Institute for Financial Transparency

Shining a light on the opaque corners of finance


The Reasonable Investor and Disclosure

One of the primary tools used by the Opacity Protection Team for limiting disclosure is to hide behind the Supreme Court’s 1976 decision in TSC Industries vs Northway.

The US Treasury summarized this decision as follows

In TSC Industries v. Northway, 426 U.S. 438, 445 (1976), the Supreme Court stated in that “[t]he question of materiality, it is universally agreed, is an objective one, involving the significance of an omitted or misrepresented fact to a reasonable investor.” The Court then held that a fact is material “if there is a substantial likelihood that a reasonable shareholder would consider it important.”

Ugh.  Fortunately, the US Treasury also provided a summary of this decision for those of us who don’t have a legal background.

Materiality is an objective standard based on the reasonable investor, as opposed to a subjective standard that is based on what a particular investor may view as important.

So the key to understanding this decision is to think about what is a “reasonable investor”.

The reasonable investor is a retail investor.  It has never made sense to put limits on the disclosure to non-retail investors as it is assumed they have ready access to experts to assess any information disclosed.

I have an image of a reasonable investor in 1976.  They sit at their kitchen table and read through physical copies of quarterly and annual reports.  Then, they go to the public library to do more research.  After this, they then called their broker to make an investment.  By dollar value of their investments in 1976, this reasonable investor represented almost all retail investors.

My image of a reasonable investor in 2017 is dramatically different.  The only similarity is the investor still sits at their kitchen table.  The Information Age and the rise of professional asset managers has changed everything else.

For those who want to do it themselves, the investor can browse quarterly and annual reports online.  Then they can use any number of online tools to slice and dice the financial statements.  Rather than go to the public library, the investor uses the Internet to identify and reach out to experts in the area of interest and solicit their opinions.  The do it yourself reasonable investor then places their order with a few clicks of a mouse.

For those reasonable investors who don’t want to do it themselves and this represents well over 50% of the retail investors’ investments, they simply invest using a professional asset manager.  By investing this way, these reasonable investors also access the experts.

These dramatically different images of the reasonable investor in 1976 and 2017 are very important for disclosure.  The ability of the reasonable investor to handle much greater levels of disclosure increased exponentially.  It has now reached the point where the reasonable investor can be expected to handle the disclosure experts would want to see.

With this change in ability to handle disclosure also comes a change in what is material and therefore should be disclosed.  Facts that didn’t have to be disclosed because they had no significance to the 1976 reasonable investor are now significant to the 2017 reasonable investor.

Do I think the SEC is up to increasing disclosure requirements to keep up with the changes in the reasonable investor?


This is where the Transparency Label Initiative comes in.  For purposes of deciding if a label is appropriate, the Initiative is not limited to what the 1976 reasonable investor can handle.  The Initiative instead looks at what the 2017 reasonable investor can handle.