The SEC’s concern about unicorns misses the point

Accounting

The Securities and Exchange Commission is worried about a lack of oversight in how large, private companies raise capital. To be clear, pushing for more transparency is simply an effort to correct the unintended consequences from the passage of the Sarbanes-Oxley Act in 2002. Indeed, investing in these firms has become so easily accessible, and private markets so deep and liquid, that there is little incentive for startups to ever go public, hurting small investors while big institutions reap the rewards.

The idea behind Sarbanes-Oxley was that public companies require an extra layer of accounting checks and internal controls that private companies do not in order to protect average investors in the wake of a number of high-profile accounting scandals in the early 2000s, including Enron Corp. and WorldCom Inc. But it made operating as a public company too onerous and expensive for many small firms. The result has been the decline in IPOs, denying individuals the potentially lucrative investment opportunities from getting in early on companies that have the potential to change whole industries. The number of initial public offerings since 2001 has plummeted 61% to 2,567 from 6,517 in the prior 20 years, according to data compiled by University of Florida finance professor Jay Ritter. Worldwide, there are more than 900 unicorns, or start-ups worth $1 billion or more, about twice as many as two years ago.

There are advantages to remaining private, not the least of which is the lack of scrutiny on things like revenue and earnings every three months, and dealing with the Wall Street analyst community. Also, there are no requirements to reveal executive compensation for the whole world to see. And don’t forget that the primary benefit to going public, accessing liquidity for insiders, has diminished over the years as the equity of private companies has become somewhat tradeable. Going public is a giant hassle that most unicorns avoid at all costs until they exceed the threshold of 2,000 investors set by the SEC.

The right thing to do is to make it easier for companies to go public rather than making it harder for them to stay private. Instead of layering more regulations on private firms, which would seem to go against the spirit of the Securities Act of 1933, the SEC should ease regulations on public firms. I’m not suggesting we should do away with quarterly and annual reports, but perhaps the accounting regulations that are the most expensive to comply with can be pared back. Remember, CEOs today risk going to jail by signing an earnings report and it later comes to light that a rogue employee has committed fraud. In hindsight, that seems to be an overreach that reflected the anger toward CEOs at the time.

The SEC is right that there needs to be a better way of counting investors in private companies. A venture capital fund that is an investor in a private company can have dozens of limited partners, and a “feeder fund” can have dozens more investors. It’s conceivable that a unicorn probably has well over 2,000 investors that directly or indirectly own the stock. And when you have that many investors, the company is essentially public and should probably be subject to rules and regulations governing public companies. That they don’t is a loophole that has persisted for many years without any attempt to close it.

The process of investing in big private companies isn’t very democratized. The types of investors who have been able to gain access to investing in private companies are generally wealthy and well-connected. I personally would love the ability to invest in SpaceX, which is currently valued at $100 billion. I think that it could one day be worth $1 trillion. But I’m just some loser in Myrtle Beach, South Carolina, and I don’t know any venture capitalists personally; therefore, I don’t get to participate in any gains.

We could safely repeal much of Sarbanes-Oxley, or at least the worst parts of it, without creating a wave of corporate crime. The type of fraud that was present in Theranos Inc., for example, had little to do with accounting practices. A lot of legislation is passed with the best of intentions, but without much thought about the costs. There’s a simple, common sense solution without layering additional regulation on companies, which will result in even more unintended consequences down the line.

Products You May Like

Articles You May Like

Some states offer assistance to families unable to afford funeral costs
Summary of the Latest Federal Income Tax Data, 2022 Update
Surgent releases new mobile study app
Navient is forgiving the student debt of 66,000 borrowers. How to know if you’re one of them
Tom Cruise space movie producers sign deal with Axiom to build studio in orbit

Leave a Reply

Your email address will not be published. Required fields are marked *