Responding to John H. Walsh, Institution-Based Financial Regulation: A Third Paradigm, 49 Harv. Int’l L.J. 381 (2008)*
As the global economic recession deepens, the structure of financial institutions and the legal principles that they apply are of primary concern to investors. One aspect of the legal debate has focused on whether financial market regulation should be based on principles or rules. Generally, principles-based regulation refers to a broad set of standards that gesture in the direction of certain desired outcomes. These standards may be accompanied by guidelines about how to achieve the outcomes. By contrast, rules-based regulation is, as the name implies, based on a set of detailed rules that govern firms’ behavior. Such rules enable firms to “tick-the-box” to guarantee compliance with law.
Another possibility—institution-based financial regulation—has recently been proposed by John Walsh as an alternative to rules and principles. This approach appears to have two parts. First, the approach refers to offices that firms are legally mandated to establish. For example, the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) require firms to establish certain offices and structures (the “institutions” to which Walsh refers) such as the Chief Compliance Officer, compliance policies and procedures, and annual self-assessments. Second, these firms will by necessity have firm-specific modus operandi or ways of functioning. The institutional approach provides them with flexibility in terms of how the required structures evolve and operate within the organization.
In this comment, I challenge the idea that institution-based financial regulation is a third paradigm within the principles-rules debate. Firms by nature utilize their discretion with regards to the way in which either principles or rules are implemented. Under principles-based regimes in particular, firms develop their own mechanisms to
comply with the overarching legal regime within which they operate. They seek to adhere to the outcome advocated under the stated principles by utilizing policies and practices that they craft themselves. Thus, institution-based regulation appears to be simply another iteration of principles-based regulation rather than a “third paradigm.”
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* This excerpt does not include citations. To read the entire article, including supporting notes, please download the PDF.
