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SEC Commissioner Speaks on Financial Market Regulation

Whenever I talk to economists, since I cannot awe you with a fancy equation, I have to start with a bad joke.  It is a knock-knock joke, which is especially hard to pull off when trying to physically distance.  “Knock, knock.”  “Who’s there?”  “Economist.”  “Economist who?” “I kin’ o’ missed you too!”  It is a really bad joke, but I really do miss having you all here at the SEC in person and hope that will soon be a possibility. Before I begin, I must give my usual disclaimer: the views I will be expressing today are my own, and do not necessarily represent the views of the Commission or my fellow Commissioners.

I have just started reading economist Dr. Thomas Sowell’s 2010 book, Intellectuals and Society, which explores, among other things, the influence that intellectuals have had throughout history on policy makers and the public at large.  Even though I am not very far into the book, I know that the influence has not always been positive.  In fact, sometimes it has been deadly.  All of us would do well to ponder that message:  you, as intellectuals engaged in research here at the Commission or in one of our nation’s universities, and I, as a consumer of the products of your intellect.

At the risk of sounding like Peter Parker’s uncle, with your great power comes great responsibility, and I would add that with great responsibility comes an even greater need for humility.  It is a healthy thing for an expert to acknowledge her limitations and to be comfortable with the fact that each of us actually plays a very small part in any successful endeavor and with the fact that everyone else also has something to contribute.  Freedom to think and act for oneself and to cooperate with others enables each person to play her individual small role.  As Dr. Sowell puts it so nicely in his book:

[I]f no one has even one percent of all the knowledge in a society…then it is crucial that the other 99 percent of knowledge, scattered in small and individually unimpressive amounts among the population at large, be allowed the freedom to be used in working out mutual accommodations among the people themselves.[1]

Ironically, as our world grows ever more complicated, such that the role of any single person shrinks even further into the background, the temptation to empower a tiny group of people to make decisions on everyone else’s behalf has grown.  How can this be?  The answer is simple: unprecedented access to data–data coupled with a staggering technological ability to store, mine, and manipulate information to an extent inconceivable only a few years ago.  Data is the Siren’s song of intellectuals and regulators.  Idea workers’ imaginations go into overdrive conjuring up the possibilities of what massive amounts of data can empower them to do.  Mountains of data can show the intellectual what happened in the past, teach her lessons from those past events, and seemingly make it possible for her to predict and direct what will happen in the future.  Intoxicating!

Gathering data is not, however, a neutral act, nor are its uses and the motivations underlying those uses static and fixed.  In other words, how an organization initially intended or justified its data collection efforts is a flawed predictor of how that information ultimately will be used.  Once individuals have a reason to collect data, it is naïve to assume that they will not find additional and innovative uses for it.  As priorities and values shift, information gathered for one purpose, in itself perhaps unobjectionable and uncontroversial, can be exploited in ways never contemplated.  Troublingly, this can be done without the thoughtful analysis that should precede any mandated information collection.

Let me offer an example—this one from a bit outside financial regulation.  This information gathering effort veered dramatically from its intended purpose.  Official England in the late 1520s and into the 1530s was preoccupied with what came to be known as the “King’s Great Matter,” which boiled down to how could King Henry VIII legally justify getting rid of his first wife so he could marry his girlfriend.[2]  As part of this effort, Henry commissioned John Leland, thought by many to be England’s greatest antiquarian, to search the kingdom’s monasteries for ancient manuscripts containing precedents that would legitimize his annulment from his first wife, Catherine of Aragon, and his marriage to his second wife, Anne Boleyn.

Leland conducted his search for rare books with tireless diligence, and his findings were meticulously memorialized and maintained in Oxford University’s Bodleian Library, where they are housed to this day.  If you are a sucker for royal romance or good library collections, so far so good.  What Leland could not have known, however, was that Henry’s ultimate break with Rome and his dissolution of England’s monasteries would breathe, if not new life, then at least new purpose into the data he had worked so hard to accumulate.  Much to Leland’s horror, the records he had gathered so diligently to further the king’s love life were now an invaluable resource for those whose aim was nothing less than the destruction and plunder of the collections he had identified.  Thanks to Leland’s work, whole collections were reduced to ash.  Some speculate that Leland’s own mental breakdown was in part attributable to his unintended role in the destruction of so much he had held sacred and precious.  A cautionary tale, indeed.

As I have made clear elsewhere,[3] I oppose the Commission’s Consolidated Audit Trail initiative, or CAT.  For those who are unfamiliar with this program, which was prompted by the 2010 “Flash Crash,” when the CAT is fully implemented, the self-regulatory organizations, which include securities exchanges and the Financial Industry Regulatory Authority, will collect and store every equity and option trade and quote, from every account at every broker, by every investor.  As even people who support the CAT acknowledge, that is a lot of data.

Now many of you might be thinking that the CAT, though unquestionably ambitious, is an understandable reaction to such a significant market event.  After all, the Commission is charged with, among other things, maintaining orderly markets, and understanding of the causes of market disruptions, such as the “Flash Crash,” fits within that ambit.  Admirable intentions and earnest efforts to protect the CAT data are not enough, however, to outweigh the CAT’s costs.

