Five years after its enactment, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 remains controversial. Critics argue that the statute imposes disproportionately large compliance costs on small community banks, institutionalizes “too big to fail,” and drives up the cost of banking services to consumers. Comparing Dodd-Frank to past securities reforms, particularly those of the New Deal, shows that these three problems are related and are nearly inevitable features of post-crisis legislation.
The late Larry Ribstein explores the principles of a liberty-oriented securities regulatory regime.
The federal securities laws comprise one of the most important categories of regulation in the U.S. Particularly since Sarbanes-Oxley and Dodd-Frank, this regulation has been blamed for inhibiting innovation and imposing a significant regulatory tax on business activity. This essay considers some general principles for ensuring that securities regulation stays within limits that are consistent with a free and productive society. My central principle is that regulation should go only as far as necessary to protect market actors’ freedom to raise capital and invest in productive business ventures.
It is important to emphasize at the outset that regulation of disclosure and fraud can support rather than restrict liberty. Securities regulation promotes entrepreneurial activity by enabling investors to trust small and young firms that otherwise might not have an opportunity to develop public reputations. Firms in countries that lack these mechanisms may need to rely on family ties. This sharply limits the potential for large-scale business activities. Robust securities regulation is arguably one reason why this country has long had the world’s strongest capital markets. Thus it is important not simply to banish securities regulation because it can be costly, but focus on reasonable regulation that encourages productive business activity.
The core principle underlying securities regulation is the prohibition of fraud. Fraud is costly in part because it forces buyers to go to the trouble of investigating the truth and sellers to give buyers costly assurances. The government can reduce these costs by providing a credible enforcement mechanism that encourages firms and sellers to tell the truth. This is especially important for securities. In contrast to tangible goods whose qualities are apparent from inspection, securities often merely promise future rewards from the efforts of unseen promoters.
An important question in developing principles for securities regulation is how far this regulation should go beyond simply ensuring that the seller is not lying. In other words, why should not the law simply stop with the common law of fraud, as it did a century ago?