• IT IS HEREBY FURTHER ORDERED, ADJUDGED, AND DECREED that within forty-five (45) days of the entry of this Final Judgment, the Audit Committee of BAC's Board of Directors ("Audit Committee") shall retain disclosure counsel with expertise in disclosure issues ("Disclosure Counsel") for a period of three (3) years after entry of this Final Judgment. The Disclosure Counsel shall report solely to the Audit Committee. BAC shall require that the Disclosure Counsel: (i) review drafts of all of BAC's public disclosure statements, including all quarterly reports, annual reports, proxy statements, and current reports containing financial information; and (ii) confer, in executive session, with members of the Audit Committee at all regularly scheduled meetings of the Audit Committee, separate and apart from the nonindependent members of BAC's Board of Directors, to discuss the adequacy of BAC's disclosures in its public disclosure statements. BAC shall also require that the Disclosure Counsel, for the period of engagement, not enter into, directly or indirectly, any other employment, consulting, or other professional relationship with BAC or its affiliates, directors, officers, employees, or agents without obtaining the consent of the Commission's staff.

The approach is an interesting one.  SOX substantially beefed up the obligations of the audit committee, at least for Exchange traded companies.  See Section 301 of SOX.  The committee was given the direct authority to supervise and to hire/fire the outside auditor.  The committee was also given the authority to hire counsel without full board approval.  The approach essentially amounted to the preemption of state law by redefining the duties of the audit committee (taking them away from the full board) and by treating a sub-category of the board (a single committee) as a separate entity with its own jurisdiction and funding authority.  The approach has raised interesting ethical questions, particularly whether the privilege rests with the board or with the committee.

In the proposed settlement with BofA, the SEC is seeking to augment the authority of the audit committee one more time.  The Commission is giving to the audit committee (not the full board) the authority to hire counsel.  Counsel must not only review filings but must discuss possible deficiencies with the audit committee in executive session, without the presence of the non-indpendent directors.  The latter restriction is significant. 

While the three committees required by the exchanges (nominating, compensation, and audit) must consist entirely of independent directors, there is no requirement that they meet in executive session or otherwise exclude the non-independent directors.  Indeed, one would say that the compensation committee usually consults actively with the CEO over compensation issues.

To the extent approved by Rakoff, the change can be characterized as another example of the SEC dipping into the corporate governance debate and setting out what it thinks are good governance principals.  

The primary materials, including the proposed settlement, can be found at the DU Corporate Governance web site.

Appellant David Stone (“Stone”) worked for appellee Instrumentation Laboratory Co. (“ILC”) from 1999 to 2006.  As Director of National Accounts, Stone regularly worked with Group Purchasing Organizations (“GPOs”), which concentrated the buying power of many hospitals.  GPO’s were the major purchasers of ILC products and GPO contracts mandated that ILC pay administrative fees to GPOs equal to three percent of sales revenue generated from the purchases.  Soon after promotion to Director of National Accounts in 2005, Stone learned that his superiors were not honoring their obligations under the GPO contracts.  ILC owed over $500,000 to various GPOs.  Stone repeatedly voiced his concern to superiors and, when he was subsequently dismissed, filed a claim pursuant to SOX alleging retaliation for his whistleblowing activities.  

In June, OSHA found against Stone, but the preliminary findings were not issued within 180 days after he had filed his complaint.  Stone objected to OSHA’s findings and sought a hearing before an ALJ.  On September 6, the ALJ granted ILC’s motion for summary judgment.  Stone petitioned for review of the ALJ’s decision with the Administrative Review Board (“ARB”).  Approximately one month later, Stone notified the ARB that he was utilizing his right under SOX to bring a de novo action in federal district court.  The ARB determined that they had lost jurisdiction over the matter, and dismissed Stone’s administrative appeal. 

The U.S. District Court of Maryland dismissed the case on collateral estoppel grounds, finding that the ALJ’s ruling was a final judgment on the merits.  Stone appealed to the U.S. Court of Appeals for the 4^th Circuit, contending the district court did not have authority to dismiss Stone’s complaint by applying preclusion principles.

