January 10, 2014

The Growing Application of Cost-Benefit Analysis to Financial Regulation

Editor’s Note:  As Professor Sunstein explains, “Endorsed for more than three decades and by five presidents, cost-benefit analysis is here to stay.”

From: RegBlog/The Penn Program on Regulation

Is the enjoyment of an after-dinner coffee worth being kept awake at night and being tired the next day? When we answer that kind of question and many others like it, we evaluate the pros and cons of our choices. In effect, we do a cost-benefit analysis. Although “cost-benefit analysis” may sound like a complex concept, it is actually a practice we engage in daily.

For much the same reasons that we use cost-benefit analysis, government officials conduct cost-benefit analyses when making regulatory decisions. In fact, all three branches of government, other federal agencies, private organizations, and individuals have increasingly encouraged financial regulators to implement cost-benefit analysis in their rulemaking procedures. In response, both the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) have addressed incorporating cost-benefit analysis in their rulemaking processes, and other financial regulators are following their lead.

The Administrative Conference of the United States (ACUS), a federal agency that works to improve the rulemaking process by performing research and issuing recommendations to other federal agencies, defines cost-benefit analysis in the regulatory sphere as any government agency’s efforts “to estimate the overall benefits that a proposed or final rule would create, as well as the aggregate costs that it would impose on society.” When using cost-benefit analysis, the regulatory agency then assesses whether the benefits of a new regulation warrant the costs.

Executive orders signed by different presidents require Cabinet departments and particular executive agencies to use cost-benefit analysis as part of certain rulemakings. However, independent regulatory agencies, such as financial regulators like the SEC, and self-regulatory organizations, like FINRA, are not subject to requirements outlined in executive orders. In addition, the SEC is not required to use cost-benefit analysis at all.

As described by ACUS, independent regulatory agencies are federal agencies whose leaders cannot be fired by the president without cause. Further, such agencies are “created by an act of Congress” and have some autonomy from the executive branch.

Self-regulatory organizations are not government agencies, but still have the ability to develop and monitor compliance with industry rules. FINRA describes itself as “an independent, not-for-profit organization authorized by Congress to protect America’s investors by making sure the securities industry operates fairly and honestly” by creating regulations and ensuring compliance with these regulations, among other things.

All branches of the government seem to support the use of cost-benefit analysis in rulemaking by financial regulators. For example, although his executive order does not obligate independent agencies to use cost-benefit analysis, President Barack Obama included language in his 2011 order on regulatory review that encourages independent agencies to “take into account benefits and costs, both quantitative and qualitative.”

In addition, in 2011, a federal appeals court struck down an SEC regulation that would have given shareholders more input regarding the members of boards, finding the SEC had conducted deficient cost-benefit analysis of the new rule.

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