Treasury Secretary Paulson’s Six Principles For Reform

Treasury Secretary Paulson’s Six Principles For Reform

November 20, 2006

FEI Summary

On Nov. 20, 2006, U.S. Treasury Secretary Henry Paulson gave a major speech at the Economic Club of New York on the subject of the competitiveness of the U.S. Capital Markets. In his speech, Paulson outlined six "principles" to strengthen and maintain the competitiveness of the U.S. Capital Markets. He closed his speech noting that competitiveness of the capital markets was one among five broad policy initiatives necessary for the “overall economic competitiveness” of the U.S.

Six Principles to Improve Competitiveness of the U.S. Capital Markets

Following are the six principles to improve the competitiveness of the U.S. capital markets as outlined by Treasury Secretary Paulson in his speech on November 20:

1. It is necessary to take a global view.

o        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.

2. Our regulatory structure should be more agile and responsive to changes in today's marketplace.

o        Reform of the tort system in the U.S., which Paulson referred to in his remarks as ‘broken,’ appears to fall under this principle and enforcement.

3. To stand the test of time, rules should be embedded in sound principles.

o        Paulson emphasized the need to move to more "principles-based" regulation as a theme in his remarks.

o        He noted one factor that may impact foreign companies’ decisions to list outside the U.S. (vs. in the U.S.) was the need to reconcile IFRS to GAAP - IFRS being a more principles-based regime. Paulson also noted progress is being made on the US-EU "roadmap" on moving toward eliminating the IFRS-U.S. GAAP reconciliation requirement in the US, and toward accepting U.S. GAAP filings in the EU.

4. Regulators should take a risk-based approach to regulation, weighing the cost to shareholders against the benefits. [NOTE: Paulson’s comments on the Sarbanes-Oxley Act, particularly Section 404, appear to fall mainly under this principle, although other principles apply.]

o        “At this time, I do not believe we need new legislation to amend Sarbanes-Oxley,” said Paulson. “Instead,” he continued, “we need to implement the law in ways that better balance the benefits of the legislation with the very significant costs that it imposes, especially on smaller businesses."

o        Paulson showed confidence in anticipated proposed rulemaking coming from the SEC & 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 should encourage common sense reliance on past work, and on the work of others."

o        Regarding small business, Paulson said: "[T]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.

o        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."

o        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 concern about the incentives for cooperation outlined in the Thompson Memorandum including having companies waive attorney client privilege, and refusal of companies to advance legal fees to employees accused by the government of wrongdoing]. Paulson 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?"

Five Broad Policy Initiatives to Maintain ‘Overall Economic Competitiveness’

In closing his November 17 speech, Treasury Secretary Paulson said competitiveness of the U.S. capital markets is but one of five broader policy initiatives that need to be addressed to strengthen the overall economic competitiveness in the U.S. Paulson identified these initiatives as the need to:

1. reform our entitlement programs
2. advance energy security
3. maintain and strengthen trade and investment policies that benefit American workers
4. focus on economic and educational policies that will add jobs, improve productivity, and result in tangible income growth for all Americans, and
5. strengthen and maintain the competitiveness of our capital markets [detailed in today's speech]

FEI Positions Consistent with Paulson on Sarbanes-Oxley
FEI's position on Sarbanes-Oxley Section 404 (as stated in FEI Congressional testimony during 2006 and comment letters filed with the SEC by FEI's technical committees during 2006, here, here and here) is consistent with Paulson's statement in his Nov. 20 speech, in which he said: "At this time, I do not believe we need new legislation to amend Sarbanes-Oxley. Instead, we need to implement the law in ways that better balance the benefits of the legislation with the very significant costs that it imposes, especially on small businesses.”

Links to More Information

The full text of Treasury Secretary Paulson's speech is available here.  

A more detailed summary of Treasury Secretary Paulson’s speech is available in this post in FEI’s Section 404 blog. To receive automated emails of blog posts, enter your email address here.

Prepared Nov. 21, 2006 by Edith Orenstein (eorenstein@FinancialExecutives.org), Director, Technical Policy Analysis, Financial Executives International (FEI). This summary does not represent FEI opinion, unless specifically noted above.