The Perils of Paulson

If regulations are so bad, why are stocks up?
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Hank Paulson believes what's good for Goldman Sachs (GS) - Get Report is good for America.

That was fine, of course, when Paulson was CEO of the nation's premier investment firm. But now he's the Treasury secretary, entrusted with the well-being of constituencies far beyond Wall Street.

Judging by his recent comments, Paulson sees regulation more as a burden on his former colleagues than as a way of maintaining investor confidence. But the secretary's push to prune back oversight of securities markets seems strange in light of this fall's sharp uptick in stock prices.

In a recent

speech to the Economic Club of New York, Paulson bemoaned that U.S. securities regulations increasingly are driven by a concern over whether something is legal. He suggested the U.S. should move away from a "rule-based mindset" to one that "gives regulators more flexibility to work with entities on compliance within the spirit of regulatory principles."

The Treasury secretary's view got a big boost on Thursday when a group of like-minded corporate leaders issued a 135-page report that says lawyers are playing too big a role in shaping regulatory policy. The report from the Committee on Capital Markets Regulation blames "the growth of U.S. regulatory costs" with eroding the nation's competitive edge.

The committee, among other things, recommends that legislators establish more legal protections for company auditors and directors. It also advocates a greater use of private arbitrations to settle disputes between companies and shareholders, as opposed to litigation.

Paulson's speech and the committee report no doubt are being applauded on much of Wall Street. His former colleagues at Goldman Sachs,

Lehman Brothers

(LEH)

,

Merrill Lynch

(MER)

and

Morgan Stanley

(MS) - Get Report

certainly would like nothing better than to cut down on their legal expenses, which have escalated in recent years in the wake of a series of costly corporate scandals and regulatory investigations.

The same sentiment no doubt prevails in corporate boardrooms, where the Sarbanes-Oxley corporate governance reform law, enacted in the wake of the accounting frauds at Enron and WorldCom, is often treated like a four-letter word.

SarBox's mandate that companies beef up their internal financial controls is blamed for an assortment of miseries. The added cost of complying with the law is said to have deterred foreign companies from listing shares on the

New York Stock Exchange

and

Nasdaq Stock Market

and to have driven public companies into the arms of leveraged-buyout artists.

To be sure, in calling for a more flexible regulatory system, Paulson isn't seeking to bring back the days of the Wild, Wild West. In his speech, Paulson says he has no desire to "engage in a regulatory race to the bottom" and does credit regulation with instilling investor confidence. Moreover, with the Republicans about to lose control of Capital Hill, the prospect for sweeping regulatory changes appears unlikely in a Democrat-controlled Congress.

But some say Paulson and his supporters in the business community are trying to lay the groundwork for an eventual weakening of the regulatory reforms of the past few years.

The Council of Institutional Investors, an association of public and private pension funds, says the recommendations made by the Committee on Capital Markets "would undermine the effectiveness of market watchdogs and weaken critical investor protections."

Jill Fisch, a securities professor at Fordham University School of Law, describes the committee's report and Paulson's speech as "a last-ditch attempt at a pro-business legacy." Fisch gives short shrift to most of the business community's complaints about the cost of complying with SarBox. She says the law's requirement that companies strengthen their financial controls was long overdue.

"The issue of how you implement this for small business is complicated, but small business is where most of the fraud occurs," says Fisch. "The Enrons and WorldComs are rare events."

Curiously, the growing call for a rollback of SarBox comes at a time of record corporate profits. So far this year, Standard & Poor's says corporate profits are up 17% compared to 2005. Better yet, corporate profits are running 88% above their level in 2002 -- the year SarBox took effect.

At the same time, corporations are spending a record sum on stock buybacks, an indication that business still has plenty of cash to throw around despite higher regulatory costs. Over the first nine months of this year, corporations spent $325 billion on share buybacks, up 32% from a year ago.

And, of course, the stock market continues to roll along, with the

S&P 500

rising 12%.

If it ain't broke, don't fix it.