Conclusion: Efficient Investing in Inefficient Markets
Do the current regulatory regimes actually protect investors?
Securities regulators in United States, Canada and Europe have all more or less accepted the efficient market hypothesis (EMH) in forming regulations for full, plain and true disclosure by reporting issuers. The foundation of these laws is the belief that the market’s price discovery mechanism will manifest all known information in the public domain in the trading price of securities and the market can only be an effective mechanism for capital allocation if the investing public is armed with full disclosure of all material facts that could affect the price or value of the securities traded in public markets.
One might think that “price” and “value” would be synomymous and the distinction irrelevant if the EMH held true. Eugene Fama, the Nobel laureate most often associated with the EMH, hasn’t published anything that I have seen that would be of assistance in distinguishing price from value, since his work substantially concludes that price=value. Canadian securities commissions and the Securities and Exchange Commission tacitly admit that price and value may differ and think that investors deserve full disclosure of any information that could affect either. It can’t be both.
Insider trading prohibitions are founded on the view that there may be information not in the public domain that would benefit persons possessed of the information and the public needs protection from those who would use “inside information” to gain an advantage in purchasing or selling securities. At the same time, issuers have a binding obligation to disclose any material information that could affect the price or value of the issuer’s securities. Presumably, if an issuer through the agency of its “insiders” (officers, directors, consultants, lawyers, accountants, etc.) has knowledge of material fact that could affect the price or value of its securities the issuer is burdened with an obligation to make timely disclosure of that information. How is it that an “insider” can have an information advantage if the issuer has the obligation to disclose any information that might create such an advantage? I would think the circumstances where an “insider” in fact had knowledge of such a material fact and the corporation had not met its obligation to disclose that information would be quite limited and when it did occur, both the “insider” and the issuer would both have culpability.
The primary motive of the regulator in takeover laws is the protection of the shareholders of the target company, mandating substantial disclosure by the bidding company and limiting their purchases of securities of the target company in various ways. I have often wondered why public shareholders of the target companies are a protected species and public shareholders of bidding companies are exposed to a regulatory regime designed to extract the best price possible for the target company shareholders obviously at the expense of the public shareholders of the bidder. If there were information that made the target company more valuable than the market price its board and management are required to disclose that information. The “premium” being offered by acquirers does not reflect “hidden values” [how could there be hidden values if the target board is meeting its disclosure obligations] but typically reflects “synergies” only available if the bid succeeds and to which the target company shareholders contribute nothing. This nonsensical approach to regulation creates a cottage industry for consultants, accountants, advisors, valuators, and law firms all of which are paid for by investors and come at the expense of the returns they sought for putting money at risk in public markets.
Regulators jobs depend not only on enforcing existing securities laws but also on creating new “regulations” that have the force of law to expand the scope of their activities and protect against a reduction in force if their organizations become too successful in policing malfeasance by issuers, intermediaries or members of the public. These forays into subjective regulation seem to have no bounds. ESG, climate change mandated disclosure, rulings based on the “public interest” [an undefined term giving regulators broad freedom to punish investors or issues whose conduct they disagree with] and significant scope to punish “offenders” with large fines and bars from acting as an officer, director or promoter of any company, or in the case of intermediaries the loss of a license. This unbridled power does not make markets more efficient, it just makes regulatory jobs more secure.
While securities markets are highly regulated, the markets for “cryptocurrencies” [which are neither securities nor currencies, but a wild west of worthless “tokens”] which have deluded many people into parting with actual money for to buy into some of the 19,000 “tokens” that it seems every tech savvy teenager can create and market. The “crypto” fad has cost investors billions and will eventually end in tears, but not before a number of fast-moving fast-talking “entrepreneurs” take advantage of the regulatory void to bilk investors with their plethora of “coins” “stablecoins” “tokens” and so on. None of these create anything nor have any actual assets backing them, and in my opinion will cause even more damage to securities markets and investors too eager to jump on the latest fad and too lazy to make an effort to understand why they will lose their shirts. Smart money avoids the space in its entirety - leave it to Cathie Wood who collects millions of fees to transfer wealth from the gullible to her and her ilk.
Regulation of securities markets is and was needed to make ordinary members of the public willing to provide capital to companies with opportunities to expand and help build our economy. But, that regulation should have stopped with the minimum necessary to meet its legitiimate objectives. Instead, unelected members of security regulation organizations heap rules on rules at great cost to the investors they were put in place to protect.
The failures of FTX, Silicon Valley Bank and Signature Bank are regulatory failures coupled with dishonest or incompetent management. More failures are likely - the “hold to maturity” portfolios of U.S. banks in aggregate have “mark to market” losses equal to about three quarters of the equity capital of the banking system and higher rates seem more likely than lower ones, so that valuation gap is more likely to grow than diminish. Despite major regulatory reform following the Global Financial Crisis and the enactment of Dodd-Frank and Sarbanes-Oxley, the financial system of Western democracies has major weaknesses and those weaknesses are manifestations of regulatory failure.
Western leaders are doubling down on stupidity - exacerbating the risks and exposing their citizens to calamitous economic outcomes by increasingly use debt to finance “programs”, increasing their “climate change” rhetoric, and doing nothing to ease the global shortage of fossil fuels. Instead their narrative today is more about diversity, equity and inclusion and ESG with a certainty that investors will suffer lower returns as a result as regulatory failures continue. On the bright side, we can be confident our leaders will use their preferred pronouns.