On Sept. 15, SEC Chairman Mary Schapiro testified before Congress and noted that, over the past two decades, “the markets, products, and participants… have undergone a truly sweeping transformation” and that the SEC must carefully examine how it operates to ensure its “effectiveness.”
Nowhere is there a greater need to examine effectiveness than with mandatory disclosure. SEC Commissioner Troy Paredes wrote in 2003 (then as an Associate Professor of Law) about mandatory disclosure and whether market participants are subject to information overload. Saying mandatory disclosure may be “the most hotly contested debate in the history of securities regulation,” Paredes concluded that to the extent market participants are “subject to information overload, the model of mandatory disclosure that says more is better than less may be counterproductive.”
Paredes reasoned, in part, that psychological literature suggests consumers overloaded with information make worse decisions when provided more information. He also underscores that a premise of a “regulatory regime based on disclosure”: the users of the information “need to use the disclosed information effectively.”
Yale Management Professor Daylian Cain recently offered a sobering view of what academic research reveals regarding conflicts and disclosure. “Conflicts of interest are a cancer on objectivity. Even well-meaning advisors often cannot overcome a conflict and give objective advice. More worrisome, perhaps, investors usually do not sufficiently heed even the briefest, bluntest and clearest disclosure warnings of conflicts of interest.”
Professor Cain’s remarks came during a panel discussion “Crafting Effective Disclosure – is it Possible?” at the Fiduciary Forum 2011 on Sept. 9. The event, co-sponsored by The Institute for the Fiduciary Standard, The Heartland Institute and TD Ameritrade Institutional was held just as the SEC, in accordance with Dodd-Frank, and the Department of Labor engage in rule-making on the fiduciary standard.
Cain was joined on the panel by Arthur Laby, Professor of Law Rutgers-Camden School of Law; Ira Hammerman, general counsel at SIFMA; and David Bellaire, general counsel for the Financial Services Institute.
The Institute for the Fiduciary Standard also released a paper by University of Texas Professor Robert Prentice, “Moral Equilibrium: Stock Brokers and the Limits of Disclosure,” to be published early next year. Prentice reviews the existing research on disclosure, behavioral psychology, and “new developments in the field of behavioral ethics” and concludes disclosure is inadequate.
Lobbyists for the brokerage industry, Hammerman and Bellaire, both pointed out that securities regulation has been based on disclosure since the 1930s. Bellaire also suggested that there is effectively no other option besides disclosure.
Professor Laby disagreed and commented that, in fact, there are alternative options to addressing conflicts of interest and that even the disclosure option comes in various shapes and sizes.
“The SEC has many options at its disposal. Some conflict-of-interest transactions are permitted with minimal disclosure, others are permitted with disclosure and informed consent, while in rare instances certain transactions are banned outright. The SEC could consider a graduated approach, pegging the strength of disclosure and consent to the magnitude of the conflict,” Laby noted.
The independent academic research speaks clearly how disclosure generally does not work for investors. There is no real debate that disclosure often fails to overcome conflicted advice.
Smart regulation adapts to changing circumstances, markets and investors. The “truly sweeping transformation” over the past two decades that SEC Chairman Schapiro referenced last week is important, but also pales against the far larger changes since the 1930s when mandatory disclosure was instituted in securities laws. A disclosure-based regime may well have been deemed effective in 1930 when just 1.2% of the population–the wealthier segment of the population–owned stocks. That was then.
Today, 80 years later, 50% of the population is invested in the capital markets, and individual’s depend hugely on their retirement accounts. Smart regulation is more crucial than ever. As both the SEC and DOL examine what it means for a plan sponsor, advisor or broker to exercise fiduciary duties, it is time to rethink the role of disclosure in fiduciary relationships in securities regulation to ensure that investors’ interests always do come first.