SOX provides protection for whistleblowers of publicly traded companies.  See 18 U.S.C. § 1514A(b)(1).  The provision provided a whistleblower with the right to seek relief by “filing a complaint with the Secretary of Labor,” and if the Secretary (or OSHA on behalf of the Secretary) does not “issue a final decision within 180 days of the filing of the complaint” the aggrieved can bring an action “for de novo review” in federal district court.  Although the ALJ had ruled on the matter, OSHA had not not issued a final decision within 180 days.  Stone argued that under the plain language of the statute he had a right of de novo review. 

This provision was a matter of first impression among all circuit courts. The Fourth Circuit looked to the canons of statutory interpretation for guidance.  The court noted that if the plain language of the statute is unambiguous, and if a literal interpretation does not lead to an “absurd result,” then the intent of Congress is clear and judicial inquiry stops.  Only if the language is unambiguous should courts defer to an administrative agency’s interpretation.           

The appellate court reasoned that the Secretary did not issue a final decision within 180 days and that the plain language of SOX unambiguously gave Stone the right to de novo review in federal court.  The court rejected ILC’s contention that SOX could not abrogate a district court’s power to apply collateral estoppel, stating that “Congress unquestionably has the right to create a complainant-friendly statutory scheme that affords no deference to non-final agency findings.” 

Furthermore, the court was unpersuaded by ILC’s argument that a literal interpretation leads to an absurd result, and thus deference should be given to the Secretary of Labor’s belief that abrogating a district court’s preclusion power is a waste of resources.  The court determined that precluding collateral estoppel in this situation was not absurd, and reasoned that Congress intended for whistleblower claims to be resolved quickly, and thus specified an alternative process to resolve the conflict should the DOL not act within 180 days.

In summary, the Fourth Circuit held that when a whistleblower does not receive a final decision from the DOL within 180 days of filing a complaint, SOX gives the complainant a right to de novo review in federal district court.  An ALJ’s decision between the end of the 180-day period and the filing of suit in district court cannot preclude, on the basis of collateral estoppel, the complainant’s right to de novo review.  

The primary materials for this case may be found on the DU Corporate Governance Website.

The Economist reported on a study by Grant Thornton about a decline in the competitiveness of US securities markets.  The study, A wake-up call for America, looks to the decline in the number of listed companies since the 1990s. From 1991 through 2008, the number of listings fell from 6,943 to 5,401, or a decline of 22%.  The study puts the decline at 52.8% when adjusted for GDP growth.  The statistics mask considerable difference among the exchanges.  While the NYSE fell only 1.3%, Nasdaq dipped by 27.9% and Amex by 43.5%.

What is the culprit?  The decline in the IPO market.  While the US needs 360 new listings a year just to replace departing companies, the number of IPOs has averaged only 166 since 2001, with 54 in 2008.  As the Economist noted:

• For all the talk of a revival in initial public offerings (IPOs), domestic markets are on track to add a mere 50 or so new companies this year, one-seventh of the level needed to offset the average annual loss of listed companies in recent years.

And, in turn, what caused the decline in IPOs?  Not SOX.

• Grant Thornton argues that the root cause of “The Great Depression in Listings” is not Sarbanes-Oxley, as some will suggest. Rather, it is what we call “The Great Delisting Machine,” an array of regulatory changes that were meant to advance low-cost trading, but have had the unintended consequence of stripping economic support for the value components (quality sell-side research, capital commitment and sales) that are needed to support markets, especially for smaller capitalization companies.

In other words, much like the harm flowing from the repeal of Glass Steagall, the decline in listings is a product of deregulation, not the governance reforms contained in SOX.

But, as the Economist notes, there are other explanations for the dearth of IPOs.  US underwriters charge excessive fees, much higher than those imposed by foreign underwriters.  This no doubt reflects at least in part a lack of serious competition for underwriting business.  Yet as bad as things have been, they will now likely get worse.  The class of independent banking firms has largely ceased to exist, a consequence of this ongoing financial crisis. 

