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More Fraud, Few Jobs: Why the JOBS Act is a Bad Bill

David Callahan

It was just a few days ago that Goldman Sachs insider Greg Smith reminded us of an essential truth about today's financial services sector: It puts its own interests above those of its clients and, as a result, routinely misleads and exploits those who entrust investment firms and advisors with their financial future.

Given this fact -- which was also spectacularly underscored last year when MF Global stole over $1.6 billion in client money to try to stay afloat -- why in the world would Congress want to loosen regulations on Wall Street? And why would smart Democrats on the Hill, and in the White House, go along with this effort?

This is the pressing question that surrounds the JOBS Act — an acronym for Jumpstart Our Business Startups -- which supposedly will create jobs by reducing investor protections and which passed the House last week by an overwhelming bipartisan vote (390 to 23!).

The short answer to the question is that nearly every incumbent in Congress is running scared right now, desperate to show voters that they can do something useful -- particularly to help the economy -- before November amid record levels of public disapproval of that institution.

Unfortunately, upon closer inspection, the JOBS Act is just one more reason to kick the bums out this fall.

The basic idea of the JOBS Act is to free companies from certain reporting requirements related to raising investment capital and therefore make it easier for them to go public, raise money, grow and generate jobs. The bill would ease investor protections put in place under Sarbanes-Oxley in 2002, in the wake of the Enron and Worldcom scandals, that require companies to provide lots of information to investors and meet certain auditing standards before going public. The bill is supposed to be focused on small companies, but in fact would ease rules for many larger companies.

Now, on the surface, this is not an entirely bad idea. Sarbox has been widely criticized for making it difficult for small companies to go public and for the burdens it imposes on small public companies. Sarbox needs to be fixed at some point, for sure. But this law uses a meat cleaver when a scalpel is called for. And it's doubtful that the bill will actually create many jobs.

As you may have noticed, start-ups are not exactly hurting for cash these days. Even amid the downturn of recent years, the tech industry has been booming and, last year, venture capital funding levels for web start-ups hit a ten-year high. The scope of this funding has allowed many companies to get very big without IPOs -- Facebook being a case in point.

Anyway, the biggest reason there aren't so many IPOs lately may have nothing to do with Sarbox. As three business scholars wrote last year, IPOs are down for other reasons:

We posit that the advantages of selling out to a larger organization, which can speed a product to market and realize economies of scope, have increased relative to the benefits of remaining as an independent firm. Consistent with this hypothesis, we document that small company IPOs have had declining profitability, consistently low returns for public market investors, and an increasing probability of being involved in acquisitions.

The JOBS Act, in other words, appears to be a solution to a nonexistent problem.

Meanwhile, though, leading experts warn that the bill could greatly aggravate the very real problem of investor fraud. John Coffee, the securities law expert at Columbia, in congressional testimony, called the bill the "boiler room legalization act" because it would allow firms to raise money from investors over the Internet with little disclosure, a recipe for abuse.

And SEC chair Mary Schapiro has warned that the JOBS Act is overly broadly and poorly conceived, and would weaken "important protections" for investors. The result, said Schapiro, could be less capital for investors, not more:

if the balance is tipped to the point where investors are not confident that there are appropriate protections, investors will lose confidence in our markets, and capital formation will ultimately be made more difficult and expensive.

Former SEC chair Arthur Leavitt has also warned against this bill, as has the North American Securities Administrators Association, the AARP, the Consumer Federation of America, the Council of Instutional Investors, the Main Street Alliance, and Americans for Financial Reform. (See a list of opponents here.)

This is a bad bill. It won't create that many jobs, but it could unleash a new wave of financial frauds. Has Washington learned nothing in the past few years?