Obama’s Regulations Aren’t the Only Trump Target
The Sarbanes-Oxley Act has multiplied audit costs for small firms and slowed IPOs—for what benefit?
President-Elect Donald Trump and Republican leaders in Congress have pledged to repeal many regulations put in place by President Obama. This would be a good start, but they need to go further. Overregulation didn’t start during the Obama administration.
In the spirit of bipartisanship and fostering economic and job growth, Mr. Trump and Congress should remove all regulatory barriers needlessly obstructing America’s entrepreneurs, consumers or investors, regardless of which party implemented them. They can start with a law signed and implemented by President George W. Bush.
In 2002 the Sarbanes-Oxley Act, or Sarbox, was rammed through Congress and signed by President Bush in response to the Enron and WorldCom accounting scandals. But its regulatory burden has fallen heaviest on small and midsize public companies. As noted in a 2011 report from President Obama’s Council on Jobs and Competitiveness, “Regulations aimed at protecting the public from the misrepresentations of a small number of large companies have unintentionally placed significant burdens on the large number of smaller companies.”
One of Sarbox’s most onerous mandates stems from two brief paragraphs that comprise Section 404, which requires that public firms have effective “internal controls.” The section itself mandates merely an “attestation” by the outside accounting firm that these controls are effective in preventing fraud.
The law was implemented by the Public Company Accounting Oversight Board, a quasi-public accounting rule-making agency created by Sarbox. Under the PCAOB’s boundless interpretation, Section 404 requires full-blown audits of “internal controls” of any company processes that could potentially enable “a reasonable possibility of a material misstatement in the financial statements.” This extremely broad standard may encompass all manner of company operations.
Academic studies and annual reports reveal that Sarbox has caused auditing costs to double, triple and even quadruple for many companies. A 2009 study by the Securities and Exchange Commission found that smaller public firms have a Sarbox cost burden more than seven times those of large public companies.
Since Sarbanes-Oxley’s enactment, there has been a rush to the exits from U.S. exchanges, and very slow traffic for initial public offerings. Yet Sarbox failed to catch subprime mortgage shenanigans that led to the financial crisis, prompting analysts to question the law’s worth even in its stated purpose of preventing financial fraud.
The recent stock-market surge obscures that over the past decade the number of firms listed on U.S. exchanges has dropped dramatically. In 2001, the year before Sarbox became law, there were more than 5,100 companies that investors could purchase on exchanges such as Nasdaq and the New York Stock Exchange. By 2015 there were just 3,700—fewer than during the “bear market” year of 1975, when publicly traded stocks numbered more than 4,700. Meanwhile, non-U.S. stock listings rose 28% from 1996 to 2012, according to the National Bureau of Economic Research.
Another worrying sign is the ballooning size of IPOs in the U.S. In the early 1990s, Starbucks and Cisco Systems had IPOs raising less than $50 million, as did 80% of companies launching IPOs at the time. Both firms’ market valuations were less than $250 million when they went public. Entrepreneurs were able to get public capital to grow their firms, and average investors were able to grow wealthy with the firms they invested in.
A few years after Sarbox, however, 80% of firms launched IPOs greater than $50 million, according to the Obama Jobs Council report, and IPOs of greater than $1 billion have since become a normal occurrence. Facebook waited until it could launch an IPO of $16 billion and had an $80 billion market valuation before it went public in 2012. Many speculate that Uber may not go public until it is worth more than $100 billion.
Yet there are two reasons for optimism. First, prominent Democrats, as well as Republicans, have recognized the burden imposed by Sarbox and have expressed a willingness to tackle the problem. In 2012 President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act, which exempts newly listed small and midsize public companies from Sarbox’s internal control audits for five years after they are listed.
Second, Mr. Trump can do a lot administratively, thanks to a 2010 Supreme Court decision. In Free Enterprise Fund v. Public Company Accounting Oversight Board , the court ruled that members of the PCAOB are subject to at-will removal by a majority of members of the SEC. If the existing oversight board refuses to revise its accounting standard to be in line with the statute and call for a simple “attestation” of internal controls, instead of a full-blown audit, a 3-2 majority of SEC commissioners could fire current members of the board and appoint replacements.
By saying his trademark phrase “you’re fired” to the PCAOB, Mr. Trump’s SEC could clear a path of growth for U.S. firms to expand and tell thousands of workers, “You’re hired.”