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Academic Paper Questions Judicial Review of Agency Cost-Benefit Analysis in Financial Services

In a recent paper, John Coates, a professor at Harvard Law School, questions the benefit of cost-benefit analysis in financial services regulation.  The paper expresses concern that judicial review of rulemakings will harm the judgment of regulators because even in “gold-standard” cost-benefit analysis, the quantification of costs and benefits are nothing more than guesstimates.  As a result, the paper concludes that judicial review of these cost-benefit analyses “can be expected to do more to camouflage discretionary choices than to discipline agencies or promote democracy.”

The paper uses case studies to illustrate that “precise, reliable, quantified [cost-benefit analysis] remains unfeasible.”  One of the case-studies is a review of the SEC’s fund governance rules that would have required boards to be composed of 75% independent directors and have an independent chair.  The paper notes the difficulty in identifying the value or costs of fund governance to the fund’s performance because anything that changes the value of the fund’s investments will obscure the impact of fund governance on a fund’s returns.  The paper defines the costs that were at issue in the case not as these larger costs to fund performance, but rather “adjustment costs that were “an immaterial subset of the likely costs and benefits of the rule.”  The paper concludes that the SEC may have declined to re-propose the rules because of the threat of litigation on the cost-benefit analysis and the risk that the SEC would be subject to another “morale-draining, resource-depleting court loss,” even if it continued to believe that the “governance rules would benefit investors at a low cost.”  The paper acknowledges that the qualitative comments against the rules could have been the reason for the change, but that “a dysfunctional system of judicial review seems likely to be a bigger part of the explanation.”