Capital Markets Committee Urges Major Reforms

A high-level committee on reforming the US capital markets has issued a wide-ranging report making recommendations in many areas of federal securities regulation. The Committee on Capital Markets Regulation is an independent, bipartisan committee composed of 22 corporate and financial leaders from the investor community, business, law, accounting, and academia. The committee made a number of action recommendations on issues ranging from Sarbanes-Oxley internal controls, shareholder rights, SEC rulemaking procedures, market regulation, and enforcement. The report is 152 pages long and will be the subject of future blogs on discrete topics.

I consider this committee to be the equivalent of what the European Commission would call an expert group. This white paper is destined to be seminal and is highly likely to be the genesis of legislation and regulations. The committee posits that US markets are losing their competitiveness to foreign and private equity markets. There are a number of reasons for this, including differing legal regimes.

The committee does not recommend any statutory changes to the Sarbanes-Oxley Act, not even to section 404. But it noted that the implementation of the internal control mandates of 404 by the SEC and the PCAOB has produced a regime that is overly expensive. The report urges regulatory changes to the 404 regime, including a redefinition of materiality, more guidance from the PCAOB, and multi-year rotational testing permitted within an annual attestation.

The report concludes that the US, compared with other countries, is falling behind best practices in shareholder rights. In order to restore some balance, the group recommends that shareholders be given the right to approve poison pills in companies with staggered boards. The committee also approves of the trend toward the adoption of majority voting requirements.

The expert group is concerned about auditor liability and the concentration of independent audits of company financial statements in four audit firms. In light of the Arthur Andersen experience, the committee believes that criminal enforcement should truly be a last resort reserved solely for companies that have become criminal enterprises from top to bottom. Going where others have feared to tread, the committee urged Congress to carefully examine the case for caps on auditor liability or safe harbors to prevent the failure of another audit firm.

More granularly, the committee recommends specific changes in SEC rulemaking procedures, For example, the SEC should systemically implement and carefully apply a cost-benefit analysis of its proposed regulations. Rules should not only be evaluated initially at the front-end, but also should be reviewed periodically to ensure that they are achieving their intended effect at an acceptable cost.

With the passage of Gramm-Leach-Bliley and the advent of financial institutions offering a wide range of securities and banking products, there has been a welcome increase of cooperation between bank and securities regulators. Thus, the SEC is urged to apply more bank-like prudential regulation to broker-dealers and investment advisers.

On federalism, Congress is asked to improve enforcement coordination between the SEC and state securities regulators. The states should be able to pursue civil enforcement in the absence of parallel SEC action and the SEC should have the final say on settlements involving structural remedies of national importance.