09 Apr Regulatory Overload
“If you want more of something, subsidize it. If you want less, tax it.” –Ronald Reagan
“And if you want less efficient markets, over-regulate them.” –The Lonely Realist
There are good regulations and bad regulations. In a nation that has flourished under the Rule of Law, clarification-by-regulation creates intelligibility and precedential consistency. Regulations that provide demonstrable consumer protections are a public good. Not surprisingly, however, many regulatory rationales fail on a cost-benefit analysis because they disproportionately increase government size and create market inefficiencies without sufficient public benefit. Over-regulation – government policies that arrogate legislative power to the executive branch (Statism) – weakens democracy and undermines free markets. Such policies add complexities that constrict freedoms, empower entrenched interests, and impede law enforcement.
Two months ago, TLR criticized proposed SEC rules that, if adopted, would banish caveat emptor from the private equity and hedge fund industries. Similar concerns have been raised about another set of SEC proposals that would expand the definition of “securities dealer,” significantly increasing the regulation of entities that actively trade in the markets, and a third set of SEC proposals that would limit – or, arguably, eliminate – shareholder activism in which hedge funds seek to acquire shares in order to influence corporate actions, a pursuit that is good for investors, good for America and good for Capitalism (as described here).
The flip side of regulatory over-reach is Congressional under-reach. In “Regulatory Rigor Mortis,” TLR described a nonpartisan plan that would have reduced poverty, simplified America’s complex welfare system, and shrunk the swollen Federal bureaucracy. At that time, members of both political parties had a unique opportunity to enact nationally-beneficial legislation. Congress instead decided to consume itself with partisan infighting, a failure consistent with decades of legislative under-reach. It is not surprising that such under-reach has led to executive over-reach, a practice that has been perfected by successive American Presidents. As TLR noted in March 2020, “In the rapidly complexifying 21st Century, the invisible hand of Capitalism is being enfeebled by the barely-visible hand of government control and intervention.” That intervention has been impacting a growing cross-section of American life, sometimes through executive orders (as was most true during the Obama and Trump Administrations) and, over the past year, by the expansive regulatory actions of the Securities and Exchange Commission. Neither under- nor over-reach favor the national interest.
Congress created the SEC to restore investor confidence after the 1929 stock market crash. Its mission was to protect unsophisticated investors, in part by ensuring that companies participating in the securities markets make fulsome, truthful disclosures. The combination of comprehensive investor-protection laws and SEC oversight created precisely the degree of confidence necessary to make American markets the global leaders in all facets of capital formation, investment and trading. America’s public securities markets accordingly have been world-beaters, setting the global gold standard for safely, liquidity and efficiency. By satisfying rigorous disclosure and financial reporting rules, distributing audited financial statements, and satisfying minimum capital requirements, public companies gain global visibility and the imprimatur of U.S. credibility.
The benefits of a U.S. public listing may be changing, however. The SEC recently has taken aggressive steps to more heavily regulate public companies by proposing new disclosure obligations with respect to executive pay, cybersecurity risk, conflict diamonds, SPACs and climate-impacting actions and policies. Among their many effects, these multiple rule changes would add costs and complexity and create barriers to entry, all of which incentivize companies to remain private. They would reduce entrepreneurship, innovation and competitive pressures on existing public companies, furthering the interests of monopolists while increasing costs to consumers, all with far-reaching consequences for business formation and America’s world-beating markets. These proposals therefore would not create more efficient business operations and most certainly would not create the kinds of jobs that either satisfy Americans’ employment needs or reduce income inequality. They would, however, fertilize America’s legal, audit and environmental planning industries, which are not the businesses most likely to grow America’s economy or enhance America’s global competitiveness. These proposals also ignore the market reality that it is professional investors who actually study company disclosures. The audience that the SEC’s proposals therefore will reach is a sophisticated one that, firstly, should have no need for enhanced, largely boilerplate disclosures and, secondly, has the ability to directly ask questions and receive answers from companies’ management. It therefore is unclear who actually would benefit from the SEC’s proposals.
This is not to say that the SEC’s proposals lack all merit; however, parsing the burdens must be a necessary prerequisite to adoption. For example, granting that climate change is an urgent international crisis that requires immediate government action, it is far from clear that the SEC’s proposals would meaningfully change the investing public’s ability to informatively impact corporate climate-related action. The benefits, speculative as they are, would be incremental …, but at what would appear to be outsized cost.
Recognizing the advantages that U.S. public markets provide to American business, other countries have been seeking to establish alternatives. China is leading that effort, thus far (fortunately) with limited success. Coupled with its China First approach to financial disclosure, China has so far failed to find a competitive balance between economic efficiency and regulatory rigor and therefore is unlikely to make significant inroads until the Chinese Yuan becomes an accepted medium of global exchange. Perhaps that has led the SEC to conclude that more regulation is competitively better. It isn’t …, not unless each new regulation successfully balances investor protection and market efficiency. Moreover, considering the uses to which limited SEC resources could be put, enforcement today rather than regulatory overdrive appears the better priority. (The flip side of regulatory excess, adequate enforcement, is likely to be put to the test when the SEC addresses Elon Musk’s recent non-activist … then activist … acquisition of 9.1% (or more?) of Twitter stock.) More thinly spreading the regulatory compliance budget as these proposals would do benefits those with the deepest pockets. The heavy regulatory load will reduce competition and require those with thinner margins to cut corners, eroding compliance. Simpler indeed is better. Bureaucracy and paper-creation are anti-competitive and anti-capitalist. If America wants its markets to continue being global outperformers, the SEC must avoid regulatory overload.
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Finally (from a good friend)