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Can SOX 404 Be Measured?

Panelists at the SEC's roundtable came up short when it came to numbers that could measure the financial impact, good or bad, of SOX 404.

Speakers at the May 10 Sarbanes-Oxley Section 404 roundtable, co-hosted by the Securities and Exchange Commission and the Public Company Accounting Oversight Board, listed a host of numbers to prove their particular point of view about the impact of the internal controls provision on companies and the U.S. capital markets.

But at the end of the day, few were able to point definitively to a number that answered a key question: Have the benefits of SOX 404 been worth the cost?”

Gregory Jonas, managing director at Moody’s Investors Service, noted that in October 2002, which Jonas termed “the dark days when the market was most nervous about the quality of financial reporting,” credit spreads for investment grade companies were 2.5 percentage points over the Treasury rate. “For corporate high-yield companies, they were a whopping 10 percentage points over the Treasury rate,” said Jonas.

Fast forward to today and credit spreads for investment grade companies are only 0.85 percentage points above the Treasury rate and for corporate high-yield companies, they are 2.8 percentage points above, said Jonas.

“Clearly that dramatic reduction between the dark days of October [2002] and today, we can’t all attribute to 404, but if only 10 percent of that reduction is due to 404, put those numbers in your calculator, and you get a benefit that is absolutely enormous,” Jonas stated at the roundtable.

But Jonas admitted that was about as far as he could take the math. “It is our belief there are significant benefits [from 404],” he said Jonas, but added that the benefits can’t be conveyed in numbers.

Indeed, not everything can be neatly summarized in numbers. “An over-reliance on metrics can lead to ‘knowing the price of everything and the value of nothing’,” noted Susan Webber, founder of consultancy Aurora Advisors, in a recent issue of Across the Board, a publication of The Conference Board.

What’s more, corporate managers and investors cite numbers to measure performance or prove a particular viewpoint. So just as buyers should beware, so should audiences.

During the roundtable on Section 404, Noreen Culhane, executive vice president of the NYSE Group’s global corporate client group, rattled off several numbers about how the internal controls provision has affected the competitiveness of the U.S. capital markets in a global marketplace.

For example, the number of companies that have listed on the Alternative Investment Market of the London Stock Exchange is of particular concern to the major U.S. exchanges, which view stock listings abroad as lost business opportunities. Culhane stated, “There are now 1,500 companies listed on AIM and a third of those that listed in 2005 were non-U.K. companies.”

Actually, less than one-third of those that listed on AIM last year are non-U.K. companies; it was 23 percent. That’s not a third, in fact, it’s less than a quarter. According to the London Stock Exchange, 120 of the 519 companies that listed on AIM in 2005 were non-U.K. incorporated and 399 were U.K. firms. Furthermore, only 19 of the 519 new registrants are U.S. firms.

Additionally, selective data and non-parallel comparisons of data can lead to incorrect conclusions. “In 2000, of the 10 largest global IPOs, nine registered in the U.S. and raised money here,” stated Culhane, who then read the following statistic, “In 2005, of the companies that raised over $1 billion, 23 of the 24 companies didn’t register in the U.S. capital markets, although they did private placements.”

Just a few weeks ago, similar statistics suggesting that U.S. regulation was driving companies to list overseas drew the ire of Sarbanes-Oxley Act co-author Senator Paul Sarbanes. “The major driver of the foreign IPO markets is the privatization of state-owned enterprises,” said Sarbanes at a Senate Banking Committee hearing. “The top 5 IPOs are former state-owned enterprises.” And, he noted, the governments that spin off those enterprises typically push to have them listed on local exchanges. For example, he said, the two French IPOs in that list of top offerings listed on EuroNext.

And Sarbanes pointed to a statistic that is also favored by the NYSE’s Culhane: the valuation premium for companies listing on US exchanges — with all their regulatory requirements — runs as high as 31 percent, according to one academic study.

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