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Refreshed Policy and Financial Services Regulation Could Spur Investing

Aron Szapiro


In my role as Morningstar's director of policy research, I get a lot of questions asking why the government is (or isn't) doing something, and why government bureaucrats think an approach will be helpful. I think many people have an idea of how the government operates that fundamentally misses how it tries to accomplish policy goals.

In a new paper, I examine the tools the government uses to provide a better framework for analyzing financial services regulation and policy.

The existing framework for understanding financial services regulation is flawed

Despite popular conception, governments are not top-down hierarchies directly carrying out most social programs through their bureaucracies. While financial professionals and their government counterparts may assume their relationship is antagonistic, this need not be the case when it comes to helping ordinary investors: The government’s goals are often aligned with industry’s goals.

In fact, to help ordinary people invest, the U.S. government created a policy infrastructure built on a massive public-private partnership. Most financial services would not exist without the regulatory infrastructure the U.S. government created to facilitate serving investors. The government wants to help ordinary investors because smart, disciplined investing allows millions of people to maintain their standard of living in retirement and allows pools of capital to flow to productive uses. Given this partnership, government regulators should see their role as the conductor of an orchestra, keeping the players working together, and not as a just as the police officer, stopping bad guys.

Think about “tools” of government, not specific regulations, laws, or policies

In the new paper, we try to refresh the language around how the government tries to help investors, drawing on concepts from Lester Salamon’s breakthrough 2002 book, The Tools of Government. As Salamon explains, governments typically try to induce third parties to carry out their policy goals with a variety of tools. For example, to promote homeownership, Congress set up a variety of loan and loan guarantee programs and provided generous tax benefits for buying a home.

So, rather than focus on specific agencies, laws, or sets of regulations, we focus on the “tools” the U.S. government uses to incentivize individuals to invest and private companies—employers, investment advisors, and asset managers—to help them.

With this framework in mind, let’s examine the three tools our government relies on to help investors:

  1. Tax incentives, which promote investing for retirement, higher-education costs, and other goals.
  2. Disclosures, which help people understand which investments might best suit them.
  3. Regulation of advice, which governs the standards of conduct for financial advisors.

The tools of government could stand to be sharpened, and we aren’t always using the right tools for the job

From the ordinary investor’s perspective, the government's tools have helped some people, but they've grown dull and are inadequate for the needs of millions of Americans.

For example, despite periodic expansions of the tax incentives for investors to put more of their money into retirement savings, around half of U.S. workers are not investors, largely because small employers less frequently offer plans.

In terms of disclosures, ordinary investors find them difficult to parse and understand. Financial institutions also limit disclosures to investors only, rather than filing publicly available documents. These non-public disclosures impede third parties from effectively contextualizing the information to more broadly help investors. This is particularly true for 401(k) plan lineup information, which is still shrouded in secrecy.

Finally, the government has unevenly used regulation to govern advisors’ conduct with retail investors, enforcing different standards for different types of investment accounts, which is confusing.

Using the framework to understand new, innovative policy proposals

We see a lot of evidence that policymakers are heeding these lessons, sharpening their tools, and trying new approaches.

In terms of moving beyond tax incentives, Congress has recently dusted off a proposal to make it easier for small plans to band together to offer retirement plans, and there is considerable bipartisan support for it. The tax benefits to the principals at a small business simply are not enough to outweigh the costs—administrative expenses and matching contributions—of operating a plan. Further, small plans struggle to match the quality of large plans. Tax incentives haven’t spurred most small businesses to offer plans, so it makes sense for policymakers to try something new.

Policymakers continue to realize that a key audience for disclosures is not individual investors, but the public at large.

Recent efforts to pass the Financial Transparency Act would add structure to many disclosures, making it much easier for third-party advisors to contextualize them for ordinary people. Further, the Department of Labor plans to revisit its 2016 proposal to make 401(k) plan lineup data publicly available, and the SEC chair recently requested public input on enhancing disclosures for advisors.

Finally, financial services regulation for advice can be a powerful tool, but the varying standards of conduct advisors follow for different types of accounts is confusing—even to professionals. The SEC has been looking at this issue for years, and the SEC has said a proposal is coming soon. Coming back to the “tools of government" framework, it should not surprise us that the recent delays and litigation on the DOL rule is not the end of the story.

Read the full paper "Bridging the Investing Gap."

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