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Regulating Wall Street In The Age of Disclosure Overload by Bill Singer
Less but better disclosure may be more, U.S. SEC Commissioner Paredes says by Stuart Gittleman
Regulating Wall Street In The Age of Disclosure Overload
Pinch me. Please. Again. Am I awake?
Whoa, this is truly bizarre. I’m sitting at my computer writing a complimentary story about a speech delivered by a current Securities and Exchange Commission commissioner’s speech. Yeah, you got it. Bill Singer is complimenting someone affiliated with the SEC. Maybe it’s the holiday season.
Do me a favor – pinch me once more. Ouch – well, guess I’m awake and this is no dream. As rare an undertaking as this is, let me get to it.
On October 27, 2011, SEC Commissioner Troy Paredes delivered the Twelfth Annual A.A. Sommer, Jr. Lecture on Corporate, Securities and Financial Law at Fordham Law School. Paredes was appointed to the SEC by President George W. Bush and has served since August 1, 2008. During his speech, Paredes noted the following:
Disclosure: The Cornerstone of the Superstructure
“Even as the superstructure of securities regulation has evolved over the decades with the accretion of statutory changes and new rules, regulations, and judicial opinions, the foundational cornerstone of the regulatory regime has remained fixed: It is disclosure. For over 75 years, the SEC’s signature mandate has been to use disclosure to promote transparency.
Louis Brandeis, whose ideas were a major influence on the disclosure philosophy of regulation that continues to animate the federal securities laws, summed things up as early as 1914: “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”. . .
Bill Singer’s Comment: Frankly, not a good start Commissioner Paredes. I’m not a fan of unbridled, excessive disclosure.
What passes for Wall Street disclosure is too often little more than the dumping of phonebook-sized documents on the investing public. This supposed cornerstone of regulation strikes me as merely the pretense of disclosure that consistenty fails to achieve that goal. Worse, those drafting securities laws and rules always seem to have uncannily embedded lucrative loopholes for the well-connected and influential. Amazing how that corruption always seems to seep into the fabric of securities regulation.
In reality, most Wall Street disclosure documents are as useful as an unalphabetized dictionary – sure, all the words are there but good luck finding what you need. Wall Street’s disclosure regime is little more than a CYA process that enriches the scrivening lawyers, makes work for the reviewing regulators, and serves to obfuscate the truth from the intended recipient. So, no, Commissioner Paredes, I’m not sure that we’re on the same page with this apparent tribute to the superstructure foundational cornerstone of disclosure.
Still, lemme give the Commissioner a chance. He had a lot to say and perhaps we should hear him out a bit further. In fact, Paredes offered a qualification to what seemed his glowing support for Wall Street’s disclosure scheme:
“The essence of the disclosure philosophy of securities regulation is that, when armed with information, investors are well-positioned to evaluate their investment opportunities and to allocate their capital as they see fit. When investors are able to make informed decisions, it is more likely that the financial capital that circulates in our economy will be put to more productive uses than if investors did not have the benefit of useful information.. .
[T]he disclosure philosophy of securities regulation does not presuppose that investors are perfect decision makers. Indeed, the more recent teachings of behavioral finance suggest the extent to which investors may err. Even when investors are empowered with extensive disclosures, for example, certain cognitive biases and decision-making shortcuts — so-called “heuristics” — may lead to unfortunate decisions. That said, disclosure regulation puts into practice the view that, overall, the collective judgment of the marketplace — disciplined as it is by market forces — should be respected as a worthy alternative to more substantive government control of private-sector conduct and capital flows. For the test is not whether investors are perfect decision makers; rather, the test is whether it is preferable to leave certain decisions to market institutions instead of relying more on government officials, who also err, to dictate results through regulation. . .
Bill Singer’s Comment: Okay, that’s better. At least we agree that an informed investor is more apt to invest, which is a major driver of capital formation in our economy. Still, too much of a good thing isn’t a good thing, and too much disclosure often confuses the investing public and stymies investment.
