Financial Services Firms

Governance, Regulations, Valuations, Mergers, and Acquisitions

Zabihollah Rezaee

• Verlag: Wiley
• Jahr: 2011
• ISBN:
  9781118098530
• Auflage: 3
• Thema: Betriebswirtschaft
• Thema: Bewertung

Indispensable coverage of new federal regulatory reforms and federal financial issues

An essential guide covering new federal regulatory reforms and federal financial issues

Financial Institutions, Valuations, Mergers and Acquisitions, Third Edition presents a new regulatory framework for financial institutions in the post-bailout era.

• Provides valuable guidance to assess risks, measure performance and conduct valuations processes to create shareholder value
• Covers the protection of other stakeholders, including customers, regulators, government, and consumers
• Offers an up-to-date understanding of financial institutions, their challenges, and their opportunities in the post-Sarbanes-Oxley era

Over the past decade, substantial changes have taken place in the structure and range of products and services provided by the financial services industry. Get current coverage of these changes that have transformed both traditional organizations such as banks, thrifts, and insurance companies, as well as securities providers, asset management companies and financial holding companies with the up-to-the-minute coverage found in Financial Institutions, Valuations, Mergers and Acquisitions, Third Edition.

Part One

Financial Services Industry: Its Markets, Regulations, and Governance

Chapter One

Fundamentals of the Financial Markets and Institutions

Introduction

More than half of all households (over 115 million) in the United States are now investing in the securities markets through private investments in company shares, mutual funds, and pension funds. Furthermore, due to the recent financial crisis, bank failures, the risks regarding Social Security, and the high-profile failure of some large pension funds, Americans are being forced to take responsibility for their financial future and retirement funds. The sustainability and financial health of public companies in general and financial services firms in particular is vital to keeping investor confidence high, and this sustainability requires public trust in the reliability of financial reports. Reliability of public financial information contributes to the efficiency, liquidity, and soundness of financial markets that may drive economic development and prosperity for the nation. This introductory chapter discusses the importance of our financial markets to the nation's economic prosperity, the promotion of the free enterprise system, the vital role of financial services firms in our society, and the importance of financial information as the lifeblood of financial markets.

Financial Markets

The efficiency, liquidity, and safety of the financial markets, both debt and capital markets, have been threatened by the recent financial crisis and resulting global economic meltdown. These threats have significantly increased the uncertainty and volatility in the markets, which adversely affected investor confidence worldwide. These crises prevent investors from receiving meaningful financial information to make savvy investment decisions. U.S. capital markets traditionally have been regarded as the deepest, safest, and most liquid in the world. For many decades, they have employed stringent regulatory measures to protect investors, which has also raised the profile and status of listed companies. However, the recent global financial crisis and the competitiveness of capital markets abroad have provided global companies with a variety of choices of where to list, possibly subject to less vigorous regulatory measures. As these markets abroad become better regulated, more liquid, and deeper, they enable companies worldwide to raise their capital needs under different jurisdictions. Investors now have a wide range of options to invest globally to secure their desired return on investment.

To a significant extent, the global competitiveness of U.S. capital markets depends on the reliability of financial information in assisting investors to make sound investment decisions, cost-effective regulations that protect investors, and efficiency in attracting global investors and companies. The U.S. free enterprise system has transformed from a system in which public companies, including banks and other financial institutions, traditionally were owned and controlled by small groups of investors to a system in which businesses are owned by global investors. The United States has achieved this widespread participation by adopting sound regulations and by maintaining high-quality disclosure standards and enforcement procedures that protect the interests of global investors.¹

Recent financial regulatory reforms—both the Sarbanes-Oxley Act of 2002 (SOX) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank)—are intended to protect investors and consumers.²

Financial Information and Capital Markets

Reliability, transparency, and quality of financial information are the lifeblood of the capital markets. The efficiency of the markets depends on the reliability of that information which enables the markets to act as signaling mechanisms for proper capital allocation. Investor confidence in “the same level playing field” of all market participants has encouraged investors to own stock, and billions of shares trade hands to provide capital to businesses. Society, particularly the investing community, relies on the quality of corporate financial reports in making investment decisions. William McDonough, the former chairman of the Public Company Accounting Oversight Board (PCAOB), stated, “Confidence in the accuracy of accounting statements is the bedrock of investors being willing to invest, in lenders to lend, and for employees knowing that their firm's obligations to them can be trusted.”³ As investor confidence in financial information drives the willingness to invest, America's economic future is tied to how successfully companies respond to this call for greater transparency and reliability in financial information as well as cost efficiency and effectiveness of regulatory reforms of financial services firms.

A greater number of people are now investing through retirement funds or are actively managing their portfolios and therefore are affected by financial information disseminated to the market. Reliable and transparent financial information contributes to the efficient functioning of the capital markets and the economy. In recent years, investment banks and major brokerage firms have grown rapidly and generated record revenue. Recently five major financial institutions have failed: Goldman Sachs Group, Bear Stearns Co., Morgan Stanley, Lehman Brothers Holdings, and Merrill Lynch & Co. The subsequent government bailout of some of these firms raises serious concerns about the value-adding activities of financial services firms, their ethics and governance, as well as the professional accountability of their board of directors, senior management, internal and external auditors, and other corporate governance participants. The lack of public trust and investor confidence in corporate America, Wall Street, and its financial dealings and reports has continued to adversely affect the vibrancy of the capital market. Bailed-out banks and their continuous excessive executive compensation schemes have left us with a legacy of mistrust. Policy makers and regulators have been challenged to establish and enforce more effective and efficient regulatory reforms; business leaders have been challenged to change their culture, behavior, and attitudes to restore confidence and trust in Wall Street.

