One balmy day last week in the Rose Garden, President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. He was surrounded by a cheerful group of Democratic and Republican senators and representatives — the main supporters of the legislation who had held its hand and walked it through the partisan minefield that Congress has become.
The JOBS Act is a reflection of Congress in the sense that it contains its own minefields as well as a swamp of unaddressed issues and work not done. Still, it might turn out to be the “game changer” that Obama claimed in his remarks at the signing.
The JOBS Act is the federal government’s effort to resuscitate the initial public offering (IPO) market, which has been comatose since 2001 when the dot.com bubble burst and Congress responded with the Sarbanes-Oxley regulatory rules.
The two most significant structural changes in the JOBS Act stem from its creation of a new category of business and a new type of stock market.
The newly defined, “emerging growth companies” are those with revenues up to $1 billion a year, and the new law would cut them some slack in terms of the financial reporting now required for a public stock offering. To accommodate the hot, rapidly growing high-tech firms, for example, the new regulations would require only two years of externally audited financial statements instead of the three years now needed.
The new type of market, defined as “crowdfunding,” would allow a company to sell up to $1 million worth of stock, through the Internet or any other way, without registering with the Securities and Exchange Commission. The size of each investment would be limited to $2,000 or, in some cases, to a percentage of the investor’s annual income or net worth.
The JOBS Act is a typical piece of federal legislation, which means that it includes some extraneous goodies for various interest groups that have been waiting around so patiently. Provisions in the new law, for example, will remove the ban on advertising by hedge funds, which should prove interesting. Also, a private company can now avoid SEC registration of its shares until it has over 2,000 shareholders, while the previous limit had been 500.
Oddly enough, it is the small, unheralded provisions of the JOBS Act that will have more immediate effects on capital markets. The net effect of the two main thrusts of the new law — on crowdfunding and emerging growth companies — is less apparent.
Crowdfunding, for example, has been around on the Internet for a while, but it has generally been more effective at mobilizing donations than business capital. Whether it can make the transition to an investment market remains to be seen. There is also some doubt about the capability of the federal government to monitor crowdfunding to combat fraudulent schemes.
The establishment of a new category of emerging growth companies is more well-intentioned than well-aimed. For one thing, it has little to do with business start-ups, which rarely earn $1 billion ever, let alone in a year. Instead it looks like a helpful idea for the venture capitalists who have already capitalized a growing firm and want to take it public so they can take their money out. There is nothing wrong with that at all but it doesn’t directly affect start-ups.
Exactly how helpful the JOBS Act will be to the IPO market isn’t clear either, although to its credit, it can’t hurt. It doesn’t actually change the broad responsibilities of corporate officers under the Sarbanes-Oxley law, but merely loosens the requirements for outside verification of internal financial controls. Whether that will make a significant difference in the IPO market is anyone’s guess.
The complexity of financial controls and the equally complex task of auditing them are significant issues issue for the market, although they are not addressed directly by the JOBS Act. The requirements laid on by Sarbanes-Oxley are difficult for any corporation to contend with, but they are especially daunting in the fluid, rapid-growth environment of a typical company launching an IPO.
The value of internal controls, and the questionable ability of regulations to detect faults, was illustrated by the recent IPO market stink bomb set off by Groupon, the Internet coupon company, when its dubious accounting practices led to several restatements of its financial condition.
On balance, the JOBS Act seems a rather half-hearted effort by Congress and the Obama administration to change the capital market for start-up businesses without a full dress review of Sarbanes-Oxley’s effectiveness and unintended consequences. Chronology is not causality, but the IPO market has not fully regained consciousness since getting that Sarbanes-Oxley injection in 2002. It is hard to believe that is a coincidence.