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Investor Confidence and the Competitiveness of U.S. Markets Thank you Barbara (Franklin). It is an honor to have this opportunity to address the Economic Club of New York. Your organization has long been valued for its role in providing a nonpartisan forum to discuss great issues of the day. The Economic Club of New York also has the reputation for attracting interesting and important people. This afternoon, I am very pleased to be speaking along with my friend, Tim Geithner. Tim was a terrific choice to head the New York Fed, and he has been very helpful to me in thinking through important issues during my initial months at the Exchange. It is customary to begin a talk like this one by pointing to pressing problems that may seem unique to the times. Looking back over the past century, which witnessed two world wars, conflicts in Korea and Vietnam, as well as rampant inflation, the Cold War, and the energy crisis --- it is difficult to find many moments that were problem-free. Nevertheless, the first years of this new century have particularly tested the mettle of the American people, as well as the resilience of our institutions. Over the course of a relatively few months, the United States was attacked for the first time since Pearl Harbor, and responded by sending troops into combat and declaring war on terrorism. We entered an economic downturn that quickly became global. And we endured a series of scandals that severely undermined confidence in U.S. capital markets and corporations. Each of these challenges shook the Nation to its core. Collectively, they have severely tested America. And the manner in which our country responded is impressive. As we recall the meaning of Memorial Day past and present, we are thankful for the men and women who fight for our freedom around the world. Now more than ever, our men and women in uniform deserve our support. Here at home, the U.S. economy is recovering. What was first referred to as a jobless recovery is now regarded as a strong expansion with solid job growth, leading the industrial world. At the same time, business leaders are taking meaningful steps to increase their companies’ transparency and disclosure, and to improve corporate governance. I make these points to remind us that sometimes we need to bring perspective to our national conversation. Sometimes it is a good thing to acknowledge that progress has been made, and also, the good faith efforts most people, including those in business, are making to address problems and to meet commitments. And, sometimes it’s also important to recognize when we have gone far enough. In considering U.S. regulatory policy, I believe we have reached such a moment today. For just as patients can be overmedicated to the detriment of their health, we need to use care in setting the proper dosage of reporting and governance requirements for business and markets. As we examine these issues, it appears that we are challenged by competing priorities – those of regulation and accountability versus growth and competitiveness. Hence, a logical question arises: is there a way to resolve these competing priorities? Can we find common ground? I believe that we can. I believe that there is a unifying theme, and that is the central importance of investor confidence – the confidence of American investors as well as investors throughout the world. Improving investor confidence goes hand-in-hand with higher standards of corporate governance, as it does with better economic performance. The test, it would seem, is to ensure that U.S. standards of corporate governance do not become the enemy of U.S. economic performance. These interests must not be competing, but complementary and mutually beneficial. So today, I will focus on strengthening investor confidence by setting our sights on two clear and complementary goals: first, meeting high ethical standards and corporate accountability; and second, making certain that the regulatory burden does not harm U.S. competitiveness, and the ability of our capital markets to fulfill their central role. U.S. capital markets serve an essential national role by allocating scarce capital to supply corporate, venture and risk-taking needs. U.S. markets are the broadest, deepest, and most liquid in the world. They are the wellspring of our prosperity. They provide visionary people the means to transform ideas and innovations into jobs, opportunities and enterprises. They have enabled the United States to become the global champion for economic growth and a better life. While the U.S. is the powerful engine of global capitalism, no birthright dictates that we will remain so. In the 21st Century economy, great forces of competition and technology are accelerating change and the mobility of capital. The willingness of investors to commit their capital will be influenced by how well capital is treated – by the degree to which markets and economies encourage and reward investment, risk-taking, profits