Friday, September 29, 2006

Big Government Republicans and Internet Gambling

Internet gambling is not an issue I particularly care about (I have less of a "gambling problem" than a "parting-with-my-money problem"). Nonetheless, assuming there are basic protections in place to keep out the kids and the mob, I don't see why the government should particularly care about it either. More importantly, if you proclaim you are the party of small government, I really don't understand why you would go out of your way to put a federal ban on Internet gambling into a port security bill, like Senator Bill Frist (R-Tenn.) has done.

Where's the small government? Where's the states' rights? Where's the "freedom" and "liberty" part of the Republican Party today?

Barry Goldwater must be spinning in his grave.

What to do with YouTube

I’m a big fan of YouTube, if for no other reason than that I’m not really up on things generally and it is useful to me when friends send me emails saying, “I know you live with a family of raccoons in the woods, so you might not have seen this when it ran on TV, but I think you might enjoy it.” (Fortunately, my raccoon family has high-speed Internet access.) Also, without YouTube, I couldn’t post interesting things on this blog, such as “Bill Clinton gets mad and Chris Wallace smirks”, “Now that’s the Ann Coulter we know and love!”, “The funniest thing I've seen this week”, “More on Ann Coulter and something on Henry Rollins” or “Ann Coulter is a deconstructionist”. (Ok, I’ve got an unhealthy fascination with Ann Coulter…). I would also include “Joe Biden should stay out of Dunkin Donuts”, but the National Journal was kind enough to put that link up on its own website.

My point, and the point made by Mark Cuban on Blog Maverick and the Wall Street Journal's Law Blog, is that most of this material is pirated. In other words, it is copyrighted material that somebody (not me) posted to YouTube without the copyright owner's permission. Cuban is predicting that YouTube will go the way of Napster, in that it is making money off of this pirated material and it is only a matter of time before the powerful copyright owners shut it down.
The thing is the shock that until Universal Music Group apparently started to put the pressure on them, no one had sued them. Considering the RIAA will sue your grandma or a 12 year old at the drop of a hat, the fact that Youtube is building a traffic juggernaut around copyrighted audio and video without being sued is like.... well Napster at the beginning as the labels were trying to figure out what it meant to them. With the MGM vs Grokster ruling, its just a question of when Youtube will be hit with a charge of inducing millions of people to break copyright laws , not if.

I disagree, and the reason is that YouTube operates under a very different technological environment and, most significantly, because Cuban misses what video content providers are selling.

Technologically, of course, there is a big difference between an MP3 music file and a video file. Downloading music files is quick and the storage capacity of even a cheap computer today (an even a basic MP3 player) means that downloading and uploading entire albums is easy and the quality of the final product is good. The result has been a dramatic decrease in album sales — to the point where recording companies have begun to lose millions (if not billions) in revenue.

Video files, of course, are massive and current Internet technology means that downloading entire pirated episodes of television shows (let alone movies) is prohibitive. Storing such downloaded files is also problematic. Quality is also an issue. While few ears can tell the difference between a higher-quality MP3 version of a Metallica tune from it's CD counterpart, anyone can see that a matchbox-sized .wmv-version of "The Office" leaves something to be desired.

But technology changes and it is safe to say that many of these issues will be resolved. However, what likely won't change is the nature of the product that video producers are selling.

Recording companies sell records, and Napster, Grokster and the rest chewed significantly into the sale of those records. Movie production companies sell movies, and any sharing technology that would cut into the number of people going to the box office or renting DVDs would also cut into their bottom line (though, at this point, movie producers have much more to fear from DVD pirates than YouTube, given current technology). Television producers, by contrast, do not sell television shows. They sell eyeballs. And this is a reason that Fox News, for example, hasn’t asked YouTube to remove copies of the Wallace interview.

YouTube is free publicity, and it costs Fox nothing in terms of lost royalties. The folks who download the Clinton interview to see Slick Willie get all red in the face would not pay Fox to see the clip. Many would not even go to the Fox News website to see the clip (where Fox might eke out a little in ad revenue), perhaps out of prejudice (I have liberal friends who have used their V-chip to lock out Fox News) or other reasons (i.e, Fox News might make you watch ads before getting to the good stuff). However, when viewers see the interview on YouTube, Fox may gain a few new viewers, who want to see more such interviews.

Of course, Napster made the same argument (kids download one pirated song, then go out an buy the whole album), but that was ridiculous on its face. Kids could download the whole album for free, and recording companies made money selling albums. However, television networks make money off ad revenue, and, for them, anything that attracts eyeballs — including copyright piracy— also increases ad revenue.

Not every wronged copyright holder, of course, will view YouTube in such an enlightened fashion. And, as CBS News has pointed out, other issues arise when copyrighted material is altered and then posted on YouTube. (Though some alteration, of course, might bring the material into the realm of parody, and thus give it greater protection against charges of copyright infringement, if the nature of the parody is clear.) That said, whether YouTube fends off potential lawsuits depends entirely on who’s rights are being infringed. Lawsuits are expensive, for both parties. A plaintiff can use a lawsuit to extract a hefty settlement from the defendent, but, unlike the recent mess with Blackberry, no single clip on YouTube is essential to its business model. It can respond to a lawsuit by pulling the offending clip and arguing that damages have been mitigated. The plaintiff then has to argue that it has suffered serious economic losses, all the while its legal bills are mounting.

This changes, of course, with a large company with deep pockets, which probably has a better chance of arguing that it suffered very serious economic damages, even prior to YouTube pulling the offending material. That said, these are precisely the big players that have an incentive to set up some agreement with YouTube on royalties. For them, the calculation has to be, does YouTube rob them of viewers that it might otherwise have — are there people out there who would otherwise watch Fox News but who are now not doing so because they can always find the juicy clips later on YouTube? This seems unlikely, for several reasons. The first is timeliness — YouTube is always after the fact. The second is price — watching television is free (or at least marginally free, once you pay your cable bill and buy a television). Consequently, it seems much more likely that a television network will gain viewers than lose them.

Another factor working in favor of YouTube is the recording companies’ experience with Napster. The recording companies, unlike the television networks, were desperate because MP3 download services were significantly cutting into their revenue (something that YouTube doesn’t seem to be doing). However, after going after Napster, the download services merely moved offshore, where it has proven much more difficult for the recording companies to sue them. They have now moved on to suing individual users in an ad terrorem approach, something that may or may not work, depending on whether illegal downloaders realize that the odds of them all being sued is extremely low.

The television networks are now at the same crossroads that the recording companies were 10 years ago, and they have the benefit of hindsight. I think they are much more likely to work with YouTube than try to shut it down. (And as for ad revenue, Tivo poses a much greater threat than YouTube ever will.)

Thursday, September 28, 2006

Do you really need to be a moron to invest in YouTube?

Mark Cuban apparently told a group of advertising execs today that you'd have to be a "moron" to invest in YouTube, since it's going to be "sued into oblivion". My question is, if I'm right (read here), can I get to be a billionaire, too?

SEC Chairman Cox meets with Euronext regulators

Securities and Exchange Chairman Christopher Cox met on Tuesday with the heads of the Portuguese, Dutch, Belgian and French financial regulators, along with the head of the United Kindom's Financial Services Authority's division of market regulation. The meeting was designed to demonstrate to Europe that regulatory issues regarding a proposed merger between Euronext and the New York Stock Exchange are all under control. In particular, Cox's venture to Lisbon was a signal that the SEC has no intention of imposing SEC regulations or the Sarbanes-Oxley Act on European stock exchanges.

The make-up of the meeting was very interesting, and indicative of the shape of this merger. Euronext is a pan-European stock exchange, a combination of the former Paris, Brussels, Amsterdam and Lisbon stock exchanges, plus the London derivatives market LIFFE. The New York Stock Exchange is the world's largest stock exchange, by several times. Within Europe, Euronext is a smaller competitor to the London Stock Exchange (which rank 5th and 4th in the list of the world's largest stock exchanges, following NASDAQ, Tokyo and New York in the 3, 2 and 1 spot.) Euronext formed precisely in order to compete with London and other large stock exchanges, both in Europe and the rest of the world. Yet these mergers have yet to give it the critical size it feels it needs to be competitive.

