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Supporting The JOBS Act

Now we're getting somewhere!

Congress has passed the JOBS Act and President Barack Obama signed it on April 5, 2012. This piece of legislation has been extruded from a hodge-podge of six bills, and while some of its ingredients are questionable (e.g., "crowd funding"), the proposed Act as a whole is a giant step in the right direction. Why? Because, at long last, the Act would impale the dreaded Sarbanes-Oxley for small cap companies that desire to access the largest and most vibrant capital market in the world-ours here in the U.S.

Specifically, for IPO issuers with less than $1 billion in revenue and an IPO less than $700 million-a category that includes over 90% of all companies that went public in the U.S. last year-the Act would provide welcome relief from the requirements for external audit of internal controls and "say on pay," and the limitations on pre- and post-IPO communications to qualified investors.

Sarbanes-Oxley, or SOX, is right up there with the Smoot-Hawley Tariff Act of 1930 in the pantheon of the most destructive pieces of legislation of all time. Originally conceived post the Enron and Worldcom accounting scandals, and originally intended to apply only to the 1,000 largest companies in the U.S., in a fit of last-minute regulatory zeal SOX was ultimately applied to all U.S. public companies. It was classic Beltway thoughtlessness: one size made to fit all, lacking real cost-benefit analysis, with scant consideration given to the law of potential unintended consequences.

After a decade of investor "protection", all Sarbanes-Oxley has to show for itself are billions of dollars spent on compliance, countless hours of management time shamefully diverted away from running businesses, and full employment for accountants. Yet all the SOX compliance in the world didn't stop MF Global from imploding and with it $1.6 billion of customer funds that mysteriously disappeared. As tragic as MF Global is, failures-whatever their underlying causes-are part of a free market capitalist system. It will always be thus.

Prophets of doom will be out in full force, warning of dire consequences that will befall us should the Senate pass the bill and the President sign it into law. They must be ignored. They know not of what they speak.

Consider this gem from Barbara Roper, Director of Investor Protection for the Consumer Federation of America, on the Huffington Post website: "…the JOBS Act would undermine market transparency, roll back important investor protections, and if investors behave rationally, drive up the cost of capital for the small companies it purports to benefit."

Contrary to Ms. Roper's rhetoric, in the real world of capital formation, the elimination of SOX would in fact cause the cost of capital for smaller companies to decline sharply and rapidly. Here's why.

Public issuers enjoy a lower cost of equity capital than private issuers because investors are always willing to pay a premium for the liquidity associated with a publicly traded stock. (A public company with similar financial attributes compared with a private company is typically valued higher.) The flip side of the liquidity premium is a concept known as the "discount for lack of marketability," which basically means that investors in private companies demand extra compensation for illiquidity. This translates into a higher cost of capital for the issuer.

According to the National Venture Capital Association, since Sarbanes-Oxley the median time that it has taken for venture-backed private companies to go from initial equity funding to IPO has more than doubled. The money raised by such companies in the added years of being private has come at a much higher aggregate cost of capital than would have been the case had they gone public sooner. And, of course, it does not take into account or quantify the overall higher cost of capital for hundreds of companies that simply abandoned the desire to go public at all because of SOX.

As is often the case, the lower the cost of a good or service, the higher demand will be (other things being equal). If enacted, the JOBS Act will dramatically lower the costs of both going and being public by killing SOX for small issuers and introducing other key measures. As a result, more companies will go public, and will do so sooner, and the aggregate cost of capital for these companies will decline sharply. Stockholders in these companies will also benefit greatly because millions of dollars in precious earnings will not be senselessly wasted on SOX costs. And, as these companies mature as public companies, the higher regulatory requirements for larger companies will be phased in-well after they have created the needed jobs for our economy to grow.

Overwhelming bipartisan support for any piece of legislation these days is a rare thing. In pursuit of a grand bargain, legislators often have to pinch their noses over unpalatable provisions. The JOBS Act is one such instance where the pros so outweigh the cons that the perfect mustn't become the enemy of the good.