From the Individual to the Institution: The SEC’s Evolving Strategy for Regulating the Capital Markets

Wednesday, January 1st, 2003 at 12:00 am by Shalini M. Aggarwal
Shalini M. Aggarwal, From the Individual to the Institution: The SEC’s Evolving Strategy for Regulating the Capital Markets, 2003 Colum. Bus. L. Rev. 581

The role of “primary overseer and regulator of the U.S. securities markets” has plunged the Securities and Exchange Commission (“SEC” or “Commission”) into the center of current corporate drama. During this period, both Congress and the public have focused increased attention on the manner in which the SEC implements congressional rules and exercises its regulatory and enforcement authority. As a multifaceted organization that operates in a dynamic environment, the SEC’s various activities cannot be reduced to a single design. However, the Commission has employed certain discernible strategies to respond to the changing environment in which it regulates.

This note explores an evolving strategic shift in the work of the SEC. Namely, as the markets have grown in size, complexity, and technological aptitude, the SEC has shifted its focus from deterrence through enforcement actions at the individual level to deterrence at an institutional or organizational level. This approach looks at the environment in which the individual operates and seeks to alter the institutional structures that influence one’s ability to engage in wrongdoing. Instead of seeking to simply penalize individual actors directly, the Commission first penalizes institutions, holding them responsible for maintaining certain structures that decrease the temptation to engage in reprehensible conduct. As institutional incentives are shaped by such requirements, individual action is in turn affected.

Beginning in the 1980’s, through SEC activity and congressional grants of authority such as the Insider Trading Securities Fraud Enforcement Act, the increasing focus on deterrence at an institutional level became apparent. This *583 focus has continued in the 1990’s until today through SEC rulemaking initiatives like Regulation Fair Disclosure and Auditor Independence Standards, as well as through congressional grants of authority such as the Sarbanes-Oxley Act (“Sarbanes-Oxley” or “Act”) that support a strategy of increasing reliance on altering institutional incentives.

Arguably, the SEC’s latest attempts at targeting the institution serve to enhance deterrence by more effectively increasing the probability of detection. Historically, the Commission has sought to strengthen deterrence by increasing both the sanction and the likelihood of a sanction. For example, the Insider Trading Sanctions Act of 1984 enlarged the magnitude of potential sanctions by allowing for the imposition of treble damages. In order to increase the likelihood of a sanction, the SEC has sought to increase both the probability of detection and the probability that, if detected, a sanction will be imposed. Strengthened and visible enforcement, for example, aims to increase the probability of detection or the appearance thereof. Alternatively, certain rules and theories such as Rule 14e-3 and the misappropriation theory increase the probability that a sanction will be imposed if the wrongdoing is detected.

*584 However, due to resource constraints, it is difficult to comprehensively detect violations at an individual level. By reforming the detection regime to more effectively incorporate the institution, the SEC is increasing dependence on a process that involves detection of more tangible factors. As part of this process, institutions are first encouraged to adopt certain codes of conduct. The Commission relies on the ease of pointing out structural shortcomings such as the lack of proper policies and procedures or the lack of certain independent committees. These procedures, policies, and committees in turn aim to decrease the individual’s ability to engage in potentially reprehensible conduct. Because such structures are more focused, their presence may increase the probability of detecting individual wrongdoing, leading to an increase in the likelihood of a sanction and the resulting deterrence.

Section II of this note introduces the background of the SEC, the growth of the capital markets, and subsequent problems faced by the SEC in regulating an evolving market. Sections III, IV and V discuss changes in the SEC’s strategy in the areas of Insider Trading and Selective Disclosure, Research Analyst Conflicts of Interest, and Financial Disclosure and Accounting. Finally, the conclusion touches on issues faced by the SEC in light of its developing strategy and the current market environment.

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