Despite unpopular conditions imposed by the Sarbanes-Oxley Act, foreign issuers have continued to sell equities into the US market during Q1 2006.

The volume of foreign stocks issued to the US market increased significantly from highs set in 2000, as the graph shows (blue line - left axis).

	Foreign Equity Issues in US Market vs. Current Account Deficit

The graph indicates that the volume of foreign stock issues averaged about 15% to 20% of the U.S. current account deficit, with dampening oscillations (red line - right axis ).

More »

Net repurchases of equity by nonfinancial domestic corporations soared to an annual rate of $586.8 billion in Q1 2006 (a new record), pushing stock prices slightly higher.

This frenzied buying was five times the buyback rate in 2000, the year the Great Bubble collapsed!

Corporate executives were aided significantly in their efforts to use buybacks to boost stock prices, by unsophisticated investors acquiring stocks through mutual funds ($205.1 billion) and by direct purchases of equities by foreign investors ($226.8 billion) [net annual rates].

Option Exercisers and Foreign Issuers Are Sellers

Almost matching the frantic stock buying by corporations, mutual funds, and foreign investors, were new records of stock sales by individuals ($866.5 billion) and foreign issuers ($172 billion) [annual rates].

Most sales by individuals were related to the exercise of stock options, representing an enormous transfer of wealth from corporations to executives and insiders, to the detriment of long-term investors holding equities in tax-deferred savings plans through mutual funds.

Despite the negative features of the Sarbanes-Oxley Act and higher costs of going public in the U.S. market, foreign issuers seemed to have a clearer notion of where money could be put to use than their overpaid American counterparts. Foreign corporate issuers could not resist the low costs of capital occasioned by the buyback pressure on stock prices.

Similarities to 2000

Just as was seen at the peak of the Great Bubble, the ’smart institutions’ (property and casualty insurers, private pension funds, and state and local government retirement funds) were net sellers of equities.

The pattern of transactions between the players in the equity market in Q1 2006 was similar to that of the year 2000 when the bubble of the 1990s came to an end.

See Case Study on the Great Bubble of 2000.

The Sarbanes-Oxley Act of 2002, by discouraging companies to go public, will exacerbate the shortage of equities, with a negative effect on the U.S. stock market, although this was not the intent of its authors.

The formal intent of the Act was to “protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws.”

This goal will not be achieved. In fact, the opposite may be the outcome.

Inspired by Enron

The December 2001 bankruptcy of the Enron Corporation was the legislative inspiration for Senators Sarbanes and Oxley who swallowed hook, line, and sinker the popular press story that the Enron bankruptcy would not have happened if it were not for devious accounting practices of its admittedly unscrupulous executives.

When Enron shares reached the all-time high of $90 in August 2000 (just as the Great Bubble of the 1990s was about to burst), its shares were selling at a speculative 61 times earnings with a dividend yield of only 0.5%. The financial statement of December 2000 showed a current ratio of a mere 1.06 with equity only 17.4% of total assets. The company was engaged principally in speculating in exotic energy contracts and derivatives. Its bonds never rose above the lowest investment grade.

In other words, a quick examination of the published statements would reveal the plain truth, even to an amateur analyst, that this was an extremely highly-leveraged speculative company, with no cash reserves or working capital, borderline credit, with little investment merit and with stock that was wildly over-priced, floating in the clouds of Wall Street ballyhoo.

Many things, from a terrorist bombing to a catastrophic hurricane, could have driven Enron into bankruptcy. The company existed on the extreme edge of an asset-lite financial fantasy world created by Jeffrey Skilling, the Harvard MBA and fair-haired boy from McKinsey and Company. Just as in the case of Long Term Capital Management, the nutty ideas of the Nobel Gods had fallen to earth.

The Sarbanes-Oxley Act would not have prevented the Enron bankruptcy and does absolutely nothing to protect investors against the far more common, harmful, and widely accepted corporate practice of diverting hundreds of billions of dollars of corporate cash reserves each year into company executive bank accounts through stock buyback-option schemes, instead of equitably paying dividends to shareholders.

See: Essays on Stock Buybacks and Options.

More »