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Executive Summary

At a time when the transition to a primarily Internet-based system of disclosure is well underway in the securities industry, this report examines how the Internet can be used to improve the effectiveness of financial disclosure. Toward that end, the report identifies potential benefits and pitfalls of Internet disclosure; the pre-conditions necessary for effective Internet disclosure; the most significant barriers to effective disclosure, regardless of delivery method; and how Internet disclosure may be able to help reduce those barriers. Our analysis of these questions is informed by an extensive literature review, examination of industry websites, interviews with experts, and surveys of investors and financial professionals. The following is a brief summary of our findings, which are described in greater detail in the body of the report.

The Potential Benefits and Pitfalls of Internet Disclosure

It has long been recognized that Internet disclosure allows for information to be disseminated much more quickly, updated more easily, and delivered at a significantly lower cost to financial services firms. As the Internet has evolved, however, views of its potential benefits have expanded. Among the key additional potential benefits of well-designed Internet disclosures identified in our literature review and expert interviews are:

• the ability to layer disclosures, enabling investors to choose the level of detail they wish to receive;
• increased capacity to incorporate graphic and even video elements, to make disclosures more appealing and accessible;
• enhanced ability to search disclosures for the most relevant information;
• access anywhere and anytime from a variety of devices;
• improved archiving of information;
• the ability to package disclosures with tools, such as calculators, and other educational materials in order to improve investor comprehension;
• environmental benefits from the reduced demand for paper; and
• enhanced ability for third parties to analyze and repackage the information to make it more useful to investors.

Despite these considerable potential benefits, even the strongest Internet disclosure advocates acknowledge that there are also potential pitfalls to electronic delivery that must be taken into account when developing policies and practices in this area. Traditionally, the leading issue has been lack of Internet access for significant portions of the population (discussed further below), followed closely by concerns about privacy and information security. Experts have identified the following additional potential pitfalls:

• Internet users who have become accustomed to rapidly scrolling through long legal contracts and clicking the “I agree” button at the bottom may give electronically delivered disclosure documents the same cursory review;
• investors who have been taught to be leery of clicking on links in emails, because of concerns about “phishing” or malware, may be reluctant to accept delivery of disclosures through hyperlinks in email messages;
• email may be easier to ignore or lose track of than paper mail or may get caught in spam filters;
• disclosures may get lost, inadvertently or intentionally, on websites that serve a variety of competing functions; and
• even as we are becoming more accustomed to computer-based disclosures, increasing numbers of individuals now access the Internet primarily through a smartphone, raising a whole new set of issues with regard to security and readability.

Investors Express Mixed Views about Internet Disclosure

Investors surveyed for this report expressed mixed views about the benefits of Internet disclosure. For example, most (60 percent) strongly agreed that electronic delivery is better for the environment than paper disclosure. On the other hand, just under half of surveyed investors expressed strong agreement with regard to other potential benefits identified by experts, including: that electronic delivery makes it easier to access information prior to meeting with their broker or adviser; that it could significantly reduce the cost of disclosure and therefore reduce their fees; that the interactive nature of the Internet can make it easier to find the information that is most relevant to them; and that the layered disclosure possible on the Internet enables investors to choose the degree of detail they want to receive. Financial professionals expressed significantly more favorable views about the potential benefits of Internet disclosure in each of these areas.

Moreover, privacy and information security clearly remain a major concern for a substantial minority of investors, and these concerns appear to pose the most significant impediment to investor acceptance of electronic delivery. Nearly a third (32 percent) of surveyed investors indicated significant reluctance to permit Internet disclosure because of concerns about security and/or privacy. Similarly, a perception that paper-based disclosures are more secure and better protect privacy was considered the strongest selling point of paper delivery among surveyed investors. Despite these concerns, most investors appear to have an open mind about Internet disclosure. Only slightly more than a third (37 percent) of those surveyed expressed a strong preference for receiving all disclosures as paper documents for the foreseeable future.

Many Firms Make Good Use of Internet in Presenting Information to Investors

Our website evaluations turned up numerous real-world examples of how financial services firms are using the flexibility and functionality of the Internet to present information effectively. We found numerous examples of firms’ incorporating visually appealing design elements into their websites, layering information in order to provide that information in more consumable chunks, providing easy navigation within and among topic areas, supplementing written materials with video, putting disclosures in context by providing a broad range of supporting tools and educational materials, providing appropriate security protections around sensitive personal financial data, and allowing access through a variety of devices. On the other hand, we also found examples of potential pitfalls and one major missed opportunity. In particular, use of pleasing design elements was sometimes selectively applied and was not always extended, for example, to information about fees or revenue-sharing payments that the firm did not wish to highlight. Also, links to important disclosures were in some cases less than prominent. As for the missed opportunity, while many firms offered a tool investors could use to locate a financial adviser in their area, none of the sites we reviewed provided direct access along with that tool to an individual broker’s or adviser’s BrokerCheck or IAPD reports.

