The Incredible Shrinking Public Co.

Congress claimed it was sticking it to the fat cats 14 years ago when it passed a raft of laws regulating public stocks. But you know how these things work: Exactly the opposite happened. The cats got fatter. The rest of us? We got scrawnier. And those laws continue to hurt us, even here in the Valley region, today. We’ll get back to the local impact in a minute. First, let’s review the background: There were several stock scandals in the early 2000s epitomized by Enron, Tyco and WorldCom. Congress stepped in and passed hard regulations in 2002 in the form of the Sarbanes-Oxley Act. It was designed to rein in corporate excesses and put an end to the fat cats running amok and screwing over small investors. We could debate whether Sarbanes-Oxley accomplished that goal, but it’s absolutely not debatable that it made running a public company far more difficult and costly and even hazardous. Sarbanes-Oxley increased a company’s cost of complying with securities regulations by a factor of three or five or 10, depending on who’s talking. A smallish public company might have seen its cost of complying with securities regulations zoom from a couple hundred thousand a year to $1 million or more, thanks to the new regulations. What’s more, one provision of Sarbanes-Oxley called on top executives to sign a document taking personal responsibility – yes, personal responsibility – for the accuracy of financial statements. Suddenly, executives found themselves asking: “So, umm, can I go to prison if the accountant makes an error?” (You can almost hear the lawyer’s lawyerly answer: “Oh, no, probably not. But, I guess it is a legal possibility. So, yes. Sign here.”) Little wonder what happened next. The number of public companies plummeted. We now have about half as many as we did 15 years ago. Loads of public companies in recent years have chosen to go private or, more commonly, sell out to private equity firms or to bigger public companies. As a result, the age of the savvy individual investor, the bold day trader, has all but ended. What’s taken its place is the era of private equity firms, hedge funds, big companies, fat cats. So let’s return to the local impact. As pointed out in the Business Journal’s July 11 issue, here’s what happened in the Valley area in recent months: DreamWorks Animation agreed to merge into Comcast Corp.; United Online was bought by B. Riley Financial; Electro Rent will be purchased by the private equity firm Platinum Equity; Ceres Inc. was acquired by the private Land O’Lakes; ReachLocal is being acquired by Gannett Co.; and Crown Media Holdings was taken over by the privately owned Hallmark Cards. The loss of those and other public companies is not alarming so long as they are being replaced by young and growing companies that sell their stock in an initial public offering. But that’s not happening. Thanks largely to the hassle, expense and hazards caused by Sarbanes-Oxley, IPOs are about as common as skyscrapers in Reseda. Now, the goal of a startup is to sell eventually to Facebook or Apple or Platinum Equity, not sell their stock to you. Today’s young and growing American companies regard the public stock markets roughly the same way Taylor Swift regards Kanye West. Think about what this means. Average investors are now all but cut off from America’s most dynamic and fast-growing companies. Those have become the province of the hedge funds, private equity firms, big companies. It’s no secret that L.A.’s liveliest sector is Silicon Beach. A few reasonably wise investments there could make you rich. You know that, but frustratingly, you probably can’t invest there. You were probably aware that Dollar Shave Club of Venice was a hot local company, but it was not a public company so you couldn’t invest in it. So when it sold last week to Unilever for $1 billion, that money went to the well-connected and the wealthy, not to you. Silicon Beach is the playground of the fat cats, not mere stock pickers or even many average accredited investors. And if you are an average investor or a worker with a 401(k), what do you have to choose from? A shrunken roster of big public companies, mostly. A choice of fewer but bigger, steady-as-she-goes enterprises that may be sturdy but grow slowly and won’t make you rich nearly as easily as Dollar Shave Club would have. At the risk of getting sociological, I worry about the effect this is creating. I wonder if typical people feel as if they’ve been pushed to the side when it comes to participating in the bounty that our business sector creates. A crucial part of the American Dream – growing financially in tandem with a democratized economy – must seem more remote to more people. Sarbanes-Oxley is not totally responsible for all this, but it is largely. It abetted the devastation of public companies, the province of average investors. It created the age of private equity, the playground of the well-connected and the billionaires. No wonder Bernie Sanders is so popular. I know Congress didn’t mean to do this. Congress intended to stick it to the fat cats. But the opposite happened. Charles Crumpley is editor and publisher of the San Fernando Valley Business Journal. He can be reached at [email protected].