By JAMES K. GLASSMAN
SCRIPPS HOWARD NEWS SERVICE
A truly weird drama plays out this week in an unlikely Washington theater: the Securities and Exchange Commission.
The main actor is William Donaldson, 74, who steps down Thursday as chairman of the SEC, the federal agency set up during the Depression to protect investors. Appointed by President Bush, Donaldson has been a deep disappointment to the White House, key congressional chairmen and believers in free markets.
A few weeks ago, Donaldson abruptly announced he was resigning, and Rep. Christopher Cox, R-Calif., was immediately named to succeed him. It appeared from the timing that Donaldson had finally gotten the heave-ho.
Despite a distinguished background, Donaldson seemed out of his depth at the SEC and suffered embarrassing rebukes for management failures, like cost overruns at the extravagant new building the SEC moves into this week.
Orgy of regulation
Far worse, Donaldson presided over an orgy of regulation -- bad regulation. Donaldson sided consistently with the commission's two Democrats, creating a strange 3-2 majority. Insiders say Commissioner Harvey Goldschmidt, an activist Columbia professor, has really run the show.
And speaking of the show ...
Last week, a federal appeals court rejected one of Donaldson's more foolish 3-2 regulations, chiding the SEC for neglecting its obligation to provide actual evidence that the rule did more good than harm. By that standard, the courts should throw out practically everything the Donaldson SEC has done.
One of the hallmarks of the persistent 3-2 majority has been contempt, not only for the freedom of investors to make their own choices, but also for the importance of empiricism and economic research as the basis of sound policy. Donaldson, like Goldschmidt, believes in normative regulation -- don't bother me with the facts, I know what's right.
The rule required that mutual-fund boards be headed by someone independent of management. Never mind that research shows that funds headed by chairmen involved in the business perform better and charge lower fees. Never mind that many of the funds tainted by scandal were headed by independent chairmen. And never mind that investors have thousands of funds to choose from and can decide for themselves whom they want managing their money, relying on brand names like Fidelity and Vanguard and performance records rather than on extraneous matters like board composition.
In the end, the rule will add costs and reduce choices for the investors the SEC is supposed to be protecting -- just like other Donaldson rules, including Regulation NMS, which tries to protect antique floor trading at the New York Stock Exchange against modern electronic competitors, and the SEC's implementation of parts of the Sarbanes-Oxley legislation, which has already damaged investor confidence the old-fashioned way -- by depressing stock prices.
Right after the court ruling, in a monumental act of pique, Donaldson said he would put the mutual-fund issue up for a vote the day before leaves the SEC. He'll make a few cosmetic changes and get his last 3-2 majority, passing the rule and thumbing his nose at both the court and the president who appointed him. It's a pathetic way to go out.
Cox should rescind the regulation -- if the courts don't do it first. He'll also have to tackle the other obnoxious measures and rein in the Federal Accounting Standards Board, which also has a penchant for ignoring the economic consequences of its rules, like mandatory expensing of stock options, which endangers the competitiveness of U.S. high-tech companies.
But more important is whether America needs an SEC at all.
Institutions like the Federal Reserve, which has more respect for economic analysis, can regulate the financial institutions that fall under the SEC's purview; the Justice Department can vigorously prosecute fraud -- the most effective method of protecting investors -- on its own; and the Federal Trade Commission can alert investors to schemes to bilk them.
Degree of transparency
As for the SEC's disclosure requirements: Let companies themselves, or the exchanges on which they are traded, decide the degree of transparency. Research clearly shows that the more companies disclose, the more investors want to buy their shares. My guess is that, absent regulations, firms will disclose more than the SEC now demands, not less -- simply because that is what investors themselves want.
It's probably too much to hope for a complete shutdown of the SEC (after all, there's that new building to fill). But, with Bill Donaldson's departure, it's time -- after 70 years -- to look at the agency's role afresh.
X James K. Glassman is a fellow at the American Enterprise Institute and host of the Web site TechCentralStation.com.