The Pre-conditions for Effective Internet Disclosure: Investor Access and Attitudes

For Internet disclosure to function effectively, investors must have ready access to the Internet, and the legal framework for disclosure must permit electronic delivery. These basic requirements have largely been met. For Internet disclosure to reach its full potential, however, investors must fully embrace this disclosure mechanism, and the legal framework for disclosure must be flexible enough to allow for innovations that take full advantage of the Internet’s capabilities. Challenges remain in each of these latter two areas, as discussed further below.

Uneven or limited Internet access, which once was a major impediment to expanded use of the Internet for mandatory disclosures, appears to be largely a thing of the past. Research indicates, for example, that a sizeable majority of American adults (roughly 80 percent) and nearly all investors are Internet users, and most today access the Internet through broadband connections. While a persistent minority, particularly among older and less well-educated adults, do not use the Internet and have no intention of changing, use among minorities and among more moderate-income households has grown significantly in recent years. Moreover, those who do use the Internet use it more frequently and for uses closely related to investing, such as making online purchases and online banking. While efforts can and should be made to further close the digital divide, inadequate Internet access is not a concern it was even just a decade ago.

Although attitudes appear to be evolving, ready access to and frequent use of the Internet does not necessarily equate to willingness to use the Internet for investment-related purposes. Slightly more than half of our survey respondents reported using the Internet for investment-related purposes at least “sometimes,” but nearly as many reported using it for this purpose either rarely or never. Fewer than one in ten reported using the Internet for investment-related purposes “very frequently,” while another 15 percent reported doing so “frequently.” Among the survey findings with particular relevance for this study, just over half of those surveyed indicated they would be willing to use the Internet to receive reports and documents. Investors expressed greatest willingness to use the Internet to view account information, obtain general information, and research individual investments, with significant majorities expressing a willingness to use the Internet for each of these purposes.

On the other hand, some of this lukewarm support for receiving disclosure electronically may reflect a general lack of interest in reading disclosures, rather than a strong bias against using the Internet for this purpose. In fact, when asked about their preferences for receiving certain types of disclosure either electronically or on paper, survey respondents were slightly more likely to express a preference for electronic delivery, particularly with regard to information on compensation practices and background information on individual professionals. Not surprisingly, preferences were strongly correlated with age, with younger investors preferring electronic delivery and older investors preferring paper disclosures. Nonetheless, even among younger investors, a significant minority continues to prefer traditional paper disclosures over electronic delivery.

Despite these pockets of resistance, our findings suggest that a majority of the investors surveyed are willing to at least consider a transition to electronic delivery, including a significant minority who are already making that transition.

The Pre-conditions for Effective Internet Disclosure: The Legal Framework

The Securities and Exchange Commission established the legal framework permitting electronic delivery of disclosures in the mid-1990s. In doing so, it identified a set of simple, flexible principles for electronic delivery that have allowed electronic disclosure practices to grow and develop in concert with the subsequent dramatic expansion and technological evolution of the Internet. The framework turns on three basic requirements: direct notice of the availability of electronic disclosures, access that does not make it too burdensome for the investor to locate and read the disclosure document, and evidence of delivery. The latter can be satisfied either through direct evidence or through informed consent of the investor and compliance with the notice and access requirements. The Electronic Signatures in Global and National Commerce Act (or ESIGN Act), enacted by Congress in 2000, imposed an additional requirement to obtain consent to electronic delivery through an electronic consent method. While the SEC has the authority to adopt an exemption, it has so far chosen not to do so for broker-dealer and investment adviser disclosures.

Some now suggest that the SEC’s electronic disclosure policy needs to be updated.

Among the issues that are raised in that context are questions of what constitutes delivery and whether the time has come to switch the delivery default from paper to electronic in order to speed the transition to an Internet-based disclosure system. In addition, some suggest that the legal framework needs to be updated for a different purpose: to enable firms to take full advantage of the flexibility of the Internet in designing disclosures for electronic delivery.

What Constitutes Delivery?

Since at least 2000, various industry groups have periodically urged regulators to eliminate the disclosure delivery requirement in favor of an “access equals delivery” model. Under this model,“delivery” could be accomplished solely by an issuer posting a document on the issuer’s or a third-party’s website. Advocates have strongly objected to that approach. Although the Commission has decided the issue differently in different contexts, it has generally upheld the notion that some form of notice is required to satisfy the delivery obligation. Meanwhile, technological changes – including widespread access to email over high-speed connections and techniques for providing password-protected access to account information online – have significantly eased the burdens of electronic delivery. It is now possible to deliver even very lengthy documents via email, either as an attachment or through a link to the firm website.