Consequently, the rest of this saga reads like a Jane Austin novel.

Euronext currently has two suitors — the NYSE and the Deutsche Börse in Frankfurt (currently tied in the number 6 spot with Toronto). The NYSE originally had its eyes on London, but NASDAQ (that low-class rogue) swept in and bought a controlling share of the LSE by borrowing to the hilt. However, the LSE wants to remain independent and unmarried, particularly where the likes of an American are involved. Miss Euronext, by contrast, has been pursued very persistently by Mr. Deutsche Börse, to the point where his offer, on paper at least, appears the better — €600 million better, in fact.

Nonetheless, Miss Euronext is taken by Mr. New York. His offer is cheaper, but he's huge (umm... maybe I should rephrase that.) His parents, the SEC, have a nasty reputation, but they live far far away. And Mr. New York is just so nice. He's promised to let his lovely wife have the European villa to redecorate in any way she sees fit. Mr. Deutsche Börse, by contrast, is well-known for his Teutonic domineering attitude, and his parents live way too close for comfort. In fact, Miss Euronext already has five parents (she comes from an "alternative lifestyle" family — but she's European, so what do you expect) and all she needs are the Germans to be added into the Porto-French-Belgi-Dutch-Brit mix. I mean, please! Aren't there enough inbred impoverished European aristocratic families out there already? As inlaws, the SEC, by contrast, could be interesting. Miss Euronext knows that her own parents hate them (one of the reasons why her French parent, the Autorité des Marchés Financiers, has been encouraging Mr. Deutsche Börse). But this fact may well play into her hands, since it just means that much fewer tense family get-togethers she must attend.

Mr. New York, on the other hand, sees Miss Euronext as the perfect way to enter upper European society. He's rich, but his overbearing parents (and his positively God-awful half-uncle, Eliot Spitzer) have been driving business to Europe. With Miss Euronext, he can have a foot in both worlds — his puritanical, but extremely profitable home in New York, but also a relaxing, almost libertine estate in Europe.

The fly in this ointment are the British. Everyone knows that the London Stock Exchange has been the FSA's favorite daughter, particularly since LIFFE went off and hooked up with those Continental types. Now, a Euronext-NYSE merger poses a direct threat to the LSE, and may even give those damned Frenchies an opportunity to lord it over their British betters. Even worse, it might just drive the LSE into the waiting, grubby arms of that cowboy, NASDAQ. Intolerable!

But, at this point, there isn't much they can do about it. The British spread innuendo at every turn ("did you hear that those Yanks intend to force Euronext into a Sarbanes-Oxley corset?") And they certainly won't be a party to any of this dowry discussion (which is why the UK FSA sent a relatively junior director to Lisbon, while everyone else, including the SEC, sent their chairmen). But, still, at the moment, they grumble and pray that those damned Americans make a faux pas — maybe drink directly out of the punch bowl like a horse. One can only hope...

A Euronext-NYSE merger will prove interesting. It will create enormous competitive pressures on both NASDAQ and the LSE, while also creating for the NYSE a two-tiered market — a high-regulation market in New York, and a comparatively low-regulation market in Europe. This way, if it proves that US regulation is excessive, money is still to be made on the Continent. If, however, investors place a premium on a highly regulated market, the NYSE makes money on that, too. On the other hand, it will prove extremely expensive for the NYSE, and Euronext's Continental regulators, while weak, are not exactly as "hands off" as their UK counterparts. NYSE faces the daunting task of turning Euronext into a truly global brand, while London is already there and has been for quite some time.

That said, it will be interesting to see what happens next. Pressure to further integrate Euronext and the NYSE will come, from both investors and broker-dealers. How will the SEC respond to this brave new world?

Tuesday, September 26, 2006

Rush Limbaugh reads My Daily Fatwa

He must. It's the only possible explanation for this.

And here SOME PEOPLE (I'm talking about you, Dad) sent me an email saying there are a lot more important issues out there than Slick Willie's socks.

Well, apparently not.

(Though I'm still not sure what to make about Rush being a fan. Should I start referring to him as "Papa Bear"? I'm I "Papa Bear"? It's all so confusing!!)

Fighting the good fight against insider trading

Linda Thomsen, Director of the SEC's Division of Enforcement, testified before the U.S. Senate Judiciary Committee today on the SEC's fight against insider traders. (See Testimony Concerning Insider Trading.) The speech is mostly boring, as you might expect from Congressional testimony. But there are a few interesting points we can deduce:

  1. Since 2001, the SEC has brought more than 300 insider trading cases. When you think about the size of the U.S. market, this sounds rather low (unless the U.S. market is really clean), so it seems likely that a lot of insider trading goes undetected and unprosecuted. On the other hand, this translates into 60 cases of insider trading per year, against only a dozen or so enforcement cases of all types brought by (for example) UK financial regulators.
  2. Insider trading cases are very hard to prove, and they almost always boil down to circumstantial evidence.
  3. Of the 44 insider trading cases the SEC has brought this year, 5 involved trading by hedge funds.
  4. All really good insider trading cases (like the Reebok/Pajcin-Plotkin-Croatian grandma case) involve strippers or porn stars. (Hey, if you are going to break federal securities laws, the Marylin Starr case sets a very high bar.)
Thomsen's testimony is interesting for several reasons. The first is because not everyone believes insider-trading should be illegal (though those who make this argument most frequently tend to be ivory-tower conservative law professors or very very old economists. For example, Henry Manne or Milton Friedman.) These theorists believe that markets efficiently and quickly incorporate all available information into a stock's price, so insider trading merely puts new information into the market more quickly. (Some others, mostly idiots, suggest that laws against insider trading aren't "fair" because if I learn a secret about a company, it's not fair if the government says I can't make a lot of money off of it before it becomes public.) And, indeed, for decades insider trading wasn't even illegal in most countries. The Germans didn't outlaw it until 1987, and they were basically dragged into it by the Americans. While most countries now have laws against insider trading, most don't really enforce them. (And by "insider trading" I don't mean all trading by insiders, but trading based on "material non-public information" when you've got a duty not to trade, and a whole bunch of other legal stuff I don't really understand.)

On the other hand, where would you, as a non-insider, rather invest? On the U.S. stock market, or in India or China? Sure, you might make a lot of money in India or China, but you might make a lot of money in Las Vegas, too. Just keep in mind, though, that the house always wins in the end.

The second reason this is interesting, though, has to do with the SEC's priorities. Thomsen testifies that insider trading consistently ranks as a priority for the SEC enforcement staff. Should it? Sure, 300 cases in 5 years is a lot, and Thomsen says that in many cases the SEC has been successful in freezing millions of dollars the insiders have acquired on trades based on inside information. But even if you added up all the funds improperly acquired from all these cases over the past 5 years, they still pale in comparison to investor losses in just one financial fraud scandal like Enron.

That said, securities law enforcement is all about risk, and risk abatement is as much about responding to actual risk as it is to perceived risk. If market efficiency is determined by how risky investor perceive the market to be, and insider trading is perceived to be a serious threat to the integrity of a stock market (even if it is not), it might make sense for a law enforcement agency to devote inordinate resources to combating it.

Finally, if you do believe markets are efficient in one form or another (in other words, as one of my old Nobel-winning professors used to say, "what makes you think you are smarter than the combined wisdom of 50 million investors?"), smart investors are basically those who free-ride on the research of all those schmucks out there who haven't figured out that index funds are the way to go. In that sense, can a little insider trading be a good thing, if it holds out the (false) hope that you can beat the market? After all, if we all were smart and just decided to free-ride on the price-setting mechanism of other people's research, there would be no other people doing research, right?

Sunday, September 24, 2006

Bill Clinton gets mad and Chris Wallace smirks

I'm not really sure what to make of this, other than that Clinton is smarter than Chris Wallace (and you know how he likes to argue with people when he knows he's smarter than they are), and he really needs to buy those long over-the-calf men's socks. I mean, if you're a former president and making that much cash, you can afford better socks. I don't want to see your hairy white legs.

