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February 3, 2015

Courts Agree: Innocent Sounding "Cost-Benefit Analysis" is Really Biased "Industry-Cost Only Analysis"

Better Markets has argued for years that so-called “cost benefit analysis” is really little more than “industry-cost only analysis,” which fails to properly and fully capture the costs and benefits to the public of financial stability and preventing another crash and economic catastrophe.  Indeed, many of those benefits (like stability, risk reduction, etc.) and costs (like human suffering from losing a job or home, etc.) are inherently difficult if not impossible to quantify.  It also over-weights and prioritizes the more readily identifiable quantitative costs of individual rulemaking on the industry.  In addition, the argument is in the financial context not supported by public policy, statutory language, legislative history or legal precedent.

Notwithstanding these many deficiencies, the too-big-to-fail Wall Street banks and their allies have used this argument very effectively in the legislative, regulatory and legal arenas to weaken or kill financial reform and stability. Detailing these issues and the baselessness of the industry’s claims, we issued an extensive report more than two years ago entitled “Setting the Record Straight on Cost Benefit Analysis and Financial Reform.”  While it focused on the SEC, it is broadly applicable to the issues wherever they come up.

After a great deal of work in all three arenas over the last several years, there is good news to report, especially from the courts.  Recent decisions from the D.C. Circuit Court of Appeals signal that they understand that “cost-benefit analysis” is really “industry-cost only analysis” and that the argument may finally be losing its grip on the regulatory process, particularly at the SEC.

For years, the SEC has struggled to implement the reforms that Congress mandated under the Dodd-Frank financial reform law.  Those reforms are necessary to help make our financial system more transparent, more fair, and less vulnerable to another collapse and financial crisis like the one that has been playing out in the U.S. and throughout the world since 2008.   But seven years after the crisis, and well past many Congressionally imposed deadlines, the SEC has yet to complete nearly 40% of the rules it must write under the Dodd-Frank Act.

There are many reasons for the SEC’s slow pace in the rulemaking process (and for the often weak rules that the agency finally does adopt).  The issues are numerous and complex: the SEC has never been given the budget it needs to fulfill its mandate properly, and the Commission itself has proven to be internally and intensely divided over many of the reforms.

But one of the biggest culprits has been what we call the Trojan Horse of financial reform: Cost-Benefit Analysis.  For much of the last 10 years, the SEC has lived in fear that a court will strike down its rules on the ground that the agency failed to adequately quantify, compare, and evaluate all of the costs and benefits of each rule.  The concern was real: Since 2005, the D.C. Circuit has done just that, judicially nullifying a number of important rules on subjects ranging from shareholder participation in corporate governance to mutual fund board independence, citing the SEC’s supposed failure to conduct an adequate cost-benefit analysis.  In response, the SEC hired dozens of economists to conduct an exhaustive cost-benefit analysis of each rule—a process that has not only drained vast resources from a limited agency budget but also slowed the rulemaking process to a crawl and diluted the strength of the rules and regulations that were voted out of the SEC.

All along, Better Markets has argued that the D.C. Circuit was wrong on the law.  In fact, the securities laws have never required the SEC to conduct cost-benefit analysis, and for good reason:  Slavish adherence to cost-benefit analysis doesn’t work because so many benefits of regulation cannot be measured.  As a result, when cost-benefit analysis is applied, opponents of regulation tend to win the day based on the alarming but unsupported idea that regulatory costs will choke the life out of our financial markets.  Investors thus lose the protections they so desperately need.

The good news is this: Two recent cases from the D.C. Circuit suggest that this old view of the law is losing traction.  In NAM v. SEC, a challenge to the SEC’s conflict minerals rule, the D.C. Circuit flatly rejected industry’s claim that the SEC was required to conduct an exhaustive cost-benefit analysis, stating that “An agency is not required to measure the immeasurable, and need not conduct a rigorous, quantitative economic analysis unless the statute explicitly directs it to do so” – something Congress declined to do in the securities laws and in Dodd-Frank.  Nat’l Ass’n of Mfrs. v. SEC, 2014 U.S. App. LEXIS 6840 (D.C. Cir. Apr. 14, 2014). The court also explained why the SEC cannot be expected to perform cost-benefit analysis: It forces the agency to make an “apples-to-bricks” comparison whenever benefits cannot be framed in terms of dollars and cents, and it forces them to second-guess the judgments that Congress has already made about the costs and benefits of regulation.

The D.C. Circuit reached a similar conclusion in another recent case, holding that the CFTC  was not required to perform cost-benefit analysis under the Commodity Exchange Act:  “Where Congress has required ‘rigorous, quantitative economic analysis,’ it has made that requirement clear in the agency’s statute, but it imposed no such requirement [in the Commodity Exchange Act].”  Inv. Co. Inst. v. CFTC, 720 F.3d 370, 379 (D.C. Cir. 2013).

In light of these decisions, the SEC can and should revisit its entire approach to cost-benefit analysis.  It should explicitly recognize the actually very limited nature of its obligation to consider economic factors, reduce the amount of time and resources it devotes to the exercise, and hopefully increase the pace of its rulemaking and improve the strength and breadth of the reforms that it adopts — all as Congress intended and as the American people deserve.

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