Cui Bono From Financial Regulation?

In 125 BC, Roman politician and prosecutor Lucius Cassius introduced the legal principle of cui bono, which roughly translates to "who benefits?" It intends to cut through distractions and irrelevant details of a case to focus on motive – especially financial motive.

In modern day, critics of the current financial regulatory agenda have focused on what they consider its flaws:

• The breakneck pace of SEC rulemaking. SEC Chair Gary Gensler's tenure to date have seen 60 proposed rules, with more than 9,000 pages of text and shorter windows for public comment.
• Significantly higher bank capital requirements. The Basel III Endgame rules could increase borrowing costs to homeowners and businesses and reduce liquidity in fixed income capital markets.
• The potential for stricter oversight. According to U.S. Treasury Secretary Janet Yellen, the Financial Securities Oversight Committee is looking once again at whether certain non-bank financial institutions should be declared "significantly important" and subject to stricter oversight.
• Implementation overload. Firms needing to comply with new regulations will likely find themselves rushing to build out technology, compliance policies and operational processes. 
• An increased risk of unintended consequences. Given just how extraordinarily complex, interconnected and interdependent the modern financial system has become, the risk that something will "break" increases dramatically (see chart). 

^{The potential impacts of major SEC regulatory actions on market liquidity, risk, borrowing costs and investing costs. Source: NERA Economic Consulting, SIFMA.} 

Not to mention the potentially deleterious effect regulatory overreach could have on economic growth.

But American Securities Association CEO Chris Iacovella, who has successfully sued the SEC, offers a novel perspective: Cui bono from today's financial regulation?

"What's going on is that the Administrative State is supporting the agenda of derivative players – accountants, consultants, lawyers – who are advocating for more and more regulation," Iacovella told me in a recent interview. "This has created a self-perpetuating cycle."

"This doesn't just apply to financial services – it applies across all sectors of the economy," Iacovella said. "But in finance, one thing is clear: The implementation of an unprecedented regulatory agenda will result in a significant transfer of wealth from regulated market participants – including retail investors and small businesses who use their own capital to take risks – to a professional class who does not."

Ironically, the world view behind regulatory activism is often that financial services intermediaries are extracting too much economic rent from the economy: Their share of GDP is too high, activists claim, and needs to be squeezed down by increasing transparency and competition.

Iacovella suggests that exactly the opposite is happening. "Regulators are imposing enormous costs on financial institutions that are ultimately a tax on the investor base," Iacovella told me. 

As one example, the Consolidated Audit Trail – the subject of ASA's current litigation against the SEC – has racked up $540 million in start-up costs, with another $240 million slated to be spent this year. 80% of those costs will be passed on to financial services firms. "Those incremental costs disproportionately affect smaller firms," Iacovella told me. "They are putting pressure on independent players to look at acquisitions, which ultimately will reduce competition, not increase it."

"We're looking at a transfer of wealth from risk takers, entrepreneurs and businesspeople operating in the real world – from investors putting their savings on the risk/reward line in financial markets – to a progressive, pro-regulation administrative state. The net result is a drag on economic activity."

Whether you agree with Iacovella or not, there is no denying that the modern world leans toward regulation and bureaucracy. It may well be born from good intentions – human beings' innate belief that they can exercise significant control over what can go wrong with their environment. Some attempt at control is prudent. But after a certain point, the unintended negative consequences of a bloated administrative and bureaucratic state – and the much-larger-than-needed professional class that surrounds and undergirds it – outweigh the benefits. 

In finance, we may have already reached that point.