Micah Hauptman: Advocating for Investors’ Best Interests

Our guest on the podcast today is Micah Hauptman. Micah is the director of investor protection at the Consumer Federation of America, a nonprofit association of nearly 300 national, state, and local pro-consumer organizations. He leads CFA’s investor protection work through conducting research and engaging in advocacy on investor protection issues, focusing primarily on the regulation of investment advisors, investment companies, and broker/dealers, particularly as they relate to the provision of retail investment products and services. Prior to rejoining CFA in early 2022 Micah served as counsel to Securities and Exchange Commission commissioner Caroline Crenshaw, and before that he served as CFA’s financial services counsel for nearly seven years. He also worked at Public Citizen on a broad range of banking and tax issues and started his career as a prosecutor for the Los Angeles City Attorney’s office. Micah received his bachelor’s degree in political science from UCLA and his JD degree from the University of the Pacific McGeorge School of Law.

Background

Bio

Key Challenges for Investors

“New Offerings of Crypto in Retirement Plans Underscore Need for DOL Fiduciary,” by Micah Hauptman and Dylan Bruce, consumerfed.org, April 4, 2023.

Department of Labor’s 2016 Fiduciary Rule: Background and Issues

“Improving Investment Advice for Workers & Retirees,” U.S. Department of Labor, dol.gov, June 29, 2020.

Regulation Best Interest

Regulation Best Interest (Reg BI) Overview

“What Regulation Best Interest Means for Brokers and Asset Managers,” by Aron Szapiro, Morningstar.com, Nov. 18, 2019.

“Beyond the FINRA Suitability Comfort Zone,” by Matthew Radgowski and Jill Axline, Morningstar.com, March 9, 2020.

Cryptocurrency

“Crypto: Risks Abound,” by Micah Hauptman, consumerfed.org, Nov. 17, 2022.

“With Crypto, Advisors Need to Tread Carefully,” by Jasmin Sethi, Morningstar.com, Aug. 15, 2022.

“Bitcoin in Your 401(k)? Not so Fast,” by Madeline Hume, Morningstar.com, April 27, 2022.

Social Media

“Investors in the United States: The Changing Landscape,” A Report of the FINRA Foundation National Financial Capability Study, finrafoundation.org, December 2022.

“Why You Should Stop Taking Investment Advice From Social Media,” by Sunniva Kolostyak, Morningstar.com, June 16, 2021.

Environmental, Social, and Governance

“CFA Strongly Supports SEC Proposals to Enhance ESG-Related Disclosures and Update Names Rule,” by Micah Hauptman and Dylan Bruce, consumerfed.org, Aug. 16, 2022.

“Amid Charges of Greenwashing, Sustainable-Investment Industry Attempts to Reassure Investors,” by Leslie Norton, Morningstar.com, June 8, 2022.

Other

“Robert Powell: ‘How Do I Generate the Income?’” The Long View podcast, Morningstar.com, March 14, 2023.

Morningstar Investment Conference 2023

If you’re looking for even more investing insights, data, and analysis, join us at this year’s Morningstar Investment Conference, April 25 through 27 in Chicago. We have a great agenda this year featuring top financial minds, from market gurus like Liz Ann Sonders to great investors like Steve Romick to retirement planning experts like Mary Beth Franklin and Dr. Laura Carstensen, there is something for everyone looking to tackle the challenges and opportunities for investors in the current market. We’re in-person only this year, so check out the link in our show notes to register. We’re looking forward to seeing you in Chicago.

(Please stay tuned for important disclosure information at the conclusion of this episode.)

Jeff Ptak: Hi and welcome to The Long View. I’m Jeff Ptak, chief ratings officer for Morningstar Research Services.

Christine Benz: And I’m Christine Benz, director of personal finance and retirement planning for Morningstar.

