William Donaldson, the president of the Securities Exchange Commission, just gave U.S. CEOs a scolding. You must have an internal code of ethics that goes beyond the letter of the law to also encompass the spirit of the law, he said. The problem is, Where is the spirit of the law explained in writing, so that you know what it is? Is the SECs ethics worth the paper it is written on? Or perhaps it is obvious that this ethics is: Nothing should be done that is not approved by The Regulator.
Created in 1934, the Securities and Exchange Commission is the mother of all securities regulators. It has an annual budget of more than US$700-million and more than 3,100 employees, including 1,150 attorneys on the enforcement staff. Securities regulation only came later to Canada. The Ontario Securities Commission was created in 1945, and its Quebec equivalent in 1955. Between 1945 (the earliest date for CANSIM data on the Montreal Stock Exchange) and 1955, the value of shares traded increased 308% at the MSE, compared with 134% on all U.S. exchanges. Not bad for a market without a government regulator!
U.S. financial markets do not owe their supremacy to the SEC. As noted by Paul Mahoney of the University of Virginia Law School, [a]fter World War I and well before the federal legislation of the 1930s, New York assumed leadership of the worlds capital markets. The 1933 Securities Act and the 1934 Securities and Exchange Act were officially justified by the goal of preventing fraud in securities offerings, but it is significant that they came along with the flurry of New Deal regulations and agencies. Before that, stock exchanges had their own, private rules, and the common law rules against fraud applied (albeit with a strong caveat emptor component), not to mention regulation at the state level.
Through civil suits and administrative proceedings and orders, the SEC mandates securities registration, regulates brokerage, trading and disclosure, and helps enforce the prohibition of insider trading. It is now suing Martha Stewart and her stockbroker in civil courts. It scares large companies into settling suits without trial: Just recently, Royal Dutch/Shell paid US$120-million and Qwest was rumoured to be considering a US$250-million settlement. The agency also imposes fines and work bans.
The SEC regulates stock exchanges, which were historically private organizations. It files civil suits against violators of the new Sarbanes-Oxley Act. Brystol-Meyers Squibb is paying US$150-million to settle a suit about alleged accounting fraud, a term that now means everything and nothing. The SEC is starting to regulate hedge funds, which, by virtue of their well-known risk and sophisticated clienteles, had thus far avoided its regulation.
By mandating certain sorts of disclosure and preventing others, the SEC is, in fact, engaged in the control of information and speech. During SEC-imposed quiet periods around IPOs, information revealed through news articles or interviews is deemed to be written offers to purchase shares. At a recent technology conference, a Google executive wore a T-shirt saying Quiet Period. Cant Answer Any Questions. Besides Google, other companies have had problems with the SEC regarding interviews or publicity before IPOs, including Salesforce.com, Webvan Group and Montreal-based Discreet Logic.
Theory and evidence point to the conclusion that state regulation of financial information is economically inefficient. The prohibition of insider trading, the regulation of disclosure and the concentration of information in government-determined channels reduce the flow of information to the market. Far from improving market integrity, these regulations have generated an artificial and misleading sense of confidence. In an essay written in 1963 for Ayn Rands Objectivist Newsletter, Alan Greenspan, the current Federal Reserve Board chairman, mentioned the SEC among examples of misguided regulation.
Until recently, mere opinions on investments by individuals who were not in the business of selling securities and did not own related financial instruments were deemed to fall under freedom of speech, and outside the SECs reach. But the agency has filed a suit against an editor with Agora Inc., a Maryland company that publishes investment newsletters and owns other publishing interests (including indirectly in Les Belles Lettres, a century-old Paris publisher with which this writer has been associated as an author and book series director). The editor is sued for selling to Agora customers an investment research report with information about a pending deal between two companies. The customers who bought the research and lost moneybecause the announced event happened later than what the newsletter had forecastedwere quickly reimbursed if they complained. But the SEC wants to judge the quality of investment information. This smells of the Ministry of Truth.
More than protecting investors against fraud, the SEC is in the business of protecting the state and the establishment against financial freedom, entrepreneurship and freedom of information. Andbelieve it or notthey want to enforce their conception of ethics!
|Pierre Lemieux is a Research Fellow at The Independent Institute in Oakland, California, and Associate Professor of Economics at the University of Quebec at Outaouais in Canada.|