How to reduce fraud: abolish the SEC?

Today’s WSJ reports on the numerous investigations of Madoff by the SEC and other agencies that failed to catch him. Of course regulators and other readers will draw the wrong lesson. So in a probably futile effort to prevent this, let me remind readers what I said here and here: that the lesson is not that we need more regulation.  As I said in the last post:

I doubt that any government agency will ever do as good a job as a vibrant market whose participants are alert to the potential for fraud rather than lulled into a false sense of complacency.

What are the options?  Getting a new regulator?  Well consider this from today’s WSJ:

The failure to stop Mr. Madoff also is an embarrassment for Mary Schapiro, the Finra chief who has been nominated by President-elect Barack Obama as the next SEC chairman. Finra was involved in several investigations of Mr. Madoff's firm, concluding in 2007 that it violated technical rules and failed to report certain transactions in a timely way.

Arthur Levitt, our longest-serving SEC chair, offers advice in an op-ed in today’s WSJ:

Let's hope that the Madoff swindle is not a spur to haphazard regulatory responses, which often have unintended consequences, but instead the final prod for a fundamental reform of the financial regulatory structure that protects investors and keeps our markets free and fair.

But let's remember that some of the failed Madoff investigations were on Levitt’s watch.

In fact, if one wanted to follow these observations to their logical conclusion, one might say that we ought to abolish the SEC altogether.

Crazy suggestion? Well, what, exactly, would we lose? Backdating investigations? What came out of that? And recall that the SEC was late to this party too – the problem was spotted by some finance professors in Iowa and WSJ reporters.

What we would gain from abolishing the SEC is less misguided market interference (Reg FD; short sale restrictions) and a more alert marketplace. A market that would not ignore red flags and alarms sounded by profit-motivated watchdogs just because the SEC or FINRA had provided a clean bill of health.

Just a thought.

Additional thought: Well, ok, let's say we keep the SEC.  But remember that the justification for a public agency is to increase investor confidence and encourage investment.  In reforming financial regulation we should ask:  when does the regulation actually justify the extra investor confidence it is intended to inspire?  Because if it doesn't, then the regulation is part of a con game, isn't it?

Comments

[Michael Morse]

I'm reminded of Frank Zappa's comment on censoring rock lyrics: that's like treating dandruff with decapitation. . .

MWM

[Larry Ribstein]

I love Zappa. But the last comment applying Zappa's quote to my blog post reminds me of Spinal Tap: there's a fine line between stupid and clever.