Reasonable Investor(s)

Much of financial regulation for investor protection is built on a convenient fiction. In regulation, all investors are identically reasonable investors. In reality, they are distinctly diverse investors. This fundamental discord has resulted in a modern financial marketplace of mismatched regulations and misplaced expectations—a precarious marketplace that has frustrated investors, regulators, and policymakers.

In a new article, Reasonable Investor(s), published in the Boston University Law Review, I examine this fundamental discord in financial regulation, and seek to make a general positive claim and a specific normative claim. First, the general positive claim contends that a fundamental dissonance between investor heterogeneity in reality and investor homogeneity in regulation has created significant discontent in financial markets for both regulators and investors. Second, the specific normative claim argues that policymakers should formally recognize a new typology of algorithmic investors as an early step towards better acknowledging contemporary investor diversity, so as to forge more effective rules and regulations in a fundamentally changed marketplace. Together, both claims aim to highlight the harms caused by not better recognizing contemporary investor diversity and explain how we can begin to address those harms. Ultimately, the article aspires to create a new and better framework for thinking about investors and investor protection.

The article constructs this framework in four parts. Part I provides a typology of diverse investors. It begins with the bedrock paragon of the reasonable investor that is the central character of financial regulation. It then introduces other types of investors that deviate from the bedrock paragon in terms of cognition, activism, wealth, and personhood. It exposes the varying types of reasonable investors in the modern marketplace in contrast with regulatory theory’s dominant, singular type of reasonable investors. In doing so, Part I presents a lineup of distinct investors and reveals a fundamental incongruity in financial regulation.

Part II explores that incongruity. It reveals the critical dissonance between investor heterogeneity in reality and investor homogeneity in regulation. It then explains how this problematic dissonance has generated a dissatisfying set of mismatched regulations and misplaced expectations for regulators and investors. Part II investigates the problem of how this critical dissonance in financial regulation has harmed investors and frustrated regulators.

Part III turns from problem to solution. It proposes a new typology of investor, the algorithmic investor, as an initial step towards improving investor protection. It starts by outlining a fundamental shift in financial markets and the emergence of a new algorithmic investor typology. It describes the significant shift in finance from human intelligence and human actors to artificial intelligence and supercomputers that gave rise to a new type of investor. Part III then articulates the definitional parameters of this new investor typology to provide an early template for regulators. Part IV considers key implications of the new typology. It examines the impact of the proposed typology on the design of financial regulation in general. It then focuses specifically on the ramifications of the proposal on disclosure and materiality, two of financial regulation’s core concepts. Part IV suggests that the formal adoption of a new algorithmic investor typology can lead to a better understanding and protection of all investors.

The article ends with a brief conclusion. It recounts the comforts and complexities inherent in protecting a diverse population of investors in a changing financial marketplace and echoes the important call for a more nuanced, more honest, and more workable understanding of investors and investor protection.

The full paper is available for download here.