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Regulation Gave Us the Enron Scandal

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When pundits and politicians say the Enron scandal demonstrates the need for federal regulation of business, you have to be a little suspicious. They think everything demonstrates the need for federal regulation of business. It’s a reflex, that’s all.

What seems to have been forgotten in all the blather about preventing future Enrons is that we are overloaded with federal regulation already. The federal government has been regulating securities and other corporate activity since the New Deal. The Securities and Exchange Commission was created in 1934. According to the SEC’s website:

“The primary mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors and maintain the integrity of the securities markets… The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public, which provides a common pool of knowledge for all investors to use to judge for themselves if a company’s securities are a good investment. Only through the steady flow of timely, comprehensive and accurate information can people make sound investment decisions.”

By the SEC’s own statement, it is a miserable failure.

Since the 1930s, many more rules have been piled on. Disclosure requirements bury investors in an avalanche of data they often find irrelevant. And as Holman Jenkins Jr. of the Wall Street Journal points out, the suspicious role of the accounting firm Arthur Andersen & Co. was made possible by the federal requirement that corporations be audited annually. (A “federal gravy train,” Jenkins calls it.)

Here’s the real problem: there are so many requirements and watchdogs that people are lulled into thinking they are protected against fraud and deception. But nothing government does can guarantee security. All it can do is create a false sense of security, and that is plainly worse than no sense of security at all.

This is the great flaw in regulation. Government cannot make people be honest. Swindlers find ways around any rules and requirements. They always have and always will. The best protection is not the counterfeit protection of the state, but the “investor beware” attitude that serves us so well in other circumstances.

It won’t do to point out that Enron was exempt from some government oversight. We live in a regulatory milieu in which people generally believe the government is watching over them.

In other words, the welfare state has failed again. Yet unlike anywhere else, when government fails, a deafening chorus arises calling for more power and money. Will we ever learn?

It is indicative that the same people who so distrust corporations and demand federal regulation also oppose the most effective corporate watchdog imaginable: the market for corporate control. It has long been pointed out that most stockholders do not have enough incentive to keep an eye on their companies. It is easier to sell one’s shares (exit) than stay and change things. As a result, unaccountable managers can gain too much latitude in running things. Characteristically, the free market evolved a solution to this potential problem: the takeover artist, or “raider.” When he spots a badly managed company, he can make a profit by buying enough stock to take control, install better managers, and then sell his shares at a higher price.

That strategy, of course, upsets bad managers, who prefer not to be under the gaze of those watchdogs. (Hence the term “hostile takeover.”) Over the years, the managerial class has gotten their friends in Congress to pass laws making takeovers more difficult. For example, anyone who acquires a specified percentage of a company’s stock must publicly declare his intentions. If he had a takeover in mind, such a disclosure would tend to cause the stock price to rise, most likely ruining his plans. That’s the idea.

The upshot is that such government intervention shelters bad managers from the winds of competition. That’s bad for investors, employees, and consumers. But government regulation has never had the genuine public interest in mind.

Whether or not the worst about Enron is true, we need a thorough dismantling of the regulatory apparatus. The best protection is investor wariness in the free market. Laissez faire is not just a slogan; it’s an insurance policy.

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    Sheldon Richman is vice president of The Future of Freedom Foundation and editor of FFF's monthly journal, Future of Freedom. For 15 years he was editor of The Freeman, published by the Foundation for Economic Education in Irvington, New York. He is the author of FFF's award-winning book Separating School & State: How to Liberate America's Families; Your Money or Your Life: Why We Must Abolish the Income Tax; and Tethered Citizens: Time to Repeal the Welfare State. Calling for the abolition, not the reform, of public schooling. Separating School & State has become a landmark book in both libertarian and educational circles. In his column in the Financial Times, Michael Prowse wrote: "I recommend a subversive tract, Separating School & State by Sheldon Richman of the Cato Institute, a Washington think tank... . I also think that Mr. Richman is right to fear that state education undermines personal responsibility..." Sheldon's articles on economic policy, education, civil liberties, American history, foreign policy, and the Middle East have appeared in the Washington Post, Wall Street Journal, American Scholar, Chicago Tribune, USA Today, Washington Times, The American Conservative, Insight, Cato Policy Report, Journal of Economic Development, The Freeman, The World & I, Reason, Washington Report on Middle East Affairs, Middle East Policy, Liberty magazine, and other publications. He is a contributor to the The Concise Encyclopedia of Economics. A former newspaper reporter and senior editor at the Cato Institute and the Institute for Humane Studies, Sheldon is a graduate of Temple University in Philadelphia. He blogs at Free Association. Send him e-mail.