Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Sunday, July 15, 2007

Park on Securities Regulation

The Competing Paradigms of Securities Regulation, by JAMES J. PARK, Brooklyn Law School, is now available on SSRN.  Here is the abstract:

The securities industry is simultaneously governed by specific rules and general principles. When a rule is violated, the regulatory response is clear, enforce the rule. But what happens when conduct does not violate a rule but violates a principle? A regulator can make it clear through rulemaking that the conduct is prohibited going forward. Or, the regulator can punish the conduct through what I call a “principles-based” enforcement action. This Article examines the differences between rulemaking and principles-based enforcement and proposes criteria to guide regulators in choosing between these regulatory tools in communicating legal norms to the regulated.

The approaches reflect two competing paradigms. Rulemaking reflects the mentality that securities regulation is a technical enterprise that should be left to experts who have created a comprehensive, efficient, administrative scheme. Principles-based enforcement actions reflect the demand that regulators punish conduct violating principles reflecting public values. For the most part, the regulated prefer a predictable regulatory regime, which rulemaking provides, while the public prefers decisive responses, which can be provided by principles-based enforcement actions.

Based on these preferences, public choice theory would predict that regulators are more likely to respond to misconduct not violating a particular rule by aggressively enforcing principles when public influence is high and more likely to respond through rulemaking when the influence of the regulated is high. But this account is too simplistic – while interest groups can be influential, securities regulators are constrained in their regulatory choices by the nature of the evidence establishing the misconduct.

Ideally, in choosing between principles-based enforcement and rulemaking, regulators should take into account both the need for a predictable regulatory regime and the need to punish conduct that violates principles. They should consider: (1) whether the principle being enforced is well-established or novel; (2) whether the application of the principle is consistent with existing rules; (3) the strength and specificity of the evidence establishing the misconduct; and (4) whether the conduct caused foreseeable public harm.

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