Ptak: Our guest on the podcast today is Micah Hauptman. Micah is the director of investor protection at the Consumer Federation of America, a nonprofit association of nearly 300 national, state and local pro-consumer organizations. He leads CFA’s investor protection work through conducting research and engaging in advocacy on investor protection issues, focusing primarily on the regulation of investment advisors, investment companies, and broker/dealers, particularly as they relate to the provision of retail investment products and services. Prior to rejoining CFA in early 2022 Micah served as counsel to Securities and Exchange Commission commissioner Caroline Crenshaw, and before that he served as CFA’s financial services counsel for nearly seven years. He also worked at Public Citizen on a broad range of banking and tax issues and started his career as a prosecutor for the Los Angeles City Attorney’s office. Micah received his bachelor’s degree in political science from UCLA and his JD degree from the University of the Pacific McGeorge School of Law.

Micah, welcome to The Long View.

Micah Hauptman: Thanks for having me. Looking forward to the conversation.

Ptak: Us too. Thanks so much for being here. Maybe we’ll start with some background for people who might not be familiar with what the Consumer Federation of America is. Can you describe the organization and what its mission is?

Hauptman: CFA is a nonprofit association of more than 250 national, state, and local consumer groups that was founded in 1968 to advance the consumer interest through research, advocacy, and education.

Benz: Can you talk about how CFA gets its funding?

Hauptman: We have a number of funding streams, including other organizations that pay to be members of CFA. We host conferences and receive money from participants, advisory committees, and sponsors. We have an annual fundraiser event; we receive grants from foundations; we receive cy pres awards from litigation; and we also receive some corporate funding, including from Morningstar.

Ptak: Maybe to back up, can you talk a little bit about your career journey? You earned your JD and then went to work as a prosecutor in the LA City Attorney’s office. What drew you to the financial-services sector and specifically investor protections within the financial sector?

Hauptman: Great question. I got to CFA and investor protection in a bit of a roundabout way. First I should mention that my interest in investing began when my uncle gave me a subscription to Kiplinger’s magazine as a teenager. Perhaps a weird gift for others, but it was totally up my alley. But my interest in financial regulation grew when the market was melting down in 2008. I graduated law school in the great recession, when jobs were few and far between, and it was very difficult finding a permanent job that was the right fit. Having personally experienced the fallout from the crisis, as well as having family and friends who struggled to recover from it, it instilled in me a desire to ensure that such a catastrophe and the dynamics that contributed to it never happened again. I didn’t have a background in financial regulation. I never took securities regulation, for example, in law school. So, I needed to learn on the job.

Ultimately I landed a job at another consumer advocacy nonprofit, Public Citizen, where I worked on a broad range of financial and tax issues, which gave me a strong base of knowledge. And I had worked with Barbara Roper on several issues through coalitions and saw what an expert she is and wanted to learn from the best. So, when a position at CFA opened up, I jumped at it. I was at CFA for about seven years before I decided to go work for commissioner Caroline Crenshaw at the SEC. I was there for about a year and a half and then Barb came to the SEC to be senior advisor to Chair Gensler. So, her director position at CFA opened up, and I decided to return to CFA to take that position.

Benz: Can you discuss your experience at the SEC? Were there any aspects of that job that were particularly eye opening to you?

Hauptman: Yeah, it was a great experience. I learned a ton in a very short amount of time. I learned how the building works, how staff approach issues, the politics of the building. I was there for four chairs, two of them on an acting basis. But I was there in the minority during Jay Clayton’s term and in the majority during Gary Gensler’s term. And so, I saw widely different approaches to how the building can be run. And I think I have a much better understanding of how things work and that will help me as an advocate navigating policy, politics, and the process.

Benz: You mentioned being in the minority at one point in time. Can you discuss the dynamics of that? It depends on who you are working for within the Commission for people who aren’t steeped in this, as you are.

Hauptman: There are five members of the Commission, typically three in the majority party and two in the minority party. And whoever is president, chooses the chair. Under Donald Trump’s presidency, Jay Clayton was Republican chair. There are three Republicans and two Democrats. And I worked for one of the Democrats.

Ptak: Can you talk for a minute about how your experience there yielded insights into the way the regulatory agenda is set? And I’m sure that that could vary quite a bit depending on who was in the majority at a given point in time, but maybe as it relates to consumers in particular, what insights did that yield about what the SEC focuses on at a given point in time?

