Is A Growing China A Threat To United States Ipo Market Dominance? Comparative Securities Laws And Competition In The Market For Markets
| Author | Bjorn Sorenson |
| Pages | 07 |
Bjorn Sorenson is a JD candidate at American University, Washington College of Law. He has a BA from Western Michigan University where he studied religion and inter-cultural communication. After earning a Master's degree from Harvard studying comparative religion, Bjorn attended the Institute for International Mediation and Conflict Resolution at Erasmus University in the Netherlands. He worked for Long Island University's Comparative Religion and Culture foreign study program, teaching courses on "Religion, Conflict Resolution and Pluralism" as well as classes on intercultural communication, human rights, and development.
In short: Not yet. China's young securities markets1 are at an all time high and attracting investors worldwide who are eager to ride the progress to fortune. However, the Shanghai and Shenzhen markets also display high volatility, often jaggedly lurching up and down rather than rising at steady rates. In the United States, critics from all sides blame Sarbanes-Oxley ("SOX")2for the loss of market share in the competition for initial public offerings ("IPOs"). Despite the meteoric rise of China's capital markets, they are not a significant factor in the decline of foreign IPOs in United States markets, nor are they likely to be soon. However, given the proper development of consistency and confidence in Chinese markets, and the growing and increasingly liquid Chinese middle class, in the next decade the United States may have actual cause to worry.
After the 1929 Great Stock Market Crash, Congress enacted the Securities Act of 1933 and the Securities Exchange Act of 1934.3The Securities Act regulates the initial distribution of securities of various types, including notes, stocks, bonds, options and all manner of investment contracts.4 The Securities Exchange Act governs the manner in which securities are traded in the secondary markets.
After wide-spread fraud and corruption caused the crash, Congress was faced with a choice to govern the market by merit regulation-evaluating each offering for the underlying merit of the business, or by disclosure provisions - mandating information disclosure to investors. In the end, Congress opted for free market regulation allowing investors to choose whether offerings succeed or fail based on the interests of the market. Justice Brandeis, in approving of the disclosure laws, famously stated: "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants."5Mandated disclosure, rather than direct supervision is the defining aspect of United States securities regulation.
Insider trading laws in United States markets are premised on making the markets fair for everyone. United States securities laws in general are based on the free access of information rather than merit determination. An inequality of access or a perceived inequality of access to information inhibits confidence in the market. Thomas C. Newkirk, in a speech at the International Symposium on Economic Crime stated: "[O]ne of the main reasons that capital is available in such quantities in the U[nited] S[tates] markets is basically that the investor trusts the U[nited] S[tates] markets to be fair."6
Rules and interpretation of the Securities Act and Exchange Act all serve to instill confidence in the market. Each contains real enforcement actions with teeth, be it civil or criminal, private, derivative, or SEC enforcement. Fifty years of jurisprudence and predictability have shown companies all over the world that the United States is a fair place to do business. Though this brief section does not provide in-depth treatment of United States insider trading laws, the breadth of coverage and the ready availability of enforcement serves as a backdrop to what is missing from Chinese regulations and enforcement.
Insider trading regulations, however, do not cover the depth of fraud that an insider may inflict on a company and the millions of the company's stockholders. The collapse of Enron and Worldcom showed how securities laws did not adequately address corporate governance, supervision of the CEO and CFO, and the ability to "cook the books" to increase stated profits.
In 2002, Congress passed the Sarbanes-Oxley Act in response.7 While there was little debate that something needed to be done, there was much debate about what needed to be done. SOX primarily prohibits insiders from certain transactions, and creates drastic changes and new mandates for the way that financial information is audited.8
Additionally, SOX mandated changes to the auditing committee and auditing firms to make them more independent of corporate influence. This auditing and certification process has increased the cost of compliance drastically. General Electric, for example, spent approximately $30 million setting up the system of compliance in the first year SOX was mandated.9
While the additional checks, balances and other requirements are undeniably necessary for the public confidence in the market, SOX is also undeniably expensive. While large companies, like GE, may be able to afford compliance with minimal detriment to the bottom line, many small companies have chosen to de-list rather than comply,10 and smaller businesses and foreign business who might have chosen to list in the United States with an initial public offering have chosen to stay private or seek capital on a competitor market.11
Companies have many different venues for raising capital for business expenses, operations, investment or expansion. One of the most effective ways for a company to gain equity is by listing on a national exchange where any investor may buy stock and then trade on the value. For decades the NYSE - the "big board" - was the most prestigious of these institutions.
Because the cost of registering a security and listing it on the market may easily be upwards of $2 million, a company must be certain that it would raise at least as much in equity through the offering. The cost of compliance with SOX has placed an additional initial financial burden on such a company and also added to the expense of maintaining a listing through the enhanced regulatory compliance requirements. A company wishing to list in New York, for example, may choose to list in London if the equity raised will be similar but the costs of listing and compliance with regulatory requirements are lower. In addition to regulatory requirements, different exchanges may value a company differently,12 and companies often seek out markets that are familiar with their type of business. Arman Pahlavan, a partner at Squire, Sanders & Dempsey whose practice mostly involves IPOs, recently noted, "The question is always 'where can you raise the money you need?' The United States stock exchanges are still the best places to be ... but now there may be other options."13Time may be another factor: where a listing on NASDAQ may take six months or more, an IPO in London may be completed within two.14 For a company seeking to raise equity investments in a short period of time in a competitive market, this could be decisive.
For years, Chinese companies have listed on the NYSE for a stable and strong source of equity. However, as foreign markets become stronger, many companies choose to list abroad rather than in the United States. Recently, high-level officials in the United States government and the private sector have become concerned with the loss of hegemony in the competition in the market for markets.
Glen Hubbard, economist and Dean of Columbia University's School of Business, calls such data reporting on the decline of IPOs in the United States a "canary in a coal mine" because of the growing unattractiveness of listing shares.15 At the peak of IPO listings in the United States, the NYSE and NASDAQ accounted for 57 percent of world-wide IPO transactions. By 2006, the share fell to 18 percent.16
The Committee on Capital Markets Regulation issued a report in November 2006 examining the state of United States equity capital markets and United States competition in the global capital markets.17 The Committee expressed concern about the continued competitiveness of the United States in the global market for IPOs. Not only are United States markets losing strength in the percentage of IPOs, but companies are also opting to raise capital through private placements.18The Committee attributes the loss of United States competitiveness to the strength of the foreign markets, the development of significant "pools of capital," and the increasing ease that investments can be made across borders.19 However, the Committee pinpoints regulatory costs of compliance and liability risks as compared to other markets as an "important" factor contributing to the loss of market share.20
According to the Interim Report, "twenty-four of twenty- five of the largest IPOs in 2005 and nine of the ten largest IPOs in 2006 [as of the date of the report] took place outside of the United States."21 Although the report does not single out China for scrutiny, China was home to most of the referenced IPOs. In 2004, three of the top ten IPOs occurred in China, but none in the United States.22 In the Interim Report, China is mentioned eight times and always mentioned along side of Russia, India, or both.23 The Committee issued thirty-two specific recommendations that fell into four areas: expanding...
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