Last April I wrote about the SEC’s new ADV part 2 requirements. In that column I wrote, “Unfortunately, our society tends to pass feel-good legislation aimed at making people feel safer without actually making them safer.”. Tom Giachetti, one of the legal experts that advisors rely on to help them comply with the multitude of SEC regulations, wrote an article around the same time in the May 2011 issue of Investment Advisor entitled “You Can’t Regulate Crooks”. In that article he wrote:
What our politicians (and the SEC, which too often buckles to the political pressure of our “esteemed” elected officials) do not and—based upon recently enacted rules and regulations—will never realize, is that you can’t regulate crooks. Rather, the result of the vast majority of regulation (which is usually reactive to the unfortunate events perpetrated by crooks) is to further frustrate the 99.9% of the advisory community that works diligently every day to do, what they believe, is in the best interests of their clients. The unfortunate result of unscrupulous activity is to propound additional rules and regulations on the advisory community that add no value to the services they provide. Rather, the unintended, but real result is to further deplete precious time and resources that advisors could and should be spending on the benefit of their clients.
Voters continue to demand that “something be done” and that “they should pass a law” whenever someone does something illegal. The fact it is already illegal ought to be enough, but politicians usually oblige by passing additional feel good legislation. The Sarbanes-Oxley Act of 2002 was passed after the Enron scandal. It introduced complex and costly regulations that make it more difficult for American companies to compete globally. In fact that legislation now costs American companies the equivalent of three Enron scandals every year. None of these changes helped avoid the financial meltdown in 2008.
Giachetti predicts the same lack of usefulness for the SEC’s ADV part 2:
Will all the stress and cost associated with this new Part 2A make a substantial difference for the investing public? Unfortunately, the truthful answer is no. Will the new Part 2A stop the next Madoff or Stanford? Absolutely not. To the contrary, future crooks (and there will always be future crooks, as well as current crooks who have as of yet gone undetected) may have the most eloquently drafted written disclosure statements.
We’ve written a list of ten questions to help you select your next financial advisor as well as eight safeguards to protect your money. As Tom Giachetti subtitled his article, “Unnecessary regulation annoys the good guys, and doesn’t stop the bad guys.”
Sarbanes-Oxley addressed many securities problems, but it did not address the derivatives market. The 2008 financial collapse was due to a failure to regulate the packaging of bad loans into derivative products, giving a false sense of security. It is illogical to suggest that Sarbanes-Oxley would have fixed this.
The derivatives market fell under the Commodities and Futures Trading Commission. When the CFTC tried to implement regulations on derivatives back in 1998, they were shot down by Alan Greenspan, an admirer of Ayn Rand, and an espouser of the Libertarian principle that free markets will regulate themselves. He was wrong, of course. And so was Any Rand. And so was the Libertarian ideology that led to the financial collapse in 2008.
The 2008 financial collapse was investigated by a bipartisan Senate committee. I’ve given you the link to their report in your Seven Reasons… article as well as the PBS Frontline report called “The Warning” that details the history of the collapse. There is no need to trust me on this when public data is available.
I would like to address the matter of “regulation of crooks”, though, because it is an issue of ethical theory. We can start with “rights”. The idea of “rights” is from the sense of “how things ought to be”, or “setting things right”. There are two kinds of rights. “Rhetorical” rights are those one claims for oneself, usually as “God-given” or “Natural”. “Practical” rights are those that we agree to respect and protect for each other.
When Jefferson said, “all men are endowed by their Creator with certain inalienable rights”, he was speaking rhetorically. When Jefferson said, “and to secure these rights, governments are instituted”, he was speaking of practical rights.
To make the point, suppose your neighbor sees someone robbing your house. If he calls the police, then you have a practical right of property. If he goes back to watching TV and lets your house be robbed, then your right to property becomes merely rhetorical.
To secure the right to property, people constitute state and national governments. These governments pass laws against theft, which imply an agreed upon right to property. By that agreement, your neighbor is ethically bound to report the crook to the police. By that agreement the police bring the crook before the judge. By that agreement the judge imposes penalty which requires the crook to restore your property and spend time in jail to protect others from being his victims.
So, that’s how government regulates crooks. It would be intolerable if Mr. Giachetti’s cynical comment, that government cannot regulate crooks, were correct.
