PUBLIC RADIO'S MARKETPLACE COMMENTARIES:

Paulson Has it Backwards

Robert B. Reich
Marketplace, November 22, 2006

Treasury Secretary Henry Paulson issued a solemn warning this week. He said public companies are going private at a record pace because of regulatory burdens like the Sarbanes-Oxley legislation, which could be damaging America’s economic standing.

This is utter nonsense. If Paulson thinks public companies are going private because of regulations like Sarbanes-Oxley, he’s either naive or doesn’t want you to know the truth.

Companies that go private return to the public market within a few years. That’s the whole point of these deals. When they go public again, their stock sells at a far higher price than what the equity firm that took them private originally paid for it. So the private partners, along with the CEO and other top executives, make a killing. Why else do you suppose private equity firms are raking in so much money? Why else do you think CEOs have been so eager to do these deals?

Sarbanes-Oxley has absolutely nothing to do with it. That law, remember, was put into place to regain the confidence of investors. Many of them were small investors who got clobbered when CEOs looted their companies by pumping up share prices with false accounting, and then cashing in their stock options before reality caught up. Enron was the tip of a huge iceberg.

That iceberg is still with us. In fact, public companies are restating financial results at a higher pace than ever before. And these aren’t technicalities. The Securities and Exchange Commission reported last Friday that more than half these restatements are due to companies misapplying basic accounting rules or having the wrong data to begin with. Without Sarbanes-Oxley, investors would never know the truth.

Paulson says he’s worried that Sarbanes Oxley is causing public companies to go private. He’s got it backwards. He ought to be worried about the real reason so many public companies are going private. It amounts to a new kind of CEO looting.

CEOs advise their directors and public shareholders that the private buyout is in the best interests of the company. Then after the public shareholders sell out to the private equity firm, the CEOs stay on. At this point the CEOs typically make fixes – new products, additional job cuts, new deals with suppliers or distributors – that increase company profits. The result is to drive share prices sharply up when the company goes public again.

Had the CEOs made these fixes before the private equity deal, the original shareholders would have benefited from the increase in the share price. By making the fixes after the deal is done, CEOs and their equity partners take all the booty for themselves.

It’s a scam. CEOs shouldn’t be allowed to advise their directors and shareholders that a pending buyout is in their best interests and then make a bundle off the deal. If they give any advice at all, they shouldn’t be allowed to remain with the firm after it goes private.

If Paulson wants small investors to stay confident the market isn’t rigged against them, he should not seek to weaken Sarbanes Oxley. To the contrary, he should expand the law to prevent this new form of CEO looting.