Can You Legislate Ethics?

Sarbanes-Oxley. The Securities Act of 1933. SEC Rule 419 regulating reverse mergers. The SEC’s latest super-hyped and interestingly timed fraud case against the venerable Goldman Sachs. And now Congress’ attempt at reforming the finance industry. Let’s put politics aside (we do our best to be a non-political blog) and think about the real purpose of all this, indeed of all laws and regulations intended to curb bad or irresponsible behavior. Does a jail sentence for murder keep lots of people from doing it? Presumably. Others, well it just makes them work hard to get away with it. Must we have some laws to prevent chaos and anarchy? Of course. How far that ultimately goes in terms of restricting and controlling behavior is in many ways at the heart of the difference between the core message of democracy, including the freedom to be dumb and screw up, and other forms of government like socialism, totalitariansim and communism.

It does seem that no matter what regulations exist, folks still find a way to do bad stuff. Watching this over my 30 years in the market makes me realize that, for the most part, regulators play a giant game of “Whac-a-Mole,” slamming down bad behaving moles one at a time as they emerge while thousands of others pop up without impunity. Too often the process is reactive vs. proactive – something bad that someone did is in the news, so action must be taken to prohibit that bad thing even more  and legislators and regulators feel they did something. I’m sure that those on the enforcement side in government feel the whac-a-mole (I hope I don’t hear from the pro-mole lobby on this) frustration on a daily basis – for every bad guy you go after, you know there are tons more that resources don’t permit them to pursue. Or despite all the regulations in place you judge incorrectly about a player despite lots of warnings (read: Madoff). But they soldier on, in part feeling (probably correctly) that their work in creating and enforcing a regulatory environment at least acts as a deterrent for some. But all too often crime pays, and those who insist on doing things the right way are left in the dust by the corner cutters and “catch me if you can” types. Those of us living well and not complaining watch thieves build mansions and enjoy very expensive divorces.

As I have mentioned in both editions of my book, there is much business I have turned down over the years because of the backgrounds or behaviors of the individuals involved. Yet some of my competitors (and other professionals in this space) take any client so long as they can pay the bill. Unfortunately, in some cases it has resulted in very mixed reputations for some, even those that in some cases have built pretty good sized firms. I am by no means a Boy Scout (in fact I dropped out of the cub scouts after a few weeks since it interfered with Little League), and I don’t need my clients to be. But I do expect them to stay within the law, and to not mislead me or anyone else in the world of securities.

When there is out and out fraud there should be aggressive enforcement. But there is a point at which our tax dollars should not be spent to create multiple agencies to ensure that every single player in the financial industry take every action as if they were doing it to protect their own grandmother (maybe not perfect example as my kids’ grandmother is a super-savvy Bryn Mawr economics major). As we saw when Rule 419 was passed, many bad guys went away (though they resurfaced elsewhere, in municipal securities for instance). But others simply found other ways to beat the system. As much as I preach the importance of champing down on bad guys, I’m not a strong believer in swinging the pendulum so far in regulation that it begins to choke the otherwise free markets.

We don’t need lots more laws, we need better, smarter and stronger enforcement. Yes this means more resources, but nothing close to what is currently being contemplated. I expect all this will fall on deaf ears in the pro-regulatory environment we currently face, especially following the severe market meltdown of the last few years. Everyone has to feel they are doing something. Let’s hope it’s as balanced and thought out as possible. And oh, hopefully the permanent exemption for smaller companies from Sarbanes 404(b) will sneak in there in the final version!

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