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Will the NYSE-Euronext merger smash Sarbanes Oxley?

By Peter Morici
web posted June 12, 2006

The announced merger of the NYSE and Euronext, bringing together the largest U.S. equities market and exchanges in Amsterdam, Brussels, Paris and Lisbon, has attracted notice for its potential to drive down trading costs and competitive consequences for other exchanges. However, the merger's biggest and unintended consequences may be for overzealous national securities regulators.

The merger should pass muster with antitrust authorities because it creates an alliance among exchanges in distinct locations rather than reducing the number of the exchanges competing in any one jurisdiction. The New York Stock Exchange and NASDAQ will continue to be rivals, and don't expect the merger to drive other European exchanges out of business.

Without or without the merger, trading costs are headed south because of the growing advantages of electronic trading, the deregulation of international capital flows and the competitive discipline imposed by the Internet. Those phenomenons should not be confused with the fallout from the merger, and those may in fact advantage smaller, well run exchanges in reasonably regulated jurisdictions.

Bigger is not always better -- General Motors is not the least cost automaker. NYSE-Euronext will have several national regulatory agencies to appease and many politicians with national pride to pacify, whereas NASDAQ, Deutsche Boerse or some other exchanges, not similarly burdened, could prove more nimble and creative.

The most significant NYSE-Euronext asset may be to help companies shift more easily among national exchanges to escape regulations that impose more costs than benefits to investors.

Consider the Sarbanes-Oxley Act of 2002 (SOX). Enacted in the wake of the Enron-era accounting scandals, it requires new, tougher controls for virtually every activity affecting a publicly-traded company's financial statements.

While improvements to the reliability of financial statements and transparency were welcome, some SOX requirements are simply too burdensome. For example, compelling businesses to undertake both internal audits of financial controls and external audits, and requiring auditors to focus on virtually every transaction and asset instead of only substantial issues that truly affect the bottom line, are too expensive for small and medium-sized firms too bear.

Requiring CEOs and CFOs of large, complex enterprises to sign off on all the details of company audits and financial statements, coupled with stiff fines and 20-year prison terms, are onerous and an invitation to simple tyranny. The recent convictions of Enron executives Ken Lay and Jeffrey Skilling demonstrate that the laws in place before SOX were adequate to bring wrong-doers to justice.

It should surprise few that SOX is causing capital fight. More U.S. companies are going or staying private to avoid SOX, and capital markets are becoming bifurcated and less democratic. The private market is open to the wealthy and big institutions who can evaluate companies without the benefit of SEC disclosure, while small investors are essentially shut out of shares of businesses that would be publicly traded but not for SOX.

Similarly, U.S. firms are fleeing to the United Kingdom and other European locations to avoid SOX. The NYSE-Euronext alliance, if properly run, could provide more choices and easier exit for U.S. companies seeking to escape the silliness that is SOX.

Most fundamentally, effective stock exchanges provide a place for large numbers of investors to trade shares, certainty that traded shares are authentic and delivered as contracted, and accounting rules ensuring timely and accurate financial statements. The Internet, electronic trading and World Trade Organization rules for financial services make market entry for any national government choosing to meet those requirements reasonable and easy.

Just as Delaware provides a convenient, least-cost jurisdiction for many U.S. businesses to incorporate, NYSE-Euronext or one its competitors could form an alliance with Switzerland, Lichtenstein or Bermuda to create a transparent and more efficient stock exchange that trumps New York, London and other financial centers.

If established stock exchange companies don't figure this out, the next Bill Gates will sell some principality on the idea of creating a transparent, secure and least-cost equity market.

Hopefully, the Congress will reform SOX before it is too late; however, too often, the U.S. government has acted as if American firms only compete with themselves and has driven able businesses to move operations to Asia and Europe.

SOX was concocted at a time of public hysteria and congressional outrage, and has the predictable shortcomings of sovereign hubris.

Leave SOX in place as is, and Americans won't have to worry as much about the evils of capitalism, but they will enjoy fewer of its blessings too.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission. He serves on the Bloomberg and Reuters macroeconomic forecasting panels.

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