Saturday, September 23, 2006

I'm not really much of a diplomat type, but...

...why did the State Department apologize for this? Seriously, Venezuela's foreign minister must be as dumb as this guy. Personally, I always show up at least 3 hours before my international flights that I pay for with cash.

Thursday, September 21, 2006

Sarbanes-Oxley: What this is all about (and why you should care)

I dearly love stupid stuff, and stupid people. They are fun to write about. But my last several posts have been about serious, very boring stuff. In particular, the Sarbanes-Oxley Act and the increasingly bitter pissing match going on between London and New York over regulation, whose got the better market, etc. Today, in fact, after several weeks of teeing it up, the Financial Times issued its own editorial on the issue (“Regulatory creep from across the Atlantic: Sarbanes-Oxley’s writ is offensive and damaging to business”).

Hey, “regulatory creep from across the Atlantic”. Doesn’t that sound familiar? Why yes, I believe it does — in the article I mentioned yesterday. You know, the one masquerading as news rather than opinion? Well, they upgraded it today.

This all seems like a tempest in a teacup, except that it’s not. A tempest in a teacup is Hugo Chavez giving speeches at the UN. Please, he’s a little mouse running around saying the tiger is out to get him and that the rest of the “South” needs to line up behind him to fight off the nasty tiger. But the tiger doesn’t even know he exists, as evidenced by the fact he still exists. While the US does think Iran is a problem, running up and kissing Iran’s president doesn’t put you in his league. It just makes you look kinda gay — and in a creepy, rather than hip, sorta way. (Plus, Latin American pseudo-Marxist dictators are just so 1970s. I half expected to see Chavez wearing an open-collared brightly colored disco shirt and a Rerun hat while visiting Cuba. Oh, wait a minute—I did!)

Trillions of dollars, however, is hardly a tempest in a teacup. And, at the end of the day, that’s what all this Sarbanes-Oxley and London Stock Exchange stuff is about.

Professor Jeremy J. Siegel of the Wharton School of Business at the University of Pennsylvania had an article in today’s Wall Street Journal called “Gray World” in which he describes the impeding demographic changes that much of the developing world is about to experience, and the need to do something about it by finding a source of income for all these old fogies. His solution is to attract the capital of the developing world.

There is no easy way out of this crisis. To be sure, rising productivity brings higher income, but it also brings higher benefits, since benefits are based on income. Immigration of high-income workers would ease the situation, but the numbers would need to be prodigious to keep the retirement age from rising.

But there is a solution that can help aging economies. The developing world has a much younger age profile than the developed world. This difference in age establishes an opportunity to make a trade: Goods produced by the younger developing world can be exchanged for assets of the older developed world. This trade is not new. The transfer of goods for assets has taken place throughout history, first between family members (parents giving to children in exchange for old-age support), and then extending to clans, communities and, finally, whole nations. Soon it can be done on a worldwide basis. The developing world has the capability of simultaneously providing us with goods and acquiring our assets, filling the gap left by our aging workers.

I call this the "global solution to the age wave" and it relies on huge global capital flows to be effective. My studies show the inflow of goods and services produced abroad in exchange for capital can have dramatic effects, reducing the projected retirement age in the U.S. from the mid-70s to the upper 60s.

Why would the developing world wish to acquire our capital when their countries are expanding so rapidly? One of the first lessons one learns from studying international capital markets is that the best returns are rarely found in countries that are growing the fastest. Witness China's dismal returns despite being the fastest growing country in the last 20 years. Investors can often find better returns in slow-growing countries and industries.

To that end, U.S. capital markets have many attractive attributes. Our country is still viewed as the fountainhead of innovation, discovery, invention and entertainment, and our institutions of higher education are second to none. Our capital markets are deep, and easy to access, and willing to provide capital to those who wish to innovate. Equally important is that many U.S. brand names have great appeal world-wide so the growth of consumer markets abroad holds high promise for many U.S. firms.

For these capital movements to occur, we must be far more receptive to international capital. Although there has already been a large number of cross-country mergers, there has also been increasing opposition, witness Cnooc's bid for Unocal and the Dubai Ports fiasco. But if we rebuff goods or capital originating abroad, our growth will decline since we will be forced to rely only on our own dwindling supply of savings.

We cannot escape from our demographic realities. But we can take actions that will lead to a much brighter outcome. The integration of the world's economies and capital markets is the key to our future well-being. If we shun this path, our future will in no way be as bright as our past.

UCLA Law Professor Stephen Bainbridge writes about this article on his blog here, and uses it as a launching point to attack the Sarbanes-Oxley Act. His blog does a good job pointing out why this issue is so important. But he woefully misses the main point, juxtaposing Siegel’s concerns about the need to be more receptive to international capital, and’s blog about Sarbanes-Oxley pushing initial public offerings to London. The two might both be problems, but they aren’t logically linked.

The reason that they aren’t logically linked is that Sarbanes-Oxley isn’t an example of being unreceptive to international capital. You could argue that it’s unreceptive to capital formation (period), but it is not more harsh on foreign companies than on domestic. In fact, the SEC’s implementation rules for foreign issuers are considerably more lax than they are for domestic issuers. SOX may be a good thing or a bad thing, but it is a largely equal-opportunity thing.

Second, Bainbridge makes the rather surprising mistake of confusing raising capital with investing it. Siegel says we should be more accepting of foreigners who want to put money into our economy, because that will generate economic growth. But Bainbridge confuses this with foreign companies coming to the United States and asking Americans (among others) to invest in them. (That, after all, is what a company does with an IPO — it asks investors to give it money.)

But that isn’t to say that investing in foreign companies isn’t also a good thing (though Siegel, if you read closely, questions this at least for developing markets, since studies show that the companies in the fastest growing economies rarely post the best returns to investors). America’s baby boomers need to seek the highest return on their savings if they are going to have sufficient money to retire, and a portfolio with a high return is a diversified portfolio. Foreign stocks are a key component of a diversified portfolio, because foreign companies may do well when domestic companies do poorly (for a variety of reasons).

But this itself argues against Bainbridge’s position (and gets back to why this is all important). Sarbanes-Oxley has definitely raised the transaction costs of selling stock in the United States. But this isn’t about transaction costs. It’s not even about companies. It’s about investors. Smart investors don’t put their money into just any investment opportunity. And they don’t invest in just any market. Even if they don’t read all the financial literature their brokers send them, they have faith the market is transparent and the price-setting mechanism for company stocks is efficient. And, unless you believe in an absolutely strong version of the efficient market hypothesis (in which case all regulation is unnecessary), this efficiency depends on regulators with strong enforcement powers and regulations that require thorough disclosures of all material information about the company’s prospects. Otherwise, you might as well take your savings and go play the slots in Atlantic City.

The crucial question in all of this is whether the costs imposed by Sarbanes-Oxley — in particular, forcing companies to test their internal controls to make sure that their financial statements are accurate — are more than or less than the benefit investors derive from the additional faith in the market. Because if the benefit to investors is greater than the costs to issuers, issuers themselves will benefit by paying less for the capital they seek. Certainly, there will be some companies who will actually find that transparency raises their cost of capital. But do we really want our retirees investing in crooked companies? Who’s going to pay the bill on that when it comes due?

Finally, to take Professor Siegel’s point, nothing is more receptive to foreign capital than a market with integrity.

And that’s the reason all of this is so important.

Wednesday, September 20, 2006

An American (inspector) in London

Speaking of the extraterritorial reach of U.S. regulators (goooooo, Empire!)... One of the things that has the UK folks upset these days (in addition to the NatWest Three, and our beloved president referring to Tony Blair as "Yo, Blair!") is a recent inspection by the Public Company Accounting Oversight Board (PCAOB) of the London offices of the accounting firm Ernst & Young. (See Barney Jopson's "US inspectors scrutinise E&Y in London". I particularly like his opening paragraph describing it as "the latest case of US regulatory 'creep'".)

