Sarbanes-Oxley: A Chilling Effect on Venture Capital?
Here's something that I didn't go into in my article on venture capital: the role that financial regulation is playing. Sure, it makes sense that given all the financial problems going on in today's economy, venture capital activity would be down. But according to some, this is coming at the worst possible time.
In the wake of Sarbanes-Oxley legislation passed in reaction to the Enron scandals of 2001, "the psychology of the entrepreneur has changed dramatically," say Mark Heesen, president of the National Venture Capital Association. The basic reason is that in a world with Sarbanes-Oxley, everyone who wants to take their company public has to deal with extra paperwork and hoops to jump through. Those costs can add up and sometimes make going public simply not worth it. "Today you have a lot of entrepreneurs who say if acquisition is coming along, I'm taking it," Heesen says. "They say, 'I don't want to deal with all of these accounting rules. It's not fun going public anymore.' They'd rather sell out and go create another company or go play golf."
The possibility that Sarbanes-Oxley has become too much of a burden on companies has become real even in the eyes of previous supporters of the bill. Two years ago, Rep. Nancy Pelosi admitted that Sarbanes-Oxley has had "unintended consequences" and that it needs some "fine-tuning." But we haven't seen any real action from Congress.
At a time when many people are saying that more regulatory oversight is the only way to fix our financial markets, it is important to remember that a "crisis mentality" approach to regulation often results in overreaching that creates new problems. The lack of venture capital-funded IPOs might be one example of such a problem.
Tags: venture capitalism | government intervention
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Reader Comments
Plumbers and financial statements
The Sarbanes Oxley Act regulated some activities that were shown during the Enron era to be widely abused (such as corporate loans of over half a billion dollars to an officer, very aggressive (outlandish even) revenue recognition and expense recognition (calling marketing costs an asset because they created an asset called mindshare). In short, the statements managements and the statements being issued could not be trusted. So the law said the CEO and DFO must sign the statements with an oath that they were true.
The intent was good. By comparison, we demand that the piples that our plumbers put together do a reliable job. Why shouldn't we demand that our financial statements be reliable? If we don't neither one will hold water.
Personally, I don't agree with everything in the restrictions. A simple advance to an officer for travel related expenses, the kind routinely given to non-officers, is a loan. This if forbidden by the law, and should be revised. Of course, half a billion dollar travel advances might change my mind.
I probably don't need to go into the stock option treatment. There've been many stories about underreporting of expenses due to misuse of, mis-dating, and accounting for stock options as management wished the rules to be instead of as they are.
I don't always agree with having the CFO sign the statements or with oath mandated. The CFO might disagree with the contents of the oath, but is still required by law to give those exact words. Sometimes, by law, he is forced to give a false oath.
Anytime the CFO has someone else (e.g., a boss) who controls his compensation, then the CFO should not, in my opinion, sign the statements. Those who ultimately control his compensation and the resources he has (e.g., the number of people in the accounting department) should, instead.
The rules are complex. They are overly complex. Sometimes they don't make much sense and are hard to understand or nearly impossible to apply (what's the fair market value of an asset that has no market?). The rules should be changed, and changed so that they are made simple, conservative, and easy to apply.
Conservativeness used to be a principal taught in introductiory accounting classes, as in when there are multiple reasonable interpreations, choose the one which reports the lowest income. That concept seems to have been lost, replaced by just the opposite. When someone says it is aggressive accounting, the word aggressive says right away that it is wrong. Yet, aggressive accounting somehow became the norm.
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