Chelsea Follett: Jennifer J. Schulp is the Director of Financial Regulation Studies here at the Cato Institute in Cato’s Center for Monetary and Financial Alternatives, where she focuses on the regulation of securities and capital markets. She has testified before Congress multiple times, including before the US Senate Committee on Banking, Housing, and Urban Affairs, the US House Committee on Financial Services, and The Committee on House Administration. Her writing has appeared in Business Insider, CoinDesk, Law 360, Market Watch, National Review, NBC News, the New York Daily News, and many other outlets. And she joins the podcast today to discuss the relationship between financial policy and progress. Thank you so much for joining me, Jennifer.

Jennifer Schulp: Thanks for having me today.

Chelsea Follett: Okay, so let’s get started, sort of big picture. Tell me about some of the hopeful trends or progress that we are seeing in the financial industry with regards to access to investments. I know this is something you do a lot of work on. We’ve seen all sorts of changes with things like Robinhood recently. Could you tell me about that?

Jennifer Schulp: Sure, and I think Robinhood and apps like that are the place to kind of focus in on because one of the most hopeful trends for me in the financial industry is the broader access to financial investment by really all people. Traditionally, investment, particularly in the United States, but really this is a worldwide phenomenon, has been limited to those who were already wealthy. And in the US, that tended to mean already wealthy groups of people tended to be the ones most often invested in the stock market. Investing in the stock market is really important because that is one of the ways to have long-term growth in investments. And in wealth, because over the past decades, the S&P 500, if it’s remained invested, has returned approximately 8 percent per year, which is way more than you get leaving your money under your mattress in the first place. But tends to be greater appreciation than investment in other things like real estate or, say, other investments that aren’t equity investments.

Jennifer Schulp: So things like Robinhood, which is an online, I’ll say online is not even the right word, which is a phone-based trading app. Has really opened up access for individual investors to be able to invest in the stock market. And I want to put that in perspective because we talk about Robinhood because that’s the thing that’s been in the news. And Robinhood gets a lot of attention for bringing what they call no cost trading to individuals. Really, it’s low cost in a different way. But allowing people to trade from their phone for no individual commissions on each trade. But Robinhood is part of a much longer story about decreasing barriers to financial access for individuals over the course of the past 50 years. Say before I was born, but not much before I was born. In the mid 70s, for example, the way that you could make a stock trade was to call up your broker.

Jennifer Schulp: So you needed to actually get someone on the phone that worked with you. And then you would need to tell them what you wanted to trade. And then they would charge you for the pleasure of doing so. And when I say charge you, I mean like $50 in order to place a trade. Those fees could vary, but they tended to be pretty high. So you didn’t want to place a trade unless you were placing a large trade, because otherwise the fee would overwhelm the trade. And you didn’t want to trade very often because there was a lot of fees involved. Plus the problem of trying to get someone on the phone, working with a broker who, if you’re an average person, might not know about how to deal with that part of the financial services industry. All of it made it very difficult for regular people to invest in the stock market. Over the course of decades, those fees came down as there was additional competition brought into the brokerage space. In the 1990s, we saw the rise of internet trading towards the late 1990s with E-Trade, which allowed you to place trades on your own without needing to know a broker in order to get it done. And we’ve seen over time, the fees continue to decrease and the ease of access continue to decrease up until kind of what’s the Robin Hood effect.

Jennifer Schulp: Robin Hood in 2015 started offering no commission trading on a phone app, which basically opens up the opportunity for people to trade regularly because you’re not worried about fees eating into your profits or losses or adding to your losses. And it has also made it so that people can make, say, investing in the market kind of more of a regular part of their, say financial plan. You could take a little bit of money out of each paycheck and put it in. All of which is much more difficult when you have to interface with a live human broker and have to pay for the privilege of doing so each time. That’s been huge. Robinhood started that trend, but really the entire brokerage industry has moved towards easy phone access for trading and easy, cheap trading. That’s made a huge difference in the number and type of people accessing investment in the stock market in the United States. In 2020, we saw, I’d say during the pandemic, a massive rise in retail trading that a lot of people wrote off to people being bored when they were stuck in their homes.

