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AEI-Brookings Joint Center Policy Matters 05-18 * * * After many meetings, investigations and complaints, the SEC gave forth with a new rule that, as far as the normal human eye can see, has nothing to do with the causes or remediation of the mutual fund scandals. In all their wisdom, the commissioners promulgated a rule requiring that three-fourths of the directors of every mutual fund -- even those that are merely division-like parts of a mutual fund family -- be "independent," and also that every chairman be independent. Independence was defined to preclude any employee of the parent company of the mutual funds from these positions. One might have thought that the Commission believed that interested directors were responsible for the significant losses that mutual fund investors suffered as a result of market timing and late trading in mutual fund shares. Had there been such a showing, then the rule might have made some sense. But in fact all the evidence available pointed the other way: funds with non-independent boards and/or chairs did better for their investors than did funds run by more independent boards and chairs. The SEC came up with no evidence to the contrary. In response to a study by the mutual fund giant, Fidelity -- and significantly without any countervailing study by the Commission -- William Donaldson, the unlamented former chairman of the SEC, uttered perhaps the most ironic and economically unsophisticated statement ever to come from the head of an economic regulatory agency: "There are no empirical studies that are worth much," he said. "You can do anything you want with numbers." Surely this is a most peculiar sentiment for the chairman of an agency whose very life blood is empirical data, the kind otherwise known as financial statements. And how did the D.C. Court, often referred to as the "supreme court of administrative law," react to this bit of banal sophistry? Even though there was nothing concrete to make the new rule sensible, the reviewing court said it was sufficient for the Commission to adopt the rule as a prophylactic measure with no showing other than "its own experience and intuition" to justify its action. That, the court said, provided a reasonable basis for the rule. What "experience"? What "intuition"? The staff of the SEC has bureaucratic experience in surviving in a federal regulatory agency and legal experience in parsing the words of its own regulations. But these are a long stretch from any real business experience in mutual funds or elsewhere. Nor do the all-powerful SEC legal staffers have any experience doing rigorous economic analyses of the costs and benefits of new rules. They may include in their pronouncements references to empirical data submitted in rule-making proceedings, but that is a far cry from engaging as experts in the serious intellectual exercise of collecting and analyzing hard economic facts. Unfortunately, enough legal jargon can obscure even the need for economic analysis, much less the quality of the analysis, as it clearly did in this case. * * * For a court to say, as this one did, that it has "no basis upon which to second-guess [the SEC's] judgment" is a confession of a system of lawlessness. If the courts cannot "second-guess" the regulators, who will ever prevent them from abusing their powers? Not the voters, not Congress, not the executive branch, not the marketplace, not their conscience. The rule of law is the last and only hope for making regulators demonstrate a minimal intellectual good faith in their work. The judges, reasonably enough, do not want to be making judgments on costs and benefits of policy choices. Judges' expertise is in understanding and applying the law. So the judges in Chamber of Commerce, not surprisingly, invoke those soothing words that regulatory agencies live by and long to hear over and over again: "The court owes extreme deference to the agency when it is evaluating scientific data within its technical expertise." This sentiment does have its place in our legal system, but when an agency is engaged in nothing more than following its own highly debatable prejudices, surely a court no longer owes it deference. Here it is clear that the SEC did not want to do, or could not do, the down-and-dirty work required to justify its rulemaking. Since the rule was never intended in fact to address mutual fund timing or late trading issues, a serious effort to justify it would have revealed an inherent non sequitur. Instead, the prevailing commissioners tried to use the excuse of recent scandals to promote, without further explanation, the misplaced idea of shareholder democracy, one of the SEC's collection of financial myths especially beloved of the departing chairman. And the Court of Appeals let them get away with it. * * * Likewise with the rule for independent chairmen. Though the Commission presented no evidence that this rule would accomplish what the majority said it wanted, the court said "we have no basis upon which to second-guess [the Commission's] judgment." But that was not a "judgment" by the SEC; it was arbitrary rulemaking by fiat. Courts faced with agency decisions obviously unsupported by real evidence should not dignify them as the embodiment of Solomonic wisdom -- or accord them any respect at all. The Chamber of Commerce actually argued that the Commission should have directed its staff to study the effects of independent chairmen on fund performance, but the court held that it was perfectly all right for the Commission to base its rule on "informed conjecture." Conjecture? Yes. Informed? Not on your life. On page 15 of the unanimous opinion, a different style of writing and reasoning belatedly kicks in, a sure sign that the opinion is a "committee" effort, intended to keep all the judges in unanimous harness (recalling the old saw about a giraffe being a horse designed by a committee). It is not entirely clear that the judge or judges whose voice comes through toward the end of the opinion would not have been better off unhitched from the others. At this point, the court states, in almost direct contravention of the logic of everything it had said so far, that "the Commission is not excused from its statutory obligation to determine as best it can the costs of the rule it has proposed." The court proceeded to give the SEC a lesson in very simple cost-benefit analysis and remanded for the Commission to do the job of actually looking at the likely effects of its rule. The court also gave the Commission a small lesson in good manners and administrative civility. Apparently, the two dissenting members of the Commission had offered an alternative to the independent chairman rule. They had proposed that a fund make disclosure to the public of the degree of independence of the chairman. The court says that the majority would have been within their rights to disregard this alternative if it had been frivolous or out of bounds. But, since "disclosure" is the fundamental philosophy of SEC regulation, clearly this idea was neither frivolous nor out of bounds, and the case was also remanded for consideration of this alternative. * * * Well, there you have it, a most unnerving picture of how laws are made in the administrative state. Determined regulators take cynical advantage of judicial deference, and judges, supposedly the personification of the rule of law, are reduced almost to non-players in the game. And yet, without repeated and serious judicial intervention, there will be no restraint on these administrative lawmakers. Substantially the same problem exists when the Supreme Court allows local government "planners" to advance their view of the good life at a large emotional and financial expense to private citizens. Or when the judiciary reads the "interstate" out of the interstate commerce provision out of the Constitution and allows Congress to override a duly adopted state law of purely local impact. But at least in each of these cases there is a costly but feasible remedy through the ballot box. In the case of the SEC, there is not even that; there is only the judiciary. If the rule of law is needed for progress and freedom in Russia and in Iraq, can it be so blithely sacrificed in the United States? |