Although the securities industry is primarily regulated by specific rules, it is also governed by general principles. When conduct violates a rule, the regulatory response is obvious-enforce the rule. The issue is more difficult when conduct does not violate a rule but violates a principle. A regulator can excuse the conduct on the ground that the law is unclear and prohibit the conduct going forward through rulemaking. Or, the regulator can punish the conduct through what I call a "principles-based" enforcement action. Since 2002, there has been a surge of principles-based enforcement actions, provoking criticism that regulators are engaging in "Regulation by Enforcement." This Article compares these regulatory tools and proposes criteria to guide regulators in choosing between them in communicating legal norms to the regulated. These approaches represent two paradigms that must coexist but can also compete. Rulemaking reflects the mentality that securities regulation is a technical enterprise that should be left to experts who have created a comprehensive, efficient administrative scheme. Principles-based enforcement actions reflect the demand that regulators punish conduct that violates principles reflecting public values. For the most part, the regulated prefer a predictable regulatory regime, which rulemaking provides, whereas the public prefers decisive responses, which principles-based enforcement actions provide. Based on these preferences, public choice theory would contend that regulators are more likely to address arguable misconduct by aggressively enforcing principles when public influence is high, while utilizing rulemaking when the regulated are influential. But this account is too simplistic-although the relative strength of interest groups can affect the incentives of regulators, their choices are subject to significant constraints. For example, a regulator cannot credibly bring a principles-based enforcement action without uncovering specific evidence of misconduct. Even if regulators are so constrained, they should counter the perception that their choices are made to appease interest groups by considering the circumstances in which principles-based enforcement is appropriate. In doing so, regulators should take into account both the need for a predictable regulatory regime and the need to punish conduct that violates principles. They should consider: (1) whether the principle being enforced is well established or novel, (2) whether the application of the principle is consistent with existing rules, (3) whether there is compelling evidence establishing the misconduct, and (4) whether the conduct caused foreseeable public harm.
James J. Park,
The Competing Paradigms of Securities Regulation,
57 Duke Law Journal
Available at: https://scholarship.law.duke.edu/dlj/vol57/iss3/2