Regardless of the initial (or at least stated) rationale underlying mandated information collections like the CAT, I am always concerned about the follow-on exploitation of information that can occur to the detriment of individual liberty.  As the CAT takes concrete shape, I note with alarm, though not surprise, the increasing emphasis that is being placed on the database’s ultimate utility as an enforcement tool.  Staff at the Commission and at the exchanges will wade through the data pool to troll for securities violations.  Seeing that Constitution Day coincided with the start of this conference, I cannot help but ask once again how the CAT, which will track unsuspected and unsuspecting Americans’ every move in the hopes of catching them in some wrongdoing, is consistent with the principles undergirding the Constitution.

Others do not share my concerns about the implications of mass data collection for liberty and privacy, but rather look at all of this information in increasingly exploitable databases as a source of hope for a brighter future.  The sheer volume of data available enables, according to some people, successful central economic planning, something that has never worked in the past.  Take Jack Ma, the founder of Alibaba Group, who reportedly said:

Over the past 100 years, we have always felt that the market economy is excellent, but in my opinion, in the next three decades will be a significant change, the planned economy will become increasingly large.  Because we have access to all kinds of data, we may be able to find the invisible hand of the market.[4]

Mr. Ma is not the only one to believe that big data housed in databases, accessible only to a small group of regulators, is the modern replacement for the invisible hand, which is the shared property of the masses.

The search for the invisible hand is a futile one for the reason that Dr. Sowell articulated.  Yes, we can collect lots of data about what people do, but wisdom, expertise, and knowledge still remains dispersed throughout the population.  Intellectuals and their regulatory pupils cannot effectively plan an economy or even a subset of it, not even with databases bursting with ever-increasing amounts of information and the assistance of the best AI on the market.

The dynamism and innovative forces that characterize the free market cannot be replicated by an algorithm.  In addition, and without even addressing the moral questions associated with the creation of a system so vast and dehumanizing, the very premise underlying central planning is flawed: it is a backward looking endeavor, tracking and cataloguing what was.  And as we all know, past performance does not necessarily predict future results.

Regulation involves an element of central planning; it displaces the ability of individuals to take actions, including voluntarily transacting with one another.  Not only does this affect the liberty of the affected individuals by displacing their free choice, but it prevents them from contributing their knowledge, expertise, and experience to society.  Both the dignity of the individual and the functioning of society are impaired when decision-making is centralized, even if the decision-makers are very smart and well-informed.

Regulation is necessary.  I think we can all agree with that.  But less is very much more when it comes to the government deciding how free citizens may invest their money, plan for their and their families’ futures, and enter into contracts with other free citizens.  The regulator, and the intellectual who informs her, always should consider the cost of regulation, not only in terms of dollars and burden hours, but in terms of freedom denied.

My skepticism does not, however, prevent me from understanding how those who long for the just-so precision of the central planner have come to place their faith in the transformative power they see waiting to be tapped in these unprecedented repositories of information.  I do not trust them with that kind of power…but then I do not trust anyone else, including myself, with it either.  A regulator needs her data, but she does not need unlimited data.

The people who spend their working lives at the Commission are a uniquely talented group of people.  They care intensely about their work and about the people they serve; they are naturally eager to protect American investors from fraud and that commitment is borne out in their work.  As an institution, however, I think that we are occasionally guilty of trying to protect grown men and women from making decisions that we view as unwise.  When we do that, we overreach and we exceed our mandate.

All that is a very long way of asking those of you here today to think beyond the interesting technical discussions that each paper provokes.  Remember that you, because you are intellectuals, play an important role in setting the tone for responsible use of data, a recognition of its limits and dangers, and a respect for the wisdom of the people who are not in the room.

ENDNOTES

[1] Thomas Sowell, Intellectuals and Society (Perseus Books Group: Basic Books, 2010), 16.

[2] The following account is drawn largely from Literary Review, Timothy W. Ryback, Bonfires of Reason Burning the Books: A History of Knowledge Under Attack, by Richard Ovenden, https://literaryreview.co.uk/bonfires-of-reason.  See also https://www.britannica.com/biography/John-Leland; https://www.christs.cam.ac.uk/john-leland-c1506-1552.

[3] Commissioner Hester M. Peirce, “Statement of Hester M. Peirce in Response to Release No. 34-88890; File No. S7-13-19” (Washington, DC, May 15, 2020), https://www.sec.gov/news/public-statement/peirce-statement-response-release-34-88890-051520.

[4] James Pethokoukis, “AI and the hopes for utopian socialism.”  AEIdeas (blog).  AEI, May 11, 2018.  https://www.aei.org/economics/ai-and-the-hopes-for-utopian-socialism.

A version of these remarks was delivered on September 18, 2020, by Hester M. Peirce, commissioner of the U.S. Securities and Exchange Commission, at the 7th Annual Conference on Financial Market Regulation.

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