The Decline and Fall of the U.S. Capital Markets: Sarbox is Only Part of the Picture

Changes in securities regulation, like changes in tax policy, often gives rise to a variety of intended and unintended consequences which can have a catastrophic effect upon the marketplace. Sarbanes-Oxley (“Sarbox”) is one of those changes that is held up as a scourge of new capital formation in the U.S., driving potential issuers to other markets where more issuer-friendly regulatory regimes prevail. There is no question that Sarbox has raised the bar for those considering a public offering in the U.S., whether one is talking about young, emerging growth companies looking towards an IPO or established foreign companies seeking to access new pockets of capital and to raise their global profile. A provocative and insightful editorial by Jonathan Macey in today’s Wall Street Journal put forth a theory on the effects of Sarbox and its chilling effect on potential U.S. issuers. And while I directionally agree with Mr. Macey’s points, I think they leave out one critical reality: the U.S. capital markets, notwithstanding their historic prominence, are destined to lose power and influence simply due to the growth and maturation of competing markets across the globe. And as these markets often play host to some of the most exciting and rapidly growing companies on the planet, it is natural that their influence should rise relative to the U.S. This is simply a fixture of a changing world and one that cannot be lost in the wake of analyzing the U.S. regulatory landscape.

The framework supporting Mr. Macey’s perspective on the impact of Sarbox is as follows:

Over the years two divergent hypotheses emerged to
explain America’s dominance in the capital markets. On the one hand,
economists pointed to structural features to explain America’s singular
position. After World War II, the U.S. was the world’s only source of
capital. Europe and Asia, especially Japan, were emerging from vast
physical and economic devastation. In sharp contrast the U.S. was
building, not rebuilding. The accumulation of U.S. savings and pension
assets created the largest pool of investment capital in history.

Professional bureaucrats at the Securities and
Exchange Commission and their allies in the corporate and securities
bar had another theory. America, they said, was dominant thanks to its
superior government regulations and protections for investors.
According to this hypothesis, if a company didn’t want to go public in
the U.S. it must have something to hide.

On this view, the additional regulatory freight
brought into play by the 2002 Sarbanes-Oxley Act should have been a
godsend. By restoring the confidence in U.S. corporate governance that
had been shaken by the Enron-era corporate scandals, America would
assure its continued dominance of world capital markets well into the
new millennium.

Alas, things have not quite turned out that way.
Whatever good might be said of Sarbanes-Oxley (and there isn’t much
good to be said for its intrusive, circulatory and duplicative grab-bag
of rules), the statute has triggered a complete change in the way the
world views the U.S. as a center for capital formation.

Mr. Macey is a very bright individual (not to mention a persuasive writer), and provides an accurate and powerful historical context for the attractiveness of the U.S. financial markets and its subsequent decline in the wake of Sarbox. That said, I think the first point - the fact that the U.S. market used to be the only game in town but which is no longer the case - receives precious little attention from both Mr. Macey and other commenators on the Sarbox issue. Let’s face it, U.S.-centricity is a problem that has plagued us for centuries, with particularly sharp consequences over the past forty years. And the problem is just getting worse. THE protector of the free world? THE provider of capital and fair markets for capitalists the world over? These previously accurate statements have become weakened over time, not due to some change in U.S. moral or ethical standards but because the world has changed.

Yes, we can grow, but not as fast as Asia and other emerging markets. We just can’t, and this is self-evident. Yes, we have incredible wealth, but increasingly powerful pockets of wealth  - durable wealth (read: not just petro-dollar wealth but wealth created through the building of business empires across an array of global industries) - have sprung up in every corner of the globe. And financial markets in these far-flung regions have become more established, more reputable, more respected than ever before, and the trend is clearly poised to continue. So why should we be surprised that issuers are choosing to tap markets other than the U.S. for either primary or secondary equity issuances? We shouldn’t be. And while Sarbox doesn’t help, it is only one part of a problem that the U.S. equity markets will be facing for a long, long time. And the sooner we face into this reality the better.

It is no different than the need to face into the Social Security mess, as this is a feature of a secular demographic shift that can’t be reversed. Global financial markets are getting more powerful; intellectual property is being created more than ever outside of the U.S.; more wealth is being created across the foreign financial landscape; and leading-edge companies are being established in offshore locations to serve global consumers as technology costs have declined and the barriers to bringing ideas to market have fallen. This is an inexorable shift that can’t be reversed regardless of changes to the U.S. regulatory framework. I am a big supporter of simplifying both the regulatory and legal paradigms in the U.S., and this will invariably help our competitive positioning relative to London, Hong Kong and nascent exchanges the world over. But it won’t change the fact that even the U.S. at its best is facing a decline in its primacy and prestige, and that we have got to wake up and take stock of our role in the global financial ecosystem before we become truly marginalized. Because unless we do, Mr. Market will quickly show who the winners in the 21st century financial markets will be - and the U.S. won’t be among them.