Results matching “sarb”

Bainbridge on Sarbanes-Oxley - PointOfLaw Forum

Prof. Bainbridge published this op-ed in the Examiner on the costs of the corporate governance law, shortly before giving a luncheon talk Tuesday at the Manhattan Institute in New York.

Arbitrary and Unfair - PointOfLaw Columns

By Ted Frank

This piece originally appeared in the Wall Street Journal, 5-31-07.

Subsequent to the publication of this article, the Securities and Exchange Commission voted 3-2 to recommend submitting a plaintiffs' side brief in Stoneridge. The Department of Justice declined to accept the SEC's recommendation and did not submit a brief for the plaintiffs; the DoJ may or may not decide to file a defendant's side brief within the remaining filing deadline.

Treasury Secretary Henry Paulson called securities litigation the "Achilles heel for our economy," endangering the global competitiveness of American financial markets. Last January a report released by Senator Charles Schumer, Democrat of New York, and New York City's Republican Mayor Michael Bloomberg concluded that investors were being driven away from American shores because "the highly complex and fragmented nature of our legal system has led to a perception that penalties are arbitrary and unfair."

The proposed solution to the legal mess offered by the so-called Paulson Committee Report was modest enough: "Greater clarity for private litigation." Yet even this small step could suffer a big setback. The plaintiffs' bar is heavily lobbying the SEC to intervene in a pending Supreme Court case, Stoneridge v. Scientific-Atlanta, on the side of a gigantic expansion of private litigation.

The case's facts are straightforward: Charter Communications purchased set-top cable boxes, but got back some of the money in the form of advertising bought by the vendors. Charter executives recorded the outgoing money as a "capital expenditure" (to be depreciated over several years) but the incoming money as revenue recorded within a single year, thus falsely inflating operating cash flow. Three Charter executives went to prison over the shenanigans. Plaintiffs' attorneys sued Charter and the executives, of course, but named as codefendants two of the vendors, Motorola and Scientific-Atlanta.

The suit makes little sense. The vendors had no say in how Charter accounted for or reported its transactions. Worse is the precedent it represents: How can a business function if it is potentially liable for hundreds of millions because those whom they trade with misreport a day-to-day transaction? The Supreme Court stopped such private "secondary liability" suits in Central Bank v. First Interstate Bank, a 1994 decision that Congress ratified the next year, explicitly rejecting private suits for "aiding and abetting" in the Private Securities Litigation Reform Act (repeating the rejection in the 2002 Sarbanes-Oxley Act.)

A federal court in Missouri dismissed the case against the equipment vendors, and the Eighth Circuit Court of Appeals affirmed that decision: Such liability would, the court said, create far-reaching "uncertainties for those engaged in day-to-day business dealings." Nevertheless, the Supreme Court has agreed to hear an appeal.

Why? The Court may—one hopes—be stepping in to reassert itself, since some courts have permitted plaintiffs' lawyers to whittle away at Central Bank. In the Enron litigation, for example, a federal court in Houston erroneously certified a class action after plaintiffs alleged investment banks doing business with Enron were "primary violators" of the securities laws—even though these defendants took huge losses when Enron collapsed. With plaintiffs claiming total liability of $40 billion, many banks caved when offered a chance to settle for less than a nickel on the dollar. Such a settlement is a better bargain than a 90% chance of winning at trial—a basic cost-benefit analysis the plaintiffs' bar counts on when bringing baseless litigation. (Plaintiffs with meritorious cases do not settle for pennies on the dollar with a solvent defendant.)

Innocent investors paid out $7.3 billion in settlements, about $700 million of which was diverted to attorneys, including Democratic fundraiser and trial lawyer William Lerach. Merrill Lynch, among others, fought the court's ruling and was vindicated when the Fifth Circuit Court of Appeals tossed out the case.

Mr. Lerach has appealed to the Supreme Court, asking that his case be joined with Stoneridge. Representative Barney Frank, Democrat of Massachusetts, will helpfully hold hearings in June to highlight trial-lawyer criticisms of the SEC; meanwhile trial lawyers are attacking SEC Chairman Christopher Cox for supposedly being insufficiently supportive of investors—by which they mean, of course, the interests of trial lawyers.

