Even the SEC realizes the process it uses for setting disclosure requirements has been captured by Wall Street.  To compensate for Wall Street’s capture, the SEC is looking for a private market solution to set disclosure standards so investors can know what they own.  Not only is the Transparency Label Initiative this private market solution, but the SEC wants it to succeed.

This interesting fact was included in a report from the Center for American Progress on the ongoing failure of existing disclosure regulations.  What caught my attention wasn’t just the failure of existing disclosure regulations or the call for a private market solution, but the authors also identify the reasons the SEC is unlikely to cure these disclosure failures.  Hence the reason for a private market solution.

The Transparency Label Initiative is the private market solution the SEC is looking for and wants to succeed.  It has no conflicts of interest and has been set up so it is immune from capture by Wall Street.

The Initiative focuses solely on the issue of identifying what information investors need to know what they own.  If the investment discloses this information, it is awarded a label.  This label indicates investors can Trust the valuation story they have been told by Wall Street and have access to the information needed to Verify if this story is true or false.  If the investment does not disclose this information, it doesn’t get a label.  In this case, the valuation story cannot be verified and the investment is a blind bet.

The authors start their report by explaining why we have disclosure regulations by looking at

the question of whether investors, markets, and key corporate stakeholders are sufficiently informed—and from that information, empowered—to do the basic work of the capital markets: drive smart capital decisions for the long term. This report asserts that the answer to that question is “no.” Shareholders and stakeholders of all types and sizes do not have access to the long-term-oriented information they need….

How are investors suppose to get this information?

Public oversight of the nation’s stock markets is premised on the need for government to mandate corporate transparency.

Why?

Corporations are understandably unwilling to voluntarily share information that might not be flattering but that investors and the public need to distinguish between good and bad investments. Moreover, information must be shared in a consistent, comparable, and reliable manner for it to be useful to investors and the public—and hence to enable efficient markets.

In the early 1930s, the Pecora Commission established investors were unable to force firms to disclose the necessary information so they could know what they owned.  The reason why investors couldn’t do this is no investment requires every investor.  They only need a subset of investors.  Wall Street understood how to find the subset of investors who were willing to blindly bet on any specific investment.

Since the investors hadn’t found a way to organize themselves, the FDR Administration had the government do it for them.

The Securities and Exchange Commission (SEC) was created during the Great Depression to address market failures and ensure this very transparency.

However,

Over the years, as investors, the economy, and the public interest have evolved, the SEC has had to update its requirements. When it has failed to do so, the consequences to investors of all types and to the public interest have been severe.

Regular readers know the consequences of its failure to ensure transparency was the Great Financial Crisis.  The crisis took place along the multi-trillion dollar opacity fault line in the global financial system.

As a result of the financial crisis, has the SEC restored transparency?

Today, the SEC is behind the curve on mandating the disclosure of sufficient long-term-oriented information, especially ESG information.

The SEC is also behind the curve on restoring transparency.  For example, the banks are still black boxes.

Why is the SEC behind the curve?  Wall Street captured the process by which disclosure regulations are set.  For example, the SEC issued new disclosure regulations for subprime mortgage-backed deals that leave these deals every bit as opaque as they were before the updated regulations were issued.

So what is the alternative to the SEC?

Its reliance to date on the private market to execute this public regulatory function has not worked.

Not surprising given the SEC has until now not acknowledged it needs the private market to take over this public regulatory function.

Regular readers know the Initiative is the private market solution of choice for taking over the SEC’s disclosure function.

The Initiative recognizes the SEC sets minimum disclosure requirements.  The Initiative uses its label to identify which firms provide investors with the information they need to know what they own.  Sometimes, the information needed to be awarded a label is the same as the SEC requires.  In most cases, the information required to be awarded a label is substantially more.  Examples of this additional required information include environmental, social and governance information.