November 30, 2006
Apparently the Problem is Not Sarbanes-Oxley
Posted by Lisa Fairfax

The Committee on Capital Markets Regulation, established to explore issues aimed at maintaining and improving the competitiveness of America’s capital markets, has issued its first report (a whopping 152 pages). The report begins with an affirmative finding that US markets are losing their competitive edge. Two key measures of this loss are (1) the decline in the US share of IPOs (in terms of value, a fall from 50% in 2000 to 5% in 2005 and in terms of numbers, a drop from 37% in 2000 to 10% in 2005) and (2) the increase in going private transactions. The report acknowledges that there may be reasons for this loss that do not relate to defects in US systems, including the fact that foreign markets have improved over the past few years. Yet the report does conclude that there are some aspects of the American system that have created the disadvantage.

Interestingly, however, the report strongly suggests that Sarbanes-Oxley is not the problem. Indeed, the report makes 32 recommendations, only six of which focus on reforms associated with Sarbanes-Oxley, and those six are relatively modest proposals about how the Act should be implemented differently (including possible exemptions for small and foreign companies). Moreover, the report states at the outset “we recommend no statutory changes in the Sarbanes-Oxley Act, including Section 404.”

What then is the problem? Apparently, much of the problem is the upsurge in white-collar prosecutions or the “liability risks” associated with being a public company in the US. The report does focus on the need to enhance shareholder democracy (a point I will post on later) as well as the need to reform the regulatory process. However, many of the recommendations center on ways to reduce the nature and intensity of corporate prosecutions. Hence, the report recommends such reforms as allowing directors who act in good faith to be insulated from out of pocket damages in securities actions, ensuring that entity liability is sought only in exceptional cases, prohibiting the DOJ from seeking waivers of attorney-client privileges or seeking denials of attorneys fees for their officers and directors, and protecting auditing firms by creating safe harbors for certain conduct or otherwise capping their liability. By focusing its recommendations on these areas, the report suggests that the costs of increased prosecutions simply outweigh the benefits—at least with respect to our competitiveness in the global marketplace. By contrast, the relatively light coverage of Sarbanes-Oxley (which comes at the end of the report) suggests that the benefits of that legislation in fact may outweigh its costs.

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