Regulatory Path Dependency in Securities Regulation: Evidence from Israel and U.S.

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Various forces may undermine efficient regulation. This essay concentrates on two such forces: regulatory inertia and regulatory vulnerability to undue external influences. Regulatory inertia is best described as the tendency of regulators to adhere to their original proposed rules and to resist change, even when that change may make rules more effective. Undue external influences consist of the power and leverage that narrow interest groups often exert on regulators in order to ensure favorable regulation, often at the expense of the public welfare. This essay examines the effects of these two forces on the Israel Securities Authority (ISA) rulemaking process during the years 2003-2010, and explores whether this process was flexible and open to changes and whether it was significantly influenced by small interest groups. The ISA process provides us with a unique opportunity to examine both forces. Since the ISA has limited rulemaking power, its rules must pass through three stages that together last almost two years. At stage 1, a rule is valid for one year but can be extended for an additional year if the ISA considers its extension essential and with the consent of Minister of Finance (stage II). Within two years of passage, the ISA can request that the Minister of Finance and the Knesset (Israeli parliament) Finance Committee anchor the rule into secondary legislation (stage III). If the rule is not anchored into secondary legislation it expires. At each of these stages the rules are published for public review. Next, the article examines the rulemaking process of the American Securities and Exchange Commission (SEC), focusing on rules enacted between the years of 2006-2009. Unlike the ISA, the SEC has very broad rulemaking authority. Unlike the ISA, rules promulgated by the SEC may last indefinitely, and do not need the specific support of secondary legislation. Rather, all SEC rulemaking is authorized by the SEC’s enacting legislation, as long as the agency can demonstrate that its rules are within the scope of its legislative mandate. The SEC, like all American administrative rulemaking entities, engages in “notice and comment rulemaking.” The SEC publishes a notice of its proposed rules, and solicits comments from the general public. The SEC must then consider all of the comments it receives before promulgating the final version of its proposed rules (although the rules need not actually incorporate all, or even any, of the public comments that the SEC receives).The Article shows that the structure of the ISA rulemaking process causes its final rules to exhibit a high level of regulatory inertia and immunity from external influence. A substantial majority of ISA rules passed through all three stages without material changes, suggesting that regulators resist change throughout the rulemaking process. This conclusion is sustained by a review of (1) ISA plenum (board) protocols, which reflect stages 1-3 plenum discussions; (2) Knesset Finance Committee protocols, which reflect the Committee discussions at stage III, and (3) SEC rulemaking in the years 2006-2009. The essay explains the aforementioned conclusion by reference to ISA institutional features, with an emphasis on the lack of transparency inherent in ISA rulemaking;; the lack of legislative, executive, or judicial supervision over the ISA rulemaking process; and the general lack of participatory and supervisory mechanisms within ISA internal structure itself. In contrast, the structure of SEC rulemaking promotes flexibility and revision, fighting against regulatory inertia. The SEC’s process is exceptionally transparent, and its promulgated rules are frequently challenged in court under the Administrative Procedure Act (APA). For better or for worse, the SEC is much less affected by regulatory inertia, which also suggests that it is vulnerable to undue external influence from small special interest groups.