Jennifer Schulp: It’s turned out that that’s not the only reason, because a lot of those people have remained in the market, even though we are now all allowed to go back out and do other things. So what might have started with kind of a pandemic induced interest in stock market trading has become a much longer term trend towards additional retail trading that has brought in more racial minorities, more people with less wealth to begin with, and younger investors as well. And that’s exciting and really a great opportunity to expand the wealth creation for more than just those who were already comparatively wealthy.

Chelsea Follett: Tell me more about that. You’ve described this as a democratization of investment, this expanding access that is allowing more women, minority, younger, and lower income investors access to this way to create wealth that traditionally they’ve not been able to access as well.

Jennifer Schulp: So that’s all right. I mean, it has, it’s really allowed people the freedom and the ability to say experiment with the stock market, to start to learn by doing. One of the things we hear about all the time is that Americans financial literacy is abysmally low. That we don’t understand anything about finances. I think that’s generally true of the human condition that we tend to do pretty poorly on financial literacy tests. We can set aside whether financial literacy tests are testing the right thing, but I think we can… We all agree that it makes sense to be smart about how you invest your money. And it makes sense to help people learn how to do that. There’s a movement to try to ensure in the United States that people get access to financial education in high school.

Jennifer Schulp: I don’t think that’s a bad idea, but it tends to be that even classes that you might pick up in high school that teach you about risk and return or about, say, the stock market, don’t tend to have the same lasting impact if you don’t then invest in the market for decades after you’ve learned that information in high school. What this type of, say, quote, democratization, I said that’s a word that we throw around a lot, and it’s not one that I necessarily love because it carries a lot of things, a lot of baggage with it, but it’s definitely a way to describe what’s happening here. This democratization is important because not only is it lowering barriers to access, it’s lowering barriers to information. Because one of the best ways that we learn is learning by doing. So having the ability of an 18 year old or a 22 year old who started their first job and doesn’t have a lot in the bank already to put a little bit of that money into the market and see how it works.

Jennifer Schulp: Folks that have a long time horizon. So if they lose a little bit of money now, they’re paying for their education and paying it forward. Learning by doing is great and something that this low cost access allows to happen. In fact, there was a study that came out not too long ago by FINRA and NORC at the University of Chicago that looked at the investors who opened accounts in 2020. And they had a big study back in 2021 about the types of investors that were opening accounts. And that study was great because it showed that it was a different type of investor. They were lower income, younger, from minority populations. The newer study looked at whether those same investor, the same types of investors stayed in the market past the pandemic and how they’re faring these days. And that study found that yes, people stayed in the market. And what I thought was notable about the study is that people showed an increase in their financial literacy having been in the market for a couple of years now.

Jennifer Schulp: So learning by doing, according to the study, and I think according to a lot of other places, works. And having this access, having people with greater financial literacy is a plus. It allows them to understand their own risks better, and it allows them to allocate their own capital better. So there’s a lot of potential here in not just lowering access when we’re talking about individuals, but kind of us as a society, having more people invested in the larger economy, in this ownership stake, in this equity stakes, and having them be smarter about it. It’s just a way to, I think, compound benefits over time.

Chelsea Follett: So what are some of the other benefits of this expanding access? You have, on the one hand, the potential for increased financial literacy, a greater feeling of investment in society. What are some other possible benefits, maybe better personal financial outcomes, contribution to economic growth? Could you describe the other benefits?

Jennifer Schulp: Oh, absolutely. So certainly better personal financial outcomes. Kind of on an aggregate basis. Of course, some people are going to make poor decisions, and we should not be protecting people from making those decisions. So you can’t say, just because you put money in the market, you’re going to be better off. But for people who are looking for long-term investment options, the stock market is, I’d say, the greatest generator of that type of growth and wealth that we’ve ever seen. So having people invest in the market as part of a grander investment strategy, as part of their diversified investment strategy, has the potential to have people grow that wealth and to have better personal financial outcomes, generally speaking. Kind of hand in hand with better, more investment in society. I think we do see more economic growth here for a couple of reasons.

Jennifer Schulp: One, more investment in society allows people to take a stake in it, be interested, and that itself can drive growth. But having retail investors put money that might otherwise be under the mattress or in a low interest earning savings account into businesses allows those businesses to flourish and create jobs. And then there’s additional equity returns for those retail investors. And you can get into, I think, a, say, a positive feedback loop there where you have potential to grow. We’ve seen kind of in other countries where you’ve had more individual investors kind of coming online and being involved in the stock market, kind of an opening of economic growth.

