- The Washington Times - Tuesday, June 26, 2001

Rep. Michael G. Oxley, Ohio Republican, has been trying to get the Securities and Exchange Commission to follow the law ever since the National Securities Market Improvement Act (NSMIA) was passed in 1996. Now that he is House Financial Services Committee chairman, he and subcommittee Chairman Sue W. Kelly, New York Republican, will hold an oversight hearing today to uncover the reason for the lawlessness.

In April 2000, Mr. Oxley wrote to Arthur Levitt, then the Securities and Exchange Commission chairman, asking if he had followed the 1996 legal requirement to "also consider, in addition to the protection of investors, whether action will promote efficiency, competition and capital formation." After receiving the Levitt and SEC staff response in a May 24, 2000, letter, Mr. Oxley concluded that current SEC practice "does not meet that standard." Reading the SEC response, one is forced to agree. This SEC disregard for the law continues to this day, provoking the hearing.

There is nothing more important to the economic prosperity of the United States than capital formation. It is the engine that feeds the creation of jobs, supplies earners with additional income, and accumulates savings for retirement. Yet, the government agency most responsible for overseeing the capital markets does not take the economic effects of its rule-making on capital formation into account when it exercises its powers of regulation. This is a public scandal.

The most serious example of this mode of thinking occurred in 1999 when the SEC effectively eliminated its most important capital-generating initiative by eliminating public offerings from coverage under so-called Rule 504. This little-heralded rule was passed by the Reagan SEC on April 15, 1982, and empowered small business to raise up to $500,000 (later raised to $1 million) of essential capital with limited bureaucratic red tape. This one rule may have had as much to do with the nearly two-decade boom starting in the early 1980s as any of the more well-known contributing factors. Yet in 1999, the SEC eliminated this source of capital for public companies and, with the NASDAQ Over the Counter Bulletin Board, required them to report to the very bureaucratic SEC rather than the states (which approved stock offerings within a few weeks rather than months).

The result of these changes was that efficient, low cost, public Rule 504 capital offerings were denied to all companies and 2,982 companies were thrown off the OTCBB into the more turbulent "pink sheet" market, or worse, into bankruptcy. This pink sheet market is the same one that during the penny stock scandal was reputed to have a fraud rate of 20 percent.

This rash action was taken even as the SEC acknowledged that the original "scope of the abuse is small." In other words, in the name of fraud protection, the remedy was to throw the overwhelming number of companies that were not engaging in fraud into a less regulated market where they were more subject to fraud. It is understandable that the private OTCBB would desire to have its own market as free from abuse as possible and to wantonly cast out the good (but poorly capitalized) companies with the bad. The supposed rationale for the very existence of the SEC, however, is to look at the larger public good.

The result was disastrous. With all stock markets pushing up through March 1999, the SEC's ruling denying use of Rule 504 to small companies took effect on April 7, 1999. From that date until the OTC eligibility period ended, there was great instability in the small cap market for those companies awaiting SEC and OTC action. After the OTC action was finalized on June 28, 2000, the NASDAQ small-cap market dropped like a rock to the bottom, while stocks generally continued to boom. Small-cap stocks have not recovered to this day.

Given the cavalier manner in which the SEC's cost-benefit analysis was performed, it is not unreasonable to conclude that the SEC, in fact, ignored the NSMIA requirements. It is hard to fathom that the final change for Rule 504 was published two days after the chairman of the predecessor committee reminded the SEC that it should consider the NSMIA changes in any rules it adopted, and that oversight hearings would be held "to ensure that final rules are consistent" with it. It is almost contempt for Congress.

Let the hearings begin. Reps. Obey and Kelly must now make the SEC follow the law and assure that this destructive economic dislocation never is caused by the government again.

Donald Devine, former director of the U.S. Office of Personnel Management, is a columnist and Washington-based policy consultant.

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