and growth. In this regard, U.S. tax policy has moved boldly to unleash the spirit and dynamism of entrepreneurship – which is America at its best. At the same time, Sarbanes-Oxley and other disclosure requirements, including those of the NYSE, ensure that companies have solid governance structures, that corporate financial statements are accurate, and that all relevant facts about companies are disclosed. These are important reforms. However, they come at a cost -- both in the expenses companies must incur and in senior management time and effort to comply with the new rules. Clearly, the ethical breakdowns, and in some cases, criminal behavior in the most recent corporate scandals broke fundamental bonds of trust with investors. For thousands of people, they resulted in the loss of a livelihood and of life-savings. These scandals clearly illuminated the need for a new commitment to higher standards of corporate governance and accounting and regulatory oversight. Chairman Donaldson described Sarbanes-Oxley as “the most important securities legislation since the original federal securities laws of the 1930’s.” I agree. Sarbanes–Oxley is groundbreaking legislation. The new governance and accountability standards are far-reaching. The strength of the legislation, reinforced by the efforts of Bill McDonough, at the Public Company Accounting Oversight Board, is helping to restore investor confidence in U.S. companies. Having said that, we also need a sense of balance, and perspective. The U.S. stands at the vital center of global growth and prosperity. At the end of 2003, Americans held $12 trillion of U.S. and non-U.S. equities—which represents 38 percent of the market cap of the world’s major exchanges. In addition, domestic and foreign companies raised $122 billion in new capital on the three major U.S. markets during 2003. That’s one-third of the capital raised publicly in the world’s stock markets. The stakes are great. As other nations forge ahead to develop markets and lure investment, the U.S. cannot afford to stifle investment and innovation, to forfeit the competition and fail to answer 21st Century challenges. So, let me address these issues from my perspective as CEO of the New York Stock Exchange – and, in that capacity, as a voice for 85 million investors and the leaders of 2,700 listed companies who, I believe, want the U.S. to compete to its fullest potential. Since becoming CEO of the Exchange four and-a-half months ago, I’ve worked to restore confidence in the integrity of the Exchange. I’ve also spent a great deal of time listening to our customers. In conversations with leaders of NYSE-listed companies, as well as with executives from abroad hoping to do business here, I continue to hear the same refrain: They are saying, “The pendulum has swung too far. The costs of compliance are too high. The risks of litigation are too great.” And thus, “We’ll avoid the risks. We’ll defer our decisions. We’ll delay our investments.” Some of these comments are the inevitable reflection of adjusting to the new era of compliance and governance. As companies adjust to the new reality, these complaints should diminish. But in the meantime, companies around the world are voting with their feet. One sign of that negative posture can be seen in the decline in new listings of foreign companies in U.S. financial markets. Between 1996 and 2001, the NYSE listed an average of 50 non-U.S. companies a year. During the past two years, that number dropped to 25, with the decline particularly sharp among European companies, dropping from 19 to 6. So far this year, there has been only one new listing of a European company. Listings are an important barometer of foreign interest in the U.S. economy. Listings offer a multitude of possibilities:
Investor confidence, in turn, can lead to higher valuations and better equity performance. Obviously, from a national standpoint, every listing strengthens possibilities for more U.S.-directed investment, more growth and more jobs. Unfortunately, the recent drought in foreign listings indicates a declining willingness or necessity to participate in U.S. markets. I see four fundamental causes: three are U.S.-centric, and one is Euro-centric:
The value proposition for overseas companies seeking to list in the U.S.—and to remain listed—changes fairly significantly when the costs of meeting our reporting requirements are so high. Companies we have spoken to note the complexity of integrating international operations into these new processes. They note the high expense to build, test and maintain systems and software to monitor operations consistent with the new rules and guidelines. In some cases, these requirements could increase current auditing costs for European firms listed in the U.S by up to 100%. As many other countries and the EU have adopted policies very similar to Sarbanes-Oxley, our competitive disadvantage should shrink. But for now, we expect to see listings of overseas companies remain lower than they would otherwise be.
