Will The US Adopt Principle-Based Regulation?

You expect to hear about "regime harmonization with Europe" when the subject is something that Europe has a lot of and the US has none of – carbon trading, for example. But today we heard it from Michael Oxley, on the subject of something the US has a lot of and Europe has much less of: capital-markets regulation.

Capital markets are subject to globalization just like the steel industry in his home state of Ohio, said Oxley today – and that means that the well-established American way of doing things just might have to change. "I predict that you will see, for the first time, probably, American regulators moving towards a principles-based approach," said Oxley, who's now vice chairman of Nasdaq.

Harvard's Hal Scott, a lawyer, wondered whether such a move might be harder on this side of the pond. "If the FSA promulgates a rule, they interpret it as well," said Scott of the UK regulator. "Whereas if the SEC promulgates a rule, it's the court who interprets it."

Scott answered his own question, however, by quoting Sam DiPiazza, the CEO of PriceWaterhouse, who says he prefers principles to rules, even in court.The reason has everything to do with the thicket of regulations which presently encumbers anybody working in the capital markets: any given action is subject to any number of rules, and that means that an auditor or any other market participant can be accused of not following rule 6 even if he followed rule 1. On the other hand, if he can more simply say "I followed the principle," that would help him even if he had to do so in front of a judge rather than a regulator.

In general, a principles-based approach has regulators which, when faced with a problem, seek to solve it. A rules-based approach, on the other hand, has regulators which, when faced with a problem, seek to punish it. I definitely get the impression that the SEC often doesn't think it's solved a problem unless there's a settlement involved. A move away from that attitude and towards something more constructive would certainly start helping mitigate fear of the US regulatory system.

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