One of the most important developments in the capital markets over the past decade presents a puzzle that needs to be solved. The development is the dramatic expansion of the unregulated market for private securities in the United States. The puzzle is that public choice theory, the dominant theory for explaining SEC behavior, fails to account for it. After all, the traditional public choice account predicts that the SEC will grow its regulatory turf, not erode it. In this Article, I develop a theory that solves this puzzle. The argument is that the traditional public choice account overlooks an important class of cases where regulators have incentives to expand the unregulated portion of their industry. With respect to the SEC, I argue that by growing the private securities market actors at the SEC maximize support for their current and future careers in the face of uncertainty over how to reinvigorate a dysfunctional public market.
The theory developed in this Article has important implications for securities regulation and beyond. With respect to securities regulation, it suggests that any attempts to minimize the potentially high social costs of an expanding private securities market will need to take into account the effect of underlying political forces. To this end, I sketch the outline of a novel approach for dealing with an expanding private securities market, the centerpiece of which is an entity (independent from the executive branch and accountable to Congress) whose goal is to focus greater public scrutiny on the SEC for the purpose of counteracting the political forces underlying the growth of that market. This theory also has important implications for the literature on regulatory arbitrage and optimal policy-making more generally. In particular, it suggests that the conclusions drawn in this literature are misleading to the extent that they downplay or ignore the possibility that political forces may favor regulatory arbitrage and that these same political forces may cause regulators and lawmakers to avoid uncertainty in policymaking altogether, just as the SEC has sought to avoid the uncertainty associated with reform of the public securities market.