Stock Exchanges, IPOs and A Misguided Attack on SOX

We don't often write about the editorials in the WSJ but a recent one caught our eye.  The WSJ apparently conducted an interview with Duncan Niederauer, the CEO of NYSE Euronext and transformed some of the discussion into an editorial. 

The editorial essentially argued that the decline in the number of IPOs in the US was a result of the costs associated with Sarbanes-Oxley.  The basis?  Everyone just knows.  Or, as the WSJ put it:  "It's clear to most stock-exchange watchers that no business combination can relieve the burden that the 2002 Sarbanes-Oxley (Sarbox) law places on firms seeking to join the public markets."  In legal writing, the general rule of thumb is that if you have to say its clear, its not. 

Did Mr. Niederauer actually make this argument?  Despite talking with him, the WSJ can only assert that "[t]his is no doubt one of the reasons that Mr. Niederauer sees advantages in a merger with a foreign partner that has most of its business overseas."  In other words, they are guessing which is an odd thing to do when he was there and they could have asked. 

The only example of some aspect of SOX that explains the decline in IPOs was the requirement that companies get an opinion from their accounting firm on their internal controls, the so called Section 404(b) Report.  Only this is tough to criticize because Congress just exempted companies below $75 million in public float from the requirement.  This is not good enough, according to the WSJ, because "every company aspires to rise above $75 million".

The unfortunate thing about the editorial is that a discussion on facilitating public offerings is certainly a worthy topic but it cannot be reduced to a simplified attack on regulation, particularly when it comes down to one provision of one act. 

One potential explanation for the decline in the number (besides the obvious one, the economy), is the lack of competition among underwriters.  The last financial crisis essentially saw the loss of Merrill, Bear and Lehman as significant players in the underwriting market.  The business has been captured by commercial banks which, with their lending operations, have a potential conflict of interest.  Lending relationships are likely more lucrative than underwriting ones. (This is discussed in The "Great Fall": The Consequences of Repealing the Glass-Steagall Act). 

As a result, fees in the United States are higher than those overseas.  As one article (admittedly from 2006) described:

• U.S. investment banks charge underwriting fees—the percentage of the offering that investment banks keep for themselves—that are the highest in the world. Examining IPOs from Jan. 1, 2003, through June 30, 2005, Oxera found that average fees paid by companies going public on the NYSE and the NASDAQ were 6.5 percent and 7 percent, respectively. By contrast, the median fee for companies on the LSE's Main Market and the Alternative Investment Market were 3.25 percent and 4 percent, respectively.

Whatever the costs of SOX, certainly the millions taken off the top in additional fees in the US probably make those amounts pale by comparison.  If anything might force an IPO overseas, certainly a far less expenisve underwriting process ought to be one of them.  Moreover, with the continued decline in competition among underwriters, this is only likely to get worse.

For a more balanced analysis of the issue, take a look at Is Going Public Going Out of Style? in CFO magazine.  As for the role of SOX in any decline, the article noted that "there is little clear evidence that Sarbox is the true culprit." 

The debate on making IPOs easier is a good one that ought to occur.  To the extent used as a singular attack on corporate governance regulation, however, it will get nowhere.