Reconceptualizing Investment Management Regulation

This Article looks at mutual funds, hedge funds, and similar financial instruments as making up a single market - one whose operation is potentially marred by flawed investor decision-making born of imperfect information and bounded rationality. The piece then analyzes whether the current regulatory regime, which sharply divides this market into a heavily regulated sector that is accessible to all investors and a lightly regulated sector that is accessible only to the wealthy, is a well-reasoned response to this threat. I conclude that the current scheme is an ill-fit to the problems of incomplete information and irrationality, and that, in fact, the rules significantly reshape this marketplace to the detriment of ordinary investors. To better respond to these concerns, I propose a reform agenda based on the libertarian-paternalist notion that government intervention should aim to bolster consumer decision-making without undermining freedom of choice. Under this revised framework, regulators would provide investors with information and guidance designed specifically so that investors are better situated to make sound financial decisions even though they are not perfectly rational. The rules, however, would not restrict investor alternatives. Instead, investors would be free to choose from an array of funds subject to varying levels of regulatory oversight. This system unwinds the deleterious aspects of the current regime and responds directly to the flaws in this marketplace, which creates an environment conducive to the type of robust competition that is in the public's interest