Are foreign issuers shunning the U.S.? Lots of rumors suggest that's happening, and there is some evidence that listings here have suffered in the wake of Sarbanes-Oxley. But the situation is complicated, and more than just rules are involved.

There's a theory out there, the kind heard around water coolers and in the halls during investment banking seminars, that the Sarbanes-Oxley Act is a bogeyman scaring potential foreign registrants from U.S. exchanges. More specifically, the rumors say, the Act's Section 404, the infamous internal controls section, has become to overseas firms a kind of horror story passed around the proverbial campfire.

[ILLUSTRATION OMITTED]

The stories aren't new; they've been building over the past three years as U.S. public companies wrestled with the law and the number of foreign companies opting not to list in the U.S. has surged. And, like most stories, there is both truth and misperception. A closer look shows that the situation is far less black-and-white than it might seem on the surface.

Statistically, there's no question that foreign exchanges are doing much more business--but not all of that is being taken from the U.S. And while Sarbanes-Oxley is frequently cited as a reason for steering clear of the U.S., market observers say those fears have been moderating as the law's dimensions have become better known. Moreover, many foreign companies continue to list in the U.S.--listing dollar totals have doubled this year over last--because its capital markets are the deepest, the most liquid and the most transparent in the world.

Still, it's impossible to ignore a number of developments with respect to foreign issuers:

* The rise of the London Stock Exchange's Alternative Investment Market (AIM), which has become a market of choice for many emerging companies, including many in the U.S. (see "The AIM is Growth," box on this page). It touts its regulatory "flexibility" and lack of formal, documented requirements for its sharp growth in recent years.

* The continued distaste in Europe for Sarbanes-Oxley-type regulation. "The European tendency is to let issuers regulate themselves by adopting codes of corporate governance, not to impose good practice on them, as Congress and the SEC [Securities and Exchange Commission] do," wrote Prof. Roberta Karmel of Brooklyn Law School in an article in the Bowne Digest in October 2004.

Similarly, a study by Mazars, the European accounting and professional services firm, indicated that European companies were more hostile to this type of regulation than those from Asia and Latin America, which saw compliance as a means of winning investors' trust.

Episodes like the flight of Porsche AG, the German sports car legend, certainly provide evidence of some European annoyance. In October 2002, Porsche announced it had decided not to go forward with its intended listing on the New York Stock Exchange (NYSE), due to Sarbanes-Oxley. It subsequently listed on the Frankfurt Stock Exchange.

* The documented chill coming from Asia. According to Dealogic, which tracks investment banking transactions, in 2000 the NYSE and Nasdaq had a 25 per cent market share (in value terms) of listings from companies based in Asia, excluding Japan. In the year to date, the comparable number is a paltry 4 per cent.

* The fact that all but one of the 25 largest initial public offerings (IPOs) last year listed outside the U.S. Many of those, however, were state-owned enterprises that chose to list on their local exchange, including China, where three of the five largest IPOs in 2005 came out on the Hong Kong Stock Exchange.

Yet, for all of this, the dropoff in foreign registrants hasn't been exactly momentous. The total fell from 1,344 at yearend 2001 to 1,236 at the close of 2005, a slide of 8 percent (see table on page 28). The Over-the-Counter (OTC) index for small companies still has the most listings, followed closely by the NYSE and then Nasdaq, both for its Stock Market and the Capital Market for small-cap companies. Canadian companies represented fully 515 of the listings, or 42 percent; the U.K. was a distant second, with 88.

"There is something there" in terms of Section 404 being a deterrent to foreign issuers, but the Securities and Exchange Commission "doesn't want to put the brakes on any import of foreign registrants, only to have them go elsewhere," says Jerry Arnold, a professor at the Leventhal School of Accounting at the University of Southern California. (A related issue, which finds the regulatory burden driving listed companies to "go dark," or de-list from U.S. exchanges, will be covered in an upcoming issue of Financial Executive.)

Certainly, U.S. regulators haven't had their heads in the sand on the subject of foreign issuers. The SEC has provided repeated extensions to foreign registrants for compliance with Sarbanes-Oxley Section 404 (see "Cutting Foreign Filers a Few Breaks," on this page), and regulators have spoken out about the issue directly, as well.

For instance, Public Company Accounting Oversight Board (PCAOB) Board Member Charles Niemeier, speaking in August to Brazilian executives and securities officials, said: "Today, some in the United States complain that burdensome regulation has discouraged companies from tapping U.S. capital markets. In support of this argument, they point to circumstantial evidence such as the number of large new IPOs choosing to list on non-U.S. markets as well as the growth in the London Stock Exchange's Alternative Investment Market for smaller companies, but it's not clear to me that this is the case."

Niemeier argued that more than compliance costs, the expenses associated with an IPO in the U.S. might be the problem. A recent study, he noted, estimated that underwriting fees consume 6.5 to 7 percent of IPO receipts in the U.S., compared to 3 to 4 percent in Europe.

Arguments for U.S.