But one can help investors without paying billions to the likes of Mr. Lerach. The SEC has criminal and civil enforcement authority against real "secondary violators," and Sarbanes-Oxley mandated that fines collected by the SEC be returned to defrauded investors instead of to the Treasury. These "Fair Funds," while suffering from bugs of government bureaucracy, are still more efficient and fair than the contingency fees of up to 30% to trial lawyers.

Unfortunately, we cannot be certain why the Supreme Court has taken the case, or if it will do the right thing. While Chief Justice John Roberts and Justice Stephen Breyer have spoken of the need for judicial modesty, both have recused themselves from the case. All the more reason for Treasury and the SEC to stand firm and ask the solicitor general to urge the Supreme Court to keep liability circumscribed. And for Senator Schumer to explain to his Democratic colleagues why that would be a wise choice—before they criticize the Bush administration for making the wrong decision.

Ted Frank is a resident fellow and director of the Liability Project at AEI.

"Sarbanes-Oxley and Corporate Risk-Taking" - PointOfLaw Forum

A paper by Kenneth Lehn and colleagues of the University of Pittsburgh:

Many policymakers and corporate executives have argued that the Sarbanes-Oxley Act of 2002 (�SOX�) has had a chilling effect on the risktaking behavior of U.S. corporations. This paper empirically examines this proposition. Using a large sample of U.S. and U.K. companies, we find that compared with their U.K. counterparts U.S. firms have significantly reduced their R&D and capital expenditures and significantly increased their cash holdings since SOX. We also find that the equity of U.S. companies has become significantly less risky vis-�-vis U.K. companies since SOX. Finally, using a large sample of U.S. and U.K. initial public offerings (�IPOs�), we find that the likelihood that an IPO was conducted in the U.K. increased significantly after SOX and that this effect was especially high for firms in high R&D industries. Taken together, the results support the view that SOX has had a chilling effect on risk-taking by publicly traded U.S. corporations.

The authors will present their paper at AEI on Monday; Charles W. Calomiris (AEI/Columbia), Allen Ferrell (Harvard Law), and Kate Litvak (Texas Law) will comment.

Pollock on Sarbanes-Oxley - PointOfLaw Forum

AEI's Alex Pollock writes on

[W]e can say there are two competing theories:

A. Sarbanes-Oxley is bad for investors because the costs are excessive relative to the benefits, and

B. Sarbanes-Oxley is good for investors because it protects them and makes them willing to pay more for securities.

Theory B is usually used as an argument for keeping Sarbanes-Oxley Section 404 mandatory, but it is actually a great argument for making it voluntary.

Prof. Bainbridge on Sarbox - PointOfLaw Forum

His new book, The Complete Guide to Sarbanes-Oxley, is now shipping from Amazon.

"The Future of Wall Street: Can New York Stay On Top?" - PointOfLaw Forum

On Thursday the Manhattan Institute hosted a half-day forum in downtown Manhattan on this subject, with a keynote speech by Treasury Undersecretary Robert Steel; Jim Copland moderated a panel on Sarbanes-Oxley which included blogger-lawprofs Steve Bainbridge and Larry Ribstein as well as MI's Nicole Gelinas, and I moderated a panel on litigation which included Christine Edwards of Winston & Strawn, Prof. Michael Perino of St. John's, and Peter Wallison of AEI. Press coverage (mostly of Undersecretary Steel's comments on hedge fund regulation): Bloomberg, Reuters, New York Sun, and among blogs, Bainbridge, Ribstein, Dealbreaker.

Are U.S. IPOs DOA? - PointOfLaw Columns

By James R. Copland

This piece originally appeared on the, 04-12-07

Since the days of America's first Treasury secretary, Alexander Hamilton, New York's financial markets have driven and sustained the nation's economy. And for the last century, companies worldwide that sought to raise capital overwhelmingly came to the United States.

Sadly, and distressingly, that era may be coming to an end, as companies looking for money on the public markets are increasingly going to Europe or Asia. In 2005, initial public offerings of stock in Europe surpassed those in America—in both number and dollar volume. Even as the American IPO market improved in 2006, that trend accelerated: According to PricewaterhouseCoopers, there were 651 IPOs in Europe last year, versus 224 in the U.S., and the European offerings raised almost $40 billion more dollars. China's markets, with fewer IPOs, raised 30 percent more capital than those in the United States.

