Waste makes haste: Sarbanes‐Oxley, competitiveness and the subprime crisis
| Published date | 14 November 2008 |
| DOI | https://doi.org/10.1108/13581980810918422 |
| Pages | 365-383 |
| Date | 14 November 2008 |
| Author | Donald Nordberg |
| Subject Matter | Accounting & finance |
Waste makes haste:
Sarbanes-Oxley, competitiveness
and the subprime crisis
Donald Nordberg
London Metropolitan Business School, London, UK
Abstract
Purpose – The passage of the Sarbanes-Oxley Act of 2002 followed hard on the collapses of Enron
and WorldCom. Waste makes haste. Official reports for US government agencies worried that the
legislation may have impaired New York’s competitiveness as a venue for international capital
transactions. But a threat from a seemingly different direction – the subprime shakeout – exposed
bigger issues. This paper aims to raise questions about many of the assumptions made in the
discourse about the relative competitiveness of US and European capital markets.
Design/methodology/approach – Building on Healy and Palepu’s analysis of Enron, it compares
the root issues at Enron with a preliminary view of the sources of the subprime crisis to build an
outline for regulatory response.
Findings – Remedies in Sarbanes-Oxley failed to address several of the ailments in evidence in
Enron. The haste of making “Sarbox” may have led us to waste an opportunity to prevent or reduce
the impact of the subprime debacle.
Originality/value – The comparison of the seemingly unrelated cases reveals similar ethical gaps
and regulatory lapses, suggesting a different type of legislative and regulatory response may be
needed. It makes suggestions for further research to guide future policymaking.
Keywords Corporate governance,Regulation, United States of America,Capital markets,
Competitive strategy
Paper type Viewpoint
Introduction
US Senator Charles Schumer of New York State and Mayor Michael Bloomberg of
New York City saw the situation like this: “Traditionally, London was our chief
competitor in the financial services industry,” they wrote in the introduction to a report
from the consultants McKinsey & Co., challenging the competitiveness of New York as
a global financial hub. “But as technology has virtually eliminated barriers to the flow
of capital, it now freely flows to the most efficient markets, in all corners of the globe.
Today, in addition to London, we’re increasingly competing with cities like Dubai,
Hong Kong, and Tokyo.” They claimed that New York is still – in some sense – in the
lead, whatever that means, but warned not to take the lead for granted. “In fact, the
report contains a chilling fact that if we do nothing, within ten years while we will
remain a leading regional financial centre; we will no longer be the financial capital of
the world,” they said (McKinsey & Co., 2007, p. i).
The main body of the report said that the declining position of the US went beyond
“natural market evolution to more controllable, intrinsic issues of US competitiveness”.
Why? Part of the answer lies in the Sarbanes-Oxley Act of 2002, which Schumer, a
Democrat, might well want to use this report to alter now that his party has won control
of both houses of Congress. But there’s more than that: “The more lenient immigration
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Waste makes
haste
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Journal of Financial Regulation and
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Vol. 16 No. 4, 2008
pp. 365-383
qEmerald Group Publishing Limited
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DOI 10.1108/13581980810918422
environment London also makes it easier to recruit and retain international
professionals with the requisite quantitative skills,” McKinsey wrote. “Finally, the
FSA’s [the UK Financial Services Authority’s] greater historical willingness to net
outstanding derivatives positions before applying capital charges has also yielded a
major competitive advantage for London” (McKinsey & Co., 2007, p. 13).
The McKinsey report for New York State and City was one of three reports that
raised issues about the competitiveness of America’s capital markets, including
another commissioned by US Treasury Secretary Hank Paulson, and a third giving a
blueprint for a new regulatory environment, penned in part by the Treasury Secretary
himself (Paulson et al., 2008). They traced the roots of the problems to HR.3762 The
Corporate Responsibility Act (Library of Congress, 2002).
An interim report commissioned by US Treasury Department, entitled The
Competitive Position of the US Public Equity Market, was published about the same
time as McKinsey’s. The final version, completed towards the end of 2007, said the first
had stimulated much discussion, but added: “Not nearly enough has been done. What
is still lacking is commitment and political leadership. This Report, therefore, is a
second wake-up call” (Committee on Capital Markets Regulation, 2007, p. v). “By any
meaningful measure, the competitiveness of the US public equity market has
deteriorated significantly in recent years,” it added (2007, p. 1). Since 1996, the US share
of global initial public offerings had “dramatically dropped”. Between January and
September 2007, only just over 10 per cent of new international equity offerings were
made on US-based exchanges. The level had been 44.5 per cent in 1996 and averaged
21.2 per cent for the decade from then until 2005, it said. The picture was even more
dire if you looked at the value of those new issues. US exchanges raised just 7.7 per cent
of the total value of global IPOs through the first nine months of 2007, compared to
58.8 per cent in 1996 and an average of 30.9 per cent in the period from 1996 to 2005. It
was small consolation that the US share in 2007 was a bit higher than in 2006, when US
exchanges captured 8.9 per cent of global IPOs by number and 6.6 per cent, measured
by value. In 1996, eight of the 20 largest global IPOs were conducted in the US.
A decade later only one was. To make matters worse, US companies in increasing
numbers were going overseas to raise capital, eschewing US exchange listings
(Committee on Capital Markets Regulation, 2007, p. 2).
The message was loud and clear: The Sarbanes-Oxley Act was too much of a
straightjacket. A lighter-touch regime would make American equity capital markets
more competitive. But towards the end of 2007, the US capital markets were not really
listening. Credit markets had seized up in fear of defaults and insolvencies that might
arise from distressed selling of mortgage-backed securities issued by US investment
banks on the back of lending in what had been fierce competition for customers in
Florida, California and a few others states where household incomes were not rea lly
high enough to afford the houses they aspired to hold. Unlike previous property booms,
this one had been conducted increasingly by mortgage brokers. The originators might
have been banks themselves, but they were working under the guidance of the big
investment banks on Wall Street, which, under guidance of the credit ratin g agencies,
then packaged the mortgages into tranches, and using derivatives built credit default
protection around them, making the new “collateralised debt obligations” worthy of
Triple A credit ratings and investment-grade status. These instruments found their
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