On December 1, 2010, Commissioner Kathleen L. Casey of the Securities and Exchange Commission (SEC) spoke before the Annual Meeting of the American College of Business Court Judges in Fairfax, Virginia. Commissioner Casey’s remarks, which are published on the SEC’s website, discussed the evolving relationship between the SEC and the corporate law of the fifty states.
For readers who are unfamiliar with SEC politics, the SEC is composed of five Commissioners appointed by the President of the United States. When most people think about the SEC, they are really referring to the SEC’s staff, the public servants who do most of the work. The Staff works at the direction of the five Commissioners, and it is these Commissioners who make all the policy decisions. When the SEC adopts a rule, it is in fact the Commissioners who vote to approve it. The Staff, of course, does the work required to draft the rule.
This organizational structure makes the SEC politically accountable, since the Commissioners are each appointed by someone (the President) who has been voted into office. Since our democratic system is composed primarily of two dominant political parties, and we all have to get along, the political agreement is that the majority party chooses three Commissioners, while the minority party chooses two.
As it happens, Commissioner Casey was chosen by the Republicans. Her views can be assumed to be largely consistent with the views of the current minority party.
Commissioner Casey’s speech decried what she regards as the continued encroachment of the federal government on corporate law, which has historically been left to the fifty States. This is a well-worn refrain. Commissioner Casey, echoing many state’s rights advocates, thinks the Sarbanes-Oxley Act represented a severe intrusion into matters best left to State law, and Dodd-Frank even more of a trespass.
Commissioner Casey also makes the same shopworn arguments in favor of leaving matters of corporate law in the hands of the States. She argues that the States are in the best position to respond to the needs of corporations organized by their laws and their investors. In addition, the States can serve as "laboratories" for innovative approaches to corporate law. Finally, she contends that the advocates for federal intervention, whose complaints about the shoddy treatment of investors has led to the adoption of stricter federal standards, have not demonstrated that corporate governance improvements would result in increased shareholder value. So far, so familiar.
Then, Commissioner Casey dropped a bombshell. She disclosed that U.S. regulators, by which I think she means the SEC, "increasingly are under pressure from our international counterparts" to adopt what she describes as the "muscular national regulations of financial markets, including corporate governance at public companies."
Commissioner Casey’s statement raises a host of questions. What is this pressure and how is it being applied? After all, the people of the United States have not elected the regulators of other nations, or even the people who appoint them. How is it that these regulators can cause our regulators to adopt rules to govern our conduct? If it is true that the SEC is under pressure from other nations’ regulators to adopt their rules, then why worry about States’ rights? The democratic rights of the people of the United States are much more important.
Regulators of other nations, of course, have no authority over regulators in the United States. However, other nations and their regulators can refuse to go along with the wishes of U.S. regulators, unless they get their way. That refusal to go along can have economic repercussions. In an age where "it’s the economy, stupid" is the dominant political mantra, economic pressure can indeed inspire fear and loathing in the halls of Congress. On the other hand, pressure goes in both directions.
For example, the United States for over sixty years has been prosecuting the directors and officers of public companies who trade on the basis of material non-public information received because of their privileged positions. In contrast, Europeans for a very long time considered this just a perk of office. It has only been within the last 15 to 20 years that European governments, under considerable pressure from U.S. authorities, adopted laws prohibiting insider trading. Most of the European prosecutions in this area have been brought within the last five years or so, causing alarm bells to go off in European corporate boardrooms.
The good news for equity traders is that the pressure for more equity market regulation, if anything, seems to be applied to European and Asian regulators, rather than upon U.S. regulators. For example, the SEC has tried to put pressure on other countries’ regulators to strengthen equity short sale regulation. European regulators generally have thought short sale regulation is best left to emergency situations and have adopted greater restrictions only grudgingly.
When it comes to corporate governance, the real issue is executive compensation. The Europeans generally think things have really gotten out of hand and require a strong regulatory response. But a lot a people in the United States agree with that assessment, some of whom are sufficiently unhappy about it to let it influence their voting decisions.
One way to handle the pressure, from external and internal sources, would be to kick the ball into the laps of the fifty states, or more accurately, into the State of Delaware, where most public companies are incorporated. But, that would violate the two most important reasons for having a United States.
First, as a people, we wanted a federal government strong enough to negotiate successfully with foreign powers. The State of Delaware is in no position to bargain with European or Asian powers over the workings of financial markets, even if it were so inclined.
Second, we wanted to avoid competition among States that would make everyone worse off. Would the people of the United States support a system where each State competed to offer the easiest place for corporate executives to increase their compensation packages without interference from their shareholders? Where each State competed to offer the most lenient rules governing securities fraud?
Economic issues tend to demand political solutions. The United States of America was organized to deal with the national economic issues that could not be successfully managed by the loose agreement among the original 13 colonies represented by the Articles of Confederation. The European Union began as the "European Coal and Steel Community," intended to give the coal and steel industries more clout than they were able to exercise as national industries.
The current pressure for convergent securities regulation emanating from the G-20 powers suggests that some political solution may someday follow. That political solution may not take the form of "one-world government," although some sort of global regulation is not out of the question. It would most likely begin with some sort of securities regulation treaty. The European Union is still a treaty among member states, as compared to a Constitution among the European people. A treaty would be one transparent way for the elected representatives of the United States to negotiate favorable terms for U.S. citizens with their European and Asian counterparts. That Constitutionally-ordained process would be better than Congress enacting legislation or the SEC promulgating rules without disclosing to the public that the new regulation is intended to respond to international pressure.
It is certainly true that local issues are best handled locally. Experimentation at the State level has from time to time yielded approaches to law and regulation that were beneficial and adopted elsewhere. Federal securities regulation began with attempts by various States to deal with the problem of fraudulent securities offerings in the Roaring Twenties. But it soon became clear that this problem was big enough, comprehensive enough, and mobile enough to demand a national solution.
The States are not equipped to deal with problems of national scope, or systems and markets with national scope. Our national market system would be inconceivable without federal securities regulation. It is all the more difficult to contemplate meaningful State regulation of securities issues that have an international reach.
None of this is welcome news to believers in States’ rights. It is also true that Tea Partiers insisting on a direct message from the Founding Fathers will be disappointed to note that internationally convergent securities regulation cannot be found within the text of the U.S. Constitution, no matter how much anyone wishes to stretch it. But, then again, in the words of a famous jurist: "The Constitution is not a suicide pact." If there must be international economic regulation, it behooves us to find a way to control through free elections those who regulate us.
Stephen J. Nelson is a principal of The Nelson Law Firm in White Plains, N.Y. Nelson is a weekly contributor and columnist to Traders Magazine’s online edition. He can be reached at sjnelson@nelsonlf.com
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community. Please send your comments to Traderseditorial@sourcemedia.com
