June 09, 2005,
It’s hard to imagine that President Bush could have made a better choice for Securities and Exchange Commission chairman than Chris Cox, the Republican congressman from California. Cox, a former securities lawyer and one of the most market-oriented members of Congress, is perfectly qualified to restore sense to the SEC after the regulatory excesses in which William Donaldson, the departing chairman, indulged.
Cox’s detractors decry his “reputation as a deregulator” (as the Washington Post’s editorial page put it). It might be countered that reluctance to regulate should be considered a cardinal virtue in an SEC chief. (We are reminded here of Ronald Reagan’s comment upon appointing National Review’s Dan Oliver to be chairman of the Federal Trade Commission: The Gipper said that Dan was “everything I want in an FTC chairman, and less.”)
There are two main criticisms against Cox. First is his sponsoring of the Private Securities Litigation Reform Act, passed in 1995 over Bill Clinton’s veto, thanks to support from many Democratic legislators. This law was designed to curtail the abuses of class-action lawsuits brought by shareholders against corporations, often for little more than a drop in share price. Critics claim that the legislation weakens shareholder protections against corporate malfeasance, and often try to taint Cox with that most frightening of words, “Enron.” But, if anything, plaintiffs are probably better off because of Cox’s legislation. Courts are now allowed to supervise attorney fees, and to appoint class representatives a privilege formerly given to the first lawyers to file, who were often inept ambulance-chasers. In addition, while fewer class-action suits now get to trial, those that do result in higher settlements. This suggests that the act is doing an effective job of weeding out frivolous suits and holding genuine wrongdoers accountable.
The second main criticism of Cox concerns the stock options some employers give to top employees. Many businesses report their profits without subtracting the estimated value of the options they have granted. (The cost of the options shows up in profit reports only when employees exercise their options.) Critics say that they are thus inflating their profits and misleading investors. The Financial Accounting Standards Board has proposed to require the immediate expensing of options. Silicon Valley, and many congressmen, including Rep. Cox, have objected. The issue has aroused heated controversy. The Post pompously declared that Cox had “failed” a “test of his mettle” by disagreeing with it.
Yet it is hard to see what all the fuss is about. All corporations report the estimated value of the options they have issued. Rational markets are perfectly capable of taking account of these liabilities and pricing shares accordingly. For the same reason, requiring that profits be calculated differently should not have much adverse effect on companies: The markets already know the information.
eschew anti-competitive favoritism.”
But viewed from a different angle, Cox’s position makes more sense. Immediate expensing is the opening move in a campaign to change the tax treatment of options. At the height of the hysteria about corporate-accounting scandals, Senators John McCain and Carl Levin proposed to limit corporate deductions on stock-option compensation. Their proposal would have created strong disincentives to granting options and that would have deprived corporations, especially start-ups that can offer ambitious employees future profits more readily than current cash, of a valuable tool. Cox is right to resist this agenda.
Bush’s first two choices for SEC chairman were less inspired. Harvey Pitt faced enormous pressure to join the hysteria. He did not give in to that pressure but he could not successfully resist it, either. He was unable to make an argument for market solutions to accounting problems, and he was too compromised by his ties to the accounting industry to be credible even if he had made one.
William Donaldson, Pitt’s successor, bought himself better press by joining the regulators. He sided with the SEC’s Democratic commissioners to create new restrictions on the composition of mutual-fund boards of directors and to require that hedge funds register with the SEC. Neither proposal makes much sense: The mutual-fund industry is extremely competitive, and if any group of people can look out for their own interests, it’s hedge funds’ clients.
Donaldson has also seemed more concerned with protecting privileged institutions than with promoting competition: for example, siding with SEC Democrats to require that brokers accept the best quoted price for a stock transaction, regardless of which stock exchange it comes from or whether the buy and sell orders match in size. Suppose, for example, that a broker needed to buy 10,000 shares of a company, and that 10,000 such shares were available on NASDAQ. If, in addition, 1,000 shares were available on the New York Stock Exchange, but at a lower price, the broker would have to purchase these shares first, and then look for another block of stock to complete the order. Large transactions would thus be executed piecemeal, during which time stock prices might change and result in a worse overall price than if the trade were executed all at once. The regulation will have one beneficiary, however: the New York Stock Exchange, where the lowest prices are often found and of which Donaldson was once chairman.
Chris Cox can be expected to eschew such anti-competitive favoritism. He should be helped in his efforts by the impending departure of the pro-regulation commissioner Harvey Goldschmid. If President Bush fills that vacancy as wisely as he has filled the chairman’s seat, the SEC should be well poised to reverse Donaldson’s follies.