The Committee of Corporate General Counsel ("Committee") of the ABA Business Law Section presented a program on March 16 that included a panel ("ABA Panel") entitled "New Commissions, New Recommendations: U.S. Capital Markets and Corporate Reforms." The panel discussed three reports containing recommendations to improve the competitiveness of U.S. capital markets and the institutions that use them. These reports are (1) Report and Recommendations of the Commission on the Regulation of U.S. Capital Markets in the 21st Century established by the U.S. Chamber of Commerce ("Chamber Report"), (2) Interim Report of the Committee on Capital Markets Regulation ("CCMR Report") and (3) Sustaining New York's and the U.S.' Global Financial Services Leadership. ("Bloomberg/Schumer Report").
The Editor interviews Robert R. Glauber, a participant in the ABA Panel and Visiting Professor, Harvard Law School and Former Chairman and CEO of the NASD. Mr. Glauber is a member of the Committee on Capital Markets Regulation which prepared the CCMR Report.
In our May issue, we published interviews of participants in the Chamber Report. See the interviews of Christine Edwards on the front cover and of Richard H. Murray and Michael Ryan on Page 5 of that issue.
The views of the interviewees do not necessarily represent the views of the organizations responsible for the reports.
Editor: What was your role in the CCMR Report?
Glauber: I drafted the introduction and Section II of the CCMR Report. The introduction focuses readers on the fact that we are clearly losing our competitive position in the financial services area. Although the fact that foreign markets are maturing is an important reason for the decline in our competitive position, the U.S. regulatory framework is also responsible for the loss.
The introduction discusses the need for well regulated markets that provide a balance between effective regulation and the costs and burdens incurred by the regulated companies. We are not advocating a race to the regulatory bottom, because if investors do not feel safe in a particular market, they will not use it. We think that there are a number of ways that we can get the benefits of effective regulation at a considerably lower cost and burden.
Section II suggests ways that our competitive situation can be improved. It provides a series of recommendations relating to the roles that the SEC, the states and prosecutors play in securities regulation. It begins with a discussion of why the SEC should adopt more effective procedures for cost-benefits analysis. It recommends that the SEC and SROs should move toward a principles-based approach to regulation and that they should have separate rules for dealing with wholesale and retail investors. It urges them to modify their supervisory and enforcement approaches, putting more emphasis on prudential supervision, as bank regulators do. It proposes that the President's Working Group on Financial Markets take steps to increase coordination among the federal regulatory agencies and that Congress prevent states from imposing structural remedies as part of litigation settlements without the approval of the SEC.
Editor: In what respects does the CCMR Report differ from the Chamber Report and the Bloomberg/ Schumer Report?
Glauber: Our Report puts greater emphasis on securities regulation. We talk a great deal about cost-benefit analysis and principles-based regulation. Sarbanes-Oxley is a great example of the need for the SEC to engage in cost-benefit analysis. Before Section 404 was implemented, the SEC estimated that it would cost $91,000 a year per issuer. The true cost has been upwards of $5 million per issuer.
The Report also discusses the problems surrounding the existing fragmented regulatory structure, which has separate regulators for banks, securities firms, insurance companies and commodities traders, but it does not recommend any structural changes. We recognized the impossibility of trying to redevelop the regulatory system. Instead we focused on the need for coordination among the different regulators. For instance, banking regulators are concerned with prudential oversight directed to assuring safety and soundness. Likewise, the CFTC is concerned with efficiency and competitiveness. The federal regulatory bodies could learn much from each other to develop best practices.
Our proposals include recommendations that the SEC move towards a prudential regulatory process similar to that used by banking regulators. Currently SEC regulators are focused on supervision of compliance with specific rules coupled with high-profile enforcement actions. This approach does not foster cooperation between regulators and companies and limits the ability of companies to predict outcomes. By contrast, the "safety and soundness" approach by banking regulators is more likely to foster a cooperative environment where firms step forward with self-identified problems.
Editor: Why was the Chamber Commission concerned with the enforcement approach taken by the SEC?
Glauber: The SEC on a number of occasions uses enforcement action to make rule changes. The Chamber and our Report view this approach with concern. If the rules need to be changed, they should be modified through the regular administrative process and not through enforcement actions. When enforcement actions are followed by codification of the result of the case, it leads to confusion and distrust of the regulatory process. The result is uncertainty and an inability to predict what is permissible and what is not.
Chairman Cox had it right that the problem with Section 404 of Sarbanes-Oxley is not with the words but with the regulatory implementation. If you go back and look at the words, they were taken from a 1991 Banking Act, which never caused major concern for banks because of the way it was implemented. Fortunately, there appears to be progress toward making 404 more livable. The SEC and PCAOB have already proposed rule changes to clarify the meaning of "materiality" as used in Section 404, to make 404 audit procedures both risk-based and scalable, and to encourage outside auditors to rely more on the work of internal audit staffs. I hope that they will continue to provide appropriate guidance in these areas.
Editor: What is needed to encourage the free flow of information that is essential if the prudential approach to regulation is going to work?
Glauber: The more prudential approach to supervision that we recommend is designed to encourage cooperation between the SEC and the regulated businesses to assure compliance. Therefore, the free flow of information between companies and the SEC needs to be encouraged. Companies need to have a self-assessment privilege to encourage them to examine their own processes without fear that the self-assessment itself will become fodder for plaintiffs' counsel and trigger civil litigation. We also recommend that there be a self-examination privilege to protect any communications of information to the SEC. That is the approach currently taken by banking regulators.
