The SEC recently held a day-long “Evidence Summit” to mark the start of its new investor research initiative, dubbed “Policy Oriented Stakeholder and Investor Testing for Innovative and Effective Regulation,” or “POSITIER.” The purpose of the summit was to discuss strategies for raising retail investors’ understanding of key investment characteristics such as fees, risks, returns, and conflicts of interest. According to the SEC, POSITIER seeks to inform the rulemaking process with evidence obtained from surveys and specific testing projects. Those speaking at the summit included academics specializing in economics, psychology, law, and marketing, as well as government officials.
Commissioner Kara Stein called POSITIER an exciting initiative and said she looked forward to the public-private partnership under the initiative. She noted that the American investor is an individual, and a “one-size-fits-all” approach will not serve the informational needs of all investors. Stein said that with data and analysis, the SEC can design new tools and methods that make the most of the information provided to investors, be it in the form of data, visualization, or narrative. Technology can also be used to provide “just in time” information and comparison shopping across fund groups, she observed.
Keynote. The summit’s keynote address was delivered by George Loewenstein, a professor of economics and psychology at Carnegie Mellon University. According to Loewenstein, disclosures rarely help much because most are not read, and when they are read, they are not understood. In addition, disclosure usually benefits people who need the least help—the experts. In addition, Loewenstein observed, disclosure can have perverse effects by acting as a substitute for regulatory interventions that are more effective, thereby letting policymakers off the hook.
However, there are ways to improve disclosure, Loewenstein said. Disclosures should be presented in terms people can understand. Products should also be compared rather than being presented one at a time, he advised. In addition, disclosures should be designed by those who will be using the information (or their advocates) rather than those that are providing it. Doing otherwise reveals the “curse of knowledge,” he said, offering as an example health care disclosures that health care professionals may not find complicated, but the average person would.
The effectiveness of simple disclosure depends on the simplicity of the product, according to Lowenstein. Studies have shown that the most important types of regulations that influence effectiveness of disclosure are those that mandate simplification of products. However, describing complex products in simple terms risks sweeping complexities under the table, Loewenstein warned.
Loewenstein advocated the use of modern technology to improve disclosure, moving beyond pencils and paper to computers and tablets. Interactive technologies in particular can have benefits and can enhance the value of interactions with human investment advisers. He also explained that there is a virtual consensus that to be effective, assessments must be “frequent, early, and informative.”
Effective disclosure. One panel discussed how the SEC’s disclosure regime can facilitate disclosure in the most effective manner for a wide variety of users. Rick Larrick, a professor of business administration and Duke University, outlined four core principles of disclosure to provide better information for consumer. The first principle involves doing the calculations for the consumer, such as in a MPG chart or a plan to pay off credit card debt. The second principle is translating the information to personal objectives, such as translating the number of calories consumed to the amount of exercise needed to burn those calories.
The third principle is providing relative comparisons. To illustrate this principle, Larrick gave the example of comparing one’s energy use to one’s neighbors, which can create a sense of competition. The last principle—expanding scales to increase importance—would recommend, for example, disclosures of gallons per 1000 miles compared to gallons per 100 miles.
Ginger Jin of the Federal Trade Commission outlined three types of disclosure: disclosed, hidden, and non-disclosed. Disclosed information includes regulations requiring restaurants to post a letter grade for food hygiene, which research has shown to be effective in catching people’s attention. “Hidden” disclosures include things like ticket transaction fees. According to Jin, consumers are more likely to buy more tickets and pay higher prices if the transaction fees are disclosed at the back-end instead of up front.
Tom Lin, a law professor at Temple University Beasley School of Law, explained that the heart of the SEC’s disclosure regime, the reasonable investor, is a “convenient fiction.” Designing regulations for the “idealized” reasonable investor is not difficult, he said, but the idea of a reasonable investor puts day traders, hedge fund managers, and retirees all in the same category of “reasonable investor,” despite having asymmetrical information. Disclosure reform efforts should recognize diverse investors, including enhancing disclosure by using new media technology such as interactive interfaces like the SEC’s new rule requiring reports filed with the SEC to include hyperlinks to exhibits.
Disclosure of discrete items. In a panel discussion regarding how the SEC can improve the disclosure of discrete items like fees, strategies/risks, and performance, Brain Scholl, the principal economic advisor in the SEC’s Office of the Investor Advocate, echoed other participants’ views that a one-size-fits-all disclosure regime does not benefit all investors, particularly retail investors, which his office has colloquially referred to as “Aunt Millie.” Like others, he also emphasized the importance of comparison shopping. If he tells Aunt Millie that she is paying 2.5 percent on her funds without comparison, she only has that information in a vacuum, he explained.
Division of Investment Management Assistant Director Michael Spatt continued the common themes of comparison and technology in improving the SEC’s disclosure regime. To facilitate comparison, fund disclosure should make use of things like graphs and charts. They should also harness the use of technology by using structured data in filings.
Ahmed Taha, a professor at Pepperdine University School of Law, discussed mutual fund advertisements and “the cost of chasing past returns.” According to Taha, mutual fund investors tend to be financially unsophisticated and pay too little attention to fund risks and expenses and too much attention to past performance, despite little evidence of past performance being indicative of future performance.
Mutual fund advertisements are required under Rule 482 to include a disclaimer that enshrines this principle; however, Taha believes the current disclaimer is ineffective. While it could say to the investor that past performance is a poor predictor of future performance, it could also convey that returns may vary, or that past performance is a good predictor of future performance but does not guarantee it.
Taha proposed a stronger disclaimer for mutual fund advertisements, and possibly the prospectus, that reads:
Division of Investment Management Assistant Director Michael Spatt continued the common themes of comparison and technology in improving the SEC’s disclosure regime. To facilitate comparison, fund disclosure should make use of things like graphs and charts. They should also harness the use of technology by using structured data in filings.
Ahmed Taha, a professor at Pepperdine University School of Law, discussed mutual fund advertisements and “the cost of chasing past returns.” According to Taha, mutual fund investors tend to be financially unsophisticated and pay too little attention to fund risks and expenses and too much attention to past performance, despite little evidence of past performance being indicative of future performance.
Mutual fund advertisements are required under Rule 482 to include a disclaimer that enshrines this principle; however, Taha believes the current disclaimer is ineffective. While it could say to the investor that past performance is a poor predictor of future performance, it could also convey that returns may vary, or that past performance is a good predictor of future performance but does not guarantee it.
Taha proposed a stronger disclaimer for mutual fund advertisements, and possibly the prospectus, that reads:
Do not expect the fund’s quoted past performance to continue in the future. Studies show that mutual funds that have outperformed their peers in the past generally do not outperform them in the future. Strong past performance is often a matter of chance.Taha also described the possible benefits of outright prohibiting performance advertisements. According to Taha, disclaimers about past performance might not even be read; a stronger effective disclaimer might end such performance advertisements anyway; they could prevent selective timing of performance advertisements; and may benefit low-cost funds.