The Cost-Benefit Analysis of Financial Regulation: Lessons from the SEC's Stalled Mutual Fund Reform Effort
Sherwin, Edward, Stanford Journal of Law, Business & Finance
Over the last twenty-five years, under both Republican and Democratic presidents, no analytical tool has become more fundamental to the modern administrative state than cost-benefit analysis (CBA).1 As commonly used, CBA helps regulators reach informed decisions on policy matters, but it does not dictate regulatory outcomes.2 When agencies have utilized CBA properly, it has helped those agencies and members of the public decide whether a proposed rulemaking would be better than the status quo and choose between regulatory alternatives. At the same time, government watchdogs have expressed concern over the quality of the economic analysis employed by federal regulators.3 As the technicalities and complexities of government regulation have further escaped the grasp of legislators and the lay public, CBA has become the focus of efforts to produce optimal regulatory results through rational decision-making procedures.
Nevertheless, CBA has not been utilized consistently across the different sectors of government regulation. In particular, the nation's financial regulators have largely failed to perform the rigorous analysis required of most other government agencies, especially those in the fields of health, safety, and environmental regulation. This shortcoming is peculiar at best, and troubling at worst. Financial institutions regulated by the federal government are central to the health of the U.S. economy, and much of this country's wealth is held in regulated financial instruments, such as bank accounts, stocks, bonds, mutual funds, and futures contracts. Moreover, in light of the corporate scandals of the late 1990s and early 2000s, effective financial regulation has taken on increased political importance.4 As much as any other sphere of regulation, the government's policies toward financial institutions are both susceptible to and deserving of comprehensive reviews of costs and benefits.5 Nevertheless, there has been no effort by agencies to justify their regulations to Congress, regulated parties, or the general public on the simple principle that the benefits of such regulations ought to exceed the costs they impose. This is true not only of the U.S. Securities and Exchange Commission (SEC, or the Commission), but also the Commodity Futures Trading Commission (CFTC), the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board, and the Federal Trade Commission (FTC).6 This Article argues that the use oí cost-benefit analysis by the SEC has been inadequate, and that this has led to an overall reduction in the quality of rulemaking.
Until recently, the government's near-total failure to articulate and apply cost-benefit principles in the context of financial regulation has escaped the attention of regulators, coordinate branches of government, and the public.7 However, the SEC's use- or lack thereof- of CBA in a controversial recent rulemaking on the governance of the mutual fund industry shed light on the issue for perhaps the first time.8 Two of the SECs five commissioners dissented from the rulemaking, relying explicitly on the fact that the Commission failed to consider the costs imposed by the regulation. Congress, in turn, passed legislation demanding that the SEC justify its position on cost-benefit grounds. A major business lobby petitioned for judicial review of the SEC action, and in a landmark ruling in June 2005, the D.C. Circuit struck down the regulation because the agency failed to satisfy "its statutory obligation to determine as best it can the economic implications of the rule it has proposed."9 After the SEC hastily re-adopted the same rule, the D.C. Circuit again invalidated the rulemaking in April 2006.10 Given the size of the mutual fund industry- which had nearly $9.6 trillion of assets under management as of August 200611 - the gravity of this conflict cannot be ignored. While mutual fund governance has drawn the most attention to how financial regulators fail to engage in rigorous CBA, it is far from the only area of rulemaking that would benefit from a healthy dose of regulatory analysis. …