Editor: Why does the Report recommend a principles-based approach to regulation?
Glauber: The SEC should move away from the excessively detailed rules that govern behavior and develop a system based on broad behavioral principles. In the UK, the FSA has a set of rules, but they are driven by a clear set of principles. One of the benefits of that system is that regulators seek enforcement actions against those who violate their responsibilities rather than those who have a procedural lapse. In the U.S. much of oversight is directed to whether you go through the right process rather than the effects of the way you deal with your customers. Detailed, prescriptive rules often lead to box-ticking.
We are explicit about the benefits of a principles-based system. The lawyers are very uneasy about this system because it is more ambiguous. That's understandable. For it to work, there needs to be guidance. I experienced this when I was at the NASD and we put out the first principles-based rule on business entertaining. It said essentially that you should conduct business entertainment in a way that makes clear that its purpose is not to attempt to influence the decisions of the clients. We left it to the firms to write detailed rules, for example to determine whether a vice president can buy a bottle of wine for a client. Many general counsel were concerned about the perceived ambiguity of that rule. It will take regulatory guidance to give clarity and time to develop a greater level of trust between firms and regulators. Once that happens, the system can be very successful. Indeed, this is the system the CFTC uses. I think that Chairman Cox fully appreciates the distinction and the benefits of a principles-based regime, and I hope he will lead the SEC in this direction.
Editor: Explain why subjecting regulations to a cost-benefit analysis is important?
Glauber: The SEC is exempt from federal legislation that requires a formal cost-benefit analysis. We think that it should be installed. Chris Cox has said favorable things about it but it will be a challenge to implement. Most of the people at the SEC are lawyers and not economists. The culture is legal and to do effective cost-benefit analysis you also need economists. Nevertheless, our Committee felt it's worth the effort. More formal cost-benefit analysis at the SEC could be done either by setting up a special internal staff or by outsourcing the job to OMB or somewhere else.
Editor: Is there a need for reforms that would give shareholders a greater voice in the governance of corporations?
Glauber: Yes. We are lagging behind in this regard.
Editor: Does this mean that we should reduce some of the restraints on hostile takeovers?
Glauber: We recognize that classified boards are a serious impediment to takeovers. We think that where that barrier is raised by inclusion of a poison pill, the two together become an almost insurmountable obstacle. In that case we think that the shareholders should be empowered to vote on the installation of a pill. As a general rule (with a limited exception), any installation of a poison pill by a classified board ought to be subject to shareholder vote.
Editor: What about majority voting?
Glauber: We were supportive of majority voting. We did not go too far. We said that we think it is a sensible part of a shareholder's rights program. Requiring a majority, rather than a plurality vote would give shareholders more ability to determine the outcome of an election for directors. Nominating committees could no longer operate under the assumption that they can always obtain the necessary amount of votes during an election for their candidate. Nevertheless, there are some details that need to be worked out. For instance, what constitutes the majority and whether you want it to exist in the case of a contested election? We are supportive of it. It's a trend that has begun (about 25% of S&P 500 companies have adopted it), and I think it will continue to grow.
Editor: What about shareholder nomination of directors?
Glauber: We discussed it but did not go very far. Part of it is that we have new rules on voting proxies and the confusion created by Second Circuit's decision in American Federation of State, County & Municipal Employees, Employees Pension Plan v. American International Group, Inc. which states that a company may not exclude certain shareholder proposals for board candidates. As a group, we did not form a consensus on this.
Editor: Are these proposals saleable to the business community?
Glauber: Most companies would probably support our proposal with respect to poison pills coupled with a staggered board. Majority voting will become increasingly saleable because it will happen. The proxy access issue is still highly controversial with no early resolution in sight.
Editor: What about giving directors more leeway to rely on auditors and officers?
Glauber: Our securities laws were designed at a time when most members of the board were officers. It was important to place the burden on these directors to do the necessary homework to get it right. With a majority of independent directors on the boards of public companies, these policies need to be reconsidered. Now, regulators need to reconsider policies that deny directors the right to rely on auditors or on the expertise of company officers.
Editor: Do you believe that the recommendations of the Committee will be implemented?
Glauber: The question is whether these three reports will have an impact. They have had some already. It has been helped by the fact that the Secretary of Treasury feels that these issues are worth his concern. Whether there will be a serious or meaningful impact is an open question. Also, the U.S. Chamber has created a Center to champion the recommendations in the three reports. Support for the proposals should be substantial and not be limited to financial services companies. All companies benefit from healthy capital markets and from reforms that improve the regulatory climate and reduce their exposure to unmeritorious litigation.
Editor: Do you have any final comments?
Glauber: We are facing a world which is different from the last 70 years. In the past the financial services business came to the U.S. because here was the natural place to do it. Much of the capital was here and much of the investment opportunities were here. Now capital and investment opportunities exist all over the world. Capital is not only more spread out but it flows more easily. We have to battle for these transactions now. To succeed, we have to get right the balance among mechanisms that protect investors - regulatory laws and rules, the activities of courts and regulators, shareholder voting rights - and the cost, burden, and intrusion that these mechanisms inevitably impose on capital market participants. That's a tough challenge, but if we focus on it, we can get the balance right.
Published June 1, 2007.