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Standards-based financial regulation?

Other things being equal, there might be a decent case for adopting a more "European" approach to financial regulation in which, rather than promulgating formalistic and rigid rules, agencies announced outcome-oriented principles to guide regulated entities in how to behave. But one big problem with the idea -- argues AEI's Peter Wallison in the Financial Times -- is that our legal methods of enforcement are so different from those that prevail in Europe:

A principles-based regime may work if the only enforcer is the regulator and if the regulator -- like the FSA [Financial Services Authority] -- is more interested in achieving compliance than imposing fines and penalties. But public companies and securities companies are subject to civil enforcement actions by the SEC, criminal enforcement by U.S. attorneys, criminal and civil enforcement by state attorneys-general and private class actions in both state and federal courts. Banks and insurance companies are subject to essentially the same array of public and private enforcers. In this unwieldy and enforcement-oriented structure, a principles-based system would open new doors to litigation and liability.

Nor can a compliance-oriented regime like the FSA's work in the presence of the private class action system that continues to flourish in the U.S. By definition, private class actions are outside the range of government or regulatory policy. The courts and Congress have found it almost impossible to restrict the scope and cost of private class actions under a single SEC rule -- the famous 10b-5. It is not hard to imagine the mischief that might be done by class action lawyers if they were gifted with a whole series of SEC rules that were similarly broad and malleable.

This raises the final point. A rules-based system, whether for accounting or regulation, has a safe harbour effect. If one complies with the rules there is some degree of absolution. This seems essential in the litigious environment of the U.S. Certainly, as in the case of Enron, rules-based regimes are subject to abuse by those who use the rules as a roadmap for deception, but given the political and legal system that prevails today in the U.S., most U.S. companies would probably prefer a fully transparent and certain system of rules.



Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.