Speech by SEC Commissioner:
Rethinking Disclosure in the Information Age: Can There Be Too Much of a Good Thing?
Commissioner Laura S. Unger
U.S. Securities & Exchange Commission
Internet Securities Regulation
American Conference Institute
June 26, 2000
Thank you for inviting me to speak here today. This is getting to be a regular event for me. Before I begin my remarks, I need to tell you that the views I express here today are my own and not the official views of the U.S. Securities and Exchange Commission.
As most of you must know, I've spent the majority of my tenure as Commissioner focusing on and speaking about the impact of the Internet on investors and the securities markets. Although I have directed much of my energy during the past couple of years to online trading issues, I am very happy to participate in a conference that also covers a variety of capital-raising and corporate governance matters so I can talk about something a little different for a change.
In reviewing the topics discussed on the various panels today and tomorrow, the trend seems clear: the Internet is rapidly eroding the informational advantages formerly enjoyed only by big players in the markets and breaking down barriers to individual investors' participation in offerings and the corporate governance process.
The Information Highway
We know that the Internet, the Information Super Highway, delivers truckloads of information about the markets, securities products, public and private securities offerings, companies, corporate management and corporate governance right to the homes of millions of interested individual investors. That's a fact.
Statistics from last year showed us that one new web site was being established every minute and the number of Internet users and web pages doubled every 100 days.1 I don't have this year's statistics, but the continued growth of the Internet in the past year makes it safe to say that things are happening even faster today.
What we don't know yet is what investors will do with the truckloads of information Will the Internet deliver timely, relevant information to make investors more knowledgeable or will it be more like a dump truck depositing information that overwhelms and buries them? What role will securities professionals - specifically analysts - play in processing information and servicing their customers in the Information Age? Will investors become overconfident and trade too much as a result of all the information at their fingertips? A recent NY Times article on the investment information deluge noted an investment strategist's belief that the instant dissemination of information is creating a tendency for investors to trade first and think later, thereby causing greater market volatility. 2 The Times article also discussed the role of analysts in adding value to information available about companies. It referred to a study by three professors who, over a 15 year period, studied analysts' forecasts to determine what value the forecasts added to companies' financial statements. The study found:
- Analysts provided the most value in forecasts about technology companies whose financial statements were the least informative about new products;
- Analysts help investors more during economic booms than during recessions; and
- Analysts contribute more to investors' returns with respect to companies reporting losses than those reporting gains.
Will investors reject the need for securities professionals like brokers and analysts to help them sort through and interpret the information? If so, will investors become sophisticated enough to analyze financial information and industry trends on their own? Even more importantly, will they be able to distinguish reliable information from the unreliable or even fraudulent information?
Finally, armed with all kinds of information not previously readily available to them, will individual investors become more involved in corporate governance? We can only guess at the answers to these questions. While the Internet may be spawning a breed of die-hard "do-it-yourself" investors, the current trend for firms to offer more value-added and advice-related products shows that many will continue to seek these services from securities professionals. It also seems likely that the average investor will use the Internet to become better informed and more sophisticated.
Most likely, an informed investor will become a more involved investor. I don't know how corporate America feels about this potential for increased investor involvement in corporate governance -- cyber-style -- but I'm hopeful that it will benefit investors and companies alike.
We've been hearing for a while now from individual investors who want greater access to initial public offerings, roadshows, and analyst calls. The Internet is a perfect vehicle for creating cost-efficient and broad access. I'll talk a bit later about the Commission's initiatives relating to some of these issues, and some potential pitfalls associated with them.
The Informed Electronic Investor of the Future
First though, before getting into the details and problems we're all grappling with today, I'd like to do something rarely attempted by regulators. Let's look into the future and see what informed investors of the future could look like and how they might harness the power of the Internet -- to invest in stocks and participate more fully in the offering and corporate governance processes.
Due to the pace of electronic evolution, we don't need to venture too far into the future. So, let's fast forward to the year 2001 for a shareholder's cyberspace odyssey.
Okay, we're there. Most investors are cyber-savvy and have online brokerage accounts. They access real-time stock information and can trade at any time of the day or night in any securities market. Before investing, the future investor consults a number of trusted web sites that include reliable information. Believe it or not, this includes the EDGAR database. What's this? The future investor even reads prospectuses and periodic reports before investing and pays close attention to risk factors and the company's financial information.
Investors contemplating an IPO will be able to view an online road show to size up management, listen to the questions posed by the industry analysts and answers given in response and even ask a few questions of their own. For those investors who determine that an IPO investment is appropriate for them, an allocation is available. Investors also will be able to keep abreast of the companies they own an interest in by participating in analyst calls after earnings announcements and press releases.
