Outlaw Selective Disclosure? --- No, the More Information the Better
Wall Street Journal; New York, N.Y.; Aug 10, 2000; By Kevin A. Hassett;
Abstract:
The Securities and Exchange Commission is scheduled to vote today on Regulation FD, a
proposal to require firms to release information to everyone if they release it to anyone. The
intent of Regulation FD is commendable, and consistent with SEC Chairman Arthur Levitt's long
track record of championing the cause of the small investor. The impact of the regulation,
however, will likely be the opposite of the chairman's intent.One view supported by some securities lawyers is that this is a classic bureaucratic
power-grab. Regulation FD could be conceived as an attempt to go around the insider trading
standard promulgated by the Supreme Court. The Supreme Court has ruled that it's only
illegal for an insider to give an analyst material information if the insider profits from the
revelation. If an executive is trying to make personal gain from a "tip," it's a crime. If he
answers a question that turns out to be useful investment information, it's not a crime.Which is not to say that the SEC should just leave the problem alone. About 40% of firms still
strictly limit participation in conference calls, a practice that is not defensible. The SEC could
go a long way toward addressing Mr. Levitt's concerns by requiring firms to broadcast
conference calls live on the Internet. The SEC may also consider prohibiting the disclosure of
earnings numbers to any but the broadest of audiences. Conversations, however, are best
left to existing laws.
Full Text:
Copyright Dow Jones & Company Inc Aug 10, 2000
The Securities and Exchange Commission is scheduled to vote today on Regulation FD, a proposal to
require firms to release information to everyone if they release it to anyone. The intent of Regulation FD is
commendable, and consistent with SEC Chairman Arthur Levitt's long track record of championing the
cause of the small investor. The impact of the regulation, however, will likely be the opposite of the
chairman's intent.The regulation is an apparent response to several recent episodes where executives shared important
negative news with a few analysts. These analysts were able to sell the troubled stocks before individual
investors had a clue that something was wrong.That stinks. But economists who have studied the issue know that it is very difficult to write a rule that
governs communications without undermining the process that helps make the market the most efficient
collector and sorter of information on earth. How difficult? Just take a look at some of the likely
consequences of Regulation FD.Analysts interact with firms in at least two ways. They participate in conference calls, and they visit firms,
kick the tires and cross-examine the executives. Is a firm hiding something ominous about its future
prospects? The best analysts shrewdly design questions that ferret out that information.Analysts do this hard work because they (or their firms' clients) will profit if they are a little bit smarter or
faster than the next guy. Regulation FD may, if the final version of the regulation looks anything like the
proposal distributed for comment, stop the process in its tracks. Under the new rule analysts' material
questions may only be answered by firms if the information is promptly shared with everyone. What's
"material" mean? Nobody knows for sure, but rest assured, if an analyst is able to profit from the
information, then it might well be found to be material.So the rule may create a world where a firm is subject to an enforcement action whenever an analyst is
able to make a good call based on information gathered from a visit that is not simulcast on the Internet.A firm's measured response might be to only interact with analysts and other outsiders at large meetings. If
firms do that, then analysts will have little incentive to invest the time necessary to devise difficult questions,
and a strong incentive to free-ride on the efforts of others attending the meetings. The quality and quantity
of information available to the market will plummet.While the regulation is apparently a reaction to anecdotal horror stories, the SEC has not demonstrated
that selective disclosure is an important problem. So why the rush to change the rules?One view supported by some securities lawyers is that this is a classic bureaucratic power-grab.
Regulation FD could be conceived as an attempt to go around the insider trading standard promulgated by
the Supreme Court. The Supreme Court has ruled that it's only illegal for an insider to give an analyst
material information if the insider profits from the revelation. If an executive is trying to make personal gain
from a "tip," it's a crime. If he answers a question that turns out to be useful investment information, it's not
a crime.In one of the key cases, Dirks v. SEC, the Supreme Court revealed why such a standard is so important.
The one-on-one interplay is a vital source of information for the markets, and "it is the nature of this type
of information, and indeed of markets themselves, that such information cannot be made simultaneously
available to all of the corporation's stockholders, or the public generally."A broadly defined Regulation FD neutralizes the "tip" requirement, and potentially hatches countless
lawsuits. Firms must make public any material information given to analysts, even if that information is not
an illegal tip. If the firm fails to broadly disseminate information that may be material, it has committed a
disclosure violation, and the firm can face severe sanctions.If the regulation is passed, firms will face a difficult choice. If they open up their offices and factories to
analysts, there will likely be shrewd operators who make money. If that happens, the information
egalitarians at the SEC may be offended and start disciplinary action. This will likely start private suits as
well.To defend itself, the firm can, as the SEC suggests, require that attorneys attend meetings with analysts
and advise executives on a question-by-question basis whether they can answer. Sounds like fun, doesn't
it?Alternatively, the firm can choose to stop talking to individual analysts altogether. This is the outcome that
the securities industry rightly fears. As Stuart Kaswell of the Securities Industry Association put it, "The
playing field will be more level, but it will be empty."Which is not to say that the SEC should just leave the problem alone. About 40% of firms still strictly limit
participation in conference calls, a practice that is not defensible. The SEC could go a long way toward
addressing Mr. Levitt's concerns by requiring firms to broadcast conference calls live on the Internet. The
SEC may also consider prohibiting the disclosure of earnings numbers to any but the broadest of
audiences. Conversations, however, are best left to existing laws.---
Mr. Hassett is a resident scholar at the American Enterprise Institute and co-author of "Dow 36,000"
(Times Books, 1999).