The SEC Chases Fraud After The Fact

A comment I posted on The Baseline Scenario blog, "An Inside Perspective on Regulatory Capture."

Due to a misdiagnosis of the 1929 stock market crash, the US creates a huge regulatory and enforcement structure, the SEC, to prevent investor and securities fraud and stock market crashes. In the subsequent 75 years, investor and securities fraud continues, including Enron, Madoff and many other similarly notorious cases over the period. Many of the SEC protections, such as insider trading, are common law rights recognized prior to the creation of the 1933 and 1934 Acts and the SEC.

Contractual legal rights are a powerful mechanism for protecting the rights of parties to commercial transactions. In fact, most transactions are based on contractual protections as opposed to regulatory protections. Shareholders and other interested private parties, and not the SEC, often sue to enforce their legal rights in securities transactions, when courts have recognized their right to sue to protect themselves.

While the counterfactual of life without 75 years of an SEC is difficult to envision, the existence of the SEC did not prevent major securities and investor fraud. Additionally, the SEC is always requesting more funding and staffing to investigate and litigate fraud. It is unclear that the 33 and 34 Acts have decreased fraudulent activities.

Unlike banking, where FDIC insurance creates moral hazard, distorts the risk reward relationship of bank investments and makes the government (and the FDIC) an interested and potentially aggrieved party, the SEC is not in a similar relationship to the parties and transactions it supervises.

Maybe in a market economy as enormous and as complicated as the US capital markets and economy, it is impossible to have an adequate regulatory supervisory structure. It might be better to allow private participants to negotiate and protect themselves on a transaction level. The SEC is always chasing the fraud after it has happened. Is that worth the expense and false expectation of investor and securities protection?