JThe SEC is under new management, and on June 12, it announced its latest regulatory agenda. He should add one more priority to his to-do list: restore the integrity of the SEC’s economic analysis.
This is essential to inform good policies and to withstand any legal challenges. Litigation has torpedoed a variety of rules in the past, and they weigh on the SEC today as it grapples with regulatory responses to issues ranging from climate change to meme actions, social media, apps smartphone trading and insider trading.
The Commission has sufficient intellectual firepower to achieve this. Its Economic and Risk Analysis Division (DERA) is home to dozens of talented doctoral students. economists. But DERA must return to its mission and follow its own advice.
This means facing two formidable challenges. The first is to resist any political pressure – internal or external – for the DERA to become a partisan tool to advance a particular rule proposal instead of providing unbiased and comprehensive economic analysis.
The second challenge relates to the inherent limitations of economic analysis itself. As critical as economic analysis is, it must be candid in recognizing when it is not possible to produce dollar estimates of the costs and, importantly, the benefits of a proposed rule.
In 2011 (when I joined the SEC), it had been battered by a series of court losses. The most notorious blow came that year, when the DC Circuit struck down the SEC’s proxy access rule on the grounds that economic cost-benefit analysis (CBA) was arbitrary and capricious. It was the seventh time in seven years that appeals courts have struck down SEC rules. The proxy access decision prompted an outcry of criticism from legal scholars. Nonetheless, the collective weight of court rulings has relegated DERA veto power over potential SEC rule proposals.
At that time, progressives viewed the CBA’s demands as a cudgel wielded by conservatives to thwart any regulation they opposed. The industry groups involved, not lacking in motivation or resources, were only too happy to offer cost estimates. But how could you quantify widespread and diffuse benefits for everyone, such as reduced fraud, increased investor confidence, or investor protection? It is one thing to point out the high costs of the accounting scandals at Enron and WorldCom or the global financial crisis of 2008. It is quite another to “monetize” the benefits of particular regulation with significant dollar estimates of the projected impact.
Perceptions of the role of economic analysis have changed under the Trump administration. A majority of commissioners, including the president, engaged in an aggressive series of mostly deregulatory rulemaking and progressives turned to economic analysis to stop, or at least slow, the speeding train. Regardless of administration, DERA was used selectively to advance policy goals rather than to provide neutral and unbiased economic analysis.
Critics include academics whose work has been cited in economic analyses. They objected to quotes, statements or analytical interpretations that were misleading, distorted, omitted essential information or relied on outdated information. The SEC’s own Investor Advocate denounced the Commission’s hypocrisy in its fiscal year 2019 report to Congress:
These are very serious accusations that raise the specter of regulatory hypocrisy, given that the SEC often takes enforcement action against market participants who misrepresent facts or select data to present misleading half-truths.
The SEC’s Investor Advisory Committee (IAC) also pointed to inadequate and unbalanced economic analysis that failed to live up to case law and the Commission’s own guidance. The IAC’s January 2020 recommendation called on the Commission to revise and reissue its proposals on proxy advisory firms and shareholder proposal thresholds.
But there was more. DERA had suppressed critical information about the impact of the shareholder proposal until August 14, 2020, when DERA’s then-director quietly placed a note on file. This was 11 months after his team completed an analysis of the data and six months after the public comment period expired. (The SEC’s chief economist said he didn’t reveal the study earlier because he didn’t think it was relevant.)
The SEC’s Investor Advocate – whose repeated requests for information from the DERA had been ignored for nearly a year – said the economic analysis violated Commission policy and at least the spirit of the law. In a fiscal year 2020 report to Congress, he also noted the irony of late disclosure:
“Notably, the SEC – an agency that prides itself on its commitment to transparency – issued no press releases, official statements, or even tweets to draw public attention to this new information.”
The SEC adopted both rules last year, but announced on June 1 that it was reviewing them and suspended the application of one of them.
Last May, DERA co-hosted an economics-focused conference on financial regulation. Commissioner Caroline Crenshaw devoted her keynote address – aptly titled “Mind the (Data) Gaps” – to a call for action to fill in the missing economic data.
“Bad information, or a lack of information, can lead to poor regulation, which can lead to both unnecessary burdens and missed opportunities,” she said. “It can also lead to an inability to regulate where regulation would be appropriate, which can lead to a failure to address real issues and mitigate harm.”
I would add another suggestion. DERA is an internal brain trust for policy development. During the formation stages of a regulation, each SEC office involved should have unrestricted access to the DERA to discuss the economic implications. And that includes all Commissioners and the Investor Advocate, regardless of their view of the proposal.
DERA is a jewel in the Commission’s crown. Now is the time to restore its shine.
Disclosure: Stephen Deane previously worked in the SEC’s Office of Investor Counsel and served as a liaison with the Investor Advisory Committee.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.