I am frequently asked “if investors want more information, why don’t they just ask for it?”.

The short answer is investors do ask and issuers don’t provide the information.

Why don’t issuers provide the information?

Issuers believe and in some cases they actually do benefit from opacity.

Since the Pecora Commission in the 1930s, it has been well know the financial benefits of opacity are concentrated in the Issuers’ and Wall Street’s hands while the financial benefits of transparency are spread across all investors.  The Pecora Commission also showed individual investors do not have the leverage needed to force the issuers to provide more information.

Why?

Because no issuer needs every investor to invest in the securities they issue.  Issuers only need investors who are willing to Trust the valuation story Wall Street tells about the Issuers’ securities and are willing to invest despite not being able to fully Verify the valuation story.  Hence, the individual investor who does want more information in order to be able to Verify the valuation story has no leverage to get this information.

In response to the Pecora Commission findings, the FDR Administration faced the question of how to organize the investors so they acted as a single entity (call it the buy-side), rather than as powerless individuals.

The answer the FDR Administration came up with was to create the SEC.  The SEC was given responsibility for ensuring issuers disclosed the information investors needed in order to know what they own.

This solution worked well until the 1980s when the Reagan Administration decided Wall Street should be the SEC’s “client”.  Despite Pecora’s observation that darkness was Wall Street’s stoutest ally, the Reagan Administration gave it a significant voice in how disclosure regulations were set.

The outcome was highly predictable.

A disclosure gap opened up between the minimal amount of information the SEC requires be disclosed and the information investors need disclosed so they can know what they own.

Finally, in 2007, we had a financial crisis because investors could not assess the value of trillions of dollars of opaque securities in the global financial system.  In 2008, we had a banking crisis as the earthquake along the opacity fault line in the global financial system showed opaque securities were not limited to subprime mortgage-backed deals and related derivatives, but extended to the Wall Street firms themselves.

So how did the Bush, Obama and now the Trump Administrations respond?  With a whole lot of sound and fury, but nothing that restored transparency to the global financial system.  They did not end Wall Street’s capture of the SEC’s disclosure process.

In fact, a decade later we have more opacity in the global financial system than we did in 2007*.  As a result, the necessary condition (a critical mass of opaque securities) for the next phase of the financial crisis already exists.  All the next phase is waiting for is Wall Street’s valuation stories to be called into doubt.

Investors don’t have to wait for another phase of the financial crisis and the 100s of billions of dollars of losses on opaque securities it will cost them.  Nor do investors have to hope for the government to end Wall Street’s capture of the SEC’s disclosure process.  Investors could choose to act as a single entity today.

The Transparency Label Initiative gives investors the ability to act as a single entity.   The Initiative turns opacity into an asset class.  An asset class investors can choose how much or how little exposure they want to.

Identifying a security as opaque puts pressure on its Issuer to disclose the information investors need so they can know what they own.

Why?

Because investors are smart enough to know if they are going to blindly bet on opaque securities, these securities better hold out the promise of a very high rate of return to compensate for their high likelihood investors will lose money buying them.

From an issuer’s perspective, this higher rate of return investors require is the cost of opacity.  A cost many issuers would prefer not to pay.  And a cost they don’t have to pay if they provide the investors with the information the investors need to know what they own.

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* The growth of the asset management industry has actually made the problem of opacity in the global financial system worse.

How?

Asset managers hold themselves out as “experts”.  In particular, they claim to have the expertise to assess the risk/return of the securities they are allowed to invest their clients’ money in.  Investors trust them as the investors know they don’t have the ability to assess these securities.

But how is it possible to assess the risk/return of an opaque security?  When you don’t have the information needed to know what you own, you cannot do this.

So asset managers are misleading investors about their capabilities.

Of course, asset managers dismiss this with a couple of their favorite arguments to justify why they didn’t bother to tell their clients they were blindly betting the clients’ money on opaque securities.

First, “it is the investors who want us to be investing in these opaque securities; if they didn’t want us to, they wouldn’t have given us their money to manage”.

Or second, “they are paid to dance, not to complain about the music”.

Both of these arguments fall under the category of we assume our clients know what the risks are and despite these risks want us to invest.   Of course, the clients don’t know what the risks are as they are never disclosed in big bold print saying:  THE ASSET MANAGER WILL BE BLINDLY BETTING YOUR MONEY.

One of the benefits of the Transparency Label Initiative is it also impacts the disclosure asset managers make to investors.  Asset managers have to disclose if they are limited to only investing in securities where there is a Label or if they can blindly bet the investors’ money.