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The Regulators Will Botch It Again / Artikel mises.org

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The Regulators Will Botch It Again
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by Gregory
Bresiger

[Posted February 18, 2004]

<img alt src="http://mises.org/images3/money.gif" align="right" border="0" width="234" height="202">Will
the regulators ever get it right? Are the regulators ever capable of getting
it right? This constant infernal tinkering with our lives and businesses never
seems to end like the ever expanding bureaucracies that rule us.

Regulators, in the
midst of various securities industry scandals over mutual funds,
are under pressure to come up with a set of reforms that will, well, correct
the previous set of reforms. Unfortunately, regulators, and their friends in
Congress, usually just end up acting like historical illiterates—repeating
the mistakes of the past.

Take soft dollars. Soft
dollars are the custom whereby large institutional investors pay more than
they normally would for brokerage execution services. In exchange, they
receive a variety of research products and services that they would not
normally be able to afford and can be valuable in helping to find the right
investment strategies.

For decades the
regulators have allowed the use of soft dollars without objection. In fact,
regulators, in effect, invented soft dollars in the 1970s. And then issued
rule after rule modifying how and when they could be used. Often they expanded
their use. For example, recently they permitted them for use in the Nasdaq
market. However, the question of the validity of soft dollars was not a
debatable matter until recently. All that will change now.

Now the regulators,
facing the criticism of a populist press and pols, are looking at abolishing
or severely curtailing soft dollars as are some officials of trade industry
groups.

Many trading and
brokerage firms won't use soft dollars, believing the practice compromises the
credibility of their actions. Others believe soft dollars are critical, that
they benefit both the firm and their clients. Advocates argue that soft
dollars give their clients a much better quality of service. Both sides can
make a case.

Still, soft-dollar
defenders have the ultimate rationale—the regulators have condoned the
practice for over a quarter century. Soft dollars were created back in 1975,
with an amendment to the Securities Exchange Act, Section 28(e). That
amendment permitted higher commissions in exchange for research services.
Since that amendment, the Securities and Exchange Commission has repeatedly
certified the use of soft dollars.

Probably no one can
impose a sensible soft dollar standard that is reasonable for every financial
firm. And it is a futile exercise for those overseeing markets to say that no
one should use soft dollars. Or that everyone should. But that has never
stopped regulators before and likely it will not stop them now. They have
bureaucracies to protect and, as always, competition tends to scare them. So
the regulators, the same as their counterparts in the rest of the leviathan,
often want splashy new rules and regs, just as Congress always wants to reform
campaign finance laws. The regulators fail and so does Congress.

Back in the 1970s, in
the wake of the Watergate scandals, Congress passed a package of campaign
reforms that were hyped for the American people as a foolproof way
of showing the door to all the bad pols.

Out of that era of
reform came Pacs, the notorious political action committees. Today, soft
spending, spending on political action committees, is the bane of the
reformers. The cry in the political arena is for another round of, you guessed
it attentive reader, more reform so as to fix the previous round of reforms,
which were designed….

After a while, reforms,
like the civil rights laws and the big government they feed, become a
major growth industry. Regulators and pols always want more, never fewer, new
laws or cumbersome rules. Fewer laws, like fewer government departments or
commissions, is never a serious option. But the market, when it is
unencumbered by the social engineers who want to regulate everything, has its
own way of settling an issue, even something as exotic as soft dollars.

Some firms use soft
dollars. Some don't. It was the same kind of situation here in the Rancid
Apple before our draconian anti-smoking laws, another episode in regulatory
mayhem. Some businesses voluntarily imposed these restrictions on themselves,
thinking it would be good for them. Others, with lots of smokers as customers,
wanted no part of it. The city didn't like that. Mayor Mad Mike Bloomberg
ultimately decreed that only one flower could bloom here in Sodom on the
Hudson. The mutual fund industry itself, at least its biggest trade group,
seems to like the one flower philosophy.

