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Creating Infrastructure for Private Regulation

Creating Infrastructure for Private Regulation
by Alex Merced

 Everyone on both sides of the aisle have empathy for consumers who are defrauded, swindled, and are tricked into entering trade under false premises. The debate isn't should there be mechanisms to protect and put oversight on the consumer market that'll help prevent these kind of problems, but what should the mechanism be?

 Those typically on the Right believe in the markets ability to take care of itself, and that firms that participate in fraud will eventually fail since they'll cannibalize their consumer base, and only legitimate reputable firms will exist when all is said and done that regulation of any form shouldn't exist cause it inhibits the level of competition that'll keep prices reasonable for consumers and allow pressure to keep firms honest.

 Those typically on the Left believe that even if this is true, the market will leave massive collateral damage in the wake of weeding out these fraudulent firms. They advocate regulating industries into "best practices" via government run regulatory monopolies also known as regulatory agencies. While this may have some effect on prices and the amount of competition, they feel the amount of confidence that consumers will have will outweigh the costs since consumers will feel safer to spend more.

The Problem with both of these positions

- The amount of collateral damage from having no mechanism for oversight can and will deter market confidence for sometimes long periods of time, which can create a society that is skeptical beyond necessity. This can actually inhibit the amount of investment and consumption in the economy.

- Centralized oversight from government monopolies are heavily subject political conflicts of interest and regulatory capture, and since there is no alternative it becomes the equivalent of no oversight but with the added danger of a public that thinks they are being protected and behaving as they are. (Imagine jumping out of plane thinking you are wearing  a parachute, but really they gave you a backpack of bricks, you feel perfectly safe till you hit the ground)

- Overconfidence is just as bad as no confidence, not only is fraudulent firms a problem but also is overconfidence by consumers to trade without doing their due diligence.

- Government enforced monopolies which use police/legal force to force best practices only make it more expensive and difficult for new start ups to compete against larger more established firms who might become more fraudulent feeling safe from competition and also grow too big because of this protection allowing them to capture regulators.

So Then what does Ideal Oversight look like?

Ideal oversight would come from a market of regulation, where competing firms compete to earn fees from consumers for regulatory services such as product reviews/rankings, product disclosures, and consumer education. This offers several benefits:

- Avoid regulatory capture since consumers can switch regulators when one regulator becomes too corrupt

- Since participation by the consumer and the firm is voluntary, consumers don't feel unduly protected unless paying for regulatory service and by trading with firms approved by that regulator.

- This allows for oversight with minimal collateral damage, doesn't move the barrier to entry since compliance with any of these regulatory companies is voluntary (if you don't, you don't have access to their members as customers)

As with anything the answer is not to have something or to have central provision of it, but to have market provision of the service or good. Although there is one way the government can help in fostering such a market in private regulation, by helping establish a model for consumers and regulators to find each other and disclosure of information. While I am against all government intervention, this is more a method to transition from the current monopoly to a regulatory market. To understand my proposal we must understand the logic of the securities act of the 1933.

The Securities Act of 1933

 In the 20's most of the communication technology we take for granted today didn't exist or was in it's earliest stages. A investor looking for an investment had no internet in which to pull a particular companies financials or information to base a decisions off of, only what a broker chose to provide them who had a conflicting interest in getting them to like any particular investment cause of commissions.

 So the logic of the act of 33 wasn't to prevent companies of varying quality to make their securities available to the public, but instead to require that the sale of the securities be made through a disclosure of information we now know as a prospectus. Also, these prospectuses must be registered with the Securities Exchange Commission to make sure all proper disclosures are made.

 The basic idea of disclosure is one of the most interesting parts of this act, it wasn't about making the decision for a customer in what's good for them in the way the FDA does with drugs or more modern financial regulation may do but instead empowering the consumer to be able to carry out their responsibility of making a decision.

 As technology involved, access to information has evolved with the internet and now the SEC has their EDGAR database in which anyone can look up all this disclosure information for any company. Although again, this was not perfect for many reasons...

- The SEC is a public monopoly that use legal/police force which tends to make consumers feel unduly safe so while there is more disclosure retail investors have less incentive to read it feeling the SEC has broad enough jurisdiction

- Consumers will deal with any firm since they assume that all firms are registered with the SEC, instead of looking for an approval sticker or id of some kind (although Broker Check was made to address this, they'd be more willing to use such a service if they were educated to use it)

If the SEC was established not as a monopoly but as a model for what other firms can do as a regulatory business, other firms would approve on many of the shortcomings of the SEC in order to take their market share. A Market would develop and the competition would eventually allow a phasing out of the SEC and the expense for the government... of course government doesn't like competition with their agencies or phasing out power which is just the problem with governments themselves (thus why I'm an anarcho-creatarian).

How do we apply this to today?

The Government could establish a model, an online platform where regulatory businesses can put up all their information and allow consumers to subscribe to their services. The government could of course put stipulations similar to registering a prospectus to putting your company on this platform and take assessments on subscription fees to help fund the platform so it doesn't use taxpayer money.

This platform can categorize all these private regulators by industry, geography, and by services offered. Education materials can be made available on this platform on how to use the services from these regulators, and profits from assessments can be used on ad campaigns (similar to Got Milk commercials).

This should be done in a non-coercive way, regulatory companies are not obliged to post on this service although they stand to benefit from air of legitimacy they'll get and marketing from ad campaigns. Also other companies should be free to create their own competing platforms so this way eventually the government can either close the platform as it loses market share to more innovative platforms or sell it to buyer of their choosing.

This would handle many issues of oversight, regulatory capture, consumer confidence, anti-competitive, and other issues prevalent with the mainstream right and left views of regulation.

Posted Sep 12 2010, 08:17 PM by Alex Merced