With growing concern, we fear that we are watching the SEC face a death by 1,000 cuts. No, we do not mean that the SEC is likely to be abolished by either executive or legislative action (although the Department of Education is facing just such a prospect). Rather, we mean that the SEC is on the verge of being shrunk by both budget cuts and mandated staff reductions, while it is losing its traditional independence (as an Executive Order now requires any policy decision to be approved in advance by the Office of Management and Budget (“OMB”)). [1] The end result might be a shell of its former self, as the SEC becomes an agency with little power, capacity, or independent judgement.

We believe our concerns are fully consistent with our goal of providing independent and non-partisan research, evaluations, and opinions on securities-related issues. Although some with a strong “anti-regulatory” point of view may welcome the SEC being decimated, the majority of experienced practitioners on both sides of the political aisle understand that the  SEC adds value to our capital market system and that its staff does significantly improve the quality of disclosure. Consider here that former SEC Chairman Jay Clayton has repeatedly testified to the high professional caliber of the SEC staff,[2] and that peer-reviewed research has demonstrated that SEC review enhances disclosure quality.[3] In any event, because staff review is statutorily required and because the SEC received over 2,200 registration statements for review in 2023 (totaling over $1 trillion in the amount offered for sale), the prospect of chaos in our financial markets seems significant if the staff’s numbers were greatly reduced.

Do we exaggerate? Already the Trump Administration has directed deep cuts in the budget and staff of the “independent” federal regulatory agencies.[4] In response, the SEC has offered $50,000 to many Commission employees if they will resign or retire by March 21, 2025.[5] In effect, the Executive Order requiring prior OMB approval effectively makes the OMB the supervisor of the SEC, which is placed on a very short leash.

We are aware that some SEC skeptics have argued that the SEC brought this pending loss of independence on itself through the energy and independence that have long characterized the agency. Others claim that the SEC can operate with less resources by reallocating its troops, moving them from less active offices and departments to more active ones. Both claims are erroneous. As experienced securities counsel are aware, the SEC’s role is statutorily required and works best when counsel and the SEC staff work cooperatively. Nor, under current law, can the SEC itself shift the appropriations that Congress gave it; Congress directs its appropriations to specific projects and offices and the SEC cannot engage in wholesale reallocations.

The reasons why the SEC’s staff should not be drastically shrunk need to be clearly and simply stated:

1. We Have Seen This Movie Before: The View From History

Inadequate funding of the SEC has occurred before with severe impacts on investor protection and the economy.[6]

In particular, the inadequate funding of the SEC program to regulate our largest investment-bank holding companies contributed to the 2007-2009 economic collapse, starting with the March 2008 near bankruptcy of Bear Stearns and subsequent declines of 54-56 percent in stock indices between selected dates in October 2007 and March 2009. This same period saw aggregate job losses of close to 9 million employees by 2011 and household income falling by nearly 39 percent between 2007 and 2010. Further, the federal deficit exploded from $459 billion in 2008 to $1.413 trillion in 2009.[7] To be sure, other factors besides SEC underfunding also played a large role, but we must suggest that those who ignore history have a good chance of repeating it.

2. Delay, Loss of Talent, and the Impact on Capital Formation

All registration statements must be reviewed and implicitly approved by the SEC’s staff. The difference between an experienced and able staff of reviewers and others with less experience and/or ability can be significant, and the registration process goes much more smoothly when the reviewer is the former. We do not suggest that all registration statements will simply come to a halt after large staff cuts, but the process can be greatly extended and delayed depending on the size of the cuts. This implies that public corporations will be less able to rely on the registration process and may turn to other sources of capital, including bank debt.

Similarly, because of the broad wording of the federal securities laws, and the rapid rate of innovation in financial products, counsel may often need to seek a “no action” letter from the staff. But if the staff is significantly depleted, it may not be able to respond in a reasonable period (in part, because staffers with experience in the area may have departed). One cannot assume that the staff will have the same level of expertise if its size is substantially reduced. Indeed, the sad truth is that ability and mobility go together, and those most likely to leave will be those whom private firms most want to attract.

