“I promised I’d never let anything happen to him.” ~ Marlin
“That’s a funny thing to promise…Not much fun for little Harpo.” ~ Dory
Beware of politicians offering protection. An interesting statistic came across my desk earlier this week: Empower, a large retirement plan recordkeeper, is attempting to add private equity options to 401(k)-type retirement plans. An executive from the company claimed that 87 percent of U.S. companies with revenues above $100 million annually are now privately owned. That is an astounding statistic.
That was the first time I have ever heard it put that way, but it makes sense. In the year 2000 there were approximately 2,000 companies owned by private equity; today there are more than 11,500. During this same period, the number of companies publicly owned and listed on a major stock exchange has gone from roughly 7,000 to 4,500. This century has seen an explosion in private investing and simultaneously a decline in publicly traded companies. Why?
In the 20th century, going public was the goal of almost every fast-growing corporation. This is how entrepreneurs finally realized the fruit of their labor: They started the company with their own blood, sweat, and tears. If they were initially successful, they could find private investors who would provide the capital to take the company to the next level. Then, if the success continued they would go public, listing on a stock exchange and selling the stock of the company to anyone and everyone who wished to invest.
The company would then enter the realm of the small company stock. If the success continued, it would grow into a mid-cap stock and finally a large-cap stock. This led to the phenomenon of small-cap stocks outperforming large-cap stocks over long periods of time. Any investor who could participate in a company 401(k) or simply save some money to put into a mutual fund had the opportunity to invest in these companies.
That all changed in July of 2002, when George W. Bush signed the Sarbanes-Oxley Act into law. Enacted in response to the corporate scandals involving Enron and WorldCom, it was the largest single increase in corporate regulation since the Great Depression. Its goal was to protect investors; after all, we can’t let anything happen to them.
For our younger readers, Enron and WorldCom were both guilty of fraud. They basically lied in their financial statements. Investors in the companies lost most if not all of their money. The key executives went to jail and their auditor, Arthur Andersen, went from being one of the largest accounting firms in the world to ceasing to exist.
Sarbanes-Oxley is, in my opinion, the worst piece of legislation in U.S. history. It made the accounting requirements for being publicly traded so onerous that today we have fewer public companies since its inception after 23 years of economic growth. Investors were “protected” from countless opportunities as companies now stay private much longer than they did historically. Instead of average 401(k) investors getting the opportunity to invest in companies at an early stage in their growth, that honor is reserved for institutional and accredited investors. In other words, the rich get richer. No regulation has contributed to inequality quite as effectively as Sarbanes-Oxley.
Was it necessary? Well, the villains went to jail because what they did was against laws that already existed. Bethany McLean, the reporter who broke the scandal, had little to no financial expertise; she leaned on her BA degree in English to see accounting irregularities that Arthur Andersen chose to ignore. Yet, Congress and the W. Bush administration determined that accounting fraud needed to be more illegal than it already was, and accounting rules needed to be far stricter so the accounting majors who went to work at large accounting firms could analyze financial reports as easily as an English major who wrote for a major magazine.
Milton Friedman noted in his 1962 masterpiece, “Capitalism and Freedom,” that there is a direct link between inequality in a society and the amount of regulation. There is no greater example of this than Sarbanes-Oxley. Thousands of companies that would be available for investment for anyone are kept in the private market in the name of protecting investors. Dory, the reef fish with a memory disorder in Disney’s classic “Finding Nemo,” knew better: “Well, you can’t never let anything happen to him. Then nothing would ever happen to him. Not much fun for little Harpo.”
Hopefully this administration is serious about regulatory reform. We don’t need private equity in 401(k)s, we need those companies to go public so all investors have access. We would be better off if we had a little less Marlin and a little more Dory. At least that is my perspective.
Warm regards,
Chuck Osborne, CFA
