(The news featured below is a selection from the news covered in Federal Securities Law Reporter.)

Study Urges SEC to Focus on Efficiency, Capital Formation in Rulemaking

Peter J. Wallison and Cameron D. Smith presented a paper on SEC reforms at an event sponsored by the Financial Services Roundtable's Anthony T. Cluff Research Fund. The authors stated that the suggested reforms would reflect the Commission's obligation to consider efficiency, competition and capital formation when conducting its rulemaking activities. Mr. Wallison is a resident fellow and co-director of the American Enterprise Institute, while Mr. Smith is the chief strategy officer for INET ATS, an electronic marketplace for equity securities. Mr. Wallison explained that investors' interests would be better served if SEC rules balanced the protection of investors with the promotion of efficiency, competition and capital formation.

According to the authors, the SEC has created obstacles to the development of an international securities market by requiring reconciliation to Generally Accepted Accounting Principles in the United States and by refusing to allow better access to foreign securities exchanges and foreign brokers for U.S. investors. The authors suggest that foreign-based companies be allowed to rely on international financial reporting standards when selling their securities in the United States without reconciling or restating their financial reports to conform to U.S. GAAP. They claimed there was very little difference in financial statements prepared using IFRS and those prepared under U.S. GAAP. The "reverence" afforded to GAAP is misplaced, in the authors' view, and should not be an obstacle to the development of a global securities market.

The authors also suggest that the SEC adopt a mutual recognition system for securities markets in the European Union that would permit U.S. brokers to become members of foreign securities exchanges and foreign brokers to become members or to place orders directly on U.S. exchanges. They cite a study which found that the electronic European Union markets compare favorably with U.S. markets in the firmness of their quotes, the speed with which transactions are reported to the public and the absence of "frontrunning."

The SEC's enforcement program has a substantial impact on share values, according to the authors. The study notes that companies are seldom told that an investigation has been abandoned so a risk premium that is reflected in the stock price from the announcement of an investigation may remain for years. The authors propose a number of measures to bring about procedural fairness.

The SEC's mutual fund independent chair and 75 percent independent directors rule has been stayed by the D.C. Circuit Court for failing to adequately consider the costs and benefits associated with its implementation. The authors believe the SEC should consider the withdrawal or a substantial revision to the rule.

The authors also urge the SEC to conduct a pilot program to test the validity of extending the trade-through rule to the electronic markets. With the conversion of Nasdaq and the New York Stock Exchange to private, for-profit organizations, the authors said the SEC should rethink the regulatory structure for exchanges and brokers. They should eliminate any direct regulatory responsibilities for the exchanges themselves and allow qualified groups to offer their services as contract regulators, in the authors' view.

The authors believe the SEC has increasingly bypassed the notice and comment process required by the Administrative Procedure Act in favor of adopting policies at the staff level that have not been subject to the approval of the Commission or the notice and comment procedure of the APA. This policy-making activity has appeared more frequently in the enforcement process when defendants are required to agree to various undertakings as part of a negotiated settlement, according to the study. The study also points to policy-making through speeches by senior officials. The authors said that any significant policies that affect an entire industry should be vetted through the APA process.

The authors also presented a proposal for reducing the costs of Sarbanes-Oxley Act Section 404. When the SEC and the PCAOB began hearing complaints about the costs of Section 404, they concluded that the accountants were to blame for requiring too much detail and for not focusing on material issues when auditing internal control disclosures, according to Mr. Wallison. He noted that the SEC, in Staff Accounting Bulletin 99, said that materiality was dependent on context. The SEC also ignores the liability to which accountants may be subject, in hindsight, if a loss occurs that could have been prevented by an internal control. Mr. Wallison believes the SEC is partly at fault for the costs in implementing Section 404 because it has caused accountants to spend a great deal of needless time on their internal control reviews.

One of the requirements of the SEC's rule is that the controls provide reasonable assurance relating to the prevention or timely detection of unauthorized acquisitions, uses or dispositions of assets that could have a material effect on the financial statements. The safeguarding of assets has only a limited relationship to financial reporting and a material loss is an extremely rare occurrence for public companies, according to the study. The authors recommend that the SEC eliminate this requirement as part of the definition of controls under Section 404.

Finally, the authors believe the SEC should assert its primacy as the sole regulator of the securities markets. Congress has granted the SEC the authority it needs to preempt state actions when they interfere with a uniform set of securities regulations, in the authors' view.