To some extent, America's loss of position is inevitable. Other countries' markets are becoming more sophisticated, and some of the loss in U.S. share is driven by the privatization of formerly state-owned enterprises in Asia and Eastern Europe.

Still, strong evidence indicates that America's public exchanges have lost their privileged position as the market of choice, since the U.S. IPO decline over the past two years has been even more pronounced among "international" stock offerings—i.e., those from outside the home region. In the last quarter of 2006, U.S. exchanges attracted only nine international IPOs. European exchanges attracted 31, including companies from Australia, Pakistan, South Africa, Singapore—and five from the United States itself.

What explains the reversal of fortune for American capital markets? No fewer than three comprehensive studies in the past sixth months have sought answers, drafted respectively by a task force loosely formed by Treasury Secretary Hank Paulson; a blue-ribbon panel sponsored by the U.S. Chamber of Commerce; and the consulting firm McKinsey and Company (where I once worked), hired by New York's mayor and senior U.S. Senator, Mike Bloomberg and Chuck Schumer.

Two common threads emerged from these in-depth reviews. First, America's securities regulations have become overly burdensome, especially for smaller companies. The Sarbanes-Oxley reforms of 2002—well-intentioned to correct the frauds that led to the collapse of Enron and WorldCom—have proved far more expensive to implement than anticipated. And with increased threats of criminal sanctions for corporate managers, directors, and auditors, the leaders of publicly traded companies in America have had to devote far more time to accounting and compliance issues than to growing their businesses.

Sarbanes-Oxley also presented corporate leaders and auditors with new litigation threats, on top of already astronomical costs. Simply put, our competitor nations have nothing comparable to America's system of private securities litigation, in which large law firms generate class action suits where one class of shareholders sues the company—in other words, all other shareholders—for stock price declines attributed to accounting restatements. While the number of such suits has declined in recent years as the stock market has recovered from the bursting of the dot-com bubble, the cost of securities litigation settlements has exploded. Excluding the Enron and WorldCom settlements last year (each over $6 billion), the total value of securities settlements in 2006 was $10.6 billion, an increase of over 300 percent from 2005, according to a report released on March 21 by Cornerstone Research.

Any effort to reverse recent trends and return U.S. capital markets to their world-leading position should take serious account of the regulation and litigation issues. The three aforementioned studies have suggested concrete, achievable reforms, though in general, they have not gone far enough—as might be expected given the "task force" nature of two of the three efforts. These reports' recommendations should thus be viewed as a beginning, not an ending, of our discussion about needed change.

America's public financial markets have been vital to our economy's creativity and dynamism, and they have afforded everyday Americans the ability to participate in and reap the rewards of corporate success. Thoughtful regulation is important to facilitate share pricing and to prevent corporate managers from defrauding their investors, but our anger over past corporate misconduct should not blind us to the real risks to common shareholders if American companies leave our markets.

James R. Copland is the director of the Center for Legal Policy at the Manhattan Institute.

Sarbanes-Oxley and mens rea - PointOfLaw Forum

Lawprofs Craig Lerner (George Mason) and Moin Yahya (U. of Alberta) have a new paper on SSRN entitled "'Left Behind' After Sarbanes-Oxley". Abstract:

Although the common law's embrace of a mens rea requirement in the criminal law reflected an advance - on both moral and efficiency grounds - over ancient law, recent legal developments suggest an unfortunate return to what are, in effect, strict liability crimes. Some modern criminal laws have explicitly abandoned any mens rea requirement, creating de jure strict liability; more commonly and insidiously, criminal laws applicable to many regulated industries are so ambiguously drafted, and entail such severe penalties, that the effect of the law is what we call de facto strict liability. In this article, we argue that these two trends - soaring penalties for corporate crimes and dilution of a mens rea requirement - could have the paradoxical consequence of creating more corporate crime and not, as the standard story goes, less.