So under pressure from
regulators and the public, the Investment Company Institute (ICI)—itself the
target of much press criticism because of the mutual fund scandal, which, by
the way, isn't really much of a scandal because many of the supposed bad
practices have been known to regulators for years—recently asked the
Securities and Exchange Commission to bar the use of soft dollars for
stock-research products, computers and software that comes from outside
vendors. The goal of the soft dollar opponents is to have more effective trade
executions. These executions would keep costs and expense ratios low, thereby
obtaining, in theory, better returns for the average individual investor, few
of whom know the details of soft dollars and fewer of whom even care,
providing they are getting good returns. But how far do the regulators want to
go down this road that leads to more and more regulation of anything and
everything?

Will mutual funds that
have high expense ratios—and there will always be some—also be slammed by
the regulators as immediately under suspicion. Indeed, in the fund business,
some investment companies charge clients 12b-1 fees. On the other hand, many
fund complexes don't and make a point of using it as a selling point. That's
competition. Competition, in theory, is exactly what the regulators and their
bosses on the Hill claim that they want.

However, many of our
leading reformers—like our hired help on the Potomac who, for many years,
found nothing objectionable in smoking and happily gave butts to their good
soldiers in World War II—have suddenly been knocked off their horses. These
Sauls turned Pauls have come up ready to impose a dictatorship of virtue.

This crusade now
requires that soft dollar relationships not be slightly modified—with better
disclosure so everyone knows what is going on. Instead, it calls for soft
dollar relationships to go the same way as the venal Soviet Union—to the ash
heap of history. Indeed, one wonders if, as in the case of the big butt
companies hauled before our ayatollahs of political correctness, there will be
ex-post facto penalties for those who employed soft dollars because they
thought that it was in the best interests of their clients and because the
regulators said it was a legal practice (like smoking used to be in most
places).

Yet ex-post facto
penalties are supposedly outlawed by the United States Constitution. But given
the lawlessness of the biggest criminal in our society, the federal government,
our revered document of liberty has become, in many cases, a dead letter,
about as valuable as bonds issued by the Confederate States of America. (By
the way, I'm putting this in a parenthesis so no one will read it and I will
not have my humble hovel picketed by a pack of political correctness
terrorists, but Lord Acton called our Civil War"the Second War of
American Independence").

But reformers beware.
Dramatic changes in soft dollar relationships, like the political reforms of
the 1970s or the incredibly flawed"save" Social Security reforms of
the 1970s and 1980s, will likely have unintended consequences. For example,
another goal of abolishing soft dollars is to provide better, more independent
research that would benefit the individual investor. Nevertheless, one of the
leaders of a giant fund complex, a fellow apparently not marching to the ICI
party line, recently warned of the unintended consequences of rigorous soft
dollar reform.

"I think it is
likely that a number of highly valued, independent research organizations
would no longer be in business. We would all lose valuable input which we
think is integral to our investment process," said Stephen Canter,
chairman and chief executive officer of Dreyfus and vice chairman of parent
Mellon. Indeed, an analyst with the TowerGroup, a research firm covering the
securities industry, says ending soft dollars would be a bad move.

"It would be a
disaster. The industry is built on these kinds of reciprocal relationships,"
says Robert Hegarty, vice president, securities and investments, for
TowerGroup. Hegarty's point is well taken. Indeed, much of the business world,
much of our personal relationships, are built on"reciprocal
relationships."

Once again, the
regulators and reformers are about to make the wrong decision. Their system of
relentless intervention is flawed in the same way American intervention around
the globe is flawed—the people who supposedly have all the answers end up
winging it. That means another generation of social engineers will have to
come up with more reforms to correct the errors of the previous generation of
reformers and busybodies.

Maybe, just maybe,
given the sorry record of regulators—who remind one of the members of
Congress constantly playing around with the tax code—it's time to stop
tinkering. Maybe, it's time to leave the market alone. Maybe the regulatory
social engineers should retire.

___________________________

Gregory Bresiger, a
business writer living in Kew Gardens, New York. gbresiger@hotmail.com.
See his archive.