Article by Erik F. Gerding
For securities disclosure, it is both the best of times and the worst of times. On the one hand, some scholars, such as former United States Securities and Exchange Commission (SEC or Agency) Commissioner Troy Paredes, Steven Schwarcz, and Henry Hu, have either renewed an old attack on mandatory issuer disclosure or questioned the effectiveness of securities disclosure in the context of modern financial instruments. Paredes claims that mandatory disclosure rules prove ineffective because investors suffer from “information overload.” Schwarcz and Hu argue that disclosure cannot describe the complexity of modern firms and finance. These attacks have coincided with a broader academic critique of mandatory disclosure as a tool for protecting consumers and come after a global financial crisis that stemmed in large part from massive information failures in financial markets, particularly in securitization and derivatives. The academic criticism of mandatory securities disclosure has provided some of the intellectual underpinnings for recent SEC regulatory initiatives, such as the Agency's “Disclosure Effectiveness” initiative, and proposed legislation in the United States Congress to simplify or cut back disclosure rules.
On the brighter side for mandatory disclosure, the SEC has launched, or is considering launching, new initiatives to use technology to improve the effectiveness of mandatory disclosure in informing investors and helping them analyze issuers and securities issuances. As an early example, the SEC's “XBRL” initiative required issuers to attach data tags to their disclosures to enable investors to pull similar financial data from a range of issuers and place it in spreadsheets or other analytic tools, enabling investors to compare issuers side-by-side. The SEC followed with a rule requiring that data tags be affixed to loan-level assets in securitization transactions. The Agency has also moved incrementally towards requirements for more real-time disclosure.
These technological approaches might be taken a step further, including by borrowing from work done by the Consumer Financial Protection Bureau (CFPB) in improving consumer finance regulation. A next generation of securities rules might promote web-based disclosure with carefully designed, hyperlinked, and nested layouts. The SEC might also pursue other interactive disclosures, such as calculators, to allow investors to adjust the assumptions underlying disclosure or tailor disclosure for their particular investment priorities. Still more ambitious reforms might require issuers to disclose more granular information about their investment portfolios or to make the risk models they use open-source.
These two sides of disclosure--a deep skepticism combined with a technological optimism--raise questions about whether technology can address some of the potential information failures involved in mandatory disclosure. Can new technologies help investors understand complex firms, particularly financial institutions, as well as complex financial instruments and markets, while not overtaxing the cognitive abilities of individuals? Investors need a rich set of information to value firms and securities, but the fear is that they cannot process too much information or that too much information will exacerbate behavioral biases and prompt cognitive errors.
This Article proceeds as follows. Part II summarizes and critiques the information-overload and complexity criticisms of mandatory disclosure, provides a thumbnail sketch of some of the information failures in the recent financial crisis, and outlines recent regulatory and legislative initiatives to “simplify”--or roll back--regulations requiring issuer disclosure. Part III examines several of the initiatives and proposals to use technology to improve mandatory issuer disclosure and describes the advantages and drawbacks to each. Part IV concludes by advocating for more empirical and experimental testing of proposals either to remove or technologically enhance disclosure. It also argues that old-fashioned disclosure on the purposes for certain securities issuances, the due diligence performed by issuers and intermediaries, and the incentives of those parties might have a far more profound effect on the understanding of investors and the disciplining of issuers and intermediaries than either rollbacks of disclosure regulations or hi-tech disclosure solutions.
About the Author
Professor of Law and Associate Dean for Academic Affairs, University of Colorado Law School.
90 Tul. L. Rev. 1143 (2016)