[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
AMERICA'S CAPITAL MARKETS:
MAINTAINING OUR LEAD
IN THE 21ST CENTURY
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE, AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
APRIL 26, 2006
__________
Printed for the use of the Committee on Financial Services
Serial No. 109-87
U.S. GOVERNMENT PRINTING OFFICE
30-538 WASHINGTON : 2006
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma MELVIN L. WATT, North Carolina
ROBERT W. NEY, Ohio GARY L. ACKERMAN, New York
SUE W. KELLY, New York, Vice Chair DARLENE HOOLEY, Oregon
RON PAUL, Texas JULIA CARSON, Indiana
PAUL E. GILLMOR, Ohio BRAD SHERMAN, California
JIM RYUN, Kansas GREGORY W. MEEKS, New York
STEVEN C. LaTOURETTE, Ohio BARBARA LEE, California
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut JOSEPH CROWLEY, New York
VITO FOSSELLA, New York WM. LACY CLAY, Missouri
GARY G. MILLER, California STEVE ISRAEL, New York
PATRICK J. TIBERI, Ohio CAROLYN McCARTHY, New York
MARK R. KENNEDY, Minnesota JOE BACA, California
TOM FEENEY, Florida JIM MATHESON, Utah
JEB HENSARLING, Texas STEPHEN F. LYNCH, Massachusetts
SCOTT GARRETT, New Jersey BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia
J. GRESHAM BARRETT, South Carolina ARTUR DAVIS, Alabama
KATHERINE HARRIS, Florida AL GREEN, Texas
RICK RENZI, Arizona EMANUEL CLEAVER, Missouri
JIM GERLACH, Pennsylvania MELISSA L. BEAN, Illinois
STEVAN PEARCE, New Mexico DEBBIE WASSERMAN SCHULTZ, Florida
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin,
TOM PRICE, Georgia
MICHAEL G. FITZPATRICK, BERNARD SANDERS, Vermont
Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina
JOHN CAMPBELL, California
Robert U. Foster, III, Staff Director
Subcommittee on Capital Markets, Insurance, and Government Sponsored
Enterprises
RICHARD H. BAKER, Louisiana, Chairman
JIM RYUN, Kansas, Vice Chair PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware GREGORY W. MEEKS, New York
PETER T. KING, New York DENNIS MOORE, Kansas
FRANK D. LUCAS, Oklahoma MICHAEL E. CAPUANO, Massachusetts
DONALD A. MANZULLO, Illinois HAROLD E. FORD, Jr., Tennessee
EDWARD R. ROYCE, California RUBEN HINOJOSA, Texas
SUE W. KELLY, New York JOSEPH CROWLEY, New York
ROBERT W. NEY, Ohio STEVE ISRAEL, New York
VITO FOSSELLA, New York, WM. LACY CLAY, Missouri
JUDY BIGGERT, Illinois CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MARK R. KENNEDY, Minnesota JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia
TOM FEENEY, Florida NYDIA M. VELAZQUEZ, New York
JIM GERLACH, Pennsylvania MELVIN L. WATT, North Carolina
KATHERINE HARRIS, Florida ARTUR DAVIS, Alabama
JEB HENSARLING, Texas MELISSA L. BEAN, Illinois
RICK RENZI, Arizona DEBBIE WASSERMAN SCHULTZ, Florida
GEOFF DAVIS, Kentucky BARNEY FRANK, Massachusetts
MICHAEL G. FITZPATRICK,
Pennsylvania
JOHN CAMPBELL, California
MICHAEL G. OXLEY, Ohio
C O N T E N T S
----------
Page
Hearing held on:
April 26, 2006............................................... 1
Appendix:
April 26, 2006............................................... 53
WITNESSES
Wednesday, April 26, 2006
Carter, Marshall N., Chairman of the Board, NYSE Group, Inc...... 12
Copland, James R., Director, Center for Legal Policy, The
Manhattan Institute............................................ 42
Evans, Donald L., Chief Executive Officer, The Financial Services
Forum.......................................................... 10
Franko, Lawrence G., Professor of Finance, University of
Massachusetts-Boston, College of Management.................... 45
Gingrich, Hon. Newt, former Speaker, U.S. House of
Representatives................................................ 14
Pinelli, Maria, Americas Strategic Growth Markets Leader, Ernst &
Young, LLP..................................................... 41
APPENDIX
Prepared statements:
Baker, Hon. Richard H........................................ 54
Brown-Waite, Hon. Ginny...................................... 58
Hinojosa, Hon. Ruben......................................... 59
Carter, Marshall N........................................... 61
Copland, James R............................................. 77
Evans, Donald L.............................................. 90
Franko, Lawrence G........................................... 98
Gingrich, Hon. Newt.......................................... 102
Pinelli, Maria............................................... 130
Additional Material Submitted for the Record
Feeney, Hon. Tom:
The Sarbanes-Oxley Debacle--What We've Learned; How to Fix it 140
Hinojosa, Hon. Ruben:
HESTEC Documents............................................. 277
AMERICA'S CAPITAL MARKETS:
MAINTAINING OUR LEAD
IN THE 21ST CENTURY
----------
Wednesday, April 26, 2006
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:10 a.m., in
the Rayburn House Office Building, Hon. Richard H. Baker
[chairman of the subcommittee] presiding.
Present: Representatives Baker, Gillmor, Lucas, Kelly,
Feeney, Hensarling, Fitzpatrick, Campbell, Kanjorski, Hooley,
Meeks, Moore, Capuano, Hinojosa, Israel, McCarthy, Baca, Lynch,
Miller of North Carolina, Scott, Velazquez, Watt, and Davis.
Chairman Baker. We have the good fortune of having a
distinguished panel with us this morning. I very much look
forward to hearing their opinions on the issue of global
competitiveness.
The ability to have the world's most efficient capital
markets is not an American birthright, but rather a position
earned through hard work over the years. If the U.S. capital
markets are to retain this distinction, there must be a
continual recognition of the principles that enabled our
historic success. Further, for those who regulate, and for
those of us who legislate, these markets must necessarily
undergo reform from time to time, to maintain this position of
primacy, or we stand to inherit consequences of our own
inaction.
Over the last 5 years, both legislators and regulators have
spent a great deal of effort in responding to the identified
crises and the consequential erosion of investor confidence.
Enron, WorldCom, Global Crossing, and Tyco--all of those
related matters--caused the Congress to act as a result of the
dotcom bubble bursting.
It also brought home the reality that there were material
weaknesses not only in the way the companies operated, but
perhaps more importantly, in the manner in which the regulatory
structure was organized. As a result, Congress enacted a series
of reforms, creating the PCAOB, enabling SEC with new actions,
and creating other new courses for business management to
follow.
As a result of these actions, investor confidence has
improved. And with 95 million American households now invested
in the markets, investor confidence has never been more
important.
Restoring fairness and enhancing transparency in the
markets requires continued vigilance. However, I believe our
markets are now facing an even greater challenge in order to
retain their supremacy in the form of global competitiveness.
If the NYSE/Archipelago and the NASDAQ/Instinet mergers were
not enough proof of the changing nature of our markets, NASDAQ
has just purchased 14 percent of the London Stock Exchange,
while the NYSE has expressed interest in gaining a share of a
European exchange as well.
Innovations in technology have had dramatic impact on both
trading and capital formation. And such innovation has resulted
in great strides in increasing market efficiency. Today, U.S.
markets are the most sophisticated and technologically advanced
in the entire world. But why are so many companies, therefore,
choosing to list abroad, in other exchanges, as well as taking
IPO's overseas?
I have come to the conclusion there are three basic areas
for us to be concerned about: number one, the irresponsible
attitude to litigate, and the cost it imposes on businesses,
shareholders, and consequently, consumers; number two,
inefficiencies in our current regulatory structure of capital
markets; and number three, the historical lack of progress in
addressing accounting complexities.
These domestic issues, combined with the increasingly
efficient and liquid foreign markets, pose significant
challenges to our continued supremacy. If unaddressed, these
barriers to attracting capital will continue to put the United
States at a growing disadvantage in a very competitive
marketplace.
Investor protection and global competitiveness, however,
are not necessarily contradictory goals. Congress must ensure
that the regulatory system is effective, while enabling
innovative and profitable activities in the marketplace.
Responsible tort reform is essential to combat the high
cost of frivolous lawsuits. Class action suits oftentimes do
little to provide restitution to injured investors, but all too
often, only enrich a few legal representatives. There is a need
for rebalancing justifiable actions vs. frivolous lawsuits.
Such review and reform is essential.
As an aside, I would point to actions taken in Sarbanes-
Oxley, with the creation of the fair fund, enabling the SEC,
through its own legal counsel, to pursue wrongdoers, and to
retain and regain control of ill-gotten gains.
Since the passage of the Act, over $7.5 billion has been
identified by the SEC for recovery. This is an effective way to
respond to unprofessional conduct.
Also, a comprehensive review of the manner in which
securities transactions are regulated is essential. Smart and
efficient regulation increases the value of a market for both
companies and investors. Duplicative and unnecessary regulation
does little other than to raise costs and lower returns. Many
of the redundant and outdated regulations are within the
authority of regulators to address administratively. However,
aggressive oversight is still necessary at the Congressional
level, and I intend to do so.
Finally, our current accounting environment is being
hindered by a rules-based, retrospective view of financial
reporting. As we have heard from witnesses in recent hearings,
fostering transparency through technological advance is
absolutely a necessity. Projects such as XBRL, known as
Extensible Business Reporting Language, will help provide
participants in U.S. markets with relevant data more quickly,
enabling all market stakeholders to understand and make more
informed decisions, moving away from quarterly earnings
statements.
And the time reporting will also help to serve minimizing
market volatility, while diminishing the need, or incentives,
for management to be creative in managing their earnings. This
will also assist toward an international convergence of
accounting standards, enabling capital to flow more easily at
the international level.
For many years, the capital markets were considered by
investors to be, in the United States, alone at the top.
However, while we have been tying our own markets down with
more regulatory rope, China, Europe, and other foreign markets
have been pursuing the risk-based model that made our markets
great.
The foreign markets have now gained significant ground in
the competition for capital. Of the last and most significant
IPO's, 23 out of 25 have been issued in foreign markets. Many
large companies now prefer to list in London or Tokyo, as
opposed to New York. These facts should serve as a wake-up call
to all of us.
While we should be very concerned that capital is leaving,
we also have an obligation to American investors. With over
half of working Americans now invested in U.S. markets, we have
a high standard of responsibility to ensure that markets are
efficient, but also transparent to these investors. When
necessary, there should be regulatory action taken against
those who fail to discharge their fiduciary duties.
This is not really a complicated task. The balancing of
equities with investor protection and efficient market function
just makes sense. When investors have confidence, capital flows
freely. A free flow of capital means innovative products and
job creation. This is the essence of a balanced capital market.
This is what makes America work. We cannot accept anything
less. Mr. Kanjorski?
Mr. Kanjorski. We meet this morning to examine how we can
maintain America's lead in our global capital markets. This is
an important issue, and I commend you for convening this
hearing.
The United States has the strongest, most liquid capital
markets in the world. As one of our witnesses comments in his
prepared testimony, ``With just 5 percent of the world's
population, and 25 percent of its gross domestic product, the
United States has captured more then 50 percent of the global
capital markets.'' We need to work in Washington to ensure that
we continue to maintain that lead to the maximum extent
possible.
In my view, we can preserve our lead by continuing to
protect investors. About 1 year ago, then SEC-chairman
Donaldson delivered a speech in London. At that time, he noted
that efforts to promote transparency for investors and the
fiduciary duties of corporate leaders are helping to raise
standards throughout the world. He also observed that there are
still distinct advantages to listing on the U.S. exchange, and
registering with the SEC.
He went on to draw a parallel to the United States Marine
Corps. Of all of our military organizations, the Marines are
known as the best of the best. Because individuals want to be a
part of that elite corps, the Marine Corps has traditionally
had few problems in meeting its recruitment goals. We want our
U.S. capital markets to be like the Marines, viewed as the
elite, and attracting the best companies and the best
investors.
The many requirements of the Sarbanes-Oxley Act demonstrate
our commitment to maintaining the highest standards in the
world's capital markets. Many existing companies have stepped
up to, and met, this challenge. Many emerging companies are
doing the same. In fact, according to research by SME Capital
Markets in 2005, a record 881 small companies registered with
the SEC to raise more than $16.3 billion in capital.
That said, we must do more to ensure that small companies
are not discouraged from entering the marketplace. Arthur
Levitt, another former SEC chairman, recently wrote in the Wall
Street Journal that we need to work within the framework of the
Sarbanes-Oxley Act to identify ways to make compliance easier
and less expensive. I agree with his assessment.
We must also ensure that investors are protected with
access to accurate accounting information, regardless of the
size of the public company. While it is somewhat off-the-
subject for today's hearing, which deals with publicly-traded
companies, we must also remember that there are many smaller
private companies seeking access to venture capital.
I would be remiss if I, therefore, did not maintain that we
must ensure that these fledgling businesses have access to the
money needed to grow and thrive, so that one day they can
register as a publicly-traded company on a U.S. exchange.
Additionally, many of the participants in today's hearing
will doubtlessly observe that we live in an increasingly global
economy. Some others may point to one variable or another, like
excessive regulation, frivolous litigation, unwarranted
taxation, or lagging education as a reason why the U.S. capital
markets may lose their competitive edge.
In reality, we live in a multi-dimensional world, and no
one factor alone is likely to contribute to America's
continuing success or decline as the world's leading capital
market. To ensure that we maintain that dominant role, we need
to adhere to the principles of making sure that we have the
quality of capital markets with appropriate investor
protections.
In closing, Mr. Chairman, today's hearing should help us to
better understand what we need to do to make sure that our
capital markets continue to lead the world. We should, in my
view, remain on the cutting edge of quality regulation, ensure
that every corporation plays by the rules, and make certain
that all investors have access to reliable information needed
to make prudent decisions.
We must also strive to ensure that each party who violates
our security laws is held appropriately accountable. I look
forward to hearing from our distinguished witnesses on this
matter.
Chairman Baker. I thank the gentleman. Are there further
opening statements? Mrs. Kelly?
Mrs. Kelly. Thank you, Chairman Baker, for holding this
hearing. I believe that keeping the United States competitive
is vitally important. While today's hearing is going to focus
on regulatory and legal barriers to competitiveness, the
greatest threats to our competitiveness right now are the
continuing rise in energy prices and the threat of terrorism
backed by the specter of an Iran that may be building nuclear
weapons.
Our financial markets, no matter how well managed and
regulated, will not be global centers of excellence if the
economy they support is ravaged by declining production from
high energy costs, or decimated by terrorist attacks. I look
forward to asking each of the witnesses to address what we can
do to protect our markets against these twin threats that we
currently face.
I appreciate you holding this hearing, and I yield back the
balance of my time.
Chairman Baker. I thank the gentlelady. Ms. Hooley?
Ms. Hooley. Thank you, Chairman Baker and Ranking Member
Kanjorski. Thank you for scheduling today's timely hearing. I
hope it marks just the beginning of a critical debate about
what actions should be taken to maintain, and even grow, the
competitive advantage that our capital markets have earned in
this last century.
As the policymakers, it is critical that we work
proactively to avoid losing our dominant role in global capital
markets, rather than being forced to play catch-up after our
advantage has been significantly diminished.
At the same time, we should not act too hastily, and become
engaged in a race to the bottom against our global competitors.
Confidence is king, and we should not sacrifice investor
confidence for a quick fix. While some will say IPO trends in
the past year indicate a down turn in the fortune of our
markets, I would note that, after closer examination, many of
last year's largest IPO's were a result of emerging capital
markets, the listing of state-owned enterprises, geographic
barriers, and increased global competition.
In fact, I believe it is somewhat disingenuous to argue
that many of these companies would have listed in the United
States if only regulations or litigations were lessened. Many
simply listed on their more natural markets.
I believe our markets maintain a significant advantage due
to their well-earned reputation for transparency, good
corporate governance, and appetite for innovation. These
pillars of our markets continue to lead to significant
valuation of U.S. offerings, valuations that are unmatched
throughout the globe.
Our markets remain pre-eminent in effectively raising
capital. With leadership in our investment community and among
policy makers, we will maintain our status as home to the
world's strongest capital markets. In short, the sky is not
falling, but we can do better.
I look forward to working with members of this committee
and with our investment community in a thoughtful way to
facilitate the strongest and most innovative capital markets
possible. And I yield back the remainder of my time. Thank you.
Chairman Baker. I thank the gentlelady. Mr. Hensarling?