3. False Economy

The Trump Administration may claim that all agencies should be reduced in size by a roughly similar margin, in effect sharing proportionate reductions. But this ignores one extraordinary fact about the SEC: It consistently has generated more in fees than in operating expenses. In effect, the SEC pays for itself and costs taxpayers nothing.[8]Cutting its staff and budget is thus counterproductive and inflationary.

Worse still, a disparity is growing between the SEC’s size and the growing markets it is expected to monitor. Among financial regulators, the SEC is relatively small. But the fields it is expected to watch over can grow by leaps and bounds, as new markets and new types of securities suddenly appear (witness the astronomic growth of cryptos over recent years). As of 2024, the SEC was expected to oversee the disclosures and aspects of the behavior of 30,000 registered entities, 16,000 registered funds, 15,300 investment advisers, more than 35,000 trading centers, 10 credit agencies and 7 registered clearing agencies.[9] This works out to something like 11.8 registered/reporting entities per SEC employee, and all the foregoing numbers could increase significantly, while the SEC is required to reduce its own staff. As we noted in our Statement No. 1, empirical research has established a relationship across the world’s financial markets between the independence and funding of securities regulators and the cost of equity capital. This data supports our belief that reducing the size and independence of the SEC may well have a hidden cost: a higher cost of capital for U.S. issuers. Of course, this will have an adverse impact on the ability of U.S. issuers (which today have a uniquely low cost of equity capital) to compete with foreign rivals.

4. The Costs of Failure

We have already discussed the losses to investors following prior instances in which SEC funding was reduced. But such a focus may still undercount the losses. When securities enforcement is constrained, the impact may not be discovered until much later. For example, Bernie Madoff went undiscovered for decades, and Enron, WorldCom, and others played games with accounting that were not detected for years, deepening the eventual losses. Today, in what is clearly an era of increasing deregulation, there may be entrepreneurs who are willing to gamble that violations will not be detected by undermanned regulators or that technical rules will not be enforced closely. For example, a company intent on launching takeovers may believe that it can ignore the requirement to immediately disclose its securities holdings once its ownership in a company crosses the Williams Act’s 5% threshold. The result likely would be an increasing number of undisclosed blocks as to which the target company could not identify the true owner. Such practices could erode the tradition of law compliance that has characterized most U.S. public companies.

Beyond actually unlawful acts or practices, there is also the possibility (particularly in gray areas of the law) of a “race to the bottom.” Many broker-dealers and investment advisers may avoid practices or products that they feel are inconsistent with their own high standards or that will result in increased oversight from the SEC. Of course, this is desirable. But if the SEC is perceived as weak or so overloaded that it cannot take on more enforcement actions, other less scrupulous broker-dealers may enter these gray areas in the belief that the SEC lacks the manpower to respond. Eventually, those with high standards may feel compelled to follow them. Although this injury is harder to measure, it too is a cost of a weak SEC.

Finally, large numbers of private actors—attorneys, investment bankers, accountants, and entrepreneurs—can expect their ability to pursue transactions, implement business plans, offer new products, or respond to new developments will be impeded if the SEC’s staff is greatly reduced. These actors will face both delay and uncertainty if the SEC is unable to give the timely responses they desire. In addition, the absence of early SEC review when a disclosure document is filed may result in issuers and others facing greater risk and liability at a later point when litigation may be brought by either the SEC or private plaintiffs.

5. Conclusion

If the SEC is shrunk and placed under the de facto supervision of the OMB, the potential for an increase in the cost of capital becomes real and the losses cannot be reliably estimated. Moreover, such a change produces no real savings because the SEC actually makes a profit. Thus, the upside of the proposed cuts is negligible and the downside is catastrophic. To our minds, no rational decisionmaker would accept such a gamble where it can win little and lose much.

ENDNOTES

[1] Executive Order, “Ensuring Accountability for All Agencies” (February 18, 2025).

