Marcus Cake

This article is inspired by the Harvard Law Journal article A Blueprint for Cross-Border Access to U.S. Investors: A New International Framework and Beyond Borders: Time To Tear Down the Barriers to Global Investing. These are exceptional articles on the regalation of capital markets. I encourage you to read the originals. The following quote seems to be a quality analogy for the state of securities regulation:

The first car I owned was produced in 1934, as was the Securities Exchange Act. I hasten to add that the car was quite used before it came into my hands, again, like the ‘34 Act. It was a good car for the needs of its day, and so were the Exchange Act and its companion, the Securities Act of 1933. But, while the federal securities laws have been the subject of numerous modernizations over the past seventy-two years, they look and function more like the original model than current automobiles look like my 1934 Ford. - Richard Murray - The Emperor has unsuitable clothes (and by the way, he is no longer the emperor)

The internet and online industry networks are only just starting its to reshape industries. Financial markets are likely to be the most changed given all aspects of the industry is information. There are no physical goods and quite often, no physical presence or office is required by market participants. Capital can reside in any country. To a lesser extent, companies, advisers and investors can also reside in any country. The opportunity for regulation arbitrage is real. The introduction of Sarbanes-Oxley Act has resulted in many companies simply raising capital in other markets.

Regulations have trailed the opportunities and benefits presented by technology. The SEC has only recently changed its regulation to allow the delivery of shareholder information by the internet. The internet presents the world with an opportunity for a truly global capital market. Capital markets are largely country based. Regulation is critical to the integrity and credibility of equity markets. However, in an era of global business and the internet there are limits to the reach and effectiveness of regulation. Spam email containg stock recommendations are common. I suspect many receive similar emails. It is difficult to see how any method of regulation could protect an investor from Spam, or point to point communication. Can we protect the “investor” in a world where information can travel from individual to individual, companies can shift countries and advisers could use the internet to mask their identity. The challenge for global regulators is real. A careful balance must be struck between the need for efficient and effective capital markets, effective investor protection at a minimum of transaction costs. The efficient and effective operation of global capital markets is critical to capital formation, economic growth, taxes to fund government and having available resources to address the critical environmental, health and social problems of our time.

Economic development and new technologies can require significant adjustment for existing players. In financial markets, many of these business models were formed in the early 1900’s. Large organisations and signficant infrastructure was required to distribute information from point to point. In an era of the internet, the cost of distributing information point to point is almost zero. Information distribution business based upon old business models must adapt. Given the significant investments, many current players are unable to change. Only new entrants have the flexibility to offer new business models offered by the internet. Many of these businesses may also lobby government and endeavour to influence the nature of regulation. Five years ago, these arguments may have been successful. I previously wrote an article titled will the people asphyxiate on the information superhighway? and the following quotes from that article come to mind

“Dear Mr. President: The canal system of this country is being threatened by a new form of transportation known as ‘railroads’ … As you may well know, Mr. President, ‘railroad’ carriages are pulled at the enormous speed of 15 miles per hour by ‘engines’ which, in addition to endangering life and limb of passengers, roar and snort their way through the countryside, setting fire to crops, scaring the livestock and frightening women and children. The Almighty certainly never intended that
people should travel at such breakneck speed. - Martin Van Buren, Governor of New York, 1830.

Rail travel at high speed is not possible, because passengers, unable to breathe, would die of asphyxia. - Dr Dionysys Larder (1793-1859), professor of Natural Philosophy and Astronomy, University College London

The primary purpose of this article is to introduce a number of articles which discuss that discuss the challenges of regulation of a global financial markets. I encourage you to read the originals. If you are engaged in the equity market, then this may help you to reposition for the next generation of capital markets.