Jennifer Schulp: I was just recently reading an article about India, where retail investors have really started investing far more in the Indian stock market. And that takes the rupees that might have been just stored somewhere and puts them to use. We’re also seeing, say, in countries like Japan that have very high savings rates for individuals, but low investment rates, a real interest in trying to get, say, the folks in Japan to put some of that money that they’re just saving, to put it to active use in the equities markets and in the investment markets in order to fuel growth in domestic and foreign businesses that can then make more jobs, that can make more money. That can give more money to the investors and to the employees who can then themselves invest. So there’s a real possibility for positive feedback that just allows more growth with more of a share by everyone.

Chelsea Follett: Right. So you could get a bigger economic pie and you get more people partaking in the benefits of that. And those are just some of the benefits to the society as a whole and to investors. Let’s also talk about benefits to those who are trying to raise capital from investors, people trying to start businesses, maybe in rural areas or female business. Owners or startup owners, minority communities, and how all of these different groups are now gaining better access to startup capital.

Jennifer Schulp: Sure. And that, excuse me, brings up a set of different questions. Because what we’ve been talking about so far has been retail investment in public equities markets. So stocks that you can buy on the NYSE or mutual funds or exchange traded funds, really what we think about when we think about the stock market. But our stock market doesn’t generally provide what we think of as startup capital. You generally have to be a pretty mature company to want to bring an initial public offering that gets you listed on the stock exchange. Over the decades, you have become a more and more mature company before you’re interested in listing on the stock exchange, which has actually led to a decrease in the number of public companies that there are available for these retail investors to invest in. That’s a problem in and of itself.

Jennifer Schulp: And I think we’re going to get to talking a little bit more about that. But let me kind of divide the world there into public investing and private market investing. And private market investing is where the startup investing happens. And you might think that that’s small. But it’s not. In the United States, far more money is raised in the private markets than in the public markets. So the number of investment opportunities and the amount of money that’s flowing into startups and non-public companies dwarfs what’s available to invest in for the public markets.

Jennifer Schulp: Your average person is not allowed to invest in these private investments in the United States, and generally there’s restrictions on these types of private investments in most economies across the world, where you are only allowed to invest in private investments if you meet certain criteria. In the US, that means you need to be what’s known as an accredited investor, and it might shock you to know that to be an accredited investor, you already have to be wealthy, and that’s the primary consideration for whether or not you are allowed to invest in private market investments, if you make more than $200000 a year or if you have a net worth of over a million dollars, you are allowed to invest in start-ups.

Jennifer Schulp: That’s a problem, and that’s a very serious problem because it assumes that the only people that are smart enough, sophisticated enough, and worthy enough of getting these investment opportunities are people that already have money. That makes no sense. It also makes no sense that people that are wealthy are smarter about investing in the first place. You could win the lottery tomorrow and suddenly become an accredited investor, and that doesn’t make you any smarter at investing than you were the day before.

Jennifer Schulp: And it doesn’t make you any more of a capable investor than someone who say has studied startup investing in their MBA program, but isn’t yet making the money to allow them to invest themselves. So these wealth thresholds are completely arbitrary and do a very over and under-inclusive job at identifying who’s a sophisticated investor. It also happens that in the US, the people that already have that much money tend to be white and tend to be concentrated on the country’s higher income costs, so you have a real divide in terms of who has the ability to invest in start-up companies.

Jennifer Schulp: We’ve talked a lot about investors already, so let’s turn to the entrepreneurs as you asked. Entrepreneurs, the folks that are trying to build businesses out of their garages, out of their local farmers markets or wherever they’re trying to build businesses tend to turn first for money to their community. People tend to raise money from the people that they know best and that they think would have a stake in their businesses. If you are a minority, if you live in a rural area, you don’t know as many people who meet that accredited investor standard, and you’re already at a disadvantage in raising money and getting your business off the ground, that continues to depress the ability of entrepreneurs in less wealthy communities to say, grow their businesses and contribute to the economy as a whole, and it hurts those investors who also can’t invest because they’ve lost the opportunity, A, to support someone that they might think is a very capable entrepreneur, but B, to share in the potential growth of that business. Private market investing is a high risk, but it can also be high reward and those two things go together.

