In testimony before Congress, both SEC Chairman Chris Cox and PCAOB Chairman Mark Olson testified, as Cox put it, that "those parts of SOX that aren’t working as well as they should – notably Section 404 – can be made to work better through better implementation." They're referring to Section 404 of the Sarbanes-Oxley Act, which requires companies to implement and certify extensive internal controls designed to ensure accurate disclosure of finaancial information. Compliance with section 404 has become vastly expensive - on the order of millions of dollars per year per company.
Although SOX 404 may seem like a dry and technical issue, let me remind you of what the stakes are. In a very important op-ed in today's W$J, Wharton finance professor Jeremy Siegel writes:
The United States and the rest of the developed world stand at a precipice. Over the next two decades, tens of millions of Americans, Europeans and Japanese -- members of the prosperous "baby boom" generation that was born following the Second World War -- will leave the labor force. Many are expecting a long and comfortable retirement by relying on government and private pension plans as well as tax-supported medical services.
But unless we can exploit the dramatic demographic and economic changes that are before us, our future will be much poorer. Instead of stepping into an easy retirement, many retirees will tumble into a future marked by bankrupt government social programs and declining asset values that will quickly deplete their cherished nest eggs. ...
Although it is widely known that our Social Security and Medicare Programs are threatened by these demographic trends, there are many who believe that they have accumulated sufficient private wealth to fund their retirement.
But this may not be so. The same crisis that strikes the public pension programs can overwhelm private pensions as well. Since there will not be enough workers earning income, there will not be enough savings generated to purchase the assets the retirees must sell to finance their retirement.
One solution, of course, would be an open borders policy that allowed young workers from developing countries to move here to offset the domestic demographic trends. Another, which is the one proposed by Siegel, is to attract masses of foreign capital:
The developing world has a much younger age profile than the developed world. This difference in age establishes an opportunity to make a trade: Goods produced by the younger developing world can be exchanged for assets of the older developed world. This trade is not new. The transfer of goods for assets has taken place throughout history, first between family members (parents giving to children in exchange for old-age support), and then extending to clans, communities and, finally, whole nations. Soon it can be done on a worldwide basis. The developing world has the capability of simultaneously providing us with goods and acquiring our assets, filling the gap left by our aging workers.
I call this the "global solution to the age wave" and it relies on huge global capital flows to be effective. My studies show the inflow of goods and services produced abroad in exchange for capital can have dramatic effects, reducing the projected retirement age in the U.S. from the mid-70s to the upper 60s.
Siegel then emphasizes the resulting implication for public policy:
For these capital movements to occur, we must be far more receptive to international capital. Although there has already been a large number of cross-country mergers, there has also been increasing opposition, witness Cnooc's bid for Unocal and the Dubai Ports fiasco. But if we rebuff goods or capital originating abroad, our growth will decline since we will be forced to rely only on our own dwindling supply of savings.
It's not just cross-border mergers that are at issue, however. Consider what's happened to IPOs:
So far this year, there have been just 17 international initial public offerings (IPOs) on the New York and Nasdaq stock markets, worth a mere $6bn in total. This is in stark contrast to the booming London IPO scene, where the London Stock Exchange (LSE) and its small-cap Alternative Investment Market (AIM) have grabbed 59 floats worth $16bn. It was not always thus: as recently as 2000, before the collapse of the dot.com bubble, 78 foreign firms listed in the United States, against just 12 in London.
Why is London attracting so much capital, while the US is lagging?
By a huge stroke of luck, ... the attractiveness of London’s main rival – New York – has collapsed at a much faster rate, thus boosting Britain’s competitiveness by default.
The Sarbanes-Oxley regime imposed by a short-sighted Congress in the wake of the Enron and WorldCom scandals can now be seen to be a gross over-reaction, making it excessively onerous to list on US stock exchanges or to raise capital in America. Sarbanes-Oxley’s complex and astonishingly prescriptive reporting requirements mean that international companies now much prefer the lighter touch regulation they encounter in London, a location they also find attractive for a wide variety of cultural, linguistic and time-zone reasons.
Section 404 is at the core of the problem. I have repeatedly documented the high costs domestic companies experience in complying with 404. In the long run, however, it may be that SOX 404's main detrimental effect is to make US capital markets far less attractive to foreign investors, at precisely the moment in our demographic history when we need foreign capital more than ever.
Instead of trying to band-aid the situation by yet another round of purported "fixes," Congress should simply repeal 404.
