The Legal Framework for Financial Advertising: Curbing Behavioral Exploitation

Abstract

Policy makers and behavioral finance scholars express growing concern that marketing practices by financial institutions exploit retail investors’ behavioral biases. Investor protection regulation should thus address these marketing practices and include mechanisms curbing behavioral exploitation. That raises the question whether the marketing communications regime of the new European Markets in Financial Instruments Directive (MiFID II) can live up to this demand. This article aims to bridge the gap between empirical insights and normative arguments by developing a regulatory model that integrates behavioral finance insights into the new marketing communications regime. It then determines how regulatory authorities can apply this model when they interpret and apply specific regulatory requirements. It demonstrates how a regulatory authority or a court can translate empirical behavioral finance research findings into legal arguments when assessing whether marketing practices can significantly distort a model investor’s decision-making process. The article further establishes that the detailed requirements imposed on investment firms by the new Markets in Financial Instruments Directive are necessary in order to protect investors from behavioral exploitation. Finally, the article submits policy proposals that aim to protect investors more effectively from behavioral exploitation.

Keywords: advertising, marketing, behavioral finance, behavioral exploitation, MiFID II, investor protection

JEL Classification: G02, K00, K10, K22, M37