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Smash Sarbanes-Oxley law

Prof. Peter Morici - 6/16/2006

The announced merger of the New York Stock Exchange and Euronext -- bringing together the largest U.S. equities market and exchanges in Amsterdam, Brussels, Paris, and Lisbon -- has attracted notice for its potential to drive down trading costs and competitive consequences for other exchanges. However, the merger's biggest and unintended consequences may be for overzealous national securities regulators.

The merger should pass muster with antitrust authorities, because it creates an alliance among exchanges in distinct locations, rather than reducing the number of exchanges competing in any one jurisdiction. The NYSE and NASDAQ will continue to be rivals, and don't expect the merger to drive European exchanges out of business.

With or without the merger, trading costs are headed south, because of the growing advantages of electronic trading, the deregulation of international capital flows, and the competitive discipline imposed by the Internet. These phenomena should not be confused with the fallout from the merger, and may in fact benefit smaller well-run exchanges in reasonably regulated jurisdictions.

Bigger is not always better -- General Motors is not the least-cost automaker. NYSE-Euronext will have several national regulatory agencies to appease and many politicians with national pride to pacify, whereas NASDAQ, Deutsche Boerse, and other exchanges not similarly burdened could prove more nimble and creative.

The most significant NYSE-Euronext asset may be helping companies shift more easily among national exchanges to escape regulations that impose more costs than benefits on investors.

Consider the Sarbanes-Oxley Act, of 2002. Enacted in the wake of the Enron-era accounting scandals, it requires new, tougher controls for virtually every activity affecting a publicly traded company's financial statements.

While improvements in the reliability of financial statements and transparency were welcome, some Sarbanes-Oxley requirements are too burdensome. For example, compelling businesses to undertake both internal and external audits of financial controls, and requiring auditors to focus on virtually every transaction and asset, instead of just the ones that truly affect the bottom line, are too expensive for small and medium-sized firms.

Requiring chief executive and chief financial officers of large, complex enterprises to sign off on all the details of audits and financial statements, coupled with stiff fines and 20-year prison terms, is onerous and an invitation to simple tyranny. The recent convictions of Enron executives Ken Lay and Jeffrey Skilling demonstrate that the laws in place before Sarbanes-Oxley were adequate to bring wrongdoers to justice.

It should surprise few that this law is causing capital flight. More U.S. companies are staying or going private to avoid the law, and capital markets are becoming bifurcated and less democratic. The private market is open to the big, rich institutions that may evaluate companies without the benefit of Securities and Exchange Commission disclosure, while small investors are essentially shut out of shares of businesses that would be publicly traded if not for Sarbanes-Oxley.

Similarly, U.S. firms are fleeing to European locations to avoid this law. The NYSE-Euronext alliance, if properly run, could provide more choices and easier exit for U.S. companies seeking to escape the silliness that is Sarbanes-Oxley.

Most fundamentally, effective stock exchanges provide a place for large numbers of investors to trade shares; certainty that traded shares are authentic and delivered as contracted; and accounting rules ensuring prompt, accurate financial statements. The Internet, electronic trading, and World Trade Organization rules for financial services make market entry for any national government choosing to meet these requirements reasonable and easy.

Just as Delaware provides a convenient, least-cost jurisdiction for many U.S. businesses to incorporate, NYSE-Euronext or one its competitors could form an alliance with Switzerland, Liechtenstein, or Bermuda to create a transparent, efficient stock exchange that could trump New York, London, and other financial centers.

If established stock-exchange companies don't figure this out, the next Bill Gates will sell some principality on the idea of creating a transparent, secure, and least-cost equity market.

It's to be hoped that Congress will reform Sarbanes-Oxley before it's too late. However, too often the U.S. government has acted as if U.S. firms competed only with themselves, driving able businesses to move operations to Asia and Europe.

Sarbanes-Oxley was concocted in a time of public hysteria and congressional outrage, and has the predictable shortcomings of sovereign hubris. Leave the law as is, and Americans won't have to worry as much about the evils of capitalism -- but they will enjoy fewer of its blessings, too.