SEC Should Support Markets and Not Central Planning

Harvey Pitt had to go. He had lost the credibility to run the Securities and Exchange Commission. Now, President Bush should move swiftly to replace him. The SEC has too much on its plate for dawdling. What the country needs is someone who

  • has the guts and stature to tell interlopers such as New York Attorney General Eliot Spitzer to stick to state business and stop using blackmail to remake national-securities policy.
  • believes that free markets and tough fraud laws are the antidotes to corporate accounting scandals, not more arcane rules and oversight boards.
  • understands that integrity and clarity can never be compromised.

I do, however, feel sorry for Pitt’s successor, who will have to deal with the Sarbanes-Oxley bill that Congress passed in a panic. Just a few of this foggy law’s dire unintended consequences are now becoming clear. For instance, to avoid its strictures, companies are choosing to bypass the public markets altogether. This same axiom — regulate something excessively, and you’ll get less of it — applies as well to stock analysis, now an endangered species.

The alternative? An SEC chair whose top priority is to educate the 50 million US families that own stock — as Pitt’s predecessor, Arthur Levitt, recognized. Use the bully pulpit. Name names. But do something few Washington regulators of any sort have done: Encourage investors and clients, not central planners, to punish the miscreants. Markets are delightfully brutal and fast.

As for stock analysts: Sure, they have conflicts of interest. Conflicts abound in a free society. Just consider journalists. According to one respected survey, nine out of ten Washington bureau chiefs voted for Bill Clinton for president in 1996. Yet no journalist will admit any kind of bias. Some, in fact, manage to deal with conflicts and report objectively. Others don’t, and readers learn to discount their views. Similarly, stock analysts who develop a reputation for not telling the whole truth are ignored and ridiculed. If the distortions are serious enough, then the firms that fail to police them lose customers and go out of business.

If investment firms think that, to boost credibility, they need to separate their analysts more effectively from the rest of their business, then they should go ahead (as Citigroup has done). But the decision should be theirs, not the SEC’s – and certainly not the New York Attorney General’s. Spitzer’s idea of establishing a consortium (i.e., cartel) of investment firms to fund and oversee “independent” analysts is the kind of absurdity you would expect from a politician who believes in central planning rather than markets. But the firms themselves – which have done more to democratize finance and increase America’s wealth than a million Eliot Spitzers – need to speak up and shoot it down.

The Sarbanes-Oxley accounting oversight board is also a disaster, but one that Pitt’s successor will have to deal with. Appointing someone like John Biggs – who has already stated that he wants to force companies to hire separate firms to do their auditing and consulting work and that he favors expensing stock options – would be a terrible mistake. William Webster should withdraw as nominee to head the oversight board, and the new SEC chairman should pick someone with strong free-market credentials.

Will investors flee stocks if they don’t get an SEC chairman who will be obsessed with enforcing the nitpicky Sarbanes-Oxley rules? To the contrary. What investors want is for companies to be free to pursue profits, for managers to worry, not about filling out forms, but about running businesses efficiently.

In the end, worse than Wall Street’s conflicts is the message politicians have sent investors: If you lose money in the market, someone must be cheating. In fact, stocks never go straight up, and bear markets are common. Investors also must know that gleaning hot stocks — from analysts or anyone else — is not the key to success. It’s sensibly allocating your assets, diversifying and having the discipline to hold for the long term. Now, there’s a lesson Pitt’s successor should spread.