U.S. Chamber Commission Reports on Capital Markets Competitiveness, Recommends Securities Reform

On March 12, 2007, in the latest in the apparently never-ending series of big thick reports on the competitiveness of U.S capital markets, the U.S. Chamber of Commerce released the Report and Recommendations of its Commission on the Regulation of the U.S. Capital Markets in the 21st Century (here). An Executive Summary of the Report can be found here.

The Chamber Commission advertises itself as “an independent bipartisan Commission established by the U.S Chamber of Commerce.’ The Commission is co-Chaired by Arthur Culvahouse, who is Chairman of the O’Melveny & Myers law firm and former White House counsel in the Reagan administration, and William Daley, Vice Chairman of JPMorgan Chase and Commerce Secretary in the Clinton administration. The Chamber Commission report will be formally released on March 14, 2007, as part of the Chamber’s “First Annual Capital Markets Summit: Securing America’s Competitiveness” (here)

Including appendices, the Chamber Commission’s Report weighs in at 179 pages, putting it in a competitive position, girth-wise, with the Interim Report of the Committee on Capital Markets Regulation and the Bloomberg/Schumer Report. (The Chamber Commission's Executive Summary even weighs in at 20 pages.) The Chamber Commission did reduce its recommendations to six bulleted points:

• Reform and modernize the federal government’s regulatory approach to financial markets and market participants.

• Give the Securities and Exchange Commission (SEC) the flexibility to address issues relating to the implementation of the Sarbanes-Oxley Act of 2002 (SOX) by making it part of the Securities Exchange Act of 1934.

• Convince public companies to stop issuing earnings guidance or, alternatively, move away from quarterly earnings guidance with one earnings per share (EPS) number to annual guidance with a range of EPS numbers.

• Call on domestic and international policy-makers to seriously consider proposals by others to address the significant risks faced by the public audit profession from catastrophic litigation, as well as the Commission’s suggestion that national audit firms be allowed to raise capital from private shareholders other than audit partners.

• Increase retirement savings plans by connecting all employers of 21 or more employees without any retirement plan to a financial institution that will offer a retirement arrangement to those employees.

• Encourage employers to sponsor retirement plans and enhance the portability of retirement accounts through the introduction of a simpler, consolidated 401(k)-type program.

The six principal recommendations are discussed further in the March 12, 2007 Wall Street Journal article (here, subscription required). The recommendation regarding the incorporation of SOX into the ’34 Act is discussed further on the FEI Financial Reporting Blog (here). The CorporateCounsel.net Blog also has a post on the Report, here.

While not included in the six principal recommendations, the Chamber Commission does also make “a number of specific recommendations designed to enhance the effectiveness of the U.S. legal system.” The most significant of these recommendations is based on the Commission’s view that there is a “strong need to investigate the accuracy of the widely held global perception that the U.S. securities litigation and regulatory environment makes it dangerous to participate in our capital markets.”

But rather than make any specific reform recommendations in that regard, the Commission “recommends that Congress call upon the SEC to undertake a comprehensive study of state and federal securities enforcement mechanisms to assess whether they are enhancing the goal of investor protection and capital formation and whether the PSLRA is achieving the objective set forth by Congress.” The Commission specifically recommends that the study analyze:

• civil and criminal cases brought by governmental agencies and regulatory actions brought by [self-regulatory organizations];

• PSLRA’s impact on the effectiveness of the federal securities laws; and

• impact of post-PSLRA litigation on the dual objectives of protecting investors and promoting capital formation.

The Chamber Commission notes that “time is of the essence” in the study’s completion. (These issues are discussed at pages 28 to 31 of the full Report.)

The Chamber Commission Report also identifies three other “problem areas” in private securities litigation and makes recommendations that “should reduce costs while preserving investor protections”:

Fair Funds: The Chamber Commission recommends that “the SEC adopt a forma policy that prohibits duplicative payments from Fair Funds and private litigation on the same claim.” (Discussed at page 88-89 of the full Report)

Scope of Professional Liability: The Commission recommends the adoption by the other federal judicial circuits of the Second Circuit’s bright-line test for primary liability of secondary actors in securities fraud cases; and the Commission advocates that other circuits follow the Eighth Circuit in rejecting “scheme liability” as “incompatible with the Supreme Court’s rejection of aiding and abetting theories under Section 10b and Rule 10b-5.” (Discussed at pages 90-92 of the full Report).

