Tuesday, January 6, 2009

Another One Bites The Dust, and So Should Sarbanes-Oxley Act

Google trends alerts me to the sad(?) news that Adolf Merckle has committed suicide. I've got to be honest, I've never heard of this fellow and since he took the coward's way out, I really don't even feel too bad for him although I do have some sympathy for his family. This news only weeks after French investor Thierry Magon de la Villehuchet also took the coward's way out.

And while it seems almost unrelated, I do believe that our current economic crisis, included failed banks, failing automakers, failing investment firms, and from what we are told, failing everything and add to that the Madoff scandal and these suicides, along with all of the damage still to come, I'd say a good hard look at the Sarbanes-Oxley Act, which was supposed to establish standards and ethics and clean up all of the public companies that were a bit shady for lack of a better term, is warranted.

Of course, along with SOX came less American small business trying to go public, meaning less new ideas and creations are/were being funding and the old guard was all that was left to seek investor money and try to grow.  How many new technologies are sitting around in someone's garage because some inventor can't gather the funds for their product? How many American inventors, products or businesses have simply gone overseas with their work to avoid SOX? And where is there any proof that SOX has somehow made the market and public companies more responsible? It certainly didn't give investors much warning that the housing markets, mortgage lenders, banks, etc were about to fail.

The Wall St Journal has an article on SOX from 12/21/2008 asking the same basic questions. It's worth a read, and our legislators down in DC should have a read and consider getting government out of the free markets, or at least ditching SOX. A copy/paste of the original article appears below:



DECEMBER 21, 2008, 9:22 P.M. ET

Washington Is Killing Silicon Valley 
Entrepreneurship was taken for granted. Now we're seeing a lot less of it.

By MICHAEL S. MALONE

Even as economic losses and unemployment levels mount, America's most effective engine for wealth and job creation is being dangerously -- perhaps fatally -- compromised.
 
For more than 30 years the entrepreneurship-venture capital-IPO cycle centered in Silicon Valley has generated new wealth, commercialized innovation, and created new companies and industries. It's also spun off millions of new jobs. The great companies created by this process -- Intel, Apple, Google, eBay, Microsoft, Cisco, to name just a few -- have propelled most of the growth in the U.S. economy in the last two decades. And what began as a process almost exclusively available to scientists and engineering Ph.D.s became open to just about anyone with a good business plan and a healthy dose of entrepreneurial drive.

At its best, the cycle is self-perpetuating. Entrepreneurs come up with a new idea, form a team, write a business plan, and then pitch their idea to venture capitalists. If they're persuaded, the VCs invest, typically through several rounds during which the start-up company must meet performance benchmarks. Should the company succeed, it then makes an initial public offering of stock.

The IPO can reward the founders and venture-capital investors, and enables the general public to participate in the company's success. Thousands of secretaries, clerks and technicians at these companies also have come away from the IPO richer than they ever dreamed. Meanwhile, some of those gains are invested in new venture funds, and the cycle begins again.

It has been a system of amazing efficiency, its biggest past weakness being that it sometimes (as in the dot-com "bubble") creates too many companies of dubious viability. Now, this very efficiency may be proving to be its downfall.

From the beginning of this decade, the process of new company creation has been under assault by legislators and regulators. They treat it as if it is a natural phenomenon that can be manipulated and exploited, rather than the fragile creation of several generations of hard work, risk-taking and inventiveness. In the name of "fairness," preventing future Enrons, and increased oversight, Congress, the SEC and the Financial Accounting Standards Board (FASB) have piled burdens onto the economy that put entrepreneurship at risk.

The new laws and regulations have neither prevented frauds nor instituted fairness. But they have managed to kill the creation of new public companies in the U.S., cripple the venture capital business, and damage entrepreneurship. According to the National Venture Capital Association, in all of 2008 there have been just six companies that have gone public. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986.

Faced with crushing reporting costs if they go public, new companies are instead selling themselves to big, existing corporations. For the last four years it has seemed that every new business plan in Silicon Valley has ended with the statement "And then we sell to Google." The venture capital industry is now underwater, paying out less than it is taking in. Small potential shareholders are denied access to future gains. Power is being ever more centralized in big, established companies.

For all of this, we can first thank Sarbanes-Oxley. Cooked up in the wake of accounting scandals earlier this decade, it has essentially killed the creation of new public companies in America, hamstrung the NYSE and Nasdaq (while making the London Stock Exchange rich), and cost U.S. industry more than $200 billion by some estimates.

Meanwhile, FASB has fiddled with the accounting rules so much that, as one of America's most dynamic business executives, T.J. Rodgers of Cypress Semiconductor, recently blogged: "My financial statements are a mystery, even to me." FASB's "mark-to-market" accounting rules helped drive AIG and Bear Stearns into bankruptcy, even though they were cash-positive.

But FASB's biggest crime against the economy and the American people came when it decided to measure the impossible: options expensing. Given that most stock options in new start-up companies are never worth anything, this would seem a fool's errand. But FASB went ahead -- thereby drying up options as an incentive for people to take the risk of joining a young company and guaranteeing that the legendary millionaire secretaries would never be seen again.

Not to be outdone, the SEC has, through the minefield of "full disclosure" requirements and other regulations, made sure that corporate directors would never again have financial privacy and would be personally culpable for malfeasance anywhere in the company. This has led to a mass exodus of talented people from boards of directors in places like Silicon Valley. Full disclosure was supposed to make boards more responsible. Instead, it has made them less competent.

The most important government actions to foster business creation were the 1978 Steiger Amendment, which cut taxes on capital gains to 28% from 49%, and President Ronald Regan's tax cuts, which reduced them still further to 20%. These tax cuts unleashed the PC and consumer electronics booms of the 1980s, just as the Taxpayer Relief Act of 1997 restored the 20% rate and did the same for the Internet economy in the late 1990s.

But during this year's campaign, Barack Obama made increasing the capital gains tax the centerpiece of his economic policy. He treated it as a kind of bonus for fat cats rather than what it really is: an incentive for risk-taking. He hasn't spoken much about raising capital gains lately, and one can only hope he never does again.

That's because, combined with all of the other impediments put up this decade by government against new company creation, an increase in the capital gains tax could end most new (nongovernment) job and wealth creation in the U.S. for a generation. If Mr. Obama is serious about getting the country out of this recession using something more than public make-work projects, he should restore the integrity of the new company creation cycle: rewrite full disclosure, throw out options expensing, make compliance with Sarbanes-Oxley rules voluntary, and if he won't cut it, then at least leave the capital gains tax rate alone.

Otherwise, Mr. Obama might end up being remembered as the second Herbert Hoover, not the next FDR.

Mr. Malone, a columnist for ABCNews.com, is the author of "The Future Arrived Yesterday," forthcoming from Crown Business.

No comments: