The SEC as A Short-Only Fund

On page 141 of the 19th edition of Scott & Gelpern’s International Finance, Transactions, Policy, and Regulation, they report, “On average, firms lose 41 percent of their market value when news of misconduct is reported, far more than is recovered in later litigation or enforcement actions.”

I think the implications of this are pretty clear. The SEC should be reconstituted as a short-only hedge fund. Instead of seeking fines or settlements from the companies it investigates, it should just short their stock instead. This would have two significant positive outcomes. First, the deterrence effects of getting shorted by the SEC would be much greater than simply getting fined by them. With paying a fine, one imagines the dynamic is a lot more like, “Hey John from accounting, can you write the SEC their check this month? I’ve got to get back to my securities fraud over here.” But nobody wants to imagine some stuffy government bureaucrat making millions on the basis of their regulatory infractions. Denying the SEC the satisfaction of scoring massive gains would be a much more powerful preventive device than paying the SEC fines; at least the fines you can budget for. But there’s no accounting for the psychic shame of handing millions directly to SEC employees.

Which leads to the second positive outcome. The gains from the SEC’s short positions should be distributed to employees. Given the potential to earn lucrative bonuses for uncovering securities fraud, they might be incentivized to actually do their jobs and aggressively pursue financial criminals (instead of watching porn).