SarbOx under assault -- TomPaine.com

SarbOx Under Assault

Lee Drutman

December 14, 2006

Lee Drutman is the co-author of The People’s Business: Controlling Corporations and Restoring Democracy.

Last week, an official-sounding group called the Committee on Capital Markets Regulation released an equally official-sounding document called the “Interim Report of the Committee on Capital Markets Regulation." In this report, a star-studded group of financial industry cheerleaders from academia and business (but with no official capacity) argued that the competitiveness of U.S. financial markets is at stake, and restoring competitiveness depends not only on rolling back reforms enacted in the wake of Enron, but on creating an even looser regulatory environment than existed before.

The main target is the Sarbanes-Oxley Act of 2002 (SarbOx, for short), the accounting and securities reform legislation inspired by Enron, WorldCom and all the rest. Financial industry leaders never liked the law, and now, four and a half years later, they are hoping that memories of the scandals have finally faded enough to go back to the happy-go-lucky style of accounting that made Wall Street much more fun and profitable for those few in the know.

Don’t be fooled. The committee’s arguments are based on a number of dubious claims and a misguided set of priorities. But, then again, given that the committee comprises representatives of many of the same accounting and Wall Street firms that were behind the recent wave of corporate scandals, perhaps we shouldn’t be surprised to observe yet another questionable sleight of hand.

According to the report, a growing number of companies are looking to overseas markets to raise capital, rather than deal with the allegedly burdensome regulatory environment of U.S. financial markets. According to the report, in 2000, half of the money raised in global IPOs came from U.S. exchanges, whereas in 2005 only 5 percent came from U.S. exchanges.

But to blame this on the regulatory environment is misleading. For one, 2000 was the height of the technology IPO boom in the U.S., hardly a representative year for comparison. And in retrospect, there were many, many companies that really shouldn’t have been taken public, and a lot of investors would have actually been much better off had Wall Street not engaged in a reckless bout of IPO cheerleading. If tighter had rules stemmed the IPO flow, this actually would have been a good thing.

Moreover, as The New Republic’s Clay Risen recently noted, a likely reason that start-ups may be seeking out overseas markets may not be the regulations, but rather the greed of U.S. investment banks, which charge 6.5 to 7 percent in underwriting fees—as opposed to London firms who charge 3 to 4 percent. London markets have raised $40 billion through late October this year, as opposed to $30 billion in New York.

The Committee on Capital Markets Regulation report also notes that while in 1995 only 2.2 percent of public takeovers involved taking a company private, by 2004, 26 percent involved taking companies private. But is this all because of overregulation? Perhaps the pressure on Wall Street for constant steady quarterly earnings growth has become too intense and unmanageable, making it nearly impossible for firms to do anything resembling long-term planning anymore and making private ownership much more appealing. And maybe more companies going private is not such a bad thing, considering the often destructive short-termism that many public companies are forced to engage in to meet Wall Street expectations.

Of course, it is certainly possible and that the heightened regulatory climate has pushed some IPOs overseas and pushed at least some companies to seek private as opposed to public funding. But even if this is the case, should we really be worried about these trends? Certainly, there is no shortage of capital to grow the economy among private and overseas investors.

But Wall Street firms are certainly worried. Companies choosing to raise capital privately or overseas means less lucrative underwriting business for the big Wall Street firms. Undoubtedly, a more anything-goes approach to securities regulation would be a boon to these major investment banks, as it was in the late 1990s.

But the whole reason that we have the Sarbanes-Oxley Act is because we already tried the anything-goes approach to securities regulation. It didn’t work. Made-up corporate profits, cheered on by conflicted Wall Street analysts, duped small investors out of trillions of dollars in retirement savings. The whole point of Sarbanes-Oxley was to restore faith in markets at a time when investors had good reason to doubt. How easily we forget the very real possibility that investors could take their money and put it in treasury bonds if they lost confidence that corporate financial reports represented a realistic picture and not some elaborate trompe l’oeil . Certainly, big Wall Street firms don’t want that to happen.

It may even turn out that in the long run, having a tightly-regulated securities market is a comparative advantage. Investors tend to be risk averse, and many would prefer to invest in markets where they know what they are getting, especially when it is their retirement security at stake (even if that means a slightly diminished potential for returns). If other financial markets suffer a series of scandals (the chance of which are increased by lax regulations), a listing on an American stock market will start to look awfully good by comparison.

Still, the politics of this all promise to be interesting. This report was timed to come out right after the election, and incoming House Speaker Nancy Pelosi, D-Calif., has reportedly promised that revising Sarbanes-Oxley is a top priority. (Pelosi receives a lot of money from Silicon Valley investors, who are eager to see financial regulations loosened.) Then again, the financial industry has complained about Sarbanes-Oxley for years to a Republican Congress, with no effect. But they do not appear about to give up, either.

Certainly, some small technical fixes to Sarbanes-Oxley, particularly to the dreaded and demonized Section 404, may be in order. But a large-scale regulatory rollback of the type recommended in the “Interim Report of the Committee on Capital Markets Regulation” would be foolish. There is little direct evidence that tighter regulations are the main reason that companies are going private or IPOs are going overseas. Nor should these trends necessarily be troublesome to anybody except the big Wall Street firms that lose out on a lucrative underwriting business.

http://www.tompaine.com/articles/2006/12/14/sarbox_under_assault.php