Speech by SEC Staff:
Feedback from Individual Investors on Disclosure
Lori J. Schock
Acting Director, Office of Investor Education and Assistance
U.S. Securities and Exchange Commission
January 19, 2007
I would like to begin by thanking Vanguard and Villanova University's Center for Marketing and Public Policy Research for inviting me to speak with you today. I am pleased to be here and to participate in this investor literacy forum. As I begin, however, I must remind you that my remarks represent my own views, and not necessarily those of the Commission or its staff.1
Villanova, which means "new home" in Latin, is a fitting co-host for this forum. That's because the current disclosures provided to investors and consumers are, in many respects, like an old house filled with too much stuff and in need of an update.
I believe today's forum and similar events will help build a new home for disclosures and, perhaps, with some creative ideas and good old fashioned elbow grease, a dream home. Will we need to tear down the old and start over? Or will a major renovation be adequate? So, where do we begin with building this new home? In design, they say you begin with the flooring. I, for one, am eager to learn the fate of the yellow shag carpet.
Effective disclosure is particularly important to me. That's because the federal securities laws are derived from one simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it.
The primary mission of the SEC is to protect investors and maintain the integrity of the securities markets. I am the Acting Director of the SEC's Office of Investor Education and Assistance, OIEA for short. My Office is the "front door" to the Commission for individual investors. Every year, my staff handles tens of thousands of complaints and questions from investors who contact the SEC.
OIEA also carries out the SEC's investor education program, which includes producing and distributing educational materials, coordinating investor research projects, participating in educational seminars and investor-oriented events, and partnering with federal agencies, state regulators, self-regulatory organizations, consumer groups, industry associations, and others on financial literacy initiatives. In addition, OIEA provides input on rulemaking and other policy issues that impact individual investors.
As we fulfill these duties, we receive a great deal of useful and interesting information from investors. In light of today's forum, I thought I would share with you some feedback from individual investors regarding disclosure.
Complaint and questions data
Some of the most important and meaningful feedback OIEA receives from investors is through our investor assistance function. During fiscal year 2006 (ending September 30, 2006), my staff received 77,274 complaints, questions, and other contacts. As they have done in the past, staff members coded each of these contacts and entered them into a database.
Nearly 50% of these contacts involved telephone calls, approximately 34% came in electronically through our online complaint and question forms or by email and the remainder included letters, faxes, and personal visits.
Only a small percentage of these contacts, however, were related to disclosure issues, such as the failure to disclose fees prior to a transaction. About three percent of the complaints received during fiscal year 2006, for example, focused on disclosure. In contrast, complaints relating to advance fee fraud, the highest ranking complaint category for the last two years, represented about ten percent of last year's complaints.
Fortunately, OIEA's investor complaint and question data is just one of OIEA's resources for investor input. We've received feedback from investors on disclosure in many ways, including staffing booths and speaking at investor events, coordinating investor research, such as focus groups, and reviewing comment letters. Taken together, I think these resources point to a few common themes on how investors think disclosure should be improved.
Probably the most familiar theme is plain language. The swamp of legalese found in many annual reports and mutual fund prospectuses can frustrate even the most experienced investor. Not surprisingly, investors consistently have been telling us that disclosures should contain language that the average investor, not the average lawyer, can read and understand.
Over the years, the Commission has undertaken a variety of efforts to promote more readable documents and to encourage the use of plain English, including adopting plain English disclosure rules and publishing "A Plain English Handbook, How to Create Clear SEC Disclosure Documents." Recently, the Commission adopted rules requiring that companies prepare their executive and director compensation, related person transaction, beneficial ownership and corporate governance disclosures using plain English. Here are some of the plain language principles set forth in the final rule, which I believe echo typical investor feedback in this area:
Present information in clear, concise sections, paragraphs and sentences;
- use short sentences;
- use definite, concrete, everyday words;
- use descriptive headings and subheadings;
- use a tabular presentation or bullet lists for complex material, wherever possible; and
- avoid legal jargon and highly technical business and other terminology.
In an agency full of so many lawyers and accountants, a plain language initiative can be challenging. That's because defined terms and jargon are just part of these trades. Fortunately, input from investors can be a good check. Let me share a brief example. As you may recall, in April 2005, the SEC adopted a rule that, among other things, permitted a broker-dealer to offer fee-based brokerage accounts without being required to register as an investment adviser under certain circumstances. During the rule proposal comment process, OIEA coordinated research on the effectiveness of certain proposed disclosures through focus groups.
The disclosures, of course, were intended to be clear and understandable to investors, but many of the focus group participants indicated otherwise. Participants told us that one source of confusion was the word "fiduciary." Undoubtedly, the staff members working on the rulemaking were very familiar with the common legal term. The final rule contained revised language that excluded the term altogether.
The focus group participants essentially repeated advice we've heard from other investors follow the KISS principle or Keep It Simple SEC (at least, that's my charitable interpretation of the acronym). By actively seeking out investor's views on what's important for their investing decisions, the SEC has been able to improve some disclosure based on plain language-related feedback. But investors tell us there's more work to be done, particularly for common retail products such as mutual funds and variable annuities.
Less is more
In addition to using plain language, investors don't want more information than they need, so less is more. Whether they use the term or not, information overload is a real concern to investors.
Here are the types of reactions we've received from investors regarding the amount of disclosure they receive:
- "Give me all the information on one page";
- "A bulleted list is enough";
- "All I need is the bottom line"; and
- Less is more.
One of the challenges in this area, according to Buddy Donohue, the SEC's Director of the Division of Investment Management, involves changing the mindset of people, particularly attorneys, when it comes to the primary purpose of disclosure. The mutual fund prospectus, for example, is viewed by many in the industry primarily as a litigation protection document, rather than a tool to effectively communicate with shareholders and prospective investors. The prospectus can serve both purposes.
