Regulation and Scholarship: Constant Companions or Occasional Bedfellows?
Macey, Jonathan R., O'Hara, Maureen, Yale Journal on Regulation
When does original academic scholarship about the law and capital markets influence financial regulation? We suggest that capital market regulators often are driven by scholarly findings in the fields of finance and law to launch important new regulatory initiatives. However, we argue that private political motivations rather than the public interest drive policymakers' decisions about when to heed-and when to ignore-relevant social science evidence. We support our thesis with six examples of situations in which scholarship was, or arguably should have been, the catalyst that launched a major regulatory initiative. In three of these examples policymakers decided to regulate, and in three other contexts policymakers chose to ignore completely equally powerful social scientific evidence.
In this Essay, we discuss the puzzling disparity between contexts in which important social science scholarship in economics and finance influences regulation and public policy, and contexts in which it does not. We argue that capital market regulators often are driven by scholarly findings in the fields of finance, law, and economics to launch important new regulatory initiatives. Indeed, without the new insights provided by such scholarship, it is likely that none of the major regulatory initiatives that have altered the landscape of U.S. capital markets over the last decade would have occurred. But cutting-edge scholarship does not always provoke a regulatory response. We argue here that equally important scholarly findings often have different fates. Some are ignored by the regulatory and political powers that be, while others are embraced.
What determines whether scholarship elicits attention or fades into oblivion? We argue that private political motivations rather than the public interest drive policymakers' decisions about when to heed - and when to ignore - important and relevant social science evidence. We demonstrate this thesis using three contexts in which social science evidence in finance was used to launch major regulatory initiatives and three other contexts in which social science evidence that was at least as strong was ignored completely. Investigating these contexts provides a basis for evaluating both the role of independent research and the role of the regulatory and political process in effectuating change.
Within the category of attention-getting research, we discuss three academic studies. The first of these research blockbusters was William Christie and Paul Schultz's article in the Journal of Finance, entitled Why Do NASDAQ Market Makers Avoid Odd-Eighth Quotes?^ Christie and Schultz's empirical analysis of price fixing on the NASDAQ market led to massive antitrust and securities enforcement efforts, a private class action lawsuit that generated a settlement of over $1 billion, and an investigation by the U.S. Department of Justice into price fixing that concluded with fines exceeding $1 billion on major U.S. investment banks, as well as dramatic new regulations and market practices concerning not only the way orders are handled in the securities markets, but also how securities prices are quoted.
A second piece of scholarship in law and finance that launched a thousand (or more) lawyers into action was work done by Eric Zitzewitz on late trading in U.S. mutual funds.2 Zitzewitz demonstrated that the prices at which mutual funds bought and sold their own shares from their investors often were inaccurate, providing crafty institutional investors such as hedge funds the ability to transfer wealth to themselves from unsophisticated mutual fund investors.3 Eliot Spitzer, then an ambitious, entrepreneurial state attorney general, launched an investigation that ultimately involved virtually every major mutual fund complex, and resulted in regulatory settlements of approximately $3 billion, a figure that does not include recoveries by private plaintiffs in civil litigation. …