Mr. Hensarling. Thank you, Mr. Chairman, and thank you for
holding this hearing. With the noticeable exception of high
gasoline prices, we are clearly enjoying one of the best
economies that we have enjoyed in quite a number of years. Over
five million new jobs have been created, and in a little less
than 3 years we have one of the lowest unemployment rates we
have enjoyed in 3 decades. We have the highest rate of home
ownership that we have had in the entire history of the United
States of America. Household net wealth is up, income is up.
These are the benefits of capitalism.
But you can't have capitalism without capital. And clearly,
there are a number of worrisome trends that we see. They may be
trends. But I was looking ahead, for example, to Speaker
Gingrich's testimony, and learning that recently the London
Stock Exchange had recorded 129 new listings by companies from
29 different countries. And in the United States, NASDAQ gained
a net 14, and the New York Stock Exchange, net 6.
Clearly, there are some facts out there that should worry
us, including 23 of the top 25 largest IPO's being registered
outside of the United States.
So, again, as I talk to members of--people who are actually
out in the real world, rolling up their sleeves and creating
jobs, talking to them about capital markets, I hear the same
refrain over and over and over, and that is too much
regulation, too much litigation, and too much taxation.
And although it doesn't make a sexy sound bite, it was good
that our committee would actually engage in looking into some
cost benefit analysis, and looking very carefully--although we
know the benefits of much of what we do, and obviously
Sarbanes-Oxley was a terribly important law, and needed to
restore confidence in the investor marketplace, too often we
know, Mr. Chairman, that we, as Members of Congress,
collectively do excel in unintended consequences, and it is
good that we should look at these unintended consequences, and
ensure that we do not imperil our global leadership in the
capital markets, and do something that would undermine our
great dynamic economy today that is helping to lift so many
families and so many members of our Nation out of what would
otherwise be low economic circumstances. And with that, I yield
back.
Chairman Baker. I thank the gentleman. Mr. Moore, do you
have a statement? Mr. Moore? Mr. Capuano? Are there any further
opening statements? Mr. Baca, then we are going to go to Mr.
Hinojosa, and then Mr. Scott. Anybody else? Okay, we have one
here on the side, too. Mr. Baca, please proceed.
Mr. Baca. Thank you very much, Mr. Chairman, and Ranking
Member Kanjorski. I am pleased to be here today to discuss the
global competitiveness and how to maintain our lead in the
global economy.
While the United States still leads the world in economic
power, our percentages are dropping, and we must be on guard to
prevent further erosion. A number of factors can explain why
our dominance is decreasing.
For starters, corporate abuse continues to harm our economy
and erode public confidence. CEO salaries have gone through the
roof into hundreds of millions of dollars, where the Federal
maximum wages haven't increased since 1997. We must do more to
rebuild public trust and protect the American investors, and we
must hold executives accountable.
I know that Sarbanes-Oxley has not been popular with
business communities. And as a former small businessman, I am
sympathetic. For some small businesses, the burden of complying
with filing requirements has been very burdensome. Some small
businesses--the small business is the engine that sustains
America and creates jobs. So we must make sure that Sarbanes-
Oxley is implemented in a way that makes sense.
But if we are serious about keeping America strong, we must
put our priorities in order. We must train our workforce for
tomorrow's jobs. Today, fewer than 4 in 10 students who
graduate high school will go on to college. At this rate, the
United States will face a shortage of up to 12 million in the
college-educated workforce by the year 2020, and we must close
the gap. Closing the gap could add $250 billion to the Nation's
GDP, and $85 billion in tax revenue.
We must ensure that the American companies compete in a
level playing field, and we must break barriers in corporate
America. Hispanics are the largest minority group and the
fastest growing consumer segment. Hispanics remain
unrepresented in the workforce and corporate boards and
investment world.
As chair of a corporate American task force, I have led the
fight, along with my colleagues, to ensure that qualified
Hispanics are positioned for corporate America; to increase
procurement for Hispanic-owned businesses; and to increase
diversity in corporate senior management and corporate
boardrooms. Removing these barriers will contribute to higher
innovation and more productivity, and will enhance the American
position in the global economy.
With that, I look forward to hearing what our witnesses
have to say about this issue, as well. Thank you very much, Mr.
Chairman. I yield back the balance of my time.
Chairman Baker. I thank the gentleman for yielding. Mr.
Feeney?
Mr. Feeney. Thank you, Mr. Chairman. And I really
appreciate our distinguished panel. I will be brief, because I
am excited to get to them. I am very interested in, now that we
have some history with Sarbanes-Oxley, in the imposition,
sometimes unnecessary imposition, that is put on the United
States economy.
According to one set of experts from the American
Enterprise and the Brookings Institute, Mr. Butler from Chapman
University, Larry Ribstein from the University of Illinois, the
indirect costs of Sarbanes-Oxley compliance can be estimated at
about $1.1 trillion to the United States economy.
Sarbanes-Oxley did an awful lot of good, in terms of
providing for accountability and transparency, conflict
management, and internal controls. But I am very interested, if
the witnesses can, in addressing what is good about Sarbanes-
Oxley, what is unnecessary, redundant, and bad about Sarbanes-
Oxley, and what fixes they think can be done by the SEC and the
accounting oversight board. And then ultimately, is there a
legislative fix that is necessary?
So, I am thrilled to have this distinguished panel with us,
and very interested--since this committee has direct
responsibility for the Sarbanes-Oxley compliance issues--in how
we can be helpful in protecting investor confidence, keeping
what's good, but reforming what needs to be reformed. And with
that, I yield back, Mr. Chairman.
Chairman Baker. I thank the gentleman. Mr. Hinojosa?
Mr. Hinojosa. Thank you, Mr. Chairman. I want to thank you
and Ranking Member Kanjorski, and to express my sincere
appreciation to you for holding this hearing today.
The United States is currently at a crossroads. We can
either decide to move toward a more responsible, effective form
of government than we presently have, or we can continue down
the road that has led to the rise and fall of great nations.
Today's hearing is entitled, ``America's Capital Markets:
Maintaining our Lead in the 21st Century.''
I find it an interesting title, since some naysayers
contend that we have already lost our lead in the capital
markets, or at least are sliding down a slippery slope towards
such a loss. I am not going to go into all the ins and outs of
arguments that say we are still the lead country, in terms of
capital markets, the lead economy, or the true sole superpower
in the world. I will leave that to those who will testify here
today: Secretary Donald Evans; Mr. Marshall Carter; and the
Honorable Newt Gingrich. I look forward to hearing their
presentations.
Mr. Chairman, what I am most interested in is ensuring that
our markets do remain competitive, and I believe that this
requires an intensive and comprehensive investment in our
children and their education, particularly in the stem careers
of science, technology engineering, and math.
To address this situation, I collaborated with The
University of Texas--Pan American to develop Hispanic
Engineering, Science, and Technology Week, known as ``HESTEC
week.'' It's a year-round leadership program that emphasizes
the importance of science literacy to thousands of pre-K to
college students and teachers through professional development
workshops, presentations by world-class speakers, competitions,
and hands-on activities. Participants are encouraged to prepare
for studies in math, engineering, technology, and science.
Mr. Chairman, at this point I would ask that all of these
documents pertaining to HESTEC be included in the record.
Chairman Baker. Without objection.
Mr. Hinojosa. Trying to bring this to a close, I want to
say that the importance of HESTEC has never been greater.
Statistics show that the United States is falling behind in the
number of students excelling in those areas that I mentioned.
During HESTEC, we give children and teachers the necessary
tools, and encourage them to reach for new heights. HESTEC
allows students and educators to interact with some of our
country's top CEO's, engineers, scientists, astronauts, and
designers.
Events like Educator Day, the Hispanic Science Leadership
Round Table, Latinas in Science, Engineering and Technology,
Robotics Competitions, and Community Day allow students and
educators the opportunities to meet top role models, and learn
valuable leadership lessons.
HESTEC is a key ingredient to ensuring that our Nation
continues its entrepreneurial spirit, and that our capital
markets remain competitive and world class markets. Mr.
Chairman, I cannot stress enough how important it is for the
United States to produce additional scientists and engineers.
We need to do so in order to continue to be able to compete
with our overseas counterparts, much less to remain a
superpower. It is my hope that all of those present at today's
hearing will review information on the HESTEC program at
www.hestec.org. Mr. Chairman, I yield back the remainder of my
time.
Chairman Baker. I thank the gentleman. Mr. Israel, did you
have a statement?
Mr. Israel. Thank you, Mr. Chairman. I will be very brief.
I just want to point out to everyone that I am particularly
pleased to see Mr. Carter here. We had a good meeting
yesterday.
And Mr. Carter and Speaker Gingrich may not be aware of
this, but they have something in common, other than the fact
that they are on the panel today, and that is that they are
both Civil War historians. Mr. Carter was in my office
yesterday, saw a photograph I have of Joshua Chamberlain, and
we debated, Mr. Speaker, whether Little Round Top really was a
turning point in the Civil War, or, as some of my friends call
it, the War of Northern Aggression.
So, I appreciate you being here. I know this isn't about
Civil War history. I just wanted to point that out, and I am
looking forward to your respective comments.
Chairman Baker. I am pleased to have a cessation of
hostilities, Mr. Israel. Thank you.
Mr. Miller? Mr. Scott?
Mr. Scott. Yes. Thank you very much, Mr. Chairman. I, too,
want to congratulate you and Ranking Member Kanjorski for
holding this very, very timely and important hearing today on
the strength of America's capital system in the global
marketplace.
The American financial system remains the vanguard of world
markets, without a doubt. And we must maintain that strength.
The high standards that we have continue to give respect and
status to the companies that list in the United States. And
even though we have the best capital system, we must not be too
comfortable with our position.
The American markets continue to face strong competition
from foreign markets. And I am very concerned with the wide
number--as to why a large number of companies are delisting
from American exchanges. We have to ask why companies would
choose to remove themselves from American exchanges.
I am concerned about the impact of the financial services
sector now moving to replace manufacturing as the dominant
income-generator and money-maker in our system. What does that
portend to the future of our country and our position in
capital markets?
I am also concerned about our overwhelming debt, and the
deficit, and the impact of having so much of our debt in the
hands of foreign nations and foreign institutions. What does
that portend for us? The complexity of our tax code, and that
is driving many of our foreign partners away from us.
I also want to talk about--a little bit about--the need to
invest in human capital, as well as our infrastructure. It has
been mentioned before, but our failure to properly address, and
give the incentives and encourage our young people to go into
math and into sciences, and put the rewards systems there.
Further attention and resources are certainly needed for our
science and math education. And we must also consider, of
course, revisions to our regulatory and our tax structure so it
is consumer-friendly for our foreign friends.
But as we discuss the global marketplace, I just want to
take one moment to welcome my good friend from Georgia, former
speaker Newt Gingrich, as a witness today. Speaker Gingrich has
been a bright and shining light, an illuminating source of
fresh and bright ideas on how we can keep our American economy
and our economic system at the forefront. And I welcome you
here. You continue to be a source of global innovative
thinking.
And Speaker, as you may know--I don't know if the rest of
America knows--but I am honored and privileged now to soon be
representing a great part of your former district in the House
of Representatives, in Cobb and Douglas County. So we are glad
to have you, as a fellow Georgian, and I am sure you will add
so much to our hearing today.
As this subcommittee discusses the future of our markets,
we must keep in mind the need to have an efficient system that
provides the best prices and information for a wide variety of
investors. I look forward to our meeting, and I yield back the
balance of my time.
Chairman Baker. I thank the gentleman. I welcome each of
our witnesses here this morning. The committee is particularly
excited to have such a distinguished panel on this most
important subject. And as you can tell, members' interest is
significant, and the expression of concerns about our current
posture in international markets is prevalent. And we are not
clear as to the steps we should take to enhance our
competitiveness, but we are greatly interested in hearing each
of your perspectives and your recommendations.
As each of you are quite familiar--I just say it for the
purpose of saying it--your entire statement will be made part
of the official record. Please feel free to proceed as you
would like. We request that you try to keep your remarks to 5
minutes to enable what I believe will be a lengthy question
period.
And at this time, I would welcome our first witness,
Secretary Donald L. Evans, currently the chief executive
office, The Financial Services Forum. A pleasure to have you
here, sir.
STATEMENTS OF DONALD L. EVANS, CHIEF EXECUTIVE OFFICER, THE
FINANCIAL SERVICES FORUM
Mr. Evans. Thank you, Mr. Chairman. Let me join the chorus
of thanks to you for holding this hearing, and for your focus
on America's competitiveness. I have certainly enjoyed our
discussions on the subject, as well as discussions with other
members of this committee on the subject. It was certainly a
focus of the President's State of the Union Address, and I
compliment you and the entire committee for staying very, very
focused on this most important subject for America's ongoing
leadership in the global economy.
Chairman Baker, Vice-Chairman Ryun, and Ranking Member
Kanjorski, thank you for the opportunity to participate in
today's hearing on ways to preserve the competitive position of
the U.S. capital markets. Today's hearing is both important and
timely. America stands at a critical crossroads in our history
as a Nation.
Faced with the realities of globalization and international
competition, will the United States retreat behind a wall of
self-delusion and the false protections of tarriffs and trade
barriers, pretending the world hasn't changed fundamentally and
permanently, or will the United States embrace and meet the
challenges of competition, to the betterment of all Americans,
and the world?
By calling this hearing today, Mr. Chairman, you have
signaled that you understand that America must not turn inward.
The financial services industry thanks you for your vision and
your leadership. Not only would such a course be very damaging
to the U.S. economy, the world at this critical juncture in
history continues to need the United States to lead by example.
Mr. Chairman, you are correct when you say that being the
world's premier capital market is not our birthright. We earn
that distinction by working to make the United States the
marketplace of choice. In that regard, I think it's important
to emphasize that preserving the international competitiveness
of the U.S. capital markets begins with preserving the strength
and vitality of the United States economy.
The 20 members, CEO's of the Financial Services Forum, meet
twice a year, our most recent meeting occurring earlier this
month. At that meeting, for the first time, we conducted a
survey of our members regarding their outlook on the U.S.
global economies. As part of the survey, we asked our CEO's to
rate, in order of seriousness, a dozen potential threats to the
U.S. economy.
The four most important threats, according to our CEO's, or
the four most serious threats, according to our CEO's, were:
one, energy prices; two, health care costs; three, terrorism;
and four, U.S. Government's unfunded entitlement liabilities.
Rated closely behind were complex regulations and frivolous
litigation.
We also asked the CEO's to rate a number of the potential
actions taken by Congress to reflect their importance to
keeping the United States competitive in a global economy. Our
CEO's rated each of the following actions very highly: promote
free trade; improve U.S. education; address unfunded
entitlement liabilities; address litigation reform; extend tax
cuts on capital gains and dividends; and address general tax
reform.
Clearly, our financial sector leaders believe that Congress
has much important work to do to keep the United States
competitive in an increasingly global economy. As you know,
capital is the life blood of any economy's strength and well-
being, enabling the research and risk-taking that fuels
competition, innovation, productivity, and prosperity.
The foundation of any competitive capital market is
investor confidence. When investors put their hard-earned
capital at risk by purchasing shares in a company or its debt
securities, they must have faith that the company is telling
the truth about its business and its finances.
We all want an equity listing in the United States to be
what it has been for nearly 80 years: the global gold standard.
But it is also true that successfully competing for scarce
capital is becoming more difficult by the day. Simply stated,
the United States is no longer the only game in town. It is
entirely in keeping with the principles of our corporate
governance standards to re-evaluate whether the rules and
regulations written to implement those principles are effective
and appropriate.
Do they impose unnecessarily high and costly burdens on
regulated firms, particularly small businesses? Do the costs of
meeting the requirements outstrip the acknowledged benefits of
listing in the U.S. markets? Are there steps that can be taken
to alleviate some of the burden and cost, without undermining
investor confidence?
Asked another way, do certain of our securities laws make
it easier or harder to compete in the global economy? These are
reasonable, prudent questions to ask. And preserving a strong
and vital capital marketplace is too important to the future of
the United States not to ask them. Thank you very much for the
opportunity to appear before your subcommittee, Mr. Chairman.
[The prepared statement of Secretary Evans can be found on
page 90 of the appendix.]
Chairman Baker. Thank you, Mr. Secretary. Our next witness
is Mr. Marshall N. Carter, chairman of the board, the New York
Stock Exchange Group. Welcome, sir.
STATEMENT OF MARSHALL N. CARTER, CHAIRMAN OF THE BOARD, NYSE
GROUP, INC.
