Tuesday, February 13, 2007

Protection of whom...

An interesting article in the New York Times this morning:
S.E.C. Seeks to Curtail Investor Suits

The article details how the Securities & Exchange Commission (SEC) is moving toward protection of large public firms instead of traditional protection of investors:
The Securities and Exchange Commission has begun to take steps on two fronts to protect corporations, executives and accounting firms from investor lawsuits that accuse them of fraud.

Last Friday, the commission filed a little-noticed brief in the Supreme Court urging the adoption of a legal standard that would make it harder for shareholders to prevail in fraud lawsuits against publicly traded companies and their executives.

At the same time, the agency’s chief accountant told a conference that it was considering ways to protect accounting firms from large damage awards in cases brought by investors and companies.

Critics said that the moves signaled a major retrenchment from the post-Enron changes and showed that a lobbying push by big companies, Wall Street firms and the accounting industry was gaining traction as they seek to roll back what they see as onerous regulation and excessive investor litigation.

This is a different, and interesting tactic that the SEC is using, reversing much of its history. The statutory purpose of the Securities Acts (the Securities Act of 1933 and Securities Exchange Act of 1934) is to protect investors by promoting full disclosure of information thought necessary to informed investment decisions.

Protect Investors; Promote Full Disclosure; Informed Investment Decisions.

Yet, this is a very difficult issue, with very fine lines to maneuver. It is vital to protect investors for many reasons: ensure demand for capital investment into our markets; provide for a level playing field among investors so that investors who feel they are at a disadvantage do not take their capital elsewhere; and to provide remedy to the "average" investor who may be more easily taken advantage of by the "professional" investor who may be more informed. But all of those really boil down to ensuring that capital wants to flow into our markets because investors have complete confidence in those markets.

On the other hand, we also have to provide both ease of access into our markets, and also demand for businesses to generate capital from our markets. This requires that we keep barriers to entry low enough to ensure access and demand.

Those are somewhat conflicting interests that must be managed to effectively regulate a market. It is very easy to slip too far to either extreme too quickly. Clearly, in the late 1990s, early 2000s - in the midst of the Enron, WorldCom, Adelphia, Tyco scandals - the companies had gotten out of control, and oversight (primarily from the auditors, not necessarily the SEC) was lacking. Yet the response - Sarbanes-Oxley - is (in one man's opinion) an absolute disaster of a regulation. It is horrendously expensive to public companies, yet in real terms it simply does not increase controls - at least not in proportion to the cost incurred.

How do you balance these interests? In my opinion, the auditing firms bear much of the blame for some of the recent scandals and financial disasters...yet, there should be real concerns among the investing comunity that there are only 4 major public accounting firms left. That simply does not appear to provide adequate competition, and would seem to lead to more conflict of interest, more incentive to hedge, more dependence upon these public companies for their revenues and growth (and therefore less incentive to questions their financial decisions).

Although investors might immediately read an article like that above and jump to the conclusion that the Bush Administration is using the SEC as a tool to benefit large corporations - and that those companies and accounting firms have deep pockets to lobby for these changes that add to their bottom line. But to those who look with a more critical eye, maybe providing protection to accounting firms (in an attempt to prevent consolidation), and lessening the burdens on public corporations (in an attempt to bring more companies in to the market to raise capital - thereby giving investors more choices) is a long-run help to investors.

Clearly, the pendulum could swing too far, but these issues are much more complicated than "the SEC is selling investors out!" Our Securities laws have worked reasonably well for 70+ years now, and our markets are some of the most transparent, and trusted in the world. Even if these policies arguably go to far to protection of large firms at the expense of investors, this is unlikely to be the end of our consistently effective securities regulation traditions.

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