Ask the expert: US capital markets

The committee on capital markets regulation, chaired by Glenn Hubbard, dean of Columbia Business School and a former economic adviser to President George W. Bush, has recommended that companies and auditors should be better protected against costly shareholder lawsuits to stem the tide of litigation endangering the competitiveness of US markets

The findings of the influential group are part of wide-ranging efforts by business leaders and politicians to rein in a regulatory and legal system they say is stifling the ability of the US to compete with financial centres such as London and Hong Kong.

The committee also calls for excluding small companies from some of the more demanding provisions of the Sarbanes-Oxley legislation.

Prof Hubbard answers FT.com readers’ questions below

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What in your opinion are the main reasons US capital markets have fallen so far behind?
Jerry Walsh, Washington DC

Glenn Hubbard: The principal concern of the report is the importance of liquid, high-integrity public capital markets for shareholder value maximisation and for the ability of new companies to come to market.

The report’s key recommendations address the need for the regulatory process to embrace cost-benefit analysis (as, for example, in the UK), the importance of shareholder rights, the need for greater clarification and balance in public and private enforcement actions, and the significance of clarifying materiality in the implementation of Section 404 of the Sarbanes-Oxley Act of 2002.

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With New York’s lead over other financial centres shrinking, How can America retain its position as the world’s biggest market for capital?
James, Chicago

Glenn Hubbard: As the global economy develops, there will be (and should be) many prominent financial centres. The big question is whether the US regulatory and legal framework is conducive to a continued leadership role for US public markets; the committee’s report suggests both that there are many strengths in the US system and that modest changes can improve shareholder value and corporate accountability going forward.

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No doubt there are many world financial centres that are even more corrupt than ours are, and offer companies even more opportunities to do pretty much anything they want with their shareholders’ money, worry-free. I wonder - are there any major stock markets in the world that are currently considered to offer investors reasonably good safeguards against investors being swindled by fraudulent companies, the way American markets were ten or fifteen years ago? As best as I can tell there’s little effective protection for the small investor in any of them, which leaves most of us better off putting our money into bonds and hard assets.
Anon

Glenn Hubbard: You raise the most basic, most important issue of all – the question of how to maintain liquid public markets with integrity that maximise shareholder value for all investors. While there will always be fraudsters, the report argues that we need strong deterrents to fraud.

At the same time, we need to promote accountability and transparency at the lowest possible costs. Excessive costs of regulation (in excess of what is required for the needed benefits) are borne by all shareholders.

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Given that the Committee on Capital Markets Regulation received $500,000 from the C.V. Starr Foundation, a group with strong ties to Maurice R. “Hank” Greenberg, the former AIG chief who is fighting civil charges filed by the New York attorney general, and given that two other committee members, Wilbur L. Ross Jr and Kenneth C. Griffin, contributed a few hundred thousand dollars more, why should we believe the committee was independent? Is it a coincidence that the committee’s findings are favourable to the donors? Can you describe how the interests of investors, the public, businesses, etc. were represented in the make-up on the committee? For example, who represented the interests of individual shareholders on the committee?
Mark Thoma

Glenn Hubbard: The Starr Foundation made a grant to Harvard Law School to support the research and meetings of the 22 members of the Committee, none of whom was paid for their Committee service. Mr Ross and Mr Griffin made contributions for the same purpose from their personal funds. The committee is independent from the official sector, and the (very disparate) backgrounds of the committee members were chosen to maximise diversity and independence.

The members of the committee include CEOs, leaders of auditing firms, practising attorneys, institutional investors, private equity leaders, legal and finance academics and investor advocates.

Each member of the committee is an advocate for shareholder rights (a strong part of the report). The institutional investors on the committee (such as Scott Evans from TIAA-CREF), practising attorney advocates (such as Ira Millstein), and investor advocates (such as Peter Clapman from Governance for Owners USA) mad important contributions. These and other members of the Committee - and, of course, the academic members - are independent in their views.

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Does your committee have any recommendations as to how regulations might be changed to give shareholders a stronger voice in corporate governance, including such matters as selection of board members and executive compensation? If not, is this because the committee feels that current arrangements are adequate in this regard?
Bernard Yomtov

Glenn Hubbard: A core element of the report is the need to strengthen shareholder rights in the US. We begin with the importance of a well-functioning market for corporate control in maximising shareholder value, leading us to suggest that the combination of poison pills and staggered boards is an unhealthy one for shareholders. We also suggest that majority voting is important for shareholder democracy.

As the SEC has just promulgated new standards of disclosure for executive compensation, the report recommends that we examine the effectiveness of those disclosures before recommending further changes.

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A frequently heard criticism of the US regulatory system is that it is excessively fragmented (i.e. at federal and state levels etc). One common recommendation is the creation of a super-regulator like the FSA. However, do you see these issues being resolved when some point out that such decentralisation is a more structural feature of the US’s larger political economy while others underline the advantages of decentralisation: functional specialisation, multiple sources of information and the absence of an unrestrained, monolithic regulator?
Nathaniel Schneider, Baltimore, US

Glenn Hubbard: You raise a very important question (a subject for a future report form the committee, though US Treasury secretary Paulson has raised this issue already). In the context of the present Report, the key regulatory issues we raise are two: (1) the need to perform rigorous cost-benefit analysis (a la the UK FSA), and the need to clarify regulation (as we describe for materiality in the implementation of Sox 404 and materiality and scienter in securities litigation).

