The Securities Law Implications of Financial Illiteracy

Every financial literacy study conducted over the last few decades concurs: Americans, including American investors, are financially illiterate. This Article argues that America’s financial illiteracy poses a significant, widespread, and long-term challenge for our federal securities regime because that regime is premised almost entirely on disclosure as the best form of investor protection and, by extension, on investors’ ability to understand disclosure. By advancing a typology of investors and their disclosure needs, this Article further argues that we may have significantly underestimated the extent of the financial illiteracy problem based on at least two flawed assumptions. First, we have presumed that the financial illiteracy problem is limited to retail investors—individuals (as opposed to institutions) who invest directly in the securities markets and who represent a small segment of the overall investor population. However, such a presumption fails to sufficiently account for the literacy concerns of individuals who invest indirectly in the market in the form of holdings in mutual funds, pension funds, and other institutions, and who comprise a substantial segment of the market. The second flawed presumption relates to the notion that disclosure is not intended for the individual retail investor. Many insist that disclosure is intended for sophisticated institutional investors and financial intermediaries who provide signals to less sophisticated investors about suitable investment choices. However, the anecdotal and empirical evidence suggests not only that our presumptions about the sophistication of institutional investors and intermediaries are debatable, but also that such actors do not perform their signaling function as effectively or as consistently as we presumed. Thus, the effort to minimize the financial literacy problem through reliance on these other investors is misguided. Finally, this Article contends that the very fact that regulators have sought to combat financial illiteracy for more than two decades without appreciable changes in financial literacy rates suggests that the problem may be long-term and that the reform of choice—investor education—may require supplementation. Based on these conclusions, this Article insists that we must grapple much more seriously with the financial literacy problem and offers suggestions about the best path forward.