Mr. Carter. Thank you. Chairman Baker, Ranking Member
Kanjorski, and members of the committee, thank you for inviting
me to testify on this issue of the competitiveness of U.S.
financial markets. Chairman Baker and the committee are
exercising strong leadership to address this issue at this
time.
For the past 50 years, global leadership of U.S. capital
markets has been unmatched. Our markets are the most open,
honest, liquid, and also the deepest in the world. They have
enabled the United States to remain at the center of global
capitalism, as the world's leading engine for capital
formation, job creation, and economic growth.
U.S. capital markets are still the world's best. However,
we are facing stiff challenges. Let me outline the challenges,
and discuss the reason why our leadership is being contested. I
will conclude with a proposal to strengthen U.S.
competitiveness, and enable U.S. markets to regain the
initiative.
First, the challenge to U.S. financial markets is real and
growing. Despite a welcome resurgence in global IPO's, fewer
are listing in the United States. In 2000, 9 of the top 10
IPO's were registered on U.S. exchanges. By 2005, only 1 of the
top 25 global IPO's were registered in the United States, and
none of the top 10. Even with privatization and mergers, that's
a significant drop, as Congresswoman Hooley mentioned.
In addition, more companies qualified to list in the U.S.
markets are listing overseas. And some currently listing on
U.S. markets are actively delisting. Capital formation, though,
is still robust. $86 billion was raised through 224 IPO's for
non-U.S. companies last year. However, this capital was raised
privately through 144A IPO's, which are not registered.
Unfortunately, when capital is raised privately, millions
of U.S. investors cannot participate, and accepted standards
for corporate governance and transparency do not apply.
The landscape is changing for four reasons. First, there is
a rising perception abroad that litigation in the United States
has run amuck. Increasingly, the United States is seen as a
place where individual companies can be bankrupted by a single
lawsuit, and their executives and directors placed at personal
risk. Facing such threats, companies are saying, ``No thank
you,'' and opting out.
Second, we lack convergence in international accounting
standards at a time when the realities of globalization mandate
we need it the most. European companies are moving to a common
standard. They wonder why they must meet the U.S. requirement
for a separate reconciliation of their accounts, which is
costly and redundant. Again, they are saying, ``No thank you,''
and are choosing to raise capital elsewhere.
Third, overseas markets, especially in Europe, are growing
deeper and more liquid, and benefitting from the success of the
Euro. As foreign markets become better capitalized, and offer a
greater choice of products, including the ability to trade
across countries, they are taking away U.S. market share. It is
happening from London to Hong Kong.
Fourth, while Sarbanes-Oxley has strengthened investor
confidence and reformed corporate governance, many companies
believe the additional costs of annual section 404 reviews
outweigh the benefits. To be sure, some of these costs are
coming down, and that's good news.
Nevertheless, when companies who recently listed IPO's on
the London Exchange were polled, 90 percent responded that
London's rules of corporate governance were more attractive,
meaning less costly and burdensome. Section 404 is often cited.
However, audit firms are also criticized for requiring a one-
size-fits-all approach, and for raising fees for certification.
Mr. Chairman, we are not here to complain, but to propose a
course of action. Our solution is not to replace or reopen
Sarbanes-Oxley, which we believe has strengthened investor
confidence and the integrity of corporate governance. We
believe that three common sense reforms can stem the erosion in
listings, and re-invigorate U.S. capital raising
competitiveness.
First, we would urge Congress to move forward with
meaningful tort reform. Second, we would move rapidly to
harmonize accounting standards. We strongly support SEC
Chairman Cox's drive to eliminate the requirement for foreign
issuers to reconcile their internationally accepted accounting
standards to U.S. standards.
Third, we would initiate a risk-based approach to annual
404 certification. Companies and their auditors would annually
review the internal controls of only the most risky of
operations in finances, those that would have a material and
significant impact on the company's earnings or operations.
Let me be clear about what I am suggesting. Guidelines for
what constitutes risk-based activities would be determined by
the accounting oversight board and the SEC. A company would
have to pass the annual audit of these risk-based materially
significant criteria. Then, and only then, consideration should
be given to permitting the company to undergo a full baseline
404 audit every third year. We believe a pilot could easily be
done on this concept by the SEC.
I would like to point out that the accreditation of
hospitals and audits occurs only every 3 years. Ensuring that
our hospitals are safe for patients is arguably more critical
to the safety and well-being of the American people.
Should the United States fail to act to reverse the trends
we have heard here today, U.S. investors will follow the flight
of capital to overseas markets, and we will become more
vulnerable. They risk losing the protection of the U.S.
regulatory regime, the gold standard, and a regime that offers
greater transparency than any other in the world. Our financial
markets will become less liquid, and their preeminence and
leadership will be in doubt.
The U.S. economy, deprived of precious capital, risks
becoming less innovative, dynamic, and prosperous, and we could
face substantial job losses in the financial services sector.
So, in conclusion, let me say that, despite the resurgence
in global equity financing, the U.S. financial markets are
losing the competition for these new listings. We clearly
cannot afford to be passive and do nothing. We look forward,
Mr. Chairman, to working with our regulators and the members of
your committee to bring about that desired result. Thank you.
[The prepared statement of Mr. Carter can be found on page
61 of the appendix.]
Chairman Baker. Thank you very much, sir. And our next
witness is the Honorable Newt Gingrich, former Speaker of the
House. Welcome, sir. Please proceed as you like.
STATEMENT OF HON. NEWT GINGRICH, FORMER SPEAKER, U.S. HOUSE OF
REPRESENTATIVES
Mr. Gingrich. Thank you, Mr. Chairman, and I want to thank
both you and Ranking Member Kanjorski for hosting us, and
allowing us to come and talk about a very, very important
topic.
You have heard from the former Secretary of Commerce, and
from the chairman of the board of the New York Stock Exchange,
that we are concerned about whether or not we will retain our
leadership role. And this leadership role is very important,
because it divides both the capital for our new businesses, and
the opportunity for the kind of wealth creation which has made
us, for the last 160 years, the most successful society in the
world.
I am not going to repeat the concerns that they had. I just
want to start by saying that I do think there are some parts of
Sarbanes-Oxley that need to be significantly revisited. The
work that has been done by both Alex Pollock and Peter Wallison
of the American Enterprise Institute--I outlined some of that,
and I submitted that for the record as part of my written
testimony.
I would say, in particular, that the Congress should
consider making the section 404 voluntary. In recent House
subcommittee hearings, Representative Gregory Meeks of New York
described the experience of an unidentified 65-employee New
York biotech company with a market cap of $99 million,
specializing in Multiple Sclerosis and spinal cord injury
products. They spend $4 million a year on clinical trials, and
$1 million for section 404 compliance.
The entire issue of BioCentury for April 24th is devoted to
this problem. And the work that Pollock and Wallison have done,
I think, shows overwhelmingly that 404 is clearly very anti-
small business, very anti-entrepreneur, and very anti-start-up
in the way it's been exercised. And the easiest way to deal
with it would be to make it a voluntary act, and then the
market will decide.
If people think it, in fact, is an extra layer that they
want to pay for, they will invest more in companies that have
that procedure. If, in fact, they think it's not protecting
them, they're not going to invest in it, and companies won't do
it. But make it a marketplace opportunity, don't make it a
government mandate. I think that part of Sarbanes-Oxley was
both over-reach, and frankly, has turned out to be something
like 50 times more expensive than the original estimates.
So, Congress ought to recognize that this did not work the
way people thought it would. It is not the right thing to do.
And you have to fix that. You are going to hear from James
Copland that the Center for Legal Policy, the Manhattan
Institute, and I think that he will give you a strong feeling
for this, but Marshall Carter has already testified that--about
the problems of litigation. Let me offer you a set of reforms.
One, I think that Congress should hold hearings on the
impact of State attorneys general, and the way in which they
have been using, frankly, criminal blackmail in which attorneys
general in New York and elsewhere say to corporations, you
know, ``Cut this deal, or you're going to risk going to jail.''
And very often involving cases they can't possibly win in
court, but where the risk of going to jail is so great that
they are creating economic havoc.
And attorneys general in the United States are becoming a
major problem. As a side part of that, Congress should also
look at the degree to which attorneys general who are supposed
to be instruments of the State are now hiring private sector
trial lawyers to engage in, basically, a form of blackmail in
which the private sector lawyer gets a large share of the
recovery, the State gets a large amount of money, and companies
are basically held hostage, because they're not in an equity
fight. They're in a fight where they're going to go to jail if
they lose.
And so, it's a total abuse of the power of government. I
also would urge Congress to pass a law instructing the
Executive Branch that any interstate compact that is not
approved by the Congress be filed in court automatically as
being a violation of the Constitution.
You have a number of attorneys general around the country
who are now routinely cutting deals that have a direct effect
on the United States economy. That is a clear violation of the
Constitution, which requires that interstate compacts be
approved by the Congress, or they be null and void.
In terms of litigation reform, the system needs to be
reshaped to favor arbitration over litigation. We should have
the British losers pay model, where people who file phony
claims would have to pay back not just the cost of litigation,
but if it's truly phony, would have to pay 3 times the cost.
The caps Congress has tried to bring to bear on malpractice and
other kinds of litigation is exactly right.
In addition, I would argue that law firms should be
prohibited from bringing class action suits. If a class action
is formed, the judge should allow the class to apply to law
firms to file, and then pick the law firm which has the lowest
bid. What we have created today is an engine of self-
aggrandizement and greed on the part of law firms that are
machines for encouraging litigation.
I also would strongly recommend that you explore banning
lawyer advertising. I think the rule on that is, frankly,
wrong. That's not a First Amendment right, and it strikes me as
stunningly destructive to the country.
You should look carefully at the Sarbanes-Oxley litigation
time bomb, which is going to presently swamp the courts,
because Sarbanes-Oxley sets up two great burdens. In addition
to the regulatory burden, which accounting firms, obviously,
enjoy and support, it also sets up the burden of many more
lawsuits, and it sets up a burden that bond holders may have a
cause of action for the simple failure to comply on time. And
this is going to lead to a morass of lawsuits and of liability,
and further drive businesses outside the United States.
Three last things I just want to mention as it relates to
what you're doing. There is a project to create a much more
effective business language, and I would strongly--apparently,
we have been doing some research on this--it apparently
involves about $3.5 million to finish this. It's very important
in creating the kind of language--XBRL is the title of it--
which enables us to have a very, very sophisticated ability to
compare financial data at very, very low cost.
It is absurd that this is sitting out there being worked
on, I think currently, by one person, because it's essentially
a voluntary project. For $3.5 million, the Congress could bring
that online, and enable the United States to have a modern
system of transparency.
Chairman Cox, who is certainly very entrepreneurial in his
own right, should be encouraged to really transform the
Securities and Exchange Commission into a model 21st Century
Federal agency.
There is a paper I produced--you can see it at Newt.org--on
21st Century entrepreneurial public management. But the essence
of it is very simple. Entrepreneurship focuses on outcomes.
Bureaucracies focus on process. Every time we have a scandal,
we have a new set of process reforms which add another layer of
burden to the next scandal, and we have another layer of
process reforms. That is, in fact, a very obsolete model of
trying to play catch-up. And I would strongly--I would
encourage you to encourage Chairman Cox to look at a very
dramatic proposal to rethink the way the SEC operations.
Lastly, I would urge the Congress to revisit the question
of stock options. It seems to me that particularly for small
companies and for start-ups, there is an alternative model of
being able to account for the dilution of stock value by the
author of an options in a way which is much less discriminatory
against giving options--stock options, historically, were a
major method of attracting energetic talent to work very long
hours for very small pay, because they had a huge upside.
By requiring the kind of expense accounting we do today, we
are dramatically limiting that kind of incentive. And over the
next quarter of a century, that is going to substantially lower
the amount of innovation and then start-ups that we have.
And I would encourage you, for new businesses and for small
capitalization companies, to strongly revisit how we deal with
stock options. So I appreciate very much the chance to offer
these observations.
[The prepared statement of Mr. Gingrich can be found on
page 102 of the appendix.]
Chairman Baker. Thank you very much, Mr. Speaker. And I
must say, I appreciate each of your thoughts and considerable
contribution to our hearing this morning.
I want to maybe take in steps what I believe, based on your
comments, may be an advisable process to engage in over the
foreseeable future. It was not something that would happen
tomorrow.
Starting with Mr. Carter's proposal relative to the 404
pilot, that would be enabled by the SEC administratively,
without the necessity of Congressional action. But that should
be, I think, a precursor to a more long-term examination of the
404 requirements, if not increasing the requirements that
trigger compliance--in other words, get some of the smaller
companies now subject to the requirements exempted, or even a
longer period of re-examination, as the pilot may demonstrate
is feasible to accomplish--and then, over time, move to the
Speaker's recommendation as to the advisability of a voluntary
compliance.
I think the market has already voted, to some extent. The
disclosures you have made today, relative to IPO's and the flow
of capital, is already occurring. We need to understand the
mechanisms, why this is the case. I think each of the reasons
you have outlined are contributors, but we really need to
understand the market decision-making process that causes a
company to choose to avert our regulatory system.
For example, another step would at least be to require a
loser pay mechanism necessary for--to stem the flow of
frivolous litigation.
Another step would be to accelerate the pilot already
completed at the FDIC on the implementation of XBRL, and make
it applicable to all depositories, insurance depositories,
within the next year. And assuming the taxonomy can be
developed properly, then deploy it to all public operating
companies with a view toward a more principles-based real time
disclosure, and in my view, eliminating the quarterly earnings
report, which I think contributed vitally to the--to managerial
interest in creative accounting to beat the Street.
If we couple that with logical tax code revisions to enable
people to keep the money they make, maybe we've got a chance.
But I will say that I am very concerned about what I see
happening not only in India, but soon to come in China, and
that unless there are some basic structural changes from where
we stand today, vis a vis our foreign competitors, we are going
to be the victims of our own ideology.
We have always, as Americans, said, ``We are proud to stand
up and compete with anybody, because we can outproduce, make a
better product at a lower price; just get out of our way.'' I
am afraid that we have created a box, intended for good
purposes, to protect investors from manipulative action, and
the consequence of that system is to establish a bureaucracy
which does not enable efficiencies to be realized in a
competitive marketplace.
And I left out a couple of the things that the Speaker
brought up that I have footprints on my back to know they're
controversial, relative to attorneys general.
In the Clinton Administration, the Congress prevented State
legislatures from, in any way, affecting market structure in
the securities world. I tried a couple of years ago to provide
that same standard for State attorneys general--not to preclude
them from pursuing wrongdoing, but where they were to require a
market remedy that affected structure that they should at least
consult with the SEC before proceeding, and obtain their
agreement. It turned out to be more controversial than I first
estimated.
And with regard to expensing of options, I have agreed with
you, and I have the voting record to prove, that I was not
right, either. But I do believe those issues are things we need
to return to over time, not precipitously, and lay out an
agenda for a competitiveness that I think is highly defensible.
Now, I have made more of a statement than asked a question,
but can you add on individually to the list? I know, Mr. Evans,
Secretary Evans, that the CEO's have identified their
priorities. Would that agenda be responsive to your CEOs'
concerns?
Mr. Evans. Mr. Chairman, I think in great deal it would be.
I don't think--let me say this. I have seen some studies that
have asked a question as to whether or not Sarbanes-Oxley has
been a reason other countries have--other companies have chosen
to invest and list outside of the United States, as opposed to
in U.S. capital markets.
To me, Sarbanes-Oxley has become kind of a metaphor for all
of the various elements that we're talking about here, where
Federal Government gets in the way of productivity, gets in the
way of corporate boards making good decisions. And one of the
most important areas--I don't think you can emphasize it
enough--is in frivolous litigation.
I think that is an issue that has been around for many,
many, many years. And as I talk to CEO's across the country, I
think that is at the top of the list. I mean, some of the
issues that we're talking about with respect to Sarbanes-Oxley
I think are important to look at and review, particularly 404.
I think maybe it's putting too heavy a burden on the small and
medium-sized companies, and that needs a serious look. Maybe
there are some adjustments that can be made there, and maybe
it's a volunteer kind of program, or whatever it might be.
But I don't think you can put enough emphasis on the
importance of tort reform, the litigation reform, frivolous
lawsuit reform in this country. This is--among the CEO's, among
corporations around the country and around the world, they view
America as a very litigious society. And so, as they hear more
about that, they see more of the disasters of companies being
closed or shut down, they say, ``I don't want any of that.''
