How might a financial regulator, such as the SEC, engage in an empirically informed rulemaking? This question has been an interest of mine since my days of working at the SEC. For example, how exactly would empirically informed rulemaking work in a setting where a regulatory agency seeks to adopt a rule of first impression—a rule for which the agency (as well as the industry) lacks data to support its position?
There are a few possible approaches. One approach is for the agency to reason by way of analogy: the agency can try to argue that its new rule will operate in a similar manner as another known regulation that has been tried and tested. If the agency is lucky, it may even be able to cite an empirical study that documents the effectiveness of this other regulation. Imperfect as it is, even this option is not always available. The fact is that there isn’t always a similar rule out there for each new proposed rule. Another approach is for the agency to rely on a trial regulation: the agency can adopt a version of the rule on an experimental basis, assess the rule’s effectiveness and efficiency after some time, and then adopt a final version of the rule informed by the industry’s compliance experience. This would be considered an ex post approach—in the sense that the agency would gather compliance data from the industry after the rule has been in effect for some time. While promising, this approach has two limitations. First, reliable compliance data may not become available for a long time. Second, it is difficult to use this approach for decisionmaking purposes when the rule’s effects are irreversible.