The Committee on Capital Markets Regulation, otherwise known as the Paulson Committee (after Treasury Secretary Henry M. Paulson, Jr. who spoke approvingly of the group), issued its much talked about and anticipated Interim Report today.  While the 135 page tome did not address some of the more controversial issues discussed in recent press releases and commented on earlier, it does cover a number of issues regarding competitiveness in the U.S. capital markets, many of which will be addressed in more detail in future entries.  

Two key issues addressed relate to SEC enforcement actions and the criminal prosecution of corporations.  As to the former, the Report makes three specific recommendations:  1) that the SEC resolve conflicts among the circuits on certain issues regarding private damage liability under Rule 10b-5; 2) that the amount recoverable in class actions be reduced to the extent that investors have been compensated from funds paid under the SOX Fair Funds provision from an SEC enforcement actions; and 3) that a rule should be established to limit “pay-to-play” arrangements involving charitable donations made by class action law firms to solicit institutional investors to be lead plaintiffs.  As to the latter, the Committee recommended that the standards in the Thompson Memo for indicating a corporation be modified so that a corporation can only be charged in “exceptional cases . . . ”  (In all the discussion about the waiver of privilege it is often overlooked that the original idea behind the Holder and Thompson Memos, which at least in part emanated from the private bar, was to delimit the scope of corporate criminal liability which in theory has been extremely broad since the 1909 decision of the Supreme Court in New York Central v. U.S., 212 U.S. 481, which first held that corporations could be held accountable for criminal acts of their agents).  

The full text of the report can be found on the Committee’s web site at

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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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