This affect has eliminated the one class of financial intermediaries that profited from robust securities markets.  This will, as predicted, harm the securities markets.  Unlike traditional commercial banks, investment banks had every incentive to encourage public offerings.  Moreover, they had the capacity to accept higher levels of risk.  Without these institutions, the number of companies going public may well decline.  In other words, deregulation (particularly the repeal of Glass Steagall) likely resulted in long term structural damage to the US securities markets.  It remains to be seen whether or not they can be fixed.

Putting Glass Steagall back in place will allow for the return of a class of intermediaries committed to robust securities markets.

For more on this topic, see Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets.


Moreover, by requiring divestiture or dissolution of the securities subsidiaries of some of the country's largest commercial banks, Glass-Steagall essentially ensured the creation of a class of investment banking firms with considerable skill, prominence, and access to the highest levels of corporate America. First Boston arose from the securities division of the First National Bank of Boston; Morgan Stanley from the remnants of J.P. Morgan; and Brown Harriman & Co. from National City Co.  Formed from established banks, these new firms enjoyed instant name recognition and credibility. During the post-war period, they became the principal advisors to corporate America in regard to its capital needs.

As a result, banks and securities firms pursued different roles in the capital markets. Banks preferred arm's length relationships based on the provision of short-term funding. Securities firms, specifically investment banks, became the primary providers of long-term capital to American corporations.

Absent Glass Steagall, therefore, the United States was in the process of becoming bank dominated.  Only with a legal separation in the two categories of financial institutions did this process stop.  Once Glass Steagall was implemented, an independent and powerful set of investment banking firms developed.  At the same time, the US developed vibrant and deep securities markets.

For more on this topic, see Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets. 

Bank dominated systems involve an inherent conflict of interest: The same entities providing companies with short-term credit also give advice on long-term capital needs.  Consequently, the risk exists that the advice provided by banks will be motivated by their own self-interest rather than the best interests of the company. Moreover, banks have a reputation for conservative decision-making and risk aversion, attitudes which conflict at times with corporate interests.

The risk is that bank-dominated systems will provide access to fewer sources of capital.  Given the conflict of interest and the attitude towards risk, one can predict that bank dominated systems will engage in fewer IPOs. 

Any significant reduction in the availability of equity markets will have a disproportionate affect on companies that lack the traditional attributes sought by lenders.  Bank lending depends primarily upon indicia of the ability to repay, particularly collateral and cash flow. Many companies, however, lack these attributes, and even those that can obtain some bank funding will often not be able to borrow additional amounts to expand.  Biotechnology companies in the 1980s, Internet companies in the 1990s, and software companies in the New Millenium likely fall into this category.  

In systems with active and accessible securities markets, start up companies can sidestep banks and seek funds directly from the capital markets. In so doing, they need not meet the same standards applicable to bank loans. Instead of focusing almost entirely on indicia of repayment, securities firms must look at investor demand for shares.  The different standards allow companies with minimal track records to gain access to the capital markets, so long as they can convince an investment bank that investors will buy the shares. 

Investment banks, unlike commercial banks, profit almost entirely from the securities markets.  They lack the same conflict of interest possessed by commercial banks.  Investment banks also have an incentive to encourage companies to engage in public offierings.

For more on this topic, see Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets.

Glass-Steagall is of course Depression era legislation that separated investment and commercial banks.  Those taking deposits were prohibited from engaging in securities activities; those engaging in securities activities were prohibited from taking deposits. 

There are a number of reasons why renewed consideration of the separation makes sense.  Over the next few posts, however, we will discuss one of them.  As a matter of international practice and history in the United States, the absence of a separation of commercial and investment banking with respect to primary offerings results in commercial banks eventually controlling the market.  This is because they are more conservatively managed and have inherent funding advantages (particularly deposits). 

This risk aversion and the inherent conflict of interest by commercial banks (they favor debt relationships over the sale of securities) will likely harm the securities markets.  We are already seeing a decline in IPOs, something that may be explained at least in part by an absence of any significant number of independent investment banking firms.  We will look at some of the supporting evidence over the next few posts. 

