SECURITIES REGULATION IN LOW-TIER LISTING VENUES: THE RISE OF THE ALTERNATIVE INVESTMENT MARKET

Fordham Journal of Corporate & Financial Law, 2008 by Mendoza, Jose Miguel

As the U.S. markets slowly adapted to SOX's regulatory framework, the European Union became immersed in a series of corporate scandals of their own. Irregularities in high-profile European firms such as Parmalat and Hollinger, however, stemmed from a different source than the North American episodes. Whereas Enron, Worldcom and similar cases concerned manipulation of financial statements by management, Parmalat eventually collapsed after controlling shareholders misappropriated company assets in an amount close to $17 billion.77

Disparities in the corporate governance systems of the United States and Europe account for the methodological differences in both types of fraudulent behavior. The dispersed shareholder model that prevails in the U.S. and its equity-based system of executive compensation created a set of incentives for managers to engage in financial manipulation in order to maximize personal benefits.78 The European concentrated ownership model generated conditions under which controlling parties were able to expropriate other constituencies.79 Accordingly, the Parmalat racket largely consisted of controlling shareholders siphoning company assets through related party transactions.80 However, financial statement misrepresentations and other instances of fraud involving European public firms had been uncovered even before the Milan Stock Exchange suspended trading in Parmalat shares at the end of 2003.81 The European Commission responded by introducing a series of amendments, "including an Action Plan for the modernization of company law and plans for the reform of the statutory audit."82

Ultimately, securities regulation will have net positive effects if it reduces the cost of capital more than it raises regulatory costs for listed companies in a given jurisdiction.83 Regulatory costs, while varying in nature, are often imposed without regard to a firm's size or specific incentive structure.84 Accordingly, it is up to each firm to balance the costs of listing against its benefits when deciding whether to go public.85 If the introduction of strict auditing and disclosure rules raise listing costs too high, a firm may seek other listing venues, alternative financing mechanisms, or even undergo delisting procedures.86

However important this homogeneous cost structure is in ensuring investor protection, it might also become a deterrent for small-cap companies that cannot afford to endure such costs, or family firms that could derive higher benefits from remaining unlisted.87 It follows that one-size-fits-all rules can have negative spillover effects vis-à-vis smaller public firms, which are forced to bear a disproportionate part of the regulatory costs of listing.88 These firms are thus compelled to operate under low or even negative profit margins, which could eventually cause them to go private.89 Accordingly, it might be possible to specifically tailor cost structures to accommodate the needs of different types of firms, while still ensuring an adequate level of disclosure and investor protection.90 Specialized rules can be a natural outcome of increasing regulatory competition among stock exchanges.91 Even though some expect this competition to lead to convergence around uniform rules, the most likely outcome is increased specialization of listing venues.92