Howell E. Jackson revisits George Stigler’s famous 1964 critique of the Securities and Exchange Commission and particularly his critique of the work of SEC lawyer Milton Cohen, who headed the SEC’s Special Study of Securities Markets in the early 1960s. Although time has validated Cohen’s intuitions regarding the value of expanding SEC oversight into over-the-counter markets, Stigler’s call for more careful economic analysis supported by robust empirical justification has heavily influenced how the SEC and other financial regulators stive to operate today.
Editor’s note: In the year of the 90th anniversary of the Securities and Exchange Act, we aim to reexamine the historic record of the Act, the debates that ensued among economists, and its relevance to today’s corporate governance environment. You can read the articles part of this series here.
George Stigler’s Public Regulation of the Securities Markets, published in April 1964, marked a turning point in academic perspectives on the Securities and Exchange Commission (SEC). Anticipating by more than a decade other economically oriented scholars like Homer Kripke and George Benston, Stigler challenged the Commission’s status atop the pantheon of New Deal administrative agencies. Specifically, Stigler’s article targeted the theoretical and empirical foundations of the then recently released Report of the Special Study chaired by a prominent SEC attorney, Milton H. Cohen. Stigler’s critique asserted: “[T]he Cohen Report makes poor use of either empirical evidence or economic theory, so its criticisms are founded upon prejudice and its reforms are directed by wishfulness.”
To the modern reader, Stigler’s denunciation is jarring as the Special Study of 1963 has itself attained almost mythical status among securities law practitioners and legal academics. Consider the following excerpt from the introduction to a 2018 report calling a new Special Study for the 21st Century, explicitly modeled on Cohen’s work:
The 1963 publication of the Special Study of the Securities Markets marked a seminal moment in the history of U.S. securities regulation. Headed up by legendary SEC lawyer Milton Cohen, this 3000 page report evaluated every aspect of the processes by which individuals and institutions acquire direct or indirect interests in securities and by which savings are channeled through the capital markets to new real investments. The impact of this study was enormous, generating the information and ideas behind most of the important securities regulatory initiatives undertaken over the next several decades.
Where Stigler saw prejudice and wishful thinking, this received wisdom elevates the Special Study to be the font for a generation of important and successful regulatory reforms. So how should we understand the tension in these two diametrically opposed views of Cohen’s tome?
My own reading is that while Stigler’s methodological critique has been fully vindicated, his specific criticisms of Cohen’s work stand up rather less well with the benefit of hindsight. One of the central theses of the Special Study was that federal securities laws should be applied more rigorously in the over-the-counter (OTC) markets (simplistically, markets without a central exchange), both with respect to securities firms serving those markets and the mandatory disclosure requirements imposed on OTC-listed companies. Here, a key recommendation of the Special Study was to replicate for OTC markets the regulatory regime that in the early 1960’s governed the New York Stock Exchange and other SEC-registered exchanges.
Stigler both denigrated the expansion of what he claimed to be the Special Study’s simplistic standards for the NYSE to OTC broker-dealers —“My lengthy experience with ‘account executives’ of major NYSE firms has not uncovered knowledge beyond what would fit comfortably into a six-hour course”—and then, even more provocatively, introduced empirical evidence suggesting that “grave doubts exist whether if account is taken of costs of regulation, the S.E.C. has saved the purchasers of new securities one dollar.” Stigler thereby called into question the value of expanding an SEC disclosure regime to securities traded in OTC markets.
As it happened, in 1964—the same year that Stigler’s article was published— Congress amended federal securities laws to extend 1934 Act disclosure obligations to OTC companies with large numbers of shareholders, following one of the Special Study’s more significant recommendations. The impact of that extension has been the subject of rigorous economic analysis, most notably by my colleague Allen Ferrell, who concluded that the imposition of mandatory disclosure requirements to the OTC market was “associated with both a dramatic reduction in the volatility of OTC stock returns and with OTC stocks enjoying positive abnormal returns.” Tellingly, the Ferrell paper explicitly acknowledges that it is building on the empirical strategy developed in Stigler’s 1964 study even while coming to strikingly different findings with respect to the benefits of this aspect of the Special Study’s recommendations for investors and market performance.
