Small Biz Jobs Act Is a Bipartisan Bridge Too Far
A spirit of bipartisanship is sweeping Capitol Hill, with lawmakers poised to approve a package of bills aimed at reducing regulatory burdens on small business.
We wish we could raise a glass. This moment has been too long in coming. But the legislation it has spawned would be dangerous for investors and could harm already fragile financial markets.
At issue is a measure called Jumpstart Our Business Startups, or JOBS Act, which lawmakers in both parties claim would relieve small businesses seeking to raise capital from burdensome regulations, and thereby create jobs. The U.S. House overwhelmingly passed the measure 390-23 last week, and the Senate is expected to consider it this week. The White House has said President Barack Obama will sign the legislation.
We agree that red tape can needlessly tie up small companies. We also agree that securities laws that bar startups from harnessing the power of the Internet to raise funds could use updating. And it makes sense to allow, as the bill does, an initial public offering on-ramp, which would give startups a chance to grow before saddling them with certain costly and time-consuming regulations.
But the JOBS Act goes too far. It would gut many of the investor protections established just a decade ago in the 2002 Sarbanes-Oxley law. A wave of accounting scandals -- think Enron and WorldCom -- had destroyed the nest eggs of millions of Americans and upended investor confidence in Wall Street. The relief would extend beyond small businesses and apply to more than 90 percent of companies that go public.
At the center of the is a new class of emerging growth companies, defined as those with as much as $1 billion in annual revenue, which would be exempt from a host of disclosure, reporting and governance rules. These companies would be able to operate for up to five years without an independent test of their internal controls -- the checks and balances that help companies prevent outright fraud and costly accounting mistakes.
Emerging companies would also be able to promote public offerings with less-than-complete information by “testing the waters” with fancy PowerPoint slides and other pre-IPO materials. Executives wouldn’t be held accountable for any misrepresentations. To go public, companies would ultimately have to file an official prospectus -- where they must reveal their financial secrets, warts and all -- with the Securities and Exchange Commission. But investors who have seen the glossy brochures might never read those documents.
These companies would also be able to use so-called crowd-sourcing to raise capital, an idea that deserves support. The bill, however, puts an overly high $2 million ceiling on what entrepreneurs can raise with little oversight (more on that later).
Perhaps most disappointing, the bill rolls back rules meant to prevent analysts from misleading investors by talking up stocks simply to win investment banking business. Such conflicts of interest were banned in 2003, after federal and state investigations revealed analysts were privately deriding stocks they were publicly touting and failing to disclose conflicts.
Supporters of the bill point to the falloff in initial public offerings as evidence that regulatory costs are dissuading entrepreneurs from creating businesses or taking them public. And they say rescinding the analyst research restrictions would benefit small companies, which Wall Street otherwise ignores.
That sounds great in theory, but the reality offers a different picture. It’s true the number of initial offerings has declined, but evidence suggests that has less to do with regulation and more with global economic trends.
IPOs of small companies -- those with less than $50 million in annual sales -- have declined more than 80 percent since 2001. It would be easy to blame the Sarbanes-Oxley law, which ushered in sweeping accounting and governance rules after a series of bankruptcies revealed that companies were cooking the books and auditors were looking the other way. But the SEC has long exempted companies with less than $75 million in sales from some of the law’s more onerous provisions, including the most costly of all, the internal controls audit.
As Jay Ritter, a finance professor at the University of Florida has documented, the decline in IPOs is related to declining profitability of small businesses. Many are opting to merge with larger companies to quickly get bigger and more profitable, rather than go public.
What’s more, many of the rules the bill seeks to upend have helped companies, including the internal controls rule. An SEC study, for example, found that such audits helped companies avoid financial restatements, which are costly exercises that often drive down share prices.
Luckily, a bipartisan group of senators has realized the damage this package could inflict and plans to offer changes during this week’s floor consideration. Among them: lowering the threshold for emerging growth companies to $350 million in annual sales. That’s a vast improvement, but probably still too high -- $350 million in sales isn’t exactly small beer.
The senators would cap the amount raised through crowd-funding at $1 million, and require those soliciting funds to register with the SEC. To help unsophisticated investors, it would cap investments at the greater of $2,000 or 5 percent of income for those who earn less than $100,000. (Those earning more could contribute a maximum of $100,000 per year.)
The senators would also wisely prevent analysts from recommending the pre-IPO stock of an emerging growth company.
There is room to improve small-business rules, but Congress should tread carefully. History is full of examples of legislation enacted in the name of deregulation, only to have it backfire. The 1999 Gramm-Leach-Bliley Act, which ended the Depression-era ban against mixing investment and commercial banking, and the 2000 Commodity Futures Modernization Act, which allowed explosive, but unregulated, growth in over-the-counter derivatives, are two. Both laws helped set the stage for the 2008 financial collapse.
It shouldn’t be necessary to gut investor safeguards to promote job creation. If investors lose confidence because of worries about fraud, they will demand a higher return on their money, raising the cost of capital for all.
To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at email@example.com.