In a NY Times op ed, Joel Seligman, an eminence grise of securities regulation, comes out in favor of funding the SEC through fees. His basic argument – that funding the agency through fees charged to industry rather than through Congressional appropriation will make the agency more independent – has much merit. Seligman writes how the binge and purge nature of staffing the SEC has left the agency strapped during prominent episodes of financial fraud.

I agree with much of his analysis if not with his exact prescription. In a 2006 article, The Next Epidemic: Bubbles and the Growth and Decay of Securities Regulation, I looked at how the SEC’s overall budget and enforcement budget failed to keep pace with the stock market in the 1990s, leaving the SEC vastly outgunned during the tech stock boom. Here’s one of the graphs from that article showing the ratio of the SEC’s overall budget to the Dow Jones Wilshire Index (i.e. dividing the overall SEC budget by the DJ Wilshire Index in a given year) from 1990 to 2000.

The article includes other data and graphs showing how the number and dollar value of restatements correlated with the years in which the SEC was most outgunned. Colloquially, one could call this the height of the Enron era. My guess is that similar trends might appear in the last decade. So, like Seligman, I’ve been in favor of changing the SEC budget to allow the agency – particularly the enforcement side – to keep up with market levels and transaction volume.

But the Seligman/Obama proposal to fund the SEC through fees has a potential downside. It may create perverse incentives for regulators to take steps to increase the overall number of licenses/registration statements -- or, more profoundly, to not take steps that would decrease the amount of fees generated.  To turn around the title of Seligman's oped, there is some danger with telling the SEC "help yourself."  To continue our blog's recent movie theme - we don't want the SEC to think of itself as Blanche DuBois and having to be dependent on the kindness of the regulated.

That’s why I’ve been in favor of tying the overall SEC budget (and the budget of bank regulators) to market capitalization levels without relying on direct fees. Given that market capitalization depends on many different factors, the incentive of regulators to change their behavior to earn more fees is weaker. This is a fairly simple version of countercyclical regulation.

(To give credit where it is due, I came to this conclusion after a long conversation in 2004 with Lynn Stout. I still appreciate the time she took to talk with me even though I was still in practice and years from being a law professor).

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