The Dangers and Drawbacks of the Disclosure Antidote: Toward a More Substantive Approach to Securities Regulation

Abstract

This article analyzes and critiques the federal securities laws' reliance on disclosure as the primary method of protecting investors and regulating the securities markets. Since the inception of the federal securities law seventy years ago, the policy has always been that, as long as corporations disclose all material information about their operations and their stock, public investors can make their own informed investment decisions. The unprecedented number of corporate frauds, scandals, and bankruptcies in recent years has revealed weaknesses in the traditional disclosure strategy of regulation. Disclosure rules did not protect American investors from the damages they suffered when large public corporations, such as Enron and WorldCom, collapsed. As a regulatory response, Congress enacted the Sarbanes-Oxley Act, which many legislators described as "sweeping reform." However, the thrust of the Sarbanes-Oxley Act was to require corporations to provide even greater disclosure to the investing public. This approach to regulation reflects the customary belief that disclosure is the antidote for most of the securities market's ills.

This article challenges the underlying policies of disclosure-based regulation and identifies several drawbacks of the disclosure remedy. Using the psychological research on cognitive and behavioral biases and heuristics, Professor Ripken questions the assumption that investors can rationally and efficiently process disclosed information to their advantage. Rules that require more and more disclosure can lead to information overload and less effective decision-making. The article argues that we must be careful about placing too much confidence in the disclosure solution. Professor Ripken proposes a more substantive approach to securities regulation that deals with difficult corporate governance issues on their merits and regulates corporate conduct in a more direct manner.

Keywords: securities regulation, disclosure, sarbanes-oxley, investor protection, investor confidence, corporate governance, information overload, securities market, rational choice, heuristics, cognitive bias, overconfidence, optimism, confirmation bias, sophisticated investor, securities fraud

JEL Classification: D21, D23, G14, G34, K22, K42, L15, L21, M14