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The Government Loves the Fee-Disclosure Tool

But what can fee disclosures realistically accomplish?

Aron Szapiro

 

Morningstar’s recent paper (co-written with NORC at the University of Chicago), “Expensive Choice: What Wall Street Can Learn From Costco,” has a very interesting upshot: Some investors have a hard time accounting for fees even among nearly identical index-fund investments. In addition to the interesting behavioral economics implications of this finding, there are also some policy implications.

We must be realistic about what fee disclosures can accomplish

As we explained in a related paper, the government’s fee-disclosure tool has some limits, which this paper further serves to put into relief. The fee-disclosure tool is not very coercive, direct, or automatic, and it's only modestly visible compared with other interventions the government might use to help investors.

4 dimensions of the fee-disclosure tool

  1. Coerciveness describes the degree to which a tool merely encourages (or discourages) certain behavior or whether it requires certain behaviors. Disclosure requirements are highly coercive only for financial institutions, which may be fined or even lose access to a market for failing to provide necessary disclosures. Ordinary investors are free to read or ignore disclosures, and even if they read them, they may not understand them. This is in sharp contrast to other kinds of public information campaigns, which generally have a much clearer call to action. For example, Smokey Bear's message about forest fire prevention is pretty direct.
  2. Directness measures whether the government carries out a program itself or relies on third parties to do so. Fee disclosures are often very indirect—the government asks a third party to reveal some information to another third party. As such, it shouldn't surprise us that these disclosures are often designed in a way that doesn't provide a useful nudge to investors to avoid higher-fee products.
  3. Automaticity—or how well a tool uses existing administrative structures—is also low for disclosures. When they design fee disclosures, regulators must constantly update the information they collect, as it often becomes out of date as norms and practices evolve.
  4. Disclosures are modestly visible. After all, investors receive them and probably flip through them. However, when disclosures are filed with a regulator and publicly available (such as on the SEC’s EDGAR system), that’s when they rise to highly visible.

Fee disclosures work best when third parties can easily contextualize them for ordinary investors

Over the past few decades regulators have missed a small revolution in who actually uses disclosures. It is not ordinary investors. Rather, an army of “fintech” and “regtech” companies use data—when they get it—to contextualize disclosures. In particular, third parties help ordinary investors contextualize what fee disclosures mean, such as whether their fees are high or low relative to other options.

Our new research showing ordinary people picking high-cost investments over low-cost ones because of an overabundance of choice reinforces the need to ensure that fee disclosures are in a standard taxonomy and publicly available to the third parties that can use these disclosures and illuminate investing for ordinary people.

Read the full paper “Expensive Choice: What Wall Street Can Learn From Costco.”

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