The OIRA Module: Published Research

The Securities and Exchange Commission and other federal agencies are between Scylla and Charybdis—the original rock and a hard place of Greek mythology—when it comes to performing required cost-benefit analyses for the Dodd-Frank Act rules they are in charge of writing.

Conduct too little analysis and the agencies leave themselves open to second-guessing by industry associations and corporate lobby groups, which can then challenge the rules on the basis of inadequate cost reviews and get them stricken from the books. That’s exactly what happened to the proxy access rule that ended up getting tossed aside after the U.S. Chamber of Commerce and others launched a legal challenge. (More on that and other challenges to rulemaking in a moment.)

Conduct too much analysis and federal agencies can head down the rabbit hole of trying to put hard numbers on what are still vague notions of how the rules will actually work in the real world. They can end up spending too much of what little resources they have on getting to the bottom of what it will cost companies to comply. They can also apparently spend months and even years doing it, which is partly to blame for why the Dodd-Frank Act is two-and-a half years old and still more than half the rules remain unwritten.

All of this begs the question: Is anyone doing a cost-benefit analysis on the costs and benefits of this analysis?

Actually, someone is.

Last month the Government Accountability Office issued its report on federal agencies’ efforts to analyze the costs and benefits of their Dodd-Frank Act rulemaking. Its findings are not encouraging. After reviewing regulatory analysis required by various federal statutes, the GAO found that many of the agencies did not follow guidelines set by the Office of Management and Budget. The GAO also determined that on many occasions regulators did not evaluate their chosen approach in comparison to the costs and benefits of alternate approaches.

“Most of the regulations have not been finalized to date, but there are concerns among the industry that the impact of the rules, either individually or collectively could be too great,” says Nikki Clowers, a director in the GAO’s Financial Markets and Community Investment Team, which oversaw the analysis. “There’s been a question about whether the benefits of the rules will outweigh the costs.”

For compliance officers, this is no small point. Federal regulators are famous for underestimating the cost of complying with rules. For example, when the SEC first issued its rules on Section 404 of the Sarbanes-Oxley Act, which require companies to file an audited report on the adequacy of internal control over financial reporting, the SEC estimated that it would cost a total of $1.24 billion for all companies to comply. The real price tag? According to estimates by the Financial Executives Institute, it’s $35 billion and counting.

But there is some good news in the GAO report. While it knocks many federal agencies for not conducting thorough cost-benefit analyses, it does give the SEC and the Commodity Futures Trading Commission credit for more closely following OMB  guidelines.

These agencies haven’t had much choice but to bulk up their cost-benefit analyses, given the legal scrutiny they have faced on such reviews. Last fall, the U.S. Chamber of Commerce and the National Association of Manufacturers asked a federal court to scrap a Dodd-Frank provision known as the Conflict Minerals Rule based on the idea that it will be far more costly than the SEC has suggested and its benefits are debatable. The rule requires companies to investigate and report on the use and source of four metals in the manufacturing process, including tin and gold, to determine if they might comes from the war-torn Congo region of Africa, where the mining of such minerals has funded human-rights abuses.

Compliance officers have complained that the language of the Conflict Minerals Rule is incredibly vague. One chief compliance officer of a global engineering and construction company said it was the most ill-conceived and poorly written regulation he’s ever come across. So how can the SEC conduct water-tight cost-benefit analysis when it’s not entirely clear what the full extent of the rules are? Hard to imagine they can, but it’s a matter for the courts to decide now.

How the lawsuit plays out will have a big effect on the rulemaking process by federal regulators of all stripes, and especially on the cost-benefit analysis that goes into the calculations. If the SEC should lose on the basis of faulty cost-benefit analysis again, you can bet that it will have staffers working overtime to get the analysis right. There are already signs that such deep number-crunching is already happening—based on the time the SEC is taking to issue Dodd-Frank rules these days.

The bigger benefit, however, is that the Commission and other federal agencies may be forced to write clearer, more exact rules so that they can put harder numbers around them. And that would be a welcome development for any compliance officer.