And so, I think if I was going to pick an area that I would
really put a lot of emphasis on, and a lot of focus on, it
would be the whole area of tort reform, litigation reform, and
frivolous lawsuit reform. I think that can do more to kind of
restore the confidence of companies here in America, and
continue to kind of move this country in a direction that has
made it so strong in a global economy, which--we're not afraid
to take risks.
When you put kind of--when you have--when you're worried
about being sued around every corner, then you become risk-
averse. And if you're not taking risks, you're not being
innovative. And if you're not being innovative, you're not
being productive. And if you're not being productive, the
economy is not growing.
So, I just--I think it puts a chilling effect within the
board rooms of America, and with small business owners, that
they are less likely to take risk, for fear of being sued, fear
of having a frivolous lawsuit.
And so, I mean, as I look at all these issues that we're
talking about, I think they're all important to address. But if
you want me to put one at the top of the list, that's one that
I would put at the top of the list.
The other thing I would say that I don't think has been
mentioned here, what happens in board rooms and businesses
across America, they are spending far too much time dealing
with these kind of process issues, and governance issues, and
jurisdiction issues, and not near enough time on the strategy
of their company, and where to invest, and where to take risk,
and where to place capital.
So, it's a big time drain. It's a big energy drain on the
leaders of businesses, small, medium, and large, across
America. So--and that's something that doesn't get mentioned.
Congressman Feeney talked about it costing $1.1 trillion. I'm
not sure where that number came from, but the only place I
could see it coming from would be all of the time it cost these
boards and businesses, in terms of just dealing with this over-
regulation, and worrying about lawsuits, etc.
My time is way expired. I will come back in the next round
and follow-up on my questions. Mr. Kanjorski?
Mr. Kanjorski. Thank you, Mr. Chairman. I want to make two
observations before I start. I am really proud to be--and Mr.
Israel pointed out that the Speaker and Mr. Carter are Civil
War veterans, and I'm proud to be in your presence.
[Laughter]
Mr. Kanjorski. But I want to make a second observation
regarding my home State of Pennsylvania. We have two characters
here, one on the committee, Mr. Scott, who was born in
Scranton, Pennsylvania, and had to go south to Georgia to get
elected to Congress, and Mr. Gingrich, who was also born in
Pennsylvania, Harrisburg, and had to go south to get elected to
Congress, which may indicate the flexibility and mobility of
the American society. And I would tend to think that maybe that
speaks well for our society in the past, coming up to the
future, since we sent two of our great sons and bright candles
south to help out the--
Chairman Baker. Careful now, careful.
Mr. Kanjorski.--and lessen the retardation of the South.
[Laughter]
Mr. Kanjorski. All that having been said--nastily, but in a
friendly spirit--Mr. Gingrich, I appreciate your comments. But
you know, it's interesting that you make this observation about
Sarbanes-Oxley at this point in time, when the Enron trial is
in process.
And listening to your argument, you would think that we all
sat up here a number of years ago, and said, ``How can we jab a
stick in the eye of American corporations?'' And as you recall
well, in history, that's not what happened. American
corporations became abusive, to huge extents--particularly
Enron--costing believing, innocent investors billions of
dollars of their savings. And I think there is a responsibility
of the government, as a last resort, to step in when there is
irresponsible corporate activity.
To listen to your argument, and the Secretary's argument,
well by golly, we should just go back to laissez faire, because
4 years is a great time that's past, we no longer need these
protections. It's corporate America that caused Sarbanes-Oxley
to be enacted, not the reverse. We didn't want to do it.
And I guess I worry about as much the protection, not only
of the investor, but also the worker. I didn't hear anything
arguing to whether or not we have a fair return to the average
worker in American industry, even though we have had this great
productivity and all this efficiency that has occurred over the
last decade or two. When you look at the numbers, to how that
has squared to the average working American, they haven't been
too successful.
But let's look at the real facts of Sarbanes-Oxley. The
Stanford Law School did a study on security law filings. And
they found that they dropped from 213 in 2004 to 176 in 2005,
below the average of the 8-year period from--in 1996 to 2004,
of 195 cases a year. They attributed that dropping to the
success of Sarbanes-Oxley.
And in--the drop that continued even occurred when there
were 1,200 restatements in the year 2005, and that the errors
found in those restatements wouldn't have been found, except
for Sarbanes-Oxley.
Now, we are not dealing with a few errant executives or
boards here, we are dealing with a pervasive activity in
American corporate life that have forgotten fiduciary
responsibility and responsible accounting processes, maybe as a
result of competition, or whatever is out there. I can
understand that.
But it astounds me to hear you argue that, ``Let's go back
to laissez faire with corporate life,'' when we have just come
off, and are in the process of a trial now that is horrendous.
I don't even like to listen to that trial, because to hear
a CEO sort of give the German alibi that, ``It wasn't my
responsibility, I didn't know, I was just following orders,''
and only this one guy out here is responsible, even though the
chairman and the CEO ran the corporation, but it was so
important and so well run that they didn't know that somebody
was stealing money and cooking the books, and that caused the
collapse of, I think what, the fifth largest American
corporation in the United States. How many other corporations
there are, we really don't know.
I would say that I would always favor and would look at--
and I think Mr. Carter's suggestion that we evaluate how often
we have to review 401 areas and how often we have to go, that's
something reasonable to look at. We should understand that if
something happens every 365 days isn't necessarily the Golden
Rule. Maybe it could happen every 1,000 days. I don't know. We
should examine that.
But we should have some sort of an indictment, it seems to
me, of corporate activities in the heydays of the 1990's and
the early 2000's, because corporate executives and corporate
boards did not carry the fiduciary burden that the American
investor expected. And certainly, even today, they don't carry
the responsibility to the American worker. And I think anybody
who argues against that just is looking with a jaundiced eye
toward everything for capital, and nothing for the participants
of capital in our system. And I would just hesitate to think
that should be our world.
The other point I would like to make is I have heard so
much about this litigation. You know, again, I am aware, and I
would examine litigious activity in our system. But you know,
it's very funny. I didn't hear anybody talk about advertisement
of drugs, and the horrendous expenditure of the pharmaceutical
industry in selling drugs.
But, Mr. Gingrich, you referred to maybe stopping the
advertising of litigation or lawyers. I may indicate to you
that that was Chief Justice Warren Burger, who was appointed by
Republican President Richard Nixon, who came up with that
brilliant idea. I never did support it, and think it was a
foolish decision, and I would reverse it tomorrow if we want to
get, again, another layer of government into this system.
As far as--as the trial bar and litigation, you know, if
somebody comes up with a better system of protection, I would
certainly look at it. But doing away with the trial bar,
outlawing class actions, putting them aside, that's only going
to turn the less responsible in corporate life loose to carry
on.
I appreciate your testimony. I think you--certainly, Mr.
Speaker, you always give great ideas, and we appreciate them.
Mr. Secretary, I know from whence you come, philosophically and
politically, and we appreciate your activity now in your new
role. Mr. Carter, as a former Marine, we sort of give him
special reaction here, the best of the best. And I shouldn't
say that, because I don't know what you--you look like a Marine
too, so maybe I'm not being a fair guy.
But I think that one of the things I'm proudest about with
the chairman of this committee, subcommittee, and this
committee as a whole, is it's one of the most bipartisan
committees of the Congress. We do not try and politicize these
issues. I, for one, have really searched my 20 years here on
this committee, to do what is right, and appreciate the
magnificence of the American capital system.
But I always understand that there is a tendency--I think
Mr. Carter and I talked about it yesterday--sometimes greed
occurs. And I don't know how we cut it out, how we contain it.
But we have to watch it, because the money, Mr. Secretary, that
you are talking about today of investors, is basically pension
and 401(k) money of American workers. And we just can't afford
to cut irresponsible leadership loose.
So, if you have suggestions of what we can do, and get the
same standards that the Stanford study indicates the success of
Sarbanes-Oxley has brought, I am all for it. But unless we find
that, I am not for laissez-faire corporate activity. Thank you.
Chairman Baker. The gentleman's time has expired. Anyone
care to make a response?
Mr. Carter. To your list, I would add two things. We need
to set a date starting when we can harmonize accounting
standards right now. Something is supposed to happen in 2009,
but I do not believe that 3 years from now is going to be
sufficient.
And second, I would urge the committee to ask the
accounting oversight board and the SEC to determine the
feasibility of our proposal, which is to have materially
significant risk items put into the 404 requirement.
Chairman Baker. Thank you. Anyone else? Mr. Speaker?
Mr. Gingrich. Two things. First of all, since I am not up
for re-election, on behalf of Mr. Scott I want to say he is an
able representative of Georgia, and should not be viewed in his
campaign for re-election as being an export from Pennsylvania.
I think you are running a very delicate line there.
I say, although I am proud to have been born in Harrisburg,
there is a delicate line in the South, as I am sure the
chairman will be glad to share with you in detail.
Second, the only observation I make about Sarbanes-Oxley is
if you go back and look at the original estimates of what it
would cost small businesses to implement section 404, I believe
they are off by a factor of 50. And that is the one section of
Sarbanes-Oxley I specifically thought is really worth your
looking at, and either finding a carve-out for small businesses
below a certain size, or doing something--and then the
suggestion of making it optional below a certain size.
And then the market would say to those small businesses
either, ``I understand I am taking a slightly greater risk
because you're not complying with 404, and I will buy the
stock,'' or, ``I am not going to buy the stock, so you better
comply with 404.'' But as it currently exists, it's a very
anti-entrepreneur, very anti-start-up.
The only other comment I would make, Mr. Kanjorski, is that
to the degree we kill jobs, whether it's through litigation or
through other devices--you know, France now has, for people
under 30, the French have a 24 percent unemployment rate. And
if you don't have jobs, you can't help workers.
One of the reasons I so strongly favor your looking at
stock options again is because stock options, historically,
have been one of the ways that everyday workers suddenly become
very successful. And you see this in a number of parts of
American life, where over a 10 or 15-year period, they are
dramatically rewarded for having invested in a small company.
Again, I'm talking about stock options for start-ups, and for
relatively small companies, and not for large corporations.
But thank you so much for engaging us today.
Chairman Baker. I thank the Speaker--
Mr. Evans. Yes, let me just--I hope in my remarks I didn't
suggest that I am ready to go back to a laissez faire kind of
attitude. I mean, in terms of Sarbanes-Oxley, I think it
accomplished some great things, which--one of the main ones is
it put a white hot light on the boards of directors of
companies all across the country, and gave them a clear, clear
message as to what their fiduciary responsibility is to the
people who own the company, which are the shareholders and the
workers, and the people you talk about. I couldn't agree with
you more.
I think one of the attitudes that too often gets into the
management structure of companies is that they own the company.
They don't own the company, the shareholders own the company.
The workers own the company. And I want a white hot light on
the boards of directors, knowing that they have the
responsibility to protect those shareholders' interests who own
the company.
So, agreeing with Speaker Gingrich, I couldn't agree more.
I mean, what--you know, I am here talking about steps I think
we can take to make sure our economy does continue to grow and
create jobs for young men and women across this country,
because I don't think we have any more important responsibility
than to do that.
But in terms of Sarbanes-Oxley, I think it has accomplished
some great things. There is this one area of 404. As to what it
does to stifle entrepreneurship and small businesses because it
puts such a heavy burden on them, I think that's an area that
can be looked at.
Chairman Baker. I thank the gentleman. Mr. Feeney? Excuse
me, is it--Mr. Hensarling, I'm sorry, is next.
Mr. Hensarling. Thank you, Mr. Chairman. Gentlemen, each of
you, in your testimony, I believe raise the specter of the loss
of global competitiveness of the American capital markets. But
I am curious what the implications of that loss of
competitiveness is.
If we do not change the way we do business here, what does
America look like in--15 years from now. Not unlike Dickens'
``Christmas Carol,'' the Ghost of Christmas Yet to Come, just
how healthy is Tiny Tim 10 years from now? What does this mean
for job creation, entrepreneurship, creation of family wealth,
and our standard of living?
And I believe, starting with you, Mr. Carter, I think you
actually raised the specter that we could actually see greater
risk and less transparency among investment opportunities for
average Americans if they choose to diversify their portfolios
with overseas holdings, if I read your testimony right. So why
don't we start with you, sir?
Mr. Carter. That's correct, you would see that because you
are not protected with our set of rules and regulations when
you invest outside the United States.
This is especially important as we shift the pension burden
away from companies to find benefit plans to the individual. We
have 93 million Americans who own stocks and bonds, and they
must be given a wide choice of flexibility for their
investments. As we narrow that, we hurt our ability to have
people set aside money for their retirement in adequate
investments.
Mr. Hensarling. Let me turn now to my fellow Texan,
Secretary Evans. Do you have a view on this?
Mr. Evans. Well, you know, I think it is important for us
to create the environment here so that the investors of this
country have the opportunity--vast opportunities.
One of the trends that does concern me is the one that
Marshall referred to. Lately, we are seeing more and more
capital go into these private equity funds, and those private
equity funds are typically for the larger investors and more
sophisticated investors, and it takes away from the opportunity
for the average worker to have a wide array of investment
opportunities.
So that is another reason I think it is so important that
we kind of maintain a friendly kind of environment here for
companies to list on our public exchanges. So anything that we
can do to accomplish that, I think, is wise.
Mr. Hensarling. Speaker Gingrich, let me turn to you, and
let me first say for a number of us here, that you continue to
enlighten and inspire. And for that, we appreciate you, sir.
Your views on this question?
Mr. Gingrich. Well, look, I think you are raising a very
important question. And I do think hearings matter. And I would
encourage, on a couple of the topics that may not be right for
legislation, that this subcommittee look at very aggressive
hearings. Because they do set a record that matters.
And let me pick up your observation about 15 or 20 years
from now. I believe we are actually entering a period of
enormous challenge to this country. And several people
mentioned at the beginning of this hearing comments about
worker training, comments about education, comments about
return to the folks who are working all their life, in terms of
their pension funds.
And I think we have to recognize that the system we
inherited from the Second World War is not going to carry us
through a world in which China and India and Japan are direct
and aggressive competitors. When you get to a real-time,
worldwide, global financial system, money flees risk. And so,
if you have a high-risk litigation system, money is just going
to leave. If you have a system in which you have rules that are
so burdensome that it's not the right place to build the next
factory, the next factory is not going to go there. And one of
the tests that Congress should set for itself on a regular
basis is, ``What are the ground rules?''
And let me give you an example out of today's headlines. We
have spent 30 years making it harder to build oil refineries in
the United States. And now we are shocked to discover that we
don't have refineries. Well, at some point we should have had
Congressional hearings that raised your kind of question, which
is if we keep doing this, what's the net result going to be on
the price of gasoline? Oh, it's going to be a lot higher.
Now, nobody offered the Higher Gasoline Amendment, but they
created that by the way in which they established an entire
series of energy patterns which have made it harder to produce
energy, harder to refine energy, harder to move energy in the
United States.
I just want to say what you are doing in this hearing is
the forerunner in the financial services world, of the energy
mess we're in right now. Because if we continue to assume that
the United States is going to continue to inherit the most
successful economy in the world, there is going to be a point
in the not-too-distant future, when we're going to have our
lunch eaten by our competitors.
Mr. Hensarling. Specifically on page 11 of your testimony,
you reference that, ``Congress needs to assess how to pre-empt
any Sarbanes-Oxley litigation time bomb,'' which is fairly
strong language. Can you add a little more detail to what you
see in your crystal ball, as far as this time bomb is
concerned?
Mr. Gingrich. Well--
Chairman Baker. And let me just add, for process purposes,
it's the gentleman's last question, as his time has expired.
But please respond.
Mr. Gingrich. Okay. Since you have cited my testimony, I
have to comment. Let me just say again, I want to encourage you
to look at Peter Wallison and Alex Pollock's works at the
American Enterprise Institute on this topic. And you are
presently going to have James Copland talk to you along the
same lines.
The point that has been made is, for example, securities
class action settlements increased on an inflation-adjusted
basis from $150 million in 1997 to $9.6 billion in 2005.
Sarbanes-Oxley creates an entire new series of presumptions of
sue-ability, and sets an entire new series of benchmarks. And
anybody who has watched--and these things become--they are
evolutionary. So whatever happens this year is not going to
happen the same next year.
There are a set of trial law firms who are engines of
litigation, who have strategic sessions that say, ``Here is
how, over the next 5 years, we will maximize our number of
lawsuits.''
If you take that track, and then you follow it up with the
fact that one of the rules in Sarbanes-Oxley allows the bond
holders to go after the equity value of the stock holders for
any non-compliance, and that there is an emerging industry of
exploiting any technical mistake in filing late in order to
exert the ability to basically swap capital from the equity
holder to the bond holder. That's going to lead to an entire
second round of litigation on top of the current litigation.
