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By Nicole Gelinas

After The Fall: Saving Capitalism From Wall Street--and Washington

Eye on the News

Nicole Gelinas
Not NYSE for New York
The stock exchange’s bid for Europe’s stock markets isn’t good news for Gotham.
May 24, 2006

Selected Responses:

Sent by Bob Benoit on 05-24-2006:

Have you considered the research done of 2,481 companies that underwent two years of Section 404 audits, whose stock price increases exceeded the Russell 3000 index by 10 percent--for those companies with good internal controls?

The link is on, called, "Lord & Benoit Report: Do the Benefits of 404 Exceed the Cost?"

Maybe this will help with the misunderstanding people are under that the costs of Section 404 exceed the benefits . . . because apparently the stock market disagrees.

Nicole Gelinas responds:

Lord & Benoit's May report, "Do the Benefits of [Sarbanes-Oxley Section] 404 Exceed the Cost?", is the first empirical study to address how the stock market has treated individual companies as they begin to comply with the law.

As Mr. Benoit notes, the study found that over a two-year period, companies that reported insufficient "internal controls" under Sarbanes-Oxley's Section 404 watched their stock prices fall, while companies that reported sufficient controls, or reported insufficient controls in the first year while certifying that they had fixed them the second year, enjoyed large stock increases.

But Wall Street could well be rewarding established companies in compliance with Sarbanes-Oxley for showing that they can jump quickly through regulatory hurdles, regardless of the cost, rather than rewarding them for actually having good internal controls. Moreover, it is not surprising that Wall Street would punish firms that cannot comply with these regulatory requirements, since they may also be more likely to de-list from major exchanges, thus hurting investors' liquidity; that fear may well show up in today's stock price.

Moreover, L&B's study does not consider the costs and benefits incurred by the smallest public companies, those that must comply with Sarbanes-Oxley's 404 starting next year. These companies may experience the largest costs relative to annual revenue and income to comply with Sarbanes-Oxley, and thus may be the firms most easily deterred from listing or remaining listed on a major American stock exchange. Of course, a few of these companies, domestic and international, may be the next Apples or Microsofts, and America will lose if these companies choose to issue their stock elsewhere. Thus, Sarbanes-Oxley may have long-term negative implications for the U.S. capital markets, and the U.S. economy, that this study does not address.

The New York Stock Exchange’s proposed merger with Paris-based Euronext, which runs four electronic stock exchanges in Europe, may seem like positive news for New York’s economy. Wouldn’t it be great for Gotham to have the world’s first global stock exchange headquartered right on Wall Street, as the NYSE intends? But in fact one of the NYSE’s key reasons for initiating the merger carries troubling implications for New York’s economic future.

Many corporate executives, particularly those heading up-and-coming entrepreneurial companies at home and abroad, now consider the New York market an obsolete place to do business, and they are flocking to exchanges in Europe instead. In 2005, the NYSE and the Nasdaq won only 28 new international listings, a modest 16 percent increase from the year before; by contrast, the two major European exchanges, the London and the Luxembourg Stock Exchanges, won 50 listings between them, more than double their new listings in 2004. The NYSE is reaching across the Atlantic just to stay competitive.

Europe is winning business that once went automatically to New York largely because companies find that the burdensome requirements imposed by America’s four-year-old Sarbanes-Oxley law simply aren’t worth the trouble. Sarbanes-Oxley (SOx), enacted in haste by Congress and signed by President Bush just months after Enron’s 2001 demise shook the financial markets, requires companies to jump through numerous hoops each year at the behest of government regulators. Companies of all sizes now must spend millions of extra dollars annually to ensure that they have adequate “internal controls” in place if they want a listing on a U.S.-based stock exchange. The Chicago-based Foley & Lardner law firm has estimated that for medium-sized companies, the “cost of being public” has risen 223 percent since 2002, due to these new rules.

SOx’s purpose is to minimize the risk of improper and inconsistent accounting practices, especially those that some managers employ to smooth over volatile quarterly numbers or to paint a falsely positive picture of their companies to investors. But because regulators haven’t spelled out exactly what they mean by good “internal controls,” company executives must guess, adding massive uncertainty to the cost of doing business. The law also forces companies’ chief financial officers to spend inordinate amounts of time shuffling through bureaucratic paperwork, instead of helping to map corporate strategy.

European and Asian companies that, like the vast majority of their American counterparts, already boasted rational accounting and auditing policies long before SOx understandably aren’t interested in spending all that extra money just to list in New York. And they’re finding plenty of willing investors abroad anyway. “Five years ago, most big companies seeking public financing felt compelled to list their shares in New York. Today, non-U.S. companies are finding markets like London and Hong Kong equal to the capital-raising task,” the Wall Street Journal reported Monday.

Worse, foreign companies aren’t the only firms that SOx deters from listing in New York. According to Wharton prof Christian Leuz, 198 companies delisted from American exchanges in the year after Sarbanes-Oxley went into effect, nearly triple the number the previous year. Among the factors pushing companies to delist: SOx-related costs like “higher audit and legal fees, new internal control systems . . . higher director and officer insurance premiums, and a host of other expenses associated with compliance.”

The NYSE may be trying to buy Euronext in part to encourage smaller and mid-sized American companies to go public in Europe if it’s financially prohibitive for them to do so here. American companies could list their shares abroad to raise capital in euros, and still do business in the U.S. But then they’d need bankers, stock underwriters, and financial advisers in Europe, not in New York.

One New York congressman has grasped how debilitating an unreformed Sarbanes-Oxley will be for New York’s economy. Queens Democrat Gregory Meeks has joined two southern colleagues to propose scaling back SOx as it applies to smaller companies. “We cannot lose our lead in America, and particularly here in New York,” Meeks said Monday, according to the New York Sun. Chuck Schumer, call your office: it’s time for the rest of New York’s congressional delegation to wake up to this crisis in the making, and work with Meeks to fix this law.

As for Mayor Michael Bloomberg: the next time he wants to tell rich New Yorkers how to direct their political contributions, as he did last month when he told them to support national candidates who back New York on such foolish causes as getting more federal money for subsidized “affordable” housing, perhaps he should remember Sarbanes-Oxley.

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