Regulating the Regulators

To what extent should regulators have discretion to interpret America’s laws?” – The Lonely Realist

Ronald Reagan famously said, “If you want more of something, subsidize it. If you want less, tax it.” He could have added “And if you want to further a political agenda, appoint the appropriate regulators.” Regulation is the easiest way to implement partisan policies, and the Supreme Court this term (in Loper Bright Enterprises v. Raimondo) will decide whether regulators indeed should have the final say in interpreting laws passed by Congress …, a tug-of-war between partisan policy-making, Constitutionalism and market efficiency. A potentially more consequential legal battle involving the same question began in August when the Securities and Exchange Commission promulgated a set of “Private Fund Adviser” rules, leading a coalition of private fund industry organizations to file suit in Federal court to strike down those rules based on their “unreasonableness.”

The Loper Bright litigation was brought by a group of commercial fishing companies that challenged a rule issued by the National Marine Fisheries Service requiring the industry to pay for the costs of observers to monitor compliance with fishery laws (at $700/day). The District and Circuit Courts relied on the Supreme Court’s 1984 decision in Chevron v. Natural Resources Defense Council to defer to the NMSF’s interpretation of Federal fishery law. Because the Supreme Court has elected to review the Loper Bright decision, it will be revisiting its Chevron precedent (noting that Justice Thomas has stated that he believes Chevron to have been wrongly-decided and that the determination of whether regulations are reasonable should be made by judges rather than regulators). Chevron stands for the legal doctrine that public policy decisions are within the Constitutional domain of the Executive Branch and not within the power of the Judiciary. Congress often enacts ambiguous laws and sometimes explicitly directs the Executive Branch to issue regulations to implement those laws. Commentators have questioned both the ability of Congress to delegate to the Executive Branch such an inherently Legislative power as well as whether, if such delegation is Constitutional, the final arbiter of “reasonableness” should be the courts or the regulators. It was thought that Chevron had put those questions to rest during the Reagan Administration when the belief was that liberal judges were remaking laws based on their own progressive political preferences by selectively upholding and striking down regulatory interpretations made by Reagan Administration regulators. Whether regulators truly possess the “expertise” presumed by Chevron can reasonably be questioned since regulators are appointed by politically-motivated Presidents. In 1984, those appointments had a decidedly Reaganesque prejudice. In 2023, they are Bidenesque.

In a nation that has flourished under the Rule of Law, clarification-by-regulation is a necessity, providing intelligibility and consistency. However, excessive regulation weakens democracy and, at times, undermines free markets. It adds complexities that constrict freedoms, empower special interests, and impede law enforcement, adding financial costs that siphon away personnel and dollars. Those are among the issues presented to the Supreme Court in Loper Bright …, as well as to the Federal courts in National Association of Private Fund Managers et al v. Securities Exchange Commission.

Congress created the SEC to restore investor confidence after the 1929 stock market crash to protect unsophisticated investors. The combination of comprehensive investor-protection laws and SEC oversight created the confidence necessary to make American markets the global leaders in capital formation, investment management and trading. Those laws and that regulator accordingly have set the global standard for safely, liquidity and efficiency. They also have made America’s private funds businesses (hedge, venture capital, and private equity) world-leaders, further enhancing the preeminence of America’s financial industry.

Among the reasons for the global primacy of America’s private funds is the principled-based balancing between disclosure, reporting and audit processes, on the one hand, and the requirement that only financially-sophisticated investors may invest in private funds, on the other. Foundational to private funds’ success has been the absence of systemic abuses, providing strong evidence of an industry subject to an appropriate level of government regulation. Excessive regulation, after all, can stifle growth, distort markets, and drive businesses to alternative jurisdictions …, which are among the concerns expressed by the petitioners in National Association of Private Fund Managers, a litigation arising from the SEC’s adoption on August 23rd (by a 3-2 vote) of new and amended rules that will significantly impact the private funds industry. The rules are far-reaching – comprising 660 pages – and a material departure from the SEC’s pre-2021 approach of judiciously regulating the industry to ensure that investors are protected without unnecessarily burdening markets. Unfortunately, the new private fund adviser rules are only the latest among a recent over-abundance of SEC proposals that attempt to address perceived deficiencies in America’s financial market regulatory structure, deficiencies that have not manifested themselves in adverse practices or resulted in litigations or enforcement actions. For example, the post-2020 SEC has taken aggressive steps to regulate public companies by adding new disclosure obligations with respect to executive pay, cybersecurity risk, conflict diamonds and climate-impacting actions and policies, excluded cryptocurrency firms from engaging in any form of regulated financial services business, and proposed significant limitations on the ability of activist funds to influence corporate actions. Among the cumulative, adverse effects of these rule changes are added compliance and consumer costs that create size disadvantages and barriers to entry that will impact the functioning of America’s markets and the preeminence of its financial services industry. The action taken in National Association of Private Fund Managers in response to the SEC’s most recent regulatory edict is unprecedented, the only instance in which the industry has instituted such litigation.

Both Loper Bright and National Association of Private Fund Managers present the Constitutional question of whether the Executive Branch should have the authority to broadly interpret legislation without clearly-defined judicial guardrails. It is a practical impossibility for government regulation to be clear and unambiguous, especially given 21st Century complexities. Moreover, it is beyond Congress’s authority, as well as its ability, to micromanage the day-to-day administration of its legislation. Chevron says that Congress should rely on Federal regulators appointed by the President to do so, that the act of policy-making should abide not in America’s Judicial Branch, but in the two elected branches of America’s government. The question for the Supreme Court is how far that policy-making should be allowed to go. From a purely legal perspective, it is difficult to once again sanction a Supreme Court reversal of 40 years of precedent. On the other hand, the NMFS’s fishing boat “tax” of $700/day and the SEC’s 660 pages of needless onerous new private fund rules (especially when added to the recent cornucopia of unnecessarily burdensome SEC regulatory proposals) both appear excessive, raising legitimate questions about what, indeed, is “reasonable.”

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Finally (from a good friend)


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