Bryan Caplan  

What's Wrong With the SEC?

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"Virtually Bone from the Neck ... My Book Commercial...

Greg Mankiw's not impressed by Jeff Miron's argument for abolishing the SEC. In his response, Miron gets closer to my position, but I still don't think he hits the nail on the head.

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.


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Robert Schwartz writes:

The SEC really is not that paternalistic. If it were, it would have what is called merit regulation of securities, which is something the states used to do, and still do in some circumstances.

The SEC runs a disclosure system for corporate securities that resembles nothing so much as old-style soviet censorship. This creates millions of pages of unreadable, and unread, documents, which are supposed to put Joe Investor on a level playing field with his broker and the wise guys on the street.

This is simply a bad joke and a waste of money. If you don't believe me I have some Refco shares I want to sell you.

I could go on for a while. The accounting regulations are designed to produce useless numbers and inhibit investment insight. Arguably the whole system is designed to deflect attention from the absolutely miserable job that the investment business has done for their customers.

But it is late so I shall stop here.

Robert Speirs writes:

Perhaps the only good effect of SEC characterization of securities' worthiness is to remind investors that some stocks are not prudent investments, not just because they're not necessarily going to go up, but because they might be fraudulent in some way. But for an investor to go beyond this and assume that the SEC knows which stocks are and which aren't fraudulent or imprudent investments is foolish in the extreme.

Gordon Mohr writes:

Indicative of SEC paternalism: the "accredited investor" exceptions, which effectively confine many kinds of risky but lucrative private investments to the already-wealthy.

After all, the government can't have the poor and middle-class investing their money in risky ventures -- who would then be left to buy lottery tickets?

This is incompetent paternalism: the "father" should lose custody. Perhaps someday the Institute for Justice can have these wealth-discriminatory rules struck down on constitutional grounds.

Randy writes:

Just occurred to me that "maternalism" is more accurate than "paternalism". My daddy would be telling me to get out there and do it myself. Its momma that wants to protect me from harm at all cost.

Les Livingstone writes:

Both author and commentators are under a common misunderstanding of the SEC. The SEC does not, and cannot, "certify" securities. That would be as impossible a task as having the Agriculture Department "certifying" every product on supermarket shelves.

The SEC can, and does, mandate what kinds of disclosure must be made by companies offering securities to the public. The SEC policy is "full and fair disclosure" based on the notion that "sunshine is the best disinfectant."

That is like the Agriculture Department requiring the listing of ingredients in all food products.

There is an issue of how cost effective SEC regulation may be. That's a legitimate question.

But its a matter of empirical analysis, and not snap value judgments such as "paternalistic" or "maternalistic" which add heat but no light to the issue.

RP writes:

I always thought the SEC did a pretty good job of making sure the mugged investors pocket was picked clean, just in case the mugger left any behind...steal from the poor, give to the...hey, were do SEC fines end up? ;)

Mike writes:
Why is the government supposed to have a comparative advantage in certification, anyway?

They can subpoena records.

(Don't take this as disagreement with the general premise, just as a source of comparative advantage).

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