Article from SFGate.
In recent years, LinkedIn, Groupon and Demand Media all suggested they were profitable while privately held. But when the businesses were forced to file audited financial statements as they prepared to go public, those years or quarters in the black mysteriously vanished.
That’s just one of many reasons why it’s disturbing to see legislators hard at work on laws that would actually make it easier for companies to seek investments without also providing thorough and transparent financial data. And it’s why the proposals demand serious scrutiny.
This week, Sens. Pat Toomey, R-Pa., and Tom Carper, D-Del., introduced a bill that would raise the number of shareholders that companies are allowed to have before being forced to routinely disclose finances. Under the proposal, the threshold would rise from 500 to 2,000, minus employees.
Companies often feel compelled to go public when they near the 500 mark, because the disclosure requirements are nearly the same as those for a public company. Observers were quick to note that the law could ease IPO pressure on businesses like Facebook, which is bumping up against that threshold, further inflating private trading markets without adding any financial clarity.
“Lots of companies with fairly substantial market capitalizations would avoid the transparency of being reporting companies,” said John Coffee, a law professor at Columbia University.
Crowd funding
Separately this week, the House approved legislation proposed by Rep. Patrick McHenry, R-N.C., that would allow small businesses to raise capital through what is called crowd funding. That would mean startups could solicit investments from a pool of small investors, not just high-net-worth investors.
Individuals could invest the lesser of $10,000 or 10 percent of their annual income. As long as the firms raise less than $1 million a year, they could provide scant if any financial disclosures (though they would have to highlight the risky nature of the offerings).
Meanwhile, the private-equity and investment-banking industries are pushing for even bigger changes. Last month, a group calling itself the IPO Task Force – including representatives from Hummer Winblad Venture Partners and the law firm Wilson Sonsini Goodrich & Rosati – submitted an audacious wish list for policymakers.
Complaining about the paucity of IPOs in recent years, it recommended a looser set of rules for “emerging growth companies” with less than $1 billion in annual gross revenue.
These companies would be able to take advantage of a five-year “on-ramp” period that would reduce requirements for disclosures of historical financial data. The bill would also exempt companies from regulations concerning shareholder voting rights on executive compensation and loosen rules regarding analyst conflicts of interests.
Some corporate governance experts think the very premise of an on-ramp is flawed.
The first five years “is exactly when you would need to have the best disclosures,” said Charles Elson, director of the center for corporate governance at the University of Delaware.
The argument in favor of these proposals is that freeing companies from onerous regulations put in place in recent years would allow them to more easily build capital, accelerate innovation and create jobs.
Advocates for the task force recommendations contend that the rules are directly responsible for the decline in IPOs in recent years. Without that potential payday, venture capitalists and other investors have less incentive to take chances on young companies.
“Given the urgency to get America back on the path to economic growth, we need to get capital back in the hands of companies that create jobs,” said Kate Mitchell, chair of the task force and managing director of Scale Venture Partners, in a statement.
These are all tantalizing promises in the current economic climate. But we’ve seen again and again why transparent information is critical for the investing public..
Shareholders of Enron lost $11 billion and employees saw their life savings evaporate when it turned out the company was hiding billions in shell firms and fudging its balance sheet.
More recently, Lehman Bros., Bear Stearns and AIG crashed and nearly took the global financial system with them after losing highly leveraged, complicated and opaque bets on toxic mortgages.
These economic crises prompted laws like the Sarbanes-Oxley Act of 2002, which required more thorough disclosures of things like off-balance-sheet transitions. Similarly, the Dodd-Frank Act, passed in the aftermath of the 2008 economic collapse, granted greater oversight of complex instruments like credit default swaps.
Watering down
But political memories are short, and the instinct to enact reforms to prevent future catastrophes fades as constituents shift their frustrations to stubborn unemployment rates. And so now, we see proposals to water down the protections that were just passed.
From the moments these rules went into effect, industry has lamented how the burdensome and expensive regulations harm business and discourage IPOs. But maybe these things should be burdensome and expensive.
There’s a great responsibility that goes along with accepting millions of dollars from college endowments, pension funds, mom-and-pop stock pickers and, yes, even accredited investors.
I’d submit that the decline in IPOs had at least as much to do with the market crashes brought about by dot-com pump-and-dump schemes and the subprime mortgage and derivatives fiasco.
In other words, the private-equity and investment-banking industries haven’t exactly proven themselves worthy of lighter regulations. On the contrary, they’ve repeatedly demonstrated an unconscionable eagerness to get away with exactly as much as they can, even at immense cost to the broader economy.
Obviously, this isn’t universally true, and not all startups, venture capitalists or investment banks should be tarnished by the acts of a few. But the best way for the rest of us to know the difference is through crystal-clear transparency.”
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