Jennifer Schulp: So preventing people from having the ability to take that risk, also prevents them from being able to get the reward, and when start-up companies… I’d say on average, I think it takes over 11 years now for a company to go public, so that’s 11 years until the average investor can invest in that company, and that tends to be after the company has already passed its high growth phase. So all of those rewards, the high rewards for the high risk are remaining with people that are already wealthy.

Chelsea Follett: So let’s talk more about that. Obviously, the rationale for these kinds of restrictions are to prevent. Risk access to opportunity also means expanding access to risk. Tell me about some of the regulations around that in more detail which you’ve described, I believe that sometimes over-stepping into paternalism.

Jennifer Schulp: Oh yes, and if I’ve described it, sometimes I should describe it always as overstepping into paternalism. The justification for this accredited investor limitation is that investors need to be sophisticated to understand the risks and rewards and investing in private market investments, because private market investments do not have the same required mandatory disclosures, the public market investments do. So the idea is that there’s less investor protection in the private market space, so people need to be smarter to invest in the private market space.

Jennifer Schulp: Coupled with that, the Securities Exchange Commission has worked into that definition, that if you are going to invest in the space, you should also be able to bear a loss, so that is the truly paternalistic part of this equation, it’s plenty of paternalistic to decide who’s smart enough to invest, but when you couple that with the idea that you need to be able to handle the loss, and the government is deciding what it means to handle the loss, and it doesn’t allow you to take into account your own determination about whether an investment is worth it. So the Securities Exchange Commission view here is that if you make more than $200000 a year, you got some money to burn, and that’s okay, so you could lose it in a private investment, that’s fine.

Jennifer Schulp: That’s nuts. And shouldn’t ever be part of the equation. The sophistication angle is a lot longer standing in US securities law than this risk of loss concept, and we’ve seen some movement in Congress lately trying to better tie the accredited investor definition to ideas of sophistication rather than wealth. I say from the outset, I think all of this is generally a problem because it means the government is standing in the individual investor’s shoes and making decisions for them about, Are they smart enough? Are they rich enough? Is this a good idea for them?

Jennifer Schulp: There really shouldn’t be any restrictions in the space, but I said That’s a hard sell right now for both the SEC and congress, so congress has been taking, say, more baby steps to better reform the definition to better tailor it to ideas of sophistication. The house recently passed three bills looking to reform the accredited investor definition, two of them have codify an SEC modification to the rule that said, “If you’ve passed certain securities tests, so if you are a broker or an investment advisor, you too can qualify as an accredited investor, even if you’re not wealthy enough, because we know that you understand how to invest, because you have passed the test that allow you to give other people advice on how to invest.

Jennifer Schulp: So two of those bills kind of codify that and require the SEC to look and see if there are other designations or professional certifications that should be considered similarly. So perhaps if you have an MBA or if you have a CPA, or if you are chartered financial analysts, there’s any number of things that they could look at, and these bills would require the SEC to really sit down and think about who is sophisticated and who should be allowed to invest in these investments. The third bill is a little bit broader than that, it actually opens up the testing concept generally, and will allow, if passed by the Senate and signed by the President, will allow anyone who passes a test to be able to invest as an accredited investor. Again, it’s not an ideal circumstance because there will be costs associated with the testing, it doesn’t really get at the underlying paternalism question, but what it does is open up the doors to more people who are motivated to want to invest in the space to be able to access the accreditation standard with, say, fewer barriers that exist today. So it’s a step forward.

Jennifer Schulp: I testified in front of the house financial services committee on this topic, and I testified with a number of individuals who are involved in the startup investing space, and one of them had spent, I say almost 20 years, serving his advisor on startup investing to start-up investing funds where wealthy people would be able to put money into start-up enterprises, but he never made quite enough money to qualify himself to invest until a year ago. It’s hard to say that he wasn’t sophisticated enough, he’d spent 20 years telling people what to do and how to invest their own money, but he couldn’t invest his because he wasn’t wealthy enough, having an exam will allow someone like him to be able to invest. And while it’s not an ideal situation, it’s better than what we’ve got today.

Chelsea Follett: Absolutely, and as rules around these things can be more or less restrictive, can you tell me about the effect of that on investors and economic dynamism?