For more on this topic, see Of Brokers, Banks and the Case for Regulatory Intervention in the Russian Securities Markets. 

• The Investor Protection Act of 2009 in its current form would repeal this important requirement of an independent audit for public companies with a market cap under $75 million. Some are describing this repeal of Sarbanes-Oxley as relief for "small businesses." I think people are confused when they hear the words "small business." The companies that would be exempted are not mom and pop neighborhood stores. These are publicly traded companies that offer their shares to all types of investors. And just so you know, this repeal has wide-ranging ramifications and would appear to affect the majority of public companies. Although the SEC generally does not track companies based on market cap, the SEC does have data on companies that generally have $75 million or less in public float, and our staff estimates that over 6,000 public companies may fall under that threshold.

• To repeal this part of Sarbanes-Oxley now is to throw away a substantial amount of work done by regulators, companies, and private organizations to make compliance with 404(b) more cost-effective. Since the passage of Sarbanes-Oxley, the SEC has repeatedly deferred smaller public company compliance with the independent internal control audit requirement. During the period of the SEC deferrals, the SEC and the Public Company Accounting Oversight Board (PCAOB) were active in developing rules and guidance to allow 404(b) to be implemented in a manner that would work for both large and small public companies. A central goal of this work focused on making sure that costs for smaller public company were not overly burdensome.

We could not have said it better.  Nice to see that the defense of SOX is not limited to the ivory tower.

So it is a bit startling to see that the House Financial Services Committee, over the objection of its Chair and, apparently, the chair of the SEC, voted in favor of a bill that would weaken rather than strengthen SOX.  The so called "Investor Protection Act of 2009" (HR 3817) was amended to exempt companies with less than $75 million in market capitalization from Section 404(b), the provision that requires outside auditors to "attest" to management's assessment of the internal controls and procedures.  The amendment was approved by a 37-32 vote before the entire Act was approved by the Committee by a vote of 45-28.

And the reason?

• The "one size fits all" regulatory approach to implementing section 404 of Sarbanes Oxley has had a disproportionately negative impact on small and medium sized companies. The current and pending compliance burden has sent many companies to market overseas or dissuaded them from going public here in America.

This is devoid of any real content and harks back to the era when SOX was attacked by all manner of made up statistics, that it reduced foreign listings, that it caused companies to go dark, most of which proved incorrect.  For a discussion of these arguments, see Criticizing the Critics: Sarbanes Oxley and Quack Corporate Governance. 

There is no evidence that suggests that small US companies have been dissuaded from conducting IPOs by Section 404(b).  Indeed, the statement was made just when the IPO pipeline seems to be opening up and the evidence (developed in an SEC Study) indicates that the costs of complying with Section 404(b) are coming down. 

It is not a bad idea to take cost into account when addressing smaller businesses.  But there is no evidence that this is what is taking place in these circumstances.  The amendment not only exempted these businesses but required the Commission to conduct a study of methods of reducing "the burden" of complying with Section 404(b) for companies with a market capitalization between $75 and $250 million. 

The importance of Section 404(b) is to require another set of eyes, outside the company, to assess what management has done in developing internal procedures and controls.  With Delaware and the Delaware courts imposing few real obligations on management and the board to protect the interests of shareholders, the internal governance system is not sufficiently robust to ensure that adequate internal procedures are put in place.  Like the pay czar, to fix governance problems increasingly requires a solution outside the corporate governance process. 

Plaintiffs alleged they brought the matter to the attention of their original superiors at IGT.  They met later with IGT’s General Counsel, formerly of Anchor.  Plaintiffs alleged they suggested the failure to disclose Bally’s defense materials was conduct that related to shareholder fraud.  Within approximately three months of these allegations, IGT fired the Van Asdales.