Hauptman: That’s a great question. It’s very top-heavy. It really is based on the chair’s priorities. Typically, a chair goes into the building having a number of priorities and they want to get them through. To a certain extent it can be informed by staff, to the extent that staff have been working on issues that need addressing, then the chair can decide to include those on the agenda. So, include some that are, I would say, more politically motivated and more that are more I would say administrative in nature.

Benz: Let’s stick with the SEC for a minute. What are chair Gensler’s priorities as you see them?

Hauptman: I think his top priority is enforcement of crypto markets. He’s made the point that most crypto assets are securities and most of those are not registered. And so, they’re in violation of the law and he’s been very aggressive in enforcement of crypto markets. On the regulatory side, it’s an expansive agenda and it ranges from public versus private markets to equity market structure, modernization to digital engagement practices, to cybersecurity and everything in between.

Ptak: The SEC under Chairman Gensler, has been quite aggressive in the words of our colleagues on Morningstar’s policy team. Would you agree with that characterization?

Hauptman: I would agree in some respects and I would disagree in others. He’s been aggressive in setting a regulatory agenda with about 50 rule-makings. The SEC has proposed a bunch of those rules but hasn’t finalized many of them. We’ll have to see how many the agency actually finalizes before the end of Chair Gensler’s term and what the content of those rules is. Also Chair Gensler, as I said, has been very aggressive with crypto enforcement. However, I would point out that Chair Gensler has not been so aggressive in implementing and enforcing Regulation Best Interest, and so far I think that’s a lost opportunity to give the rule real meaning. I wish he would make more of a priority of it.

Benz: You mentioned that your predecessor, Barbara Roper is now senior advisor to Chair Gensler, and she focuses on retail investor protection. We would assume you probably have a good channel for regular communication with the SEC, but can you describe how you work with the SEC on an ongoing basis?

Hauptman: I advocate before the SEC on behalf of the investor interest. That includes advocating for the SEC to pass strong rules that protect investors from being harmed in the market. Advocating for the SEC to engage in robust examinations of members of the industry. And advocating for the SEC to zealously enforce the law. I’m often a countervailing voice to the voices the SEC usually hears from the members of the industry that the SEC regulates. Members of the industry are typically motivated by their business interests, and they seemingly have limitless resources and they are in constant contact with the SEC. But I have the privilege, which I don’t take lightly, of trying to figure out what’s best for investors, not the industry, and then tailoring my advocacy efforts toward those ends.

Ptak: I think some observers, they might look at the financial-services industry and come away with the idea that the industry always get its way, sometimes to the detriment of consumers and investors, because it has such deep pockets and is so well-connected in Washington. And I think that you’ve alluded to that dynamic already. Can you think of any recent examples when this hasn’t been the case, either legislation or regulation that benefits consumers potentially at the expense of the industry and its profits?

Hauptman: Yeah, so this answer may prove your point. Because consumers ultimately lost. I don’t know if it’s the best example, but the 2016 Department of Labor fiduciary rule, which would have required all financial professionals who provide retirement investment advice to be fiduciaries and act like prudent professionals without regard to their own financial or other interests was finalized, despite almost ubiquitous and vociferous opposition from the financial-services industry. What made that rule-making so successful was we had quality research proving conflicts of interest are pervasive and very harmful to investors. We had a compelling story to tell the public, the Department of Labor had staff that were committed to doing the right thing, and the White House, all the way up to President Obama, was on board. And we had organized a broad and diverse coalition to support the rule.

So, while we weren’t able to match the industry’s resources, we had everything else going on for us. And I think that that is really what it takes to win in that type of environment, but sadly the rule was struck down by the 5th Circuit Court of Appeals where two judges who issued the opinion engaged in what I think is a profound misreading of the law. So ultimately the industry did win, more so based on good form-shopping than anything else, though. But since that answer was kind of depressing, I’ll answer with a more recent happier example.