Stigler’s skepticism about the value of extending stronger supervisory standards to securities firms servicing clients in OTC markets is somewhat more difficult to evaluate even with the passage of many decades. No doubt, at the Commission and among securities professionals more generally, there is a shared assumption that robust SEC oversight of OTC securities firms—supplemented through FINRA supervision and state securities commissions—is an essential component of U.S. capital markets regulation, and the growing literature on the benefits of robust public enforcement is consistent with this intuition. But the precise content of that regulatory regime remains a contested question, as recent controversies over the adoption and enforcement of the Regulation Best Interest standard of conduct as well as the Department of Labor’s various incarnations of a fiduciary rule demonstrate. And these modern debates often echo Stigler’s critique of Cohen, with proponents of more stringent supervisory requirements relying heavily on intuitions and anecdotal evidence. In response, critics echo Stigler’s demand for empirical evidence that the benefits of such interventions outweigh the costs.
Where Public Regulations of Securities Markets clearly stands the test of time is in its central claim that regulatory interventions into financial markets should be based on sound economic theory supported by well-developed empirical evidence. Indeed, within two decades of the publication of the paper, legal debates over the theoretical desirability of mandatory disclosure regimes were routinely being discussed in terms of addressing market failures, and recent evaluations of more complicated market structure issues are similarly framed in terms of impacts on market efficiency and the cost of capital. Within much of the academy, Stigler’s orientation has become the coin of the realm.
What’s more, this sensibility has been increasingly incorporated into the structure of SEC decision making over the past few decades, with increased attention on cost-benefit analysis and the creation of the Division of Economic Research and Analysis to support the Commission’s mission. Whereas the SEC—especially back in 1964—was an agency of lawyers, the Commission now employs a deep bench of economists, many of whom are trained up in the kind of theoretically informed empirical analyses that Stigler found lacking in the Special Study. So while Stigler may have picked the wrong battle in lambasting the Special Study’s recommendations with respect to extending federal securities laws to OTC markets, he clearly was vindicated in the larger war over the centrality of grounding capital market oversight on sound economic theory and robust empirical testing.
Perhaps nowhere is Stigler’s victory clearer than the primacy of market efficiency as a focal point of modern securities law practice. In a decades-long process launched in the 1960s but stretching into this century with the Commissions’ 2005 public offering of reforms, and with more recent innovations harmonizing exemptions under SEC Chair Jay Clayton, the Commission has radically reformed the reporting requirements of public companies based on the extent to which the securities of those firms trade in informationally efficient markets. The steps necessary to accomplish this process—the integration of the 1933 Act and the 1934 Act, incorporation by reference, and the proliferation of different registration forms—ironically all trace back to the work of the Special Study and were implemented by SEC staff who understood themselves to be walking in Milton Cohen’s footsteps. Indeed, the Harvard Law Review article routinely cited as launching this reorientation of federal securities laws was authored by none other than Cohen himself. As it turns out, the target of Stigler’s critique in many ways set the course to a system of securities regulation incorporating many of the insights that Stigler advanced.
Let me make a final point on Stigler’s pairing of economic theory and empirical validation. Both elements are important to complete policy analysis, but it’s easier to spin out economic theories and harder to work up compelling empirical validation. Theory, moreover, is often ambiguous, especially when it comes to important issues of securities regulation. Do insider trading restrictions lower the cost of capital by reducing informed trading on material information (a good thing) or by reducing market efficiency by delaying the incorporation of new information into market prices (a bad thing)? Do stricter duties for securities firms serve primarily to reduce agency costs for retail investors (a good thing) or to increase the cost of financial services (a bad thing)? In the face of theoretical uncertainty, policy analysis should and does look for empirical evidence. But empirical evidence is often lacking or ambiguous. Moreover, the most relevant data is often in the hands of industry sources with strong incentives to disclose selectively in a self-serving manner (for an overview of the debate over the challenges of doing cost-benefit analysis for financial regulation, see Howell E. Jackson & Paul Rothstein (2019); for an illustration of an area of financial regulation where academic analysts have lacked access to critical industry sources of data, see Howell E. Jackson & Jeffery Y. Zhang (2023)).
As Stigler so famously demonstrated, regulated industries often capture their supervisors, and one of the channels of capture can be the control over empirical analysis, allowing firms to exaggerate costs and downplay benefits of proposed regulatory action. Accordingly, government officials must often proceed on the bases of intuition and anecdotal evidence, sifted (ideally) with disinterest and the guidance of experienced advisers. In short, in much the same way that Cohen and his colleagues proceeded with the Special Study. As Stigler points out, this can be a perilous path. But sometimes it is the only way forward. And, if steered with steady hands, can even lead to good results. Here, the case of Stilger v. Cohen remains—and likely forever will remain—dependent upon the facts and circumstances of each particular instance. Stigler may well provide the most appropriate framework for analysis, but sometimes a Cohen is needed to execute in practice.
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