Commission on the Regulation of U.S. Capital Markets in the 21st Century - Report and Recommendations

Commission’s Report Highlights the Importance of Legal Reform
March 13, 2007

On Monday, the Commission on the Regulation of U.S. Capital Markets in the 21st Century released its report detailing recommendations that would significantly improve the U.S. position in the global markets. The report contained several solid recommendations for legal reforms, with a particular emphasis on securities class action reform and preservation of attorney-client privilege.

The Commission is an outgrowth of the U.S. Chamber’s Investment and Growth Initiative, which is pursuing policies that encourage stability, fairness, transparency, and innovation in U.S. capital markets. As part of the initiative, an independent, high-level commission – co-chaired by Bill Daley, former Secretary of Commerce under President Clinton, and A.B. Culvahouse, former White House Counsel under President Reagan – gathered information at public “town halls” around the country. The Institute for Legal Reform also provided extensive data and analyses to the Commission. The report issued today is the outcome of their deliberations.

The Commission details the hurdles to overcome in keeping American capital markets competitive in a global marketplace, and offers specific reforms to better protect investors and foster capital formation. While the Commission addresses a range of issues critical to enhancing U.S. capital markets, the importance of reforming the legal system is a dominant theme throughout the report.

Among its key findings, the Commission recommends:

Continued reforms of the litigation system to reduce the burden of private lawsuits, which it regards as necessary for the United States to remain a leader in global capital markets.

• The Commission recognizes that a company’s decision to participate in the U.S. capital markets exposes it to a unique burden – the broad ability of individuals to initiate lawsuits to recover damages attributable to a wide range of conduct that violates the federal securities laws. There is real concern that this burden is making U.S. markets less competitive when compared to the capital markets in Europe and Asia.
• The Commission supports reforms to reduce the litigation burden, recognizes that substantial work has already been undertaken by groups (including the U.S. Chamber Institute for Legal Reform), and encourages the efforts underway to examine fundamental reforms to the securities class action litigation system.
• The Commission urges Congress to call upon the SEC to undertake a comprehensive study of the state and federal civil, regulatory and criminal enforcement mechanisms to assess whether they are enhancing the goals of investor protection and capital formation, including whether the PSLRA is meeting the objectives set forth by Congress. The assessment should include an analysis of the PSLRA’s impact on the effectiveness of the federal securities laws.

Several specific reforms, which may be achievable in the current legislative and regulatory environment and which would quickly improve the legal climate.

• Sarbanes-Oxley authorized the SEC to combine civil penalties and any disgorgement obtained from a securities law violator into a “Fair Fund” to compensate harmed investors, but did not address whether payouts from these Fair Funds were intended to supplement or offset funds obtained by an investor from the same securities law violator as the result of private litigation. Without coordination, there is a risk that investors will be able to obtain compensation from the same company twice, through the SEC Fair Fund and through a traditional private action. The Commission recommends that the SEC adopt a formal policy which prohibits duplicative payments from Fair Funds and private litigation on similar claims.
• Noting ambiguity in the interpretation of Rule 10b-5, the Commission supports the “bright-line test” adopted in the Second Circuit under which professional services firms may be found primarily liable for securities fraud under SEC Rule 10b-5 only if they actually make a material misstatement or omission. In addition, the Commission supports the rejection by the Eighth Circuit of “scheme liability” for professional service firms and secondary actors under SEC Rule 10b-5. The Commission advocates the adoption of these two standards by all federal courts of appeals or by the Supreme Court, and recommends that the SEC also actively support the adoption of these standards.
• The Commission also recommends that Congress, government agencies, and market participants engage in serious discussion about proposals made by others—including safe harbors or damage limits in specified circumstances—to address the risk of losing another large audit firm.

Preservation of the attorney-client privilege.

• The Commission recommends the Department of Justice (DOJ) not request waivers of attorney-client privilege and work product protection from business organizations under the threat of indictment or other enforcement action, and that waiver should not be considered as a cooperation credit factor in the decision whether to indict the organization.
• The Commission urges DOJ to reassess the circumstances under which vicarious criminal liability for corporations is appropriate and to provide additional guidance on the proactive efforts business may undertake to avoid vicarious criminal liability.
• The Commission supports efforts to permit selective waiver whereby a private party could share some privileged information or documents with external audit firms or government-appointed corporate compliance monitors (subject to a confidentiality agreement) without waiving the attorney-client privilege as to other third parties.

Focusing criminal prosecutions on the responsible individuals, rather than the whole business entity.

• Because a criminal indictment poses a unique threat to the continued existence of a business entity, the threat of indictment gives prosecutors undue leverage to force corporations and other business entities to give in to their demands. The Commission recommends that only those individuals accused of the alleged criminal activity be prosecuted, not the corporation as an entity, unless the criminal activity is pervasive throughout the top echelons of the entity.

Ending regulatory overlap in the enforcement of financial services regulations.

• To address U.S. competitiveness within global capital markets and to take into account the extent to which the international regulatory structure impacts the U.S. regulatory model, the Commission recommends greater coordination of U.S. financial services regulatory policy. As a first step, the Commission recommends that the President enhance the role of the President’s Working Group on Financial Markets (“PWG”) by calling upon the PWG, in consultation with financial firms, investors and regulators (federal and state) to increase coordination among the nation’s financial services regulators.

Many of these recommendations track closely with the earlier findings of the Scott-Hubbard and Bloomberg-Schumer reports. On the whole, this report adds substantial impetus to efforts to fundamentally reform the securities class action litigation system in America.