The Hindu Business Line : Over-regulation can drive companies out of the public markets

LATELY, more frightening than the market noise has been the regulatory sabre-rattling. Thus, one day we heard party spokespersons putting a spoke in the Sensex wheel, by talking of the strange smell of scam even as the Finance Minister hurriedly reassured everybody that there was no foul play. Another day, the regulator came up with dos and don'ts to guide investors; and the day's news spoke of exchanges on `high alert'. The index saw seismic shifts, reportedly because the Government had ordered a probe.

Quite aptly, a recent posting on www.accountingweb.co.uk asks, "Is regulatory pressure hitting the stock exchange?" The story is about a report from KPMG titled `The pressure of regulation on business'. Though it is not about our markets, there are valuable insights to draw from the report.

The foreword by Mike Rake, Chairman, KPMG International, notes that there can be `unintended consequences' of regulatory pressure, and that these may not necessarily work to investors' advantage.

"Many suspect that business is becoming more process-driven as a result of the regulatory pressures," reports Rake, giving a glimpse of the views packed in the report. Consensus seems to be that judgment and principles, rather than rules, are important for the security and stability which capital markets require, he writes.

Robert Bruce's overview captures some of the punch lines: "`Everyone is doing too much', said Prof. Dr Klaus Pohle, Chairman of the German Accounting Standards Board. `We are reaching a high point of regulation', said Paul Boyle, Chief Executive of the Financial Reporting Council in the UK. `It is unfortunate that everything is now seen as happening at once', said Sir David Tweedie, Chairman of the International Accounting Standards Board."

Extensive and cross border reactions in a post-Enron world are seen to have caused rather more chaos and cost than they have brought certainty to investors, states Bruce. Sarbanes-Oxley or SOX law has turned into a bugbear to the US corporate world. The key Section 404 in the SOX legislation is 171 words long, points out Sir David Tweedie. "The interpretation of it from the Public Company Accounting Oversight Board (PCAOB) runs to 20,000 words. And the big accounting firms are issuing around 100,000 words each of guidance."

SOX is feared to have "not only produced too much irrelevant systems work but also failed to focus on the real issues."

Boyle is worried about the movement towards the high point of regulation, with the pendulum swinging too far. "Certainly there is widespread concern that regulation has gone beyond the point at which it is useful. The balance between investor protection and creating prosperity may have been over-stepped," he says, and that may sound like a universal truth.

"It is very easy to say that every new regulatory requirement applies to all listed companies. But many listed companies are now smaller than unlisted companies. We cannot carry on putting obligations on publicly held companies. The attractions of being publicly held will diminish," says Boyle about the overhead of being a widely held company. Over-regulation can drive companies out of the public markets.

Universal norms such as International Financial Reporting Standards (IFRS) look attractive. But Boyle cautions that the cost of implementing IFRS will turn out to be more than people expected. "Everyone was completely enamoured of the idea when we were still in the aftermath of the dot.com bubble. But if someone had produced a full project plan back then, showing the costs of implementation, the cost of agreeing the texts of the standards, the rising costs of implementing them, the demand for interpretation committees, the enforcement authorities in different countries all collaborating, the increase in enforcement authorities, then a different view might have been taken."

Robert Koethner, Vice-President for Accounting, Planning and Reporting and Chief Accounting Officer at DaimlerChrysler, suspects that SOX has become a job-creation programme for accounting firms and law firms, "with the accounting firms winning from two sides — new accounting standards and internal control over financial reporting requirements", and the law firms benefiting from the governance regulations. He is categorical that in many cases organisations have been harmed. "People should care about selling their products. Whole organisations have been infected by these regulations."

Neil Lerner, Global Head of Regulatory Issues, KPMG, makes a wry comment: "For years people have been complaining about what they saw as under-auditing. Now they are complaining about over-auditing." The focus on regulatory requirements has dulled the focus on business itself, he adds. "It is not so much the cost but the management time."

Pohle concedes that there are positive effects in the form of improved transparency, corporate governance and `more comparative figures'. To counterbalance, the enterprise is burdened by too much administrative work, he adds. "If you look at a simple balance sheet it will have been reviewed by the audit committee, the auditors, the enforcement agencies and the board of the company. All that costs money. The investor is paying a lot of money for these improvements and I am not sure the improvements are worth the money we are spending."

As if to offset, Stavros Thomadakis, Chairman, Public Interest Oversight Board, welcomes regulation. "`The long-term effect of improving corporate governance and accounting and auditing standards all have a dividend in the form of higher confidence. It will be easier for companies to raise capital. There will be less volatility than in the past and the risks of fraud will be easier to recognise and avoid, to the obvious benefit of investors," says Thomadakis.

A report you'd love to read for the lessons it offers. And, when visiting www.kpmg.co.uk for the download, don't forget to see other recent studies from the firm. For instance, `Hedge Funds: a catalyst reshaping global investment' is a global research paper identifying "the impact of hedge-funds on key components of the investment industry"; and the `International Survey of Corporate Responsibility Reporting 2005' encompasses "trends in Corporate Responsibility reporting of over 1600 of the world's largest companies".

AccountSpeak@TheHindu.co.in

D. Murali

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