We conceive of the competition for corporate control as waged by three human �types� - ideal entrepreneurs (who are risk-neutral with respect to business decisions, but risk-averse with respect to compliance with the criminal law), swashbucklers (who are risk-neutral with respect to both business decisions and criminal law compliance) and bean counters (who are risk-averse on both of these margins). From society's perspective, the optimal environment is one that allows the ideal entrepreneur to thrive. Unlike bean counters, she is willing to take entrepreneurial risks that benefit society. Unlike swashbucklers, she is hard-wired to comply with the criminal law even at substantial cost. But as the criminal law becomes increasingly draconian, and its application unpredictable - that is, as it becomes one of de facto strict liability - our model demonstrates that she will flee for other environments. As every increase in criminal penalties more thoroughly drives away the ideal entrepreneurs, adverse selection operates, and swashbucklers more completely dominate the field. The ultimate irony is that the indeterminate widening of the scope of white-collar criminal law, and the penalties that attach for its violation, may drive away the very people most susceptible to being deterred by the criminal law.

"Capital Complaints" - PointOfLaw Forum

AEI's Peter Wallison in the Wall Street Journal on Sarbanes-Oxley and securities class actions:

Foreign companies are still coming to the U.S. to raise funds, but much less so in the public securities markets where class-action liability lurks. In 2006, for example, for the first time, more equity financing was raised in private transactions under the SEC's Rule 144A ($162 billion) than was raised in IPOs on the NYSE, Nasdaq and the Amex combined ($154 billion).

So what are the benefits of the class-action litigation system? Precious little. Companies are often compelled to settle meritless class actions in order to avoid even more costly legal fees and drains on management time. Class actions do not always punish the actual wrongdoers, who are often indemnified by their companies or covered by insurance. And with recoveries averaging 2% to 3%, class actions don't even compensate the people who actually suffered losses--the defendant company's settlement is in effect a transfer to the complainants and their lawyers from the innocent long-term shareholders of the company. Perhaps most significant of all, a single successful class action judgment could result in the destruction of one of the Big Four auditing firms--a catastrophic loss for the global financial community.

With so little to recommend them, why have securities class actions survived for so long? One reason may be a misperception that they are part of the pattern of the securities laws. Some people even think of them as constitutional rights. But this is wrong. A private right of action under Rule10b-5 was created by a court in 1946, and since then Congress and the Supreme Court have been trying unsuccessfully to place some limit on them. (Congress has authorized private rights of action under some sections of the securities laws, but not for the section on which Rule 10b-5 was based.)

Yet the odd mystique of this costly compensation system lives on. Despite all the reports indicting securities class actions, only Mayor Bloomberg and Senator Schumer called for more than a mere study: "The SEC," they said "should make use of its broad rulemaking and exemptive powers to deter the most problematic securities-related suits."

It's doubtful that the SEC will pick up this baton, but even if it did history shows that courts cannot discipline themselves to distinguish effectively between the well-founded suits and the "problematic" ones. The only solution is restoring what Congress originally intended--enforcement of Rule 10b-5 only by the SEC. The fact that a Democratic senator has stepped forward to press this issue should encourage those who know what the problem is but have thus far been reluctant to address it.

Wallison has more detail in the March Financial Services Outlook.

Around the web, March 16 - PointOfLaw Forum

  • Buffett's Berkshire Hathaway spent $14 million extra on accountants last year because of Sarbanes-Oxley [Carney/DealBreaker]

  • "Human greed has no bounds" says Microsoft, objecting to counsel fees in Wisconsin class action [Koppel/WSJ law blog]

  • Regarding that cy pres-funded antitrust documentary: c'mon, David, winning an award doesn't mean it's not propaganda [Giacalone; earlier post here]

  • Class-actioneer Michael Hausfeld hits London in a whirl of publicity [Times Online, Kranenburg]

  • Sure, cardiac catheterization can cause chronic mental illness. What do you mean you're skeptical? [KevinMD, WV Record]

  • Layoffs at prominent asbestos/toxic tort firm Baron & Budd [Texas Lawyer]

Sarbanes-Oxley employee whistleblowing, cont'd - PointOfLaw Forum

Professor Bainbridge: "When I go on the road to present my overview of SOX, I routinely hear from lawyers that employees are in fact gaming the SOX whistle blowing provisions." More here and (regarding foreign application) here, here, and here.

The Capital Market Crackup - PointOfLaw Columns

To shoot yourself in the foot is bad enough for U.S. capital markets; so why are we reloading and firing again?

