State of Innovation

Patents and Innovation Economics

Circumventing Sarbox and the IPO Drought

Sarbanes Oxley (Sarbox) is starving high technology start-ups for capital.  Mathew Bandyk, in US News and World Report, suggests that not only has Sarbanes Oxley hurt venture capital, and decreased the number of IPOs, it is imposing costs on small businesses.[1] The reason that Sarbox is increasing the costs for small business, according to Bandyk, is that accountants are applying Sarbox rules to small businesses out of habit or conservatism.  In order for a company to go public nowadays, a company needs somewhere near $1 billion in annual revenue.  For more information on the damaging effects and absurdity of Sarbox see Sarbanes Oxley – The Medicine is Worse Than the Disease.  Since it does not appear likely that Washington is going to fix Sarbox anytime, how can we mitigate its damage?

I suggest that states create public markets for equities in their own state.  These markets would only be available for in-state companies and investors would have to be residents of the state.  Under our system of federalism this would allow the state public market to avoid the federal securities laws.

These state public markets would provide an IPO (Initial Public Market) outlet for local companies, with many of the benefits of going public in the national market.  Clearly large companies would be constrained in state public market.  However, smaller companies could go public and be incubated until they are large enough to transition to a national public market.  Not only would a state public market provide much needed capital for start-up companies, it would encourage funding sources, such as venture capital firms to locate in the state.  A state public market would also encourage investment banks and entrepreneurs to locate in the state or create branches in the state.  This would help mitigate the damage caused by Sarbox.

Some people might suggest that a state, such as Colorado, does not have a large enough economy to create a state public stock market.  In 2006, Colorado had a GDP of $230.5 billion.[2] The Buttonwood Agreement that was the beginning of the New York Stock Exchange was signed in 1792.  The total GDP of the U.S. in 1792 was $220.0 million.[3] The population of Colorado is about 5.0 million people in 2008, while the total population of the U.S in 1792 was around 3.9 million people.  Clearly, a state the size of Colorado is big enough to have a vibrant public market.

In order to ensure a vibrant public market, it is important that state laws associated with trading stocks on the state public market not follow federal law.  Investors should receive a statutory warning about the risks associated with investing in stocks or bonds in the state public market.  Only if the company or its officers are guilty of fraud or breach of contract will investors have recourse against the company.  This would be similar to Colorado skiers law, that was necessary to shield ski resorts from frivolous lawsuits that threatened to destroy the ski industry.  State judges must be prohibited from looking to federal laws for guidance in cases related to the state public market.

Publicly traded companies would be required to provide complete financial reports quarterly.  There would be no other disclosure requirements, however a company could clearly disclose more information.  Financial reports would not have to conform to GAAP rules, however companies must point out the differences.  This would provide flexibility for the market to determine which accounting rules are important to the market, as opposed to those that are important to government officials.  This would also allow “pooling of interest” mergers, which were useful for high technology start-up companies.

Employees and officers of any company listed on the state public securities market, must report any purchase or sale of stock in their company.  The report would be posted as part of normal market reporting.  Insiders would then have to wait some period of time, for instance 2 hours, before purchasing or selling their company’s stock.  The other arcane rules on insider trading at the federal level would not be followed.  The SEC has refused to define what insider trading is.  This hurts the market and is violation of the rule of law.  The rule of law demands the government clearly define laws so that citizens are not subject to de facto ex post facto law (retroactive laws).

In summary, a state public stock market would mitigate the effects of Sarbanes Oxley and potentially force the federal government to rethink this law.  It would also attract entrepreneurs and investments dollars to the state.  States the size of Texas, California, and New York could easily support a state public market.

[1] (Accessed 11/4/09).



[3], while the website does not specifically say, it appears that the GDP is measured in 2000 chained dollars.

November 9, 2009 - Posted by dbhalling | Uncategorized | , , , , | 1 Comment

1 Comment »

  1. [...] Go to comments ST. LOUIS (Alpha Found) — Dale Halling has some good ideas about how to end-run Sarbanes Oxley by innovating state specific equity markets. We doubt it could work given SEC’s jurisdiction jealousy, but it’s certainly worth [...]

    Pingback by Sarbanes-Oxley cancer spreads at a cost of $80bn a year « Alpha Found – Opinion & Analysis | November 18, 2009 | Reply

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