-induced decline in the number of U.S. initial public offerings over the last decade may have cost the economy as many as 22 million jobs.
Is election-year politics playing a role in the Obama administration’s sudden concern about red tape? Certainly, and Sarbanes-Oxley regulations are a politically smart choice as a target, since the act burdens the high-tech and “green tech” companies Obama champions, as well as many other firms. Also, whereas several other major regulatory efforts were signed by Obama himself — such as Obamacare and Dodd-Frank — Sarbanes-Oxley was signed in 2002 by George W. Bush. (In fairness, the JOBS Act does contain a modicum of Dodd-Frank relief as well.)
But politicians’ mixed motives should not detract from the fact that this bill, which does not spend a dime of taxpayer money, will do more to create jobs — by getting out of the way and letting the private sector create jobs — than most every so-called stimulus package that Congress has passed over the last few years.
The JOBS Act is based on the finding — from the IPO Task Force, and from respected research institutions such as the Kauffman Foundation — that young firms, the “emerging growth” companies responsible for the bulk of American job creation, are being hobbled by loads of red tape from Sarbanes-Oxley and other mandates.
Some of these findings were incorporated this fall into a report of President Obama’s Council on Jobs and Competitiveness. As the council noted: “Well-intentioned regulations aimed at protecting the public from the misrepresentations of a small number of large companies have unintentionally placed significant burdens on the large number of smaller companies. As a result, fewer high-growth entrepreneurial companies are going public. . . . This hurts job creation, as the data clearly shows that job creation accelerates when companies go public.”
The JOBS Act would significantly reduce these burdens. It does so in two main ways.
First, it lifts the “threshold” at which a business must register with the Securities and Exchange Commission from 500 to 1,000 shareholders (and to 2,000 shareholders for community banks), and exempts employee shareholders from this count. Companies registered with the SEC are subject to most of the provisions of Sarbanes-Oxley, some provisions of Dodd-Frank, and numerous other SEC mandates.
As Senator Pat Toomey (R., Pa.) explained recently on the Corner, with a higher shareholder limit, “small- and medium-sized businesses will have greater access to privately raised capital, and greater opportunities for growth.” And by exempting employees from the count, the JOBS Act offers greater opportunities for workers to become owners and share in the wealth.
Second, if a company wants to raise substantially more capital by going public, the JOBS Act gives it a running head start, temporarily exempting it from some of the most burdensome mandates of Sarbanes-Oxley and Dodd-Frank. Under the JOBS Act, companies launching an IPO would be exempt from these rules until their fifth anniversary of going public, reaching $1 billion in annual revenues, or reaching $700 million in market valuation, whichever comes first.
It is clear that companies create more jobs when they go public; virtually no one has disputed the IPO Task Force’s finding that 90 percent of a public company’s job creation occurs after it goes public. Rather, JOBS Act opponents claim that reducing regulation won’t encourage IPOs.
To explain the current decline in IPOs, these opponents typically point to the bad economy. This theory is easily refuted by a simple look at IPO numbers over the last two decades. In the years since Sarbanes-Oxley was passed in 2002 — a span that included good economic times as well as bad — not once has the number of IPOs come close to the numbers recorded during the slow-growth years of the early 1990s, let alone the boom years of the later part of that decade. As I noted in testimony to the House Energy and Commerce Committee, using data I compiled from the IPO Task Force report, there were about 50 more IPOs in 1991 than there were in 2006 or 2007, relatively good years for economic growth. The decline is especially severe among small firms; as noted by the Obama jobs council, “the share of IPOs that were smaller [in market valuation] than $50 million fell from 80 percent in the 1990s to 20 percent in the 2000s.”
In fact, there is considerable evidence that IPOs helped power the U.S. out of the early-1990s recession and into the boom. Among the stock offerings in those years were the now-familiar corporate names of Cisco Systems in 1990, Starbucks in 1992, and PetSmart in 1993. With the 1990s as a backdrop, a 2009 academic paper concludes that “greater flexibility in issuing equity . . . allows for milder business cycles.”
But today, the flexibility to issue equity has been greatly impeded by Sarbanes-Oxley. The SEC has found that one aspect of the law that is tackled by the JOBS Act, the “internal-control mandates” of Section 404, alone costs public companies an average of $2.3 million per year. And a 2011 study found that these mandates cost even the smallest public firms an average of more than $1 million a year. “Effects of this order of magnitude could cause private companies to simply forgo growth opportunities and stay small,” the study concludes.
Who knows how many jobs or how much wealth these firms could create if liberated from this red tape? Home Depot co-founder Bernie Marcus, whose firm raised capital by going public in 1981, when it had just four stores, has said that the company likely would not have gotten off the ground if today’s regulations had been in effect. And if Home Depot hadn’t succeeded, jobs would not have been the only thing that was lost. Millions of dollars of wealth would not have been created for the ordinary investor who took risk but grew rich with the company.
The JOBS Act does nothing to deter the vigorous prosecution of fraud under federal and state law. Investors, however, will be more able to choose the level of risk they wish to assume. And remember that despite Sarbanes-Oxley, Lehman Brothers and General Motors still imploded, as no stock can be 100 percent risk-free.
To paraphrase my boss, there will still be 9,999 commandments from the government even after the JOBS Act is signed, with many more still coming from the Obama administration. But with this breather from regulations that impede essential capital-market functions, Obama and the GOP House have definitely made a good start.