By Jim Copland

(This piece appeared in the December 2006 issue of Chief Executive Magazine)

At the turn of the 20th century, most American companies were incorporated in the state of New Jersey. Today, of course, public companies are typically chartered in Delaware.

How did New Jersey lose the valuable corporate charter business to its southern neighbor? As New Jersey's governor, Woodrow Wilson led a crusade to "trust bust" big businesses through the state's unique position as the incorporation state of choice. Predictably, however, businesses chafed at the new restrictions and moved to Delaware, which had incorporation laws identical to New Jersey's old regime. Today, Delaware's low taxes are due in part to Wilson's folly; the state earns over 40 percent of its general revenues from incorporation fees.

This history lesson is apropos today, as the U.S. appears to be losing its long-established grip on the market for publicly traded securities. IPOs on European exchanges surged past those in the U.S. in 2005, in terms of both number (603 to 433) and the total offering value (51 billion euros to 28 billion euros)�marking the first time that the U.S. had not led at least one of the two categories Only two of the 20 largest IPOs in 2005 were listed in the U.S.

Although some weakening of the American position is inevitable as foreign capital markets grow more sophisticated, closer examination of 2005 numbers makes this reversal of fortune more ominous. Among overseas IPOs, in which a registrant listed in a non-home market, Europe placed 126 offerings worth 9.6 billion euros, as compared to America�s 23 offerings worth 3 billion euros. London has become the venue of choice for large Russian and Chinese IPOs. Even for venture-backed start-ups, European exchanges hosted 60 IPOs in 2005 versus 41 in the U.S.; nine of the 10 largest VC offerings went public in Europe.

What explains the rush away from the U.S.? The biggest explanatory factor is the Sarbanes-Oxley Act of 2002. Its many new demands include greater reporting requirements for insider trading; firewalls to ensure auditor independence; bans on most personal loans to company officers and directors; and stiffer civil and criminal penalties.

Notable from the perspective of being publicly listed on U.S. exchanges is Section 404 of SOX, which requires an internal control report in each mandated annual 10-K filing. According to a survey of over 200 businesses with average revenue of over $5 billion, annual Section 404 compliance costs totaled over $4 million per company; analysts estimate a total direct compliance cost of $6 billion. Small-cap companies suffered a 22 percent rise in audit fees, versus 6 percent for mid-cap, and 4 percent for large-cap corporations.
What's more, SOX imposes huge indirect costs through what Professors Larry Ribstein and Henry Butler, authors of The Sarbanes-Oxley Debacle, characterize as "interference with business management, distraction of managers, risk aversion by independent directors, over-criminalization of agency costs, reduced access to capital markets, and the crippling of the dynamic federalism that has created the best corporate governance structure in the world." Ribstein and Butler estimate the total indirect costs of SOX to top $1 trillion and point to a "litigation time bomb" waiting to explode.

American businesses already suffer from an out-of-control legal system, which, even excluding securities litigation and the massive multistate tobacco settlement, costs more than twice as much as the legal systems of other developed nations as a percentage of the economy. Moreover, America's securities litigation industry imposes a direct tax on companies that enter the U.S. public equity markets. Though hailed as defending the small investor, securities litigation brings no direct benefit to most shareholders.

What�s more, though the threat of litigation clearly creates incentives that affect the behavior of corporate officers, the changes in behavior do not seem to be related to improving information relevant to market pricing. In part, this failing can be explained by the excessive cost of discovery in securities class action litigation, which enables plaintiffs' attorneys to extract substantial settlement values from defendant firms, regardless of case merits.

In 1995, Congress tried to reform securities litigation through the Private Securities Litigation Reform Act (PSLRA). First, the PSLRA tried to rein in "strike suits" in which securities lawsuits are filed whenever a stock price sees a rapid, major decline. Such stock price drops are regular occurrences in the technology sector, which naturally trade at high multiples of current earnings, if any, and are priced based on speculative assumptions about future earnings growth. The PSLRA sought to address the issue by requiring more in-depth pleading standards to support a securities claim and automatically staying discovery while a motion to dismiss is pending.
Second, the PSLRA tried to remedy what legal scholars call the "agency cost" problem inherent in any class action litigation. By definition, individual claims are small for class litigation, so no individual plaintiff typically has sufficient interest to monitor or control the class attorneys. As securities class action king Bill Lerach once boasted to Forbes, "I have the greatest practice in the world. I have no clients." To fix this issue, the PSLRA forced judges to select the investor most likely to protect the class of claimants' interests�typically the largest investor�as the lead plaintiff, rather than permitting the first plaintiff filing suit to control the litigation.