Financial professionals surveyed for this study appeared at the very least to be confused about what satisfies delivery requirements. When asked their view of delivery obligations, for example, roughly two-thirds of financial professionals said that obligation was satisfied by providing transparent access. On the other hand, while an overwhelming majority of financial professionals viewed mailing of paper documents and email with printable attachments as satisfying the delivery requirement, only half believed that sending an email with a hyperlink to the document would constitute delivery, and fewer still felt that providing a link on a website would constitute delivery. This may represent their view of what would satisfy legal requirements rather than what ought to be sufficient. However, the SEC’s electronic delivery policy clearly suggests that an email containing a link to a document would satisfy the delivery requirement, so long as the investor had consented to electronic delivery.

Investors surveyed for this report were highly skeptical of an approach based on access alone. Asked their preference among various electronic delivery methods, fewer than one in ten expressed a preference for receiving disclosures through notices on their broker’s website. Half expressed a preference, if disclosures are delivered electronically, for receiving those disclosures in the form of a printable attachment to an email, while three in ten expressed a preference for receiving disclosures in the form of a hyperlink within the email. In other words, an overwhelming majority of investors wants even electronic disclosures to be delivered to them in some fashion.

Meanwhile, some firms are using electronic delivery to improve the likelihood that disclosures are actually read by investors. One firm with a heavy retail customer base has adopted the practice of monitoring whether those customers who have chosen electronic delivery are in fact accessing disclosures they receive electronically. When customers go too long without accessing the disclosure documents, the firm sends them a message which, if ignored, causes the customer to be defaulted back into paper delivery. Another firm described a system of A/B testing they use when emailing notices to customers. Testing two different versions of the email, the firm can determine almost immediately which is the more effective, i.e., which is most likely to be opened and read by recipients. They then switch to the more effective version. These efforts to increase the likelihood that disclosures will be read simply wouldn’t be possible or practical in the context of paper disclosures.

Who Gets to Choose the Delivery Method?

In recent years, the debate appears to have shifted away from whether firms have an obligation to deliver disclosures to the question of who gets to choose the delivery mechanism. Consumer advocates have traditionally argued for an “opt in” approach, requiring consumers to affirmatively choose to receive disclosures electronically. Some industry representatives and Internet disclosure advocates see this approach as impeding the transition to electronic delivery, as simple inertia keeps individuals who might be willing to receive disclosures electronically from making the switch. The issue is important, since research has shown that how we set the defaults – opt in versus opt out – has a dramatic effect on the choices investors will make. Indeed some behavioral science research suggests that defaults have a far stronger influence on the actual choices made than preferences. This suggests that an approach that aligns defaults with preferences will produce the optimal outcome. However, survey data on investor preference for paper versus electronic delivery offers no such clear signposts.

The significant percentage of investors who continue to prefer paper delivery suggests that investors may not yet be ready for electronic delivery to be the default option for investment disclosures. On the other hand, the discrepancy between those who indicated a preference for electronic delivery (44 to 48 percent) and those who actually report receiving at least some disclosures electronically (30 percent) suggests that the current opt-in approach is not producing results that align with investor preferences. Although investors generally expressed satisfaction with their disclosure delivery mechanism, respondents who said they receive some of their disclosures electronically were more likely to say they are “very satisfied” with their delivery method.

If it were possible to move away from the opt-in/opt-out paradigm and structure choices about delivery as a neutral choice, such an approach might produce decisions about delivery that more closely reflect actual customer preference. In the meantime, many firms are offering investors what one might characterize as the best of both worlds.At these firms, even those who prefer to receive disclosures in paper form have the option of accessing those same documents online, often through a special password-protected area of the website where their account information and relevant documents are maintained.

Is More Design Flexibility Needed?

Disclosure rules often dictate such details as what information must be provided the document’s cover, the order in which other items must be presented, and in some cases even the minimum type size for certain disclosures. A number of experts have suggested that investors will not receive the full benefits of Internet disclosure – such as greater use of layering of information or break-down of documents into multiple screens of information – until rules are revised to allow more flexibility in the design of disclosures to take advantage of the Internet’s capabilities. The review of company websites for this report provided ample support for this viewpoint. A striking contrast exists between the innovative design many companies employ in presenting supplemental information on their websites, such as investor education material, and the much more mundane presentation of mandatory disclosures.