Financial Crisis and Financial Regulatory Reforms

A historical perspective of the financial crisis in the United States indicates that real estate markets started to collapse in the second half of 2007, and investors began shorting real estate markets. Where shorting or short selling is defined as; borrowing an asset from a third party and selling it with a promise to buy back at a future point in time at a predetermined price. Collateralized debt obligations (CDOs) and mortgage-backed securities were written down, and financial panic continued into 2008, which caused major financial institutions to go bankrupt. The persistence of the financial panic in 2009 and lack of public trust and investor confidence in the financial system have caused the disappearance or reorganization of once-prominent Wall Street firms, some of which have changed their corporate structures and become bank holding companies. The U.S. financial crisis eventually affected global financial markets. Financial institutions worldwide have lost more than $1.5 trillion on mortgage-related losses. The failed financial institutions Bear Stearns, Lehman Brothers, AIG, and Merrill Lynch played important roles in the recent financial crisis by engaging in risky mortgage lending practices, credit derivatives, hedge funds, and corporate loans. The Federal Reserve responded by reducing interest rates and flooding the market with money, and the Treasury Department asked for a $700 billion package dubbed the Troubled Asset Relief Program (TARP) to buy toxic mortgages and other assets. The U.S. government responses to mitigate the financial panic were the TARP stimulus packages, temporary increases in deposit insurance coverage of $250,000 per person by the Federal Deposit Insurance Corporation (FDIC), and the Dodd-Frank Act of 2010.

Recent financial reforms (Dodd-Frank), and corporate governance reforms, including SOX, convergence in regulatory reforms (from the Group of 20 [G-20]) worldwide, and TARP have shifted the power balance among shareholders, directors, and management of all entities, particularly banks. Shareholders including the U.S. government have been more proactive in monitoring and scrutinizing corporations. Directors are held more accountable in fulfilling their fiduciary duties by overseeing management's strategic plans, decisions, risk assessment, and performance. Management is expected to achieve sustainable shareholder value creation and enhancement and to enhance the reliability of financial reports through executive certifications of internal controls and financial statements. Some provisions of SOX that were not previously practiced by public companies and that are intended to benefit all companies include:⁴

• Creating the PCAOB to oversee audits of public companies and to improve the ineffective self-regulatory environment of the auditing profession.
• Improving corporate governance through more independent and vigilant boards of directors and responsible executives.
• Enhancing the quality, reliability, transparency, and timeliness of financial disclosures through executive certifications of both financial statements and internal controls.
• Prohibiting nine types of nonaudit services considered to adversely affect auditor independence and objectivity.
• Regulating the conduct of auditors, legal counsel, and analysts and their potential conflicts of interest.
• Increasing civil and criminal penalties for violations of security laws.

Six provisions of SOX address the quality, reliability, transparency, and timeliness of public companies' financial reports:

1. The board of directors should adopt a more active role in the oversight of financial reports.

2. The audit committee is responsible for overseeing financial reports and related audits.

3. Management (chief executive officer [CEO], chief financial officer [CFO]) must certify the completeness and accuracy of financial reports in conformity with generally accepted accounting principles (GAAP).

4. Pro forma financial information must be presented in a manner that is not misleading and that is reconciled with GAAP items.

5. All material correcting adjustments identified by the independent auditor must be discussed with the audit committee and reflected in any reports that contain financial statements.

6. Management must assess the effectiveness of internal controls, audit of internal control over financial reporting (ICFR), communication of significant deficiencies to the audit committee, and public disclosure of material weaknesses in ICFR.

The first summit of the 20 largest advanced and emerging countries, better known as the G-20, was held in Toronto in June 2010 to ensure international economic cooperation by addressing the global economic crisis, reforming and strengthening global financial systems, and promoting a full return to growth with quality jobs.⁵

The 2010 G-20 agreed to:

1. Reduce budget deficits by cutting the global deficit in half by 2013.

2. Promote growth through global economic stimulus and more government spending.

3. Full return to growth with quality jobs.

4. Reform and strengthen financial systems.

5. Create strong sustainable and balanced global growth.

6. Reduce government debt–to–gross domestic product (GDP) ratios by 2016.

The important provisions of the 2010 G-20 are discussed next.

• The Framework for Strong, Sustainable, and Balanced Growth assesses global policy actions and strengthens policy frameworks.
• Financial service reform establishes a more resilient financial system, improving risk assessment, promoting transparency, and reinforcing international cooperation.
• International financial institutions (IFIs) should develop as a global response to the financial and economic crisis and a platform for global cooperation including $750 billion by the International Monetary Fund (IMF) and $235 billion by the multilateral development banks (MDBs).
• Fighting Protectionism and Promoting Trade and Investment by refraining from raising barriers or imposing new barriers to investment or trade in goods and services at least until the end of 2013.
• Moving toward convergence in accounting standards by adopting a single set of high-quality globally accepted accounting standards.

The most important ...