As I have noted in prior posts (most recently here), the several blue-ribbon panels that have recently examined the competitiveness of the U.S. financial markets have been particularly concerned with the apparent loss of company listings to overseas exchanges, particularly the London Stock Exchange’s Alternative Investment Market (AIM). These would-be reformers have cited AIM’s success as evidence that the U.S. regulatory structures, and the Sarbanes Oxley Act in particular, are driving potential issuers to competitor financial markets. They have similarly contended that in order for U.S. financial markets to reclaim their competitive position, the U.S. regulatory structure (and SOX in particular) should be reformed.
Lacking from these studies has been a detailed analysis of the causes of AIM’s success, and the absence of this perspective arguably has led the would-be reformers to proscribe “solutions” that may not be best calculated to help U.S markets meet AIM’s challenge. An August 2007 paper by Jose Miguel Mendoza of Javeriana University in Bogot�, Columbia, entitled “Securities Regulation in Low-Tier Listing Venues: The Rise of the Alternative Investment Market” (here), takes a closer look at the reasons for AIM’s success. His observations may suggest that an approach to regulatory reform that is more finely-tuned than that proposed by the reformers could be likelier to improve U.S markets’ competitive position while preserving its advantages.
Perhaps the most interesting aspect of Mendoza’s paper is his exploration of the historical reasons for AIM’s success. In his view, AIM’s success in recent years was in significant ways the result of historical circumstance. The failure of the other European New Markets (such as the Neuer Markt) left a relatively open field, at a time when the bursting of the Internet bubble in this country caused the senior U.S. exchanges to heighten listing requirements -especially with respect to minimum market capitalization requirements. These forces were exacerbated by the demutualization of the leading exchanges, and the exchanges’ conversion to listed, for-profit enterprises, which made smaller companies’ listings less attractive. As a result of these developments, a “public equity financing gap” developed for smaller enterprises, a need that the AIM was well-positioned to meet. As Mendoza puts it, the “main reason behind AIM’s growth lies with the fact that it supplies a scarce product to the marketplace: rapid and low-cost access to public equity for small firms with high growth potential.”
Mendoza also points out that AIM’s platform was successful because it was built in recognition that a “one-size fits all regulatory scheme” that works well for larger, better-capitalized companies may be poorly suited to the needs of smaller companies. AIM’s regulatory structure is “tailored to fit the needs of small firms with high-growth potential.” Mendoza characterizes this calibration of regulatory structure to company size and maturity as “the specialization of listing venues” and attributes AIM’s success to its specialization for smaller growth stage companies. As the same time, Medoza recognizes that more rigorous regulatory structures, which are better suited to larger, better-capitalized companies, can have benefits for those companies, such as lower costs of capital and higher valuations.
In my view, it is an appreciation for this aspect of AIM’s success formula that is missing from the would-be reformers’ analysis; that is, the reformers overlook AIM’s particular value and attraction for smaller companies. The reformers’ proposed across-the-board reforms is a purported “one size fits all” solution to a problem that is due to a “one size fits all” regulatory system. But an across the board regulatory reform could eliminate the advantages of the U.S. markets for better-capitalized listing companies that benefit from lower costs of capital and higher valuations on U.S exchanges as a result of the U.S.’s highly regulated system. As alternative reform proposal that would be more likely to enable the U.S. financial markets to compete with AIM would be one that is not across the board, but rather one that is, to paraphrase Mendoza, tailored to meet the needs of the smaller, growth-stage companies that are attracted to AIM but that may be closed out now from the senior U.S. exchanges.
For that matter, it may be that the competitive dynamic of the global financial marketplace is already tending in this direction, without the need for governmental action. The recent launch of the OTCQX listing service (refer here) is a direct marketplace response to AIM’s success. Similarly, the recent debuts of the Nasdaq Portal (refer here) and the GSTrUE trading platform (refer here) – both of which are designed to permit institutional investors to trade ownership interests in companies that are not interested or not able to take on the reporting company burdens and responsibilities – are two additional ways that the marketplace is evolving to challenge AIM’s success and to provide smaller companies with access to equity capital.
The arrival of these trading innovations and the likelihood that further advances of this type will follow suggests the possibility that regulatory reform may not even be necessary for U.S. markets to be able to meet AIM’s challenge. Although Medoza’s paper does not expressly address this point, the logical extension of his analysis is that if there is to be any reform, it should be fine-tuned to meet the competitive challenge, and that an across the board one size fits all approach could weaken current competitive advantages the U.S markets offer companies that are able to meet the U.S.’s stricter regulatory regime.
If Mendoza’s paper has a weakness, it is its tendency to minimize the concerns that commentators have noted with respect to the AIM approach (about which refer here). Even while acknowledging that it “remains to be seen whether [AIM’s] particular system of self-regulation can take the strain of increased numbers of non-UK companies” and that the “venue’s performance could have been negatively affected by the poorer quality of companies coming into the market during 2006,” he nonetheless is an emphatic advocate for AIM’s self-regulatory approach, and particularly for the benefits of its Nominated Advisor (Nomad) gatekeeper system.
Prospective issuers are clearly well aware of the potential shortcomings of an AIM listing (as discussed here), and that awareness will clearly affect AIM’s competitive position going forward – indeed AIM’s growth has slowed in 2007, and AIM offerings during the first four months of 2007 were more than 50% below the number of offerings in the comparable period in 2006.
If the U.S. financial markets want to not only regain their competitive position but in fact achieve a competitive advantage, the best approach would be to encourage further marketplace innovation calculated to meet the needs of smaller, growth-oriented companies, while avoiding the concerns that AIM market participants have noted. By the same token, an across the board regulatory reform that is not fine-tuned to meet the needs of smaller companies could weaken the advantages of the senior U.S. exchanges and ultimately reduce the competitiveness of the U.S financial markets.
My prior post examining the question whether the proposed reforms would solve a problem or introduce a weakness can be found here.
Hat tip to the Ideoblog (here) for the link to Mendoza’s article.
Add One to the Subprime Lawsuit Tally: Regular readers know that I have been maintaining (here) a running tally of the subprime lending-related securities class action lawsuits. The filing this past week of a new securities class action case against Thornburg Mortgage (press release here), brings the number of subprime lending related securities class actions to 13.
More About Climate Change and D & O Risk: In earlier posts (here and here), I have examined the possible risk exposure of directors and officers arising from regulatory, legislative and judicial developments involving climate change. In the latest issue of InSights (here), I take a closer look at “Global Climate Change and D&O Insurance.”