The SEC recently finalized new rules to require funds to send investors tailored shareholder reports. The rule will require funds to provide concise, visually engaging shareholder reports that highlight key information such as fund expenses, performance, and portfolio holdings. While the fund industry didn’t oppose the reports or their content. They did oppose how these disclosures will be sent to shareholders. They wanted to be able to use electronic delivery to put these disclosures online and then provide a paper notice that the disclosures are online instead of directly providing the reports to shareholders. And we and other investor groups strongly oppose that approach. There are many investors who want to receive their documents in paper format and don’t want to search for them online. And the final rule said that funds can’t provide these disclosures electronically unless the shareholder has elected to receive the disclosure electronically. That way, all investors will receive the disclosures in a way that they want, and I think that’s an important win for investors.

Benz: I want to go back to the topic of investment advice, which you mentioned previously. If you think about the landscape for people seeking financial advice, investment advice, and you had to give it a grade from A to F in terms of how easy it is to find an advisor and figure out what you’re paying and so forth—if you had to give it a grade from A to F, the landscape currently for consumers, where would you put it?

Hauptman: Well, I’m feeling particularly optimistic today, so I’m going to give it a D.

Benz: Oh boy. Sounds like you’re pretty downbeat. It’s a confusing area, I would agree. Can you discuss why you think the landscape isn’t as good as it could be, and why some of the regulations currently in effect maybe aren’t as strong for the consumer as they should be?

Hauptman: I mentioned that the DOL rule was struck down. So, we have reverted back to the rules that applied in 1975. And basically, there are several loopholes in the definition of who is fiduciary. So, if you don’t want to be a fiduciary, you don’t have to be. In the wake of the DOL fiduciary rule being struck down, the SEC under Jay Clayton stepped in and finalized Reg BI, Regulation Best Interest, for brokers, providing recommendations to retail customers. And while it’s not a fiduciary rule, the SEC has said it is drawn from key fiduciary principles that include an obligation to act in the retail investors’ best interest and not place their own interests ahead of the investors’ interest. And that sounds great but the evidence to date suggests that it hasn’t really changed anything.

Ptak: And what sort of evidence would you be looking for to determine whether or not Reg BI was changing things for the better?

Hauptman: There are a couple of places. First, state securities regulators have published several reports highlighting the fact that many broker/dealer firms still place their financial interests ahead of their customers. The state securities regulators said that most firms are operating in the same manner as they were under the previous suitability rule, especially when it comes to harmful compensation conflicts, and that firms continue to sell what the state securities regulators report refers to as complex, costly, and risky products and their speaking of leveraged and inverse products, private placements, variable annuities, and nontraded REITs.

Finra also put out a recent exams report and found that firms are failing to comply with their obligations under the rule. Specifically, Finra found that firms are making recommendations without a reasonable basis to believe that they’re in the best interest of retail customers. Their firms are not identifying or addressing all potential conflicts of interest relevant to the firm’s business model. Firms are not providing retail investors with full and fair disclosures, and they’re failing to adopt written policies and procedures that are reasonably designed to achieve compliance with Reg BI.

And most recently, there was an SEC risk alert highlighting deficiencies found during exams, as well as examples of weak practices that could result in deficiencies. Specifically, they found firms did not have reasonably designed policies and procedures to comply with various parts of the rule. And in addition to compliance failures, staff observed instances where broker/dealers failed to understand the recommended product, failed to obtain or consider the customer’s investment profile, and failed to understand the potential risks and costs associated with the recommendation. Meanwhile, there’s only been one enforcement action for violation of Reg BI. So, the evidence to date is disturbing, it may be too early to tell, but we’re losing time to make the rule real and meaningful and retail investors are paying the price.

Benz: What steps would you, in an ideal world, take to make Reg BI more effective and really do what it set out to do?

