Due by the end of this week is the first report from the so-called Committee on Capital Markets Regulation, otherwise known as the Paulson Committee. The private study group, chaired by Harvard Law School Professor Hal S. Scott, includes representatives of Wall Street, the giant accounting firms and large corporations and has been praised by Treasury Secretary Henry M. Paulson. According to the initial September 2006 press release the group intends to focus on four key issues: 1) Liability issues affecting public companies and gatekeepers, such as auditors and directors with a focus on securities class action litigation, criminal enforcement and federal versus state authority; 2) SOX, with major emphasis on Section 404; 3) Overall regulatory processes to allow the U.S. to do a better job of evaluating changes of law and regulation; and 4) Shareholder rights.

The Committee has not officially indicated the direction of its work. Some reports, however, suggest that the Committee will seek in part to reduce potential liability in securities class actions by limiting or eliminating private liability under Exchange Action Section 10b and Rule 10b-5, the favorite antifraud provision of the private class action bar as well as the SEC. Some comments have raised the possibility of “dis-implying” the cause of action for damages implied under Section 10b and Rule 10b-5 by the courts for years. Other reports suggest that the Committee may seek to limit the use of the antifraud provision to enforcement actions brought by the SEC. Still others suggest that some private damage actions brought under the Rule may have be arbitrated instead of being brought in federal court.

Reportedly the Committee will seek to implement its recommendations though regulatory agencies such as the SEC rather than Congress – an approach developed before the recent mid-term elections changed control of Congress. In the case of Exchange Act Section 10b and Rule 10b-5 that means asking the SEC to limit or eliminate private liability the antifraud provision. Yet the SEC has stated repeatedly over the years that private enforcement through damage actions under the Section and Rule is an important and necessary adjunct to its enforcement program. The SEC has made this assertion in congressional testimony and court briefs on many occasions. Pushing recommendations designed to eliminate or severely constrict private liability under Exchange Act Section 10b and Rule 10b-5 would thus directly contradict a long established SEC position. Efforts to have the SEC repudiate its position could place the independent regulatory agency in political cross hairs.

The SEC historically has acted as an independent regulatory agency, not only in name but in practice. The agency has resisted efforts to politicize its agenda. Whatever the final recommendations of the Paulson Committee later this week, and whatever your views on securities class actions, one thing is clear: The SEC should not be politicized. If that happens, it will not strengthen the capital markets or make them more competitive – the stated goal of the Paulson Committee. Politicizing the SEC will fail everyone.

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The Department of Justice is reportedly considering significant changes to the Thompson Memorandum. While it is unclear what the scope of any such changes might be, the Senate hearings held in September 2006 may provide some clue. During those hearings Senators Specter and Leahy reportedly made it clear to Deputy Attorney General Paul McNulty that either the Justice Department could initiate changes or there would be a legislative fix. These comments followed the ruling by Judge Kaplan in U.S. v. Stein, which held portions of the Thompson Memorandum unconstitutional for violating KPMG employees’ Fifth and Sixth Amendment rights and the passage of resolutions by the ABA decrying government actions that undermined the attorney-client privilege and the right to counsel.

Senator Spector has also proposed legislation in the Senate that would significantly impact the Thompson Memorandum. The bill, titled the “Attorney-Client Privilege Protection Act of 2006,” would preclude government investigators from requesting a waiver of the attorney-client privilege or the work product doctrine. It also would prevent government investigators, when evaluating cooperation, from considering whether the organization asserted privilege, entered into joint defense agreements, shared information with employees or paid legal fees for employees. The concluding section of the bill would permit organizations to make voluntary disclosures of privileged material to the government without a waiver as to third parties. In essence, the bill appears to be a combination of the ABA resolutions, the holding in U.S. v. Stein, and the proposed limited waiver rule, Federal Rules of Evidence Rule 502(c).

It would certainly be a welcome relief if the Justice Department reconsidered the Thompson Memorandum and its application. At the same time, it is clear that the SEC should reconsider the impact of its Seaboard Release, which suffers many of the same problems of the Thompson Memorandum. In this regard, the comments of SEC Commissioner Atkins in September noting that the Commission should not consider whether there was a waiver in evaluating cooperation serves as a welcome beginning, but the SEC needs to move further and reform Seaboard.

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