In the Hoover Institution of Stanford University's Defining Ideas Journal, Professor Jonathan Macey argues that the SEC suffers from "three serious maladies" that are causing it to fail. Prof. Macey's article ("The SEC's Publicity Hounds") is a must-read piece that offers some deeper-level thinking on the reasons why, in his view, the SEC is failing in its mission to protect capital markets.

First, Macey says, the metrics used to measure the SEC's success create "perverse incentives" that cause the agency to "fail, even when it thinks that it is succeeding." For one thing, he says, it is in the SEC's interest to "promote the appearance that the capital markets are in crisis" and the the SEC's form of crisis intervention is the best solution. In addition, the SEC presently must try to impress and satisfy its congressional monitors with "(a) the raw number of cases that it brings; (b) on the sheer size of the fines that it collects." 

Macey argues that a focus on such metrics causes the SEC to pursue a policy of opting for quick settlements to increase its numbers; to sue companies rather than individuals "because companies don't defend themselves as vigorously as individuals do;" and to promote expansive and vague interpretations of the law to make it easier for the agency to bring cases.

I have written about the SEC's reliance on such metrics, and how they can be deceptive, here. To its credit, the SEC has acknowledged in recent years that figures such as “actions brought” are not an ideal barometer of agency enforcement. Shortly after he joined the SEC as director of enforcement, Robert Khuzami testified before the Senate that he wanted to “de-emphasize the current quantitative metrics used to evaluate personnel and programs—the number of cases opened and the number of cases filed—in favor of a more qualitative standard, which includes concepts like timeliness, programmatic significance, and deterrent effect of a case.” If such qualitative standards have become the norm, however, I have not seen it.

Second, Macey says, the SEC does not have a clear idea of who it should help. Macey offers the example of the recent high-profile SEC enforcement action against Goldman Sachs concerning collateralized debt obligations, and says the only investors being protected in this case were two of the largest banks in Europe.

Finally, Macey argues that a third key problem with the SEC is that it is dominated by lawyers (a charge that is not new).  Macey says that as a profession, lawyers lack understanding of the "fundamental economic and financial characteristics of the markets [the SEC] regulates." By way of example, Macey states that the Nasdaq market maker scheme from the mid-1990s was the subject of a detailed article in the December 1994 Journal of Finance, but drew no attention from the SEC because "nobody at the SEC bothers to read the Journal of Finance. It's only the world's most important journal of financial economics. It was not until the Wall Street Journal published a story about the article that the SEC took notice." He argues that a similar pattern occurred with academic research about options backdating that the SEC received but did not act on until the Wall Street Journal covered the topic with a front page story.

You may not agree with all of his contentions, but Prof. Macey's article is a thoughtful and detailed analysis of some of the big picture issues facing the SEC. Highly recommended.

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