A Blueprint for Cross-Border Access to U.S. Investors: A New International Framework , Harvard International Law Journal, Volume 48, Number 1, Winter 2007, Ethiopis Tafara & Robert J. Peterson

Extract:

• Today, mergers and talks of mergers among the world’s stock exchanges make obvious what many finance professionals have long known: capital markets are global. Greater investor wealth and education have created the demand for such markets, and technology, in particular, has made globalized markets feasible. Investors now search beyond their own borders for investment opportunities and, unlike the past, many of these investors are not large companies, financial firms, or extremely wealthy individuals. A good number are “typical” retail investors—individuals with normal jobs and average incomes—who save for retirement and their children’s education, and who may be well-educated, but nonetheless are not “sophisticated investors” in the legal sense. Investors (whether retail or professional) and large firms pursue international opportunities for the same reasons: higher investment returns and the reduction in risk offered by portfolio diversification.
• It is this seamless capital market, made possible by technology, that now, more than anything, presses on financial regulators around the world. The fundamental mandate of the Securities and Exchange Commission (“SEC”) remains the same—protecting investors, ensuring the efficiency and transparency of U.S. markets, and facilitating capital formation in the United States. However, the manner in which the SEC can best achieve this mandate in the face of this new investor demand is changing. Borders that have blurred for most market participants are proving as sharp as ever where market regulation is concerned. Also, the technology that has proven so beneficial for investors and issuers poses a serious threat to the integrity of markets. As a consequence, the traditional methods that the SEC and its foreign counterparts use to oversee cross-border market activity have lost some of their historical efficacy. Our markets are now interconnected and viewing them in isolation—as we have for so long—is no longer the best approach to protecting our investors, promoting an efficient and transparent U.S. market, or facilitating capital formation for U.S. issuers.
• This Article proposes a new framework to apply to foreign financial service providers accessing the U.S. capital market, by providing investment services and products not otherwise available on the U.S. market. Rather than requiring such foreign stock exchanges and foreign broker-dealers to register with the SEC, as is currently the case, the proposed framework relies on a system of substituted compliance with SEC regulations. Instead of being subject to direct SEC supervision and U.S. federal securities regulations and rules, foreign stock exchanges and broker-dealers would apply for an exemption from SEC registration based on their compliance with substantively comparable foreign securities regulations and laws and supervision by a foreign securities regulator with oversight powers and a regulatory and enforcement philosophy substantively similar to the SEC’s. The SEC would still retain jurisdiction to pursue violations of the anti-fraud provisions of the U.S. federal securities laws. The comparability finding would need to be complemented by an unambiguous arrangement between the SEC and its foreign counterpart to share extensive enforcement- and supervisory-related information. This should greatly reduce the transaction costs investors currently pay when investing overseas, and allow the current situation of overlapping and duplicative registration and oversight requirements for certain stock exchanges and broker-dealers to end.
• The overarching objective of the framework is, first and foremost, to further the SEC’s mandate of investor protection. As foreign markets develop and adopt higher regulatory standards, U.S. investors predictably are looking at them as potential investment opportunities. However, the current international environment has enforcement and oversight gaps that present risks that do not exist in a domestic context. U.S. investors also face high transaction costs when investing overseas—transaction costs that provide investors with no real benefit. By constructing a new model for international cooperation between the SEC and certain like-minded foreign securities regulators, the framework will facilitate the SEC’s ability to protect U.S. investors and lead to a collaborative effort in promoting high-quality regulatory standards in a globalized market. It will also increase competition in financial services—both here and abroad—and lower cross-border transaction costs, to the benefit of investors around the world.
• In laying out this framework, we first discuss how technology and globalization are changing the shape of modern capital markets and how they are regulated. We also explore how recent financial scandals, both in the United States and abroad, have changed the shape of securities regulation and created new mandates, burdens, and demands for regulators that, if not implemented carefully and in a coordinated fashion, threaten to harm investors and issuers with unnecessary regulatory transaction costs. Second, we lay out the critical elements of U.S. securities regulation and the legislative “first principles” that constrain what the SEC can do, and the manner in which these first principles have led to the SEC’s historic approach to regulating cross-border securities activities. We then discuss how these first principles necessarily shape any SEC response to this new global capital market. Third, and finally, we detail a framework, based on these first principles, that would increase U.S. investor access to foreign investment opportunities and lower investor transaction costs while bolstering the integrity of the U.S. capital market and discouraging the type of “regulatory arbitrage” that can undermine investor confidence in markets everywhere….

