Risk in regulation: a US piblic firm ownership perspective

"The study examines different approaches to the regulation of the capital markets with a focus on explaining why certain assumptions about markets, actors, and systems came to be embedded in the regulatory practice in the American capital markets. More specifically, I examine regulatory assumptions about the nature of public firm ownership, the distortions that these assumptions introduced into the regulatory framework governing the securities markets, and the epistemological and risk-based implications of these distortions to actors, markets, and the regulatory system. The analysis draws on a number of theoretical approaches and methodologies including legal history, law and economics, comparative law, complexity/systems analysis, socio-legal analysis, and political economy.

This study analyzes the performance of the US Securities and Exchange Commission as the principal regulator of the American capital markets. The regulatory framework arguably reflects the Commission's perceptions (of market realities) and preferences (in response to these ""market realities""). The federal proxy rules found in s. 14(a) of the Securities Exchange Act of 1934, used as a case study in this volume, exemplify this claim. As one of the original responsibilities assigned to the Commission by Congress, s. 14(a) of the 1934 Act gave the agency near-complete authority to regulate the federal proxy process. Thus, the functioning of the federal proxy regime hints at the Commission's performance as a regulator. Since s. 14(a) deals with proxy solicitation of shareholder votes, one essential policy consideration is the nature of corporate ownership. To evaluate the Commission's knowledge in relation to ownership, we need to appreciate how the agency evaluated underlying assumptions vis-à-vis ownership; displayed awareness of changing socio-economic realities in the securities markets; and developed responsive regulatory measures accordingly.

The analysis highlights how the Commission missed learning opportunities (to varying degrees) over the years vis-à-vis (i) distortions introduced into the regulatory framework in the 1930s, (ii) implications of these distortions to the stability of the regulatory framework, (iii) demographic changes in the nature of public firm ownership leading to the formation of an ownership structure not previously discussed in the literature, which I call the ""market oriented blockholder model,"" (iv) new forms of endogenous risks relating to the regulatory framework, which I call ""regulatory systemic risk."" The cumulative impact of these factors have negative implications to the agency's reputation and legitimacy.

These findings suggest that the Commission needs to optimize its process to become what I call a ""learning regulator""-an organization displaying adaptability to the evolving environment subject to its oversight through the acquisition, generation, and translation of knowledge and the modification of its behavior to reflect new knowledge and insights. To facilitate such optimization, I develop an organizational learning model tailored to administrative agencies-the ""learning regulator framework."" Measures adopted pursuant to the model encourage organizational learning, risk reduction, and enhanced efficiency in the regulated environment. These measures, in turn, enhance the regulator's reputation and shield its legitimacy from criticism."