This court found that the district court could hear testimony regarding plaintiffs meeting with defendant’s senior executives as long as the court avoided hearing testimony relating to attorney-client privilege in the Bally litigation.  It also concluded that Section 1514(A) of SOX expressly authorized any “person” to allege discrimination based on protected conduct and to file a complaint.  This included in-house attorneys, such as the plaintiffs.  

This case was an issue of first impression. The court looked to Section 1514(A) of the SOX whistleblower statute, which requires that the plaintiffs have a reasonable belief that their employer violated a listed law.  The court found the plaintiffs met this minimum threshold requirement. 

Next, it found Shawn Van Asdale’s meetings with IGT supervisors were protected whistleblower activities.  The court also found that the plaintiffs made a prima-facie case of retaliatory termination.  Thus, the court concluded that the defendant did not establish by clear and convincing evidence that plaintiffs would have been fired if they had not been whistleblowers, preventing the defendant from prevailing on summary judgment.  Based on this finding of error in summary judgment, the Court also vacated the dismissal of all of plaintiffs’ state law claims and remanded them for reconsideration.

The primary materials for this post are available on the DU Corporate Governance website.

There was no provision that received more vituperative criticism than Section 404(b).  Section 404(b) required the outside auditors to "attest" to the assessment by management (required by 404(a)) of the company's internal controls.  Section 404 essentially required outsiders to assess the system of internal controls implemented by management.  This did not make managers happy.  In addition, however, the provision coincided with an increase in auditor fees.  As a result, it was a relatively easy matter to quantify increases in fees and lay them at the doorstep of SOX. 

The attempts to attribute increases in auditor costs to Section 404(b) were way off the mark.  Auditor fees increased in part because of the changed environment after Enron and the heightened risk of liability.  In other words, some of the increase had nothing to do with SOX and would have happened anyway.  They also increased because auditing fees in a pre-SOX era were subsidized by consulting fees.  Once SOX essentially separated auditing and consulting functions, the auditing fees increased to reflect the lost subsidy.  In that case, the increase may have been related to SOX but had nothing to do with Section 404.

Section 404 did increase costs.  It was an extra service that had to be paid for.  In addition, there was a concern that auditing firms took the opportunity to bulk up on hours (and fees) in performing the service, a matter of opportunity rather than necessity.  Nonetheless, those criticizing the Act rarely noted that Section 404(b) was at best responsible for only a portion of the increase.  

We don't hear much about Section 404(b) anymore.  The SEC took some of the pressure off by exempting for a time smaller companies (non-accelerated filers).  Moreover, accounting firms got better (and presumably more efficient) at performing the service.  Anecdotal evidence also suggests that software and other forms of increased efficiency have been utilized.  Mostly, though, with the current financial crisis taking place, critics have a much harder time taking the position that whatever the costs, they outweigh the benefits.  This crisis has emphasized that there is a need for greater oversight by gatekeepers, not less.

We give all of this background because we noted that the SEC is conducting a survey on the costs associated with Section 404.  The survey can be found here.  The survey notes that all "companies with experience in complying with 404 rules are invited to participate."  Perhaps the SEC would also like to hear from non-companies about the perceived benefits of the attestation.  In any event, whatever the costs, we have little doubt that under this Commission, the benefits of the provision will outweigh the costs.

In affirming the lower court’s ruling, the appellate court’s decision contained a thorough statutory analysis of Section 304. It quickly concluded that it did not contain an explicit private right of action and focused on whether Congress intended to provide one. The court rejected the plaintiff’s argument that Congress wrote Section 304 to resemble other language, which has been interpreted to create such a right. Moreover, the court examined the statute as a whole and found that analogous provisions expressly provided for private enforcement. This implied that where Congress intended to provide a private right of action within SOX, it would do so with express language.

The primary materials for the post are available on the DU Corporate Governance Website.

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After the adoption of Sarbanes-Oxley back in 2002, the knives came out as pundits blamed the Act for everything from a decline in the number of IPOs to the number of companies "going dark," to the increase in listings on the London Stock Exchange.  Most of these charges were wrong or at least misleading.  These were addressed in Criticizing the Critics: Sarbanes Oxley and Quack Corporate Governance.   The criticism died down both because the empirical underpinning for the claims proved incorrect and because the constant stream of corporate wrongdoing (Enron followed by the backdating scandal followed by the subprime loan scandal) made arguments for weakening governance regulation must less credible.

