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SEC Disclosure Reg: a Perilous Foray into Foreign Policy

Author: Benn Steil, Senior Fellow and Director of International Economics
September 3, 2001
Securities Industry News

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In a May 8 letter to Congressman Frank Wolf, acting Securities and Exchange Commission chairman Laura Unger revealed that the SEC would now require foreign companies listed on US exchanges to disclose business dealings in countries-such as North Korea, Iran and Libya-that are subject to US commercial sanctions. It is hard to imagine what agenda could possibly lie behind this awkward lurch into foreign policy by America's securities and stock market regulator.

This and past US administrations-all the way back to the middle of the last century-have placed free trade and open markets at the center of their foreign and economic policy agendas. Open capital markets have been a particular interest as the United States has attempted to overcome non-tariff trade barriers so as to allow its financial institutions to operate in foreign markets under a policy of national treatment. Of all the US financial regulatory agencies, the SEC has been the most criticized for imposing restrictions on foreign entry to US securities markets that come closest to the non-tariff barriers the US has denounced elsewhere. Now, it seems, that agency is determined to live up to its reputation by injecting foreign policy considerations into what should be purely a matter of financial due diligence on the part of American investors.

The SEC's actions are even stranger because its mandate is so narrow. The agency's role is not to advise investors about what would be good for them-let alone the United States-but simply to insist that companies disclose all material facts about their activities. Thus, if a company's business were so heavily dependent on its operations or sales in a country under US sanctions that it amounts to a material fact about the company-perhaps because US sanctions may ultimately impair the company's profitability-the SEC would be justified in requiring disclosure in the company's prospectus and periodic reports. But that is current law anyway. If the SEC is asserting that a foreign company's lawful operations in a country covered by US sanctions is a material fact for investors-even though those operations would not be a material portion of the company's business-it can only be to damage the company's ability to market its securities in the United States. Such a policy is beyond the authority of the SEC and a clear violation of the long-standing trade objectives of the United States.

Although this step is reminiscent of the SEC's successful effort, in the 1970s, to require US companies to disclose whether they were paying bribes to foreign officials, that is not an apt analogy. Responding to objections that the bribes were not material to the financial position of the companies involved, the SEC asserted that the willingness of a company's management to pay bribes was a material fact about the company. This point won the argument, and eventually Congress passed legislation that endorsed disclosure of foreign corrupt practices. But how is it a material fact about a foreign company that it is engaged in entirely lawful activities under the laws of its home country, involving no moral turpitude, which happen to violate regulations applicable only to US companies? The extraterritorial implications of this policy are breathtaking. Would it be a material fact about a foreign company that it does not pay overtime in accordance with US wage and hour laws? Or that it doesn't clean up mining sites in its home country as EPA regulations might require? Or that it doesn't offer medical care for the same-sex partners of its employees? These questions might well be important to some investors'and in that case they should seek satisfactory answers before investing-but it is not the business of the SEC to require disclosure of these facts unless they are material to the company's operations.

The fact that the SEC is attempting to further US foreign policy goals rather than informing investors about political risks in general is revealed by the fact that it is not requiring disclosure of a foreign company's compliance with non-material political risks arising under the laws of countries other than the US-for example, if a company doing business in Israel were threatened by the Arab boycott, or if China were to threaten companies openly supporting US human rights initiatives. One doubts that the SEC would wish to draw attention to these risks if they were not material.

But the most serious deficiencies of the SEC's step are its inconsistency with US trade policy and the encouragement it offers for the emigration of market activities to foreign jurisdictions. Today, US mutual and pension funds, as well as private investors, own billions of dollars of foreign stocks which they are increasingly trading abroad. By focusing its rule on US exchange listings, the SEC is actually promoting this trend-driving more and more securities activities out of the United States and into foreign markets. Despite the fact that the SEC forbids foreign stock exchanges from offering brokers and investors direct access to their electronic trading systems within the US, institutional brokers, such as Instinet, are increasingly providing American clients with their own electronic links to foreign exchanges. As a US exchange listing is therefore becoming less and less necessary with the spread of electronic trading linkages around the globe, politically motivated disclosure standards will only encourage foreign companies to access US capital through foreign exchanges, beyond the reach of the SEC.

Finally, although the SEC has asserted its interest in obtaining higher disclosure standards from foreign companies whose securities are traded in US markets, it is obvious that this cannot be achieved by discouraging foreign companies from US listings. Instead, requiring disclosures that have no purpose other than to further US foreign policy interests is a sure road to isolating the United States from a growing world capital market.


Benn Steil is the Andre Meyer Senior Fellow in International Economics at the Council on Foreign Relations

Peter Wallison is a Resident Fellow at the American Enterprise Institute

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