We live in the Information Age with easy access to experts.  Unfortunately, SEC mandated financial disclosure requirements live in the pre-Information Age.  The financial disclosure gap between pre-Information Age and the Information Age is unlikely to close because Wall Street has captured the process by which the SEC sets disclosure requirements.  Investors need a way to close this gap.  This is where the Transparency Label Initiative comes in.  The Initiative helps investors close this gap by using a label to highlight where disclosure meets what experts want to see and where disclosure falls short.

SEC Commissioner Kara Stein made an interesting speech about this gap to the Council of Institutional Investors.

After the stock market crash in 1929, Congress began to investigate the crisis and find solutions to the problems it uncovered. The investigation revealed investors’ dissatisfaction with information they received about the companies they owned. … investors couldn’t perform basic analysis or compare one company to another or the same company over different time periods.

Further, economic factors in the 1920s encouraged companies to withhold financial information or to disclose less than the amount of information desired by market participants. Company management said they were afraid too much disclosure would put their companies at a disadvantage when competing with other American companies and their foreign counterparts.

Left unsaid by the Commissioner is investors in the 1920s were unable to force the companies to disclose the information they needed to know what they own.  The reason investors could not force companies to disclose is the issuer doesn’t need every investor to buy their securities.  Issuers only need investors Wall Street finds who are willing to “Trust” Wall Street’s valuation story about the issuer’s securities without the ability to “Verify” if the story is true or not.

Commissioner Stein goes on to say

there has been a debate about how the information needs of today’s investors have changed. For example, on the one hand, we hear that public companies are “overloading” investors with information. In particular, they are so inundated that “it [is] difficult for investors to focus on the information that is material and most relevant to their decision-making.” Moreover, one report called information overload a “pressing concern.” However, I must reveal that during my five years on the Commission, I have not heard this concern expressed by even one investor. Not one.

In fact, it has been my experience that investors and others are asking for more information. In 2014, when the Commission sought comment on its disclosure framework, it received over 26,500 comments. The “overwhelming response…seem[ed] to reflect an enormous pent up demand by disclosure recipients for more and better disclosure.”

Wow.

I would like to thank Commissioner Stein for confirming there is a tremendous market for the service provided by the Transparency Label Initiative.  

Regular readers know the Initiative only serves disclosure recipients.  It uses a label to distinguish between investments.  Investments that provide enough disclosure so an investor could know what they own receive a label.  Those that leave the investor blindly betting do not receive a label.

Finance theory confirms this distinction is important.  Finance theory predicts investors will pay a higher price for securities where they know what they own then for securities they are blindly betting on.  Studies have shown this prediction holds true.

The Initiative lets investors put pressure on issuers to provide more and better disclosure.  Why?  Because the issuers have an economic incentive (higher price for their securities) to qualify for a label.

This demand has not subsided. Just a few weeks ago, a group of institutional investors, asset managers, state treasurers, and others petitioned the SEC. They asked the Commission to require disclosure of environmental, social, and governance (ESG) information by publicly traded companies in a standardized format.

This same group of institutional investors, asset managers and state treasurers could use the Transparency Label Initiative to achieve the same outcome with a higher probability of success.

Why?

Wall Street has captured the process by which the SEC sets disclosure requirements.  Wherever possible, Wall Street prefers to limit disclosure.  To the extent ESG requirements might limit Wall Street’s ability to sell issuers’ securities, it will block/limit this disclosure.

Since the Transparency Label Initiative is not and cannot be captured by Wall Street, it doesn’t place limits on disclosure.  Issuers that should and don’t provide ESG information in a standardized format don’t receive a label.

Investors understand investments without a label must be priced so investors can earn a much, much higher rate of return to compensate for the risk hidden by the lack of disclosure.  This puts pressure on the Issuers to disclose the information investors want and need.