When you look at the Madoff scandal, bad banking practices, irresponsible use of derivatives, and poor mortgage lending practices that have contributed to the worst recession since the great depression, it is easy to jump to the conclusion, as many politicians have, that the answer is greater and more rigorous regulation.
My question is whether greater regulation and spending on enforcement really solves the problem, and whether it will have the unintended consequence of having a significantly disproportionate impact on small businesses. This is a very important question given that according to the Small Business Administration FAQs small businesses represent 99.7% of all employer firms, employ about half of all private sector employees, and have generated 60-80% of net new jobs annually over the last decade.
While I don’t disagree that there may be additional enforcement and/or regulation that may help prevent substantial problems created by irresponsibility or malfeasance at large companies, I am skeptical whether in many cases the cure is better than the disease. In the early 2000s, two of the largest company failures due to malfeasance were Enron and WorldCom. At the time, the SEC spent between $300 and $400 million on enforcement. With both businesses, it was not the SEC or any other governmental agency that discovered their wrong doing. With Enron, short sellers figured out what was going on, and with WorldCom it was internal auditors. However, in response to these scandals the SEC’s enforcement budget was increased to close to $1 billion. Yet, since then there continue to be problems with malfeasance. The most notable current problem is the Bernie Madoff Ponzi scheme. Despite an outside individual, Harry Markopolos, repeatedly contacting the SEC and providing data on why he felt that Madoff was running a Ponzi scheme, the SEC did not do anything about it. The Madoff scandal came to light when Bernie Madoff confessed to his sons that he was running a Ponzi scheme and they turned him in. I suspect that the government could create all sorts of new regulations, and increase enforcement activities, but if there is a clever person who lacks ethics there will still be ways that such an individual can game the system.
Even if greater regulations and enforcement did catch a few additional bad apples, is it worth the negative impacts? What I’m referring to is that increasing regulation and enforcement not only require significant government cash outlays, but they also have compliance costs for businesses. As a business broker, I see small business owners struggle with compliance on a daily basis. These compliance costs are, in effect, a hidden tax. A SBA report titled “The Impact of Regulatory Costs on Small Firms” found that already Federal regulations cost small businesses with fewer than 20 employees $7,647 per employee, which is 45% more than larger firms who incur costs of $5,282 per employee. At a time when we really need to be encouraging small businesses to continue to be drivers of economic growth and providers of the majority of jobs in this country, do we really want to lower entrepreneurs’ incentives by adding greater regulation compliance costs?
Codiligent Business Brokers - Portland, Oregon based business brokers representing sellers of businesses with $500k – $20 million in annual revenue. To schedule a free consultation to discuss the possible sale of your business you may contact Eric Williams at 503-535-8817 or E@codiligent.com
