Reconciling Tax Law and Securities Regulation

Issuers in registered securities offerings must disclose the expected tax consequences to investors investing in the offered securities (“nonfinancial tax disclosure”). This Article advances three arguments regarding nonfinancial tax disclosures. First, nonfinancial tax disclosure practice, as the Securities and Exchange Commission (the SEC) has sanctioned it, does not fulfill its intended regulatory purposes. Currently, nonfinancial tax disclosures provide irrelevant information, sometimes fail to provide material information, create unnecessary transaction costs, and divert valuable administrative resources to the enforcement of largely-meaningless requirements. Second, the practical reason for this failure is the SEC and tax practitioners’ unsuccessful attempt to address investors’ heterogeneous tax preferences. Specifically, nonfinancial tax disclosure practice assumes the existence of a “reasonable investor” who is also an “average taxpayer,” and tax disclosures are drafted for the benefit of this average taxpayer. The concept of an “average taxpayer,” however, is not defensible. Third, the theoretical reason for the regulatory regime’s dysfunctionality is the misapplication of mandatory disclosure theory to nonfinancial tax disclosure requirements. Mandatory disclosure theory, even if accepted at face value, does not support the current regulatory framework, due to the special nature of tax laws. To remedy this failure, this Article describes the types of tax-related disclosures that mandatory disclosure theory would support. Under the proposed regulatory reform, nonfinancial tax disclosures will only include issuer-level tax items (namely, tax items imposed on the issuing entity) that affect how “reasonable investors” calculate their own individual tax liabilities. Under such a regime, there is no need to rely on the “average taxpayer” construct.