Don't get me wrong--I'm all for extraterritoriality. But I fail to see how this lives up to my high standards of reaching across borders to impose your rules on someone else. I also don't see how this is news.

For one thing, this isn't about imposing U.S. regulations abroad. Basically, following the Enron, Worldcom, Adelphia, Tyco, and Xerox debacles--and before the Parmalat, Royal Dutch Shell, Ahold and other debacles that didn't actually happen in the United States--the U.S. Congress decided we needed some kind of oversight body to regulate the auditing industry. In each of these scandals, financial problems had gone undetected by these independent auditors charged with making sure a company's books are accurate. Hence, the PCAOB.

The Sarbanes-Oxley Act (yes, I do live and breathe SOX these days) says that if you are going to audit the financial statements of a company listed on the U.S. market, you have to be registered with the PCAOB. And if you are registered with the PCAOB, you have to be open to inspections by it. However, most big companies don't operate in just one country. And not all companies listed on U.S. stock exchanges are based in the United States. In both cases, part of the company's operations are overseas and those parts must be audited as well if the company's financial statements are to have any meaning.

This gets tricky here because most countries have laws that say you can't be an accounting firm in that country unless you have a license there. So big accounting firms like Ernst & Young have local "partners" or "affiliates", licensed locally, that audit the financial statements of the local part of the U.S.-listed company.

How does a regulator ensure that the audits of the foreign subsidiaries of a company are thorough and not undermined by conflicts of interest? There currently are two different approaches. (Well, three, if you count "we don't care" as an approach.) The first (and most common in Europe) is to hold the "lead" auditor responsible for the entire audit. If the local auditor screws up, the lead auditor takes the hit. The problem with this approach is that if liability rests entirely with the primary auditor, there is no way that auditor will permit the company to use any other local auditor than the one it is affiliated with. Why should it? At least it has some control over that guy. This can create problems of competition, particularly since there are only four big audit companies in the world, and not all of them operate everywhere.

The United States takes a second approach--every audit firm is liable, but only for that portion of the audit they conduct. The only way this approach works, though, is for everyone to be subject to PCAOB oversight.

Some of the UK folks over at E&Y apparently are complaining that the PCAOB inspections are duplicative of what the UK authorities already do. This is partly disingenuous. U.S. Generally Accepted Auditing Standards are different than those used in the UK and the EU, so the inspections can't be entirely duplicative. Second, these kinds of cross-border inspections are not unique. The SEC and UK FSA currently conduct joint inspections of investment advisers operating in both the U.S. and UK (as mentioned here, in a speech by Ethiopis Tafara of the SEC).

So, is this an example of U.S. "regulatory creep" or "British firms under US rules" (as Steve writes at the Pub Philosopher)? Or is this just U.S. rules for U.S. markets in a world where firms don't recognize the niceties of borders?

Tuesday, September 19, 2006

SEC Chairman Cox: Sarbanes-Oxley not unique in world, U.S. just early adopter

Securities and Exchange Commission Chairman Chris Cox today testified before the House Financial Services Committee. A copy of his testimony can be read here. The title of today's Committee session was "Sarbanes-Oxley at Four: Protecting Investors and Strengthening the Markets" and the central question was whether the Sarbanes-Oxley Act of 2002 is undermining the competitiveness of U.S. capital markets.

(Mark Olson, chairman of the Public Company Accounting Oversight Board, the U.S. auditing company regulator, also testified. His written testimony can be read here.)

Cox's testimony made several key points:
  1. Sarbanes-Oxley has, for the most part, proven extremely successful, improving investor confidence, increasing corporate transparency, and improving auditor oversight. Overall, most SOX provisions are a net contributors to the nation's economy.
  2. A little-noticed fact about SOX has been that most of its key provisions have been adopted by other countries around the world. "As we consider the effect of Sarbanes-Oxley on U.S. competitiveness, it is important to keep in mind how broadly many of its tenets have been taken up overseas. It would appear, four years later, that America's approach is not unique -- we just happened to be early adopters. "
  3. The one part of SOX that hasn't worked well is Section 404, and the SEC believes that this is an issue of implementation that can be corrected and the SEC is working to correct.

This last point seems clear, and if you are into the technical aspects of SOX, what he said will be heartening. Cox admitted that Section 404 has proven more expensive than Congress or the SEC expected, particularly for smaller companies (Cox was a Congressman when SOX was passed). While Section 404 may be benefiting larger companies, there are questions whether the costs outweigh the benefits for smaller issuers. However, since it is uncertain whether the SEC has the legal authority to exempt smaller companies from Section 404's internal control provisions, Cox said the SEC has instead decided to postpone implementation for smaller companies until the PCAOB has time to adopt improved implementation rules which will not be so expensive.

On this same issue, Congressman Tom Feeney (R-Florida) suggested that Section 404 could be improved by introducing a de minimis standard of 5 percent of the company's gross sales. In other words, if the company's internal controls are off by 5 percent of the company's sales (in Walmart's case, let's say $2 billion), the company wouldn't have to revise its financial statements or worry about correcting the internal controls. I don't know about you, but if my internal controls were off by $2 billion, I think I'd want to know about it. (Feeney also asked whether all the recent corporate accounting restatements were necessary and did investors really care if the company got its financial statements wrong. There's an easy answer to that one, Tom--what did the company's stock do when the need for a restatement became public? If the stock dropped, investors probably cared.)

Cox's comments on the international aspects of SOX were also interesting. In response to a question asking about the recent UK Balls Clause and possible cross-border mergers between the New York Stock Exchange and Euronext or NASDAQ and the London Stock Exchange, Cox responded that the SEC has stated repeatedly that it has neither the intention nor the legal power to impose Sarbanes-Oxley abroad. Congressman Mel Watt (D-North Carolina) then asked how U.S. investors investing abroad in less transparent markets ("France" being the example given) could be protected if Sarbanes-Oxley did not apply to them. Cox answered that while "regulatory arbitrage a real issue," the SEC "works closely" with its foreign regulatory counterparts, and "we want to have an understanding that we live in a high standards world. We [in the U.S.] have the highest standards and the largest market, and I like to think this is not unrelated." Cox pointed out that the number of other large markets adopting SOX-like provisions (clearly referring to a recent study by the SEC's Office of International Affairs) indicates that other markets see the value of having higher quality regulatory standards.

When asked about why so many foreign IPOs have occurred abroad rather than in the United States, Cox pointed out (as this blog did here--glad to see he's a reader) that the largest of these foreign IPOs involved state-owned companies with a preference for listing in their home markets and that many were "unable to live up to our standards of transparency." The rest list elsewhere for a variety of reasons, including the high litigation risks in the United States, but also the increasing pools of liquidity that can be tapped in developing markets around the world. Cox added that, in a sense, the U.S. is a victim of its own success, since it for years has been advocating markets as a solution to poverty and development, and other countries had "finally taken us up on this." As a result, increased market competition was something that U.S. exchanges were going to have to get used to, but that this competition was good for both America and the world.

Nice to see a Republican who actually still believes in markets.

Monday, September 18, 2006

It's not SOX; London is just better

Clara Furse, chief executive of the London Stock Exchange, has an op-ed in the Financial Times today ("Sox is not to blame – London is just better as a market") adding to the transatlantic pissing match between the London Stock Exchange/H.M. Treasury/UK Financial Services Authority and the New York Stock Exchange/NASDAQ/Securities and Exchange Commission. Nothing is more fun to watch than regulators and finance firms in a cat fight, huh? Huh?

Even so, as I keep telling all you doubters out there, this really is a high-stakes game for both countries, even if it does seem so dreadfully boring. (To give it some context, think about how much the Iraq war has cost the United States so far--maybe $300+ billion? The total market capitalization of all the companies trading on just the New York Stock Exchange is $21.2 trillion. That's with a "t". $7.9 trillion of that are foreign companies. You skim 1/10th of 1 percent off just those foreign listers in terms of fees, etc. and you've practically paid for a full year of Congressional "Emergency Supplemental Appropriations".)