Hauptman: Well, given the lack of enforcement, that’s the place I’d start. In my view, strong enforcement has the greatest potential to put meat on the bones of what is a very principles-based standard. Particularly as far as what the rule permits and what it prohibits in practice. I also believe that strong enforcement has the greatest potential to provide real teeth to the rule and meaningful protections to retail investors. So, in my view, the goal should be to make clear that the best-interest standard is a substantially stronger standard than the Finra suitability rule that it replaces. And to ensure that firms aren’t permitted to encourage and reward bad advice, no matter how profitable it is to them. And ensuring that the rules requirements to consider costs and reasonably available alternatives is not merely a box-checking exercise.

Benz: What should consumers do in light of where the regulation stands currently? What should they look for if they’re seeking a financial advisor?

Hauptman: The best advice I can give is look for an advisor who minimizes conflicts of interest in their business model. And the best place to look is with a fee-only advisor. The only way they get paid is directly and transparently from the investor, and that minimizes conflicts of interest. And you can find a fee-only advisor on NAPFA’s website, the National Association of Personal Financial Advisors. In addition, the CFP board has stronger fiduciary standards than the SEC and you might consider looking for a CFP professional, and you can go to their website to find one. I think it’s important to note that at this point the development of the market, investors can pay for services a variety of ways, whether it’s assets under management or hourly, or by engagement, or monthly subscription. And so that should cater to a variety of retail investors’ needs.

Ptak: I wanted to go back to your optimistic D, so to speak, and we talked about Reg BI and how it’s been somewhat toothless to this point. I have to think, though, that there’s maybe some other reasons for your optimistic D that go beyond Reg BI. So, I guess if one wanted to address the state of the state in terms of consumer-friendly regulatory priorities, what are other things that you would want to see the SEC or others focused on to lift that D to hopefully an A someday?

Hauptman: I think it goes back to enforcement, strong and meaningful enforcement to give the rule real teeth. And I think that sends a powerful message to the industry that they have to meaningfully change conduct. They need to minimize conflicts of interest. They need to ensure that they are really considering costs and reasonably available alternatives that it’s not just a box-checking exercise and that their job is to serve investors, not themselves. And I think you can do that through zealous enforcement of the law.

Benz: You referenced cryptocurrency as one of the SEC’s priorities, and it’s something I know that CFA has written about as well how consumers and how advisors should approach cryptocurrency. Can you discuss that, share your thoughts on that space and how consumers should be thinking about it?

Hauptman: There are many risks in the crypto market. And I think investors need to be incredibly careful when approaching crypto markets. They can be highly speculative and volatile investments with prices that can swing wildly and crash without warning. It can be extraordinarily difficult, even for expert investors, to separate the facts from the hype with regard to crypto assets. Crypto-related assets are not held like traditional assets in trust or custodial accounts, which can expose them to heightened risk of fraud, theft and loss, and FTX’s recent failure illustrated these risks and the harms that can flow from them. And crypto-related assets raise valuation issues because they may not be subject to traditional empirically validated valuation methodologies.

And finally, as Chair Gensler has made clear so many times. Crypto-related assets are often unregistered and they’re often offered by or through providers who are unregistered or operating outside of or not complying with existing regulatory frameworks. And so that creates additional risks for investors. And finally, we have no idea what the government is going to do with crypto and that is an additional risk that crypto regulation may evolve in unpredictable ways. And so, anyone who’s thinking about investing in crypto or recommending investors invest in crypto, really fully understand the implications of doing so.

Benz: One thing that came up was the idea of crypto in retirement plans in the 401(k) context. Can you give us your take on that idea and whether you think that will actually gain any traction, that we’ll start to see that?

Hauptman: I hope not. There are a couple of providers who have expressed an interest in providing crypto to plans. And I think it’s still early to see what the uptake is going to be. But as I mentioned, crypto is incredibly risky and it can be particularly risky and volatile and have particularly devastating impacts for people who are approaching retirement. And I think it’s important to note that the financial-services firms that are offering access to crypto are not going to be on the legal hook. Ultimately, it’s going to be the plan sponsors. Typically, these are businesses that—the employers—who decide what to include in their plan lineups. They are fiduciaries, they are going to ultimately be liable for the decisions they make and those decisions may be deemed imprudent and they expose themselves to enormous legal exposure if they offer crypto and it ends poorly for investors. And given how volatile the market is, that at some point, I think that is likely.