Costs and Benefits
Although Paredes’ speech sort of started out as an end-around-reverse play, that seems to have merely been a clever misdirection – the Commissioner quickly handed off to the fullback, who plowed straight up the middle. Consider these quite eloquent comments:
“If one carefully balances the costs and benefits of mandatory disclosure when it is put into practice, it becomes apparent that regulatory requirements that demand more disclosure in the name of transparency may not always provide the benefits needed to justify the costs. Leaving it to the marketplace to sort out what, if any, additional information should be forthcoming and under what conditions is sometimes preferable…
[O]ut-of-pocket compliance costs, which can be considerable, are the most obvious cost of complying with mandatory disclosure requirements. In addition, time and effort committed to meeting regulatory demands can distract valuable resources from more productive efforts that, on net, better serve investors and our economy generally.
Financial and other regulatory burdens can be particularly challenging for small businesses. By disproportionately straining new and emerging companies, regulatory burdens can create barriers to entry and expansion. This is problematic because startups and maturing enterprises fuel economic growth, generate new innovations and technologies that improve our standard of living, and are an important source of competitive pressure that disciplines larger enterprises to run themselves more productively. Companies that today are household names can trace their origins to entrepreneurs and innovators of earlier periods who had the wherewithal and backing to start and grow a business. More to the point, if the regulatory regime stifles small business capital formation by making it more difficult and more costly for businesses to raise funds, investors enjoy fewer investment opportunities for putting their money to work.. .
Bill Singer’s Comment: An SEC commissioner who champions a balancing of the costs and benefits of mandatory disclosure — wow, how refreshing and overdue! It’s particularly comforting to see that someone charged with promulgating regulations is sensitive to the reality that “more disclosure in the name of transparency may not always provde the benefits needed to justify the costs.” And what a wonderful point about how small businesses are disproportionately strained and stifled when regulations are poorly drafted and unfairly enforced.
Am I fully sold on Paredes’ worldview of Wall Street’s regulation? No — I get a little nervous when I see the suggestion that the “market” always gets it right. That’s the same market that produced the Flash Crash, and that’s the same market in which the forces of fraud and manipulation often have their way. On the other hand, even if I don’t buy into the purity of the markets, that doesn’t mean that I accept that there is some purity in government and regulation. I reject the either/or option of solely relying upon the markets to regulate Wall Street or, in the alternative, trusting that duty to bureaucrats who are too often corrupt and incompetent.
Commissioner Paredes told his audience about the workable path that he urges regulators to take:
“In my view, there is room to do still more. We need to consider new opportunities to alleviate regulatory demands that stifle the funding and growth of small business. This means that we should press forward on refining the regulatory regime to allow issuers more flexibility to raise capital privately and that we need to consider regulatory changes that address the risk that the regulatory regime itself unduly dissuades companies from going public and listing on U.S. exchanges.
Accordingly, I am pleased by the recent discussions that have centered on such worthwhile ideas as:
modernizing the prohibition on general solicitations under Regulation D so that businesses can raise funds more efficiently and at lower cost;
increasing the 500 shareholder threshold at which a private company is forced to report publicly;
substantially increasing the current cap on offerings permitted under Regulation A; and
facilitating “crowdfunding” as a means for small business to raise capital more easily from individuals…
Bill Singer’s Comment: Please – before some of you send in the criticisms and nasty emails – don’t put words in my mouth and don’t set me up as a strawman.
I don’t fully agree with Commissioner Paredes’ agenda. My views on Wall Street regulation and reform are nuanced and complex. Before you throw the first stone at me, at least do me the favor of
Googling my name and read some of the pro-reform, pro-consumer articles that I have published on this topic over the past two decades.
I fear the corrosive influence of big business and politics, and their conspiratorial ability dilute reform, if not undo it. Offsetting those fears, I am a libertarian who strongly supports Capitalism, which means that I have more faith and confidence in individual entrepreneurs, small business, robust competition, and truly free markets, than in international conglomerates and career politicians/regulators.
Nonetheless, I have always argued that Congress and regulatory organizations have been allowed to wrap themselves in the flag of regulatory reform for too many years, when all that they have produced is reams of rules that few understand and too many use for the loopholes. In the end, much of what is billed as regulatory reform is unedited text that overwhelms the investing public and imposes substantial costs upon smaller businesses.
You can’t respect a law that you don’t understand; you can’t respect enforcement that’s biased. No, I’m not against regulation or even more regulation; what I disfavor is the diarrhea of laws and rules that flood our society.