And it is that cynicism that seems to be the heart of Libertarian ideology.
Government is not perfect because it is run by imperfect human beings. But it is the means by which we regulate crooks. When it fails, then we need to fix it, with better law. That’s why we enacted Dodd-Frank, to restore the CFTC’s ability to regulate derivatives and to avoid a repeat of the financial collapse of 2008.
David John Marotta
What is remarkable is to think that regulation which costs three Enrons a year is worth trying to prevent one Enron a decade.
And after every debacle, there is always more regulation proposed in hindsight which (it is postulated) would have solved all of our problems.
You can call it cynicism, but I would simply call it practical.
First, I’m going to presume that your estimate of the cost of Sarbanes-Oxley enforcement is inaccurate.
Second, I believe the cost of not having Sarbanes-Oxley is probably bigger than three Enrons. Going by Wikipedia, Sarbanes-Oxley provided the following changes in how the securities business was conducted:
1. Assure the independence of auditors by not allowing them to sell other services to the company they were auditing.
2. Requiring securities analysts to disclose conflicts of interests (prior to regulation, some were found to be recommending their customers buy when they were busy selling their own shares).
3. Establishin criminal penalties for the “manipulation, distruction, or alteration of financial records”.
4. Defines corporate fraud and establishes criminal penalties.
The cost of NOT having Sarbanes-Oxley was potentially the collapse of the securities market due to lack of public faith in their ability to invest without being ROBBED. THAT was why Congress under Bush passed this bipartisan law with nearly unanimous approval (423 to 3 in the House and 99 out of 100 in the Senate).
You might need to be a bit more skeptical of your right-wing information sources. If I can look it up in Wikipedia, then so can you and everybody else.
David John Marotta
You presumption is convenient, but inaccurate. See Government Regulations Don’t Make You Safer for more details.
The benefits you list are not benefits at all, but have driven IPOs out of the United States to the Alternative Investment Market in London. The securities market did not collapse for the 100 years before Sarbanes-Oxley was passed and there was no danger of it collapsing if it had not been passed. It is exactly that type of crazy thinking that passes regulations which do more harm than good.
Thanks for referring me to your article “”Government Regulations Don’t Make You Safer”. But I didn’t find the calculation supporting the claim that the cost of compliance was “3 Enrons per year”. And according to the Wikipedia article on Sarbanes-Oxley, the compliance costs have been steadily decreasing over the years.
And it is not just about Enron. Many companies were using deceptive practices to boost their own stock prices. Bernard Krushnik, in his article, “The Sarbanes Oxley Act: ‘Big Brother is Watching You’ or Adequate Measures of Corporate Governance Regulation?” (referenced in the Wikipedia article), said this,
“It was enacted in the wake of a series of precedent accounting and bankruptcy scandals, which started with the collapse of Enron and was followed by the downfall of WorldCom, Adelphia Communications, Tyco, Sunbeam, Waste Management, Xerox, Global Crossing and others.”
It may indeed be more expensive to hire independent auditors, but you are less likely to have them shredding an actual ton of documents like Arthur Andersen LLP did. The Sarbanes-Oxley created the Public Company Accounting Oversight Board (PCAOB) to audit the auditors.
I found it odd that you would make this statement, “The financial services world may very well be filled with sharks who want to separate you from your money. But even teams of regulators can’t replace your own vigilance and education.”
Really? On the one hand you say the regulators can’t even control the crooks, but somehow I’m supposed to discover what they cannot? Thousands of individual investors have lost money due to corruption in the market over the years. And you wish to “blame the victims” for being duped?
No thank you. What we do in a democracy, when enough of us have been robbed, is to create laws against robbery, and insist that they be enforced.
David John Marotta
Yes, Marvin, really. All the legislation that is in place doesn’t protect you as well as these eight ways to safeguard your money. There is no legislation requiring financial institutions to follow these eight guidelines, but they are the best way to safeguard your money. Here are Ten Questions to Ask a Financial Advisor before you engage their services.
You can’t regulate robbery either. We have laws against robbery and they are enforced to the best of our ability. But we do not add an additional burden onto honest citizens that they certify the ownership of all the belongings in their house accurately via outside accounting on penalty of imprisonment.