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Financial Times: Sarbanes-Oxley is an unhealthy export

By Harvey Pitt

Published: June 21 2006 03:00 | Last updated: June 21 2006 03:00

Although the early Ptolemaic and Aristotelian concept of geocentrism – that the planets and Sun revolve around Earth – was discredited by Copernicus and Galileo by the late 16th century, many Americans residing in Congress and at certain regulatory agencies adhere to their own brand of “American geocentrism”. This takes as axiomatic that anything and everything American is not only good, it is the best. Nowhere do adherents deem this doctrine more applicable than in the regulation of capital markets.

For decades, American geocentrism, while misguided, was not terribly damaging. US capital markets have been the most liquid and efficient. Over the past two decades, however, the application of American geocentrism to US capital markets has been discredited. Regulatory counterparts abroad have done an admirable job, not only catching up with American capital market regulation, but surpassing US standards and performance in many areas.

With the corporate scandals of 2001, any belief that US companies were inherently better run or better regulated dissolved. It was not that these incidents reflected purely American problems. Parmalat, Royal Dutch Shell and Royal Ahold, among many others, disproved that assertion. Rather, these scandals reflected shoddy corporate practices and a lack of commitment by some to important fiduciary ideals. Such incidents arise every decade, so it is erroneous to think that the solution is to throw another statute or regulation at the problem.

Sarbanes-Oxley, overwhelmingly adopted by Congress in 2002, demonstrates the point. All the misconduct at Enron, WorldCom and their like was already illegal under existing laws. Indeed, every successful criminal prosecution of corporate officers to date has been based on pre-Sox laws and rules. The one prosecution based on Sox – involving Richard Scrushy of HealthSouth – failed. Nonetheless, US leaders needed to signal unambiguously that this conduct would not be tolerated. Sox was hastily and badly drafted, but it promotes several useful ideas. Not least of these are the creation of the Public Company Accounting Oversight Board, the need for companies to maintain and evaluate their internal controls and a two-business-day reporting requirement that would have limited much of the current scandal involving stock option grant backdating.

The problems with Sox, however, are far more serious than reflected by Congress’s overwhelming enactment. Its “one-size-fits-all” approach to regulation stifles innovation, creativity, risk-taking and competitiveness. Worse, Congress’s exportation of Sox’s standards has created huge difficulties for multinational companies and produced scorn for US standards. This embodiment of American geocentrism has resulted in a loss of foreign listings on US exchanges and diversion of initial public offerings to non-US locales.

Confronted with the prospect of declining relevance in a global economy, US exchanges have sought to acquire foreign exchanges. The New York Stock Exchange has entered into a definitive merger agreement with Euronext, and Nasdaq’s recent shopping spree has made it impossible for any other exchange to acquire the London Stock Exchange without Nasdaq’s consent. Because Congress did not ameliorate the extraterritorial effects of Sox, these initiatives by the NYSE and Nasdaq have led to speculation that such market consolidation would effectively impose US regulatory standards across national boundaries. Those who favour global consolidation have asserted, accurately, that the mere globalisation of capital markets does not automatically trigger Sox’s application.

But that assertion misses the point: by virtue of cross-border market consolidations, Sox will become the de facto world standard of corporate regulation unless Congress acts. Why? Companies listed on US exchanges are subject to US federal securities laws. Only if consolidated US-foreign exchanges maintain separate identities for each marketplace can companies continue to list solely on a foreign exchange and ensure that they are not subject to US regulatory standards. That is not, however, the purpose of these consolidations, which is to provide a single platform globally. Once achieved, it will be impossible for consolidated exchanges to have “A” and “B” listing standards. US exchanges cannot adopt lower standards than those required by US law. Otherwise, General Electric, IBM and many other companies listed on the NYSE would simply delist, list on a foreign exchange and claim they are no different from foreign companies that choose not to list on US markets.

Even if separate platforms were maintained, listing on a US exchange is not the only way companies can become subject to US requirements. Once 500 Americans hold shares in a foreign-listed company, it would be subject to US laws and rules, including Sox. The model for exchange consolidation presumably includes separate platforms for component exchanges, monitoring to ensure non-US companies do not have 500 American shareholders and efforts to obtain relief from the Congress that imposed Sox on the world. A simple solution is to modify Sox to allow the Securities and Exchange Commission to give comity to comparable regulatory systems without requiring them to replicate every facet of Sox. This would give all regulators the ability to move towards a world best-in-class model without being anchored to, or by, geography.

The writer is the chief executive of Kalorama Partners, the strategic consulting firm. From 2001 to 2003, he was chairman of the SEC

Copyright The Financial Times Limited 2006

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