Notwithstanding this evolution, some still occasionally try to blame SOX for all that is wrong with corporate America.  An example occurred in the WSJ on Monday.  The editorial, Washington Is Killing Silicon Valley, was full of unsubstantiated, largely discredited, claims about the impact of SOX (and, incidentally, the system of corporate disclosure).  The one piece of empirical evidence in the piece concerns the decline in the number of public offerings.  As the piece notes:

• The new laws and regulations have neither prevented frauds nor instituted fairness. But they have managed to kill the creation of new public companies in the U.S., cripple the venture capital business, and damage entrepreneurship. According to the National Venture Capital Association, in all of 2008 there have been just six companies that have gone public. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986.

The cause?  Why SOX of course. As the article notes:

• For all of this, we can first thank Sarbanes-Oxley. Cooked up in the wake of accounting scandals earlier this decade, it has essentially killed the creation of new public companies in America, hamstrung the NYSE and Nasdaq (while making the London Stock Exchange rich), and cost U.S. industry more than $200 billion by some estimates.

It takes a significant amount of termity to blame SOX for a weak IPO market when the stock market has fallen 40%, investors are fleeing in droves, and the blame mostly rests with excessive risk taking by corporate management. 

But let us examine the allegations a bit more closely.  First, it doesn't explain how SOX "killed" public companies or limited the stock exchanges. It's important to identify the grievances in SOX because usually they are not in SOX at all.  Thus, there are plenty of people who complain about the requirement that the board of a public company include a majority of independent directors and have three standing committees (nominating, audit and compensation), all made up of independent directors.  Yet these requirements are not in SOX at all but were imposed by the stock exchanges themselves.

SOX mostly regulated accounting firms and strengthened audit committees.  Other than requiring audit committees with independent directors as a listing standard, SOX had little or no impact on the stock exchanges.  The Act did require officer certification of financial statements and did require accounting firms to examine each company's internal controls but the requirement has largely not applied to smaller public companies.  Moreover, while there was considerable concern (and expense) initially, the SEC (and the PCAOB) has backed off the requirements to some degree.  Moreover, there is general agreement that much of the accounting attestation process has become more efficient and less expensive.

But the real weakness is in the data itself.  For one thing, the data in the editorial shows that the number of IPOs was already in decline by the time the late 1990s rolled around.  In other words, there was something going on that was causing a decrease and it wasn't SOX.  For another, the data apparently comes from a study done by the NVCA along with Reuters.  Sure enough, the study reports that through the first three quarters of '08, there have been only six IP0s of "venture-backed companies."

The same study, however, shows that in 2002 there were 22 IPOs, a number that increased to 29 in 2003, 93 in 2004, 57 in 2005, 57 in 2006 and 86 in 2007.  In other words, until 2008, the lowest ebb of IPOs preceded the adoption of SOX and, with the adoption of SOX, the numbers increased.  The data, therefore, does not show that a decline occurred after the adoption of SOX.  Quite the reverse.  The number of IPOs increased after the adoption of SOX. 

In the end, SOX improved governance.  If there is a serious problem with SOX, it is that it did not go far enough.  That is what the latest set of scandals demonstrates.

Its almost hard to remember the vehement outpouring of criticism that swirled around Sarbanes-Oxley for the first three or four years after its adoption.  Everything was criticized, whether the hurried process employed in adopting the Act to greater reliance on independent directors.  For more on these views, see The Criticizing the Critics: Sarbanes Oxley and Quack Corporate Governance.

Any piece of data that could be used to challenge SOX was trotted out, the need for rigor usually a casualty of the process.  The decline in IPOs, the drop in foreign listings, the number of companies "going dark" were all trotted out as "proof."   But probably none was trumpeted louder than the rise of private equity and the likely disappearance of public companies from the market place.  No longer willing to put up with aggressive shareholders and the costs of SOX, companies would simply sell out to private equity firms.  Take a look at Lynn Stout's position on the subject.

