Paulson's Initiatives and U.S. Capital Market Competitiveness

On May 17, 2007, Treasury Secretary Henry M. Paulson, Jr. announced (here) his latest “initiatives…to enhance U.S. capital market competitiveness.” In a Financial Times op-ed piece published the same day (here), Paulson said the purposes of the initiatives were to “ensure we preserve an efficient financial reporting system that provides reliable information, is supported by a sustainable auditing industry, and has enhanced compatibility with foreign reporting requirements.”

The most substantial part of the initiatives is the commencement of two studies. One study, to be led by former SEC Chairman Arthur Levitt and former SEC Chief Accountant Donald Nicolaisen will “address auditing industry concentration” and “consider options available to strengthen the industry’s financial soundness and its ability to attract and retain qualified personnel.” The second study will “analyze the factors driving financial restatements and their impact on investors and financial markets.”

The rise in the number of restatements, up from 116 in 1997 to 1,876 in 2006 (or one for every ten public companies), is a point of particular emphasis in Paulson's op-ed piece. Paulson notes that “restatements pose significant costs on our capital markets. They have the potential to confuse investors and erode public confidence in public reporting.” The volume of restatements reflects, in part, “the complexity of our financial reporting system.” The Treasury’ study is intended to complement the SEC’s efforts to reduce the complexity.

The Treasury Department also announced its support of the SEC’s and the PCAOB’s efforts to “improve the application of Section 404” of the Sarbanes Oxley Act. In his op-ed piece, Paulson states that “a more risk-based implementation will be a positive step.” Finally, the Treasury Department also expressed its support of SEC effort to effect the convergence of the U.S. GAAP and International Financial Reporting Standards, and eliminating the U.S. GAAP reconciliation requirements by IFRS-reporting foreign companies by 2009.

With their proposal for a couple of studies and their expression of support for SEC proposals, the Treasury initiatives are strikingly modest. (To be sure, the recent announcement took great pains to emphasize that this is only the first salvo; the Treasury announcement specifically notes that "Secretary Paulson will continue to provide follow up steps to other ideas.") But even if the initiatives themselves are modest, it seems fair to ask whether their underlying premise is overstated, or even valid. That is, while Paulson and others (refer here) are fretting loudly about U.S. capital markets’ competitiveness, the markets are busy surging ahead.

According to news reports (here), total U.S. capital markets equity underwriting of common and preferred stock during the first quarter of 2007 rose 42.6 percent compared with the prior year period, and raised $61.4 billion in connection with 202 deals. Corporate bond issuance rose during the first quarter to a record $308 billion, up 23.6 percent from the first quarter of 2006. According to a PricewaterhouseCoopers report (here), U.S. IPO activity during the first quarter of 2007 was at its highest first quarter level in 7 years. During the first quarter of 2007, there were 64 IPOs that raised $12.1 billion, compared to 54 deals that raised $11.6 billion during the first quarter of 2006. And as I have noted in prior posts (most recently here), foreign companies continue to be attracted to U.S. capital markets, contrary to the contention of the would-be reformers.

There may or may not be good reasons for the various studies Paulson has launched, and there is no harm at taking a closer look at things. But to the extent reform proposals emerge that are premised on the supposed declining competitiveness of the U.S. capital markets, there is reason to be skeptical, if not concerned. As the CFO Blog noted (here), the “whole argument” for Paulson’s Capital Market Plan is “looking kind of shaky.” While studies themselves can do no harm, the danger is the possibility of reform proposals that undermine the very things that give the U.S. markets their strength, -- that is, their justified reputation for transparency and integrity.

Whistleblower’s Lament: In prior posts (most recently here), I have examined the question whether the whistleblower protection under Sarbanes-Oxley may actually be discouraging fraud detection. Anyone who doubts this concern may want to review the May 18, 2007 CFO.com article entitled “Five Years Out of Work” (here). The article contains an interview with David Welch, the first person to file for whistleblower protection under Sarbanes-Oxley. After five years of unemployment and attorneys’fees of over a half million dollars, his case if far from over and seems likely to have years left to run. His conclusion?: “ If you are a whistleblower and you have no money, you have to stop. The deep pockets of corporations can starve out an unemployed whistle-blower.”

As I noted in a prior post (here) discussing Welch’s case, the Sarbanes-Oxley whistleblower protection may be “more theoretical than real.”