Federal Regulations Should Draw as Much Scrutiny as Facebook IPO

Facebook’s fall following its much-hyped initial public offering has politicians scrambling for “solutions.” But were it not for politicians’ meddling, Facebook’s and other recent IPOs probably would not be as prone to problems in the first place. Overregulation may have made the IPO of Facebook and other IPOs too big to succeed in generating a return for ordinary investors.

The size of Facebook’s IPO — over $100 billion in market capitalization — has attracted much attention. But a decade ago, even a $1 billion IPO — which LinkedIn, Groupon, and others have all exceeded in the past couple years — was unheard of. Before the last decade, as noted by President Obama’s Council on Jobs and Competitiveness, 80 percent of IPOs had market caps of less than $50 million.

In fact, Home Depot only had four stores when it went public in 1981. As the retail chain grew, so did the portfolio of its initial investors. This is also true for Starbucks, PetSmart, and other firms that went public in their early growth stages before they became household names.

What changed?

The sheer amount of regulation that burdens smaller public companies. Home Depot cofounder Bernie Marcus has said many times that his company never could have gone public when it was that small if provisions of the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010 had been in effect back then. The Securities and Exchange Commission has calculated that the average annual cost of one Sarbanes-Oxley provision alone — the mandates requiring extensive audits of a company’s “internal controls” — comes to $2.3 million per public company and hits smaller public firms the hardest.

Even the Obama administration, not generally known as a critic of regulation, agrees there is too much red tape strangling smaller public firms. As President Obama’s jobs council has 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.”

That fewer firms are going public, and that others wait until they are almost as big as Facebook before doing so, is bad news for both the investing public and for job growth. There are fewer opportunities for middle-class investors to add small-cap stocks to enhance the growth of diversified portfolio. Research noted by the Obama Jobs Council indicates that 90 percent of a public company’s job creation occurs after it goes public. Every dollar a smaller firm can raise by going public is one less dollar it has to beg for from a bank, and one more it can use to expand and add jobs.

But there is some good news. Since the bipartisan Jumpstart Our Business Startups Act passed Congress and was signed by President Obama in early April, there has been a trickle of smaller firms returning to the IPO market. Among other things, the JOBS Act creates a five-year “on-ramp” for most firms going public in which they are exempt from the Sarbanes-Oxley internal control mandates, costly provisions of Dodd-Frank that specifically apply to public companies, and other burdensome regulations.

Despite Obama’s signature, the JOBS Act has been bashed by the usual suspects to whom regulation is religion — i.e., The New York Times editorial page and Rolling Stone’s Matt Taibbi — as somehow benefiting giant corporations and the “big banks.” But the data shows the first firms taking advantage of this law are the small, growing firms that supporters of the law had pointed to as beneficiaries. ClearSign Combustion, a Seattle-based firm that makes energy-efficient furnaces, launched an IPO with a market cap of just $12 million and cited the JOBS Act as allowing it to do that.

Those launching Facebook’s IPO should be held accountable if any rules were violated. But smaller firms should not be punished for Facebook’s failure with more red tape. Both big and small stocks carry certain risks that must be weighed against potential return. But investors and entrepreneurs should hope that the smaller public offerings enabled by the JOBS Act and future prudent deregulation are the wave of a prosperous future.