My view: The essence of SEC regulation is paternalism. If the SEC's goal were to protect investors against fraud, it would simply refuse to certify securities that weren't up to snuff, and let investors buy what they wanted. In fact, however, a willing investor can't buy securities the SEC has not approved, even if he is well-aware of the SEC's complaints.
Now economists have been talking a lot about paternalism these days, and wondering if they've judged it too harshly. Aren't there a lot of idiots out there? Sure. But there are the SEC's brand of paternalism is particularly indefensible. There are two main reasons why even paternalists ought to be embarassed by it.
1. The SEC only forbids a strange grab-bag of foolish investments. There are still endless ways to part a fool and his money - just watch late night infomercials. The SEC's effort to protect naive investors is similar to preventing suicide by putting up a fence on one side of a building.
2. Informed trading transforms a lot of seemingly idiotic decisions into prudent ones. You might assume that investing by throwing darts at the Wall St. Journal is a sure route to disaster, but thanks to all the well-informed traders out there, it's quite safe. Similarly, you might think that investing in firms that don't issue SEC-approved prospectuses would be dangerous, but that's hardly clear. As long as informed traders know what's going on - and they probably do - there's nothing to worry about. The upshot is that the SEC prevents people from taking a lot of "foolish" risks that are actually prudent.
OK, what would be wrong if the SEC got out of the paternalism business and limited itself to certification? (If Greg is willing to go this far, I'm a lot more persuasive than I think!) This would definitely put a cap on the damage, because if the SEC's rules were silly, investors would stop caring about whether a security was SEC-certified. But once you put it that way, you're left with the obvious question: Why is the government supposed to have a comparative advantage in certification, anyway? I've never heard a good answer.