The original article and PDF is available here. There are also other responses to this article which provide an additional perspective.

The Emperor has unsuitable clothes (and by the way, he is no longer the emperor), Harvard International Law Journal, 48 HARV. INT’L L.J. ONLINE 15 (2007), January 28th 2007

• The first car I owned was produced in 1934, as was the Securities Exchange Act. I hasten to add that the car was quite used before it came into my hands, again, like the ‘34 Act. It was a good car for the needs of its day, and so were the Exchange Act and its companion, the Securities Act of 1933. But, while the federal securities laws have been the subject of numerous modernizations over the past seventy-two years, they look and function more like the original model than current automobiles look like my 1934 Ford.
• My first and strongest reaction to the Blueprint is a blend of admiration for the authors’ insight and appreciation that individuals of their stature at the SEC have the freedom to speak so clearly of the need for new tailoring of the U.S. regulatory wardrobe. It is also a pleasure to recognize how deftly they suggest that this wardrobe needs only a few nips and tucks to facilitate the healthy global marketplace that will best serve the interests of U.S. investors in the rapidly shifting conditions they describe.
• Put in more traditional terms, Mr. Tafara and Mr. Peterson offer suggestions for how the United States can enable the creation of “a new international framework.” They recognize that the United States will be unable to dominate global capital markets activity in the 21st century as it has done in the past, but they posit that it can legitimately aspire to lead one global marketplace. In addition, they make a convincing case that competing through collaboration will further the interests of U.S. investors and commerce.
• The authors’ vision for the future is both clear and ambitious. They seek two goals for capital markets: transparency and liquidity, and egalitarianism and blindness to national origin.
  

  An efficient capital market requires transparency and liquidity. Transparency is afforded by thorough disclosure requirements, top-notch accounting standards, and independent audits conducted under the highest-quality audit standards. Liquidity is offered by investors who have confidence in the market and the standards under which market participants operate, and who have faith in the legal system and the quality and thoroughness of the enforcement of securities laws and regulations.

  An efficient capital market also requires a degree of egalitarianism and blindness to national origin. Ceteris paribus, the larger the pool of investors bidding on a company’s securities, the more efficiently the price of those securities will be set and the more liquid the market for them will be. If our objective is to offer U.S. public companies the lowest cost of capital a market can provide, these companies should be free to accept that capital from whichever investors offer them the best price for their securities.

The original article is available here.

Beyond Borders: Time To Tear Down the Barriers to Global Investing, Edward F. Greene48 HARV. INT’L L.J. 85 (2007) (forthcoming, Winter 2007)

Extract:

• This is an idea whose time has certainly come. Indeed, it is one that is long overdue. There can be no argument that the securities markets are now global and that the dominance of the United States as the leading player in the global marketplace is being challenged. The SEC can no longer afford to sit on the sidelines and pretend that the U.S. market is the only game in town. It must acknowledge that other securities markets and regulators have matured to the point where they rival (and some might argue exceed) the United States in sophistication. Investing in non-U.S. markets is no longer the exclusive province of megainstitutions or the ultrawealthy; it is an essential component of prudent portfolio diversification for all investors. The SEC must find a way to work with its counterparts outside the United States to eliminate barriers to cross-border investment. Tafara and Peterson have proposed a new framework (the “Proposed Framework”), one built on the idea of “substituted compliance,” to commence this process. The Proposed Framework is certainly a step in the right direction and its basic tenets should be embraced and pursued by the SEC. The SEC, however, must exercise careand restraint in its implementation (especially with respect to its assessment of the comparability of non-U.S. regulatory regimes) in order for the Proposed Framework to succeed. Moreover, the SEC needs to be bolder and go farther in its response to the globalization of the securities markets. It should extend the substituted compliance approach to other areas, such as capital raising, and to other market participants. And it should do so quickly….

The original PDF is available here.