Advice to Chairman Cox: Avoid a Regulatory Ratchet

By William A. Niskanen
This article appeared in Investor’s Business Daily, August 8, 2005.

A question for Christopher Cox: Why did you want the position as chairman of the Securities and Exchange Commission?

You sailed through your confirmation hearing without controversy. But the price of avoiding controversy is that you seemed perilously close to endorsing all existing securities legislation and regulations.

You described the Sarbanes-Oxley Act of 2002 as “now a pillar of our securities regulatory charter,” even though the accumulating evidence suggests that this Act has not increased investor trust in corporate accounting.

You said that you would not thwart a plan to require the expensing of stock options, although you strongly opposed this plan as a Member of Congress. You stated that one of your high priorities would be to maintain the continuity of SEC rules.

I expect that the SEC under your leadership will pay greater attention to empirical evidence about both the benefits and costs of proposed new rules. Fine! This commitment to study the probable effects of proposed new rules promises to avoid many of the types of mistakes that are embedded in current securities legislation and regulations.

But this would create a double standard between new rules and current rules: New rules would be subject to increased scrutiny. Current securities legislation and regulations, in contrast, would get a pass, regardless of the accumulating evidence about the effects of these rules.

This would also create a regulatory ratchet that would increase the total number of regulations, both good and bad, over time. With your commitment to a market economy and a background in securities law, I cannot believe that you would regard this as a desirable outcome.

The only way to avoid a regulatory ratchet is to examine current securities legislation and rules on a periodic basis with the same scrutiny and criteria applied to proposed new rules. This should not be an unusual burden. The budget of the SEC has doubled over the past three years, providing ample resources for increased policy analysis.

And current rules are usually easier to study than proposed new rules because of the accumulating evidence of the effects of these rules.

Maintaining the continuity of SEC rules is surely less important than weeding out bad current rules. The only unusual cost of evaluating both proposed new rules and current rules by the same standard, the necessary condition for avoiding a regulatory ratchet, is that you must be willing to risk some controversy by those who proposed or benefit from the current rules.

Many of us who were puzzled by your wanting to be the SEC chairman will await your decision on this issue with considerable interest.

William A. Niskanen is chairman of the Cato Institute and editor of the recent book After Enron: Lessons for Public Policy. He served as acting chairman of President Reagan’s Council of Economic Advisers.