The investors of the future compare notes with one another on the Net about things the company is doing right and wrong. The Internet helps unify their voices when there is a particular matter of concern. It also helps investors educate themselves and each other about certain issues without having to resort to proxy solicitations.
These shareholders receive the proxy statement electronically and always cast an informed electronic vote. Frequently, the shareholders even virtually participate in shareholder meetings held thousands of miles away. Shareholder apathy largely becomes a thing of the past and individual investors collectively become as involved and interested in corporate governance as their institutional brethren. As a result, corporate governance becomes more transparent and companies are held more accountable to all of their investors, not just the big ones.
Proxy contests occur in cyberspace and the barbs fly back and forth faster than ever. News about the company, whether good or bad, is available quickly. Information flows like water and the investors wouldn't have it any other way.
From a shareholder's perspective, the future looks pretty good. As you know, a lot of individual shareholders already conduct themselves like the future investor. Although not every shareholder will choose to take advantage of the opportunities and information made available by the Internet, I believe that a substantial percentage will. We probably all can agree that, in theory, investors generally will benefit from access to more information, especially high-quality information and information that comes directly from companies.
As a Commissioner of a disclosure-based agency, I believe that more information is generally better. But is that always the case? Right now, the Commission needs to consider what role it can or should play in regulating the information flow. In doing so, we must look beyond our traditional role of mandating specific company disclosures to determine what other information may help investors make meaningful voting and investment decisions. To illustrate this point, I thought it would be helpful to discuss briefly some of the ways that the Commission is looking to increase the information flow and improve upon the status quo.
Commission Initiatives to Make More Information Available to Investors
The first initiative involves selective disclosure. The problem is how to prevent issuers from making selective disclosure of material non-public information, usually earnings-sensitive information, in meetings or conference calls with analysts, institutional investors or others but not to the investing public at large. If left unchecked, selective disclosure could eventually lead investors to question the fairness of and integrity of our markets.
Chairman Levitt has shown his commitment to reducing disparities between retail and institutional investors' access to investment information. He has spoken about it and had the staff draft proposed Regulation FD (Fair Disclosure) to accomplish this goal. The proposed rules would require issuers intentionally disclosing material nonpublic information to one or more outsiders to disclose that information to the rest of the world at the same time. If the issuer inadvertently discloses information, it would have to promptly tell the rest of the world.
Although I unequivocally share the goal of curbing selective disclosure, I am concerned that a proposal meant to get more information to investors could actually give them less. Of course, in theory, no one would have that information so the playing field would still be leveled- but at what cost?
The proposals don't mandate specific company disclosures they state simply that if an issuer chooses to disclose material nonpublic information to someone, it has to tell everyone. This does present a danger of slowing the information flow if issuers decide not to talk at all rather than get it wrong.
Thousands of commenters submitted letters in response to the selective disclosure proposal. The staff is now analyzing comments. Not surprisingly, the common complaint from corporate commenters and securities lawyers is that the proposals would ultimately have a "chilling effect" on corporate communications. These commenters assert that determining materiality is too difficult and risky, making corporate officials less inclined to discuss important information at all.
What if companies choose to say very little or not talk at all outside of their filings and press releases? If companies won't talk to analysts, the financial press or shareholders, how will information reach the marketplace?
Ironically, another big concern voiced by some commenters is the opposite scenario what if the proposals are adopted and result in significantly greater amounts of information coming out in the form of press releases. How will the information be disseminated and digested in a meaningful way?
Do we need to be concerned about potential "information overload?" Admittedly, it is a lesser concern than the one about information drying up. But still, if Regulation FD is adopted and does make significantly more information available to individual investors, will it be the sort of information the average investor would want to know?
Even though the release only calls for material information, many issuers will err on the side of caution - disclosing material and non-material information. Will investors be able to distinguish one from the other? Another important issue to consider is how investors will process information that isn't first filtered through industry analysts and the financial press.
News services are expressing concern that their systems are not equipped to handle the volume. They also worry that if issuers begin filing press releases every time they say anything to someone outside the company, they too will have a hard time culling out the newsworthy pieces.
Of course, the comments from individual investors support the proposals and are optimistic about how they will help level the playing field. Interestingly, over 5,000 of the individuals who commented e-mailed their support for the proposals. It is unusual for us to hear so much about our proposals from individual investors. (Maybe in another speech, I'll talk about the SEC's information overload!) The high response rate on these proposals signals how strongly they feel about getting more information. The fact that the commenters e-mailed their remarks suggests that they are an Internet-savvy group of individuals.
