Recently, I was asked if the SEC and the Transparency Label Initiative™ can peacefully co-exist or will the SEC want to regulate the Initiative out of existence.  This is a very good question.

I responded by saying my expectation was for peaceful co-existence.

Why do I expect this?  The SEC and the Transparency Label Initiative™ work together in a “belt and suspenders” manner.

The SEC is the belt.  Its disclosure process is focused on what the mythical reasonable investor needs to make an informed decision. Its regulations set a minimum standard for disclosure.

The Initiative is the suspenders.  It asks the question “what information would the expert need to truly assess the risk and reward for a security or financial benchmark”.  It then compares the answer to this question to what information is currently disclosed.  A label is awarded where the information the expert needs is currently disclosed.

For many industries, what the mythical reasonable investor needs is also what the expert wants.  So the SEC’s belt is adequate.

However, there are some very real limitations to the SEC’s belt.  For example, while the SEC is not required to let a cost/benefit analysis influence its disclosure requirements, in reality it does.  Based on conversations with the individuals involved, I know an internal cost/benefit analysis heavily influenced the SEC’s pre-financial crisis disclosure requirements for structured finance securities.  These opaque securities subsequently featured prominently in the financial crisis.  This example demonstrates sometimes the SEC’s belt is not enough.  It is in these cases the Initiative’s suspenders are needed.

The Initiative’s suspenders are also needed where the SEC does not have the authority to set disclosure requirements.  Examples of this include private placements and global benchmark financial prices.

Finally, there is a bridge that links the SEC and the Initiative in our modern financial system.  Every investor can now easily access either directly or indirectly experts to assess risk and reward.  The experts might be mutual fund asset managers or independent third party experts hired by the asset managers.  As a result of the easy access to experts, the mythical reasonable investor now requires disclosure at the expert level the Initiative sets as the baseline for rewarding a label.