Facebook Rips Sarbanes-Oxley, Dodd-Frank in IPO Filing

Facebook Rips Sarbanes-Oxley, Dodd-Frank in IPO Filing
February 13, 2012

John Berlau

John Berlau is a senior fellow for finance and access to capital at the Competitive Enterprise... (read full bio)

In his letter to prospective shareholders in the middle of the 201-page “Form S-1” Facebook filed Feb. 1 to launch its much-anticipated initial public offering, company founder and CEO Mark Zuckerberg stated one mission of Facebook is to “bring a more honest and transparent dialogue around government.”

In one important way, another section of the IPO already does so in communicating the incredible burdens on companies attempting to go public—burdens that create difficulties even for companies as big as Facebook and are almost insurmountable for smaller firms. On page 30 of the S-1 (page 37 if counting the total number of pages), Facebook singles out the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010 as “risk factors” that will impose substantial costs to the company and its shareholders and divert resources from the firm’s core mission of innovation.

In bold lettering, Facebook announces, “The requirements of being a public company may strain our resources and divert management’s attention.”

‘Will Increase Compliance Costs’

The prospectus goes on to explain:

“As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (Exchange Act), the Sarbanes-Oxley Act, the Dodd-Frank Act, … and other applicable securities rules and regulations. Compliance with these rules and regulations will increase our legal and financial compliance costs, make some activities more difficult, time-consuming, or costly, and increase demand on our systems and resources.”

Regarding Sarbox, Facebook registers a complaint similar to that of many entrepreneurs, investors, and economic scholars about the law’s burden. The company, the letter notes, is “in the process of designing, implementing, and testing the internal control over financial reporting required to comply with” Sarbox’s infamous Section 404, ”which process is time consuming, costly, and complicated.”

Facebook is far from the only firm—big or small—that has found Sarbox to be “time consuming, costly, and complicated.” According to John Battelle’s book The Search, considered a definitive history of Google, Sarbox was “hell for a company like Google, which made its money literally pennies at a time, from millions upon millions of micro-transactions.”

Delayed Google’s IPO
Battelle reports Sarbox compliance significantly delayed Google’s 2004 IPO. “According to engineers involved in the work, Google had to significantly restructure its advertising report system from the ground up.”

And if Sarbox makes life difficult for enormous firms such as Facebook and Google, we can only imagine the toll it takes on smaller firms seeking to raise capital by going public. These are the very firms that could be the next Facebook or Google or start the next retailing wave like Home Depot.

As to Home Depot, the firm’s cofounder, Bernie Marcus, has said many times the company likely never could have gotten off the ground if Sarbox and other of today’s regulations had been in effect.

“We could never succeed today,” Marcus bluntly told radio host Hugh Hewitt in June.

In contrast to Facebook and other IPOs this year that launched when the firms already had billion-dollar market valuations, Marcus explained Home Depot was nowhere near a billion-dollar company when it went publi. In fact, it had just four stores to its name.

Smaller IPOs Disappearing

IPOs of this size were fairly typical in the pre-Sarbox world. AOL founder Steve Case, a member of President Obama’s Council on Jobs and Competitiveness, recently noted in a Washington Post op-ed, “Initial public offerings of less than $50 million were 80 percent of IPOs in the 1990s but just 20 percent in the 2000s.”

Another key difference between the pre- and post-Sarbox eras is that when small firms went public, they did so to raise the capital they needed to grow. Today, when companies the size of Facebook, Groupon, and LinkedIn launch IPOs, they do so mainly so their limited number of wealthy investors can realize the value of the growth that has already occurred.

As Zuckerberg wrote in his letter in the S-1, the primary purpose of the IPO is to make the stock “worth a lot and make it liquid” for existing investors and employees.

Slowing Jobs Creation

There’s nothing wrong with that, but because Sarbox and Dodd-Frank prevent smaller firms from having the same access to the public markets, job creation suffers. As Case notes in his op-ed, “90 percent of job creation typically happens after a company goes public—and all too often, the alternative is for a company to be sold. While job growth accelerates after an IPO, it decelerates when a firm merges or is acquired.”

The good news is a package of bills passed the House overwhelmingly—with more than 400 votes and, in some cases, the Obama administration’s endorsement—in November to allow Facebook-like innovations such as “crowdfunding,” in which smaller firms can raise some seed capital free of much of the red tape of Sarbox and Dodd-Frank.

The bad news is, as House Speaker John Boehner (R-Ohio) noted in a statement Feb. 1, these bills have stalled in Harry Reid’s (D-NV) Senate. It’s time to “friend” solutions that allow small entrepreneurs and investors to take full advantage of the Facebook age.

John Berlau (JBerlau@cei.org) is director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute.

John Berlau

John Berlau is a senior fellow for finance and access to capital at the Competitive Enterprise... (read full bio)