This newspaper has been highlighting ways in which our law firm constituency would recommend reforms following in the wake of recent recommendations laid down by the Commission on the Regulation of the Capital Markets in the 21st Century established by the U.S. Chamber of Commerce, Interim Report of the Committee on Capital Markets Regulation and the Bloomberg/Schumer Report on Sustaining New York's and the U.S.' Global Financial Services Leadership Report. In this interview, Mr. Burdumy addresses some of their recommendations.
Editor: What do you believe should be done to discourage accounting fraud? Has Sarbanes-Oxley been a panacea in this regard?
Burdumy: The Securities and Exchange Commission has done a good job with the implementation of Sarbanes-Oxley in trying to provide a framework for accounting firms to work with their auditing clients in determining material weaknesses and to identify areas subject to uncertainty requiring a restatement in the future.
In the small- to mid-cap company environment, CFOs are struggling with their auditing firms to come up with procedures that will meet the requirements of Section 404 in a cost-effective manner. The PCAOB recently attempted to address this problem by going to a more principles-based approach. In this regard they need to provide greater clarity and specific guidelines for compliance.
When companies encounter financial reporting problems, they fall into two categories. The number of cases involving outright fraud is very small. Sarbanes-Oxley was a reaction to Enron and WorldCom, an overreaction by Congress to a limited set of circumstances at the time. The other area of problems involves restatements, which typically come about because of the grey areas where judgment is involved, without guidance from the FASB or one of the other accounting boards. To the extent that regulators can provide greater guidance in these areas in the future, they will minimize the amount of restatements and perceived financial fraud.
Because CEOs and CFOs need to certify their filings with the SEC, they understand that they are on the hook both civilly and criminally. So, they are paying attention. People who run public companies are generally honest and understand the need to play by the rules, but they need to know what the rules are.
Editor: What impact has securities class action litigation had on the U.S. capital markets?
Burdumy: Having practiced many years in Philadelphia, the birthplace of the plaintiffs' securities bar, I have witnessed this practice become an industry unto itself. This has caused a shift in capital and resources to an area that is unproductive. For instance, the cost of D&O insurance has skyrocketed. While the number of companies looking to go public in the United States has declined, the number of U.S. companies looking to go public on foreign exchanges has increased dramatically. I have had a couple of clients that are looking to go public but are not considering the United States because of the increased compliance costs associated with Sarbanes-Oxley and the potential risk of litigation. The London Alternative Investment Market offers less burdensome and costly compliance requirements with less risk for litigation in the future. Also, companies listed on the AIM only have to report results semi-annually rather than quarterly, and there is no pressure for quarterly guidance. Companies can focus on preserving capital and growing the business rather than dealing with the anxiety of quarterly reporting.
The Bloomberg/Schumer Report highlights the flight of capital that has resulted from these concerns. This has made our markets less competitive and is converting London into the financial capital of the world. Hopefully, this wake-up call will result in the implementation of reforms to resurrect New York to the prominence it once held.
Editor: Do companies look to you for advice on selecting the proper capital market for listing?
Burdumy: I counsel them generally on ways to raise capital. I do not talk them into selecting a particular market, but I do talk with them about their options. I urge them to balance the costs of compliance, litigation risks and easier access to capital versus the benefits of being listed in the United States. It is in my own best interest to keep these companies here and list in our markets, but that does not make sense for all of our clients.
Editor: Do you have any experience with the AIM (Alternative Investment Market) in London?
Burdumy: Yes. It is a different process. It is NOMAD-driven. The company that wants to list engages a nominated advisor, which is an investment banking firm or broker. The nominated advisor is charged with the task of making sure that the prospectus that is filed with AIM complies with the AIM rules substantively and does not contain any material misstatements or omissions. The nominated adviser is selected by the company seeking a listing that is certified by the FSA as a nominated adviser. The process is different in that the nominated advisor is charged with the responsibility of the accuracy of the filing, having previously gotten the company's board to certify the statements. The company's officers meet with the nominated advisor and their counsel to go through the prospectus and offering document, with the counsel for the company certifying to the NOMAD that all the statements have been verified. Once that is done and the nominated advisor is comfortable with the document, it is filed with the AIM. Once filed, there is no separate review from a regulatory regime in the United Kingdom.
Editor: How will the U.S. capital markets compete with this process?
Burdumy: I believe that the SEC does a tremendous job. They have a very dedicated and talented staff that provides insightful comments. They are strapped for resources at times, but it is a different process. The SEC attempted, through its offering reforms, to streamline the capital-raising process by making it easier for well-known, seasoned issuers to be able to access capital. However, it is still very difficult for small-cap, micro-cap and mid-cap companies to access the U.S. capital markets in an efficient manner. These companies are bearing a disproportionate share of the burden on a percentage basis of the cost of compliance with Sarbanes-Oxley, which has a greater impact on their bottom lines. Therefore, many of these companies choose to raise capital in foreign markets because it is faster, easier and less expensive.
