Thursday, August 03, 2006

Alan Murray say it's not SOX that is sending IPOs to overseas exchanges

In yesterday's WSJ, CNBC regular and WSJ editor Alan Murray espouses a different theory on why companies seeking to go public are going overseas rather than executing their IPO through the NASDAQ or NYSE.

The tradtional argument is that the regulatory environment is too stringent in the U.S. relative to European and Asian markets. Murray argues that while there may be some truth to that, the real reason is likely the fee that underwriters in the U.S. charge their clients (6.5% - 7.0%). Apparently this is often double the fees that European underwriters charge. I am not sure I agree with Murray, but it is a compelling perspective. The fees for underwriting IPOs in the U.S. haven't budged much over time, even though other brokerage related fees (see commissions on institutional sales) have decreased steadily over time.

Here is Alan Murray's article:

Fees May Be Costing
Wall Street Its Edge
In Global IPO Market
August 2, 2006; Page A2

(See Corrections & Amplifications item below.)

Is Wall Street having its Detroit moment? After a century as the undisputed financial capital of the world, New York has suddenly discovered there's competition out there.

The threat has been captured in a single fact: 24 of the top 25 initial public offerings of stock last year were issued on exchanges outside of the U.S.

That statistic is repeated frequently as financiers and policy makers wring their hands over what's happened to the nation's capital markets. Eager for a simple solution, some point to Sarbanes-Oxley, the law passed in response to Enron and other U.S. corporate scandals.

"You don't have to take my word for it," says Florida Rep. Tom Feeney, a leading Sarbanes-Oxley basher. "The London Stock Exchange is traveling the world … bragging about one thing: They are SOX free."

Unwilling to take Rep. Feeney's word for it, I went to the London Stock Exchange's Web site. What I discovered was a detailed study by Oxera Consulting Ltd. that looked at the cost of raising capital in various markets.

And guess what? The biggest source of the U.S.'s disadvantage, according to this study, wasn't the cost of complying with Sarbanes-Oxley -- although that was certainly noted. Instead, it was the high fees charged by Wall Street investment banks. In the U.S., those fees equal 6.5% to 7% of the value of shares offered. Across Europe, they are 3% to 4%. In Asia, they can be even lower.

For a big IPO, that difference easily swamps estimates of the cost of Sarbanes-Oxley. If the U.S. is losing its competitiveness, maybe some of the blame goes to its financial houses for charging excessive fees in their home market. Does anyone really believe they deserve 7% of the value of a newly listed company?

OK, now that I've gotten the attention of the folks at Goldman Sachs, let's step back and take a look at what's really going on. Not surprisingly, the situation is more complex than either the large group of Sarbanes-Oxley bashers or my smaller coterie of investment-bank bashers might make it seem.

First of all, the 24-out-of-25 figure exaggerates the issue. According to Dealogic, the market that hosted the largest proportion of IPOs by value last year was none other than the New York Stock Exchange, with 71 offerings valued at $25.6 billion. The Nasdaq came in fifth, with 139 offerings valued at $14.1 billion. Together, they handled roughly a quarter of the value of all the world's new listings.

Moreover, many of the companies on the top 25 list were privatizations of state-owned companies: China Construction Bank and Shenhua Energy in China, or Electricité de France and Gaz de France. No surprise those governments choose to launch their IPOs in their home markets.

There's also a cyclical aspect to the IPO business that's not working in the U.S.'s favor right now. The U.S. is still suffering an overhang from the wild days of 1999 and 2000, when any 30-year-old with a Web site could take his or her company public. After that financial orgy, it's no surprise the market has become more skeptical of IPOs.

Still, there's clearly something worth worrying about here. New Treasury Secretary Henry "Hank" Paulson Jr. -- former chief executive of Goldman Sachs -- said the issue will be on the table today when he meets with Federal Reserve Chairman Ben Bernanke and Securities and Exchange Commission Chairman Chris Cox, who comprise the President's Working Group on Financial Markets.

In an interview with CNBC's Maria Bartiromo yesterday, Mr. Paulson said there's no simple answer to America's IPO problem. "Markets overseas are much stronger, more competitive than they were a few years ago," he said, "so that's one of the reasons."

He also cited the U.S. "legal environment" (read: trial lawyers), the "enforcement environment" (read: New York Attorney General Eliot Spitzer) and the "regulatory environment" (read: Sarbanes-Oxley) as contributing to a reluctance to raise new capital in the U.S.

Certainly, Sarbanes-Oxley deserves its share of the blame. Carlyle Group Managing Director Robert Grady, who is also chairman of the National Venture Capital Association, says it's particularly burdensome for smaller companies, which can face compliance costs as high as $2 million to $3 million. The problem has been exacerbated by risk-averse accounting firms, which have taken a small portion of the law, known as Section 404, and turned it into an enormously burdensome new reporting requirement for companies. Some easing of the Section 404 rule seems necessary and inevitable.

But Sarbanes-Oxley alone can't explain an IPO slowdown that began well before the law took hold. Mr. Paulson and his colleagues need to cast a wide net, and include a hard look at the practices of investment banks like the one he ran for seven years, to understand why Wall Street may be losing its edge.


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