Tuesday, August 08, 2006

SOX Consequences: London Is Calling and Companies Are “Going Dark”

As detailed in this prior D & O Diary post, the Sarbanes-Oxley Act has imposed enormous compliance burdens and expense on companies whose shares are traded on the U.S. securities exchanges. It is hardly surprising that, according to an August 8, 2006 Wall Street Journal article (subscription required), U.S. exchanges have lost ground in luring foreign listings. The article states that “[n]ine of the world’s ten largest non-U.S. IPOs listed in New York in 2000; last year, 24 of the largest 25 chose other markets, with London the leading alternative.” Sources cited in the article suggest that the U.S. regulatory burden is the principal reason for the shift, but that high U.S. underwriting fees (which may be as much as double as those assessed in London) may be a contributing factor.

The aversion to the U.S. exchanges is not limited to non-U.S companies, nor is it limited to companies contemplating their public debut. According to an August 3, 2006 New Jersey Law Journal article entitled “Companies ‘Go Dark’ to Avoid SOX Compliance,” the high cost and burden of Sarbanes-Oxley compliance “appear to be driving of companies to simply withdraw from the major exchanges.” Some companies are going private, and others are “going dark” by deregistering their stock with the SEC. Shares of companies that go dark are listed on the “Pink Sheets,” an electronic quotation medium for companies not listed on stock exchanges. Public companies can generally file for deregistration if they have fewer than 300 shareholders of record or fewer than 500 holders and less than $10 million in assets in each of the prior three years. Even companies with thousands of shareholders can meet these requirements if investors have their shares in “street name” (where a customer’s securities are held in the name of a brokerage firm instead of the individual’s name, in effect representing a single shareholder of record). Other companies “go private,” that is, restructure to concentrate ownership in the hands of management or private equity investors, after which their shares are not traded publicly, even on the OTC markets.

According to an academic study cited in the article, and about which more below, in 2002, when SOX was enacted, 65 publicly traded companies “went dark” and 61 went private. In 2003, 183 companies “went dark” and 79 went private. In 2004, the most recent year studied, 122 companies “went dark” and 66 went private.

The academic study referenced in the article is the recent paper written by Professors Christian Leuz, Alexander Triantis, and Tracy Wang, entitled, “Why Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations.” The study may be found here. The study examines companies that “went dark” or and companies that went private both before and after the enactment of Sarbanes Oxley, to determine the causes and consequences of the companies’ actions. The authors found that in companies’ press releases announcing the companies’ decision to go dark, the usual reason stated is the high cost of SEC reporting and SOX compliance. The authors found the most likely companies to go dark are smaller firms with relatively poor performance and low growth, for whom reporting burdens are particularly burdensome. For many firms, the decision to go dark is a response to financial difficulties and deteriorating growth opportunities. By contrast, companies that go private are typically larger, better performing and less-distressed then going-dark firms. Interestingly, while the number of going-dark firms has “surged” following the enactment of Sarbanes-Oxley, the incidence of going-private transactions has not increased.

While Sarbanes-Oxley may have been an unavoidable reaction to the enormous corporate frauds that led to its enactment, it is clearly diminishing the number of companies that seek to be listed on U. S. exchanges. This unintended consequence is not only affecting the way business is conducted in this country but is also affecting the global economy as well, in ways that do not improve this country's economic competitiveness.

Police Power and Its Limitations: I expect that many police personnel, sitting around the station house bragging about the day they "apprehended the perpetrator," occasionally allow themselves to fantisize that some day they too might get a call, like the one that came in to Kennewick, Washington police on August 4, 2006, to run down a stolen truck full of doughnuts. Miraculously, when the perpetrator was finally apprehended, the "entire load of glazed, sugar and cream doughnuts, as well as apple fritters and bear claws" was intact. A more complicated call came in to police in Aachen, Germany on August 2, 2006, when a woman called to complain that her husband was not, shall we say, fulfilling his marital duties. Because the police confessed themselves unable to resolve the dispute, let alone issue any kind of official order, the 44-year old woman was frustrated both by her husband and by the entire police force in a single evening. On the other hand, the British police should be relieved that this sort of thing falls outside police jursidiction, as, at least according to at least one report, seven million British Women are unhappy with their sex lives. That's a heck of a lot of non-perpetrators. The D & O Diary wonders if the problem has something to do with cream doughnuts.

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