Article published in the Financial Post, August 15, 2002
The impression that financial markets were "deregulated" comes from the partial removal of artificial regulatory walls between different activities (banking, insurance, brokerage), and from the stiffer competition that followed. But the main trend since the 1980s has been for North American governments to impose increasingly stringent standards on the disclosure and circulation of financial information, and on the behaviour of market participants.
The recent creation by Canadian securities regulators of a task force on insider trading is only the latest manifestation of this phenomenon. So is the totally unreal story of Martha Stewart, suspected by American inquisitors of insider trading after she allegedly got a tip that the Food and Drug Administration was forbidding ImClone from making a new drug available to cancer victims!
If 51 investors create a company, Ontario securities laws, like those of other jurisdictions, impose a host of financial norms and controls under the guise of protecting the shareholders. If our 51 investors ignored Ontario Securities Commission busybodies and adopted their own rules, why should they be liable to fines and jail penalties? Why is it that, in a group of more than 50 investors, capitalist acts between consenting adults are forbidden? According to the late Harvard philosopher Robert Nozick, the problem with a socialist society is precisely that it must "forbid capitalist acts between consenting adults."
To this argument, an academic colleague of mine replied that one has to follow the rules if one chooses not to live isolated on one's own island. But the question is, which rules? Why can parties to a contract not "create their own law," as French legal theorist Georges Ripert described the essence of contractual freedom? Why do we need uniform, standardized rules for contractual parties who do not want to be "protected" against their own judgment?
That state bureaucrats should regulate everything open to the public is a postulate without rational foundation. The mere fact that a company is "public," i.e., has shares traded on open markets or has more than 50 shareholders, does not per se make freedom of contract inefficient.
Economic analysis shows that capitalist acts between consenting adults are generally efficient, and this also applies to financial markets. At the very least, the burden of proof lies on those who think that political and bureaucratic wisdom is more efficient than free, decentralized and diversified markets. The same reasons for which state standardization of computer operating systems would be inefficient apply to the regulation of financial transactions. If standards are really demanded, the market will create them.
Consider the case of disclosure standards. Last year, the OSC bullied Air Canada into paying a fine for disclosing so-called "selective" and "material" information that was not very selective (13 analysts were involved) and turned out to be non-material anyway. More recently, Bombardier has come under the wrath of the Québec Securities Commission. There are many reasons why a company might prefer to selectively disclose certain pieces of information, including the fact that they may be just educated guesses. Moreover, if financial analysts have no incentives to find scoops (because they are prohibited by law), information flows may actually be inhibited.
Or consider the case of insider trading. The idea that the prohibition of insider trading is necessary for market "integrity" is largely a superstition. Insider trading is legal on many non-financial markets, including real estate and art. Trading financial instruments on the basis of non-public information (i.e., insider trading) was not illegal until the mid-twentieth century in the United States, and until the 1980s in many European countries.
It may or may not be in a company's interest to control information leaks and insider trades by its employees, but no special law is required. As Henry Manne recently argued in these pages, insider trading can advantageously replace executive stock options. Moreover, insider trading contributes to incorporating all available information in stock prices.
Another case of a socialist prohibition against capitalist acts between consenting adults is the increasing power of securities commissions to impose trading and employment bans. Every year, the U.S. Securities and Exchange Commission prohibits dozens of individuals from being officers or directors of "public" companies, whatever the latter's shareholders think. The Canucks follow. In the Yorkton Securities case, OSC lawyers are trying to obtain a lifetime ban against Piergiorgio Donnini.
Since the Enron and WorldCom scandals, corporate fraud has become the excuse of choice for a new assault against free-market capitalism. New accounting standards are to be imposed by honest politicians and enforced by righteous bureaucrats -- how funny! We should compare real markets with the state as it is, not as it could be in some utopian paradise.
The task force against fraud illustrates the reality of political and bureaucratic regulation. Press reports suggest it was created at the instigation of a private company, Regulation Services Inc., which hopes to profit from the task force's recommendations. A former British cop, now a professor at Harvard University, has been hired as a consultant at an estimated honorarium of $5,000 per day. All this in order to organize a U.S.-style witch hunt against Canadian insider traders.
In fact, the inefficient prosecution of insider trading in Canada has not been deleterious but advantageous. State inefficiency is often a blessing: Fortunately, we don't have the government we pay for. And we should make sure that our financial markets are not subjected to the over-regulation to which U.S. markets may well succumb in the 21st century. Canadians are not obliged to follow. We can obtain a competitive advantage by not strangling financial markets the way U.S. regulators seem intent on doing.