Why is the Nasdaq market wobbling so feebly, on top of an incredible 30 percent decline from its high just three months ago? The unprecedented economic boom since 1983 is widely attributed to the explosion in value created by high-tech firms. They have raised the funds, lifted the stock market, created the jobs and fueled the prosperity that is the envy of the world. In fact, it is small businesses generally that has led the way in a general flowering of entrepreneurship not exceeded in modern times. Yet, bad public policy from the Clinton administration is threatening to kill the goose that laid the golden egg.
The secret to growth is reliable information on risks and potential rewards, undeterred by government meddling. If markets are efficient, businesses with the potential for success can raise the capital needed. It is America’s efficient capital markets that have made it so successful.
But it is often overlooked that there are several capital markets and all must be working for real prosperity to develop and endure. It is clear the national stock exchanges are efficient for large firms. Yet, access to capital for smaller firms is much more problematical and now is under severe threat from an quiet action taken by the Securities and Exchange Commission last year.
All the new jobs created since the expansion began under Ronald Reagan have come from firms with fewer than 500 employees. Two-thirds came from firms with fewer than 20 employees. Most of these were financed by personal and family resources. But the firms that created the greatest wealth and the most jobs had to raise funds in private or public stock offerings. They cannot raise funds from the New York, American or even Nasdaq national exchanges because they are too new and small, even those worth several hundred million dollars.
Below these are three available markets: the Nasdaq small capital market, the Nasdaq over-the-counter (OTC) Bulletin Board, and the private so-called “pink sheet” markets. The problem is that the SEC in 1999 made it more difficult for them to raise funds from the first two, forcing many into the inefficient stocks not even traded on line the chaotic pink sheet market.
These firms are called “small public companies.” They are the engines of growth, the future Microsofts. But the SEC put them in a squeeze. Responding to a congressional concern about “penny stock” abuses, it doubled the asset requirements for all four Nasdaq markets.
Many sound firms that once were eligible for the quoted Nasdaq were thrown off. While the SEC admitted there were only a few abusers, it eliminated 3,000 OTC firms, according to the National Small Public Company Leadership Council. The paradox is that most firms at least those that survived fell into the unregulated pink sheet market where they are more subject to abuse.
When the OTC firms were required to re-register with an incredibly complex Form 10 that required SEC approval, the bureaucrats were swamped. Long delays resulted even for those that could afford the legions of lawyers, accountants and consultants and that were ultimately approved. This delay caused serious liquidity problems and chased many into bankruptcy.
One of the slighted reforms of the Reagan era was SEC Rule 504, which allowed firms to raise small amounts of capital at first $500,000, now $1 million over 12 months without the red tape of burdensome forms and notices. This little reform in 1982 may have been the most important germinator of the entrepreneurial creativity and wealth thereafter. Tens of thousands of small firms have used this provision on the way up to raise critical capital. Yet, after requiring the OTC firms to register, the SEC did not allow registered firms to use Rule 504 offerings any longer, dealing them a double blow in their constant search for additional resources.
Fortunately, the SEC knows many of its procedures are outmoded and it is conducting a full-scale review of its 1930s-era laws with an eye to an entire rewrite. This is an opportunity for Congress to go back to the Reagan reforms. It should limit the asset requirement levels and open Rule 504 offerings to all qualifying firms. It should return to the 1993 rule allowing stock sales without massive documentation for smaller offerings, only subjecting them to general fraud and civil liabilities statutes. While it is at it, Congress should lift the ceiling for 504 offerings to $5 million and link this limit to inflation for the future.
The Clinton administration has been lucky with this economic boom, which started under its predecessors. But the markets are now shaky and unless the small-public-firm capital market error under Bill Clinton’s watch is corrected, the whole prosperity could tank.
Donald Devine, former director of the U.S. Office of Personnel Management, is a columnist and a Washington-based policy consultant.