At any rate, Furse makes the following argument:

At one level, it has been suggested that international companies listing outside America want to avoid submitting themselves to the highest standards of regulation. As the head of one US exchange put it: “By setting the bar so high in the US, Sox has had the unintended consequence of triggering a ‘race to the bottom’ by stock markets and companies.”

This line of argument may reflect a combination of sour grapes and a tendency to believe that bigger must mean better; that in creating the world’s heaviest rulebook the US has also created the most effective and trusted regulatory environment. However, this view does a disservice to both the international companies that are coming to London and the world-class standards of regulation to which they aspire.

Indeed, London’s principles-based regime, rather than a more prescriptive rules-based approach, continues to prove itself as a model that facilitates pro-competitive innovation in a tough but sensible regulatory environment. All the important independent corporate governance surveys confirm that the UK is number one for corporate governance standards.

At a more practical level, US market participants do recognise the strength of the negative sentiment towards Sox, in particular from smaller companies for whom the cost – in time, dollars and legal risk – represents a serious disincentive to growth via initial public offerings. These participants are hopeful that, with some minor modifications to the law, US markets will once again attract the lion’s share of international listings.

This hope underestimates the attractions of the City of London and its competitive pedigree. The truth is that Sox has become a convenient focal point for explaining away the success of London’s financial district. It is easy to forget that the City has a strong track record in competing for international listings. At the end of 2000, long before Sox, there were 532 international companies on the LSE compared with 488 on Nasdaq and 433 on the NYSE.

London’s competitive advantage is clear: it has the world’s deepest pool of international liquidity; it has a wide range of institutional emerging market investors; it has broad analyst coverage; it offers an unrivalled choice of markets on which to list; it is the gateway to a budding eurozone; and, critically, the City promotes world-class regulation and corporate governance standards. This is why the profile associated with an LSE listing provides real value. London offers a highly competitive product to companies who seek to join the global economy, enhancing growth prospects around the world, helping to build new economies and providing hope through prosperity.

Furse makes some interesting points. She also claims some absurdities.

First, it is probably accurate that London has a cheaper, more efficient market. You can list in London and pay less in transaction costs than you can in New York, where investment bank underwriters will charge you so much to hawk your IPO that some companies (such as Google) have decided to go it on their own through a Dutch Auction. That is a serious concern for New York, and one they will have to address in this increasingly competitive global capital market. And the Sarbanes-Oxley Act has nothing to do with it.

But the other claims are disingenuous. London does have a largely principle-based regulatory regime which, as opposed to the supposedly "rules-based" American approach, sets out broad objectives (such as "be honest") and lets you figure out what that means. There is nothing theoretically wrong with this approach. After all, God Himself gave Moses only 10 "principles". And the UK goes one step further by making most of these principles "comply or explain" (sorta like me saying, "God, I am not going to comply with your "Thou shalt not steal" provision because I can imagine myself being in a Les Miserables-type situation where the need to steal a loaf of bread might arise...") The problem with a principles-based approach, of course, is that it is meaningless if not backed up by a strong enforcement mechanism and some kind of respected judging mechanism. (God, of course, being omniscient and infinitely just, can pull this off. But, as I discuss here, the UK FSA, with its 12 enforcement cases per year, probably can't.)

Second, Furse points to the UK's corporate governance system as an example of how the LSE's regulatory standards are world-class. This brings up two interesting points. The UK's corporate governance standards are world class, but (except for the comply-or-explain provisions), they are also hardly principle-based. In fact, the UK expressly prohibits a wide range of corporate governance activities (such as staggered boards of directors and other anti-takeover devices) that are permitted in the United States. The UK corporate governance rules are far more proscriptive than Delaware's (which really are principles-based, to the point where they let you get away with anything). At the same time, corporate governance is just one aspect of securities regulation. In other areas, the UK takes a decidedly hands-off approach to regulating even clearly problematic issues, such as the transparency of bond markets and securities analyst conflicts of interest.

Third, given the size of the LSE, I don't quite understand how Fruse can make the claim that the London Stock Exchange has the "deepest pool of international liquidity". What does this mean? As a general matter, how can a market with a $7 trillion market cap have deeper liquidity than a market with a $22 trillion market cap? She seems to be confusing foreign issuer representation on a stock exchange, with overall investor participation. (Or am I missing something here?) And what is the difference between "liquidity" and "international liquidity"?

Fourth, "gateway to the budding eurozone." Is the UK part of the Eurozone? Since that's a rhetorical question (it's not), why is it a gateway?

Granted, I'm being a bit nitpicky here, but, really, the fundamental question is not what do issuers want, but what do investors want. Do they want transparency or not? Do they want a strong securities market cop or not? If they don't, the LSE will prosper. If they do, trading on the LSE will be more volatile. The LSE may still do well for itself, but it will tend to attract lower-quality, more speculative-grade issuers.

In that regard, the LSE's censure of the investment bank Durlacher (a firm since bought by Panmure Gordon) is telling. (See the FT's Henry Tricks, "LSE’s rebuke signals Aim clampdown" and Lombard's "Mixed messages for naughty nomads".) Basically, in the middle of a private placement, Durlacher's client, Prestbury Holdings (a company listed on the LSE's "Alternative Investment Market"), found its financial performance was likely to fall significantly short of market expectations. Prestbury provided Durlacher with a draft press release announcing this fact, but Durlacher sat on it until May 26, after the placement was finished, and a day after a sharp fall in Prestbury’s share price. (Had the information come out during the private placement, the company would not have raised nearly as much capital and Durlacher's profits probably would have been lower.)

In most countries, this is the kind of activity that would spark a major investigation, and significant fines (if not a suspension of the underwriter's ability to conduct business). But in the UK, the "light touch" apparently goes beyond just regulating. My favorite quote in the FT articles is from Nick Bayley, head of trading services at the LSE, who said this was the first time an AIM adviser had been publicly censured, and this is a message to advisers “to do their jobs properly”. “I hope it will send a strong message,” he said.

Given that this "strong message" goes out to a firm no longer in existance, I'm sure it will come across loud and strong.

Friday, September 15, 2006

Harvey Pitt and the Economist: "UK Balls more show than substance”

Sorry, I can't help but go with an easy joke. Nonetheless, Jeremy Grant of the Financial Times ("Ex-SEC chief hits out at UK ‘turf protection’") is reporting that former SEC chairman Harvey Pitt has come out saying that the UK's proposed Balls Clause (see here, here and here--I do like this topic) smacks of “unilateral turf-protecting”. He says the UK is “throwing down the gauntlet” to other countries precisely when what is needed is “international diplomacy and co-operation”.

“What we need now is not unilateral turf-protecting activity but really collaborative discussions between regulators to figure out what the right solutions are to protect investors.”

Pitt left the SEC under a bit of a cloud (and when I say “bit of a cloud”, I mean “he got fired”), but he still carries quite a bit of clout in Washington. It's not like you're going to see the SEC publicly call the Brits a bunch of morons over this, so Pitt's comments are probably a proxy for more official sources and well in line with current SEC chairman Cox's thoughts on this.

Also this week, the Economist has an article (“Darned SOX”) saying that with the "widespread expectation that Sarbanes-Oxley will be toned down next year...Mr Balls' remarks look somewhat more opportunistic than confrontational..."


From the British perspective, the long arm of American regulation has reached across the Atlantic with distressing frequency lately. Financiers point to the extension of a rule about hedge-fund registration (later struck down in an American court) to British funds, which are already regulated by the FSA. The financial press campaigned around the fate of the “NatWest Three”, a group of British bankers extradited to Texas in July for the alleged abuse of the international banking system.


...[S]ome question whether Britain truly has the ability to fend off American regulation if there is an exchange merger. After all, global investment banks are already subject to the rules of both countries. This highlights the trouble with lines in the sand: sometimes the tide washes them

Yeah, no kidding. If the LSE was given the opportunity to make a lot of money from American investors by adopting Sarbanes-Oxley-like rules, would the UK FSA stand in the way? Particularly if Euronext/NYSE was doing the same? I seriously doubt it.