So, I do think that it is worth your while to hold some
hearings, specifically on the degree to which Congress is about
to inadvertently dramatically increase the amount of
litigation.
Mr. Hensarling. Thank you, sir.
Chairman Baker. All right. The gentleman's time is expired.
Mr. Meeks, did you have a question?
Mr. Meeks. Thank you, Mr. Chairman. I am sorry, I was in
another committee, and I didn't get a chance to hear all of the
testimony. I am just trying to catch up by reading some real
quick now, so I am not repetitive.
So, I guess I will first ask Mr. Carter, being that you are
a great New York Stock Exchange, with the recent merger of the
New York Stock Exchange and Archipelago, I am wondering--you
formed a nice group. Is the company now--do you believe it's
well positioned so that you can compete with other
international competitors?
Mr. Carter. It will be, over the next 6 weeks, as we do a
secondary offering of stock, and produce the capital that we
need to compete in the world market as the stock exchanges
around the world consolidate. My answer would be yes, we are
positioning ourselves to be a player.
Mr. Meeks. Right. And let me ask to anyone in particular--
to anyone, and maybe to Speaker Gingrich, since you brought up
section 404--I, along with Congressman Foley, have been running
around, and trying to get the word--and hear from businesses in
regards to, particularly, section 404.
One of the sections--I think it might have been as NASDAQ--
it was an offer with maybe some of the small businesses, of
having a random audit, as opposed to everyone being--they
thought that that might drive down some of the costs, in a
similar style that maybe the IRS does random audits now.
So, I would wonder--I direct the question to you, Speaker
Gingrich, but then I would like to hear the comments from
Secretary Evans and Mr. Carter, also.
Mr. Gingrich. Thank you. I think I actually quoted you
earlier in this hearing on the--my only observation is that
there is a huge difference in public risk between a multi-
billion dollar corporation which, if it goes sour, carries
enormous risk with it, and a very small--you cited a company
whose market cap was $91 million in another subcommittee, and
pointed out that they are spending $4 million in trials for
drugs, and $1 million in compliance.
When you are at a $91 million risk level, the level for
certification--particularly in a setting where, as I said
earlier, the original estimates of cost were off by a factor of
50. And so, I would either look for some special carve-out for
smaller businesses, or some kind of ability to get to a much
more simplified, much less onerous process, or, as has been
proposed, making it voluntary for smaller businesses, because
the market will then test and say either, ``I trust your
current level of accounting, and I will invest in your stock,''
or, ``I won't.'' But there is not a huge risk there.
And so, we have sort of taken a gigantic hammer to a very
small business, when in fact, what you may need at that level
is a much easier and simpler process.
Mr. Evans. The only thing I would add to that--and I think
those are some excellent ideas--is that I think that we can
give some thought to stepping over the accounting firms and
going directly into the companies, and telling them what is--
what represents appropriate internal accounting controls. There
is too much dialogue between the accounting firms and the
oversight board, and not enough dialogue between kind of the
oversight board and companies.
If the companies are hearing directly from the oversight
board as to, ``Here is what would encompass internal accounting
controls,'' it seems like, to me, they could get themselves in
better position to make sure they have those internal
accounting controls, as opposed to the oversight board saying,
``Okay, accounting companies, here is what represents internal
accounting controls,'' and then the accounting companies trying
to go in and say, ``Okay, here is what we understand our
internal accounting controls.''
Mr. Meeks. Let me just ask one quick question that--it's
off the Sarbanes-Oxley just for a second, just a trend that I
am noticing that affects--because I'm trying to make sure that
we get as many minority financial companies involved, also.
There seems to be a trend, where there are private equity
firms that are taking--that are buying out public firms, and
then they are going private again. And there was a period of
time where I saw there was a growing trend among smaller
minority investment banking firms, but with this new trend, it
seems as though there are less minority firms being able to get
involved in the financial markets. I was wondering whether
anyone had any comments in regard to that, and how we could fix
that, if at all, so that we could have more minority firms that
are involved in the financial services.
Mr. Carter. Well, some of the major minority firms, like
Blalock, generally get into most of the underwritings, and most
companies now realize that they need to have these firms in
their underwritings. But I don't know--I have no solution to
the issue of private equity or venture capital excluding those
firms.
Chairman Baker. Unless there is further response, the
gentleman's time is expired. Anyone else wish to speak to that
issue? If not, Mr. Campbell, did you have a question?
Mr. Campbell. Yes, if I may, Mr. Chairman.
Chairman Baker. Please proceed.
Mr. Campbell. A brief question. I, at one time, owned
dozens of securities. And last year, at one point, I--the post
office actually had to call and come by and deliver about a 2-
foot stack high of lawsuit things, shareholder lawsuits where I
was--and I was looking at all of these, versus the number of
securities that I owned, and realized it was something like 60
or 70 percent of every security I had ever owned in that period
of time had been sued. Getting to--and obviously, as a--on my
behalf, as a shareholder, without my knowledge or consent.
You have all talked about it. And it is clearly an issue.
What do you--what specifically do you--and I think you
addressed this a little bit, Mr. Speaker, but what do you think
will enable shareholders to still redress grievances when they
have genuine, legitimate grievances, but will stop all this--
where every single company seems to get sued at one point or
another for a manipulation, or some other--just simply because
there appears to be there is something in it for the trial bar?
Mr. Carter. My view would be a loser-pays type of tort
reform would put a big dent in frivolous lawsuits.
Mr. Campbell. Anyone else?
Mr. Evans. No, I would support that, too. And I think
that's a very good option to consider.
Mr. Gingrich. And I would just say, first of all, that this
is a topic--you should look at what Missouri has done recently,
because they passed very extensive litigation reform. One of
the things they did that is most important is they do not allow
the plaintiff to shop for the right jurisdiction.
Because, as you know, there are some counties in the United
States which you could almost guarantee that you are going to
lose the case to the plaintiff. And they now require that the
case be filed in the county in which the incident occurred,
unless both parties agree to move. That, by itself, has begun
to change things.
And I couldn't agree more on loser pays. I would simply add
that--to go back to--there was an experiment run by a Federal
judge in San Francisco, who said to the law firm that brought
in the case, the class action suit, that he was going to put it
up for bid, because he thought that since the law firm had
formed the case, it clearly had a vested interest.
At that point, when they put it up for bid, the entire case
disintegrated, because in fact, law firms didn't want to be
involved in actually bidding to provide this service on behalf
of the people who sue.
I just want to make an observation that is probably obvious
to all of you, but I think we make it more complicated than it
should be. The Chinese are graduating vastly more engineers
than we are, and we are graduating vastly more lawyers. And the
reason is, we have designed a system which incentivizes young
people to think that if you want to some day own a baseball
team, being a trial lawyer is a reasonable road to achieve
that.
As long as it is profitable for these firms to behave in a
purely commercial manner--this is not about the profession of
law anymore; this is about the manufacturing of money by the
creation of conflict for the purpose of increasing incomes.
Nobody should be surprised that we are going to have a rapidly
growing litigation industry in America, and that the cost is
going to be killing jobs, diverting money away from workers,
and diverting money away from stockholders to lawyers.
And as a result, other companies are going to look and say,
``Why would I want to go to the United States and get sued?''
Mr. Campbell. Thank you. I yield back.
Chairman Baker. I thank the gentleman for yielding back.
Mr. Hinojosa?
Mr. Hinojosa. Thank you, Mr. Chairman. I have listened
attentively to the information that the panelists have given
us, and I want to address one of Secretary Evans' concerns
whereas $9 out of every $10 raised by foreign companies through
new stock offerings were raised in the United States in the
year 2000, the reverse was true by 2005: $9 out of every $10
raised by foreign companies through new company listings
occurred outside the United States, principally in Europe.
Also of concern, Secretary Evans points out that in 2005,
23 out of the 25 largest IPO's did not list in the United
States. It seems to me that this trend is going to have a
negative impact on the stock market.
Mr. Carter, with the recent merger of the New York Stock
Exchange and Archipelago to form the New York Stock Exchange
Group, is the new company well-positioned to compete with your
international competitors? If yes, why? If no, why?
Mr. Carter. Yes, it is, because prior to our becoming a
public company and merging with a company called Archipelago,
we only had a single product, which was equities. Today, we
will be able to offer derivatives, options, and fixed income
instruments through our own floor, or through our electronic
crossing network.
So, one of our strategic objectives was to increase our
product offerings, which traditionally had not been offered
through the New York Stock Exchange.
Mr. Hinojosa. Thank you. Mr. Evans, you served as the
chairman of the board of regents at the University of Texas,
and I remember the tremendous leadership that you showed,
helping us create more engineers and technicians. So some of
your comments seem to lean toward education, which I like.
What do you think we could do to encourage more ventures
between the public and private sector? Would you support a line
item in the budget to ensure that we invest both in the K-12
programs and then our universities, in order to meet the
Administration's goal of an additional 100,000 engineers in the
next 5 years. We need your help.
Mr. Evans. Well, Congressman, you do bring up a very, very
important issue. I mean, in my judgement, in terms of America's
competitiveness and global leadership in this global economy as
we move into the next generations, there is not any issue that
is more important than the development of scientists and
mathematicians here in our own country. That's where innovation
is, that's where problem-solving comes from, that's where
creativity is, it's what is driving this economy today, the
great focus we put on it in the 1960's and 1970's, and we need
to renew that focus.
I have been to your campus, the University of Texas--Pan
American, and you have one of the finest engineering
facilities, quite frankly, in the country. I compliment you on
your HESTEC program. I think that spotlights it well.
This is, I think, a national debate, a national dialogue,
that is critical to our economic future and leadership, and it
needs to be a dialogue between the public and the private
sector. And I think corporations are, indeed, engaged in this
dialogue.
When I went to the University of Texas--Pan American, I can
remember many, many, many Dell computers that were in the
engineering labs there, and so I think you have companies like
Dell, and Exxon, and others, that are getting very much
involved in what they can do to promote science and engineering
all across America.
What we do further? I mean, it's just something we ought to
talk about and discuss, because as I look at--you know, another
issue that was brought up--I think it was Congressman Feeney,
earlier--I mean, the two single most important issues, in my
judgement, for our future are the development of scientists and
engineers and mathematicians. The most important problem they
have to solve is the delivery of affordable available clean-
burning energy.
And so, those two issues are the biggest issues in my mind
challenging our competitiveness and the future global economy,
and it ought to be a joint venture between the public sector
and the private sector. Some of that exists today. Can we do
more of it? Yes, we can. I would suggest more--I would suggest
hearings on it, quite frankly. What are the additional ways we
can get the private sector more involved in promoting the
education across campuses in America?
Mr. Hinojosa. I personally want to thank each one of you
three presenters, because I think that you bring forth a lot of
good information. And I just hope that Congress can take it and
do something with it. Thank you, Mr. Chairman. I yield back.
Chairman Baker. I thank the gentleman. Mr. Feeney?
Mr. Feeney. Thank you, Mr. Chairman. Earlier I referred to
a study entitled, ``The Sarbanes-Oxley Debacle: How to Fix it
and What We Have Learned.'' I would ask permission to insert
this in the record.
Chairman Baker. Without objection.
Mr. Feeney. On page 18--or 11--of that study, by the way, I
quote the authors, ``A conservative estimate is that the
indirect costs of SOX are great than $1.1 trillion, and that is
before we have imposed it on a lot of the smaller companies.''
I really appreciate all three of your testimonies with
respect to litigation abuse, and the competitiveness of
America's world markets, and would hope that my Chairman
Sensenbrenner would invite all of you to come back to the
Judiciary Committee, where we have primary jurisdiction over
those issues.
But today, I am interested in the regulatory burdens
imposed by Sarbanes-Oxley, in particular. As Congressman Meeks
said, I have actually--sometimes with my good colleague--I
visited all three of the major exchanges in Chicago. As Mr.
Carter knows, I have visited both of the major exchanges in New
York. I have come to the conclusion that Sarbanes-Oxley
sections 1 through 403 are, on balance, a huge net plus for
confidence in American capital markets. It's just 168 words in
section 404 that have resulted in the $1.1 trillion indirect
cost to our economy.
And I am afraid that, because of those 168 words, we are
outsourcing America's world leadership in capital markets.
Roughly a century ago, that leadership shifted from London to
the United States. I'm afraid it's going to the--in the
opposite direction.
Also, private equity is, as Mr. Carter suggested, a very
inefficient way to raise equity. I wonder, if 404 had been in
place, whether individual American investors would have ever
had an opportunity to invest in a company like Dell, or
Microsoft, or any of these others that have grown so
exponentially, in large part, because of their access to
competitive markets.
And when I look at the fact that pre-Sarbanes-Oxley, 90
percent of money raised by foreign entrepreneurs in the public
forum was raised in America, and now 90 percent is being raised
overseas, when I look at the London stock market that is
advertising itself throughout the globe, including in America,
as a Sarbanes-Oxley-free zone, I met with Mr. Tsang, the chief
financial officer in Hong Kong, and asked him whether a Hong
Kong entrepreneur would consider listing, as he went public, on
the American stock exchange.
He actually laughed at me. Not in an impolite way, but he
said, ``Congressman, there is no way.'' And I said, ``Is that
because their lawyer or accountant would advise them not to do
so?'' He said, ``Nobody would have to talk to their lawyer or
accountant to know that the burdens of Sarbanes-Oxley would
preclude consideration of America as a place to raise
capital.''
That being said, section 404 is 168 words. Mr. Carter, do
you know whether Standard & Poors, or Moody's, the most
important rating services in the country, avail themselves, or
use 404 on a regular basis?
Mr. Carter. You mean for their own operations?
Mr. Feeney. Yes.
Mr. Carter. I am--
Mr. Feeney. No, no, I'm talking about--evaluate the health
of a company. Do they rely on 404 in a big way?
Mr. Carter. Well, only to the extent, in the annual proxy
or the annual report, if they saw that the company failed to
meet 404 standards, as reported by their auditor, I think it
would certainly impact their--
Mr. Feeney. But they don't actually pull the 404 report, to
your knowledge? Actually, I have talked to them, and they say
they don't--they have never looked at a 404 report.
Mr. Carter. I don't believe that would even be accessed by
them.
Mr. Feeney. Another question I have about the burdens that
have been imposed. Last year, I am told, we had roughly 1,200
restatements of--by corporations in the public arena in
America. The standard for restatements is that if it's
something that would affect investor confidence, there ought to
be a restatement, which, of course, is expensive, requires a
new auditing procedure.
My understanding is that less than five of those
restatements had any impact on investor behavior in the
markets. And is the restatement proliferation that we're
seeing, in part, imposed because of 404 and Sarbanes-Oxley
requirements? Really, for any of the panelists, if you know. I
don't know.
Mr. Carter. I would think it would be more in line with the
companies and the CEO's and CFO's are concerned about
litigation if they failed to describe some change in accounting
procedures, even though it was below the materiality standard,
which might be 5 percent.
Mr. Feeney. And finally, Mr. Speaker, you talked about the
litigation explosion that's about to occur, in part, because of
Sarbanes-Oxley.
Do you think it's not just public companies that are
threatened, but because of a--trial lawyers will assert that
even privately-held companies, and even charities--I have them
in my office all the time--they are terrified that they are
going to be the next victims, once we set these impossible-to-
meet accounting standards that privately held firms and,
indeed, charities may be subject to some of the same litigation
abuses we now see in the public markets?
Mr. Gingrich. I think we have managed, over the last 30
years, to create a culture in which there--you have to think of
it as an organic growth. There is a system evolving in which
there is a permanent need to find new reasons to sue. Because,
otherwise, you can't expand the pool of money flowing into the
litigation industry.
Just think of it as an industry. This is an industry that
is in a growth curve, designed to find more and more--they've
got very bright, new lawyers that show up at their law firm,
and they say, ``Find the next four reasons to sue.'' And every
year, there is a slight expansion of that.
And part of the reason that I suggested that this
subcommittee hold hearings on the impact of State attorneys
general is the combination of State attorneys general who have
criminal power, working with private law firms to, in effect,
hunt down and blackmail companies, is a very chilling long-term
prospect in this company, and is an intervention in the
national economy by lawyers usurping Congress's role.
And I think it's a--for big corporations, whether public or
privately held, for big corporations and for fairly successful
people, that is a very serious long-term threat if it continues
to metastasize into a sort of a cancerous assault on the system
at large. And it has grown dramatically in the last 10 or 12
years.
Chairman Baker. The gentleman's time has expired. I do
understand that some of our panelists may have time
constraints. We--don't let the committee arbitrarily hold you
if there is a time obligation, but just let us know, as
appropriate. Mr. Speaker has to leave at noon, or a little
after noon? Mr. Israel, we will go with him, then.
