Regulators, confident in their own virtue and ability, have typically seen little need to have anyone check their work. As a result, regulatory requirements are flowing out of agencies such as the Commodity Futures Trading Commission without the required public, judicial, and legislative oversight.
As the government has expanded, Congress increasingly has regulated by delegation, leaving major policy decisions to regulatory agencies charged with implementing broad statutory mandates.
Force of Law
The 800-page Dodd–Frank Wall Street Reform and Consumer Protection Act is a prime example. The law charges financial regulators with bringing the statute to life through its hundreds of attendant rules. These rules, many of which each span hundreds of pages, carry the force of law. Requirements they impose are just as mandatory as those directly imposed by the statute.
The transparent nature of the rulemaking process enables Congress to keep a close eye on the agencies as they adopt and implement rules. Once a rule is final, affected parties can sue the promulgating agency for acting arbitrarily, violating procedural requirements, or regulating beyond their statutory authority.
The regulatory process, and any subsequent judicial review, is time-consuming and expensive for agencies and regulated entities. However, the rules that emerge are likely to achieve the desired objective at a lower cost than rules produced outside of such a process.
Iron Fist in Velvet Glove
Aiding agencies in this effort is a natural inclination by regulated companies to follow agency directives, regardless of the form they take. A company anticipating being under a regulator’s watch for decades to come will heed that regulator’s commands, even if they are informal.
Regulators can make life miserable for a company bucking such informal diktats. Agencies can punish noncompliant companies by withholding approval for new products or mergers and by dragging out compliance audits.
Agencies have approached backdoor rulemaking with great creativity. De facto requirements find their way into guidance documents detailing “best practices.” They show up in enforcement settlements as “undertakings,” setting a code of conduct for the entire industry.
The financial regulators in the Dodd-Frank era have made liberal use of backdoor rulemaking, and the poster child for this activity is the Commodity Futures Trading Commission (CFTC), whose jurisdiction ballooned with its Dodd-Frank derivatives mandate.
Refusing to let its limited experience and knowledge in its new field of influence slow it down, CFTC has promulgated rules quickly and carelessly. The resulting extensive new rule-set did not take adequate account of market realities, threatening the market’s ability to serve its customers.
Instead of redoing rules through the cumbersome rulemaking process, the CFTC has embarked on a backdoor rulemaking binge, cobbling together a confusing and sometimes conflicting mass of fixes.
CFTC has used a number of backdoor rulemaking methods. For example, to apply its new derivatives rules internationally, CFTC issued an 80-page guidance document, with precise definitions and compliance nuances buried in footnotes.
CFTC’s preferred backdoor rulemaking method is staff letters. Because of the process through which these letters are written, they are drafted without the benefit of input from the CFTC’s five politically appointed commissioners, the only agency employees with the authority to make policy. Instead, these letters are negotiated in the “backroom,” between the agency and whichever firm or industry organization chosen by the staff as a negotiating partner.
According to CFTC’s own regulations, these letters are not supposed to apply to anyone other than the firm requesting the relief, but the agency has used these letters to impose industry-wide changes. The letters tell firms whether, when, and how they must act. They rewrite regulatory obligations adopted through the rulemaking process.
Although some of these letters provide useful interpretive guidance or routine, targeted relief to individual firms, many are characterized by rule-like general applicability and precise compliance requirements.
Agencies unconcerned with following the law themselves are not credible regulators. By making rules hidden from the public eye and statutory accountability mechanisms, CFTC and other regulators are overstepping their legal boundaries.
Hester Peirce ([email protected]) is a senior research fellow at the Mercatus Center at George Mason University and program director for the Financial Markets Working Group.
“Regulating through the Back Door at the Commodity Futures Trading Commission,” Hester Peirce, Mercatus Center: http://heartland.org/policy-documents/regulating-through-back-door-commodity-futures-trading-commission