Troubles at the BaFin

Odds are that very few of you (well, let's be honest--there are very few of you) have heard of the Bundesanstalt für Finanzdienstleistungsaufsicht. And if you have, you are wrong--it's not a disease or psychological condition, or Heidegger's existential concept of "being-there" (that's "Da-sein"). The BaFin, as its fans like to call it, is the German Federal Financial Services Authority, Germany's combined financial regulator.

An Economist article this week ("The biter bit") details problems at the BaFin, which may present questions about how long the BaFin's chief, Jochen Sanio, retains his job. As the Economist article points out, technically the head of the BaFin cannot be fired, but those kinds of technicalities rarely mean much politically. The BaFin's problems are operational--apparently there may have been embezzlement to the order of $5 million on information-technology purchases, some padding of employee expense accounts, and nepotistic hiring.

Sanio is a politician, and a charming, intelligent one at that. He's the kinda guy who will quote Rolling Stones' lyrics to prove his point in a debate (An SEC commissioner once said to a group of Europeans complaining about Sarbanes-Oxley that, "As the Rollings Stones once said, 'You don't always get what you want.'" Sanio replied, "You've forgotten the rest of that lyric: '...but if you try hard sometimes, you just may find, you get what you need.'") That said, Sanio has made some enemies, both in the German cabinet and among the German financial community.

This situation matters to the U.S. financial community. Sanio is a politician and he is willing to make the kinds of regulatory noises that the German Left demands (you know, things like calling hedge funds and investment banks "locusts" and attacking credit rating agencies), but he is also fundamentally reasonable and understands finance. There is a chance his replacement won't be, and that could create issues for American financial firms.

Thursday, September 14, 2006

Balls Clause update

Despite the "bafflement" the SEC has expressed at the UK's proposed Balls Clause (sorry, I just love calling it that--it brings out the Beavis & Butthead in me) the UK Financial Services Authority issued a statement today supporting it. It says:

The FSA has been consulted by HMT, on its plans to make legislative changes, and is supportive of the proposed approach. The new provisions will provide confidence to UK markets and stakeholders that foreign ownership will not undermine the essence of the UK regulatory regime. The FSA remains indifferent to the nationality of the ownership of the entities it regulates.
First off, yeah, right you're indifferent.

Second, the markets and stakeholders need confidence that a foreign buyer of the London Stock Exchange will not "undermine the essence of the UK regulatory regime"? Good to see you have so much confidence in that national sovereignty thing. A foreign buyer will undermine your regulation? By demanding that you abandon that "light touch"? Because a foreign buyer wants more regulation?

Is this one of those British humor things? Like Ali G or Fawlty Towers? Otherwise, the FT sums it up best:

(Scene: The high-tech boardroom of a US exchange, Manhattan.)

Brad: OK, guys, now our takeover of the London Stock Exchange is complete we can activate phase two – the rule-change. Our drafters are in position. Order them to impose disproportionate measures ASAP. Remember: we’re aiming to wreck the pivotal economic role of our new subsidiary.

Chuck: Won’t that alienate our key clients in London and undermine one of the main reasons for our takeover?

Brad: Of course, Chuck, but this is about showing those Brits who’s boss.

(Meanwhile, in an ops room at Financial Services Authority HQ, women in pencil skirts are pushing cardboard pieces round a giant map of the Square Mile and Canary Wharf. There’s a barely concealed sense of light-touch regulation.)

Brenda: Incoming rule-change, sir.

Nigel: Prepare to launch the Balls Clause.

Brenda: Balls Clause primed and ready, sir.

Nigel: Fire!

(A colossal explosion. The room rocks)

Brenda: Rule-change hit and destroyed, sir.

(Cheers, faint murmurs of “jolly good show” etc, before calm descends).

The Balls Clause

Good to see I'm not the only one expressing "bafflement" at MP Balls' proposal to give the UK Financial Services Authority a veto over any new "disproportionate" rules at the London Stock Exchange if those nasty Americans ever take over the place. Lombard at the FT imagines this amusing scenario.

At the same time, the FT leads today with this article by Norma Cohen and Jean Eaglesham ("
City welcomes move to fend off regulation from overseas"), and this one (below the fold on the first page, no less) by Norma Cohen, Jean Eaglesham and Jeremy Grant ("Britain to legislate on LSE regulation"). I particularly like the reaction of "bafflement" by the SEC. (Ethiopis Tafara, the SEC's director of international affairs, stated that MP Balls' speech “seemed inconsistent with the conversations we’ve been having with the FSA”, given that the SEC and FSA in March signed a landmark regulatory co-operation agreement on how to deal with issues raised by exchange consolidation including Sarbanes-Oxley.)

Tafara also question the need for the legislation, noting,
as I did yesterday, that it is impossible for its rules to apply to UK companies unless they seek listings in the US. One interesting angle on this, however, is expressed by an investment banker quoted in one of the two FT articles. "Investment bankers cited concerns about how Congress might one day view a US-owned exchange that was outside US regulation. 'The Securities and Exchange Commission are pretty sensible,' one banker said. 'But you don't know what Congress will do.'"

Yeah, well except that Congress will do what Congress will do, and the U.S. Congress won't care whether the British Parliament has passed a law about it or not. If Congress ever were to pass something so blatantly extraterritorial in nature (and, hey, it wouldn't be the first time), at the end of the day it would come down to enforcement and whose is bigger.

Interestingly, at the time that the UK Parliament is marking its territory over fears that those regulation-crazy Americans are about to take over the place (Jeez, they almost make us sound like we're the French...), Euronext (which really is partly French) is siding up to the New York Stock Exchange, despite a higher buyout offer from the DeutscheBorse. And it is doing this precisely because Euronext sees an American merger as a way to maintain its independence. If Euronext gets bought out by the Germans, the trading platforms merge and Euronext is as independent as Chrysler is independent of Daimler. However, if Euronext merges with the NYSE, there is no practical way for the trading platforms to merge, since the regulatory structures are just too different.

So what's the UK's deal?

The future of world capital markets (Part 2): MP Balls goes to Hong Kong

While the debate heats up in the United States over the Sarbanes-Oxley Act and regulation of U.S. capital markets (see here), it is also going strong in Great Britain. For the past four years, the UK—and particularly the London Stock Exchange and the UK Financial Services Authority—have been advertising London as a “Sarbanes-Oxley-free” zone. Whereas in the United States, regulators brag about their ferocity and willingness to go after evil-doers and crooks, the UK FSA boasts of its “light touch,” its “risk assessment” and, generally, its overall business-friendly financial environment. Just as an example, in 2004 when it was discovered that Royal Dutch Shell had vastly overstated in its financial statements the amount of proven oil reserves it controlled, the U.S. SEC fined the company $120 million, while the UK FSA levied only a $30 million fine. Granted, a total $150 million fine is very little for a company that makes nearly $20 billion a year in profits, but keep in mind that the $30 million FSA fine was the largest fine it had ever levied, by a factor of four! (See here, if you don’t believe me.)

Add in that the FSA brings only about a dozen or so enforcement cases each year, and one wonders if crime really does pay.Nonetheless, with U.S. businesses wailing and gnashing their teeth over Sarbanes-Oxley, the UK sounds a triumphant note every chance it gets. While the Commission on Capital Markets Regulation points out that 24 of the 25 largest IPOs this past year have not listed in New York, London boasts that a good number of those actually have gone to the London Stock Exchange.Still, one wonders sometimes if not all is happy over there. For one thing, we have this little bit of news from the Financial Times (“
Warnings weaken AIM’s ambitions” by David Blackwell) that notes that the London Stock Exchange’s small-cap market has been underperforming the broader market, calling into question whether AIM’s nominated advisors are able to “carry out sufficiently tough due-diligence processes on international companies.”