Editor: Do companies raising capital abroad end up with primarily foreign shareholders?
Burdumy: They do initially. After a certain holding period, the stock becomes freely tradable and can be purchased by U.S. shareholders. Many U.S. institutional investors are reluctant to invest in small cap companies. However, those purchasing stocks listed in AIM do not have the same bias.
Editor: How should U.S. regulators deal with the concerns raised by your clients?
Burdumy: While there are always going to be bad actors for whom you need to have processes in place, there needs to be a balance between catching the bad actors while making it easier for legitimate enterprises to access the capital markets in a cost-efficient manner. This would help to retain the competitiveness of the U.S. economy. Much capital is devoted to compliance issues, D&O insurance and litigation risks in the United States. while other countries have a smaller percentage of capital devoted to these expenses. They are better able to invest in new businesses and hire new employees to grow the economy.
Editor: Please discuss your clients' concern with the litigation environment.
Burdumy: Many cases involve companies that do not meet their quarterly guidance causing the stock to drop. Plaintiffs immediately target these companies with securities class action suits.
The result is that lawyers begin to practice defensively because they want to avoid these cases. The CCMR Report talked about the possibility of having arbitration available to plaintiffs. The report recommended that parties to a dispute should have the option of using arbitration so that through a class action mechanism they can arbitrate the matter. This would be a faster and less expensive alternative. For these people who do not have the resources to hire lawyers, the class action format may be the only mechanism for them to receive compensation. Nevertheless, the percentage of recovery that shareholders actually get versus the size of the recovery is not large. There should be another alternative that would afford those harmed the ability to receive a larger recovery to mitigate their losses but also minimize the amount of meritless claims being brought. Also, someone bringing a baseless suit should have to pay a company's legal expenses and fees, thereby discouraging frivolous suits.
The SEC attempted to improve the situation when it adopted the PSLRA in 1995, which has reduced the number of cases as a result of the pleading requirements. Even with the heightened pleading requirement, though, there are still a large number of cases being brought.
Editor: Do you believe that companies should have a self-evaluation privilege to protect information provided to regulators from third-party access?
Burdumy: I believe that this is a correct approach. The problem companies face is that if they waive the privilege in their desire to cooperate with regulators, they are then vulnerable to third-party suits. But if the companies do not waive the privilege, they are seen as being uncooperative. The self-evaluation privilege is a good middle ground approach - submitting information to regulators under a confidentiality agreement should not result in a waiver of the privilege. If the company determines that something has gone awry, management would be able to negotiate immediately with the SEC rather than waiting for a formal enforcement action. Honest actors will want to correct issues that are discovered at an early stage. By cooperating with companies, the SEC will not have to devote resources to pursuing the large number of cases they are pursuing now.
Editor: Should the SEC refrain from implementing new regulations through its enforcement actions?
Burdumy: Yes. In the hedge fund industry particularly, there is regulation by enforcement that is problematic for clients because there is not clear guidance on what the rules are in many areas. For example, for years short-selling had not been of primary SEC concern. Then Regulation SHO was adopted a few years ago, which was intended to set the rules for short-selling. Nevertheless, these regulations left a lot of gray areas without clear guidance. Afterwards, there were a number of enforcement actions brought by the SEC against hedge funds based on activities that were not addressed by Regulation SHO. If there are areas that the SEC wants to address, they need to analyze those areas, publish proposed rules and let the industry comment on them, providing clarity to the situation.
Editor: Does it make sense for the SEC to implement a cost/benefit analysis of proposed new rules?
Burdumy: While the SEC has tried to do this in the past, the numbers they use often fall short of real costs, so they need to refine their approach. They should reach out to industry or trade organizations to get feedback on what proposed rules will actually cost from a compliance perspective.
Editor: Would clients have difficulty dealing with a shift from U.S. GAAP to IFRS accounting standards?
Burdumy: I believe it is a good idea as long as it would not require U.S. companies to have to undergo a major shift in their reporting system. Given the global economy we live and operate in, it will be an absolute necessity to implement a global accounting standard. Since the markets are scrutinized on a 24-hour basis, all companies would be reporting on the same basis. I have a situation where a U.S. client listed on AIM filed their statements in U.S. GAAP form because there is no requirement for them to change their accounting principles. This makes a lot of sense.
Editor: What impact do foreign investment opportunities have on the U.S. capital markets?
Burdumy: When you look at India and China, where the investment opportunities are great, we are seeing more capital focused in that area. This causes me great concern. We need to evaluate whether our competitiveness as an economy is going to continue to erode; as a result, we need to be prepared to act quickly to rectify this.