from the this-is-not-efficient dept
After the dot com bubble burst, quickly followed by major accounting scandals such as Enron, Congress, in the way that it normally does, overreacted with a kneejerk response. The most obvious part of this was the Sarbanes-Oxley rules, which didn’t do much (if anything) to actually prevent future frauds, but did make the cost of being a public company much, much, much higher — effectively creating a serious tax on startups looking to go public. It also built up an entire industry around SOX compliance, that almost guarantees the law can never be repealed. In response, an already weak IPO market went almost entirely dormant, an even as things picked up with startups, fewer and fewer actually wanted to go public. It was just too costly, and the potential liability for execs was way too high. Google resisted going public for as long as it possibly could, before it finally tripped an old SEC rule, that required companies with more than 500 shareholders and over $10 million in assets to effectively act as a public company — at which point, it figured it might as well just go public.
That was in 2004. In the six years since then, a number of other companies have worked on a number of loopholes and ways to avoid going public even longer. Witness Goldman Sach’s recent deal to invest a ton of its investors’ money into Facebook shares — which normally would have tripped this rule — except that Goldman is playing a little game, and setting it up so that it pretends there’s only one shareholder, keeping Facebook away from the magic 500 number. The SEC is apparently already looking into this.
But even before the Goldman/Facebook deal became public, the SEC had apparently begun probing the rise of these new efforts to let hot startups sell shares on a market, without actually going public. Hot startups including Facebook, Twitter, Zynga and LinkedIn have all been heavily involved in such markets, which basically let employees of those companies get many of the benefits of being a public company, without the massive costs and regulatory oversight.
This is, in many ways, the exact opposite of what was intended with things like SOX — which was designed to increase oversight. But, instead, it’s done the opposite. The end result is that wealthy clients of Goldman Sachs and other Wall Street firms can invest in these companies, but others cannot. Now, some might claim that this is a “good” thing, in that the general public shouldn’t be investing in highly risky stocks that could easily collapse. But, it’s also creating a tiered system where these companies are able to avoid going public for much longer, but the wealthy and well-connected can get in at about the same point that the public used to be able to get in. And, they are buying. Goldman has already announced that it’s already oversubscribed.
While some are cheering on the SEC investigation of these practices, it seems to be missing the real lesson here: which is that money always seeks out the unregulated loopholes, and the more you regulate, the more hurdles you put up to efficient markets, the more money will pour into whatever side pools that are left unregulated. And that’s dangerous. The economic collapse of 2008 was a result of this, as tons of money went into unregulated areas of the market and was sliced and diced in increasingly misleading ways. The classic response is to just regulate those areas — but that ignores the fact that there will always be new loopholes and new unregulated areas that money will rush into. We’re seeing it all the time.
What’s happening with Goldman, Facebook and those other startups can be traced back to SOX in the first place. If we didn’t make it ridiculously burdensom to be public, then firms wouldn’t seek out these hidden alternatives. But our government refuses to let the market ever learn lessons. The lessons from the dot com bubble and Enron and such should have been that people learned to be more careful in their investments. But the government rushes in and sets up a pretend safety net — so we never get to learn.