Liberty’s Loss

Remarks to The Federalist Society’s Capital Conversations: A Teleforum Series

Thank you, Dean [Reuter].  I have to start with my standard disclaimer, which is that my views represent my own views and not necessarily those of the Securities and Exchange Commission or my fellow Commissioners.  Last week, the nation lost economist Walter Williams.  Dr. Williams, in addition to his academic research, spent his career explaining economics to both graduate and undergraduate students in the classroom and ordinary people in his syndicated columns. 

Williams persistently pointed out the inherent conflict between government power and personal liberty.  That principle is too often forgotten by regulators, mired as we are in the details of particular rules, and may not be front of mind for regulated entities, who sometimes seek to use regulation to gain or retain advantages over potential competitors.  Our instincts as regulators are to protect people, but protection that comes in the form of overruling personal choices is what parents do for children, not what governments ought to be doing for citizens.  Financial regulation, therefore, often undercuts personal liberty. 

Let me give some examples to illustrate the point.  I am, of course, happy to talk about other issues during the discussion.

One example that has gotten quite a bit of attention over the last several years is the accredited investor standard.  Accredited investors have access to private markets that are largely inaccessible to other investors.  Historically, to be accredited, a person had to be wealthy or have a high income.  For purposes of our rules that means having a net worth exceeding $1 million (excluding the value of one’s home) or an income in excess of $200,000 in each of the two most recent years or joint income with a spouse in excess of $300,000 in each of those years.  The goal of this provision was to prevent unsophisticated people from making investment decisions that could hurt them. 

In a change that took effect this week, we expanded the accredited investor category slightly to include certain financial professionals who hold a Series 7, 65, or 82 license.[1]  In terms of the number of new accredited investors created by our amended rules, this change is a small step.  However, that incremental step reflected an acknowledged need to look beyond wealth and income because they are imperfect measures of sophistication.  A willingness to measure sophistication more creatively eventually may open additional channels—such as getting a degree, taking relevant classes, or passing a test—to get into the accredited investor pool.  Indeed, the Commission has invited members of the public to propose additional professional certifications, designations, or credentials that should qualify an individual as an accredited investor.[2] 

Although I am pleased with the progress and welcome the call for further public engagement, the presumption that people need to entreat a regulator for permission to invest still offends principles of personal liberty, which allow people both to earn and spend money as they see fit.  Why should government be authorized to assess the sophistication of the American people so as to constrain their decision-making in this particular area?  If we as a society permit government to do so in this area, is that a license for government to make other, even more consequential life decisions for us?

In addition to constraining the choices of investors, regulation restricts the liberty of people trying to raise capital for their businesses.  Recently, after hearing small business advocates ask for relief for two decades, we proposed exemptive relief for a category of people called “finders,” who match investors with businesses in need of capital.[3]  Finders are the people in your community who know lots of people, including potential investors.  Under the law as it is presently interpreted, however, finders, if they want to get paid for introducing small businesses to those investors, likely would have to register as broker-dealers, which would cost a lot more than any compensation they would get from this activity.  One commenter on the proposal explained, “A business owner should be able to compensate people for helping him or her to find and raise capital.”[4]  Our rules can hinder the kind of community support for business that, particularly at a time like the present, could keep an otherwise doomed business afloat.  Here too, well-intentioned regulation is very much in tension with personal liberty.

One area in which questions about the intersection between personal liberty and regulation loom large is crypto-regulation.  In the middle of the 2007 to 2009 financial crisis, Satoshi Nakomoto (whoever he or they may be), laid out the mechanics of “an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”[5]  That vision, which has since gained passionate adherents the world over, is rooted in a key principle that Walter Williams emphasized as well—the powerful and fundamental right of people voluntarily to engage in mutually beneficial transactions with one another.  Crypto, a way to hold easily and seamlessly transfer value, has made that principle even more powerful than ever before in history; people are able to enter into transactions with others across the world without an intermediary. 

Regulators, however, are used to dealing with intermediaries, because they are easy to grab hold of and regulate.  So crypto poses new challenges.  Those challenges are only growing as crypto evolves.  The SEC is wrestling with issues such as whether digital assets are securities, how registered entities can custody digital assets in compliance with our rules, and whether regulated investment products holding bitcoin can meet our standards.  The explosion of decentralized finance, or “DeFi,” applications designed to displace regulated entities such as exchanges and broker-dealers will pose thorny questions and decisions for us in the coming years. 

