Thursday, November 30, 2006

Paulson Committee Releases Interim Report

The Committee on Capital Markets Regulation (popularly known as the “Paulson Committee”) has released its “Interim Report” (here). Weighing in at 148 graphic intensive pages, the 11.50 mb document is a memory hog. Readers who want a quick overview and don’t want to spend the rest of the day trying to download the entire report will want to refer to op-ed commentary by Committee members R. Glenn Hubbard and John L. Thornton, entitled “Action Plan for Capital Markets” in today’s Wall Street Journal (here, subscription required), which provides an overview of the Report’s recommendations “needed to maintain and improve the global competitive position of U.S. capital markets for investors.”

The authors cite the declining valuation premium afforded to foreign securities listed on U.S. exchanges as evidence of the U.S. markets declining competitiveness. (The D & O Diary’s prior post about the valuation premium can be found here.) The Committee recommends a number of regulatory or legislative changes to address this concern including:

  • better implementation of Sarbanes-Oxley’s Section 404 internal control requirements, including a revision of PCAOB Auditing Standard No. 2 to ensure that reviews are risk based and focused on significant control weaknesses;
  • elimination of uncertainty in private enforcement of Rule 10b-5, through the SEC’s provision of more guidance on the elements of a Rul10b-5 action, including materiality, scienter, and reliance;
  • reduction of the risk of criminality of the corporate entity so that it is a last resort, and the elimination of existing guidelines in the Thompson Memo that require companies to waive the attorney client privilege and eliminate employees’ attorneys’ fee;
  • strengthening of shareholder rights and elimination of barriers to an efficient and competitive market (focusing on such elements as poison pills, staggered board, and classified boards) allowing shareholders to devise alternatives to the present litigation system, such as the waiver of the right to a jury trial or adoption of arbitration, implemented at the time of the IPO or amendment to corporate charters or bylaws;
  • elimination or reduction of gatekeeper litigation against auditors, either through a cap on auditor liability or creation of a safe harbor for certain auditor practices, and reduction of outside directors’ gatekeeper exposure by making an outside director’s good faith reliance on an audited financial statement sufficient to meet the standard of care;
  • adoption of a cost-benefit analysis for future regulation, to assure that regulations achieve the intended effect at an appropriate cost;

The Wall Street Journal has a more detailed bullet point summary of the Committee’s recommendations here.

While the Committee’s Interim Report is impressive, if nothing else for its sheer girth, this is merely the opening salvo in what will likely be a very prolonged exchange of views and proposals. Among other things, the U.S. Chamber of Commerce is expected to release its own report early next year. In addition, Sen. Charles Schumer and NY Mayor Michael Bloomberg have hired McKinsey & Co. to assess market competitiveness and its impact on the city’s economy. The Treasury department is hosting a conference early next year to discuss the state of the country’s regulatory, legal and accounting environment. What changes, if any, will ultimately emerge at the end of this process will only be revealed in the fullness of time.

The Interim Report obviously has a lot to say about issues potentially affecting the liability exposures of directors and officers of public companies. The D & O Diary will be taking a look at these portions of the Report and providing its views in a blog post to be added in the next day or two. In the meantime, I would be very interested in any thoughts or comments that readers have about the Interim Report.

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