Unfortunately, the PSLRA did not, in general, work as intended. After an initial one-year decline, the number of securities lawsuits filed annually essentially returned to the pre-PSLRA level, and indeed increased slightly.

Enterprising plaintiffs' lawyers realized that the largest investors in the economy were none other than public employee pension funds, typically governed by politicians and state employee union heads. The securities lawyers cultivated these constituencies. Furthermore, if federal prosecutors' indictment against Milberg Weiss is to be believed, at least some securities lawyers skirted the PSLRA by offering kickbacks to individuals who filed bogus suits.

Meanwhile, SOX opens up new avenues of litigation by imposing hosts of new disclosure and monitoring requirements and thus theories of liability. It also gives firms strong incentives to develop more complex mechanized oversight systems, which will make public companies even more susceptible to onerous electronic discovery.
So what's a CEO to do? There may be some synergies created by acquiring smaller companies overburdened by the new requirements. But such savings should not be overstated �and are likely outweighed by greater exposure to securities litigation.

Clearly, the incentive to take one's company private, or to delist from U.S. markets and relist overseas, is now more compelling. But the preferable�and certainly the more patriotic�response is to encourage Congressional leaders to revisit SOX as part of a comprehensive securities law reform, closing the loopholes left open by the PSLRA. If not, U.S. markets may suffer New Jersey�s fate from a century ago.
Jim Copland is the director of the Manhattan Institute's Center for Legal Policy. This article is based on his testimony before the House Financial Services Subcommittee on Capital Markets, Insurance and Government- Sponsored Enterprises of International Tort Costs.

Wall Street Worries - PointOfLaw Columns

By Nicole Gelinas

New York should heed (some of) McKinsey's suggestions.

This piece originally appeared on, January 22, 2007

On January 22, consulting firm McKinsey & Co. unveiled a report assessing how effectively New York (and more generally, the United States) competes as a hub of growth and innovation in global finance. McKinsey's study, commissioned by Mayor Michael Bloomberg and Senator Chuck Schumer, adds yet more facts and figures to the pile of evidence that shows that New York is losing its position at the top of the global-finance world. But even more ominous for the city�s future was the report's global reception.

Consider the three top headlines on the UK website of the Financial Times (based in London, New York's chief global competitor on the day the issue was reported). THREAT TO NEW YORK AS CENTRE OF FINANCE, blared the first headline, followed by POLICYMAKERS CAN STOP THE ROT IN NEW YORK and WALL STREET SEES SHIFT IN CENTRE OF GRAVITY.

New York�s finance sector is hardly "rotting." Wall Street just booked a record year for bonuses, after all, and its job growth has outpaced that of other New York industries. But when such headlines greet bank executives and their star workers around the world as they settle down to their computers, it's time for New York to worry. The perception that it is falling behind, already grounded in reality, will help shape the future.

McKinsey lists a few key areas of concern across the financial-services spectrum. First�if anyone still needs convincing after nearly a year of constant media coverage on the topic�the report notes that global firms no longer line up to list stocks on New York exchanges. "Over the first ten months of 2006, U.S. exchanges attracted barely one-third of the share of [initial public stock offerings] measured by market value that they captured back in 2001, while European exchanges increased market share by 30 percent and Asian exchanges doubled their share," the report points out. And it's not just international companies shying away from New York: even small U.S. firms "increasingly favor" London markets.

Second, the United States indisputably has fallen behind in the high-growth global derivatives markets. (Derivatives are financial instruments whose values come from other financial instruments or underlying assets; foreign-exchange derivatives are based on the underlying value of foreign currencies, for example, while equity derivatives are based on the value of stocks.) London boasts 49 percent of the global foreign-exchange derivatives market and 34 percent of the interest-rate derivatives market, while America has 16 percent and 24 percent of each market respectively. In fact, McKinsey quotes one business exec as saying that "the U.S. is running the risk of being marginalized" in derivatives.