Although it is hard to argue with Regulation FD's premise, I would hate to see a lush, green playing field that has a few weeds turn dry and barren as a result of its application. Fortunately, many in the private sector have already moved to address some of our concerns about selective disclosure. An increasing number of companies are voluntarily opening up their analyst calls to all interested shareholders -- partly at the Chairman's behest and partly due to shareholder demand. As for the proposals, I hope that we will be able to achieve a balance among the sharply divergent views of the commenters to accomplish the goal of a more level - yet meaningful -- playing field for individual investors.
Electronic Road Shows
In a session this morning, you heard about the Interpretive Release issued by the Commission in April on the use of electronic media to deliver securities documents and conduct offerings. That release left open for another day Commission action to open up communications to individual investors by providing access to electronic roadshows.
Traditionally, road shows have been viewed as oral presentations not subject to the securities law requirements for written prospectuses. Since 1997, the staff has issued a series of no-action letters about transmitting electronic road shows. Before the staff issued a no-action letter to Charles Schwab & Co., Inc. late last year, the no-action letters restricted electronic road show access to typical live road show invitees, including brokers, institutional investors and investment advisers.
Schwab requested the staff for permission to transmit an electronic road show to a certain segment of its retail investors. The staff granted that request. Under the terms of the staff's no action letter, an underwriter could provide access to an electronic road show to a class of Schwab's customers meeting certain net worth and frequency of trading standards.
After the initial no action letter was granted, there was talk of firms developing two types of road shows. One would be a full-bodied version for traditional institutional audiences, complete with earnings projections and other information often presented at road shows, but not included in the prospectus. The second version would be a watered-down "road show lite" version for retail investors consisting primarily of management interviews. A few months ago, concerned about the potential for selective disclosure, the staff supplemented the Schwab letter to clarify that underwriters can't develop two different versions of the road show.
The Schwab letter has drawn both praise and criticism. Some have applauded the letter as a significant step towards democratizing access to road show information, while others have criticized it for not providing full access to all types of retail investors, regardless of their net worth and level of financial sophistication.
Although the staff originally had planned to recommend a proposal on electronic road shows soon after the first Schwab letter was issued, it now wants to hold off and see the public's reaction to the selective disclosure proposals. Before adopting a rule, the Commission will need to answer two main policy questions: (1) Should all investors be able to access electronic roadshows? (2) If so, may issuers have different versions of that road show for different investors?
Again, we'll need to consider whether average investors really want and need the level of information provided to professionals. Will most individual investors be able to separate marketing hype from offering fundamentals? Will crucial disclosure get lost in the crush of information that may circulate in a de-regulated environment? Will the quality or quantity of information provided by issuers and underwriters be affected when individual investors have widespread access to it?
Online Investor Behavior Survey
Just so you know, I am not just going to ask these questions about what information investors want or need. I actually have a little project underway to find out the answers to some of these questions and about the investing habits of online investors. My office will be working with the Securities Industry Association and its member firms to distribute an online investor behavior survey to several thousand investors. Some of the things we hope to learn from the survey include:
- The sources of financial information that investors rely on;
- Customer expectations at online firms;
- The level of knowledge and experience of the average online investor;
- The trading frequencies of online investors vs. off-line firms; and
- How online investors analyze risk.
I hope that we can use the survey results to improve our investor education efforts and learn more about investors generally. We may ultimately publish the results of the survey on the Commission's website.
In conclusion, it looks as though investors stand to benefit greatly from the Information Revolution. The Internet has powered the revolution. It's also been a key element in the push for democratization of the flow of investment information.
We've already seen how the Internet is changing individuals' investment habits. The ease of Internet access, the unprecedented availability of online investment information and reduced transaction costs have caused investors to enter the financial markets in record numbers. About one half of all U.S. households are investing in our securities markets and about 20% of those investors trade online. We also know that the Internet will have a huge impact on capital-raising and corporate governance practices, but - -despite our odyssey earlier -- the extent of its impact in these areas isn't as clear yet.
As the Commission pursues new ways to help democratize access to investment information, we have to remember that information can only empower investors if they understand it and can effectively apply it. Access to information isn't a substitute for knowing how to interpret it. As Albert Einstein once said, "Knowledge is experience -- everything else is just information."
Interpretation of the data stream will be more than half the battle. As more information gets directly into the hands of investors, the press, analysts, brokers and other market professionals will continue to play an important role in giving meaning to the facts. Whatever we do, and however we do it, our primary goals should be to keep the information coming and to make sure that investors can make the best possible use of it.
1 David H. Peirez and Thomas D. Glascock, The Internet and its Impact, Banking Policy Report, June 21, 1999, Vol. 18 at p.12.
2 Gretchen Morgenson, Flying Blind in a Fog of Data, N.Y. Times, June 18, 2000, at C1.