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SEC Releases Study on Financial Literacy While Retail Investors Wait for the Movie

Jay Gould of Pillsbury Winthrop Shaw Pittman LLP


On August 30, 2012, the Securities and Exchange Commission (the “SEC”) released the Dodd Frank Act’s mandated study (the “Study”) on the financial literacy of retail investors which concludes, as you might have predicted, that retail investors are essentially clueless about investing and financial matters generally. That slapping sound you heard was the high-fiving by stockbrokers everywhere across America. Among the selected findings were that retail investors lack “basic financial literacy” and that such investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud. It should come as no surprise that certain subgroups, such as women, African-Americans, Hispanics, the elderly, and the poorly educated have even less basic financial knowledge than the general population.

Without water boarding you with the details of this 182 page report, the SEC obtained the information necessary to reach these conclusions by conducting focus groups and quizzing investors through an online survey. These methods revealed that investors can’t identify basic financial products, can’t calculate fees, do not understand conflicts of interest, and, if that were not enough, can’t read an account statement. The Study concludes with a strategy and set of goals for increasing financial literacy among this retail class. The goals should be to improve investors’ understanding of risk, the fees and cost associated with investing, proactive steps for avoiding fraud and increasing general financial knowledge. These laudable goals are to be achieved, quite magically, by devising education programs that target specific groups that are deemed vulnerable, such as young investors, lump sum payout recipients, investment trustees, members of the military (if you ever want to know how much we value our military personnel, look into periodic payment plans), underserved populations, and older investors.

Certain members of the financial industry have agreed to work together on an “ask and check” campaign that would encourage individuals to check the background of investment professionals before using them, and to encourage investors to verify that a potential investment is legitimate before investing. Financial regulators have agreed that more information should be added to the investor protection section of the SEC’s website and that a general campaign should be embarked upon that will help individuals understand the fees and costs associated with financial products.

But why are the findings and conclusions of the Study important now? Well, a couple of reasons come to mind, one of an immediate concern, the other longer term in nature. First, you may have read that the SEC recently released for public comment the rules that will lift the ban on “general solicitation” for otherwise private offerings. These rules, if adopted in their proposed form, would permit private issuers, including private funds, to solicit investors generally through all forms of public media, including newspapers, the internet and mass mailings. Issuers will be required to take reasonable steps to determine that all investors meet sophistication and accreditation standards before accepting an investment, but make no mistake, these rules are the most significant changes to the securities offering process since the Securities Act of 1933 was signed into law. Many state securities regulators are predicting an avalanche of new frauds aimed squarely at those categories of vulnerable investors that the Study identified.

In a world where modern means of communication have forever blurred the lines between information that is privately distributed and that which is in the public domain, it makes little sense to cling to the old concepts of private offerings to investors with whom one has “pre-existing, substantial relationships,” and we have actively supported the lifting of the ban. However, with increased rights come increased responsibilities. It will be the responsibility of all of those in the private funds business to remain vigilant against potential frauds and scams, to adopt “best practices” on behalf of ourselves and our clients, and to work more closely with regulators in order to protect not just investors, but the viability of our industry itself. We hope that fund managers and those who serve them will take these obligations seriously with a longer term view.

As for the longer term, this November the U.S. will elect or re-elect a President. One of the most significant issues in this campaign will be around entitlement reform. That is, what to do about the long term health of Medicare, Medicaid and, for purposes of this discussion, Social Security. In his second term, Bush II attempted to privatize Social Security to some degree. This proposal generally envisioned allocating a third or a half of a retiree’s account into a “personal plan” over which the retiree would have investment discretion. Rather than a guaranteed payout from Social Security after choosing a retirement age, each retiree, most of which have the level of sophistication discussed in the Study, would be responsible for making his or her own investment decisions. It is fairly easy to figure out who might be in favor of putting millions of unsophisticated, financially illiterate people in charge of the assets that would otherwise be paid out by Social Security on a monthly basis. Whether and how the results of the Study are used in the debate on Social Security reform should be, at a minimum, very interesting to watch.


Jay Gould, Partner, jay.gould@pillsburylaw.com

Mr. Gould practices in the Corporate & Securities area and is leader of Pillsbury’s Investment Funds & Investment Management practice team. He counsels clients involved in all aspects of the financial services industry. Mr. Gould represents US registered investment companies, hedge funds, offshore investment companies, investment advisers, retail and institutional broker-dealers, and municipal bond underwriters. Mr. Gould has extensive experience in drafting private placement memoranda, partnership and limited liability company agreements, subscription agreements, registration statements, proxy statements, periodic reports, no-action letters, applications for exemptive relief and other documents for filing with the SEC, the FINRA and other regulatory agencies.

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Pillsbury Winthrop Shaw Pittman LLP

Pillsbury Winthrop Shaw Pittman LLP (www.pillsburylaw.com) is a full-service law firm with a keen industry focus on energy & natural resources, financial services, real estate & construction, and technology. Based in the world's major financial, technology and energy centers, Pillsbury counsels clients on global regulatory, litigation and corporate matters. We work in multidisciplinary teams that allow us to anticipate trends and bring a 360-degree perspective to complex business and legal issues—helping clients to take greater advantage of new opportunities and better mitigate risk. This collaborative work style helps produce the results our clients seek.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Pillsbury Winthrop Shaw Pittman LLP. This work reflects the law at the time of writing in September 2012.