Ptak: Do you think this is just a cycle that we’re destined to see again and again when the markets are strong and the economy is good, that new investors flood into the market and embrace risk only to get washed out as risky assets fall? Are there any steps that you would seek that would help break that negative cycle that it seems like we so often have a propensity to fall into.

Hauptman: I absolutely think that some of this has been the function of the market going gangbusters until 2022. In the social media that I’ve seen, there were a lot of people expressing, can’t-lose attitudes, and I suspect that the recent market turbulence has and will continue to cause a lot of new investors to question their practices and there is evidence that new investors have been increasingly turning to financial professionals rather than doing it themselves, which may be beneficial to the extent that they are engaging in less-exotic, less-harmful behavior. But I do worry, though, that if some new investors lose enough of their money, and that’s their first interaction with the market they may become cynical and forgo investing altogether in the future and not participate in the gains that the market has to offer over the long term.

Hopefully they decide to turn to low-cost-efficient products and buy-and-holds and not take so much risk, but I think it’s too soon to say. But to answer your other question about whether there are any steps we could take to help break the negative cycle. I do think that there are some regulatory improvements that could help, at least with regard to complex products. I’m not sure whether crypto would be included in that. We’d have to think about how to do so. But I think that we could better ensure that only those investors who understand complex products, essential characteristics, and risks use them. By requiring broker/dealers to exercise due diligence and improving customers to trade complex products only if it is appropriate for their customers in light of the customers’ objectives and financial situation.

Benz: You referenced social media and I’d like to get your take on the role of social media in all of this. You shared prior to this podcast a Finra foundation study that examined the behaviors of newer investors in the market and it indicated that a lot of younger investors especially are getting their investment information from social media, and they’re not necessarily getting great information, as we know. So, is there any way to protect investors in social media settings?

Hauptman: Unfortunately, this one’s a bit tough. To the extent people on social media are just expressing a view, their speech is protected under the First Amendment. However, to the extent they’re getting paid and many of them are finfluencers—financial influencers—then there may be some ability of regulators to ensure at least that they’re disclosing their compensation and conflicts. A big concern that I have with social media is the potential for market manipulation on online platforms, particularly platforms like Reddit that are anonymous. Someone could engage in what is effectively a 21st-century pump-and-dump scheme—recommending a security that they hold, waiting for others to buy it, then selling it, leaving everyone else holding the bag. Anonymity may undermine the ability of market regulators to police manipulative and distortionary practices.

Benz: I wanted to follow up on that. You and I had an exchange about some activity I had noticed on YouTube where people proffering investment advice were lurking in discussions below YouTube videos, including some of our Morningstar videos. What’s to be made of that phenomenon. What do you think is going on there? What are those people trying to achieve? Are they legitimate? It doesn’t seem like they’d be legitimate financial advisors, but I’m wondering if you can give me your take on that.

Hauptman: It’s bizarre, but I think that there are people who are trying to get attention by any means. And I think that if they’re trying to get attention with people who are already interested in investing, then it would make sense that they would follow and respond to Morningstar’s social media.

Ptak: I suppose one protection against some of the manipulative, exploitative behavior you’ve been talking about is financial education. Yet many investors’ knowledge levels aren’t where they ought to be on basic matters like the importance of fees, how past performance doesn’t protect future results, let alone the more complicated investment concepts and products based on them. Are there any financial education efforts that you’re especially enthusiastic about that could be beneficial to those that might otherwise be exposed and exploited by some of the practices you’ve been talking about?

Hauptman: Unfortunately, most of the research shows financial education doesn’t work. There are a lot of people who believe that it should work and in another world it would, but the evidence is the evidence and what I would say is we have to look to the evidence. And while a bit dated, there was meta analysis published about a decade ago reviewing, it was like 200 studies on financial education, and they found that interventions to improve financial literacy were remarkably ineffective. And you have to think about why? For one, as with other things that we learn in school, we don’t remember them very long. So even if a high schooler is taught about financial concepts, they may not remember those concepts when it comes to making financial decisions.