In closing his remarks, Paredes offered the following overview:
“The bottom-line risk with information overload is that investors will have so much information available to them that they will sometimes be unable to distinguish what is important from what is not. Too frequently, investors do not bother carefully studying the information that is available and get overwhelmed or distracted, misplacing their focus on less important matters. In short, the sheer amount of information can frustrate its effective use. The trouble is that when information is not processed and interpreted effectively, decision making may not improve with additional disclosure. Ironically, if investors are overloaded, more disclosure actually can result in less transparency and worse decisions.
[T]his leads me to a practical suggestion. Disclosure serves key regulatory objectives, but too much disclosure can be counterproductive. The Commission should account for this in fashioning its disclosure regime. We need to consider the impact on investors as disclosure obligations mount and investors are thus presented with more and more information to work through. It may be better for investors to have shorter, more manageable prospectuses and proxy statements, for example, that contain more targeted information instead of lengthy documents that are not fully digested and that in too many instances are entirely ignored. While new disclosures may be required from time to time, we should be open to the prospect that certain disclosures should be more narrowly focused or otherwise scaled back.
What is disclosed to investors should be presented, when practicable, in a more accessible way — such as charts, graphs, tables, and summaries — so that the information is more digestible and understandable. Technological advances like the Internet and smartphones allow us to consider new and innovative opportunities for how disclosures can be packaged and distributed to investors.
Less but better disclosure may be more, U.S. SEC Commissioner Paredes says
“If every instance of adultery had to be disclosed, there would probably be less adultery,” Al Sommer wrote in 1976 on how disclosure can help improve corporate governance and prevent and detect mismanagement and corruption. Sommer, then a member of the Securities and Exchange Commission, helped build the securities practice at Morgan Lewis, which sponsors an annual lecture at the Fordham Law School Corporate Law Center to honor its mentor, who died in 2002.
SEC Commissioner Troy Paredes on Thursday night at Fordham echoed the point Sommer made 35 years earlier, that disclosure has been a crux of federal securities law since the Securities Act of 1933. But Paredes suggested reevaluating the potential costs and benefits of disclosure, and whether it can be done more efficiently and effectively in light of the economic, social and technological changes of the intervening eight decades.
Paredes urged issuers, investors, Congress and the SEC to ask “how do real people make real decisions with the information they have” and efficiently allocate their investment resources. Congress rejected leaving the decision to market participants, subject to the antifraud provisions of the federal securities laws, but the SEC can “assess the costs” of the current, and upcoming through the Dodd-Frank Act, rules and “weigh [them] against the benefits,” he said.
Paredes said the regulatory burdens can also “distract valuable resources” from issuers, especially small and growing companies that are currently exempt from the Securities Act under Regulation D. He urged continuing to “allow more flexibility” for such issuers to raise capital by considering, for example, raising the 500-shareholder threshold, allowing “crowdfunding,” and further scaling and refining the mandatory elements of Reg D.
A related issue is whether investors are receiving an “information overload” of too much disclosure for them to absorb and use, Paredes said, giving the example of the Dodd-Frank Act mandates on executive compensation and corporate structure. There is a risk that shareholders “may not be able to distinguish between what is important and what is not,” which “can result in less transparency” rather than more, he said.
Paredes suggested increasing the use of charts and graphs and offering shareholders the option of web-based disclosure delivery, and assessing the costs of other Dodd-Frank mandates, such as pre- and post-trade transparency, dark pools and securitizations, as well as their benefits.
One of the biggest challenges facing the SEC in implementing Dodd-Frank is “working through the mandate in a thoughtful, constructive and considered way,” Paredes said, adding that market participants can help through the comment process.
Paredes also said the SEC has “really complicated challenges” in implementing the Volcker rule on proprietary trading, saying there is a “difficult set of determinations” to avoid eliminating the exempted activities that have real economic benefits. Trying to define what is prohibited is a major challenge for the SEC, he noted.
Another conundrum is whether the expense of moving to international financial reporting standards is cost-justified and will protect investors as well as they are under generally accepted accounting principles, Paredes said. The SEC should evaluate IFRS in terms of the institutional framework it provides, including its impact on corporate governance, not just on accounting standards.
Although several large multinational corporations are ready to transition to IFRS, key remaining questions for the SEC include the impact of IFRS on smaller companies, how well IFRS is scalable, and whether its use should be mandatory, Paredes said.