Mr. Israel. Thank you, Mr. Chairman. I would like to follow
up with Mr. Carter on Mr. Feeney's concerns about section 404.
I understand the notion of trying to exempt small firms from
the--what some would argue are the onerous burdens of section
404.
One of the concerns I have is that if you look at the tech
boom several years ago, small firms became big firms. And I
wonder whether your suggestion of applying a risk-based review
to all firms is the answer, and would provide for more
consistency and reliability.
As I understood your testimony, this will provide for a 3-
year benchmark with intensified annual reviews on specific
criteria in the interim. And I noted from your testimony that
you have a very good analogy. You talk about the joint counsel
on the accreditation of hospitals, auditing hospitals every 3
years. Their work is vitally important to the protection of
U.S. citizens, and their very survival, and yet hospitals don't
get audited on an annual basis.
So, I wondered if you could just help us kind of flesh out
the details of the proposal as you--
Mr. Carter. Well, I am also--one of my other retired duties
is that I am the chairman of the Boston City Hospital, which is
the old St. Elsewhere, from TV days.
If, in fact, the hospital has some serious lapses in
treatment, patient deaths and things like that, then they do
get audited, absolutely, every year.
The proposal that we make, or the suggestion, is that if a
company could establish the materiality criteria--that is,
something in their operating environment, or their business
model that produces serious risk--those particular items--and
it might be anywhere from 10 percent for a small company, to 25
percent for a big, multi-national company, would be audited
every year.
If, in fact, that audit produced a satisfactory result of
internal controls, then there would be no 404 baseline audit
done that year. So that would be year one. Year two, you would
do the same thing. If, in fact, on year two they flunked that
test, they would do a baseline 404. If they passed it, they
would still do, at the third year, the baseline 404.
But these are very specific criteria. For example, in a
commercial bank you might look at the loan losses. And if the
company was providing less loan losses than their loss
experience told them to do over 10 years, that would be a
materially significant risk, which is if loan losses go up, it
will impact the revenue.
The advantage of this, of course, is that it can be done by
the SEC and the Oversight Accounting Board; it does not require
reopening the legislation.
Mr. Israel. Thank you. And before I yield my time, Mr.
Chairman, let me just say that I have an interest in running
the traps on this with you, and seeing if we can create a
dialogue with some of my constituents in New York, who have
complained to me consistently about the straight-jacket
approach of section 404.
Mr. Scott. Would the gentleman yield?
Mr. Israel. Yes, I yield to my colleague.
Mr. Scott. Thank you very much, Mr. Israel. I wanted to get
this question in, and I appreciate your courtesies before the
Speaker has to leave.
I am very, very much concerned about our debt and its
implications on our capital markets for the future. And as you
know, I would like all of your opinions on this, but I
certainly want to get to the Speaker before he has to leave.
As an historian, Mr. Speaker, you fully realize that
history is replete with those civilizations and great nations
who have gone down, and have collapsed for three basic reasons:
one, global over-reach; the other one is because of a loss of
resources at home; but the most glaring one is a ballooning
debt, especially in the hands of foreign governments and
institutions.
On all three of those criterion, it points to that the
United States is in serious, serious trouble. But nowhere are
we in as great a trouble as with our ballooning debt, and with
that debt, nearly 50 percent of our debt in the hands of
foreign countries and foreign capital markets.
And I want to try to put our hands around this, especially
given the fact that in the--in this last 5-year period, under
the President, this present Administration, and under this
Congress--couldn't have been without the collaboration of
both--we have borrowed, in the last 5 years, more money from
foreign governments and foreign institutions, than all of the
preceding 41 Presidents and Administrations in the history of
the United States.
Chairman Baker. Mr. Scott, you are going to need to give
him a chance to respond, because he is going to have to get out
the door here in just a--
Mr. Scott. Right. Would you please give me your response
on--in terms of the significance of this debt, and the peculiar
perilous position it is placing our country in?
Mr. Gingrich. Well, you picked a heck of a question to
close out my opportunity here. But it's an important question,
and it's worth taking a minute on.
First of all, I believe, both as a practical long-term
matter, and as a moral matter, that governments ought to
balance their budget. And I was very proud of the fact that, in
the late 1990's, we did get 4 straight years of a balanced
budget, and we paid off $405 billion in debt. And I think
that's a useful--strategically, the Congress should try to get
back to that.
And to do that, frankly, you have to transform the health
system, because health is 26 percent of all Federal spending,
and the fastest growing section. So if you're serious about
getting to a balanced budget, you have to really think through
transforming health.
Second, I worry a fair amount about the international debt
and the degree to which we are spending more overseas than we
are selling. There are some technical reasons, but that's
partly a function of our strength, because a lot of people
around the world want to send money here because we're the best
place to invest in the world.
But I would say this reinforces Secretary Evans' point that
there is no single topic, other than transforming health, that
Congress could take up that would be more important than the
energy issue, because a substantial portion of our total
balance of trade problem is the degree to which we now borrow--
buy huge quantities of oil overseas, and basically ship the
money out.
So, if you had--if you were back to where we were 30 years
ago on energy, and if you had transformed the health system,
you would be very close both to balancing the Federal budget,
and having a dramatically healthier--long-term balance--so it
is an important topic, and it's one worth--certainly worth
pursuing.
Chairman Baker. The gentleman's time is expired. And let me
express appreciation to you, Mr. Speaker, for your time and
appreciation here today. It has been most helpful. And we will
be calling on you as we go forward. Thank you very much, sir.
Mr. Lynch?
Mr. Lynch. Thank you, Mr. Chairman. I want to thank the
ranking member as well, for holding this hearing.
One of the hats that I wear on another subcommittee is on
the Committee on Government Reform, Subcommittee on Regulatory
Affairs. And while this committee is looking at a whole set of
issues, that subcommittee is looking specifically at 404. And I
appreciate the Secretary and also Mr. Carter, with their
suggestions earlier in the hearing.
It seems like we're in general agreement on the fact that
the effect of 404, generally, is negative upon small and
medium-sized businesses, which are principally the source of
our innovation and competitive edge.
However, being mindful of what the Speaker said earlier
about the pendulum of scandal, and then the pendulum of reform,
it comes back the other way. And sometimes it overswings, if
you will.
I would like to talk about what our subcommittee thinks
might be a consensus view. We're concerned about exemption, and
that the idea of exempting companies from filing under 404 may
be overswinging the pendulum a little bit. And we are also
concerned about what might happen on the voluntary compliance,
or random auditing scenarios, not that those have been
dismissed--I think we have an open mind toward it--it's just
that there is some concern that we may be eliminating some of
the benefits of Sarbanes-Oxley, and eliminating some of the
transparency and the accountability, by going that route.
But one thing that I think we are hearing from both the
panel and some members up here is that, first of all, the idea
that right-sizing this section 404 so that we perhaps go to the
materiality standard, and we're not asking for a full-blown--
what I call the full employment act for accountants approach,
which we have right now. If we went to a materiality standard,
and went to a biannual compliance, rather than every year--and
I know, Mr. Carter, you suggested every third year; I'm a
little worried about that, about having 36 months go. Would we
be losing some of the accountability and some of the
transparency that we're getting right now from Sarbanes-Oxley
by moving the reporting out 3 years?
But if you take those two initiatives in conjunction, one,
adopting a materiality standard, instead of the everything out
of the sun standard, and you make it every other year, it would
seem that that step alone would reduce the cost by 50 percent,
roughly speaking. Would those two steps, in your mind, be
enough to have a significant impact on the cost right now, and
the burdens on small and medium-sized businesses?
Mr. Carter. Well, we would not support exemptions, nor
would we support voluntary compliance. I think the--don't be
confused about the biannual nature and the third year. In each
of the years, if the materiality criteria were met, you would
not have to do the in-depth 404 audit. If they weren't met, you
would. And these materiality criteria would be the ones that
would impact more than, say, 5 percent of the revenue.
So you certainly could start it on a biannual basis. You
get a free year, and then you do the 404. I don't think that
would relieve the burden as much as the third year approach
would.
Mr. Lynch. And what about your concerns regarding
transparency or accountability? You think it's still there
with--
Mr. Carter. Well, it would still be there for those
material items. We're talking about material items that are
going to significantly impact investor confidence, because they
would impact the expenses and the revenue.
Mr. Lynch. I guess what we're concerned about is that if
something were to slip through the cracks on the materiality
standard--something is at 4 percent, not 5 percent, it falls
through, and then over 3 years it balloons into something that,
a couple of years ago, would have been material but you don't
catch it because you're waiting every third year. We're
concerned about things percolating up over that 3-year interim,
I guess.
Mr. Carter. Well, if they didn't meet the materiality
criteria in the intervening years, you would, of course, do the
full 404 audit. This is why a pilot program would be nice, to
look at--you could sort of crank that up in 6 or 8 months.
Mr. Lynch. Yes, okay. Mr. Secretary, your thoughts?
Mr. Evans. Well, I don't have a lot of the facts as to how
much it would save or wouldn't save. But let me just say this.
I mean, the benefits of Sarbanes-Oxley, to me, have been
enormous. And they have been enormous because the one thing
that was lost in 2001 was trust in the markets.
Mr. Lynch. Right.
Mr. Evans. I mean, as I travel around the world, people ask
me all the time, ``How has America been so successful?'' And I
always tell them, ``Well, it's our freedoms, it's our
democratic, capitalistic system that creates this incredible
environment for competition, it leads to innovation, our
productivity, and all of that.''
And third, I tell them, it's ``the American people are good
people. They're honest people, they're decent people, they tell
the truth.'' And so, when that last tenet is violated, it hurts
the character of the country, and it shakes the trust and
confidence of the investors. And that's what happened.
And so, Sarbanes-Oxley stepped in, and however many pages
it is, and however many items it is, the main thing it did is
it restored trust in the markets. And so, now what we have to
do--but it also, at the same time, created a lot of
uncertainty. And that's what I am sure caused a lot of other
companies angst as to, ``Do I want to really get into the
middle of that, not knowing really what it means to me yet,''
as a company or as a CEO? ``So maybe I will just go to some
other exchange until I more clearly understand the impact of
Sarbanes-Oxley on my company if I wind up listing there.''
So, you have to--you know, you have the trust that I think
it restored, and I think that's evidenced by the remarkable
results of the stock market over the last 3 or 4 years since
then--not all attributable, of course, to Sarbanes-Oxley. We
have a strong economy, but the market is up about $5 trillion
in value.
But at the same time, it created some uncertainty, and we
have got to work through these various areas of it that seem to
be somewhat troublesome, like 404. And I don't have enough of
the facts to tell you, Congressman, you know, how I would do
it, whether I would have, you know, every other year review, or
make it voluntary, or what I would do with it, but it seems to
me that is an area that is stifling innovation, it's stifling
entrepreneurs, it's draining energy away from where we ought to
be directing energy in this country for innovation, and
creativity, et cetera.
So, you know, without the facts, I have a hard time, you
know, telling you exactly what I would do with it. But I would
look at it hard, and probably do something with it. But don't,
by any means, underestimate the power of Sarbanes-Oxley and
what it did to restore trust in our markets at a very, very
important time.
Chairman Baker. The gentleman's time is expired.
Mr. Lynch. I just want to thank both of the gentleman for
helping the committee out with its work. Thank you.
Chairman Baker. I thank the gentleman. And Mr. Scott is
going to be recognized now on his own time for other members.
He was yielded time by Mr. Israel, so he is entitled to his own
time. Mr. Scott?
Mr. Scott. Thank you very much, Mr. Chairman. I appreciate
your courtesies. I would like to ask both of you a question.
First, let me start with you, Mr. Carter, in terms of the
health of the New York Stock Exchange.
Have any New York Stock Exchange-listed companies left the
Exchange this year? And if so, what were the reasons that the
cited for leaving?
Mr. Carter. There have been a number of foreign countries,
non-U.S. companies, companies like Vivendi and Kohl, a company
in Australia, who left. And they left because of those four
reasons: the litigation; atmosphere; 404; the depth of their
own markets allowed them to raise plenty of capital.
Mr. Scott. How would you describe this problem? Do you see
this as a trend? Do you see this as just a blip on the radar,
or do you see this as presenting some serious problems for the
future of the Stock Exchange?
Mr. Carter. We don't view it as an anomaly just for 1 year,
we view it as a trend, starting in 2000, where we had 9 out of
10 IPO's registered here in the United States, and last year we
had 1 out of 25. This year I think we need a few more months in
the year before we see what's going to happen.
Mr. Scott. Now, have any New York Stock Exchange-qualified
companies that might, in the past, have listed on the market
decided to list elsewhere?
Mr. Carter. Yes, they have. I think the most significant is
the fact that about--almost 200 offerings, raising about $80
million, listed--raised the money here, but did not list on a
U.S. Stock Exchange. They raised the money through the so-
called 144A offerings, which are not available to the average
investor. So this is all part of a trend.
Mr. Scott. What were the reasons that they decided for that
decision, for their decision?
Mr. Carter. It was the same--
Mr. Scott. The same?
Mr. Carter. Yes.
Mr. Scott. Going to our tax code, outside of the
regulations and the four reasons you've cited, do you believe
that our current tax code is too complex and cumbersome for
foreign companies to navigate? And did the President's
commission on tax reform provide any helpful ideas on improving
the system? And do you have any ideas on how to have a more
fair tax decision? One, is it a factor in making it more
difficult for foreign companies--
Mr. Carter. The complexity is a factor, but it doesn't
measure up to the top four that we have talked about here
today.
Mr. Scott. Okay. Mr. Evans, let me turn to you, please. You
recommend that we evaluate whether rules and regulations are
effective and appropriate. Can you evaluate the current
regulatory structure, including Sarbanes-Oxley, on whether they
are achieving their intended objectives?
Mr. Evans. Well, Congressman, I think probably some are,
many are, and probably many are not. Much of the regulatory
structure was put in place in the 1930's. Our economy,
obviously, has changed dramatically since the 1930's. So I
think there is a variety of regulations that do need to be
reviewed and thought through.
We have a tremendous amount of duplication, in terms of
jurisdiction, a lot of jurisdictional overlap that I know a
number of our members have to deal with. We have members that--
in the financial services forum--that would have to deal with
the OCC and the FDIC and the Federal Reserve Board, and the
SEC. Others would have to deal with the Federal Reserve and the
SEC, and then State regulatory bodies.
And so, there can be a tremendous amount of overlap. And in
some instances, just conflicting regulations. So, you know, I
just--I think it is a regulatory structure that was, as I said,
put in place back in the 1930's, and there are elements of it
that probably need some serious review. Do we need four or five
different agencies regulating the same institution?
Mr. Scott. Do you feel that they impose unnecessarily high
cost burdens on the regulated firms?
Mr. Evans. Indeed I do. Now, I can't tell you--you know, I
don't have any specific studies. I can just tell you that,
indeed, they create inefficiencies in the marketplace.
Mr. Scott. And you would agree especially on smaller
businesses?
Mr. Evans. Indeed I would.
Chairman Baker. And the gentleman's time has expired, if I
may, Mr. Scott.
Mr. Scott. All right, thank you, Mr. Chairman.
Chairman Baker. I thank the gentleman. Ms. Velazquez?
Ms. Velazquez. Thank you, Mr. Chairman. Mr. Carter, I heard
your answer to the question raised by Mr. Meeks and Mr.
Hinojosa regarding the merger of the New York Stock Exchange
with Archipelago, and how you feel that you are in a better
position today to compete in the ever changing global capital
markets.
The second part of that question is, do you believe, giving
as an example, the bid that was put out by NASDAQ to purchase
the London Exchange, do you believe that for U.S. exchanges to
remain competitive globally, it is necessary to pursue mergers
with foreign exchanges?
Mr. Carter. Well, a merger applies--two companies come
together, and a single company is the result. It could very
well be that some of the strategic advantage could be done by a
minority participation. And we certainly want to participate in
that on a global basis.
Many of the markets in Asia are owned by the government, so
they are probably not going to allow a merger. But we still
have plenty of opportunity in this country, too.
Ms. Velazquez. Okay. In order, Mr. Carter, to go public
today, small companies must be more sophisticated and more
mature than ever before, and they must employ a sizable
administrative work force to comply with the many regulations
they face.
In addition, other factors have increased the challenges
that these firms face in accessing the public markets, such as
the liquidity demands of institutional investors, as well as
consolidation within the underwriting industry. Do you believe
it is harder for small firms to go public today than it has
been in the past?