The second point is a speech by Ed Balls, UK Member of Parliament and Economic Secretary to the Treasury. This speech (see
here]) starts with the (by know) standard praise for London and how it is this wonderful financial center positively kicking the pants off the Americans. And then Balls says something amazing:

[O]ur interest in the ownership of the LSE is that it should not affect the existing light-touch, risk-based regulatory regime under which the exchange and its members and issuers operate.The FSA has also made clear that the way it operates the UK’s regulatory regime in respect of exchanges is neutral to the nationality of ownership.

However, in his statement of 12 June, Sir Callum McCarthy, chairman of the FSA, made clear that overseas ownership of the LSE exchanges raises uncertainties about the regulation of the exchange and its issuers going forward.It has been put to me that the right approach is Government intervention to protect the LSE from foreign ownership.

I reject this argument. This would fly in the face of the traditions that have underpinned the City's success. A policy of protecting “national champions” would damage, not bolster the interests of London and the UK. The Government’s interest in this area is specific and clear: to safeguard the light touch and proportionate regulatory regime that has made London a magnet for international business. That has made London an economic asset for the UK, for Europe, and for countries throughout the world.

I can therefore announce today that the UK Government will now legislate to protect our regulatory approach.This legislation will confer a new and specific power on the FSA to veto rule changes proposed by exchanges that would be disproportionate in their impact on the pivotal economic role that exchanges play in the UK and EU economies. It will outlaw the imposition of any rules that might endanger the light touch, risk based regulatory regime that underpins London's success.


Clearly, MP Balls doesn’t mean this to say that the FSA should have the power to oversee the LSE’s listing requirements, like pretty much every securities regulator has. I mean, it already has that, right? (Though, I guess, maybe it doesn’t.) What MP Balls really means is that they won’t let that nasty SEC export Sarbanes-Oxley to the UK, goddammit! We shall defend our Island, whatever the cost may be! We shall fight on the beaches, we shall fight on the landing grounds, we shall fight them all over Canary Wharf! We shall never surrender!

Hey, sounds like a winner to me. You keep on keeping on with your bad self! But do you really need an Act of Parliament to keep the SEC from imposing Sarbanes-Oxley on a stock exchange in the UK, particularly since it has no power to do so and has even
gone out of its way to say this?

Seriously, are you guys scared of your own shadows, or is this just fear-mongering, as a way to keep the NYSE and NASDAQ from buying up the London Stock Exchange?

Geez, the things people will say when faced with their imminent irrelevance.

23 out of 24 IPOs...

By the way, you ever wonder who those top initial public offerings of 2005 were? (You know, the ones not listing in the United States that otherwise would be, if it weren’t for the Sarbanes-Oxley Act, that the Commission on Capital Markets Regulation has got its undies in a bunch over?) It’s not easy to find, and seldom mentioned, but here are the 24 that topped $1 billion, one of which listed in New York:
  1. China Construction Bank (Chinese state-owned company listing in Hong Kong)
  2. Electricité de France (French state-owned company listing on Euronext)
  3. Gaz de France (French state-owned company listing on Euronext)
  4. China Shenhua Energy Co Ltd (Chinese state-owned company listing in Hong Kong)
  5. Bank of Communications China (Chinese state-owned company listing in Hong Kong)
  6. Tele Atlas N.V. (Dutch company listing on Euronext)
  7. PartyGaming (Gibraltar-based gambling company listing in London)
  8. Goodman Fielder Ltd (Australian company listing in Australia)
  9. AFK Sistema (Russian company listing in London)
  10. Huntsman Corp (U.S. company on the NYSE)
  11. Raiffeisen International Bank (Austrian bank listing in Austria)
  12. Premiere AG (German company listing in Frankfurt)
  13. SUMCO Corp (Japanese company listing in Tokyo)
  14. China COSCO Holdings Co Ltd (Chinese state-owned company listing in Hong Kong)
  15. Spark Infrastructure Group (Australian company listing in Australia)
  16. Telenet Holding NV (Belgian company listing on Euronext)
  17. RHM UK (UK company listing in London)
  18. Kazakhmys (Kazakh company listing in London)
  19. EFG International (Swiss company listing in Switzerland)
  20. Sanef France (French company listing on Euronext)
  21. SP AusNet (Australian company listing in Australia)
  22. Eutelsat (French company listing on Euronext)
  23. EuroCommercial Properties (Dutch/French company listing on Euronext)
  24. TrygVesta (Danish company listing in Denmark)
Take a good look at these. What do you see?

Do you see that the first five largest IPOs were state-owned companies being privatized and listed on pretty much the home exchange? And Number 7, PartyGaming? Kinda hard to list in the U.S. if your CEO is likely to get arrested when he flys to NY to ring the NYSE's bell. And, of course, Number 9 (AFK Sistema) and Number 18 (Kazakhmys). What can be said about listing a Russian or Kazakh company that Borat Sagdiyev probably hasn't already said? (Yeah, London, good luck with those...And good luck with Rosneft, too.)

Sure, back in 1999, when investors were hurling money at companies with names like Dogwalking-dot-com, a lot of those companies might have listed in New York. But can you really imagine any Chinese, Russian or Kazakh company adhering to any decent set of accounting or disclosure standards? Is it really SOX that's standing in the way?

Wednesday, September 13, 2006

The future of world capital markets (Part 1): The Committee on Capital Markets Regulation

Several related news bits today I think highlight the deeply hidden war currently waging within the United States and between the United States and Great Britain over the future of the world’s capital markets. This war is deeply hidden mostly because it is so esoteric. The battlefield is intensely boring. You can just see most people start to slip into a coma just at the mere mention of something like “principles-based regulation” or “fair-value accounting.” Even financial reporters hate to cover these kinds of things. But this war is important because literally tens of trillions of dollars ride on the outcome. Historically, countries that control financial markets do well for themselves. (Think about how much mileage the Netherlands gets even today, just because it was a major financial center 300 years ago. How many other tiny little countries host companies as big and as powerful as ABM-AMRO, ING and Royal Dutch Shell?)

But since there are several items, I will break them up into two different entries.

Part 1

In the U.S. financial news, of course, the big announcement was the formation of a new “Committee on Capital Markets Regulation,” headed by Hal Scott, a Harvard Law School professor and co-chaired by former White House Economics Advisor Glenn Hubbard and former Goldman Sachs president John Thornton. (See the New York Times article by Floyd Norris, “Panel of Executives and Academics to Consider Regulation and Competitiveness”). It has been blogged about elsewhere (including by the Business Law Professors Blog, InsideSarbanesOxley). Very little analysis, other than by Norris, of course.

But this news is, to a degree, a side show, and a poor one at that. There are flaws with SOX, but an organization led by a group of academics and dominated by an obviously self-serving group of issuers and accounting firms is a poor tool to change it. Particularly in an election year, when: (1) the Republicans are in trouble, and don't want to look like they are just a tool of industry, (2) the two name authors of the bill are about to retire and have no intention of seeing their bill repealed this year (if ever), (3) Eliot Spitzer looks like he’s one his way to the New York governor’s mansion, and will use any attempt to repeal SOX as ammo in his campaign (and the Republicans know this), and (4) did I mention that there is a strong chance that the next Congress might not be so, shall we say, sympathetic to business?

I mean, who are these idiots?

I also particularly like Hal Scott’s statement about why this group includes no former regulators among its members—even former regulators with lots of business experience.

“We generally tried not to include regulators,” Mr. Scott said. “We would not want to put people in the position who had formulated these rules in the past. They may have a lack of objectivity. ... Anybody on this committee is in the real world and will bring with them real-world perspectives,” he said.
Coming from a Harvard Law professor, that’s just too rich! There are so many funny things in that statement (Lack of objectivity? Academics with “real-world” perspectives?), I feel like Eric Cartman when he blew his funny fuse. I may never laugh again.

But I no doubt will.

Professor Jim Cox at Duke University Law School commented on this on National Public Radio yesterday (you can listen here or see the transcript here). Cox's analysis offers some valuable insight into the real issues involved behind U.S. financial competitiveness. In particular, he points out that:

  • [W]hat we found is with Sarbanes-Oxley new rules have been introduced so that the accountants are more independent, the directors are much more independent and accountable than they were in the past. As a result, they're holding management much more accountable. So, management doesn't like the new rules in the game because it's reduced something of a competitive advantage that they had in running the business or organization vis a vis the owners of the company.