Officials at the NYSE and Nasdaq have taken the high road, promoting the value of listing in the U.S. rather than disparaging standards elsewhere. "For the non-U.S. companies, the U.S. provides unrivaled access to a very deep and broad pool of investors and enables companies to extend their own visibility on a global stage," noted Noreen Culhane, executive vice president of the Global Corporate Client Group at the NYSE, in a report on IPOs published this year by Ernst & Young.

At Nasdaq, Charlotte Cross-well, head of International Listings, has noted that "Sarbanes-Oxley has taken away some of the bigger business from the U.S., due to the complexity of listing for those companies, but people are becoming more familiar with Sarbanes-Oxley, and there is the desire to comply with the highest corporate governance standards in the world."

Others outside the exchanges echo those sentiments. "Our financial markets are based on knowing that the financial statements of every company are accurate," says Ronald Mosimann, president of BI International, a consulting and software firm in Malvern, Pa., that specializes in Sarbanes-Oxley compliance. "Companies currently listed or desiring to be listed in the U.S should take pride in that principle. Meeting this high standard separates and makes our financial markets superior from those overseas."

"There is no market that understands our business better than the U.S.," said Shaun Wang, CFO of Baidu.com, after Baidu did an IPO on Nasdaq in August 2005. The Chinese-language search engine didn't want to list in Hong Kong, he said, adding, "For a technology offering, the Nasdaq is the place to be."

A great deal of the attitude toward the U.S. from foreign firms depends on variables like size, company history and country of origin. Mary Anne Busse, managing director of Great Disclosure LLC, an advisory firm in Royal Oak, Mich., and a former SEC lawyer, has been leading compliance training for larger companies from Europe, Canada and Latin America.

"What I hear from a lot of folks that come to our training is that they are basically gearing up for dealing with compliance," she says. "Most of them are very large multinationals, and they're deciding to bite the bullet and comply." Just about all are already reporting in their home counties and experiencing a certain level of regulatory oversight, she says.

Busse says that a number of more mature companies have come to see the value of listing in the U.S. and regard Sarbanes-Oxley as a cost of doing business here. But for far smaller and newer companies, the equation may be a lot different. A U.S. listing "may be cost-prohibitive for the smallest issuers," she says.

For foreign companies in general, Busse adds, "there has always been a hesitancy to come to the U.S. They're asking themselves, 'What rewards will I reap?' And the cost of entry has tripled or quadrupled [under Sarbanes-Oxley]."

It Isn't All About Regulation

Some foreign companies choose to list outside the U.S. for reasons that have nothing to do with regulation. "Given our industry specialization and [the fact that] our peer group of companies, such as BHP Billiton and Rio Tinto, are listed in London, it was the natural choice for us as well," said Young Keu Cha, CEO of Kazakhmys, a major copper producer in Kazakhstan, in an interview last year. He added that "the U.S. is too far away, and our managers do not know this market."

A newfound liquidity is washing over Asian markets, and exchanges there are perceived as relatively well-regulated. Companies no longer have to suffer long flights to the U.S. to drum up capital, and a number of key U.S. fund managers work in Asia as well.

Moreover, far from shying from stricter codes, Japan is preparing to adopt its own version of Sarbanes-Oxley. The so-called "J-Sox" law, drafted earlier this year, would apply language similar to Sections 302 and 404 for Japanese companies, effective April 2008; some 3,800 Japanese-listed companies would be subject to the law.

What's happening in other burgeoning Asian cities like Singapore and Hong Kong is indicative of a new era. "We are seeing the continued globalization of capital markets, with increasingly more companies, investors and exchanges looking worldwide for growth opportunities," says Gregory Ericksen, global vice chair of Strategic Growth Markets for Ernst & Young. "This is causing a shift in the IPO landscape."

Statistically, the U.S. share of IPOs dropped from 36 percent in 2001 to 24 percent last year. But it isn't simply a matter of companies turning from the U.S.; they are embracing their home markets. A record 29 countries hosted IPOs of $1 billion or more last year, a strong signal of the diversification of markets around the globe.

Moreover, the fact that the biggest IPOs of 2005 and this year--the $9.2 billion issue for China Construction Bank and the $11.2 billion offering for Bank of China, respectively--went to market in Hong Kong defies the theory that companies over a certain size need to list in the U.S. in order to raise sufficient capital.

Still, U.S. regulators aren't changing their rules in response. While willing to cut foreign issuers some slack on deadlines, it seems clear that they haven't been ready to create Sarbanes-Oxley "Lite" or otherwise water down standards to lure foreign registrants.

Change may be in the wind, however. The creation of a new commission, The Committee on Capital Markets Regulation, in mid-September does signal concern on Wall Street and in Washington. The body is tasked with recommending changes to regulations, including Sarbanes-Oxley, if they are deemed to be hurting the competitiveness of U.S. capital markets.

The committee has high-profile leadership, being co-chaired by former White House economic adviser Glenn Hubbard and former Goldman Sachs President John Thornton. Its recommendations are due in late November, and they may send a strong signal about how concerned U.S. officials are about whether rumor has now become fact.

RELATED ARTICLE: The AIM Is Growth

The London Stock Exchange (LSE) may still be an also-ran in relation to The New York Stock Exchange and Nasdaq, but its Alternative Investment Market (AIM) for small and growing companies has been getting plenty of action and a lot of buzz as an option to its U.S. rivals.

