Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Elected Regulators

Rose and LeBlanc posted a paper last month (Rose, Amanda M. and LeBlanc, Larry J. , Policing Public Companies: An Empirical Examination of the Enforcement Landscape and the Role Played by State Securities Regulators (May 23, 2012). Available at SSRN: http://ssrn.com/abstract=2065378) showing that in the US elected regulators (typically attorneys general) at the state level were far more aggressive in pursuing securities related enforcement than non elected regulators:

states with elected enforcers brought matters at more than four times the rate of other states, and states with an elected Democrat serving as the securities regulator brought matters at nearly seven times the rate of other states.

Of course, this is completely consistent with the incentive structures facing elected and appointed regulators. Appointed regulators do not gain much from pursuing complex matters; as many of the reports about the SEC failures during recent years have shown, SEC enforcement staff are incentivized to pursue a numbers game – pursuing a large number of easy, low risk and low cost was the best way to make the internal appraisal reports look good. On the other hand, elected regulators have incentives to pursue high risk, high stakes actions. Success could help the elected regulator move on to a higher political position – Spitzer became Governor of New York after a very controversial stint as attorney general.

The difficulty with this model (as with any other high power incentives) is the possibility of harassment of innocent people to gain political mileage. The solution is obviously an appellate process that limits the ability of the regulator to unilaterally destroy legitimate businesses and people. The US has got this reasonably right, but regulators can still put pressure on regulatees to pay fines and settle cases that lack merit to avoid expensive litigation.

The big issue with the paper is whether the empirical results are driven entirely by New York. Tables T.7 and T.8 (page 23) show that the effect remains very strong even if New York is excluded. But the statistical regressions reported in the paper do not use a New York dummy.

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