A Blueprint for Cross-Border Access to U.S. Investors

Introduction*

Today, mergers and talks of mergers among the world’s stock exchanges make obvious what many finance professionals have long known: capital markets are global. Greater investor wealth and education have created the demand for such markets, and technology, in particular, has made globalized markets feasible. Investors now search beyond their own borders for investment opportunities and, unlike the past, many of these investors are not large companies, financial firms, or extremely wealthy individuals. A good number are “typical” retail investors—individuals with normal jobs and average incomes—who save for retirement and their children’s education, and who may be well-educated, but nonetheless are not “sophisticated investors” in the legal sense. Investors (whether retail or professional) and large firms pursue international opportunities for the same reasons: higher investment returns and the reduction in risk offered by portfolio diversification.

It is this seamless capital market, made possible by technology, that now, more than anything, presses on financial regulators around the world. The fundamental mandate of the Securities and Exchange Commission (“SEC”) remains the same—protecting investors, ensuring the efficiency and transparency of U.S. markets, and facilitating capital formation in the United States. However, the manner in which the SEC can best achieve this mandate in the face of this new investor demand is changing. Borders that have blurred for most market participants are proving as sharp as ever where market regulation is concerned. Also, the technology that has proven so beneficial for investors and issuers poses a serious threat to the integrity of markets. As a consequence, the traditional methods that the SEC and its foreign counterparts use to oversee cross-border market activity have lost some of their historical efficacy. Our markets are now interconnected and viewing them in isolation—as we have for so long—is no longer the best approach to protecting our investors, promoting an efficient and transparent U.S. market, or facilitating capital formation for U.S. issuers.

This Article proposes a new framework to apply to foreign financial service providers accessing the U.S. capital market, by providing investment services and products not otherwise available on the U.S. market. Rather than requiring such foreign stock exchanges and foreign broker-dealers to register with the SEC, as is currently the case, the proposed framework relies on a system of substituted compliance with SEC regulations. Instead of being subject to direct SEC supervision and U.S. federal securities regulations and rules, foreign stock exchanges and broker-dealers would apply for an exemption from SEC registration based on their compliance with substantively comparable foreign securities regulations and laws and supervision by a foreign securities regulator with oversight powers and a regulatory and enforcement philosophy substantively similar to the SEC’s. The SEC would still retain jurisdiction to pursue violations of the anti-fraud provisions of the U.S. federal securities laws. The comparability finding would need to be complemented by an unambiguous arrangement between the SEC and its foreign counterpart to share extensive enforcement- and supervisory-related information. This should greatly reduce the transaction costs investors currently pay when investing overseas, and allow the current situation of overlapping and duplicative registration and oversight requirements for certain stock exchanges and broker-dealers to end.

The overarching objective of the framework is, first and foremost, to further the SEC’s mandate of investor protection. As foreign markets develop and adopt higher regulatory standards, U.S. investors predictably are looking at them as potential investment opportunities. However, the current international environment has enforcement and oversight gaps that present risks that do not exist in a domestic context. U.S. investors also face high transaction costs when investing overseas—transaction costs that provide investors with no real benefit. By constructing a new model for international cooperation between the SEC and certain like-minded foreign securities regulators, the framework will facilitate the SEC’s ability to protect U.S. investors and lead to a collaborative effort in promoting high-quality regulatory standards in a globalized market. It will also increase competition in financial services—both here and abroad—and lower cross-border transaction costs, to the benefit of investors around the world.

In laying out this framework, we first discuss how technology and globalization are changing the shape of modern capital markets and how they are regulated. We also explore how recent financial scandals, both in the United States and abroad, have changed the shape of securities regulation and created new mandates, burdens, and demands for regulators that, if not implemented carefully and in a coordinated fashion, threaten to harm investors and issuers with unnecessary regulatory transaction costs. Second, we lay out the critical elements of U.S. securities regulation and the legislative “first principles” that constrain what the SEC can do, and the manner in which these first principles have led to the SEC’s historic approach to regulating cross-border securities activities. We then discuss how these first principles necessarily shape any SEC response to this new global capital market. Third, and finally, we detail a framework, based on these first principles, that would increase U.S. investor access to foreign investment opportunities and lower investor transaction costs while bolstering the integrity of the U.S. capital market and discouraging the type of “regulatory arbitrage” that can undermine investor confidence in markets everywhere….

* This excerpt does not include citations. To read the entire article, including supporting notes, please download the PDF.