The strict regimen that Congress imposed on corporate boardrooms and securities in the wake of the Enron scandal in 2002 is prompting companies to avoid U.S. markets by going private and offering their stocks on overseas exchanges, recent studies show.
The move away from U.S. markets was seen dramatically last year as initial public offerings on the London Stock Exchange and London’s Alternative Investment Market for small companies for the first time surpassed first-time offerings on the New York Stock Exchange and Nasdaq Stock Market.
The U.S. accounted for 20 percent of all initial share sales worldwide last year, down from 35 percent in 2001, according to the Financial Service Forum, and the number of foreign companies offering their shares through American Depository Receipts on U.S. markets is at a 19-year low.
Unless the thicket of bureaucratic strictures is trimmed back, the U.S. risks ceding its pre-eminence to London, Hong Kong or other financial centers, a study commissioned by New York City Mayor Michael Bloomberg and Joint Economic Committee Chairman Sen. Charles E. Schumer, New York Democrat, warned earlier this year.
“U.S. financial markets are no longer seen as hospitable,” said Peter J. Wallison, a financial analyst at the American Enterprise Institute, a Washington free-market think tank. “Foreign companies are avoiding the United States and financing transactions are increasingly carried out in freer and more efficient markets abroad. What this should tell us is that U.S. regulation has now gone over the tipping point.”
Mr. Wallison said the Sarbanes-Oxley law passed nearly unanimously in 2002 in reaction to scandals at Enron, WorldCom and dozens of other once-prominent companies was the “last straw” that sent companies scurrying overseas. Since the end of 2004, 30 foreign companies have left the NYSE and Nasdaq, and 35 U.S. companies have listed on the London markets, he said.
“The United Kingdom is a particularly strong competitor for the United States, offering a stable and predictable legal system and the English language, in which many financial contracts are written,” he said. The lion’s share of global bonds, derivatives and currencies already are traded in London and “no other financial center in the world can equal the depth and scale of London’s international markets.”
The increasing number of companies going private also is an alarming comment on the regulatory obstacles businesses face, he said. Since 2001, the number of public companies going private has doubled, including some of the biggest transactions ever, such as the $32 billion buyout of energy company TXU announced last month. They also include big names such as Hertz, Neiman Marcus, Metro-Goldwyn-Mayer and Toys “R” Us, but many small, entrepreneurial businesses also are choosing to go private or not to go public in the first place.
“This is a highly adverse trend” that makes fewer stocks available for Americans saving and investing for retirement, Mr. Wallison said. “The once-significant advantages of public ownership have now fallen behind the reporting costs, regulations, and litigation risks associated with having public shareholders.”
The Government Accountability Office, Congress’ investigative arm, found “the costs associated with public company status were most often cited as a reason for going private,” in a 2005 study that predicted the privatization trend would continue.
Businesses have complained since it was enacted about the regulatory burdens imposed by the Sarbanes-Oxley law. A University of Rochester study in 2005 estimated U.S. businesses lost $1.4 trillion in market value as investors bid down stock prices in anticipation of its regulatory costs. The most cited “culprit” is Section 404, which requires companies to establish internal financial controls and have their auditors certify the controls’ effectiveness.
The law’s requirement that a majority of all corporate boards be composed of independent members, who often know little about the business and are more averse than company management to taking risks, has contributed to a more conservative corporate culture in which businesses avoid the risks of starting up new ventures and instead hoard their profits and cash, according to another 2005 academic study.
Beyond the Sarbanes-Oxley law, businesses also cite the risks of class-action lawsuits and aggressive enforcement by the Securities and Exchange Commission as reasons to avoid public U.S. markets.
Political leaders of all stripes are vowing to do something about it. Treasury Secretary Henry M. Paulson Jr. says he wants to ensure the United States maintains its place as the leading financial center, saying the country needs to “strike the right balance” on regulation and enforcement without imposing “needless costs on investors.”
In addition to lightening the most burdensome regulations, the Bloomberg-Schumer report recommended reforming securities litigation statutes and easing immigration restrictions that prevent financial companies from hiring talented foreign workers.
The measures to reduce litigation ironically were endorsed by New York Gov. Eliot Spitzer, a Democrat who as the state’s attorney general frequently outdid the SEC by filing dozens of lawsuits targeting corporate crime.
But now, Democrats as well as Republicans have heard the cries for corporate relief.
“This is not simply a New York issue,” said Mr. Schumer, a top Democratic fundraiser who noted that financial services firms generate 5 percent of U.S. jobs — and some of the highest paid. “Seven states, including New York, have more than 10 percent of their state’s GDP derived from financial services.”
The SEC has heard the calls for regulatory relief and is crafting an exemption for many small companies from the onerous Section 404 rules. But regulators by and large defend the reform law, saying it has contributed to higher quality and better functioning securities markets in the United States.
The increased share of market activity on foreign exchanges reflects the growth of the global economy and global financing activity more than any diminished role for U.S. markets, regulators and some economists say.
Recent surveys show that year-to-year costs of complying with the law have subsided for businesses that footed the admittedly large up-front costs of hiring independent auditors and putting accountability systems in place.
Federal Reserve Chairman Ben S. Bernanke recently urged Congress to stick with the new rules, arguing that, because they are designed to protect investors and give them the best information possible, in the long run they will increase the attractiveness of U.S. markets to the rest of the world.
SEC Commissioner Roel Campos said the 2002 rules “have done a tremendous service to investors and the markets” and the U.S. should not cave in as companies rush overseas to list in venues that enable them to avoid regulatory scrutiny.
“It’s a losing proposition to tout lower standards as a way to promote your markets,” he said. Many companies in the London alternative market, for example, “can’t even meet the standards of our over-the-counter, or pink-sheet situations,” he said. “They’re hoping that they’ll get lucky” with investors.
“I’m concerned that 30 percent of issuers that list on [London’s alternative market] are gone in a year,” he said. “That feels like a casino to me, and I believe that investors will treat it as such.”
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