Unprincipled Investor Bifurcations

Abstract

The investment world is full of bifurcations—that is, divisions among groups of investors that the securities laws establish for the purpose of furthering the regulatory goal of investor protection.  The notion behind these bifurcations is that only more wealthy investors should be permitted to invest in riskier investment products.  However, as this Article details, a more pernicious bifurcation has emerged in recent years, alongside the growing popularity of exchange-traded funds, or “ETFs.”  Investing in ETFs is desirable for many investors because ETF shares, unlike shares of mutual funds, can be traded throughout the day.  In addition, ETFs allow investors to access asset classes in which many of them would not otherwise be qualified to invest, thereby helping to diversify these investors’ portfolios.  Although securities regulation permits anyone, including so-called retail investors, to buy ETF shares, in practice ETFs are not an option for a certain group of investors—namely, those whose only involvement with the securities markets occurs through their participation in retirement plans sponsored by their employers. 

This Article suggests that this exclusion is not the product of investor-protection regulation but rather a side effect of inertia and conflicts of interest among financial firms that dominate the retirement plan market.  It is a problematic side effect, moreover, not only because, under relevant employment law, these firms are obligated to act in retirement plan participants’ best interests. Rather, it is problematic also because the investors who are harmed most by the exclusion of ETFs from retirement plan menus are those at the bottom end of the wealth and income spectrum, particularly Black, Hispanic, and women-led households.  Presenting both litigation and regulatory action as options for opening retirement plan doors to ETFs and providing greater investment opportunities to lower-asset individuals, the Article ultimately concludes that the Securities and Exchange Commission, as the relevant regulator, should pursue strategic rule changes.