As this technology gains adoption outside and now inside the legacy financial system, we should figure out a way to embrace the personal liberty principles undergirding it.  If we were instead to steamroll the technology’s liberty-enhancing features under the weight of regulation, we would lose a lot of the power of the new technology to afford opportunities to people whose autonomy has previously been curbed by, for example, limited access to the traditional financial system, geographic location, social standing, or subjection to a repressive government.

The decentralization of crypto is the opposite of central planning, which is making something of a comeback, with financial regulation as one of its primary tools.  After an unsuccessful history, people would reject central planning out of hand unless it came in a disguise.  The disguise of the day is climate policy.  At first blush, central planning measures undertaken to protect the climate do not raise the same kind of fears that other types of central planning would.  Indeed, governments have come to believe that by directing capital flows away from what they determine to be anti-climate uses and toward what they decree to be pro-climate uses, they may be able to reach their desired climate goals.  Thus, for example, the Network for Greening the Financial System, a who’s who of global central bankers and prudential and securities regulators, seeks to “help strengthen[] the global response required to meet the goals of the Paris agreement and to enhance the role of the financial system to manage risks and to mobilize capital for green and low-carbon investments in the broader context of environmentally sustainable development.”[6]

Familiar regulatory levers—capital requirements, stress tests, asset management regulation, and corporate disclosures—are being repurposed to divert asset flows to “environmentally sustainable investments,” as defined by government taxonomies.[7]  By employing these regulatory tools, governments effectively decide where capital should flow based on their expectations of what will be good for the environment.  Such an approach assumes that financial regulators have the knowledge and wisdom to assess the relative environmental benefits and costs of different industries or that they can identify what future innovations are likely to address which climate phenomena.  This assumption is wildly optimistic and almost charmingly naïve.

Regulatory fiat is no substitute for the valuable role that financial markets play in directing capital to productive uses, including companies developing solutions for mitigating climate change.  When not constrained by government taxonomies, capital can shift quickly to new sustainable solutions as they emerge.  Pre-planning by regulators is not nimble, and I can guarantee that regulatory taxonomies, even if initially well crafted, will not keep up with technological innovation.  The Commission, after all, still requires some regulated entities to submit reports via telegram.[8]  Government rulebooks may not be the place to look for the authoritative word on state-of-the-art technology, whether in communications or in sustainability.  Regulatory usurpation of decision-making by individuals voluntarily engaging with one another to fund and build transformative technologies will be harmful to liberty and to our shared goals for a greener, safer, healthier, and more prosperous world.

There is no doubt that the financial markets are essential to developing effective responses to climate issues, as they have been to solving so many other problems.  Attempting to direct the whole effort through financial regulation—including through so-called “ESG” (Environmental, Social, Governance) disclosure requirements that are detached from our traditional materiality standard—will make the capital markets more brittle and less effective at serving all sectors of the economy.  Every choice a regulator makes displaces a choice that a free-thinking individual who faces real-world consequences for the decision otherwise would make.

I will close with another issue of deep concern from a personal liberty standpoint—the Consolidated Audit Trail (“CAT”).  I have spoken so often of my concerns about the CAT that I dread seeing my moniker change from CryptoMom to CATLady.  The liberty implications of this proposal, however, warrant continued mention.  The Commission, in concert with numerous self-regulatory organizations, has been building the CAT so that it can track all equities and options orders as they wend their way through the markets.  As with many other ideas that give me concern from a liberty standpoint, the objective is unobjectionable—affording regulators easy and holistic insight into what is happening in the markets.  Nevertheless, the price is too high.  Regulators, without having any grounds for suspicion, will be able to watch every move of every person who trades in our markets.  We would not find it pleasant or appropriate for a government minder to monitor our purchases at a farmers’ market, and it is no more pleasant or appropriate in an equity market.  The CAT is an example of a regulatory project that got unmoored from liberty concerns as everyone was focused on very real technical concerns.

Walter Williams “want[ed] students to share [his] values that personal liberty, along with free markets, is morally superior to other forms of human organization,” but he also wanted them to think for themselves: “The most effective means to accomplish that goal is to give them the tools to be tough, rigorous, hard-minded thinkers and they will probably reach the same conclusions as I have,”[9] he said.  I am grateful to the Federalist Society for similarly promoting rigorous free-thinking.  I suspect that we will have many case studies in the coming years about how government policy and personal liberty interact.  So there will be many opportunities for us to sharpen our thinking and to reembrace our national passion for personal liberty.