Another issue is that financial education is unlikely to work in a market as complex as ours, and so rather than spend time, energy, and money on an endeavor that doesn’t work. I’d rather focus on things that we know do. And just-in-time education, which aims to provide financial education when it matters most, when the financial decision itself arises and the education can be immediately applied. For example, teaching about mortgages when you’re about to buy a house. Or teaching about investing before you sign up for your work’s 401(k). We know those are more effective than financial education more broadly. Another idea that’s not financial education-related at all, but I think it’s worth noting, is creating good defaults and any need for education. For example, auto-enrollment in 401(k)s and auto-escalation. That way we don’t have to rely on education to address problems. We can address them through other ways.

Benz: Well, speaking of that, we’ve discussed nudges at length on this podcast, but one thing I’d be curious to get your perspective on is for people who are about to retire—that there’s a confusing juncture for people where they’re handed their 401(k) assets, or whatever retirement plan they have, and sent on their merry way. Do you think that there could be room for innovation to make things better for consumers at that life stage than is currently the case?

Hauptman: Yeah, absolutely. I think you were talking with Bob Powell about retirement planning and I agree that target-date funds are a great option for accumulation, but we don’t have a similar vehicle for decumulation. And I think it’s because there are a lot of choices that have to be made. But it could certainly be simplified, and I think that technology offers the opportunity to do so. There was a robo-advisor that did retirement planning and focused on decumulation issues, collecting Social Security, planning for Medicare. And I believe it was bought and I don’t know the status of it, but they use technology to help investors make these decisions and I think that we could adopt an approach more broadly and help investors at a really difficult, challenging time in their financial lives.

Ptak: What’s your take on the growth of private securities markets and the fact that so much capital formation is happening through securities that aren’t required to register with the SEC?

Hauptman: The securities laws are based on a simple idea that all investors should have access to certain basic facts about an investment prior to buying it, and as long as they hold it, and those basic facts allow investors to value their investments and make sound and informed investment decisions. But over the last four decades, Congress and the SEC have repeatedly chipped away at that basic principle, and they have allowed more and more securities to be offered and sold without providing the basic facts necessary to enable informed decision-making.

So, the point where full and fair disclosure seems to be the exception rather than the rule. I think that we’ve gone too far. And I think it’s important to contrast public markets with private markets. In public markets, registrants operate with transparency and accountability. In private markets they carry significantly higher risks for investors and permit issuers who operate without transparency or accountability. It’s dark. And investors may not receive complete and reliable information. Investors may not get the best available price when buying and selling private securities.

Favored investors can get access to special deals that retail investors are unlikely to get, and so it’s a really two-tiered market. And private securities are generally illiquid and trading can be very expensive and inefficient. Today, hundreds of billions of dollars in private securities are now being sold without providing the basic facts necessary for an informed decision and that poses significant risks. Not just for individual investors who risk making poor investment decisions, but also the broader economy, which suffers when capital fails to flow to its best uses. And private markets appear to be more prone to fraud and other predatory practices, and that shouldn’t come as a surprise given the lack of transparency and limited regulatory oversight. Because bad things happen in the dark. So, I think restoring a healthier balance between lit and dark markets is really important. And I’ll note that there are rule-makings on these issues on the SEC’s regulatory agenda. So, I’m optimistic that will make some headway.

Benz: Speaking of the SEC’s agenda, when we were talking about the SEC earlier, you mentioned that ESG—environmental, social, governance—investing, is something the SEC is looking at. And I know that’s something that you have looked at CFA as well. It’s become a bit of a political football, ESG has. Do you think investor protection should be strengthened in that space and if so, how?

Hauptman: Yes, I do. I’ll mention two areas where retail investors interact with markets through funds and advisors because I think that makes the most sense here. But as background, I’ll say that the umbrella term ESG is very broad and undefined. So, to a certain extent, I think that that’s a good thing because there are a range of preferences among investors and approaches taken by asset managers to reflect different ESG-oriented objectives and expectations. And I think as a result, the ESG asset-management market is incredibly diverse with different funds and advisors approaching ESG innovation in myriad ways. However, the lack of definitions and consistencies also raises risk that funds and advisors might use the ESG moniker to attract assets without conforming their practices to meet investors’ preferences, objectives, and expectations.

