SEC Rules, Stakeholder Interests, and Cost-Benefit Analysis

The D.C. Circuit’s 2011 decision in Business Roundtable v. SEC , 647 F.3d 1144 (D.C. Cir. 2011) spawned a lot of debate regarding the value of cost-benefit analysis in financial regulation. On one side of the debate were those who felt more should be required of the SEC. as well as other financial regulators. At least some members on the Hill must have thought so. No fewer than three independent legislative efforts[1] sought to impose a more stringent cost-benefit analysis requirement on the SEC, including one that proposed to have the SEC and other independent regulatory commissions submit their cost-benefit analyses to the Office of Information and Regulatory Affairs (OIRA) for review. To date, none of them have been enacted. On the other side were many administrative and securities legal scholars who were far more sympathetic with the SEC. They argued that conducting a robust and defensible cost-benefit analysis of financial regulation–or at least, sufficiently robust to withstand the type of “hard look” the D.C. Circuit gave–is not possible.[2] Still others have suggested that regulators, in the presence of uncertainty, should take a more experimental approach to rulemaking, including strategically including sunset provisions to take advantage of the real-option value of regulation.[3]

In a pair of articles (one recently published and one forthcoming), I ask a slightly different question. I move away from the debate of whether it is possible to do a sufficiently reliable cost-benefit analysis for securities regulation. After all, whether or not such analyses are possible, the SEC must continue to conduct some analysis akin to a cost-benefit analysis. The existing statutory requirement isn’t going anywhere. Therefore, I assume that some level of meaningful cost-benefit analysis is feasible for SEC rules, and ask the following: Is cost-benefit analysis really the right criterion for evaluating the overall desirability of a majority of SEC rules? A “no” response may seem preposterous. But I think the answer is somewhat complicated.

Consider first what is being demanded of a regulatory agency when we require it to conduct a cost-benefit analysis. In doing so, we implicitly subscribe to the Kaldor-Hicks criterion of efficiency of regulation. This criterion says that a policy is desirable only if the aggregate benefits accruing to all parties exceed the aggregate costs to be borne by all parties, even if some parties may come out net positive and others net negative. Therefore, if a rule is efficient under the Kaldor-Hicks criterion—in other words, if the rule passes cost-benefit analysis–then society’s total surplus is expected to increase. Therefore, having an agency conduct a cost-benefit analysis makes sense in cases where an existing market failure is causing an economic loss for society.

But now consider the role of the SEC. Most people would say the primary mission of the SEC is investor protection. But it is not entirely clear what “investor protection” exactly looks like in economic terms. For instance, does it mean that the SEC should use various means to reduce the cost of raising capital in order ultimately to increase the total surplus of society? Or does it mean that the SEC should focus exclusively on protecting the financial interests of investors only (and not worry about others’ interests)? And if it is the latter does it mean that the SEC should focus on protecting the financial interests of investors only insofar as such financial interests depend on their capacity as investors (and say, not on their capacity also as employees of the firm)? To the best of my knowledge, this type of inquiry has not been systematically answered. Nevertheless, it readily implicates an important policy question for the SEC: Should an SEC rule be considered efficient if its benefits outweigh costs from the perspective of investors’ financial interests or if its benefits outweigh costs from the perspective of total surplus?

This policy question is warranted for the obvious reason that a rule intended to protect investors may increase investors’ economic welfare or financial interests, while decreasing total surplus; conversely, it may increase the latter, while decreasing the former. After all, total surplus includes surpluses of many constituents of society other than investors, including managers, intermediaries, gatekeepers, employees consumers, and taxpayers. Similarly, the market for capital is only one of many markets in society. If corporate law scholarship has for the most part moved past the stakeholder view of corporation, the same has not necessarily happened in the sphere of understanding the costs and benefits of securities regulation.

There is no obvious answer to the policy question. Plausible arguments can be raised to defend either criterion. In “SEC Rules, Stakeholder Interests, and Cost-Benefit Analysis,” I consider whether we can expect these dilemmas to arise in practice. To this extent, I examine how the cost-benefit analyses of certain SEC rules may look different based on which stakeholder interests are taken into consideration. These stakeholders can include managers, gatekeepers, vendors, employees, consumers, and taxpayers, as well as others. The upshot of these analyses is that for many of the rules examined, the efficiency outcome may very well depend on whether we consider the costs and benefits from the perspective of investors only or whether we do so from the perspective of all relevant stakeholders.

Two implications follow. First, those who believe that the SEC should focus its attention on protecting the financial interests of investors only are probably better off not demanding that the SEC justify its rules under the type of cost-benefit analysis that executive agencies perform under OIRA guidance. Second, the current calls to have the SEC conduct more rigorous cost-benefit analyses of its rules should be preceded (or accompanied) by a more candid discussion as to the appropriate criterion for determining the efficiency of SEC rules.

ENDNOTES

[1] These included: the Financial Regulatory Responsibility Act of 2011 (reintroduced in 2013), the Independent Agency Regulatory Analysis Act of 2012 (also reintroduced in 2013), and the SEC Regulatory Accountability Act of 2013.

[2] See e.g., James D. Cox & Benjamin J.C. Baucom, The Emperor Has No Clothes: Confronting the D.C. Circuit’s Usurpation of SEC Rulemaking Authority, 90 Tex. L. Rev. 1811 (2011); Robert B. Ahdieh, Reanalyzing Cost-Benefit Analysis: Toward A Framework of Function(s) and Form(s), 88 NYU L.Rev. 1983 (2013); Bruce Kraus & Connor Raso, Rational Boundaries for SEC Cost-Benefit Analysis, 30 Yale J. on Reg. 289, 300 (2013) ; Jeffrey N. Gordon, The Empty Call for Benefit-Cost Analysis in Financial Regulation, 43J. Leg. Stud. S351 (2014); John C. Coates, IV, Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications, 124 Yale L.J. 882 (2015); Cass R. Sunstein & Adrian Vermeule, Libertarian Administrative Law”__ U. Chi. L. Rev. __ (forthcoming);

[3] See, e.g., Yoon-Ho Alex Lee, An Options Approach to Agency Rulemaking, 65 Admin. L. Rev. 881 (2013); Zachary J. Gubler, Experimental Rules, 55 B.C.L. Rev. 129 (2014).

The preceding post comes to us from Yoon-Ho Alex Lee, Assistant Professor of Law at USC Gould School of Law. The post is based on his recent article, which is entitled “SEC Rules, Stakeholder Interests, and Cost-Benefit Analysis” and is available here.

1 Comment

  1. Bruce Dravis

    You note in your text: “One implication is that, for those who believe the SEC should focus its attention on protecting the financial interests of investors only, it may not be in their interest to demand that the SEC justify its rules under the type of cost-benefit analysis that executive agencies perform.”

    I would argue that Business Roundtable shows that the reverse is also true–those who desire to hamper SEC efforts at protection of investors will use cost-benefit analysis arguments not for policy optimization, but as cudgels to beat policy makers for the benefit of their political and economic constituents.

    With regard to the specific case of proxy access, companies may be coming around to accept that some form of proxy access is inevitable–but only after 5 years of considerable expenditure of legal fees battling proxy access in the name of ‘private ordering.’ Society lost the network effects of a uniform proxy access rule and bore the deadweight expense of company by company proxy access battles because the opponents of proxy access argued the SEC’s cost-benefit analysis in adopting 14a-11 was insufficient.

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