[2] Jay Clayton, the last Republican chairman of the SEC, testified before the Senate in 2019 that the SEC’s “human capital [is its] most important resource,” adding:

The quality of the women and men who serve America’s investors in our headquarters and our 11 regional offices are the reason I am confident that the resources Congress has provided to the SEC are well spent.

See Jay Clayton, “SEC Chairman Clayton Testifies to Senate on 2020 Budget Request” (May 14, 2019). Later in 2020, he further testified that the SEC staff “have shown time and time again how fortunate we are as a nation to have individuals of strong character and unwavering commitment serving at this great agency.” Jay Clayton, “Statement of SEC Chair Jay Clayton Regarding the Conclusion of his Tenure” (Dec. 23, 2020). This is largely the same staff as the one now facing downsizing.

[3] Comment Letters from the SEC’s staff appear to be associated with a decrease in information asymmetry and litigation risk. See Zahn Bozanic, J. Richard Dietrich, and Bret A. Johnson, SEC Comment Letters and Firm Disclosure, 39 J. Acct’g & Pub Pol’y, 337-57 (2017); Rick Johnson and Reining Petacchi, Regulatory Oversight of Financial Reporting: Securities and Exchange Commission Comment Letters, 34 Contemp. Acct. Res. 1128-55 (2017); Q. Wang, Determinants of Segment Disclosure Deficiencies and the Effect of the SEC Comment Letter Process, 35 J. Account. Pub. Pol’y 109-133 (2016); L. A. Cassell, L.M. Dreher, and L.A. Myers, Reviewing the SEC’s Review Process: 10-K Comment Letters and Cost of Remediation, 88 Acct’g Rev. 1875-1908 (2013).

[4] Executive Order, Commencing the Reduction of the Federal Bureaucracy (Feb. 19, 2025); Memorandum from Russell T. Vought, Director, Office of Management and Budget & Charles Ezell, Acting Director, Office of Personnel Management, Guidance on Agency RIF [Reductions in Force] and Reorganization Plans Requested by Implementing the President’s “Department of Government Efficiency” Workforce OptimizationInitiative (Feb. 26, 2025).

[5] Chris Prentice, U.S. SEC Offers Staff $50,000 to Resign or Retire, Memo Says, reuters.com (Mar. 3, 2025). This $50,000 offer has not been funded by Congress and may prove illusory. We suspect that if a promoter made a similar order to buy the stock of shareholders and did not disclose the lack of funding, this promoter might be greeted by an SEC anti-fraud action.

[6] Joel Seligman, THE TRANSFORMATION OF WALL STREET: A HISTORY OF THE SECURITIES AND EXCHANGE COMMISSION AND MODERN CORPORATE FINANCE, 265-289 (Aspen Pub. 3d Ed. 2003) (finding that after staff reductions of 60 percent between 1940 and 1955 a revival in securities fraud occurred in the late 1950s with a substantial increase in fraudulent securities sales through boiler rooms, fraudulent penny stocks, and the near complete collapse of self-regulation on the precursor to the American Stock Exchange.

[7] Joel Seligman, MISALIGNMENT: THE NEW FINANCIAL ORDER AND THE FAILURE OF FINANCIAL REGULATION 1-3 (Wolters Kluwer 2003); FINAL REPORT OF THE NATIONAL COMMISSION ON THE CAUSES OF THE FINANCIAL AND ECONOMIC CRISIS IN THE UNITED STATES (2011).

[8] 1 Louis Loss, Joel Seligman & Troy Paredes, Securities REGULATION 578-598 (Wolters Kluwer 7^th ed. 2024).

[9] U.S. Securities and Exchange Commission, Fiscal Year 2024 Congressional Justification, Annual Performance Plan at 3-4.

The Shadow SEC is intended to provide nonpartisan comments on Securities and Exchange Commission policies and practices based on our experience as law professors and our analysis of empirical data, legal statutes, history, and market practices. See Announcement of the Formation of the Shadow SEC, available here, and The Value of an Independent SEC, available here. Each of the signers of this statement is a member of the Shadow SEC.