And greenwashing is a real problem. And greenwashing is misleadingly labeling practices or products as green or sustainable without actually making real changes to those practices or products. And recent research suggests that greenwashing is occurring with some prevalence in the fund market. Another concern is it may not be clear how funds or advisors are investing according to ESG principles. Because not only do different funds and advisors approach ESG in different ways, they also approach their disclosures in different ways. And while some disclosures are clear, many others are vague and lacking detail, and it can make it really difficult for investors to find decision-useful information, if it exists at all, and to understand, compare, and differentiate between different offerings to identify the offerings that are the best match for them.

And I’ll say when we reviewed ESG fund prospectuses, we found some prospectuses to be lacking clarity and detail about how funds incorporate ESG factors into their investing processes. These prospectuses provided vague, almost aspirational disclosures, which would not enable an investor to understand how the fund really incorporates ESG into its process and compare with other funds. And so, in order for investors to make informed investment decisions, I think it’s critical that investors understand how each ESG product or advisory service incorporates ESG considerations into their investing processes. And the SEC has a proposal on ESG disclosures for funds and advisors and the proposal is designed to ensure that investors have more meaningful information that enables them to make more informed investment decisions and we support it.

Another issue is with fund names. Many investors rely on fund names to help them decide whether to invest in a fund and fund names are often the first piece of information about a fund that an investor receives, and in some ways, in some cases the fund name may be the primary or only piece of information the investor considers. Funds clearly understand that fund names can influence investor decisions, and that’s why funds are very careful to choose names that are appealing to investors and likely to attract assets. And recent research on the use of ESG terminology in fund names found that greening a fund name, is beneficial for fund flows. So, this raises the risk that funds may be using such names to attract assets without actually making bona fide investment decisions based on ESG considerations or they’re exaggerating the extent to which they’re considering ESG factors.

The SEC has a proposal on fund names that would more effectively require that funds invest in a way that accurately reflects their name and investment focus, and it would address the use of ESG terminology and fund names by limiting the use of ESG in so-called integration funds. And those are funds that consider ESG but where ESG is not a main focus of the investment strategy. So that’s another rule we support.

Ptak: To your point about greenwashing, we recently had a portfolio manager insist to us that a strategy that employed inflation index Treasuries and options was ESG. So greenwashing is very much alive and agree with you on that. In closing, maybe to widen out a bit, and ask you about how pragmatism affects the way you decide which issues to focus on. Do you focus on the areas where your research suggests that consumers most need the help, or do you also factor in the likelihood that you’ll be able to enact meaningful change on that issue given what’s going on in Washington at that given point in time?

Hauptman: That’s a great question, Jeff. I think it’s a combination. We work on quite a number of issues and they can include issues where investors need the most help, but maybe the potential for progress, at least in the near term, is not great. And for those situations, highlighting the research and educating policymakers in the press may be the best route in the short term to gain attention and increase understanding of the issue. And we also work on live issues that are under consideration. So, to the extent that we determine that we can have a positive impact on the process and outcome. It may make sense to shift our attention to those issues. However, where we don’t feel like we can add anything to the debate, and it probably doesn’t make sense to shift our attention, we don’t want to waste our time and energy. We need to be really thoughtful and strategic and recognize where we can and can’t add value.

Ptak: Well, Micah, this has been a very illuminating discussion. Thanks for sharing your insights with us. We’ve really enjoyed talking to you.

Hauptman: Thanks, it’s been great to be here.

Benz: Thanks so much.

Ptak: Thanks for joining us on The Long View. If you could, please take a minute to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

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Benz: And @Christine_Benz.

Ptak: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we’d love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. While this guest may license or offer products and services of Morningstar and its affiliates, unless otherwise stated, he/she is not affiliated with Morningstar and its affiliates. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis, or opinions, or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)