In recent months, a number of studies have been released addressing the question of whether burdensome US financial regulations are making US financial markets less competitive—driving fledgling corporations to go public in other, more lightly regulated jurisdictions. The first study was released last November by a recently formed Committee on Capital Markets Regulation (CCMR). Another study was by mayor Bloomberg and Senator Schumer. A third was from the United States Chamber of Commerce. Also, the American Enterprise Institute and Brookings Institute recently held a joint conference focused on these studies. The studies and conference represent important work, and their conclusions should be carefully weighed. Caution is also necessary. A central observation of the CCMR study is the fact that "5% of the value of global initial public offerings was raised in the US last year, compared to 50% in 2000." This is a compelling statistic, but what does it mean? Does it indicate a need for sweeping reform of US regulations in order to make US financial markets more competitive, or does it merely highlight a known problem with one section of one existing US law? I am speaking, of course, of Section 404 of the 2002 Sarbanes-Oxley Act (SOX). SOX was a brief reversal in a prolonged dismantling of US financial regulation. Consider that financial derivatives spread in the 1980's as a massive end-run around a number of regulatory safeguards. We spent much of the 1990s wondering what the regulatory response might be. Aggressive lobbying ensured there was none. We ushered in the new millennium by discarding the Glass-Steagal Act, which had eliminated a variety of conflicts of interest from the capital markets. Well, guess what? The conflicts of interest are back. Compounding all this, in 1996, president Clinton signed the National Securities Markets Improvement Act, dismantling parts of the venerable 1940 Act. Restrictions on unregulated investment funds were loosened, paving the way for explosive growth in hedge funds and private equity funds. The CCMR study noted that "Private equity firms, almost non-existent in 1980, sponsored more than $200 billion of capital commitments last year alone." It goes on to suggest that "The dramatic increase in the use of private US markets is important evidence that regulation and litigation are contributing to the flight of many companies from the public market." This is not what recent history tells us. If Congress and president Clinton hadn't gutted parts of the 1940 Act, private equity funds would hardly exist. They have flourished, not because US regulations have been too burdensome, but because a particular US law was weakened. When it comes to debates, how a debate is framed often determines how that debate concludes. You can imagine where a debate about whether US financial regulations make US financial markets uncompetitive is likely to lead. If we slash our regulatory safeguards in the name of US competitiveness, other nations will do the same. The result will be a "race to the bottom" in which nations compete over who has the flimsiest regulations. A similar race to the bottom occurred in the 1800's, when US states competed over which would have the weakest incorporation laws. Delaware won the race, and that state has dominated US incorporations since. That particular gutting of regulations contributed to problems with corporate governance, which we are still dealing with today. During the 1990's, international bank regulators avoided a race to the bottom in banking regulation when they implemented the international Basel accords. These set minimal banking regulatory requirements that have more or less been accepted worldwide. The minimal requirements meant there was no race to the bottom, and everyone benefited. A similar international accord would be one way to avoid a race to the bottom on corporate finance regulation. The scandalous headlines of 2001-2002 have abated, but the underlying problem of corporate governance remains. Owners of corporations have lost control to managers who, in the 1932 words of Berle and Means, "employ the proxy machinery to become a self perpetuating body, even though as a group they own but a small fraction of the stock outstanding." The recent studies on US financial regulation have highlighted the important role that shareholder rights must play in a successful financial system, and they rightly call for market-based solutions. Last November, I published an article in the Financial Analysts Journal proposing a market-based solution that would address the crusty problem of managers unaccountable to shareholders. The idea is to revamp the proxy machinery by implementing a "proxy exchange." This would allow shareholders to transfer their voting rights to anyone—an uncle, a charity, a union, a financial advisor, a faith-based organization—anyone willing to accept them. The solution would, first of all, be simple. A working mom might transfer all her current and future voting rights—rights she owns directly or indirectly through a brokerage account, mutual funds and pension plans—using a free, secure website. It would take a single mouse click, and she would be done. What is more, she wouldn't have to be a financial expert or have to research any confusing proxy materials. She would simply transfer the rights to someone she trusted. She could make her selection once and never need to change it. But she could always change it later, if she wanted. Suppose the woman transferred her rights to her uncle. What would he do with them? Well, he would be in the same position as the woman. Like her, he would have an account on the exchange. This would hold all his voting rights as well as the voting rights the woman has transferred to him. With a single mouse click, he could transfer all the voting rights to anyone he chose. In this way, the proxy exchange would facilitate the aggregation of voting rights. Small blocks of rights would be aggregated into medium blocks. Medium blocks would be aggregated into large blocks. Unlike the present model of corporate governance, where large blocks of voting rights inevitably fall in the laps of corporate managers (or occasionally corporate raiders), those large blocks would end up in the laps of institutions whose interests are more aligned with the financial, environmental, political and ethical concerns of the ultimate shareholders. No longer would corporate managers be a "self-perpetuating body." The problem of corporate governance would be transformed. If you have not already done so, please take a look at my paper, which describes the concept in greater detail. If you have comments or questions, please post them here for others to read. Finally, if you believe in the idea of a proxy exchange—or would just like to see it debated in a wider forum, there is an opportunity to help out. The SEC is planning to host three roundtables on proxy voting this month, and they have solicited comments from the general public. I have already submitted my paper to them. Please add your voice to mine by submitting your own endorsement of, or comments on the concept of a proxy exchange. The SEC has set up a special webpage for you to do so. Thank you. Glyn A. Holton
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