Jennifer Schulp: Sure, so rules around accreditation and access to different types of investments are different across the world, but I think kind of a base line is what we were talking about before, in the economic dynamism front, you are really running the risk of not funding a lot of individual businesses that have the opportunity to succeed, simply because the rules that you have in place don’t allow those businesses to be matched with investors who want to see them succeed. And that’s just a problem. Dynamism requires us to have business opportunities for really everyone in the population, all the way from the smallest businesses to the largest, and I think that in these circumstances opening up investment to different types of investors will continue to diversify the types of businesses that can grow and the types of businesses that serve others in the economy.

Jennifer Schulp: Over time, that likely means that the types of investors who are giving small amounts of money now, or the types of investors who are learning how to invest will continue to grow some of them as well, and will themselves bring different voices and viewpoints to the venture capital industry and say others who can continue to find these businesses.

Chelsea Follett: This brings us to the topic of ESG. Could you talk a little bit about what ESG is and will then get into the mandates kind of in both directions on ESG?

Jennifer Schulp: Sure, so ESG is a hot topic, and it’s amazing because no one really knows exactly what it means, because it can mean so many different things based on the speaker, so we routinely see headlines about ESG is good or ESG is bad, and those headlines don’t tend to have a lot of meaning without really understanding what is being talked about. The way I like to think about ESG is we’re kind of talking about two distinct concepts when we’re talking about ESG, and it’s really important to identify which one we’re talking about, and it can be broken down into dichotomy that I’ve borrowed known as value versus values investing. And value investing in the form of ESG basically just refers to using ESG or I realize that I didn’t define it, Environmental Social or Governance factors in order to analyze the risk return potential of an investment or of a company. So that means taking a look at whether or not a company has climate risks that might affect its financial performance, whether the company is facing some sort of social risks that might effect of company’s financial performance.

Jennifer Schulp: In that context, saying ESG is good or bad, doesn’t make a lot of sense because it’s a very individualized determination, and it is undoubtedly the case that some companies face climate-related risks, say you’re insured who insures beach front property. It makes sense for you to consider whether or not ocean level rise is going to affect your financial performance in the future, but it’s not clear that that type of analysis makes sense for say, chip manufacturer, try to determine which one of those situations where ESG factors apply is really nothing new. We think a lot about how individual risks might affect companies and whether that is material to their financial performance, and trying to say that ESG is new there is difficult.

Jennifer Schulp: Where ESG sounds a little bit different is when we think about it as values investing. And there ESG Environmental Social Governance is really kind of the continuation of what’s known as impact investing or socially responsible investing, where you’re trying to reach a certain outcome by investing your money, that means investing your money in order to decrease carbon footprint, investing your money in order to save the whales. And in those circumstances, investors or companies that are making decisions based on ESG in this way, are comfortable sacrificing financial return in order to get to some other values-based end goal, and that is where ESG gets a lot stickier. Again, it doesn’t make a lot of sense to say that it’s good or bad, because investors should have the opportunity to invest their money as they see fit, if they think it makes to want to invest to save the whales.

Jennifer Schulp: They should have that opportunity to do so even if it doesn’t maximize their return, but it gets a lot more tricky when a company makes those decisions about what you do with investors’ money without being upfront with the investors about how those decisions are being made, or where an asset management firm who’s working on behalf of investors is using investor money to pursue goals that the investors are unaware of, so we hear about ESG funds and the question of, are they up-front with investors about what they’re doing, that’s a question of disclosure and whether or not the funds are being clear with investors about how their money is going to be invested and what sort of impact that’s going to have on the returns that the investors can expect, and that’s where ESG gets say more… I don’t want to say I’ll take it back. It’s controversial all the way around because of the way that we’ve created this political divide between good, bad or Black and white on ESG, and it really loses the nuance of A, being precise about what you’re talking about and B, making sure that investment opportunities are available to investors that want them regardless of any sort of government view about the right way to invest.

Chelsea Follett: Right, and so that brings us to the main point, which is, you should be able to determine what is a good or bad investment for you. It’s not the government’s place to say what you should do with your money. And yet we’ve not seen every country take the same approach on this. In Europe, for example, you looked at how they have embraced various ESG related Government mandates. Could you talk a little bit about that and some of the issues with mandates?

