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In the broader debate over Sarbanes-Oxley and its effects on foreign investment in the United States, a small but essential detail has been getting short shrift. Thanks to some overly strict regulation, our markets seem like the Hotel California of the famous Eagles song: a place you can "check out any time you like, but you can never leave." Because of the difficulty they face in deregistering their securities from U.S. markets, for many overseas companies the United States is no longer the place to list stocks and court investors. Fortunately, Securities and Exchange Commission Chairman Christopher Cox recognizes the problem the current deregistration policy poses, and the SEC is moving toward change. It is important to the U.S. economy that such a change be effective enough to encourage strong foreign investment.
Under existing SEC rules, a foreign private firm must have fewer than 300 resident shareholders to terminate its SEC reporting requirements. From a practical standpoint, this is impossible. Prior to deregistration, a foreign firm would be forced to locate and count every single U.S. shareholder, regardless of location or if they own the shares via intermediaries. Despite having minimal U.S. investor interest, the foreign issuer would be forced to comply with costly reporting requirements in a market it wishes to exit, despite the lack of investor interest.
This policy risks the future competitiveness of U.S. global markets. As markets in Europe and Asia continue to thrive without burdensome exit requirements, U.S. markets will be at a competitive disadvantage. Due to these stringent deregistration requirements coupled with other aspects of Sarbanes-Oxley and their own country's regulatory requirements, some issuers are skipping the United States altogether in favor of London or Hong Kong. In fact this year the New York Stock Exchange has listed only seven new international companies and the NASDAQ only one, the lowest level for both markets in years, according to the Wall Street Letter. In addition, according to a report in The Weekend Standard of Hong Kong, "lawyers who advise Chinese companies on share issues report that while Hong Kong is still the location of choice for primary offshore listings, London has supplanted New York as the most coveted market for secondary listings." The inability to exit markets where you have negligible investor interests only exacerbates the situation. The present-day lock-in rules are rooted in the past, when global markets were far less integrated and there was less cross-ownership of securities.
Instead of focusing solely on the number of shareholders, proposed rules should also focus on the level of investor interest. Under such proposals, escape from SEC reporting requirements would be based on the percentage of U.S. ownership interest in a foreign issuer's securities and the U.S. trading volume.
Our European trading partners have also been sounding the call for new, more flexible exit strategies. Charlie McGreevy, European Union commissioner for internal markets, asserts that the proposed rule should be more market-based. Mr. McGreevy, a chartered accountant as well as a policy-maker, states that, "even with the proposed rules, only a small fraction of European companies could deregister." This is particularly problematic and frustrating for EU firms, already operating under "first class home-country reporting requirements."
His views are echoed by other non-U.S. based issuers. In comment letters to the SEC, The Bank of New York and Hermes Securities of London both proposed one excellent suggestion: that the SEC exclude qualified institutional buyers because such institutional investors do not require the same level of protection as retail investors.
Overall, deregistration requirements should not focus on impractical head counts of U.S. investors. A functioning deregistration policy should concentrate on investor protection at all stages, including after deregistration.
But a flexible deregistration system must also take into consideration factors such as quality of disclosure, financial information and the existence of other transparent, efficient and liquid markets where U.S. investors can trade the securities of the foreign firm. This flexibility is what issuers and global markets require. Where the trading price of a security is determined primarily in a sophisticated, transparent market outside of the United States, deregistration should be applied more flexibly. Conversely, where deregistration would deny shareholders the protection and benefits of high-quality disclosure and an efficient capital market, exit rules should be more rigidly applied.
Mr. Cox himself has noted that, " 'Hotel California' is a great song, but it is a lousy business model." I believe that the SEC's proposed rule change needs to go even further in order to fix this.
William H. Lash III is a law professor at George Mason University. He served the past four years at the Commerce Department as assistant secretary for market access and compliance.
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