In my essay yesterday, “How Federal Accounting & Securities Regs Screw Up Your Chance to Invest in Facebook,” I noted how America’s counter-productive accounting, disclosure, and governance regulations are increasingly thwarting the ability of average Americans to invest in some of the leading capitalist innovators of the Digital Age. In this case it’s Facebook, but there are plenty of other innovative companies out there sticking with private shareholders so as not to trigger burdensome securities and accounting regs.  In my essay, I also noted how this represented another prime example of well-intentioned regulation having profoundly unintended, anti-consumer, anti-competitive consequences.  America’s convoluted and onerous securities regulations are choking off capital infusions into innovative companies and denying average investors a chance to own a share a piece of the American dream.

So, what does the Securities and Exchange Commission (SEC) plan to do about this fine mess?  Regulate more, of course!  As The Wall Street Journal reports today:

The Securities and Exchange Commission has begun examining whether disclosure rules for privately held firms need to be rewritten as a result of recent deals allowing investors to buy shares in Internet companies such as Facebook Inc. and Twitter Inc., according to people familiar with the situation.  The review is at an early stage, these people cautioned, and SEC officials looking at the recent deals haven’t concluded that any of them run afoul of the 47-year-old rules governing private companies. The rules require firms with 500 or more shareholders of record in a given type of stock to publicly disclose certain financial information. The requirement is designed to protect investors from risking money on companies that say little about their operations and performance.

Yes, but that requirement can also trigger an onslaught of new regulatory burdens, as the Journal story continues on to note:

While SEC officials could decide the rules need to be updated in order to provide adequate protection for investors, the agency is trying to balance that with the demands of private companies that want to raise capital. As part of the investigation, SEC officials plan to scrutinize special-purpose vehicles like the one being created by Goldman and Facebook to determine if they are being designed primarily to circumvent the so-called 500-shareholder rule, according to people familiar with the matter.

Well of course Facebook is sticking under the 500-shareholder threshold to avoid triggering an avalanche of new regulation!  Wouldn’t you?  This isn’t shady business as some naively suggest, this is smart business.  Facebook wants to be able to continue to invest, innovate, and grow.  Going public in the current regulatory environment, however, might undermine those goals because of the new regulatory burdens that would accompany expanding the pool of shareholders.

America needs to get smart about its overly burdensome securities laws before more damage is done.  As Marc Morgenstern, a securities lawyer in San Francisco and the managing partner of Blue Mesa Partners, a venture capital firm told DealBook: “Companies forming today, like Facebook, are growing so quickly, and their stocks are being distributed so broadly, that they may not fit neatly within securities laws enacted decades ago.”  That’s exactly right. Even the 500-shareholder threshold is a relic of the 1960s.  But the newer regulatory burdens are the real killers. As Anupreeta Das and Amir Efrati explained in yesterday’s Wall Street Journal:

The [Facebook private offering] is the latest example of how Silicon Valley’s newest generation of Web companies is taking capital to stay private for longer. While as recently as a decade ago it was a status symbol in Silicon Valley to go public quickly, Facebook, Twitter Inc., Groupon Inc. and others are among the new crop of firms that have recently raised big money in private financing rounds that provides them a cash cushion to continue remaining private. Across Silicon Valley, “the incentive for going public has lowered and the penalty for going public has increased,” said Ben Horowitz, a partner at venture-capital firm Andreessen Horowitz, which in November bought Facebook shares from venture-firm Accel Partners in a private transaction. “Compared to the 1990s when everybody went public as soon as possible at much lower revenues,” the regulatory environment and the rise of hedge funds has made it “dangerous” for start-ups go to public without a large cushion of cash, said Mr. Horowitz. “In general, we recommend that our companies be very careful about going public.”

Why should tech companies tread cautiously in this regard?  Why must they, as Mr. Horowitz suggests, “be careful about going public?”  Well, for starters, read this excerpt from a 2006 submission to the SEC by the Silicon Valley Leadership Group regarding the burdens imposed just by the Sarbanes-Oxley Act of 2002 (SOX):

SOX compliance brings with it a heavy burden that strains resources that could otherwise be used for critical research and development or other corporate initiatives to improve company management, expand into new markets and increase investor value.  Initially, the SEC suggested that the average company would have to spend $91,000 dollars annually.   However, in a recent survey of National Association of Manufacturers members about 50% of respondents reported spending more than $5 million in 2004 to comply.   More recently, a Financial Executives International (FEI) survey of 274 public companies indicated a 16.3 % reduction in SOX related costs in 2005 from the year previously, but that the total average cost for compliance was $3.8 million.

And there’s plenty more red tape to contend with when companies go public.  Again, this hurts not merely the companies but also those average investors who’d like a chance to buy in to hold a small share of the American Dream. As Albert Wenger of Union Square Ventures correctly notes in his essay, “The Private IPO“:

These deals should really be a wake-up call to politicians and regulators.  They are a great example of how well-intentioned regulations can backfire.  The net result of the Wall Street research settlement, SARBOX and other protections for small investors has been: small investors now have no access to the most interesting investment opportunities.  Instead, these companies are going to be more or less fully developed by the time they eventually come to the public markets, with most of the upside having been captured by private investors.  That’s especially annoying when it seems that with the Internet we should be seeing IPO 2.0 — direct to small investors without the historic flip opportunity for well connected investors.

