Testing by Results

June 1, 1964

It is doubtful whether any other type of public regulation of economic activity has been so widely admired as the regulation of the securities markets by the Securities and Exchange Commission. The purpose of the regulation is to compel full disclosure of the facts about a security and to prevent or punish fraud. No one can defend ignorance or fraud. But have the SEC and the complex regulations it enforces in fact achieved their intended purpose of protecting the investor? And did they pay their cost?

This is the question that Prof. George J. Stigler of the University of Chicago set himself in the April issue of the Journal of Business published by that university. He assumed it might be capable of statistical answer. So with the help of an associate he compared the fate of new issues of securities in the period of 1923 to 1928, inclusive, before the SEC, with the fate of new issues of securities in 1949 to 1955, inclusive, after the SEC. He examined what happened to the market prices of new issues, in each period, in each of the five years after they came out. To eliminate the effects of general market conditions, he compared these market prices, not absolutely, but relative to the market average.

SEC AND INVESTORS

His results were negative. That is, his comparisons “suggest that the investors in common stocks in the 1950s did little better than in the 1920s, indeed clearly no better if they held the securities only one or two years,” and “that the SEC registration requirements had no important effect on the quality of new securities sold to the public.”

He arrived at “two main conclusions: (1) it is possible to study the effects of public policies, and not merely to assume that they exist and are beneficial, and (2) grave doubts exist whether, if account is taken of costs of regulation, the SEC has saved the purchasers of new issues one dollar.” In a footnote he adds: “The costs of the program, that is, probably exceed even a reasonably optimistic estimate of benefits.” Allowing for “costs of the delays imposed . . . as well as costs of operating the SEC, the full costs of registration for new stock issues could be 5 percent of their value.”

Stigler’s statistical results are of course not conclusive. In a matter of this nature, no statistical result could be conclusive. For the question to be answered is: what would have happened if there had been no SEC regulations? And might-have-beens can never be proved. But Stigler’s statistical results from comparisons of the pre-SEC with the post-SEC at least raise a strong presumption. There is no evidence that investors fared any better after the SEC was given control over the registration of securities than they did before.

DID CONSUMERS SAVE?

Earlier, Stigler and an associate undertook a study of the effects of state regulatory commissions on the electric-utility industry. They came to the tentative conclusion that these effects had been quite small: “It is very doubtful whether consumers have been saved as much by public regulation of the electrical utilities as they have had to pay, directly and indirectly, for regulation.”

Yet historically, regulation of the electric utilities tends to increase rather than diminish; and since the SEC was established it has increased year by year the scope and complexity of its regulations and requirements and asked for increased powers. As Stigler puts it:

“One great invention of private enterprise . . . is bankruptcy, an institution for putting an eventual stop to costly failure. No such institution has yet been conceived of in the political process, and an unsuccessful policy has no inherent termination. Indeed, political rewards are more closely proportioned to failure than to success, for failure demonstrates the need for larger appropriations and more power.”

The prevalent economic ideology has entirely forgotten the function of the free market. It assumes that the solution of every problem must be more government intervention, more government control, and more government spending. It is being carried along by its own momentum, and disdains the application of any factual tests to its results.