This article is part of TPM Cafe, TPM’s home for opinion and news analysis. It first appeared at The Conversation.

In two major rulings this past month, the U.S. Supreme Court curtailed the authority of federal agencies to draft and enforce policies that affect the nation’s financial health. One important agency, the Securities and Exchange Commission, took a particularly big hit.

Speaking as someone who has researched financial shenanigans for almost 50 years, I’m concerned that these rulings will backfire on markets and investors.

Taken together, they could lead to watered-down regulations, weakened enforcement and less oversight of the nation’s financial markets and public companies. I fear that they could ultimately be a significant factor in a future market crash.

In one case, Securities and Exchange Commission v. Jarkesy, the court rebuked the SEC — the agency that protects investors from fraud — for using in-house proceedings to discipline firms and others for breaking securities laws. Now, the SEC will need to bring accused securities fraudsters to federal court, which could be more complicated and expensive.

And in the other case, Loper Bright Enterprises v. Raimondo, the court cut back sharply on a long-standing doctrine — the Chevron rule — that gave agencies considerable freedom to craft rules and regulations, particularly when the underlying law might be ambiguous. As a result, federal agencies, including the SEC, have less power to act, ceding that power to lengthier and costlier trial proceedings.

More layers of hidden risk for investors

Both decisions could affect the nation’s financial well-being. Investors who rely on the disclosure rules and the enforcement mechanisms of the SEC for protection – now subject to legal challenge — are about to be saddled with an extra layer of hidden risk not seen in decades — in particular, more questionable accounting practices in their regulatory filings.

Recall that in 1933 and 1934, Congress established the SEC in the aftermath of the Great Depression. What followed in the ensuing years was the formation of less risky and more informed markets.

Investors could also rely on market prices to efficiently and unbiasedly reflect all public information, rather than have to pore over complex financial statements. This led to the U.S. markets becoming the most attractive destination in the world for funds to invest in risky business projects.

The SEC later bolstered financial markets with measures under the Dodd-Frank Act of 2010 to rectify other excesses — such as overly generous credit ratings — that arguably contributed to the 2007–2008 Great Recession. Today, thanks to extensive disclosure requirements and relatively efficient enforcement mechanisms, the U.S. has perhaps the healthiest and most robust financial markets ever.

A new challenge to enforcement

Healthy and robust financial markets don’t operate out of altruism, however.

Monitoring and enforcement mechanisms are pivotal. While the SEC relies partly on the private sector to spot and discipline errant managers for violations of the securities laws – for example, through federal and state securities class action litigation – much of the effort relies on the enforcement division of the SEC.

In particular, the SEC uses “accounting and auditing enforcement releases,” or AAERs, to ensure that firms keep a clean set of books. Since 1995, the SEC has issued 3,266 AAERs, mostly to correct accounting and auditing deficiencies in company financial statements. Numerous studies confirm AAERs as evidence of financial fraud.

AAERs are also a highly efficient form of enforcement — and much less costly than a private securities class action lawsuit. Companies generally agree to settle the allegations of wrongdoing without admission of liability by taking timely steps to improve accounting and auditing and paying fines and penalties.

The payments have been substantial. For example, for 760 enforcement actions in 2022, companies paid as much as US$6.4 billion to the SEC. The announcement of an AAER action is also costly for the firm’s shareholders, with stock prices falling 50% over the next six months following an AAER announcement, according to researchers.

But the Jarkesy ruling could change everything. I don’t see why any publicly traded company would agree to settle an AAER action with fines and sanctions now that it can challenge the SEC’s arguments in a court of law.

The danger of enforcement by courts

What might be the result of removing or paring back the SEC’s key tool of enforcement?

The risk is possibly reverting to an environment like 1928 or 2007. That’s because the ruling will effectively reduce the cost of accounting or auditing violations for would-be or actual violators. It shifts the purview of deciding penalties and fines to the courts rather than in-house proceedings by the SEC, increasing the cost of enforcement to the SEC.

In short, companies will worry less about a future AAER investigation.

In addition, despite auditors’ efforts to ensure that publicly traded financial and investment firms keep a clean set of books based on generally accepted accounting principles, or GAAP, there is still much room for choice, including greater use of non-GAAP accounting rules. With less enforcement, the Jarkesy ruling will encourage more creative accounting, not less.

That creativity already skews toward optimistic earnings reports. The vast majority of earnings releases now exceed analysts’ forecasts — 77% for the S&P 500 in the first quarter of 2024. Moreover, my own research indicates that it’s not just that earning reports exceed analysts’ forecasts, but the dollar size of firms’ positive earnings surprises has grown steadily over the past decade, which is another hidden risk.

Less scrutiny, more long-term risks

Some securities lawyers say the Jarkesy decision won’t change the SEC’s behavior, since the agency has increasingly shifted proceedings to regular courts.

While that’s true for some actions, I think the largest impact will lie in SEC actions not yet undertaken. Businesses and the SEC will act differently in the future because Jarkesy makes SEC enforcement activity more expensive and more uncertain.

Expect more efforts by firms to present their financial performance in the most glowing terms possible, knowing that the cost of SEC enforcement has just increased and the detection likelihood and expected cost to a firm of violating generally accepted accounting principles or generally accepted auditing standards has just decreased.

While not all scholars agree, there are two major periods in the financial history of the United States when a financial meltdown occurred that was in part plausibly due to shoddy accounting and reporting – the Great Depression of 1929 and the Great Recession of 2007–2009.