How incredibly sad. And how incredibly frightening for the future of American competitiveness.

Let’s be clear, cleaning up this mess doesn’t mean the SEC would be devoid of any role in policing capital markets for fraud.  A certain amount of transparency is essential for good corporate governance.  But the path we are now is instead wrapping companies and capital markets in layers of red tape that suffocate investment and innovation.  Moreover, as today’s news from the SEC proves, regulatory intervention in these cases simply begets more and more intervention to correct the inevitable failures of, or dissatisfaction with, previous interventions.

In that regard, I’m reminded of what Austrian economist Ludwig von Mises had to say about government intervention in his 1949 classic, Human Action:

All varieties of interference with the market phenomena not only fail to achieve the ends aimed at by their authors and supporters, but bring about a state of affairs which — from the point of view of their authors’ and advocates’ valuations — is less desirable than the previous state affairs which they were designed to alter. If one wants to correct their manifest unsuitableness and preposterousness by supplementing the first acts of intervention with more and more of such acts, one must go farther and farther until the market economy has been entirely destroyed and socialism has been substituted for it.”  at 858 (3rd ed. 1963) (1949).

No, I do not believe we are headed into a socialist hell-hole any time soon.  Nonetheless, the SEC appears poised to dig us into an even deeper ditch before thinking about an escape plan to get us out of this mess.

MIT’s Technology Review has a great review of a new biography of Georges Doriot (Wikipedia) by Businessweek Editor Spencer E. Ante entitled, Creative Capital: Georges Doriot and the Birth of Venture Capital.  Born in France, Doriot fought in World War I, then studied at Harvard Business School, served as director of the U.S. military’s Military Planning Division during World War II as a brigadier general, and in 1946 launched American Research and Development Corporation (ARD) as the first publicly owned venture capital firm.

Doriot’s legacy looms large today, even if his name is new to most:

Contemporaneously with ARD’s watershed investment in [Digital Equipment Corporation], others began walking the trails Doriot had blazed: Arthur Rock (a student of Doriot’s in the Harvard class of 1951) backed the departure of the “Traitorous Eight” from Shockley Semiconductor to form ­Fairchild Semiconductor in 1957, then funded ­Robert Noyce and ­Gordon Moore when they left ­Fairchild to found Intel; ­Laurance ­Rockefeller formed ­Venrock, which has since backed more than 400 companies, including Intel and Apple; Don ­Valentine formed Sequoia Capital, which would invest in Atari, Apple, Oracle, Cisco, Google, and YouTube.

Doriot himself would likely have felt at home among today’s embattled and outnumbered regulation-skeptics in the technology policy community:

he opposed both the dirigiste political economy of his native France and the tax hikes and anticompetitive laws enacted in the United States under the New Deal. Such regulations, he maintained, arrogated to bureaucrats the function of the markets; their worst feature was that they let government lend money to failing businesses. Ante notes that a former colleague of Doriot’s, James F. Morgan, recalled him as “the most schizophrenic Frenchman I’ve ever met”–devoted to his original land’s wine, cuisine, and language even as “the French capacity to make very simple things complicated drove him nuts.”

Even more intriguing is what Doriot’s experience has to say about the vital role that corporations and securities laws plays in facilitating–or hindering–innovation by constraining the structures of the investment vehicles that fund the commercialization of new technologies:

Doriot endured bureaucratic regulators who did not understand or care how a venture capital firm differed from other investment companies. ARD suffered because, since it was incorporated as a publicly traded investment company, its employees could not generally receive stock options in its portfolio companies, despite Doriot’s ceaseless pleas to the U.S. Securities and Exchange Commission. The reality that Doriot’s company faced from 1959 onward was that a new organizational form–the limited partnership, born in Texas’s oil-wildcatting industry–was being adopted by newer VC firms. Ante quotes a former ARD executive who recalled that after he supervised the IPO of one portfolio company, the net worth of that company’s CEO “went from 0 to $10 million and I got a $2,000 raise.” A VC limited partnership, by contrast, gave its general partners not just management fees but also portions of its capital gains; additionally, it permitted profits to be passed on to its investors without incurring corporate taxes, and it mandated that limited partners stand clear of management. Small wonder that when Perkins helped found Kleiner Perkins Caufield and Byers in 1972, it was as a limited partnership. When Doriot finally accepted the SEC’s intransigence, he deemed ARD “not competitive anymore” and sought the merger with Textron. Similar disagreements continue between government and industry. After the dot-com and telecom crashes, Washington passed the Sarbanes-Oxley Act and new accounting rules for expensing stock options, despite the predictions of many tech­nology executives and VCs that regulation would undermine innovation. John Doerr at Kleiner ­Perkins, for one, believes that that happened: ­”Sarbanes-Oxley did have some chilling effects on technology startups in terms of the cost of being able to go public.”

R.I.P., Monsieur Dorian.  I look forward to reading Ante’s biography.

Note that an audio version of the Technology Review article is available in audio form (Flash, MP3) as part of TR’s podcast of all their stories.  Once you get used to the Audiodizer computer voices that read the story–whose unintentionally hilarious mispronunciations and mis-emphases I have grown to love–the podcast becomes a valuable source of high-quality tech news and commentary.