To the extent companies sold out to private equity, it had little to do with the costs of SOX or whiny shareholders.  Instead, it took place because of self interest.  Private equity funds were able to raise large amounts of capital and borrow at low rates.  With these funds available, they could afford to pay exorbitant amounts to buy out public companies. 

Those days, however, are gone.  The debt markets are largely frozen.  Now we learn that the capital side of things is likewise winding down.  According to the WSJ, private equity has been drawing a "cold shoulder" from large institutional investors.  As the WSJ has noted:

• Public pension funds and endowments are turning down invitations to make private-equity investments. The nation's largest public pension fund, the California Public Employees' Retirement System, or Calpers, is asking private-equity firms to ease off on requests for additional capital it had previously committed to deliver. . . . Harvard University, with an endowment of $36.9 billion under Jane Mendillo, is seeking to offload about $1.5 billion in investments with private-equity firms such as Bain Capital LLC, according to people familiar with the situation.

The article also noted that the two publicly traded private equity funds had seen their shares fall by 70%. 

All of this is to say that the use of private equity as a source of cricisim for SOX was misplaced.  But then, so was most of the criticism of SOX.  Instead, what seems clear now is that SOX did not go far enough.  Perhaps that will be a topic addressed by the new administration.

One of the early claims was that SOX would damage public equity markets.  Companies were fleeing SOX and taking their IPOs overseas.  Companies would rather sell out to private equity or "go dark" rather than confront the costs and risks of SOX.  These claims have, in general, been shown to be inaccurate or overstated, sometimes after an examination of the empirical evidence and sometimes after watching the market.  The anecdotal evidence likewise suggests a contrary interpretation. 

Purveyors of private equity were among the loudest to decry the impact of SOX.  The Blackstone Group did this.  Henry Kravis at KKR was more balanced, viewing SOX as a benefit for shareholders, but still finding reason for concern:  

• "One consequence, however, is that they are also being more conservative and risk averse. An enormous time is spent on legal process by the board, rather than pushing innovative ideas. Sometimes this is to the long-term detriment of the business. It is easier to say “no” to risk and play it safe than it is to examine the risk closely to determine if it is the right decision for the business. To the extent that Sarbanes Oxley causes public companies to be less competitive, there is an opportunity for the private equity industry in taking these businesses private and putting some energy back into growing them."

• The coming IPO is in some ways designed as an antidote to its secretive and hardball-playing image by highlighting the firm's "best practices" of corporate governance and employee compensation. On the coming "road show" to present the transaction to potential investors, KKR is expected to emphasize how the new KKR will push the company's management into deeper alignment with shareholders. By buying back the KPE stake (which is itself just a vehicle for existing KKR investments) the executives will only be adding their exposure to KKR deals.

In that regard, the NYT discussed a new study done by Professors Doidge, Karolyi and Stultz (from Ontario and Ohio State respectively) on why some foreign firms have decamped from the US to determine what role if any that SOX played in the process.  It is not, by the way, the first time that we have had an opportunity on this Blog to discuss their work.   As the abstract to the paper concludes:

• We find that these firms experienced significantly slower growth and lower stock returns than other U.S. exchange-listed foreign firms in the years preceding the decision. There is weak evidence that firms experience negative stock returns when they announce deregistration and stronger evidence that the stock-price reaction is worse for firms with higher growth. When we examine stock-price reactions around events associated with the passage of the Sarbanes-Oxley Act (SOX), we find negative average stock-price reactions with some specifications but not others. Further, there is no evidence that deregistering firms were affected more negatively by SOX than foreign-listed firms that did not deregister. Our evidence supports the hypothesis that foreign firms list shares in the U.S. in order to raise capital at the lowest possible cost to finance growth opportunities and that, when those opportunities disappear, a listing becomes less valuable to corporate insiders so that firms are more likely to deregister and go home.