High-quality
economic analysis is an essential part of SEC rulemaking, said the Division of Risk, Strategy, and
Financial Innovation and the Office of the General Counsel in recently
published guidance designed to ensure that decisions
to propose and adopt regulations are informed by the best available information
about a the economic consequences, and allows the Commission to meaningfully
compare the proposed action with reasonable alternatives. The staff noted that
the SEC has long recognized that a rule’s potential benefits and costs should
be considered in making a reasoned determination that adopting it is in the
public interest
The staff emphasized that
every economic analysis in SEC rulemakings should include the following four
elements: (1) a statement of the need for the proposed action; (2) the
definition of a baseline against which to measure the likely economic
consequences of the proposed regulation; (3) the identification of alternative
regulatory approaches; and (4) an evaluation of the benefits and costs, both
quantitative and qualitative, of the proposed action and the main alternatives
identified by the analysis.
On the first element, the
release must clearly identify the justification for the proposed regulation. In some circumstances, there
will be more than one justification for a particular rulemaking. Frequently,
the proposed rule will be a response to a market failure that market
participants cannot solve because of collective action problems. Other justifications for
rulemaking can include, among others, improving government processes,
interpreting provisions in statutes the Commission administers, and providing exemptive
relief from statutory prohibitions where the Commission concludes that doing so
is in the public interest.
Additionally, OMB’s Circular
A-4, implementing Executive Order 12866, recognizes that Congressional
direction to adopt a regulation is, itself, an independent justification for
rulemaking. The SEC staff has considered the recommendation in the Commission’s Inspector General
Report No. 499 that even where Congress directs the Commission to engage in
rulemaking, the Commission should identify a market failure or other compelling
need for rulemaking apart from the Congressional directive, and concluded that
this is unnecessary.
Instead, the staff believes the better approach is set
forth in Executive Order 12866, which states that agencies should promulgate only
such regulations as are required by law or are made necessary by
compelling public need, such as material failures of private markets to protect
or improve the health and safety of the public, the environment, or the
well-being of the American people. In the staff’s view, the Executive Order
clarifies that a statutory mandate and a market failure are alternative possible
justifications for a rule.
Although having concluded
that the SEC is not obligated to identify a justification for rulemaking beyond
a Congressional mandate, the staff acknowledged that there may be circumstances
in which it could be useful to do so. For example, where Congress has itself
stated that the mandate to engage in rulemaking is premised on a market failure
or other compelling social need, the rulemaking release may identify that
justification and attribute it to Congress in its description of the statutory
mandate and explain how the rule, including any discretionary choices the
Commission is making in the rulemaking, responds to the market failure or other
compelling need that Congress identified.
On the second element of a
baseline, the economic consequences of proposed rules, potential costs and
benefits including effects on efficiency, competition, and capital formation, should
be measured against a baseline, said the SEC staff, which is the best
assessment of how the world would look in the absence of the proposed action. The
baseline serves as a primary point of comparison for an analysis of the
proposed regulation. An economic analysis of a proposed regulatory action
compares the current state of the world, including the problem that the rule is
designed to address, to the expected state of the world with the proposed
regulation or regulatory alternatives in effect.
On the third element, the
release should identify and discuss reasonable potential alternatives to the
approach in the proposed rule. Reasonable alternatives include only those that
are available to the SEC and not those that the SEC lacks the authority to implement.
On the fourth element, said
the guidance, rulewriting staff should work with the SEC staff economists to
identify and describe the most likely economic benefits and costs of the
proposed rule and alternatives; quantify those expected benefits and costs to
the extent possible; and, for those elements of benefits and costs that are
quantified, identify the source or method of quantification and discuss any
uncertainties.
To achieve this objective,
rulewriting staff should engage with staff economists at the earliest stages of
rulemaking to determine whether there are areas in which monetization or other
quantification can reasonably be undertaken and, if so, whether the Division of
Risk, Strategy and Financial Innovation has the available resources necessary
to develop such data. Before issuing a proposing release, staff should identify
any specific data that would be necessary for or that would assist in
quantification, and should consider various mechanisms by which to seek such
data. The proposing release should also include a request for such data.
When particular benefits or
costs cannot be monetized, advised Division staff, the release should present
any available quantitative information: for example, quantification of the size
of the market affected, or the number and size of market participants subject
to the rule. Even without hard data, quantification may be possible by making
and explaining certain assumptions. For example, if proposed rules would enable
the operation of a new trading system, it may be reasonable to assume the
system will attract a percentage of all market volume. With that assumption,
reasoned staff, the cost-benefit analysis could then estimate a distributional
effect of a certain magnitude. It is important to make assumptions and the
rationales for them explicit and, where alternative assumptions are plausible,
to include analysis based on each.
Division staff noted that
court decisions addressing the economic analysis in SEC regulations have
likewise stressed the need to attempt to quantify anticipated costs and
benefits, even where the available data is imperfect and where doing so may
require using estimates and extrapolating from analogous situations.
When monetization or other
quantification is possible, said the Division staff, the proposing release
should include those numbers and solicit comment on them, and the adopting
release should address any comments on those numbers, including any data
submitted to challenge them. When quantifying costs and benefits, staff should
describe the measurement approach used, include references to statistical and
stakeholder data if available, and specify the timeframe analyzed.