Jennifer Schulp: Yes. And I think government mandates are the say the key place to focus in on here, because I do think the rest of it, it should just be up to the market to decide whether or not investing in ESG, however you look at it, is the right way to go. You bring up Europe, which is an interesting case, and then I’ll turn to the United States. Europe has decided, kind of writ large, that the way to tackle climate change, and climate change specifically, is to centrally plan, essentially how money is going to flow through the financial system in order to choke off funds for non-green investment. That is kind of an explicit determination by Europe, including in its net zero commitments and how it expects capital to line up with the net zero commitments. What’s supporting that are a whole host of European directives on sustainable finance that include a lot of disclosure by companies about how they too are going to meet their net zero goals. And how investors in them are going to meet their net zero. It kind of all works together.

Jennifer Schulp: And Europe has got essentially what we in the securities industry refer to as a double materiality standard where disclosures by European companies are supposed to disclose information that is both material to investors in making their investment decisions. So things that might impact the financial performance of the company. But companies in Europe also must disclose how their company impacts society and the environment. And that’s the second part of materiality. All of this comes with pretty heavy costs, and while it is not kind of the central plan of the days of the Soviet Union, it is definitely a centralized plan on how to funnel capital in order to meet certain goals. You can look at that as ESG in terms of values investing.

Jennifer Schulp: There’s an expectation here that there are values, net zero, that will outweigh any sort of financial concerns in putting together the financial system. The United States is considering now how far to follow Europe down that line. And we’ve seen the Securities and Exchange Commission in the US propose kind of a sweeping climate risk disclosure framework. It’s different from the European framework in that the Securities and Exchange Commission at least facially recognizes that they don’t get double materiality. That’s not the system we have set up here. We only have single materiality where the Securities and Exchange Commission is only allowed to require companies to disclose information that investors might find useful in making their financial determinations about whether to invest in the company.

Jennifer Schulp: The SEC’s climate risk disclosure rule, I think, goes well beyond that information that’s material to investors. And I think it’s going to get challenged legally on that front when it gets finalized, although it hasn’t been finalized yet and we don’t know exactly what the final version is going to look like. But what is interesting- in this space is just how sweeping the disclosure would be. It would require all US public companies to disclose an awful lot of information about the climate risk, including scope one, scope two, and for many companies, their scope three greenhouse gas emissions.

Jennifer Schulp: I think there’s a very open question whether any of that is material to investors. But what’s important about that is that it’s not some small undertaking to do this type of investment disclosure. In fact, the SEC itself, who most certainly underestimated the costs of this potential disclosure, itself admits that this would, I believe it was triple the cost of public company disclosure, which is, let’s say frankly, insane to think about. Even if some of this information was material to investors, it’s not clear that it should cost… That the company should undertake three times as much cost to provide information that might be of interest to investors.

Jennifer Schulp: And that in and of itself is going to be a massive drag on public companies’ ability to, let’s say, put that money towards their own businesses. And their own economic growth. Instead, that money is going to go into compliance and disclosure costs, which will, let’s say, spawn some side industries on consultants and accountants. But that’s not exactly the type of economic growth that I think we’re looking for. So not only does it not make sense to have kind of a centrally planned idea about how to reach net zero, if that’s a goal that you’re even striving for, this is a very inefficient way to get there as compared to making say, consistent decisions about environmental policy, for example. The securities regulators aren’t the ones that should be making these types of values-based judgments about the environment.

Chelsea Follett: Right. And this huge regulatory burden of this undertaking can also then slow down economic growth, could slow down the rate of innovations, including innovations that can help deal with many of these problems. And also importantly, as you said before, it takes the choice away from the investors and gives it to government bureaucrats, which gets us to the other side of this. So just as you oppose ESG mandates from the government, you also oppose government rules that would forcibly restrict voluntary ESG-related disclosures. Can you tell me about that?

Jennifer Schulp: Sure. As we’ve seen kind of the rise in ESG, we’ve now seen a backlash known as the anti-ESG movement. Again, the problem with both of these movements is, one of the problems with both of these movements is no one knows what they’re talking about when they say ESG. But the anti-ESG movement has say, mostly been focused at the state level at this point, but in general there’s been a lot of, say, rhetoric and legislation introduced, some of it passed, from state-level Republican legislatures who have been moving towards prohibiting the use of ESG in investment. It depends on the state what exactly that looks like. But it has this broad-based prohibition is also not the right answer, and in fact is itself values-based and seeks to import an ideology onto investing. A lot of the states that have come out with an anti-ESG stance have explicitly done so because they are concerned that ESG is harming the state’s fossil fuel industries.