Mr. Carter. It certainly is harder, administratively. But
any increased difficulty that causes smaller companies to not
go public has been more than replaced by the large amount of
cash available through private equity, hedge funds, and venture
capital that will allow our smaller company to develop the
capital resources they need in order to expand.
So, we do see, though, a reluctance of the venture capital
people to take a company public, and sometimes there is no need
for it, because they can generate plenty of capital for that
company to expand.
Ms. Velazquez. Okay. Thank you, Mr. Chairman.
Chairman Baker. The gentlelady yields back. Mr. Davis?
Mr. Davis. Thank you, Mr. Chairman. Let me thank the
gentleman for being so indulgent with us. Mr. Secretary, as you
recall from your days in the cabinet, the way these hearings
typically work is that the people you're really responding to
have long left by the time you get to ask your questions.
So I regret the Speaker is not here, the former Speaker,
and that Mr. Feeney is not here. And in a sense, my questions
would probably be better directed to them. But I do want to get
your response.
Mr. Gingrich and Mr. Feeney talked a good deal about the
litigation climate and the securities world in the past several
years, and they painted a rather dire picture of companies
having to spend enormous amounts of money on legal resources.
They painted a rather dire picture of our competitiveness being
diminished because of rising lawsuit and tort presence in the
world of securities.
Every now and then I think it's always helpful to let facts
sometimes get in the way of a good rhetorical argument. If I
understand the data correctly, we had fewer lawsuits last year
for securities-related claims than we did in the average in
1996 to 2004, around 190-some suits a year to as many, in some
years, as 215 or 216, down to apparently 175 last year.
As I think both of you are aware, the Supreme Court issued
a ruling, I think several years ago, which made it dramatically
harder, if not impossible, for litigants to go into State court
in securities fraud cases. The Supreme Court recently issued a
ruling tightening the standard of proof in a fraud case by
strengthening the causality requirement.
As I understand it, empirically, the damages awarded in
these cases are less than they were during the period 1996 to
2000. And of course all of you are aware of the Securities
Litigation Reform Act, or something similar to that, was passed
in 1995, which made its own substantive changes limiting
executive liability, and limiting large accountant liability.
So, the facts do seem to get in the way of an argument. I
have no doubt whatsoever that every company in America spends a
lot of its resources on litigation. I practice plaintiff side
and civil defense side, so I am certain of that.
But let me--I should just ask you, Mr. Carter. As you
talked to investors in the market, as you talked to large
companies in the market, what's your response to what I just
said, the fact that, in many ways, the litigation climate has
dramatically improved in the last several years?
Mr. Carter. I think most people would not agree with you on
that. They would not feel that the litigation climate has
improved. The statistics I see show that more institutional
investors are suing, as opposed to individuals, and second,
that the settlements have been larger over the last few years.
But I would say the average investor would not necessarily
agree that the litigation situation has gotten better.
Mr. Davis. Put it in some perspective for me, though,
because I'm trying to get a sense of exactly what those
individuals would have Congress do, and what they would have
the courts do.
Congress and the courts have made it harder to bring these
kinds of cases, from a substantive standpoint and from an
interpretive standpoint, by the court. So, what dramatic
acceptable direction is there for Congress and the courts to
go, given all the things I have described earlier, and all the
reductions in the scope of liability?
Mr. Carter. Well, I would say two things. I think the
chairman's idea about loser pays will certainly decrease the
number of individual lawsuits. I go back about 20 years to when
Senator Dole and Senator Kassebaum got tort reform for aircraft
manufacturers that put a 19-year limit on the fact that you
could sue somebody that made an airplane that you crashed in.
And they tied that litigation reform to jobs. I--
Mr. Davis. Let me ask you--and I cut you off simply because
I'm last, and my time is limited. The only problem I have with
that, Mr. Carter, those of us who have been in the litigation
world, there are meritorious cases that sometimes lose. And I
assume you would agree with me, that there are meritorious
cases that, for whatever reason, still sometimes are not
successful. Do you agree with that, Mr. Secretary?
Mr. Evans. I do--to a certain degree I agree with that. I
think--
Mr. Davis. Mr. Carter, I assume you also would agree there
are certainly meritorious cases that sometimes end up being
unsuccessful.
The reason that I make that point is the notion of losers
pay sounds attractive to people. But that presumes that a
losing claim is a frivolous claim and a non-meritorious claim.
We know that's not always the case. And we know that a losers
pay scenario makes it very, very difficult for all but the most
well-heeled investors.
And Mr. Carter, I think you made this point. Claims arising
by large classes of investors, but smaller classes of
investors, the ones who would be particularly deterred, it
would seem, would be the real victims of this losers claim
scenario.
Mr. Evans. Yes, but the other side of that, Congressman, is
many, many, many suits are filed that companies are obliged to
go ahead and settle before they really go through the process,
because they can't afford to destroy their image--
Mr. Davis. I agree, it's a balancing act, and I am just
trying to--
Mr. Evans. And that's the other side of it.
Mr. Davis. Right.
Mr. Evans. I mean, there are many who say, ``Look, I can
win this case, there is no question about it.''
Mr. Davis. Right.
Mr. Evans. ``But I can't afford to have my company's name
on the front page of the New York Times.''
Mr. Davis. Yes. I make my last 5 seconds' observation. I
don't dispute that the other side exists, I am simply making
that point, in the interest of balance. The job of this
institution is to realize that there is no perfect world, there
are legitimate interests on both sides of that argument. Mr.
Chairman, I think my time is up.
Chairman Baker. The defense counsel's arguments have been
most educational, but I hesitate to admit that they were not
totally persuasive as of the moment. I thank the gentleman for
yielding.
Let me express to each of you the committee's appreciation
for your participation. I have not had occasion to visit with
Mr. Kanjorski, but it comes clearly into view that over the
coming months we would be well served by a task force of folks
of your stature, working with the committee on identifying the
top 8, 10, 12 items on which we might be able to reach
agreement--as, for example, pursuit of the pilot program that
you have suggested here today.
And so, at a later time, subject to consultation with Mr.
Kanjorski, we may get a letter out to you indicating a desire
to meet more informally. We have done this on the subject of
insurance reform in the nature of roundtables, and we found
them very helpful for our members to be able to get thoroughly
engaged in understanding the need and justification for some of
the things you have suggested doing here, with an eye toward
perhaps some sort of legislative program for perhaps early next
year.
But we look forward to working with you, we appreciate your
contributions, and thank you for your time. And when
appropriate, we will get our second panel of witnesses forward.
Let me welcome you, and express appreciation for your
patience. Our hearing has gone much longer than we had
anticipated. As you know, we will make your full statement part
of the official record. We ask that you try to keep your
remarks to the 5 minutes customary.
And with that, I would call on Ms. Maria Pinelli,
representing the Americas Strategic Growth Markets Leader of
Ernst & Young. Welcome.
STATEMENT OF MARIA PINELLI, AMERICAS STRATEGIC GROWTH MARKETS
LEADER, ERNST & YOUNG, LLP
Ms. Pinelli. Good afternoon, Mr. Chairman. My name is Maria
Pinelli, and I am the Americas Strategic Growth Market leader
for Ernst & Young. I am here today to present the key findings
from Ernst & Young's third annual global IPO report. I have
submitted our full report, along with my written testimony.
Today, I will highlight the major global IPO trends that we
found. Trend number one: globalization of the capital markets
continues. 2005 was a very strong year for the global IPO
markets. The total capital raised increased by over one-third,
from $124 billion in 2004, to $167 billion in 2005, the largest
amount raised since 2000.
Although the United States is the dominant player in the
global capital markets, there are over 50 exchanges competing
for $46.8 trillion of capital around the world. Six exchanges
dominate the exchange market: The New York Stock Exchange;
NASDAQ; London; Euronext; Tokyo; and Hong Kong. But the United
States maintains the lead in both the amount raised, and number
of IPO's.
The New York Stock Exchange and NASDAQ alone represent 38
percent of the total global market cap. For the 10-year period
1995 to 2005, the New York Stock Exchange grew almost 200
percent, and NASDAQ grew almost 250 percent. In spite of this
U.S. growth, there is legitimate attention focused on the
growth of other exchanges, such as the Hong Kong stock
exchange, which increased 135 percent in the same 10-year
period.
There are many reasons for the recent growth of non-U.S.
exchanges. For one thing, many exchanges are engaging in highly
aggressive marketing campaigns to attract new listings. We have
to remember that these exchanges are businesses, competing for
a share of a $46.8 trillion market.
Trend number two: state-owned enterprises tend to list on
local exchanges. Only one of the top 10 global IPO's of 2005
listed in the United States. The five largest IPO's were state-
owned enterprises from China and France. They listed on
regional exchanges close to their home markets. We predict this
trend will continue in the future, driven by emerging capital
markets such as China and Russia.
The largest global IPO in 2005--and ever--was China
Construction Bank's $9.2 billion offering on the Hong Kong
stock exchange. A large investment by Bank of America for $3
billion represents the largest single foreign investment into a
Chinese company. This demonstrates that global and U.S.
investors are comfortable investing on less regulated foreign
stock exchange, which is an emerging trend in the global
capital markets.
Trend number three: America's reputation as a safe,
transparent economy results in a higher valuation premium for
listed companies. Issuers and investors recognize that U.S.
capital markets demand compliance with a gold standard of
corporate governance regulations, which result in higher
valuations than on foreign markets.
The New York Stock Exchange states in our report that
motivation for most companies listing in the United States is
the valuation premium. On average, 30 percent. That accrues as
a result of adhering to high standards of governance. Foreign
companies will continue to list in the United States due to
this valuation premium, and also because of unparalleled
investor sophistication.
This is one of our strategic competitive advantages over
other capital markets. And any temptation to lower these
standards in competition with foreign exchanges needs careful
consideration.
Let me give you an example that says it all. Baidu.com, a
Chinese search engine company much like Google, cited market
maturity, investor understanding of their business, regulation
requirements, and the ability to achieve a corporate identity
as an international company as the most notable criteria in
deciding to list in the United States.
Our future reports will continue to monitor the trends and
activities of IPO's around the world, and Ernst & Young will
share these reports with the committee in the future. Thank you
for this opportunity to testify, and I look forward to your
questions.
[The prepared statement of Ms. Pinelli can be found on page
130 of the appendix.]
Chairman Baker. Thank you, Ms. Pinelli. Mr. James R.
Copland, Director, Center for Legal Policy, The Manhattan
Institute. Welcome, sir.
STATEMENT OF JAMES R. COPLAND, DIRECTOR, CENTER FOR LEGAL
POLICY, THE MANHATTAN INSTITUTE
Mr. Copland. Thank you, Chairman Baker. And it's my
pleasure to speak before your committee today. It's an honor
for me to follow the distinguished panel we just heard from.
And I would like to say that I would echo many of the
sentiments expressed by all three of the panelists, and the
suggestions that were there raised, in terms of litigation
reform being a priority by Secretary Evans, the schema for
obstacles that were raised by Mr. Carter, and the multitude of
ideas suggested by Speaker Gingrich for improving our
litigation system. I would, with one or two slight exceptions,
I would agree with every one that was raised.
I direct the Center for Legal Policy at the Manhattan
Institute. We have been working on civil litigation reform for
about 30 years now. And last night we had our annual Hamilton
Awards dinner, where we honor people who are--who have made a
long, significant, lasting contribution to New York. It's named
after our first Treasury Secretary. So I think it's
appropriate, in the spirit of Alexander Hamilton, to consider
what's going on with the U.S. capital markets today.
And we definitely see some disturbing trends. I certainly
would say that the United States has been and probably, for the
immediate future, will continue to be the leader in this area.
But in terms of initial public offerings, as has been alluded
to, there has been a precipitous decline in recent times, in
terms of overseas offerings here in the United States.
In Europe last year, the IPO's were double those of the
United States, in terms of float, three times those of the
United Staes, in terms of total offerings, and five times those
of the United Staes, in terms of the number of overseas
offerings, i.e. offerings out of the area actually being listed
there. So this is a disturbing trend.
And I think a number of the points made by Mr. Carter are
valid in looking at the reasons here, particularly new
reporting standards here in the United States under Sarbanes-
Oxley, and especially the prosecutorial environment involving
many of the State attorneys general offices.
But I also don't want us to neglect the area of litigation.
It has been highlighted consistently today as an important
area. Specifically, from the bankers' perspective, if you look
at figure three on page eight of my written testimony, you will
see the long-term trend lines of filings in securities class
actions. There is a large uptick in 2001, with the collapse of
the dot-com bubble. What is driving that is a lot of IPO
allocation suits. So bankers themselves are finding themselves
much more in the hook in the U.S. market than they used to be.
And then, secondly, the so-called litigation time bomb that
Speaker Gingrich alluded to was referenced in the report by
Henry Butler and Larry Ribstein that was entered into the
evidence by Mr. Feeney. There certainly are a lot of new
avenues for suit that have been entered into the risk factor
for being listed on an American exchange in the last year.
I would like to just briefly run over some of the broad
tort statistics and securities statistics before I run into the
few specific ideas I raise in my written comments for
consideration by the committee.
The tort tax in the United States is $260 billion,
annually. That's 2.2 percent of GDP. You can see the trend
lines on figure one on page three of my written testimony. And
basically, you see that since 1950, there has been a four-fold
increase relative to GDP, and the percentage of our economy
consumed by tort from 0.6 percent to 2.22 percent. And this is
the equivalent of a 5 percent wage tax on the economy, bigger
than the entire corporate income tax. So it's a very sizable
tax burden that we place on businesses and individuals in our
society.
Internationally, if you look at the comparison on page four
of my written testimony, figure two, Germany, we have about
twice the tort tax of Germany, three times that of France or
the UK. So it's a serious competitive disadvantage.
Now, in terms of securities filings, as was raised in the
previous panel, there has been an effort--many of you were,
doubtless, involved. If you were here in 1995 in the Private
Securities Litigation Reform Act, it's been partly successful,
but it certainly hasn't lived up to its full promise for
reasons I will explain as I go into the ideas, I think, that we
could really focus on, particularly in the securities area, in
getting ourselves improved, in terms of our competitive
environment.
First of all, I would reiterate the notion that a loser
pays system could be a useful reform. I think many of the
concerns raised about that system, in terms of access to the
courts, are simply not applicable in the securities context,
because these involve large litigation industry shops that
Speaker Gingrich was alluding to that are well financed and
diversified.
I would also add that I think it would be even more useful
in a mass torts context than in a securities context. I know
that's outside the scope of this committee, but that's where
you really see the proliferation of large numbers of individual
weak claims overwhelming defendants' ability to defend against
those claims.
The second thing I wanted to bring up is the failure of the
lead plaintiff provision of the PSLRA to control abuse. In
particular, I focus in my comments on the potential that we
have seen for public State employee pension funds to use those
provisions and act as lead plaintiffs.
And because these are often controlled by political actors
who are influenced by or receiving money from the trial bar,
the potential for mischief that I outline in my report is
great. We have seen it in New York. The Louisiana Fund that I
mention in my report has been notorious, as has been CalPERS,
and several others.
So, I think we need to look at keeping employee pension
funds out of the lead plaintiff business and/or secondly, doing
what Speaker Gingrich alluded to. This is the practice formerly
employed by Vaughn Walker, district judge in San Francisco, and
that is having auctions for class counsel in securities class
action cases.
I can discuss this more under questioning, but I think it's
an idea that deserves a lot of attention. It was ruled not in
compliance with the PSLRA by the ninth circuit. Judge Alice
Kazinsky wrote that opinion. So I think he has probably got a
pretty good case, in terms of the language of the statute of
the PSLRA, but I think an auction process deserves serious
scrutiny.
And then, finally, the pleading standard that was
heightened under the PSLRA has been adopted inconsistently
across the circuits. We have seen the higher standard that was
used in the ninth circuit being effective in weeding out
frivolous suits, and conversely--and adding a higher percentage
of strong suits.
Unfortunately, a lot of the securities cases have started
moving into other jurisdictions, as you would expect. So
adopting that heightened pleading standard specifically in the
statute could go a long way, I think, to deterring some of the
weaker securities suits. Thank you, Mr. Chairman.
[The prepared statement of Mr. Copland can be found on page
77 of the appendix.]
Chairman Baker. Thank you very much, sir. I appreciate your
comment. Our next witness is Mr. Lawrence G. Franko, professor
of finance, University of Massachusetts, Boston College of
Management. Welcome, sir.