AIM has been around since 1995, but has been catching a growth wave that truly seems to coincide with the arrival of the Sarbanes-Oxley Act in 2002. Since then, the number of participants has more than doubled, and the pace of "admissions," as AIM labels registrants, has increased each year. Small wonder that when U.S. regulatory burdens are brought up, AIM is a name on many lips.

"We are still advising companies with less than $300 million in capitalization to go to AIM because of the regulatory advantages," wrote Ernst & Young U.K. partner David Wilkinson in the firm's 2006 IPO Outlook. Those regulatory advantages include "light-touch regulation and tax breaks," the firm noted.

AIM isn't just about small companies, although those have been its lifeblood. Many companies, the exchange says, have transitioned to the Main Market of the London Stock Exchange "following their success and positive experience on AIM." More than 2,400 companies have signed on to the market since its formation, raising more than 30 billion pounds in the process, the LSE says.

AIM's appeal has been especially strong in English-speaking nations like the U.K., Australia and the U.S., observers say, but it extends to markets like the Far East, Eastern Europe and the Middle East. John Porter, a managing director with Morgan Stanley, says that the flexibility that AIM offers is its key appeal. While he senses some concern among venture capital firms about whether AIM is truly a credible exchange, he thinks that perception is changing.

To join AIM, companies don't need a minimum size, number of shareholders or financial track record--listing requirements that are clearly more liberal than those on the main U.S. exchanges. Rather than listing standards, AIM has a "rulebook" that is constantly being updated, the LSE says, to ensure that the rules "are pragmatic and practicable" for smaller companies.

A critical notion behind AIM is that of "Nomads," which stands for Nominated Advisors. "Nomads act as the principal quality control mechanism for AIM, and they carry out checks on companies before agreeing to sign a declaration that the particular company is appropriate and ready to come to AIM," the LSE notes on its website. The Nomads, in turn, are overseen by a team of market specialists at the LSE; these include attorneys, chartered accounts and corporate finance professionals.

Not surprisingly, success breeds competition. France has created a second-tier market, Alternext, as has Germany, the Entry Standard, which saw 15 companies list in its first month of existence after it began Oct. 25, 2005.

Roland Mosimann, President of BI International, a consulting and software firm in Malvern, Pa., that specializes in Sarbanes-Oxley compliance, thinks that the spate of interest in exchanges like AIM will dissipate over time.

"We've been working with a few venture capital firms, and they've been lamenting the fact that people have been going to the AIM in London to list," he says. "There's a short-term truth to that [notion], and there is some short-term arbitrage going on. But once [Sarbanes-Oxley] is stabilized, we believe there will be a perceived premium to being in the U.S."

--Jeffrey Marshall

RELATED ARTICLE: Cutting Foreign Filers a Few Breaks

You can't say the SEC is holding foreign filers' feet to the fire over compliance issues.

The agency has issued a series of extensions aimed at cutting foreign registrants a break on Sarbanes-Oxley compliance with Section 404, the critical section on internal controls. On August 9, for instance, the SEC took three actions to provide relief on 404 deadlines, each of which affects foreign filers.

A final rule extends the effective date for "accelerated" foreign filers to provide their 404-b attestations on internal control to the fiscal year ending July 15, 2007. A proposed rule would extend the effective date for "non-accelerated" filers, including U.S. and foreign companies, to the fiscal year ending Dec. 15, 2007 for the 404-a management report on internal controls, and a year later for the 404-b auditors' attestation.

First-time foreign filers, including initial public offerings (IPOs), also received a proposed extension. They wouldn't be required to provide either a management assessment or auditor attestation report on internal control in their first annual report with the SEC, but would be required to do so if they had already filed at least one annual report.

However, "large accelerated" foreign filers--generally deemed to have more than $700 million in market capitalization--have run out of extensions. After getting one in both 2004 and 2005, these registrants were given a firm effective date of fiscal year ending this past July 15 to produce 404 reports for the SEC in their next annual report.

"It is very encouraging that the SEC is listening to foreign registrants, who feel that they do not have the time to adequately assess the design of internal controls and to put in place cost-effective, long-term remediation strategies," Shaun Critten, senior partner at London advisory firm willismorris, said in a published interview with Ernst & Young. "Some companies have been looking at band-aid solutions to get them across the implementation line, yet these solutions may not be sustainable in the long term."

RELATED ARTICLE: takeaways

* Rumors abound that Sarbanes-Oxley, and its Section 404 in particular, have driven foreign companies from listing in the U.S. While there is some statistical support for that idea, the situation isn't that simple.

* U.S. regulators have extended the deadlines for foreign firms to comply with Section 404, but are holding fast against dilution any of its provisions.

* Globalization of capital markets and the growth of local exchanges are the major reasons for the migration away from U.S. listings. Companies believe they don't have to come to the U.S., and some are listing locally to bolster their home-country exchanges.

Foreign Registrants: A Slide, Not a Stampede

Year  Total

2001  1,344
2002  1,319
2003  1,232
2004  1,240
2005  1,236

Source: SEC Data