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Wednesday, May 16, 2007

Paulson Committee’s “Hippocratic Method”

In case anyone doubted the hypocrisy of Treasury Secretary Hank Paulson’s Committee for Capital Markets Regulation, just take a look back at an op-ed published this week in the National Law Journal by Lawrence A. Cunningham, a Boston College Law School professor and leading expert on corporate governance and securities law.

One of the overarching hot-button issues is whether Wall Street and Corporate America should be governed by a “rules-based” or “principles-based” system. Professor Cunningham writes that while on the one hand the Paulson Committee lobbies for an overarching “principles-based” system on the other when an already established principle works to their disadvantage they urge specific language and rules - distancing industry wrongdoers from liability. In other words, the Committee is trying to have its cake and eat it too.

The most egregious example is the Committee’s full scale assault on SEC Rule 10b-5. Rule 10b-5 is a well established “legal principle” that prevents firms from making “false and misleading material statements” and is the basis for which many investor arbitration claims and class action securities lawsuits are filed. While simply telling the truth might seem reasonable, the Committee wants “detailed prescriptive language” to reduce what it considers “uncertainties” with the principle. Translation: they want to make it harder for investors to prove Rule 10b-5 was violated. Committee consultants are already on the record arguing that the rule should not be used in civil trials and arbitrations whatsoever, as my previous blog points out.

Abandoning an established legal principle like Rule 10b-5 and reversing its course in favor of more stringent standards, Paulson’s committee audaciously undermines its own reasoning for deregulation. And Rule 10b-5 is only one of a slew of examples where the Committee favors rules that insulate themselves from the legal system.

Among other examples of duplicity, Cunningham cites the Committee urging the SEC “to abandon its recently stated principle that ‘materiality’ is not a strictly quantitative concept and return to the erstwhile rule that measured materiality in terms of 5 percent of income.” This legalese basically means that fraud is only truly fraud if it equates to 5 percent of a company’s income. The “materiality” argument, mind you, was one of the defense strategies employed by Enron’s Ken Lay and Jeffrey Skilling.

Choosing when and where to apply legal principles based upon the investor’s ability to recoup fraudulently incurred losses shows the Paulson committee’s true motivation is greed. Kudos to Professor Cunningham for helping to expose the Paulson Committee’s “Hippocratic Method.”


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