Another Accounting Law Designed To Increase Transparency Does The Opposite

from the unintended-consequences dept

With all of the financial mess out there, it's likely that we'll soon see calls for new regulations to help "protect" against fraud. However, before we rush into doing so, it's worth looking at how damaging previous attempts to do the same thing have been. We've already covered the massive amount of damage done by Sarbanes-Oxley, which basically made it extremely difficult for a private company to go public and significantly increased costs for any public company -- all while doing next to nothing to actually cut down on fraud.

And, now, FAS 157 has come into play -- a new rule impacting many venture capitalists, forcing them to figure out what the "fair market value" of their investments are, and provide that number to their investors. This has many different VCs complaining about what a stupid process this is. It raises similar questions as the legal change a few years ago that required companies to put stock option valuations on their books as well. The problem is that these things are impossible to accurately value. Not difficult, but impossible. You're asking people to value a totally illiquid asset as if it were liquid.

Even if the venture capitalists use a rigorous process, the result will be wrong. There's simply no way to accurately value something like a private startup until another transaction happens where the value is actually set. And, that's the way it should be for a private investment (it's also why not everyone is allowed to invest in such endeavors, because it is inherently more risky). But forcing companies to make up bogus (no matter how well meaning) valuations for companies has dangerous unintended consequences. No matter how bogus the numbers are, since they're there, people will use them as if they're real. And that will lead to more bad investing, rather than less. So, once again, we have a law designed to stop bad investing, which will most likely cause the opposite to occur.
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Filed Under: accounting, fas 157, regulations, sarbanes oxley, unintended consequences

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  1. icon
    Mike (profile), 23 Jan 2009 @ 6:22am


    Hummm... No matter public company or private, if you are asking anyone to invest in your company you MUST have some valuation.

    It's not that you "have" some valuation. It's that the market for your shares at the time (i.e., those who invest) set the valuation. But between those times, there is no market for your shares, and thus no valuation. The problem with the law is it requires a valuation at those times.

    This has to be the most ridiculous article I have read.

    Thanks for your support.

    Fact is with out regulations, and yes I mean SOX too, plus the agencies that are there to ensure enforcement (e.g. the SEC) this global economic melt-down would be 100x worse.

    Can you offer at least an iota of proof? So far, there has been no evidence that SOX did anything to stop fraud.

    Fact is the regulations are there to attempt to stop the GREED.

    Well, tragically, greed isn't a factor that can be stopped, nor is greed illegal. So, you are wrong.

    Fraud is illegal, and SOX is SUPPOSED to stop fraud. But it does not.

    If the SEC was paying attention to any of this we would not be in this spot

    You do realize that that had nothing to do with SOX, right? The SEC's failure to pay attention had absolutely nothing to do with SOX.

    but to summarily dismiss all regulations under the pretense you do not see the value is like publishing an article that says, "...I think seat belt laws are worthless because I have never had an accident..."

    Not quite. But if you want to set up straw men after getting most of the basic facts wrong in your comment, boy, that sure adds to your credibility.

    Bottom line what is needed are the governing agencies like the SEC and laws like FFIEC to be enforced - plain and simple.

    Can you point to a single example where SOX was not enforced? There were other things overlooked, but SOX enforcement was pretty widespread. I haven't heard anything about SOX not being enforced.

    And, I note, you seem to totally ignore the unintended consequences of SOX.

    So you ignore all the downsides, pretend that there are upsides that don't exist, and you call my post ridiculous?

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