Jennifer Schulp: Again, that’s an obvious ideological stance and an obvious values-based determination as to how investing should be done. Those states want the investment to go into their oil and gas industries or their firearms industries rather than into another state’s wind farms. So we’re just looking kind of back and forth at which ideology are we seeking to enshrine an investment. At the state level, I think there’s real costs for, say, taxpayers, for folks who have state pensions to having kind of a blanket prohibition on ESG. Because one, it kind of obscures the fact that ESG as value investing actually may be necessary in order to get better returns, depending on the industry or depending on the investment being considered. Pensions in some states that have introduced legislation to prohibit the consideration of ESG factors, have put out analyses showing that over the course of 10 years, the pensions might be losing 6, 10, depending on the size of the pension, billion dollars in returns by having their investment pool artificially limited.

Jennifer Schulp: And we’ve seen in other circumstances where, for example, Texas, which prohibits Texas local entities from doing business with financial firms who are, quote, “boycotting the fossil fuel industry.” So that’s a list of firms that have gotten on the bad list. It prevents localities from doing business with those financial firms. There was a study done not too long ago that showed that the cost for municipal borrowing, so for issuing municipal bonds, has gone up in Texas municipalities because a lot of firms exited the market because they were either on the bad list or just didn’t want to deal with the issues that Texas was putting in front of them. So taxpayers in Texas were now paying more for municipal building projects, for example. So there are real costs at issue here, and we shouldn’t forget that when we’re narrowing the opportunities and narrowing the scope of investments available, you’re also narrowing the opportunities for growth.

Chelsea Follett: So switching topics a bit, although that is a huge topic, could you speak in broad strokes about the potential impact of AI on investment and the financial industry?

Jennifer Schulp: Sure. I would say that is another hot topic these days. Everyone wants to talk about artificial intelligence and the financial industry is no different on that front. But I think there’s a lot of potential for AI in the financial industry space. And in fact, AI has already been busy in the financial industry space. You use AI to… There’s a big use of AI already to be involved with investment research, for example, to look at predictions on a stock’s value, where that stock’s going, thinking about using AI for portfolio management in order to help advise individuals on how to balance their portfolios and how to keep their, say, investment picture looking sound into the future. That’s all going on behind the scenes. I would say, in fact, it’s interesting. We’ve seen several surveys recently of people, of investors from investment houses and others asking if investors want to be using AI. Investors generally seem to be pretty open to using AI, although there’s a substantial chunk that say no.

Jennifer Schulp: But I think a lot of them don’t understand how much AI is already being used behind the scenes to streamline processes in the investment industry generally. Where I think that there’s a real potential to kind of have a similar effect to the one that we were talking about earlier with respect to brokerage apps is for AI to bring investment advice to individuals, to really lower the cost of investment advice and to make it as accessible as trading on your phone is today. We’ve had kind of, it’s hard to call it artificial intelligence but in many ways it is. For a long time we’ve had what are known as robo-advisors, which is essentially being able to get financial advice from a computer.

Jennifer Schulp: Generally, that advice is pretty lockstep. It can’t do as much. It’s like talking with a chat bot that only has so many answers and your tree is pretty narrow as you work through the set of questions. But as we get more and more sophisticated AI, you start thinking about something like the large language models, your chat GPTs of the world, that are able to synthesize a lot more information and talk to investors or individuals in a true conversation, you have the opportunity to have individualized investment advice that takes into account all sorts of circumstances that investors can access at very low cost, perhaps no cost.

Jennifer Schulp: And that really opens up access in ways that we haven’t really seen thus far in the investment advice field. You can get your robo-advisor that only does so much, or otherwise you still have to go to a person who’s drawing on their experiences to understand the broader world. But in the future where you can go on your computer or go on your phone and tell the LLM, here’s what my investments look like, what should I do next? That’s pretty powerful stuff, assuming that the regulators allow something like that to happen. They should. I’m not terribly optimistic about what the SEC’s regulations are going to look like about this in the fall, and I’m not sure that they’re going to address the question yet of how individuals are interacting with AI, but rather might be thinking more about kind of the back end questions that I talked about before, where the investment advisor himself is using AI to help formulate decisions to relate to the client.

Chelsea Follett: And we haven’t talked that much yet about financial advice. So could you tell me a little bit about the potential benefits of streamlining and simplifying the regulations surrounding financial advice?

