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Holding Back The Flood



Written by April Johnston
Illustrated by Lindsey Estep

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Late last fall, Aurora Cannabis released its first earnings report since debuting on the New York Stock Exchange in October 2018. The numbers were spectacular. Buoyed by the legalization of recreational marijuana in Canada, the company reported a 260-percent jump in revenue and a 32-percent increase in net income. And then, its stock price plummeted.

For the uninitiated, it defied logic. Why would the stock price of a company that just exceeded earning expectations fall?

But West Virginia University Associate Professor of Public Administration Karen Kunz and Professor of Law Jena Martin were not surprised — at all. Kunz spent more than 25 years working in the financial markets industry and Martin was once employed by the Securities and Exchange Commission’s Department of Enforcement, so they’re intimately familiar with the way the financial world works.

For Martin and Kunz, the Aurora debacle was not an anomalous blip in the system; it was an indication of how the system is broken. They believe that the market has outgrown the very laws that are meant to regulate it, and if lawmakers don’t make changes now, the country could be headed for an unprecedented financial disaster.

Wall Street graphic

“I try not to think about it too much,” Martin said, “because when I do, I get terrified.”

In 2017, Martin put that terror aside to team up with Kunz on a book titled “When the Levees Break: Re- visioning Regulation of the Securities Markets.” The pair use a combined 35 years of experience and a volume of fresh research to suggest ways of overhauling — and improving — the system.

Described as having “vivid imagery and plain language,” the book envisions a host of innovative ways to avoid another economy-breaking recession, but none so frank as the first:

“If we had our way, the whole system of financial regulation would be burned to the ground and replaced with something entirely different.”


To understand how the securities market arrived at this juncture and why Kunz and Martin are advocating for a complete overhaul of the system, you have to go back to Oct. 29, 1929, the day of the stock market crash that helped to usher in the Great Depression. That crash led to the passing of two pieces of legislation, designed to protect investors and avoid another economic catastrophe.

The Securities Act of 1933 and the Securities Exchange Act of 1934 required companies to submit quarterly and annual reports to investors and established the Securities and Exchange Commission to oversee the process.

At the time, these kinds of disclosures, which protected individuals in the market, made sense.

“The idea was that good little boy and girl investors would read [the reports] and decide to invest based on that,” Martin said. “The problem is that nobody trades like that anymore.”

Jena Martin and Karen Kunz graphic

Jena Martin and Karen Kunz, authors, “When the Levees Break: Re-visioning Regulation of the Securities Markets.”

These days, 70 percent of the securities market is traded by institutional investors using complicated algorithms to predict the best trading strategies. In other words, computers are making decisions based on any number of predetermined factors. When those factors — economic, political or otherwise — fall into place, a sale is triggered.

So it didn’t matter that Aurora Cannabis’ performance exceeded expectations. It mattered that it didn’t perform the way the algorithms predicted it would.

“It’s day trading on steroids,” Kunz said. “They’re buying and selling based on what the algorithms tell them, which has nothing to do with disclosures.”

Despite the technological evolution of the securities market, these old-school disclosures have remained the primary regulatory device by which the government holds the securities market accountable. In fact, in the decades since the securities acts were passed, when a financial crisis has occurred, lawmakers have largely responded by requiring more disclosures and establishing more regulatory agencies.

“People tend to underestimate danger. We downplay its significance because we don’t want to think about it.” — Jena Martin, professor of law

unz says the upshot is regulatory overlap and the generation of a lot of paperwork that almost no one is reading and that has zero bearing on the algorithms that rule the market.

In addition, Kunz believes the regulations may actually be adding to the problem. Each time a quarterly earnings report arrives, it creates volatility in the market. And the more volatility, the more likely the algorithms are to trigger sales.

More sales result in even more volatility, sending the securities market into a tailspin from which there may be no recovery.

At that point, Martin and Kunz write “it’s not ‘too big to fail,’ it’s ‘too big to save.’”


So what’s the answer? Every financial expert and politician seems to have a preferred strategy for addressing the issue, but perhaps no one has suggested anything as drastic as Kunz and Martin when they advise to “burn it down.”

They know the proposition is shocking, and some of the ideas put forth in the book are a bit avant-garde, but, well, that’s the point.

“We need to think radically, so we can just start thinking,” Martin said. “When we wait until a crisis happens, it’s almost always too late, and even if it’s not too late, it’s still a reaction.”

Burning it down, for Kunz and Martin, actually begins with a fairly straightforward recommendation: embrace the technology. (Or, as some of Martin’s friends who have read the book call it, “embrace the crazy.”)

At this point, technology is so entrenched in the financial system that attempting to reverse course is a non-starter. So, instead of trying to make the technology fit the existing regulations, Kunz and Martin want to see the regulations fit the current technology, creating a system with more stability and accountability.

“That means switching from an investor paradigm to a consumer paradigm and treating stock like a product,” Kunz said.

“If we had our way, the whole system of financial regulation would be burned to the ground and replaced with some thing entirely different.” — Karen Kunz and Jena Martin 

For example, before an appliance company can put a toaster on a shelf, it must meet a host of regulations. Not so with securities, as evidenced by the mortgage-backed securities that brought about the 2008 crisis. Kunz and Martin want to see that change, with regulations imposed on the products themselves, including a financial “Lemon Law” that would protect consumers from bad financial products.

Their product regulations would accompany a rigorous examination for companies that wish to go public, and a requirement that the company prove it can make money before the initial public offering. That would be a significant shift in the status quo, where companies can go public despite operating losses. Amazon and Twitter both did it.

But once companies have earned approval to go public, they would be rewarded with fewer disclosures and financial reports. And fewer reports, Kunz and Martin hope, would equal less volatility in the market.

But perhaps their most out-of-the-box idea is to hand the derivatives market — including futures and options — over to the Gaming Commission because, the pair says, that market is essentially educated gambling.

Want to buy orange juice futures? “What you’re basically doing is betting on the weather in Florida,” Kunz says. “There’s no underlying asset there.”

Of course, all of these ideas mean nothing if Kunz and Martin can’t get the public engaged and the policymakers involved. And that might just be the most difficult part of their journey.

“I don’t know that, outside of a seismic shift in circumstances, people will pay attention,” Martin said. “People tend to underestimate danger. We downplay its significance because we don’t want to think about it. I do it, too.”

Since their book was released in late 2017, Martin and Kunz have written several articles about their ideas for national publications, appeared on public radio and gifted copies to lawmakers, including U.S. Sen. Elizabeth Warren and the House of Representatives’ Ways and Means Committee. Their hope is that their ideas — with more upfront regulation, but less regulatory overlap — will have broad, bipartisan appeal.

They’re hoping to make another concerted media push in the coming months. And they aren’t the only ones sounding the alarm. Former Federal Reserve Chair Ben Bernanke and former Treasury Secretaries Tim Geithner and Henry Paulson recently appeared together at a roundtable discussion, warning that systemic changes are needed if the nation wants to avoid or recover from another financial crisis like the 2008 recession.

But until those changes come, Kunz and Martin are taking some precautions — both have cash on hand — and are open about the challenges with those who ask. It boils down to this: Get engaged and be a prudent investor.

“You need to pay attention to what you have invested and where,” Kunz said.