Third, while New York retains a clear lead in arranging, packaging, and selling debt, there's a growing danger here, too. The report explains that "London is rapidly emerging as an effective alternative," in part because the city has adapted innovative "American" terms and conditions for Asian and European issuers. Further, it's just common sense that the U.S. will face greater competition as issuers in China and elsewhere turn to the global markets, where they�re already accustomed to issuing other securities.

New York's innovators are losing ground in part because they have a big handicap: crippling regulatory and legal environments, as well as an unwelcoming environment for high-skilled immigrant workers.
Companies around the globe are reluctant to list on American stock exchanges in part because doing so now requires complying with the five-year-old Sarbanes-Oxley Act (SOx). SOx forces executives to jump through regulatory hoops to ensure that their firms' financial statements and internal financial "controls" are in order, when many international executives, and their accountants and investors, think they�re already doing a good job of complying with internationally accepted accounting standards without Sarbanes-Oxley.

Even where SOx doesn't directly apply, executives and top workers at investment banks feel the burden of excessive American regulations. For example, in the world of derivatives, in Europe "people feel less encumbered overseas by the threat of regulation and so are more likely to think outside of the box," one U.S.-based business leader told McKinsey's researchers.

It�s easy to see why. Compliance officers at American firms don't just have to deal with the Securities & Exchange Commission and sundry other federal regulators; they've also got state attorneys-general (think Eliot Spitzer) to worry about. In London, by contrast, a single regulatory agency has primary jurisdiction over securities firms. And that authority encourages compliance with broad principles rather than with thousands of pages of fine print.

There's also global talent. New York is still tops in fostering an environment of innovation, according to business leaders surveyed by McKinsey. But to stay there, it must continue to attract the world�s best students and workers.

Unfortunately, thanks to a federal cap on visas for high-skilled workers, it�s been doing the opposite. European Union citizens can travel and work relatively freely, so it's a small matter for a London-based firm to attract a top trader or banker from Paris; it's a huge headache, though, to put the same person in a New York job.
If America had enacted Sarbanes-Oxley, say, 20 years ago, it might not have affected New York�s global preeminence. International executives would have had to put up with the rules to access the American cash and expertise they needed. But today, financial markets in London, continental Europe, and parts of Asia and the Middle East increasingly offer "American"-style expertise and deep pools of international investors. Executives simply don't have to bother with New York if they find it's too much trouble.

McKinsey offers some solid suggestions. Most important, New York should lobby legislators and agencies in Washington to fix what's obviously broken in terms of runaway regulation and litigation, so that New York doesn't lose its reputation as a cauldron of financial-services innovation. (Chicago, as a derivatives hub, has a stake in working with New York here.)

But then McKinsey makes another suggestion that's not so great. It calls for New York to create a public-private "joint venture" with a "highly visible leader" from the business world to focus "on financial-services competitiveness." This blue-ribbon panel, McKinsey suggests, would work with top financial-services firms to encourage them to create more jobs here. It would also consider the feasibility of establishing a world-class graduate school for applied finance, and, possibly, creating a "special international financial services zone" here through tax and regulatory breaks. It would also consider launching a global-marketing campaign to attract business to New York.

Regrettably, New York's elected officials likely will seize on this idea, since it's a way of avoiding the real problem�onerous regulations and an irrational legal environment�while still generating some attention. But New York pols shouldn't be thinking about how to give some financial firms and locations special treatment. Instead, they should work to ensure that all New York firms can compete on fair and equal terms against the rest of the world.

If New York were to prod Congress and federal regulators into doing their jobs, companies would soon figure out that the climate for financial-services businesses here had improved�just as they figured out that Sarbanes-Oxley was bad news long before the politicians did.

Sen. Schumer and Mayor Bloomberg call for reform - PointOfLaw Forum

The McKinsey report commissioned by the two, "Sustaining New York's and the US' Global Financial Services Leadership," follows up on their earlier Wall Street Journal op-ed, argues that the recent decline in securities litigation is a blip of recent economic good times, that the litigation and regulation environment could cost New York tens of thousands of jobs, and, per Lyle Roberts, calls for the following reforms, inter alia:

  • Limit the liability of foreign companies with U.S. listings to damages that are proportional to their degree of exposure to the U.S. markets;
  • A cap on auditors' liability;
  • Easing Sarbanes-Oxley regulation;
  • Arbitration as an alternative dispute resolution system for securities grievances;
  • Limits on punitive damages (called "critically important"); and
  • Interlocutory appeals in federal securities actions.