In the years or decades ahead, should the country face another serious financial crisis leading to a recession, it will be harder to blame the accountants and investment bankers. Instead, attention may turn to two mid-2024 court decisions and the justices who wrote them.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

This article is part of TPM Cafe, TPM’s home for opinion and news analysis. It first appeared at The Conversation.

If elected to serve a second term, Donald Trump says he supports a plan that would give him the authority to fire as many as 50,000 civil servants and replace them with members of his political party loyal to him. Under this plan, if he eventually deemed those new employees disloyal, he claims he could fire them too.

The United States has tried such a plan before.

As we write in our book “How Government Built America,” newly elected President Andrew Jackson, after he took office in 1828, fired about half the country’s civil servants and replaced them with loyal members of his political party.

The result was not only an utterly incompetent administration, but widespread corruption.

Swearing allegiance

Jackson’s actions that rewarded political loyalists and punished enemies were a dramatic departure from what the founders had envisioned by establishing an independent civil service whose members were literally pledged to uphold the country’s laws.

In passage of its very first law, on June 1, 1789, Congress required newly appointed federal officials to take the oath of office to uphold the laws of the country and faithfully carry out their duties.

Congress also passed conflict-of-interest legislation at that time to prevent employees from making decisions based on personal financial considerations.

While oaths may have less significance today, they were regarded as significant personal commitments in the 18th and 19th centuries. The U.S. Constitution, for example, contains an oath of office for the president, and it specifies that members of Congress and other federal officials “shall be bound by Oath or Affirmation to support this Constitution.”

When President George Washington — and the next five U.S. presidents — hired a new employee, reputations mattered. Each of the presidents looked at how an appointee’s neighbors regarded him and whether he had been elected to local office, an indication that the man — and they were all men — was competent and an honest employee.

That’s not what Jackson, the nation’s seventh president, and his system aimed to do; he wanted loyalists in government jobs.

The spoils system

While the first presidents were concerned with the competence and honesty of civil service employees, Jackson quickly set aside those concerns.

Instead of hiring those who wanted to work for the public interest and the good of the nation, Jackson employed members of his political party who pledged to march in lockstep with him and his policies. This became known as the “spoils system.”

Like Trump, Jackson also had a version of the “deep state” that he opposed. He claimed that the appointment process was aristocratic and blocked the appointment of the ordinary people he represented. He also insisted that experience and competence were unnecessary.

Jackson was quite wrong about some of his political appointments.

One of his worst was Samuel Swartwout, a longtime Army friend and political sycophant. Jackson named him to two consecutive terms as collector of customs at New York, where he served from 1829 through 1837.

Considered a plum assignment, the job at the time was the highest paid in federal government and involved collecting taxes and fees on imported goods that arrived in the nation’s busiest port.

But a congressional investigation showed that Swartwout had stolen a little more than US$1.2 million during his tenure, or about $40 million in today’s dollars.

Swartwout had fled to London, but he returned to the U.S. after he was assured that he would not face criminal charges.

Jackson also learned that his power to influence federal agencies with high-level appointments was limited. Such was the case with the U.S. Postal Service.

As a slaveholder, Jackson was disturbed by the mailing of antislavery flyers in 1835 by the American Anti-Slavery Society. Fearing the flyers would lead to a Black insurrection, Jackson instructed his postmaster general, Amos Kendall, an enslaver himself, to fix their problem by limiting the mailings and asking Congress to prohibit the U.S. Postal Service from mailing all abolitionist material.

Congress refused, citing freedom of speech and expansion of presidential authority as the main reasons.

Long after Jackson had left the White House, Congress, between 1864 and 1883, debated making “merit” a key condition of hiring new employees, but nothing happened until after a disgruntled office seeker assassinated President Chester Garfield.

Congress then passed the Pendleton Act in 1883, which established the merit appointment system still used today. It also put a virtual end to a system that allowed whichever party that won the White House to reward its supporters with tens of thousands of jobs.

A limited exception

Currently, most of the nearly 3 million federal employees are appointed using merit-based hiring that relies on competitive exams. They cannot be fired except for a limited set of reasons, such as poor performance or misconduct.

But the law exempts about 4,000 federal employees whose appointment requires the Senate’s advice and consent and who have been determined by the president to hold a “confidential, policy-determining, policy-making or policy-advocating character.”

The idea is to give a new president the capacity to influence his policymaking by hiring top-level federal officials.

The plan that Trump supported would extend the president’s authority under the previous exemption to hire and fire tens of thousands of civil servants without regard to merit.

In short, he intends to reestablish the spoils system.

This is no idle threat.

Near the end of his administration, then-President Trump signed an executive order establishing a new job classification within the government’s career civil service called Schedule F for “employees in confidential, policy-determining, policy-making or policy-advocating positions.”

Under that designation, employees would lose virtually all of their civil service protections and could be fired without cause. It’s unclear how much effect Trump’s order had on the federal government because it was enacted two weeks before the 2020 election and was in effect for only a few months.

Shortly after taking office, President Joe Biden reversed Trump’s order.

A thankless task

In our view, if political loyalty replaces merit as the basis of key federal appointments, Americans can expect government to be less competent — as Andrew Jackson learned during his administration.

While this might not matter to those who regard government as unimportant to the country — or worse, the enemy of the country — our book “How Government Built America” tells a much different story about the thousands of federal employees who provide everything from health services to protection from natural disasters.

Not every civil servant is a great employee, nor is every employee of private industry.

But there is ample proof that government works because of the many people behind the scenes in Washington and across the country who serve the American people — and uphold their oaths of office.

This article is republished from The Conversation under a Creative Commons license. Read the original article.