Research Spotlight: Debugging the financial system

A bug in the financial systemDo fewer regulations make markets such as New York City more competitive with other global financial centers such as London? New research by Caruth Chair in Finance Darius Miller of SMU’s Cox School of Business, Ugur Lel of the Federal Reserve Board and Nuno Fernandes of IMD International shows that relaxing rules for foreign firms listing in the United States actually has had the opposite effect.

In March 2007, the Securities Exchange Commission (SEC) passed Rule 12h-6, which loosened the regulations of the 1933/1934 Exchange and Securities Acts. The rule required foreign firms that list on the New York Stock Exchange (NYSE) to maintain registration with the SEC as long as there were 300 shareholders of record. Thus, foreign firms that wanted access to U.S. capital markets were held accountable to their investor protections, including reporting requirements, laws and enforcement.

Think tanks and industry experts lobbied the SEC to amend the 300-shareholder law. “[The SEC] relaxed the rule to allow easier deregistering,” Miller says. “The argument was that it was so hard to come to the U.S. and then leave, if needed.” Lobbyists maintained that foreign firms that might list in the United States would fear becoming trapped in a “roach motel” – where they could check in but not check out – and would prefer therefore to go to London.

The goal of the deregulation was to encourage more foreign firms to register in the United States. However, the number of deregistrations has increased dramatically. In fact, 80 firms have left since the rule was changed – the most in U.S. history.

“There was in fact a value to this type of regulation, which has been lost in the debate about regulation and U.S. financial market competitiveness,” Miller says. Though regulation is costly, there are benefits to investors, especially for certain types of firms. Now that the SEC has made it easy to leave, the type of firms that left early were those with previous run-ins with the law and those that were doing suspicious things, Miller noted in the study’s findings. “It doesn’t give one confidence that we’re doing the right thing by relaxing the rule,” he remarked.

The paper, “Escape from New York: The Market Impact of Loosening Disclosure Requirements,” will be published in Journal of Financial Economics.

Read more at the Cox faculty research website