Sarbanes-Oxley Is Suffocating Our Essential Capital Markets
Their power to fuel economic growth has made the U. S. capital markets the 8th wonder of the world. But today that power is endangered, and the potential consequences are ominous.
There is no doubt the United States has led the world for many decades now in economic growth and development. America’s greatest contribution to the economic well-being of its own citizens and of much of the rest of the world has been the development of efficient, deep, public capital markets. These American capital markets have for over a century been the envy of the free world – maybe even the 8th wonder. They have provided the most efficient access to, and allocation of, capital in human history. They have been the very engine that drives economic growth, innovation, and prosperity.
A major recent trend was highlighted in a Wall Street Journal piece, “Powering U.S. Business: Private Capital.” The article reported a reversal over the last decade in the roles played by private versus public capital raises. Substantially more capital is raised today in the private markets than in the public markets – as opposed to the decades prior to 2010. As private capital raises have increased, public markets have shrunk. Since 1996, the number of publicly traded companies has fallen by more than half. “There are fewer investment opportunities for Main Street investors,” Securities and Exchange Commission Chairman Jay Clayton reported to Congress last year.
Because private offerings are generally restricted to institutional investors (pension plans, insurance companies, hedge funds, etc.) and high net worth individual investors, small individual investors are being shut out of high-growth, early-stage investments. These high-growth companies are waiting much longer before going public - or perhaps never going public. The number of U.S. private companies worth over $1 billion has more than trebled over the past four years. Individual investors are now forced to invest in a dwindling pool of companies. As Duke University Professor Elizabeth de Fontenay explained, the public markets have become “a holding pen for massive, sleepy corporations.”
This phenomenon is definitely bad for individual investors, but it also represents a serious threat to American capitalism. If it continues, the decline of the public capital markets will ultimately diminish the strength of the American economy. Access to the public capital markets is the lifeline for economic growth. This should be a real concern for Congress, and it raises several inevitable questions. Is it just a natural development of the market? What can or should be done about it?
It is not an accident that this trend has developed. It can be traced back directly to a major piece of legislation, Sarbanes Oxley, passed in 2002. This law was a response by Congress to a well publicized financial problem: the Enron scandal. As is so often the case, Congress and regulators were looking back at the most recent problem while attempting to appear pro-active in preventing the next problem. There were serious adverse consequences to this regulatory legislation.
First, the abuses involved in the Enron scandal were fully punishable under existing regulation. Those responsible went to jail, as they should have. But Congress felt it had to act, and it passed Sarbanes Oxley, which saddled every public company in America with extra layers of accounting scrutiny and supervision. The Heritage Foundation study in 2008 found major increases in audit fees companies paid as a result of Section 404. “The costs of implementing section 404 were many multiples of what the SEC had estimated.” There is no reason to think that Sarbanes Oxley would have prevented the Enron scandal. Again, the law was clear, and the principals broke existing law. Regulation can never weed out those who are intent on breaking the law.
But when Congress acts and mandates new regulatory hurdles, as it did in Section 404 of Sarbanes Oxley, thousands of law abiding companies and their principals are permanently saddled with the expense of regulation. The major increases in corporate auditing expenses which followed passage of Sarbanes Oxley have been well documented. As the former CEO of a public company, I have seen firsthand the additional regulatory burden imposed by Sarbanes-Oxley; and I believe this burden has too often steered good growth companies away from the public markets.
The Trump administration is now undertaking a thorough review and reform of the Dodd Frank Act. The roots of this bill were similar to Sarbanes Oxley: Congress reacted to the 2009 financial meltdown with wide ranging new regulation of the banking industry. The unintended consequences of excessive regulation of banks under Dodd Frank has harmed U. S. capital markets. While overhauling Dodd Frank, Congress should simultaneously reform – or repeal — Sarbanes Oxley. Trump’s newly appointed chief economic advisor, Larry Kudlow, has long been a critic of Sarbanes Oxley. He has argued, “By substantially raising audit costs, the law has made it much more difficult for entrepreneurs to take small companies public, which in turn deprives middle-class investors the opportunity to grow wealth with these firms.”
The American capital markets are a national treasure. They need to be protected.