  • [T]he real issue here is not Sarbanes-Oxley, it's the fact that there's been a sea of change that's been underway for about a decade now in European markets that's greatly reduced the cost of doing transactions in Europe. And as a result of that, the cost advantages that were enjoyed in the United States have largely disappeared.

  • If all these deals move to other exchanges, it would be a real blow to, first, the American economy. It was not that long ago where we could say that 15 percent of the GDP of New York City is largely dependent upon the financial markets that existed there, both the Nasdaq market and the New York Stock Exchange and the allied events that went around it. Second thing is, as long as you have deals occurring in the United States, we have a terrific extraterritorial impact about what happens in other places in the world. And we would lose that influence over transactions, and therefore we would lose some of the influence over our own destiny in that regard.

  • Sarbanes-Oxley is something like a scapegoat for driving transactions abroad. It is the high fees that are being demanded by investment banking firms related to these deals as well as the law firms. Those fees are susbstantially lower in Europe than they are here. And unless there's some serious cost adjustment we're going to continue to see deals going away.

Monday, September 11, 2006

Sarbanes-Oxley: The New International Standard?

The Sarbanes-Oxley Act of 2002 has been called the most significant reform of U.S. securities laws in 70 years. And it has also been called a lot of other, less flattering, things. Despite all the domestic and international whining over SOX (as it’s affectionately called—or “Sarbox”, for those of you who like their laws to sound like detergent brands), it appears that everyone else in world secretly thinks Sarbanes-Oxley got it right. Ethiopis Tafara, the Director of the Securities and Exchange Commission’s Office of International Affairs today published a report (linked here, “A Race to the Top: International Regulatory Reform Post Sarbanes-Oxley,”) that describes how the main provisions of the Sarbanes-Oxley Act (including the dreaded Section 404, discussed here) have been adopted in countries ranging from Australia, Canada and the UK to China, Japan, France and Germany. (A version of this article appeared this past week in the International Financial Law Review.)

Since SOX appears to have become the de facto international standard for securities regulation, what does this mean for the argument that Sarbanes-Oxley is driving foreign companies from America’s shores? Also, what does this all mean for the UK Financial Services Authority and the London Stock Exchange, who have been using Sarbanes-Oxley as an advertising brochure to convince Russian and Chinese companies to list in the City rather than in New York? Interestingly, the SEC OIA report notes that the UK , rather than the United States, tends to be the outlier when it comes to the "principles-based" versus "rules-based" debate, particularly over such things as the types of non-audit consulting services that accounting firms can offer their audit clients (i.e., the types of work that got Arthur Andersen into so much trouble).

Likewise, if there are problems with Sarbanes-Oxley in the sense that it is making it difficult to attract foreign issuers, does the fact that so many of its provisions have been adopted abroad mean that the real issue may be with implementation? Are these foreign provisions going to go unenforced? Or is the fear that the SEC/PCAOB will over-enforce?

Or perhaps Sarbanes-Oxley represents another example of the SEC's "regulatory imperialism"—with the SEC first demanding that foreign companies comply with U.S. rules, and now convincing the rest of the world that this approach is the way to go? If so, does this explain the UK FSA's recent attempts at the Financial Stability Forum meetings to push for a set of global standards for cost-benefit review of domestic regulation, as a way to undercut triumphal American regulation? (Good luck on that, by the way. Congress always loves it when some international body tells them what they should do.) And if this is true—that other countries have been cajoled into agreeing with the United States on how capital markets can best be regulated—does this make some kind of future "mutual recognition" of regulatory regimes a possibility? After all, if everyone if converging around Sarbanes-Oxley as the de facto international standard (even if it is only the VHS of regulatory standards), would this not open the door to better cross-border investment and capital-raising opportunities and lower transaction costs?

For what it's worth, “A Race to the Top: International Regulatory Reform Post Sarbanes-Oxley” is an interesting read.

9-11 Memories

Five years on and it’s cliché to say that 9-11 changed America. It changed our country, it changed our lives, it changed our airports and train stations. Still, it’s worth a few words, just for today.

September is probably the prettiest month in Washington, DC. March and April have the cherry blossoms, but they also have the rain and the hay fever. And September 11, 2001 was a particularly pretty day. I remember taking the bus to the Pentagon Station metro stop (I lived about three-quarters of a mile from the Pentagon as the crow flies, but a bit longer if you are trying to actually get to the metro). Frankly, I don’t remember much of it, being just another Tuesday with me running late to work. I remember walking into the office (my relatively new office), seeing a few of the administrative folks huddled around a radio. Strange. They usually try to look busy. I thought it must be the announcement of some sports results or maybe lottery numbers.

I walk into my office, sit down and immediately get a call from my sister. Did you hear that a plane crashed into one of the World Trade Center towers? Really? That’s so weird, because just yesterday I had set up a date to see an old friend there in a few weeks. She used to work there and wanted to show me the Windows of the World Restaurant—or at least have a few drinks, since I hear the place is pretty expensive. What was it, a small private plane? Crap, I thought. I hope this doesn’t push back our meetings there next week. After all, our counterparts are flying in from the Middle East, and it would suck to have to tell them to reschedule.

Then comes the second call, again from my sister. A second airplane. That can’t be a coincidence. What was the damage? Thoughts run through my mind of stories of that B-25 hitting the Empire State Building in the 1940s. Quite a few people killed. This will probably be worse, but those are huge buildings.

Then the third call. From a friend, this time. Did you hear that there was a bomb at the Pentagon? What?? I was just there! What are we talking about, a hand grenade? A car bomb? I hang up the phone and run over to my boss’ office (the one on the corner with the huge windows). I look across the Anacostia River and it looks as if my entire neighborhood is on fire. That’s no hand grenade. That’s terrorism. It’s probably Bin Laden (strange that I knew who he was back then). There goes all hope of stopping a national ID card.

Then my sister calls again. The WTC Towers had collapsed. That’s impossible! That’s physically impossible! We had people in that complex! A colleague from Salt Lake City was supposed to be there today.

It doesn’t want to sink in. I write off an email to my friend in New York—Hey, guess we’re going to have to cancel on dinner in NY. I’ll write you soon. Gotta go.

I stuck around the office, listening to the rumors, fielding phone calls from abroad. Got a voicemail from an Israeli colleague, calling from home. She wanted me to know that she and her friends were thinking of us and worried. It nearly made me tear up. Soon other foreign colleagues called, but she was the first. That still means a lot to me, even today.

After a few hours, we were no longer deemed “essential personnel,” and most of us decided to leave. It was a long walk. Walking along the Pentagon highway, I get to a road that leads home, roped off with police tape. Unthinking, I cross the tape as if it weren’t even there. A cop screams at me, “What the hell do you think you’re doing!” At the moment, to be honest, I had no idea. I looked at him, pointed and said, “I live over there. I want to go home.” I must have looked particularly dazed and/or pathetic, because his demeanor changed instantly. You can’t go through this way. You need to go along the highway, maybe cut across the Army-Navy golf course, then head north again.

I finally got home, and my old retired neighbor said she had seen the plane. If practically flew down Columbia Pike. You could smell the smoke. Even weeks later, you could smell the smoke.

Sunday, September 10, 2006

Nasdaq hostile takeover of the London Stock Exchange

This is a week old (hey, I was busy getting all giddy about the Hewlett Packard/Larry Sonsini mess), but I'm a little surprised that this news from the London Observer ("Nasdaq may launch hostile bid for LSE") didn't receive more press here in the U.S.

The general word from anyone not associated with NASDAQ or the LSE is that they can't understand how such a merger can possibly make business sense. They can't merge their trading platforms because of regulatory differences. There's not much technology exchange that couldn't be done more cheaply through licensing agreements. But, hey, what do I know. And, besides, NASDAQ has already shot its bond rating to junk with just 25 percent ownership of the LSE--why not go for broke?