The fund profile is an example of a Commission rulemaking initiative that promoted a shorter disclosure document. Under Rule 498 of the Securities Act of 1933, the Commission permits a mutual fund to offer investors a "profile," which summarizes key information about the fund in a concise, standardized format, including the fund's investment strategies, risks, performance, and fees. The rule also requires the profile to be in plain English, and provide an investor with the option of purchasing the fund's shares either after reviewing the information in the profile or after requesting and reviewing the prospectus.
Do most mutual fund investors get the benefit of reviewing this shorter, more user friendly document? The answer, unfortunately, is no. My understanding is that few funds have chosen to use the profile for fear that they will have some liability exposure if an investor purchases fund shares based only on the summary contained in the profile rather than the robust disclosure in the fund prospectus.
Incidentally, it's not just investors who think a shorter version of the current prospectus is a good idea. Last summer, the Commission held a Roundtable on Interactive Data and Mutual Fund Disclosure Reform. The Roundtable featured speakers representing a variety of perspectives. Fund industry representatives, investor advocates, third-party users of fund disclosure and even a plain English expert were present. Out of these different perspectives came a strong consensus for a short-form disclosure document for investors containing key information about a mutual fund investment, with more detailed information available on-line, or if requested, in paper.
Deliver it my way
Speaking of paper, or the lack thereof, OIEA has received a fair amount of feedback from investors on how disclosures should be delivered. Investors have a wide range of views on this issue. Most investors have access to the Internet and many of them prefer to receive disclosures online. Other investors have told us that they don't use computers and, as a result, they have to receive disclosures on paper. For some investors, it's just a matter of preference, not access. They use email and have access to the Internet, but prefer to receive disclosures about their investments via regular mail.
Of course, there are other delivery options for disclosure, including oral disclosure. I don't have a simple summary for the range of investor perspectives on this issue, other than this: investors want to receive disclosures the way they want to receive them. Yogi Berra couldn't have said it better.
I think investor preferences on disclosure delivery are very important, particularly in light of the fact that many disclosures are never read. Disclosures likely aren't reviewed for a variety of reasons, including some that I've discussed already. But suppose that current disclosures were short, comprehensive, and written in language that average investors could understand. Would the improved disclosure be helpful to most investors? Yes, but only if they read it. Posting the improved disclosure on the Internet, for example, won't help an investor that doesn't use a computer.
Disclosure delivery was an important consideration in the Commission's recent e-proxy rulemaking. Last month, the Commission voted to adopt amendments to its proxy rules that would allow companies to furnish proxy materials to shareholders through a "notice and access" model using the Internet. But any investor who wants to receive paper proxy materials may continue to do so, without charge, under the new rules.
It is critical that disclosures reach, or at least have the potential to reach, every member of their intended audience. If there's going to be a ball, I think everyone should receive an invitation. And I was happy to see that, at least in the case of the e-proxy rulemaking, the Commission didn't forget about Cinderella.
Make it useful
The last theme I'll discuss is the usefulness of disclosure. Who is the best judge of what's useful to an investor? Is it an attorney behind a desk in Washington, D.C.? According to investors, the answer is, "No." Investors, themselves, believe they are the best judge of what's useful to them. It brings to mind the axiom that the "customer is always right."
The SEC recently has taken pro-active steps to get detailed feedback from investors on proposed disclosures. Basically, we've put disclosures in front of the investors and asked is this helpful? For example, my Office coordinated investor testing for the point of sale initiative, including focus groups and in-depth interviews.
The answer to the question is this helpful during that process wasn't always "yes." Sometimes, it was "not really," "no," and "huh, what do you expect me to do with this information?" Those responses, while sometimes humbling, helped identify areas of improvement for the point of sale forms. We learned, for example, that disclosure of costs appears to be most effective when all the components of the costs are identified, not just distribution-related costs.
Another way to create more useful disclosure is to put information in context. During the investor testing for the point of sale initiative, we observed that investors really liked forms that not only contained fee information for a mutual fund, but also showed how those fees compared to similar funds. Actual investors have also told us that this type of information is more useful when presented in context in this way.
A final message from the point of sale testing worth mentioning is that investors often preferred disclosure that is specific to the anticipated amount of their purchase. On that note, let me briefly mention interactive data. Put simply, interactive data means using technology to provide investors with quicker access to the information they want, in a format they can most easily use. Interactive data may hold great promise as a tool that can be used by investors in a targeted, meaningful way to obtain information they most care about while at the same time avoiding the "clutter" that accompanies navigating a voluminous document.
The investor input I've shared with you today has been helpful to the SEC as it has considered how to make disclosures more understandable and useful for investors. But the SEC and other regulators need more help to build a disclosure dream home. Research, particularly quantitative research, is one area in which many members of this audience can help.
With so many researchers in attendance today, I want to thank you for what you do, first of all, and, secondly, encourage you to continue to focus on disclosure as an area of research. Research on the topic of disclosure is fascinating and necessary to make things better. With the increased use of technology such as the Internet to access information, there are more opportunities to build on existing research. In addition to disclosure issues relating to technology, I am particularly interested in research on investment costs and welcome your input on this area as well.
Please feel free to email me a copy of any research relating to disclosure or individual investors that you feel would help me fulfill my Office's mission. Better yet, submit any applicable research as a comment to a proposed SEC rule. I encourage anyone who is interested in our rules to please submit your comments to us. I assure you that we greatly appreciate your input.
Thank you for your attention and I look forward to the upcoming presentations and panel.