In sum, global capital markets in the 21st century are developing rapidly. They are more robust, more competitive and more liquid. And, they are challenging U.S. leadership and preeminence. That describes the situation we face in bringing new listings of foreign companies to our Exchange and to American investors. Not surprisingly, these same issues are affecting U.S. companies as well. In the U.S. today, there is consternation over the maze of overlapping governance and reporting requirements – above and beyond requirements already mandated by Sarbanes-Oxley. Credit rating agencies, independent corporate governance groups, and others are now asking companies to submit extensive questionnaires and data, which overlap and often go beyond what is required by Sarbanes-Oxley or by the New York Stock Exchange. CEO’s are expressing deep concern over steeply rising costs, complexity and delays. Since the inception of Sarbanes–Oxley, fees paid to outside auditors have increased by double digits year over year. A recent survey of 115 firms by Foley and Lardner showed that, on average, the cost of complying with audit and reporting requirements for public companies with annual revenue under $1 billion has increased by 130%. The Foley and Lardner survey also reveals that audit fees have increased 20% for small-cap companies and 24% for S&P 500 companies in each of the past two years. The SEC is expected to approve new PCAOB rules concerning Section 404. The rules will require outside auditors to do a full audit of a company’s internal controls to assure that they are sufficient. This requirement could double audit costs. Compliance efforts have required an average of 12,000 hours of internal work, and 5,000 hours of external work – at least double original estimates. According to another survey, this one by Tillinghast- Towers Perrin, at current levels, U.S. tort costs are equivalent to a 5% tax on wages. The cumulative effect of all of these changes is sticker shock, and a mood of frustration and anxiety. These tremors across the corporate landscape affect all companies large and small. Hank Greenberg, Chairman of AIG, spoke for many of his colleagues recently when he said, “Some of us have two jobs: The regulatory burden during the day and running the company at night.” Public companies are contemplating a step that a few years ago would have seemed unthinkable. Foley and Lardner reported that one-fifth of U.S. public corporations are considering going private because of the rising costs of governance regulations. We do not want America’s most promising and successful companies to start pulling back from our capital markets. While I do not pretend to have all the answers, let me share some common-sense principles, as well as some specific proposals to strengthen investor confidence. Starting with general principles. I think we need to start by reaffirming the central role of enterprise and capital markets: quite simply, free people competing in free markets are the wellspring of prosperity and progress in free societies. Winston Churchill was fond of saying that some regard free enterprise as a predatory tiger to be shot. Others look upon it as a cow to be milked. Only a few see it for what it really is – the strong horse that pulls the whole cart. We need to let America’s strong horse pull our economy forward – or else we’ll never reach where we want to go. In that regard, I believe that we need to remind ourselves that the leaders of corporate America are, in the great majority, honorable men and women. They awake each morning with the intent of doing it right and doing right by their customers and stakeholders. That is true for thousands and thousands of companies that have good boards of directors, and that have audit and compensation and nominating committees that are meeting their responsibilities, and that are faithfully serving their shareholders. In addition, I believe that in matters of governance and regulation we should be guided, as we are in medicine, by an equivalent of the Hippocratic Oath – Do no harm. To do no harm, we need to look closely at the risks to investors and to our financial system, and mitigate the greatest risks. We need to strike the proper balance between the costs of increased time and resources devoted to compliance, and the incremental benefits they will produce in terms of transparency and governance. It is a positive sign that in these past 12 months, despite uncertainty at home and abroad, new net cash flows into equity funds have been positive -- $43 billion in new investment this past January alone. Investors have not lost sight of the opportunities presented by our capital markets. And Wall Street has learned not to lose sight of the investor. Still, investors want to see real returns on their investment dollars. They want to see CEO’s devoting their time to managing and growing their businesses. They want to see companies spending reasonable amounts of resources on disclosure and compliance. So now let me conclude with some specific suggestions on how implementation of these new rules can be streamlined – so that the principles of Sarbanes-Oxley remain intact, but at a price that makes sense to the economy:
We at the New York Stock Exchange would be willing to bring together a representative group of listed companies to discuss these rules and the cost-benefit of the new requirements. And, finally, let us insist upon standards of reasonableness in determining the resources that companies will have to spend to meet the rules. I have every confidence that we can take these steps, and realize what Bill Donaldson said of Sarbanes-Oxley at its one-year anniversary last July. He said “Indeed, a new period marked by responsibility and realism could provide the foundation for a new era of long-term growth and prosperity.” Let us build that foundation – a foundation of good governance, dynamic entrepreneurship and competitive markets that strengthens investor confidence, and will ensure the United States remains the investment capital of the world. Thank you. 
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John A. Thain, CEO, New York Stock Exchange: Remarks To Economic Club Of New York City Investor Confidence And The Competitiveness Of U.S. Markets - Investor Confidence And The Competitiveness Of U.S. Markets
Date 27/05/2004