The Role of Empirical Research in Designing, Evaluating and Implementing Regulation

1. The Role of Empirical Research in Designing, Evaluating and Implementing Regulation Jill E. Fisch University of Pennsylvania Law School AALS Workshop on Blurring Boundaries in Financial and Corporate Law June 8, 2014

2. The Power of Empirical Research The Merits Don’t Matter The PSLRA

3. Lessons from the PSLRA • Empirical research can be a really powerful tool in designing, implementing and evaluating regulation • Empirical research helps policymakers understand • The need for regulation • The effects of regulation • But empirical scholars can overclaim and • The limitations of empirical tools are often misunderstood

4. Using Empirical Research to Design Regulation “American investors lack basic financial literacy.”

5. Recent SEC Study of Investor Financial Literacy • Investors shown prospectuses from hypothetical mutual funds • Investors (according to the SEC) claimed to understand more than they actually did • SEC focused on investor satisfaction with the disclosures • Does the summary prospectus contain too much legal jargon? • Was the summary prospectus “user-friendly?” • SEC did not ask • In what ways were investors illiterate? • Could investor literacy be improved?

6. Why do Investors Make Costly Mistakes?(and what can we do about it?) • The mistakes • Trying to time the market (and failing) • Paying too much in fees • Not understanding risk • Naïve diversification • Why do investors make these mistakes? • Financial illiteracy? • Inadequate disclosures? • Investor irrationality? • Agency failures and conflicts?

7. Investors are not financially literate • 36% of our sample knew that if interest rates go up, bond prices go down • 38% knew that stocks have historically generated better returns than bonds, CDs or money market funds • 65% believed that index fund performance can vary substantially depending on the expertise of the fund managers • While most identified diversification as an important investment policy, only 49% agreed with the statement that diversification reduces the variability of one’s portfolio

8. Preliminary results • Investors are not financially literate • Investors that were financially literate or had investing experience made fewer mistakes • Investor education and tips improved investor performance but had a differential impact on the financially illiterate Why isn’t the SEC doing this?

9. Empirical research and Proxy Access • DC Circuit: “The SEC relied on insufficient empirical data” • What were they unhappy about? • SEC’s failure to demonstrate that proxy access would improve firm value • How would you do that? • What should they have been unhappy about? • Failure of SEC to demonstrate any empirical basis for the limits of the rule - who owns 3%? Consider that CalPERS and CalSTERS (the lead plaintiffs in the Enron litigation) together owned 0.7% of the company. At one time, this represented an investment of $450 million

10. Empirical Research and Halliburton Plaintiffs should be required to do an event study to prove price impact What would this cost? What’s an event study? Great Idea

11. The Theory Behind Price Distortion The corrective disclosure The lie Stock Price Ex Post Price Distortion Ex Ante Price Distortion Time

12. The Challenges of the Price Distortion Inquiry • Limits of event studies for proving ex ante price distortion • Timing of the disclosure • Confirming disclosures do not move prices • Confounding events (and bundling) • Intervening events • Methodology - single firm, single event • Interpretation of a null result • Significance of stock price reactions (or lack thereof

13. The Power of Empirical Research Revisited • Effects of regulation are not all readily measurable • Competing and incommensurate objectives inform policy analysis • Empirical scholars should be cautious about the scope of their normative claims