JOBS Act: This Is No Time for “Financially Illiterate” Investors
By strange coincidence, the SEC released a new study on financial literacy among retail investors at the same time that it and a host of other market participants are preparing for the launch of new JOBS Act funding mechanisms. We shouldn’t be surprised to find that investors are stupefied by much of what they receive and hear from the investment industry, or that what they want runs crossways with what issuers say they want to provide. What is surprising is that the lessons of just a decade ago about market integrity are so easily cast aside even as investor understanding fades.
The Commission’s study focused on the relationship between investors and intermediaries, be they brokers, investment advisers, or private wealth managers. The study’s primary finding was that investors lack basic financial literacy with “a weak grasp of elementary financial concepts.” The report also notes that investors generally “lack critical knowledge of ways to avoid investment fraud.” (Then again, lots of smart and experienced were taken in by Bernie Madoff.) These failings were most acute among women, African-Americans, Hispanics, the elderly, and the poorly educated.
The best ways to overcome this lack of literacy, SEC staff concluded, is through programs that are meat and potatoes for CFA Institute and its members: research-based, goal-oriented investor education. More problematic for investment professionals steeped in the nuances of investment strategy and products is making the programs accessible, delivered efficiently, and relevant to the target audience. It’s still worth a concerted effort.
Those are longer-term literacy objectives. In the short term, however, investors have to increase their knowledge before investing, and many recognize that they need information about intermediaries and investment products before they invest. Moreover, they recognize that the people they are dealing with often are conflicted; they just don’t know how. Consequently, they view information about conflicts of interest, investment strategy, fees, and disciplinary histories as “absolutely essential,” according to the SEC study.
As for the manner in which these disclosures are presented, investors were more comfortable with summaries of key information akin to the KIID (key investor information document) mandated in the European market. They want tables, charts, graphs, and bullet points rather than long paragraphs written in legalese. And they expressed a desire to be able to access more information via an issuer’s or intermediary’s website to supplement the KIID.
The lack of investor trust in markets has been building for more than a decade now — since the bursting of the tech and telecom bubbles in early 2000. As this study shows, investors are not prepared to make rudimentary investment decisions without assistance.
It thus begs the question of why policy makers in Washington D.C. were in such a hurry to reduce or eliminate many of the protections enacted after 2000 with the recent passage of the JOBS Act. My colleagues and I have written at length in recent months about its potentially pernicious effects, particularly upon unsophisticated retail investors and the elderly.
But many of the same disclosure principles cited by investors in the SEC study should apply regardless of whether investors buy through registered representatives, investment advisers, or crowdfunding portals. Before investing, they need to know whether a company is an operating entity with real products, real customers, and real capital — or a shell company intent on monetizing the [potentially conflicted] interests of insiders. They also will have an interest in knowing whether the principals have ever been sanctioned, censured, or otherwise disciplined by national, state, or foreign regulators before they hand over their hard-earned savings sight unseen.
The key to properly functioning financial markets is for investors to pay attention before and after they invest so that they can hold companies and their boards and managers accountable for their decisions. The Commission’s study suggests that investors have given issuers and the SEC a roadmap for helping achieve this goal. Whether investors pay attention if they get the kind of information they want, and in the manner they want it, is an open question.
Regardless, what the SEC’s latest study shows is that this is no time to be taking down our guard.