Christopher Mayer is a commercial loan officer and freelance writer.
There has seemingly been nothing but ebullient praise for the SEC’s new disclosure regulation. Dubbed Regulation FD (for “full disclosure”), the new rule has been hailed by journalists in financial magazines and newspapers across the country as a big win for the “little guy.” As Washington Post columnist Fred Barbash wrote in his Sunday column, “The Securities and Exchange Commission’s new ‘fair disclosure’ regulation is definitely a plus for the individual investor. The agency deserves our thanks.”
However, on further examination, it does not seem that Reg FD is a boon for the individual investor at all. Rather than creating a more open dissemination of market information, it will constrict the flow of information. Rather than leveling the playing field, it will foster opportunities for some professionals and companies at the expense of many others.
The regulation requires that the intentional or unintentional disclosure of “material nonpublic information” to individuals or groups that may trade on that information (that is, shareholders or stock market professionals) must also be made available to the public. If the company in question knows ahead of time that it is going to make such a disclosure, it is supposed to make it available to everyone. If it is an unintentional slip, the company is supposed to make the information available within 24 hours or before the start of the next trading day, whichever is later.
These public disclosures can be made by filing a form with the SEC, holding a press conference or Webcast, or issuing a news release. The regulation does not apply to communications made during initial public offerings or secondary stock offerings, nor does it apply to “road shows.”
The SEC’s motivation for creating the regulation was clear and is available for all to see on its Web page:
We have become increasingly concerned about the selective disclosure of material information by issuers. As reflected in recent publicized reports, many issuers are disclosing important nonpublic information, such as advance warnings of earnings results, to securities analysts or select institutional investors or both, before making full disclosure of the same information to the general public. Where this has happened, those who were privy to the information beforehand were able to make a profit or avoid a loss at the expense of those kept in the dark.
The central aim is to prevent a select group from profiting from the ignorance of the mass of investors. But let us see how this rule may shake out and who will benefit.
Some participants in the securities industry believe the regulation will result in less information being disseminated by companies out of fear of not complying with the new regulation. As analyst Jeff Tryka of RedChip recently wrote, “Most likely some companies will clam up, offering little if any commentary on the future prospects of their businesses to analysts or institutions much less individuals. Others may continue their current practices, though they may soon tire of filing a Form 8-K every time they talk to an analyst on the phone. The result, especially if corporate legal departments have their way, will be a significant slowdown in the flow of information.” Why? To lessen the risk of liability from a Reg FD violation.
This slower flow of information will inhibit security analysis by creating more opportunities for error. Management teams often tip analysts on their estimates, managing expectations up or down as the case may be. Earnings estimates and other forecasting will be even more of a crapshoot than they are now, especially if management teams are not able to converse freely with analysts. Rather than estimates being missed by pennies, errors are likely to get much wider and create even more volatility in stock prices.
Of course, as with any new law or regulation, the impact will largely depend on how it is enforced. There will likely be a lot of discussion about what is “material.” Indeed, with literally thousands of conversations taking place daily between management and the public, the law may turn out to be virtually unenforceable. Enforcement will likely be capricious and haphazard. Certainly, one group that always benefits from any new law or regulation is the lawyers; they will be fortified with new material to litigate and defend against. There will also be increased demand for a variety of communication services.
In part, the reasoning of the SEC mirrors the position against insider trading. At the core of such reasoning is the notion that information of this type ought to be widely disseminated and that acting on such private information is inherently unfair.
However, investors constantly have information available to them that others do not have, whether they are aware of it or not. Locals in Baltimore, Maryland, know more about Baltimore-based companies than people in Seattle, Washington, do. They have friends and neighbors who work for these companies. They know where the companies do business. Local businesses are frequently covered in the local papers. With this information locals have a feel for a company that someone living far away does not have. Should the locals not be allowed to trade on information publicly known but not yet put out on a Webcast or in a news release?
Notwithstanding actual information, the ability of people to process this information is inherently unequal. Human beings are a diverse lot, with widely differing talents and intellects. Even with all the same information, different investors will have widely differing opinions about the attractiveness of an investment. Is the SEC going to likewise mandate that we all share our analyses with the public so as to not profit “at the expense of those left in the dark”?
There is nothing unfair about unequal information. It is a fact of life, one that all human beings must deal with in interacting with others. Buyers and sellers in transactions everywhere seldom have the same information. Their experiences and intellect, their basic uniqueness as individuals, assure that they won’t.
It is well known that both parties to a voluntary exchange believe they benefit at the moment of the exchange or they would not have engaged in it. Likewise, the investment arena is not a coercive exercise. If an investor does not want to play the game, he doesn’t have to. No one forces him to put his money in stocks he feels he knows little about.
Regulations like FD show an unbridled faith in government, a hatred for money-making, and a fervor for liberty-killing egalitarianism. All the while, the powers of the leviathan state are expanded under a murky, fickle regulation.
Disclosure laws in general are well loved by reformers. Yet the result, as with so much government regulation, is the opposite of what was intended. As analyst Tryka noted, “Individual investors will not get more information but investment professionals will get less.” Companies will spend more time and resources on compliance; securities analysts will be less useful in guiding their clients; and the lawyers will be busier. And what of the individual investor, the “little man”? Reviewing his stock tables, having no more information than he started with and no edge against the professionals in processing what information he does get, will he be thinking to himself: “Thanks, SEC”?
The problem with our securities markets is not that there is too little regulation. Regulations in this area have become highly complex, requiring expensive legal expertise to navigate safely. The creative forces of the market itself will provide solutions to problems of disclosure. The interaction of buyers and sellers will push the investment market to deliver what investors want, as all free markets are pushed to meet the wants of consumers.