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20 November 2006

Speech Paulson: Six Principles for Competitive Capital Markets

In a speech at the Economic Club of New York U.S. Treasury Secretary Henry Paulson outlined six principles to 'guide us forward' in strengthening and maintaining competitive capital markets, which in turn, 'pave the way for continued economic growth that benefits all Americans.' At the close of his remarks, Paulson briefly outlined other policy initiatives necessary for the 'overall economic competitiveness' of the U.S.

The six 'principles' outlined by Paulson - including some details outlined earlier in his remarks as being among four 'factors' contributing to the recent decline in U.S. IPOs vs. IPO's listed outside the U.S. (and the increased number of 'going private' transactions in the U.S). - are:

1. It is necessary to take a global view.
Paulson elaborated: 'We don't operate in isolation, so it is very important to consider how changes we make affect the ability of our companies to compete globally and how these changes affect our interaction with markets and regulators around the world.

Paulson noted capital markets are growing abroad, which is impacting where companies choose to list, as well as factors that are more endemic within the U.S. regulatory structure listed below.

2. Our regulatory structure should be more agile and responsive to changes in today's marketplace.
Paulson said the 'complex and confusing regulatory structure' in the U.S. was among factors contributing to recent trends in where companies chose to list (US vs. foreign).

'A consequence of our regulatory structure,' said Paulson, 'is an ever-expanding rulebook in which multiple regulators impose rule upon rule upon rule.' 'Unless we carefully consider the cost/benefit tradeoff implicit in these rules,' he added, ' there is a danger of creating a thicket of regulation that impedes competitiveness.'

The 'broken tort system,' described by Paulson as 'an Achilles heel for our economy,' would also appear to fall under this principle relating to the regulatory structure (as well as the principle below relating to enforcement.) Paulson said that although 'a sophisticated legal structure... is necessary to protect investors, businesses, and consumers,... our legal system has gone beyond protection..' noting that U.S. tort costs reached a record quarter-trillion dollars in 2004, reaching 2.2% of U.S. Gross Domestic Product (GDP), 'with only 42 cents of every tort dollar going to compensate injured plaintiffs.' Paulson concluded that reform of the tort system 'is not a political issue, it is a competitiveness issue and it must be addressed in a bipartisan fashion.'

Paulson also noted that fear of being second guessed by the PCAOB and plaintiff's bar led to auditors increasingly asking for detailed rules vs. being willing to rely solely on professional judgment, thereby adding inefficiencies and complexities to the U.S. market.

3. To stand the test of time, rules should be embedded in sound principles.
Paulson noted the need to move to more 'principles-based' regulation was a theme of his remarks, and recognized that one factor that may impact foreign companies decisions to list outside the US vs. in the US was the need to reconcile IFRS to GAAP - IFRS being a more principles-based regime; he also noted progress is being made on the US-EU 'roadmap' agreed between the SEC and EU on moving toward eliminating that reconciliation requirement in the US, and toward accepting US GAAP filings in the EU.

4. Regulators should take a risk-based approach to regulation, weighing the cost to shareholders against the benefits.
'At this time, I do not believe we need new legislation to amend Sarbanes-Oxley,' said Paulson. 'Instead,' he recommended, 'we need to implement the law in ways that better balance the benefits of teh leglistlation with the very significant costs that it imposes, especially on smaller businesses.'

Paulson said 'Section 404 should be implemented in a more efficient and effective manner,' adding, 'It seems clear that a significant portion of the time, energy, and expense associated with implementing Section 404 might have been better focused on direct business matters that create jobs and reward shareholders.'

Paulson indicated confidence in anticipated proposed rulemaking coming from the SEC and PCAOB to address the efficiency and effectiveness of Section 404 implementation, saying the regulators 'will soon seek comments on a new and much improved auditing standard aimed at ensuring that the internal control audit is top down, risk based, and focused on what truly matters to the integrity of a company's financial statements.'

'This new guidance for companies and their auditors,' said Paulson, 'should encourage common sense reliance on past work, and on the work of others.'

'Moreover,' Paulson added, “he SEC and the PCAOB are going to provide tailored guidance for small companies that recognizes their specific characteristics and needs.'

5. Our enforcement regime should punish and deter wrongdoing and encourage good behavior without hindering responsible risk-taking and innovation.
Paulson emphasized his support for enforcement: 'Let's be clear: Those who commit corporate fraud are guilty of stealing from shareholders, employees, and consumers. That behavior can never be tolerated.'

However, he added, 'Our challenge is to make sure the tools are in place to punish bad actors, while recognizing that the vast majority of business leaders are honest, capable, and focused on the interests of shareholdres and employees.'

Paulson recommended the enforcement environment be made more 'constructive' by creating an environment in which 'public companies would be able to work with regulators to resolve ambiguities and make the right decisions,' and that 'such regulatory guidance should be easy, quick, and relatively costless to obtain.' He added, 'The combination of enforcement and guidance is liekly to be more effective and efficient than relying on enforcement alone...'

Separately, Paulson noted the Justice Department is 'seeking input from outside groups and is currently considering revisions to the 'Thompson Memorandum' ...'[Note: issues raised by the American Bar Association include incentives for cooperation in the Thompson Memorandum including having companies waive attorney client privilege, and refusal to pay legal fees of employees accused by the government of wrongdoing]. Pausl said, 'If it appears that changes are warranted [to the Thompson Memorandum], in the public interest, and consistent with the need to safeguard the integrity of our economic system, I am confident the Justice Department will revise its policy.'

6. The best way our business leaders can protect the integrity and competitiveness of our markets is to exert moral leadership, where the threshold question is, 'Is this right?' not 'Do the rules allow us to do this?'
In closing his speech at the Economic Club, Treasury Secretary Paulson noted competitiveness of the U.S. capital markets is but one of the broader policy initiatives that need to be addressed, which he hopes to assist in addressing during his term as Treasury Secretary. The five policy initiatives outlined by Paulson are:

  • reform our entitlement programs
  • advance energy security
  • maintain and strengthen trade and investment policies that benefit American workers
  • focus on economic and educational policies that will add jobs, improve productiveity, and result in tangible income growth for all Americans
  • and, strengthen and maintain the competitiveness of our capital markets.

    Full speech


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