A Gordian Knot – Investor Relations, Laws, Regulations and Case Laws

The academic part of my year is currently in full swing and that, combined with my other commitments, has caused me to fall behind on my musings. My apologies to those of you who have been eagerly awaiting yet another installment, but as a rational economic person, I’m going to do those things first which pay me, and frankly, this blog is never going to replenish my ravaged 401(K) account.  That being said, it was while I was preparing for one of this week’s classes that the idea for this post occurred to me.

One of my class topics this week focuses on the legal and regulatory framework surrounding investor relations.  It’s not a subject that business school students are naturally attracted to, but it is something that everyone involved in investor relations needs to master.  Back in the 60’s, there was a band by the name of Zager and Evans whose one and only hit was “In the Year 2525” which had the line in it, “Everything you think, do and say, is in the pill you took today”.  Which is a pretty good way to think about the laws and regulations surrounding investor relations – everything you think, do and say is governed by them.

One of the points I try to make in my class is that the laws and regulations surrounding IR are not the result of a coherent codification of the laws, cut from whole cloth.  Rather they have grown and evolved over time, from statutes, regulatory rule making and case law decisions.  The resulting Gordian Knot of laws, rules and case law is enough to send joy to the hearts of lawyers everywhere and give everyone else headaches.  Further, each is enacted from a different set of circumstances.

Statutes, for example, are usually enacted to stop some form of abuse.  This was true of the original securities protection acts, the state “Blue Sky” laws, and it continued to be true with the enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934, which were enacted following the stock market abuses of the 1920s.  More recently, the Securities Litigation Reform Act of 1995 was enacted to curb abusive securities law class action claims and the Sarbanes-Oxley Act was passed by Congress in reaction to the Enron, Adelphia, MCI and Tyco scandals. Those of you who are looking for a common theme among these acts would do well to take up a different hobby. I suggest something much easier – say, along the lines of solving The New York Times Saturday crossword puzzle.

On the regulatory side, I find that the regulations that get enacted by the SEC tend to have a political background to them.  Take, for example, the disclosures surrounding executive compensation in the proxy statement.  As executive compensation has swelled, political pressure has built up, which has resulted in the SEC layering in more and more disclosure regulations surrounding executive pay.  Way back in the dark ages (the 1970s) when I was actually writing proxy statements, it was not unusual for them to be no longer than 8 – 12 pages.  Today, between tables, graphs, Compensation Committee and other reports, Proxy Statements routinely run 4 – 5 times that length.  It has to be extremely frustrating for politicians and the regulators, because the more disclosure they require, the bigger the pay packages seem to get. I have no doubt that if they could have enacted compensation limits, they would have. But the SEC’s regulatory authority only extends to disclosure, so they keep making companies say more and more about how they come up with their pay  schemes in the hope that shareholders will get outraged and rein in the pay packages.  Similarly, other disclosure regulatory requirements have waxed and waned depending on the political climate of the time.  As a result, any hope of consistency regarding how the regulations require you to act is a forlorn one. 

Finally, much of materiality and the definition of fraudulent behavior in the securities laws is the result of case law decisions.  These are instances where, except in the most egregious or fraudulent cases, reasonable people can differ. Yet this is how we come up with our definitions for materiality, how we interact with analysts, when we choose to disclose and a multitude of other things. 

I, for one, would like to see a comprehensive overhaul of the securities laws to bring some semblance of logic to them that would serve to eliminate much uncertainty (and billable law firm hours) from the process of being a public company. Like Alexander the overhaul would cut through the many strands of laws, regulations and case decisions that are tying us up in knots with a clear unified code of securities laws. Then again, given the current administration and the mood of Congress towards Wall Street, maybe its better to leave well enough alone…

What the World Equity Markets are Telling the U. S.

Last week I conducted a workshop on investor relations in Singapore for Asian companies. It has underscored for me the fact that we live in an increasingly global village. Yes, there are cultural differences. There are also time and distance differences that sometimes make communication difficult, but the process of transferring information from companies to investors seems to be remarkably similar worldwide.

We now have publicly listed companies in spots such as China and Vietnam. These are economies that did not even acknowledge the benefits of capitalism just a short time ago. I don’t know why, but it came as a revelation to me that companies in these countries worry about much the same things that investor relations officers do here in the U. S. – being undervalued relative to their peers and the index, managements that expect everyone to love their stock, how to measure the effectiveness of IR, and hedge funds, to name a few topics. There are differences – some of the companies I spoke with had relatively low levels of public float and a number of markets were heavily influenced by speculative individual investors, leading to volatile stock price movements. My impression, however, was that many of the differences related to the equity markets being younger, and that as the markets mature and deepen, with greater levels of liquidity and professional investors, most of the differences will work themselves out of the market.

One fact came through loud and clear however – none of the companies I spoke with were listed on a U. S. exchange, and further, none of them had any remote desire to list in the U. S. The reason universally cited was Sarbanes – Oxley. None of the companies wanted to voluntarily undertake the regulatory burden imposed by the legislation. Not so long ago, it used to be that listing in the U. S. was a sign that a company had truly arrived. Today, there are growing alternatives to the U. S. markets, including Hong Kong and London, which have more attractive regulatory environments. According to the Wall Street Journal last week, more IPOs have been filed this year in London than in the U.S. (although the U.S. is slightly ahead in dollar volume of deals).

I’m not in favor of a regulatory race to the bottom, but if seems to me that the U. S. has priced itself out of the equity listings market through the increased cost of compliance with our regulations. Clearly, the rest of the world is telling us that the increased security achieved through the oversight and controls required by Sarbanes – Oxley does not justify the increased cost. To put it another way, there would have to be a tangible benefit, shown by a premium to stock valuations for companies subject to Sarbanes - Oxley in order to justify the increased cost of complying with the regulations. Companies are not seeing it, and are taking their listings elsewhere. If the U.S. intends to remain a leader in the world equity markets, it needs to take a hard look at Sarbanes – Oxley.