Selective Waiver: The Commission recommends that Congress adopt legislation “establishing a selective waiver that would permit corporations to share privileged information with the SEC and continue to assert the privilege against other parties.” The Commission also recommends that Congress establish a selective waiver that would “permit a private party to share privileged information or documents with external audit firms or government appointed corporate compliance monitors…without waiving the attorney-client privilege to other third parties.” (Discussed at pages 92-95 of the full Report)

The Chamber Commission’s Report also has extended discussion (at pages 80-87 of the full Report) of the controversies surrounding the federal prosecution of business organizations. The bulk of this discussion related to concerns regarding prosecutorial ability to seek or require production of attorney-client privileged materials or work-product materials. The Commission expresses its concern that the Department of Justice’s (DoJ) McNulty Memorandum “does not adequately address the concern that companies feel pressured to waive attorney-client privilege and work product protection under threat of indictment or other enforcement actions.” The Chamber Commission endorses the “ongoing efforts to have the DoJ eliminate as a cooperation credit factor a company’s decision to waive the attorney-client privilege or attorney work product protection.”

The Chamber Commission also recommends that Congress and the DoJ “reevaluate the standards of corporate criminality” to “place more weight on the proactive efforts of corporations to prevent criminal conduct.” The Commission recommends that “corporate criminal conduct should be largely reserved to instances where the corporate form is a mere shell or in which criminal conduct is pervasive within the company’s senior executive ranks.”

The SEC Actions Blog has a thoughtful discussion (here) of the Chamber Commission's recommendations regarding the McNulty Memo, the attorney client privlege and federal corporate criminal prosecutions.

The Report contains quite of number of other interesting suggestions, as a result of which the Report merits a full review, notwithstanding its daunting length. The sheer number of reform recommendations defies quick summary, but there are several that are particularly worth closer review, including the Report’s suggestion (at pages 71-77) that all public companies “eliminate the practice of providing quarterly guidance” because “reducing the pressures to meet precise quarterly earnings targets…is an important first step toward shifting the focus away from quarterly results and toward the long-term performance of U.S. companies.” The elimination of qurterly earnings guidance was previously recommended by the Business Roundtable Institute for Corporate Ethics in is July 2006 Report (here). The D & O Diary’s prior views regarding the pitfalls of earnings guidance can be found here and here.

The Report also recommends the creation of two federal chartering mechanisms, one for accounting firms and one for insurance companies. In both cases, the objective is to reduce regulatory burdens that add friction costs and impeded competitiveness. The D & O Diary believes the recommendation for an option federal level insurance chartering system is particularly noteworthy and is a concrete suggestion that could in fact actually help U.S. based insurance companies (which are very important participants in the U.S. financial markets) to operate more efficiently and compete more effectively.

The Chamber Commission’s Report is merely the latest in a series, and we will be hearing more of the same tomorrow (March 13) when the Treasury Department holds its conference on U.S. Capital Markets (here). But the Chamber Commission deserves credit for not replowing the same ground as the prior reports, and for avoiding the shortcoming of the prior reports of confusing the interests of Wall Street with the interests of the overall economy. The Chamber Commission’s Report seems much less concerned than prior reports with simply removing things that Wall Street finds annoying, and more focused on ideas that will aid capital formation and competitiveness of U.S.-based financial enterprises.

As the regulatory reform dialog continues, the process seems to be becoming additive and cumulative. There have unquestionably been a number of interesting and promising ideas that have emerged, and the more the continuing dialog focuses on improving U.S economic prospects and the less it focuses on weakening the integrity of the U.S. regulatory system, the more promising will be the outcome.

The D & O Diary’s prior discussion of the Interim Report of the Committee on Capital Markets Regulation can be found here and here. The D & O Diary’s prior discussion of the Bloomberg/Schumer Report can be found here. My prior commentary on the weak case for regulatory reform can be found here and here.

Another Damned, Thick, Square Book: According to history (here), when Prince William Henry, Duke of Gloucester and Edinburgh (the younger brother of King George III, and pictured above) was presented in 1781 with Volume II of Edward Gibbon's classic The History of the Decline and Fall of the Roman Empire, the Prince is reported to have said "Another damned, thick, square book! Always scribble, scribble, scribble! Eh, Mr Gibbon?"

Welcome to the Litigation Consulting Blog: The D & O Diary would like to welcome the Litigation Consulting Blog (here), which appears to be a worthy addition to the blogsphere. The blog is relatively new but has already had a number of interesting posts, including today's post (here) about activist investing. D & O Diary readers will undoubtedly find this new blog interesting. Hat tip to Werner Kranenberg of the With Vigour and Zeal blog for the link.