Mark Jickling

The collapse of Enron Corp. in the fall of 2001 had a peculiar side effect: accounting became front page news. For the next year, accounting fraud at a long series of Fortune 500 companies made headlines. The worst cases led to spectacular bankruptcies, mass layoffs, and criminal prosecutions. Many other companies remained intact, but paid millions of dollars to settle charges that their books did not correspond to financial reality. The economic costs of the corporate scandals were substantial: trillions of dollars in shareholder wealth lost and a climate of uncertainty that may have suppressed business investment and hiring after the 2001 recession ended. The barriers to corporate fraud set in place after the Great Depression had clearly failed to protect public investors and were put under close scrutiny. Congress responded by passing the Sarbanes-Oxley Act of 2002, strengthening regulation of auditors, directors, and corporate executives and increasing criminal penalties for fraud. During the 2003-2004 school year, Professor William Black's class at the Lyndon B Johnson School of Public Affairs of the University of Texas examined corporate fraud from a multi-disciplinary perspective. Rather than viewing fraud as simply a securities law matter, the class considered the insights of criminology, sociology, management science, business ethics, behavioural economics, complex systems theory, and other fields. This book is the result of their investigations. The book focuses on the internal controls on American corporations (including corporate governance, business ethics, managerial structure and compensation, internal counsel, and whistleblowers), as well as external controls (government regulation, external auditors and accountants, and the judicial process). A recurring theme is the limited efficacy of many safeguards and watchdogs in cases of "control fraud," where fraud is directed or abetted by top management, and where unethical or abusive practices may become the organisational norm. It may then be easier for employees, directors, auditors, and even government regulators to go along with the prevailing trends, rather than take a stand which might disrupt the smooth functioning of the business, and could bring on devastating personal and organisational consequences. Another broad question raised by the book is whether the post-Enron scandals were a one-time event, made possible by the stock market bubble of the 1990s and several other unique historical developments which together constituted a "perfect storm," or whether fraud is a cyclical phenomenon associated with the end of long bull markets. The question has policy implications: if recent corporate scandals represent an unfortunate result of a unique set of conditions, one might conclude that the restraints now in place are sufficient to prevent outbreaks of fraud under normal circumstances. On the other hand, if fraud is cyclical and can be expected to reappear once stock prices begin to soar again, one might conclude that the post- Enron scandals have revealed fundamental weaknesses in law and regulation.

Congress passed the Sarbanes-Oxley Act of 2002 (P.L. 107-204) to remedy weaknesses in accounting and corporate governance exposed by massive fraud at Enron Corp. and other firms. Criticism of the law, which has been fairly widespread among business groups, academics, and accountants, focuses on the costs of compliance, which are said to outweigh the benefits. Several studies and comments have argued that the rising cost of regulation has created incentives for firms to list their shares on foreign markets or to withdraw from the public markets altogether, weakening the international competitive position of U.S. stock exchanges. Specific evidence cited includes the fact that 24 of the largest 25 initial public stock offerings (IPOs) in 2005 took place on foreign exchanges, and that there has been a boom in the private equity market, where U.S. securities regulation is minimal. This book attempts to put instances like these in context by presenting comparative data on the world's major stock markets over the past decade.In terms of the number of corporations listing their shares, several foreign markets have shown faster growth than the major U.S. exchanges (the New York Stock Exchange (NYSE) and Nasdaq). However, these increases appear to be fueled primarily by growth in the number of domestic firms listing on their own national markets. While major foreign markets have seen significant declines in foreign listings as a percentage of all listings, U.S. exchanges have not been abandoned by foreign companies in significant numbers. Perhaps the most common reason for firms to delist, or leave a stock exchange, is a merger with another firm. Lower costs of regulation may be a side benefit of many mergers, but trends in interest rates and stock prices appear to be the primary determinants of merger activity. A rising number of corporate acquisitions result in the acquired firms "going private" -- becoming exempt from most regulation -- but this trend is also largely driven by economic conditions. Private equity investment has boomed since 2000 because debt financing has been abundant and relatively cheap, and because institutional investors have sought higher yields than what the stock and bond markets have provided. Figures on new issues of stock (including IPOs) are volatile, and annual data may be skewed by a few large deals. Certain foreign exchanges have recovered more quickly from the 2000-2002 bear market, but, on the whole, there is little evidence that the U.S. stock market is becoming less attractive to companies seeking to raise capital. When the bond markets are included, the role of the U.S. securities industry in capital formation appears to be as strong as ever. The data surveyed here suggest that rising regulatory costs have not precipitated any crisis in U.S. markets, and that the outcome of global competition among stock exchanges depends more on fundamental market conditions than on differentials in regulatory costs.

As government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac are hybrids: created and chartered by Congress for specific public policy purposes, they are nonetheless private, profit-seeking businesses whose shares are traded on the New York Stock Exchange. Their "government-sponsored" nature confers certain advantages over their purely private competitors. As a result, their operations have expanded rapidly over the years and they long ago assumed and continue to play critical roles in the residential mortgage market. This book provides background on the GSE reform issue, summarises the provisions of H.R. 1427 and S. 1100, and compares them to legislation passed by the House in the 109th Congress.