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Brooklyn Law School




The subject of investor confidence in the securities markets has received wide attention recently as details of fraud and avarice continue to emerge. Investors' trust in the securities markets is important for the reasons discussed in Professor Stout's marvelous paper.1 This Comment focuses on the relationship between investors' trust and government regulation of the markets. By regulation I mean congressional legislation and actions by federal agencies. I exclude the courts mainly because their lawmaking is not primarily policy-based, and my aim is to sound the alarm for legislative and regulatory policy-directed actions. Many an economist and academic have argued that regulation is costly for issuers and financial intermediaries.2 Regulation, they say, is a barrier to capital formation, that is, to inducing savers to part with their money and invest in securities.3 I assume that they are correct. Regulation does impose these costs, and the costs can be a barrier to raising capital for issuers.

But here is a puzzle. When market prices rise, one would assume that regulation can be stricter, because issuers can easily raise capital and bear regulatory costs. Yet, the opposite occurs. This is precisely when government regulation relaxes. When market prices fall, when investors avoid the markets, and issuers find it very difficult to raise capital, one would assume that regulation would be more relaxed to reduce the issuers' costs. Yet, the opposite occurs. This is precisely when government regulation becomes stricter. This is a puzzle.

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