U.S. Chamber of Congress’ Commission on the Regulation of U.S. Capital Markets Provides Recommendations

Today, the U.S. Chamber of Congress issued its Report and Recommendations from its independent, bipartisan Commission on the Regulation of U.S. Capital Markets in the 21st Century. (full report and executive summary available at http://www.uschamber.com/publications/reports/0703capmarketscomm.htm) Citing the erosion of the competitive position of the U.S. capital markets and an antiquated regulatory structure, the 146 page Report provides six principal recommendations to better protect investors and promote capital formation in today’s environment of increased globalization. The six recommendations are as follows:

• 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 Report makes four key recommendations relating to SEC and DOJ enforcement actions:

1) That DOJ “reassess the circumstances under which vicarious criminal liability for corporations is appropriate and should provide additional guidance to corporations on the practice efforts they may undertake to avoid vicarious criminal liability.” The Report supports bringing criminal actions against individuals when appropriate.

2) In making a charging decision DOJ should not request the waiver of the attorney-client privilege and work product protection from business organizations. The Report concluded that the McNulty Memo, which revised federal standards on the prosecution of organizations specifically to address the question of privilege waivers, should be revised. The Report recommends that business organizations not be given cooperation credit for waiving the attorney-client privilege or work product protection.

3) DOJ should not base charging decisions on whether a corporation advances counsel fees to its executives. Essentially, the Report endorses the approach of the McNulty Memo on this point.

4) Congress should enact legislation establishing selective waiver of privilege so that business organizations can share privileged information or documents with the SEC, without making that material available to third parties. The production to the SEC would be subject to a confidentiality agreement.

Overall, these recommendations are constructive but, for the most part, do not go far enough. Standards of organizational liability are the key point to each of the four recommendations listed above. Since the Supreme Court’s seminal decision in New York Cent. & Hudson R.R. Co., 212 U.S. 481, 495 (1909), business organizations have been subject to vicarious liability for acts of their agents that confer virtually any benefit on the company. Indeed, it is the potential sweep of organizational liability that led to the drafting of the Holder Memo in 1999, a predecessor to the McNulty Memo. The Holder Memo and its successors were designed primarily to discuss principles of organizational liability, not the waiver of the attorney-client privilege. The 2001 Seaboard Release is the SEC’s equivalent to the Holder Memo, discussing primarily considerations of organizational liability.

While the McNulty Memo and Seaboard Release do in fact provide some guidance on the question of organizational liability, the Report is clearly correct in its recommendation. Organizational liability is still broad to the point of being almost open ended. Clearly, an open ended standard is inappropriate. Thus, while the Report is correct, it does not go far enough. Its recommendation to reassess organizational liability should also apply to SEC enforcement actions.


It is a little discussed fact that, the scope of liability is, in part, responsible for the waiver issues that are the subject of the other recommendations. Since business organizations face such broad liability DOJ and SEC prosecutors have extremely broad discretion in making charging decisions. In this context cooperation is often critical to limiting liability. The failure of either the McNulty Memo or the Seaboard Release to define cooperation while holding out the prospect of amnesty or reduced sanctions in exchange for cooperation forces organizations to guess at what is necessary to avoid an action. Stated differently, organizations have little choice except to take every possible step to be viewed as cooperative, including waiving privilege. Limiting organizational liability will help solve this difficulty.

The Report, however, is clearly correct when it concludes that the only real solution to the waiver problem is to amend the McNulty Memo and eliminate any cooperation credit for privilege waivers. The Memo already places significant restrictions on the ability of prosecutors to seek privilege waivers. At the same time, it offers the prospect of credit for waivers by the corporation without a formal government request. While these waivers may be labeled “voluntary” because the government did not request them, in fact they are the product of the expansive liability business organizations face and the lack of defined cooperation standards. The Report’s recommendation to eliminate cooperation credit, which was voiced earlier by SEC Commissioner Atkins, will eliminate the so called “culture of waiver.” Yet, the recommendation does not go far enough – it should also apply to SEC enforcement actions.

Unfortunately, the final litigation recommendation of the Report concerning selective waiver fails to recognize the realities of the litigation market place. In theory if there is no cooperation credit for waivers, selective waiver would seem to be a viable option because it would permit the organization to determine when to share privileged material with DOJ or SEC prosecutors while still protecting the material from disclosure to third persons. In practice, however, selective waiver would not protect the corporation’s privileged material from disclosure. Both the DOJ and the SEC have disclosure obligations and cannot ensure that the privileged material would not be disclosed, which could result in the dissemination of corporate privileged material. Accordingly, the Report’s selective waiver proposal, while having some surface appeal, is unworkable in reality.

In sum, the Report’s DOJ and SEC litigation recommendations are constructive but for the most part do not go far enough. Organizational liability should be reviewed and more narrowly defined not just in criminal cases but also SEC civil enforcement actions. Steps should be taken to preserve the attorney-client privilege and work product doctrines by eliminating privilege credit for waivers in both DOJ and SEC charging decisions. The Report’s recommendation on selective waiver is, however, unworkable and will only undercut the essence and purpose of the privilege.