STATEMENT OF LAWRENCE G. FRANKO, PROFESSOR OF FINANCE,
UNIVERSITY OF MASSACHUSETTS-BOSTON, COLLEGE OF MANAGEMENT
Mr. Franko. Thank you very much, Chairman Baker and
committee members, for the opportunity to testify. My name is
Lawrence Franko. I am the author of a recent study on U.S.
competitiveness in the global financial services industry,
which is referenced in my written testimony, and is available
on the worldwide web under that title.
We have heard today discussion of many threats and concerns
about U.S. competitiveness in global financial services. I
don't think we should forget about these threats and concerns,
but my view is that we should also not forget our strengths,
and the remarkable position from which we start.
As Representative Kanjorski mentioned earlier, the
importance of American firms in the world financial services
industry is really quite remarkable. Indeed, the U.S. position
in the most dynamic and rapidly growing segments of the
industry is even more so.
There have been many references to IPO's, and how some of
those--many of those recent ones--have taken place outside of
the United States. But it is worth noting that U.S. investment
banks and brokerage houses dominate not just U.S., but
international capital market transactions, globally. U.S.
investment banks easily account for two-thirds of the worldwide
underwriting of these IPO's.
Our money management institutions and mutual funds manage
well over half of the world's pension fund and personal
financial assets. Far more than half of the world's hedge
fund--indeed, 85 percent or so of the world's hedge fund,
venture capital, private equity, derivatives, and risk
management activities are conducted by American-owned and
managed firms.
And again, even when these activities occur overseas, as in
London, frequently they are conducted by American enterprise.
The numbers would be even greater were one to count not
just U.S.-owned institutions, but the major U.S. activities,
some of which are of global scope in their own right, owned by
foreign, predominantly European, banks and insurance companies.
The United States has global leaders in traditional banking and
insurance, but it is noteworthy that U.S. global dominance and
capital markets has arisen and accelerated as a result of the
move toward new modes of financial intermediation, asset
gathering, and risk management in our domestic markets.
I list a number of driving forces of this development in my
testimony. Let me just highlight a few of them. First, we
should not forget the post-World War II development of the
prominence of the U.S. dollar in international transactions.
Part of the development of trust in the United States and U.S.
capital markets is the brand, the U.S. dollar, and the fact
that people have confidence in the U.S. dollar that they do not
have in other currencies.
Is it not somewhat ironic that when Saddam Hussein was
pulled out of his spider hole, he was carrying a briefcase
filled with pieces of paper that had the picture of Benjamin
Franklin on them? Franklin is probably the most viewed American
of all time, well ahead of even Colonel Sanders, even in places
like Japan and China.
Second, I think we should note the early U.S. encouragement
given to funded pension plans, as opposed to relying primarily
on government pay-as-you-go transfers. There was much mention
of U.S. debt earlier. But by far the largest elements of U.S.
debt are the unfunded liabilities of programs like social
security and Medicare. And I would hope that, at some point
before my children and grandchildren have to start paying much
higher taxes, that Congress would revisit how private pension
plans might be given even more encouragement.
Third, we had an early development of the securities
culture here, where regulation and competition interacted to
produce a large domestic market in which publicly quoted,
professionally-governed, transparency-oriented firms are the
norm, rather than the exception.
I have lived and worked in many countries around the world.
And one of the major differences between the United States and
many other countries is that we do not have large numbers of
family firms, State firms, who are entrenched and secretive,
and who do not provide the kind of transparency that our
markets do. I think it makes a big difference, in terms of why
we have been so successful as an economy, as opposed to other
countries.
I will mention the public policy implications, the
regulatory implications. Other people have stressed this. We
should do nothing that moves us back and away from the
confidence of the publicly quoted transparent, professionally
governed business model, which we have more than any other
country in the world.
I might also mention the declining protection given to
incumbent banks and insurance companies from capital markets
competition, compared to other countries, another element of
our business environment that makes us rather distinctive. And
I also want to mention skills, knowledge, which has been
mentioned earlier.
There is a good deal of talk about people training for
science and engineering and mathematics. As a professor of
finance who is all too aware that some of my brighter
colleagues came out of much more mathematically-rigorous
traditions and training than I did, just because one has
studied physics doesn't mean one can't make a contribution to
risk management. Quite the contrary. And that matters a lot for
our position.
The United States has often been the first market for
financial innovations ranging from mutual funds, to hedge
funds, to big bangs, to public security offerings on a large
scale, to providing rights for minority shareholders and many
others. Other countries gradually realized that they needed
those capital markets, and their capital markets developed in a
way that was similar to a pattern that the United States had
experienced earlier. One of the reasons for the dominance of
U.S. investment banks and securities firms is that by the time
other countries realized they needed a capital markets culture,
our companies had already developed unassailable strengths.
What does this mean for regulation? Well, I would echo many
of the conclusions and recommendations that have been made
earlier today. We should not get bogged down by the complaints
about Sarbanes-Oxley. Perhaps there are parts that need to be
refined, but we should remember goals, even when we are
preoccupied by details.
Congress makes laws, and many laws are highly detailed and
complex. Ultimately, however, maintaining and strengthening the
U.S. global capital market position means maintaining our
reputation. Our brand is not just transactions, efficiency,
knowledge, and skill, it is also honesty, transparency, and
good corporate and capital market governance. We cannot gain
the benefits of this reputation without incurring some costs.
Secondly, though this item hasn't been mentioned explicitly
today so far, I would argue that regulations should look out
for the interests of consumers and share and bond stakeholders,
not for those of managers and firms who may wish to entrench
themselves against competition.
Had our big bang not occurred first, or had our banks been
able to continue to shut out out-of-State or non-bank
competition, we would not have the thriving capital market
actors we do today. Firms hone their global competitive skills
by first competing at home. Regulation that protects today
weakens firms in the long run. We should promote the future,
not the past. Thank you for your interest and attention.
[The prepared statement of Mr. Franko can be found on page
98 of the appendix.]
Chairman Baker. Thank you very much for each of your
testimonies. I want to start with you, Mr. Franko, relative to
your closing comment, and that is the competition is what
breeds a domestic company's skills to compete internationally.
I come at this issue believing that much of our regulatory
constraints preclude that type of head-up competitiveness, and
to some extent, discourages entry into the market by smaller
and start-up companies.
Now, I am not expressing the view--an outright repeal of
Sarbanes-Oxley. That's not where I am going. What I am
suggesting is that the government should never be the
determinant of winners and losers. That has to come from
market-driven forces. Where we can identify areas where
government rule is, to a great extent, precluding that
competitive opportunity, we need to get out of the way.
Not on this topic, but on a related matter, insurance
sales. There is no reason on earth why a life insurance policy
sold in Florida can't be sold in Maine without going through 50
different State approval processes. A clear case where
regulatory barriers preclude product development which
precludes competition, and the result is very abhorrently high
insurance rates in some States because of their local
jurisdictional constrictions.
I think the same can be said of our securities environment.
Much of the body of law that governs activities was written in
the 1930's. I don't care how bright they were. They couldn't
possibly have predicted a derivatives transaction, or
understood counterparty risk in 1934.
Going forward, what I am hopeful for is an ability to have
an arms-length examination of every component of market
function, determining what regulatory aspect is perhaps not
working as intended, or worse yet, a regulation which only adds
to cost, therefore taking it out of the shareholder pocket,
ultimately, and serves no public benefit.
Am I in territory that you agree with, or is that a view
that you find inconsistent with what you have testified to here
today?
Mr. Franko. You are more than in territory that I agree
with. I completely agree with your sentiments. I empathize with
Members of Congress who wish to maintain our competitive system
in the face of lobbying for privileges and exemptions. Many
people in the banking and insurance world are surely eagerly
lobbying to use regulation as a means of maintaining or raising
barriers to entry. I think the more that we can promote
competition, the better.
Speaker Gingrich mentioned work by Peter Wallison. Peter
and I were college classmates, and I keep track of Peter's
articles and comments regularly. In an op ed about 2 days ago
in the Wall Street Journal, in which he argued that Wal-mart
should not be prevented from offering banking services, he came
up with the wonderful sentence, ``People who think they are
building walls are, in the long run, building coffins.''
One of the reasons I think we do not have more major
leaders in global banking and global insurance is that for far
too long our banks and insurance companies were much more
interested in building walls than they were in innovation and
dynamism, and I think it has come back to haunt them, because
they have lost major ground, both to domestic capital market
firms and to foreign competitors.
Chairman Baker. Well, it seems to me rather rudimentary
capital markets philosophy that if you have money and you wish
to deploy it and create a product or a service and sell it at
whatever price you may choose, your success is determined by
the consumer's willingness to pay that price for that product
or service. And if they don't, you are not going to prevail
very successfully. And if somebody figures out a better way to
make your product at a lower price, you are still in trouble.
Anything that skews that market function from occurring is
not ultimately healthy for your long-term economy. And Ms.
Pinelli, in your prepared statement, I was noting that you
indicate that the U.S. markets represent about 30 percent of
market cap, while Asia Pacific is at 28 and Europe is at 27. I
don't find great comfort in that lead. That's--in polling terms
in a political world, that's within the margin of error.
I was taken by--the tone of your testimony seems to
indicate that things aren't really that bad, that if you take
out the state-owned enterprises that were made private, and
take that out of the IPO offerings, that really it's not that
big a deal, and that you place great value in the regulatory
seal of approval on U.S. businesses that you believe enables
the flow of capital to come into our marketplace. Is that a
correct characterization of your testimony?
Ms. Pinelli. Mr. Chairman, I think, if I can summarize what
you're trying to ask me, is we are seeing growth in foreign
capital markets. That is of concern to us. Yes, it is.
Keep in mind, the United States, we have capitalized the
financial services industry: resources, utilities, and
transport industries. These organizations in China: the banking
system, the energy system, they are coming to market for the
very first time. If you take out the state-owned enterprises in
China in the last year, their IPO activity is not as compelling
as we might think.
And I believe the question that you are asking is what
about the traditional businesses, non-state-owned products and
services that a willing consumer would pay for, how do we stand
competitively in that area, in that market segment?
I can tell you that Suntech, for example, the largest
entrepreneurial Chinese company, chose to list on the New York
Stock Exchange this past year, in 2005, with a $500 million
offering. I gave you the example of Baidu.
And I support your comments that that area does need
further examination, and it's a trend that we continue to
monitor.
Chairman Baker. So your--to wrap up your summary of my
question, that although we should be concerned about market
dominance, that we are not in a death fight quite yet, that if
we're attentive, maintaining appropriate regulatory oversight,
do this examination and reduce those things which don't have
public value, enabling the free flow of capital to where it can
be most efficiently deployed, those outside U.S. markets will
list in U.S. markets principally because that gives them
credibility in the worldwide market that they are able to meet
our listing standards.
Ms. Pinelli. And, of course, there is valuation premium.
Chairman Baker. Yes.
Ms. Pinelli. They will come to market and immediately--if,
you know, we understand the New York Stock Exchange--have a 30
percent premium.
But I don't have the answers, and I share your concerns,
and I congratulate you on this special committee. The question
for me is how many more state-owned enterprises, how large will
they be? Bank of China is coming to market in 2006. It will be
massive. It will be bigger than the $9.2 billion China
Construction Bank. The Hong Kong Stock Exchange will then have
a large pool of capital. They will strengthen their capital
market.
Then the question becomes will traditional businesses
outpace--will that growth outpace that of the United States,
and when they choose to go to market in the public arena, will
they choose the United States? Well, today we do have a
valuation premium standard. We are seeing signs of very good
companies coming to the United States because of our investor
sophistication, valuation premium, very good corporate
governance--
Chairman Baker. So the observation would then be as the
Asia Pacific exchanges grow, and they become perhaps even
larger than the U.S. capital markets, does an individual need
to come to the United States to get the valuation premium, or
can they list in their own marketplace and achieve the same
end?
Ms. Pinelli. Well said.
Chairman Baker. Thanks. Last thing, Mr. Copland. I don't
want to ignore the observations about litigation reform. I
share your view, so I don't necessarily want to replow that
ground.
I want to perhaps discuss with you just a little bit
accounting generally, and the concerns about the foreign-owned
company coming to the United States, and in order to become
GAAP-compliant, having to spend an inordinate amount of time
and resources--and that's another weight in making the decision
not to come.
I am an advocate of Extensible Business Reporting Language,
XBRL, which has now undergone a pilot at the FDIC, and has been
a successful pilot, and hope to encourage the deployment of
that to all insured depositories in the near term.
Assuming we can develop the appropriate taxonomy for
private operating companies to utilize this--and I understand
the SEC has encouraged data tagging in its reporting
methodologies--that that could be a very good way to slide into
an international standard where you have more real time
disclosure of things which are not required now by the SEC to
be disclosed, but which are of value to the investor.
And secondly, it enables the Mom and Pop investor to be
able to do comparisons so we don't get Mr. Campbell's 14 pages
of documents, 14 feet of documents, but rather what you wish to
get to compare with another entity you wish to compare it with.
So, it's, I think, a very helpful tool, not only for the
knowledge of the investor, but also, ultimately, to enable us
to do away with quarterly reporting so that you don't have this
internal pressure on management to beat the Street every 90
days, which I think has been an insidious force in why we got
into all these accounting manipulations in the first place.
Do you have a view of that set of issues? And how do you
feel we can move, as a committee, in going forward, not
necessarily just to reach a single international standard, but
to enable that capital to flow more freely to us, by reducing
the accounting concerns?
Mr. Copland. I agree with you, Mr. Chairman. I think the
accounting compliance issues are very important, and the
ability to--you know, the extra cost of following the different
accounting standards is high.
I also agree with you that the artificiality of the 10Q,
10K sort of process is--creates perverse incentives for
management that aren't necessarily aligned with shareholders.
And--
Chairman Baker. Well, for my purposes, we now have a rules-
based retrospective system. And as long as you play by the
rule, you're going to be okay.
Mr. Copland. Right.
Chairman Baker. I learned that a telecommunications company
booked its revenue in a current operating quarter the sale of
broadband capacity on a broadband system which had not yet been
built. And that was legal. And I knew we were in deep trouble.
At the same time, if I knew that a company was selling
widgets, and 9 out of 10 were being returned, or customer
satisfactions surveys said I would never walk in your door
again, I know which information I would rather have about a
company's performance. The old rules-based retrospective, or
the customer satisfaction survey?
I think getting that kind of disclosure to the markets--we
seem to requite disclosure of an inordinate amount of detail
which the market has no interest in reading. And I don't know
how we got mismatched so badly, but--
Mr. Copland. Yes. I agree with you. I think, frankly, the
litigation climate is a large reason why the--this kind of
information comes out there for protective reasons, as well as
just excessive regulatory compliance.
In terms of Mom and Pop Investor, I think it's very
difficult for the mom and pop investor. You know, I have
investments as well. I get the piles of statements. You can't
read them, you can't make anything of them, you just try to
have a diversified portfolio, and hope that the system itself
is sound.
I do think that, you know, that big hedge fund managers,
mutual fund managers, etc., do read these. And I do think that,
therefore, you know, there is definitely value there. There is
informational value, and you want to maximize the ability to
get that out on the market at the minimal cost.
And you know, I don't think we have the equation quite
right yet, so I think, you know, some of these substantial
reforms, over time, the real-time ability to disclose
information could be very useful. You know, I think we do have
to have concerns about what the litigation implications might
be for companies that are doing that, and that's something I
think that we always ought to keep in mind in this environment.
But I do think that, you know, a lot of what you're saying
makes a lot of sense to explore further--
Chairman Baker. Well, we don't want to encourage forward-
looking statements that encourage litigation. We need to have
disclosure without liability.
Mr. Copland. Right.
Chairman Baker. For making what is intended to be a good
faith projection of business direction. But as we go forward, I
indicated earlier that--to the other panel--that it is my
intention, over the next several months, to investigate what
the agenda ought to be, to identify those half-dozen or dozen
issues that really need to be focused on that would make a
significant difference in our future competitiveness, because I
do have concerns that, despite the fact that we are still at 30
percent, we need to be widening the gap, not watching it
shrink.
And to that end, we certainly are going to be calling on
you for your professional insights to help create that agenda.
It's not something that--you know, I'm not going to run out and
suggest repealing Sarbanes-Oxley, I don't want to get folks all
excited, but we need to look at every aspect, and make an
informed judgement about, you know, what is warranted and what
is justified, in light of our current market conditions.
Mr. Campbell, I didn't mean to exclude you from our
discussion, but I want to express appreciation to each of you
for your contribution. We will be back to you in writing over
the coming weeks. And thank you for your participation here
today. Our meeting is adjourned.
[Whereupon, at 1:08 p.m., the subcommittee was adjourned.]
A P P E N D I X
April 26, 2006
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