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To what extent do you think (i) the arguably lighter touch the CFTC has had in comparison to the SEC has made a difference, (ii) there needs to be more harmonised rules, if not a merger, between the two regulatory bodies, (iii) the non-fungibility of product and vertically integrated clearing approach has helped or hurt innovation in the futures markets (especially in light of the debate taking place in Europe right now on the latter) and (iv) the merger of the CME and CBOT will enhance our international competitiveness in the futures markets or stifle innovation?
Joe Gawronski, New York, US

Glenn Hubbard: While US Treasury secretary Paulson has spoken to the issue of regulatory consolidation, the committee largely deferred this issue for its next report. In general, an emphasis on cost-benefit analysis and a harmonisation of rules is a sensible approach.

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Is regulation going to make any difference to competitiveness of US capital markets, if the world’s financial centre is London? Is it too late, given that London has a geographical timezone advantage that provides access to more markets?
Rob, London

Glenn Hubbard: The regulatory and legal framework is a significant determinant of the liquidity and effectiveness of a public capital market. The principal issue in the report is not New York vs London, but whether the US regulatory and legal framework is maximising the effectiveness of American public equity markets. The committee’s report argues that the US can benefit from incorporating more rigorous cost-benefit analysis in regulatory study, along the lines of the FSA in the UK.

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What empirical work is available to support the Committee on Capital Markets Regulation’s recommendations beyond what is in the report? Is there a substantial body of work published in academic journals to support these recommendations? Or are they based upon a narrower set of papers that have not been thoroughly checked for robustness? Echoing Larry Summers, will you encourage the administration to focus as intensely on helping the American manufacturing, American agriculture and American health-care industries as it is on this particular aspect of financial services? What steps can you point to that the administration has taken to help with these problems?
Mark Thoma, Eugene, Oregon

Glenn Hubbard: The committee set out to tackle issues on which there is significant evidence in academic and legal scholarship. Two such areas include the importance of the market for corporate control for shareholder value (the shareholder rights section of the report) and declines in listing premia for firms in US public equity markets (the competitiveness section of the report). Professor Luigi Zingales of the University of Chicago authored an excellent summary of the economic evidence, as well as providing some important new evidence of his own. The key economic bottom line of the Report is less ‘competitiveness’ and more the need to ensure that U.S. public markets maximise shareholder value.

You (echoing Larry Summers) raise important points about agriculture and health care, though the analogy fails. The point of the report is not assistance to an industry, but how to make markets work better. Agricultural subsidies and tax and insurance market intervention in health care have frustrated that objective.

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Could the committee have gone further with its recommendations? Sarbanes-Oxley has been cited by foreign companies as a reason not to list in the US. Do you agree that America’s exchanges are suffering as a result of Sox?
Zoe Clifton, US

Glenn Hubbard: The report argues that the Sarbanes-Oxley law is, on balance, a welcome intervention to ensure the integrity of US public markets for investors. We focus only on the implementation of Section 404, where we believe that the SEC could clarify the concept of ‘materiality’ to reduce costs, while maintaining the law’s benefits. (In general, a consideration of cost-benefit analysis would be welcome.) Looming larger, in the committee’s view, is the cost of excessive securities litigation (for which some recommendations are offered).

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Like the saying goes - a strong offence is the best defence. How can the US better ensure that it will be able to capitalise upon opportunities in emerging global financial centres? By this I mean, as a leader in world capital markets should not the US transfer its skills, knowledge, technologies and regulatory frameworks to places like China, Brazil and South East Asia in order to profit from future growth in those regions?
Graham Moores, Abu Dhabi

Glenn Hubbard: US markets remain a significant leadership position. A leadership position in emerging markets is enhanced by maintaining strong public markets with integrity, so that firms (non-US and US) will desire the benefits of participation for their shareholders. The US absolutely does have a stake in advancing the cause of liquid capital markets with strong shareholder rights around the world.

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What will be in the committee’s next report?
Robert Walters, London

Glenn Hubbard: The committee will be studying alternative approaches to regulatory analysis and regulatory consolidation around the world. Another topic is a continued analysis of shareholder rights and their impact on shareholder value.

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Why should small companies be exempt from Sarbanes-Oxley regulations? Why not a ‘one cap fits all’ system?
Ross Grant, South Carolina

Glenn Hubbard: The report specifically does not recommend that the starting point be a different regime for small companies. We would recommend the same standards. We do, however, recommend that the SEC conduct a cost-benefit analysis of 404 for such firms. To the extent that the SEC finds that, even with our proposed reforms, the costs are still too high relative to the benefits, it should ask Congress to consider exempting small companies from the auditor attestation of 404, while at the same time changing the management certification requirement to one requiring reasonable belief in the adequacy of internal controls.

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