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How Any Exchange Merger Can Create Big Losers : Financial Times

August 24, 2006 In The News

Here is an irony worth considering: European workers benefit from some of the most protective employment rights and privileges in the western world. Yet when it comes to investing the fruits of their labour in publicly traded securities, they are decidedly among the most vulnerable. The New York Stock Exchange’s proposed Dollars 10bn merger with Euronext affords European investors an opportunity finally to level the playing field; unfortunately, the deal-makers are likely to sacrifice the interests of individual investors for the sake of profit.

Indeed, individual investors in US markets enjoy far more protection and are more likely to recover funds from wayward brokers. The Sarbanes-Oxley Act, although dreaded by corporate executives, is a potent investor protection measure. The Securities and Exchange Commission is more aggressive than its European counterparts. Also, the US system of binding arbitration, although badly flawed, still offers investors who have been wronged by brokers a reasonable chance of recovering funds without racking up exorbitant legal fees. Just look at the hundreds of millions of dollars recovered after the technology bubble collapsed.

By contrast, European leaders have a more laissez faire attitude towards policing the securities markets and have been slow to strengthen investor protections. In most European countries, investors can file complaints with weak state- or financial industry-run ombudsman programmes. However, these mediation panels can only recommend nonbinding settlements. Accordingly, most investors have to take matters to court, an expensive proposition.

That is certainly true for investors whose brokers come under the aegis of Euronext’s civil securities regulators. While the latter investigate fraud, they must generally refer alleged wrongdoing for prosecution in the court system – a cumbersome, costly process.

The bad news for European investors is that a NYSE/Euronext merger would regrettably preserve the status quo. In spite of an opportunity to adopt best (or at least better) practices at both institutions, the deal provides that the respective exchanges – and the investors who trade there – will continue to be overseen by host-country securities regulators. The toothless systems that make it nearly impossible for European investors to recover investment losses caused by brokerage practices will continue to plod along in their mediocrity.

Europeans’ insistence on maintaining local regulation is driven by fears that the US might try to impose Sox rules on foreign companies. While the concern is understandable from a protectionist position, it is a moot point. Simply put, European companies will increasingly come under the same pressures as their US counterparts to generate better returns for their shareholders – regardless of whether this merger goes through. The demand for better operational performance and stronger, quicker returns is what led to many of the accounting scandals of the past few years, including Enron and WorldCom. Without reform-minded leadership, the Parmalat financial scandal will not be an isolated incident.

For the individual investor, the best solution would be for the European exchanges simply to adopt the NYSE or National Association of Securities Dealers’ regulatory rules and practices and introduce a US-style securities arbitration system. While there are many shortcomings to the system, it remains the best among the alternatives.

Rest assured, it will not happen. John Thain, the NYSE’s chief executive, is no champion of individual investors. Since Mr Thain arrived two and a half years ago, the exchange has been phasing out its securities arbitration programme. Mr Thain is also no fan of Sox: at a recent NYSE regulation conference, he blamed “excessive” regulation as the reason 23 of the 25 largest initial public offerings last year were done outside the US.

The most unfortunate outcome of the merger, should it go through, is a real possibility that the deal could effectively weaken regulation and listing standards worldwide and undermine recent advances in the US. The merger will most likely give less-than-pristine US companies a chance to play the game of regulatory arbitrage, shifting to national exchanges in Europe to escape tough US regulations. Sox is by no means perfect and the law may need some adjustments, but US and European regulators should band together to ensure that individual investors on both sides of the Atlantic enjoy good regulatory protection and a uniform investor arbitration scheme. Someone has to look out for the little guy.

The writer is a securities attorney and investor advocate in the U.S.