Evidence-based policymaking suggests an objective and systematic form of governing that upholds the authority of evidence in legitimizing regulatory decisions. Financial regulators confront contemporary trends and pressures to justify regulatory decisions in an evidence-based manner using cost-benefit analysis (CBA). However, as a mechanism for justifying financial regulation, CBA elicits polarized views. On the one hand, CBA is a quantified, scientific, and objective endeavor that reduces opportunities for regulatory capture and acts in a disciplinary capacity over regulators. However, in projecting the impacts of any given rule, it is difficult to achieve a fully quantified analysis of the benefits and costs of regulation, a problem that may be compounded when the impacts are social as well as economic. In considering that social benefits and costs may not lend well to quantification, we focus a new paper on understanding the discursive and justificatory aspects of CBA in relation to contemporary regulations purported to have important social implications.
Since the early 1980s the Securities and Exchange Commission (SEC) recognizes that considering the benefits and costs of the rules it adopts is a matter of good regulatory practice. Statutory reforms in 1996 require the SEC to consider the effect of new rules on efficiency, competition, and capital formation, which some interpret as performing CBA. Starting in 2005, several court rulings emerged challenging the SEC’s CBA with the courts’ rulings vacating three SEC rules for the SEC’s failure to conduct an adequate CBA.
Following this series of legislative and judicial decisions, the SEC adheres to a de facto mandate to conduct CBA and to document how this analysis justifies its regulatory decisions. Under this mandate, the SEC has justified decisions on socially oriented rules falling outside of the SEC’s typical domain, including whistleblower provisions, government payments by extractive firms, cryptocurrency and more recent rules on climate change, corporate board diversity, cybersecurity, and human capital management disclosures. Thus, while the stated mission of the SEC is to protect investors, maintain efficient markets, and facilitate capital formation, the regulator often finds itself in the position to consider much wider societal implications in its rulemaking. We analyze the SEC’s CBA on one such rule – the Conflict Minerals (CM) rule.
Section 1502 of the Dodd-Frank Act of 2010 mandates that the SEC promulgate a rule requiring a conflict minerals disclosure. “Conflict minerals” are certain minerals or their derivatives determined by the Secretary of State to be financing conflict in Covered Countries referring, mainly, to the Democratic Republic of Congo (DRC). Despite a peace agreement, the DRC suffers from high levels of poverty, instability, and human rights violations.
With Congressional intent that commercial entities avoid purchasing raw materials from groups financing armed conflict, the CM rule is suggested [by the SEC] to have an orientation quite different from the economic or investor protection benefits that the SEC’s rules ordinarily strive to achieve. The final rule requires manufacturing firms to annually provide a special disclosure that describes their country-of-origin inquiry and determine whether its products are “DRC conflict free”. As such, the CM rule generated a diversity of interest and contention in the rulemaking process.
In analyzing the SEC’s CBA discourse, we conceptualize the financial regulators’ requirement to justify the benefits and costs of rulemaking decisions. First, the SEC acknowledges Congressional authority yet expresses discomfort in promulgating rules outside of its traditional domain. The SEC minimally addresses the societal implications of rulemaking despite constituents raising important concerns about societal benefits and costs. While individual citizens and sustainable investors make investing and purchasing decisions with the expectation that issuers act in a responsible manner, the SEC shows its willingness to weaken disclosure informativeness in favor of issuer cost savings. Second, the SEC emphasizes the interests of regulated constituents by adapting a tone towards lowering compliance costs to issuers. The SEC acknowledges that some decisions which lower costs to issuers also lower information quality (e.g., diminishing the rule’s benefits) to market participants. In justifying lower compliance costs, the SEC’s discourse produces a vagueness around who and what is subject to the rule that allows issuers more flexibility in the application of the CM rule.
Additionally, in the CM case, the SEC relies on issuer constituents regarding the cost aspect of CBA, with a focus on the costs of the Congressional mandate. However, the SEC does not adequately distinguish the costs of its discretionary decisions or quantify the rule’s social benefits. Benefits to market participants, and more so to society, were essentially deemed impossible to measure in this context. Further, the SEC favored evidence (and cost argumentation) supplied by issuers, industry associations and industry advisors, over evidence (and benefits argumentation) contributed by individuals, NGOs and policy organizations. This begs the question of the extent to which CBA can serve as an objective, evidence-based policymaking endeavor. Key components of the mechanism are argued to be unavailable for consideration and only certain constituents granted authority, suggesting instead that CBA remains a political tool for the regulator to legitimate rulemaking decisions.
The SEC’s CBA justifications aim to create a legitimizing framework through which the SEC may discursively protect its rulemaking from criticism. However, the SEC’s CBA discourse not only evokes the notion of regulatory capture, but it also raises questions regarding the SEC’s interpretation of investor protection. Namely, we are left to wonder whether the SEC has an implicit responsibility as a government regulator to consider the expectations of society in deciding whether the benefits of financial regulation outweigh the costs.
The SEC’s CBA discourse within the CM rule suggests that societal benefits and costs are not the purview of financial regulators, despite trends suggesting a shift in financial regulators’ jurisdictional boundaries. As activist stakeholders pressure the SEC to require non-financial disclosures related to climate change, diversity and inclusion, and political spending, the SEC finds itself considering much wider societal impacts often deemed to fall outside of its capital markets focus.
We highlight the SEC’s hesitancy to operate outside of its historical domain and a willingness to use its rulemaking discretion to shield issuers from costs when promulgating a non-financial disclosure rule with social implications. Important for the future of financial regulation is how shifting boundaries may continue to challenge financial regulators to justify the benefits and costs of the broader social implications of rulemaking.