The question is whether it is possible to achieve the benefits of design flexibility without losing the benefits of standardization. While some experts are optimistic, and believe exploring ways to provide that flexibility should be a priority, others suggested that the liability that attaches to mandatory disclosures, rather than inflexibility in the rules themselves, is the main factor inhibiting innovation. Meanwhile, some firms are already experimenting with ways to realize the design benefits of the electronic delivery within the existing disclosure framework for mandatory disclosure documents. One firm, for example, is exploring presenting portions of the online version of the mutual fund shareholder report in video format. Several firms let investors customize the presentation of their account documents on the password-protected area of their website. Among other things, they offer investors the option of having information consolidated across all their accounts or presented in ways that most prominently feature the information of greatest interest to that investor. However, even those who are doing most to explore the possibilities offered by electronic delivery seem to agree that to do more they would need more flexibility under the rules.

Barriers to Effective Disclosure

Disclosure is an essential investor protection tool, but there are limitations to what even the best designed disclosures can be expected to accomplish. The report discusses a number of barriers to effective disclosure:

• Investment decisions are complex, with virtually limitless options available and numerous, often technical factors to consider in order to identify the best
• Many investors lack the skills and expertise to make good investment
• Investors don’t make good use of the information that is provided to them, often spending little time researching their investment decisions.
• Disclosures do not reflect investor preferences for disclosures that are brief, readable and delivered before they have to make an investment decision.
• Investors are often overwhelmed by the volume of information provided which may have the perverse effect of causing them to make less use of the information provided.
• Many investors don’t want to make their own investment decisions, preferring to rely instead on recommendations from financial professionals.
• Investors struggle to understand and use information about conflicts of interest, which takes on added importance given their heavy reliance on professionals.

In our survey of financial professionals, we asked about their views on the effectiveness of disclosures generally and to what degree they felt that different factors constituted a barrier to effective disclosure. A majority of financial professionals (56 percent) agreed that mandatory disclosures are “generally effective tools for protecting retail clients.” On the other hand, less than a fifth of financial professionals believe that retail clients make good use of the mandatory disclosures provided to them. Asked to rate how strongly they agree with a series of statements about possible barriers to effective disclosure, financial professionals surveyed were most likely to agree that “excessively technical or legalistic language,” “difficulty in finding useful information in lengthy, printed materials,” and “lack of interest in disclosure information among clients” undermined disclosure effectiveness. In addition, half of all financial professionals strongly agreed that clients prefer to rely on advice rather than research investments on their own.

How Internet Disclosure Can Help

Recent research suggests that even minor changes in presentation can influence investors’ willingness to read disclosures, their understanding of the information presented, and the choices they make as a result. Given the significant impact that these design choices can have on disclosure effectiveness, it seems logical that, properly implemented, Internet disclosure could have similarly beneficial effects. We are not suggesting that Internet disclosure is a panacea capable of curing all the problems that undermine disclosure effectiveness, but the research for this report does suggest that there are ways in which Internet disclosure can help. While some may require policy changes, others can be achieved within the existing regulatory framework.

The report identifies the following as key areas where electronic delivery can help to improve investors willingness to use and ability to comprehend the disclosures they receive.

• Investors consistently express a preference for receiving disclosures well in advance of any investment decision. Financial services firms have traditionally resisted such a requirement on the grounds that it would impose unacceptable Internet disclosure offers a variety of easy and affordable means of delivering disclosures prior to any investment decision.
• Internet disclosure can help to reduce information overload through the layering and better design of disclosures. Layered disclosures allow for a less intimidating introduction of disclosure information and enable investors to choose the degree of detail they wish to explore. Housing disclosure documents on the Internet also opens up new possibilities in designing disclosure documents in ways that present information in more visually appealing and consumable screen-size chunks. Investors who can as a result approach disclosures a topic at a time may be less likely to feel overwhelmed and thus less likely to be turned off by disclosure documents.
• Internet disclosure can’t make investment decisions less complex, nor can it eradicate financial illiteracy. But presenting disclosure documents on websites in combination with Internet-based tools and investor education materials could help to promote increased investor comprehension. At the very least, it could ensure that investors have ready access to the background information necessary to make a more informed choice. At the same time, Internet disclosure also could make it possible to provide certain types of disclosures, most notably cost disclosures, in ways that are more relevant to the investor. When a financial adviser recommends a dollar amount investment in a particular product to the investor, for example, or compares two or more investment options, it ought to be quite easy, using Internet-based tools, to provide the investor with dollar amount cost information.

While some investors are unlikely ever to make more than minimal use of disclosure materials, preferring to rely exclusively on a financial professional for advice, others could reap significant benefits. The easier the materials are to access, the more relevant their content, and the more appealing their design, the more likely it would seem to be that investors would make use of them.

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