Jennifer Schulp: Oh, sure. Financial advice is highly regulated in the US, which has generally led to higher costs and less access. And less access because of higher costs, but also less access because fewer people are able to give financial advice. You can think about that as that’s good because then the people that are giving financial advice are held to a higher standard and they should be smarter about it. But at the same time, there are a lot of requirements that probably don’t go towards those questions. It is very difficult, if not impossible, to become a broker, a financial broker in the United States, if you have any sort of a criminal record, even as small as drunk driving, or a 20-year-old shoplifting charge, it’s very difficult to break into the industry.

Jennifer Schulp: And there are a lot of similar requirements that keep a lot of different types of people from being able to even attempt to be brokers. But beyond that, the regulation of financial advice is exceedingly complicated. And I think your average investor just generally doesn’t understand what they’re getting when they get investment advice. You have brokers and investment advisors who are regulated differently and have different duties towards the customer who’s getting the financial advice from them.

Jennifer Schulp: Brokers are viewed as kind of a one-off transactional duty where they are required to give information or advice that’s in the now what we call the best interest of the client. But it’s only one-off advice. It looks at that client’s information to snapshot in time. So you want to come in and buy something, they’ll tell you if it’s good to buy today for you. A financial advisor has fiduciary duties towards an investor, sometimes also referred to as needing to keep the client’s best interest in mind, but confusingly, those best interests are maybe not exactly legally the same.

Jennifer Schulp: And a financial advisor who has fiduciary duties generally is tasked with kind of an ongoing understanding of the client’s financial situation. So they have to take more into account. Both financial advisors and brokers have different duties as to the conflicts of interest that they can hold in order… That they can have while they’re advising. Sometimes they have to disclose them. Sometimes they’re not allowed to have them. Again, those differ based on whether you’re a financial advisor or a broker. Sometimes the same person is a broker and a financial advisor and it determines… What duty applies, it depends on what exact advice they’re giving you about how and about what account you’re holding it in.

Jennifer Schulp: It’s exceedingly complicated. And say, one of the things that makes something like app trading or artificial intelligence so attractive is that you don’t really have to understand as much about that when you’re working with the phone. You probably should understand the background, but it’s not nearly as intimidating as knowing that there’s another human being sitting in front of you who has all of these legal obligations that you don’t understand. Really, all of this regulation keeps the industries, I say, artificially small. That’s not to say that they are small industries, but there’s a… The regulation keeps people out of the industries and makes it harder to access financial advice, just generally speaking. And to say simplification in any of that space, I think, is a benefit in order to have more people involved in the financial advice game and have different types of people involved in the financial advice game as well.

Chelsea Follett: Over the course of this interview, you’ve provided very rich detail on a number of topics, but let’s zoom out now to the big picture. You’ve already touched on this, but how would you describe the relationship between healthy, accessible financial markets and prosperity and innovation?

Jennifer Schulp: Oh, they’re inextricably tied. You need to have healthy, successful financial markets in order to have a growing economy and one that supports innovation. Those healthy, accessible financial markets allow a greater portion of the population to engage and to share in that wealth. But it also allows the same portion of the population to contribute to say the dynamism of the economy, to be able to make their capital understood and felt so that they can support products and services, say, in another way that they want to see thrive. And that’s important to innovation, allowing the best ideas to bubble up and allowing those best ideas to get support as the process, I’m gonna say, continues to roll along. The more people that can be involved in that, the better the feedback for the economy, and the better the feedback for innovation occurring in the economy. You have to have healthy, accessible financial markets in order to continue to, say, breed prosperity and innovation.

Chelsea Follett: Because this is the Human Progress Podcast, we usually try to end on a positive note. So what would you say is the single most hopeful or positive trend we’re seeing with regards to the financial industry?

Jennifer Schulp: Yeah, that I’m gonna take all the way back to what we started talking about at the future and that at the beginning. And that really is the opening of access for all different types of people to investment in the stock market. I know we talked about private market investments. I truly believe that’s very important as well. But the most hopeful trend for me is that more people who have always had the ability to invest, but were shut out because of high costs, high barriers, confusion, I would say just difficulties that made it unattractive for them to invest and unable to share in the growth of the equities markets, now have an opportunity and are taking up on that opportunity to be able to share in that prosperity.

Chelsea Follett: Thank you so much for talking with me, Jennifer. This has been fascinating.

Jennifer Schulp: Yeah, thanks for having me. We covered so much.