That last procedural reform (seen successfully also in the context of the Class Action Fairness Act) cannot be underestimated: billions of dollars of wealth has been extorted by trial lawyers because of outlier district court decisions that cannot be appealed for years and without taking the risk of a bankrupting trial court verdict. Possibly problematic: the creation of a "National Commission on Financial Market Competitiveness" bureaucracy. The Wall Street Journal, NY Sun, NY Post, and Kevin Lacroix note the irony of Governor Spitzer showing up for the unveiling of the report, given that his AG regime is the source of many of the problems identified in the report. (Larry Ribstein, however, notes that Spitzer pulled any specific criticism of his role or of attorneys general from the report.) Press coverage: WSJ; Financial Times; NY Sun; NY Times; and Newsday. Blogosphere: Ribstein; Oesterle; Roberts; Lacroix; Mitchell at Cato; ShopFloor; The Economist; and Dealbreaker.

Around the web, January 25 - PointOfLaw Forum

A monument to honor Sarbanes and Oxley? - PointOfLaw Forum

It wouldn't, however, be erected in their own country.

CEI's John Berlau notes that the Democrats actually ran to the right of the Republicans on the issue of Sarbanes-Oxley reform. It remains to be seen whether this is a case of Nixon going to China or mere lip service to prevent a revolt of New York investment banks heavily involved in financing the Democratic Party. That Schumer followed his Wall Street Journal op-ed with a post-election crowing claim that "Reaganomics is dead" is not encouraging.

"The Capital Market Crack-Up" - PointOfLaw Forum

Our own Jim Copland is in Chief Executive magazine with this article on Sarbanes-Oxley reform, based on his recent House testimony.

"The SEC Takes a First Step Toward Reform" - PointOfLaw Forum

Alex Pollock writes in today's American. A unanimous bipartisan vote of the SEC proposed guidance to reduce the costs of Sarbanes-Oxley compliance.

The news from the SEC wasn't all good; in yesterday's American, Peter Wallison takes issue with the SEC's failure to act on a Delaware court's request for clarification on proxy material inclusion rules. "The prospect that annual shareholder meetings in 2007 will become politicized by contests between shareholder activists and corporate managements has become very real." (Update: Larry Ribstein comments.)

"It's Over"? - PointOfLaw Forum

I just came from a talk by an ATLA officer boasting of the "record number" of trial lawyers elected to the House and Senate, and return to read Alison Frankel in The American Lawyer announce "The power of the plaintiffs bar is on the wane in this country, and will be for a long time to come."

The story nicely catalogs a variety of reform victories in a relatively plaintiff-friendly way (e.g., "Business interests learned that if state judges didn't vote their way, they could replace those judges with others who would", ignoring that it was the plaintiffs' bar who put those judges on the bench in the first place, and financed an attack on reformer judges in Alabama), but ignores underplays setbacks in Wisconsin and Louisiana courts, and the regrouping of the asbestos bar in Delaware. [Correction: Frankel correctly points out in an email that her piece did have a sentence reading "The relatively sleepy Wisconsin Coalition for Civil Justice Reform was just energized by a series of pro-plaintiff state supreme court rulings, and plans to campaign in nonpartisan judicial elections in April"; the piece mentions Delaware in passing, also. I regret the overstatement. Frankel's full e-mail is after the jump.]

Has the plaintiffs' bar peaked? Well, if in the sense that there will never be another fen-phen-like settlement that allows attorneys to steal billions of dollars, and that the defense bar is now warier of the most egregious abuses of the plaintiffs' bar. But fraud continues apace in the plaintiffs' bar in the Vioxx, welding, and asbestos litigations; the plaintiffs' bar is extraordinarily well-funded and seeking new entrepreneurial opportunities to create profitable new causes of action; ATLA is planning an aggressive counterattack with voters and all three branches of government, not to mention the law schools; and Congress, with Sarbanes-Oxley alone, has done about as much to abet the plaintiffs' bar in the last six years as it has to stymie it. Reformers have achieved a lot of success in the last ten years and eliminated a fraction of the worst abuses in the system. But contrary to the title of the piece, it's not "Over."

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