MF Global Reignites Debate on Regulation

In reaction to the meltdown of MF Global, Jeff Carter questions whether the Sarbanes Oxley and Dodd-Frank laws should have prevented the kind of accounting gimmicks that allowed the true health of the firm to go undetected. Carter argues that because accounting decisions are almost always to some degree subjective, fraud can never be eliminated from the system regardless of how stringent regulation is.

For instance, The Wall Street Journal is reporting that MF Global engaged in extensive "window dressing" of their financial statements. This is a practice whereby firms undertake financial transactions specifically to alter the picture presented to shareholders and regulators through its financial statements. In MF Global's case, the firm temporarily lowered its debt loads, and then re-levered after filing. This sort of behavior isn't illegal, and if it were made illegal, it'd be impossible to really prove in a court of law.

Carter concludes:

The best antidote to fraud is transparency, and the market destroying the company once the fraud is found out. The only way to be anticipatory is to set up transparent market structures that force companies to shed sunlight on their activities. The market is the greatest truth detector there is.

I couldn't agree more. But then again investors like Carter and Journalists like me are plain suckers for transparency. We thrive on information. Managers of companies don't necessarily want to show their hands all the time. There are increased costs for a company to report information to regulators, and shareholders can be harmed if a disclosure gives away some kind of competitive advantage.

Of course there is a limit to how much transparency can be practically added to the system. For obvious reasons, there must be restrictions to what the government can legitimately claim to need to know about a company or individual. Such concerns have recently been raised by Republicans about the Office of Financial Research. A bigger concern for advocates of transparency should be that at a certain point, more companies will simply eschew going public if the burdens of disclosure get too onerous. That will do nothing to promote financial stability or economic growth.

The problem with sussing all these issues out is that commercial lobbying groups tend to protest any new regulations. This makes it difficult for fair minded citizens, who believe in finding the right balance of regulations, to make an informed decision. Many on the left reflexively dismiss concerns raised by lobbying groups because of a kind of "boy who cries wolf" dynamic.