Speech by SEC Commissioner:
Rethinking Information About Issuers in the Age of the Internet
Laura S. Unger
Commissioner, U.S. Securities & Exchange Commission
At the University of Texas School of Law 21st Annual Conference on Securities Regulation and Business Law
February 18, 1999
The views expressed herein are those of Commissioner Unger and do not necessarily represent those of the Commission, other Commissioners or the staff.
The Internet has greatly increased retail investorsí access to timely and high quality information. At the same time, the Internet can be used to fraudulently hype stocks by virtue of its capacity to generate vast amounts of confusing "noise." As the Internet becomes increasingly popular, the Commission should rethink how it regulates the quantity and quality of information provided to investors.
Pre-Internet, an investor wishing to buy or sell a security could consult his broker, read an issuerís prospectus, read the financial magazines, or possibly subscribe to an investment newsletter.
Now, in addition to these "traditional" sources of information, an online investor may get stock tips from postings on online bulletin boards and chat rooms; see analystsí consensus earnings estimates at a website; or set an alert to warn her that a broker has issued a new research report on a company that she tracks.
The increased availability of information to retail investors has raised a number of interesting issues for the Commission. I would like to touch on just two of these issues.
First, how can information reach the investor in the Internet age? Second, can investors tell the difference between high quality information online and "noise?"
Increasing the quantity of information about issuers that investors get during an offering.
One former director of the Division of Corporation Finance suggested that the Commission does not need to continue to register offers. She went on to note that it is no longer possible to expect that information flows to investors can be limited effectively.
Letís consider one example. The Commission has allowed foreign companies to talk to U.S. and foreign journalists overseas during the quiet period. Practically all major newspapers have websites. I can get the Financial Times, International Herald Tribune, and Le Monde online. How do we know that information about stocks in an offering in those newspapers will not reach U.S. investors? We donít.
The Commission took a different philosophical approach in the recently proposed revisions to the Ď33 Act offering structure, otherwise known as the aircraft carrier. In that proposal, we recognize that the free availability of information in chat rooms, bulletin boards, and sites devoted to whispered earnings has made it much harder for the Commission to continue advocating a "quiet period" before an offering by a seasoned public company.
However, we believe that issuers and their underwriters should be held accountable for what they say and file any offering information used just before and during an offering. This approach recognizes that communications to investors made around the time of the offering form the real basis for the investment decision.
As a result, the Commission proposed that the prospectus would no longer have to be the exclusive sales document. Large seasoned issuers could provide any type of written communication to investors just before and during an offering. The catch, of course, is that these communications must either become part of the registration statement or be filed separately with the Commission. Once filed, all investors would have access to this information and communications used in connection with the offering would be subject to liability.
This approach raises the issue of whether Internet information should be treated as "written" rather than oral communication. The Commission has previously defined written communications to include magnetic impulses or other forms of computer data so that any multimedia would be considered a writing. The Commission will have to address this issue in connection with the aircraft carrier.
The characterization of Internet information as written may make intuitive sense when you think about what a website looks like. It becomes less intuitive when you think of a chat room where users post information as if they were engaged in a real conversation, or when you see a video prepared by the issuer, or even e-mail.
This question of how to characterize electronic information has come up recently in the context of e-mail record retention. I have had conversations with a number of brokers who argue that, under most circumstances, e-mail should be treated more like a conversation than a writing, and therefore, they should be required to keep less of it for review by our examiners.
Finally, the Commissionís approach in the aircraft carrier assumes that an efficient market has developed, at least for "large" issuers. An "efficient market" would mean that stock prices reflect all publicly available information about individual companies and about the economy as a whole.
One source for information about individual companies is sell-side analysts. On average, about 15 analysts follow companies that have a market capitalization of $250 million or more. These companies are considered the most seasoned issuers, numbering over 2,000 companies.
The aircraft carrier release notes the important role of these analysts in the dissemination of information to the public. Indeed, analyst research reports have become an online commodity.
Just pull up any brokerís website and you will find either proprietary research or a hyperlink to a research service. One of the top brokerage firms even has given away its research as a means to attract new customers.
If analysts play such a critical role in providing information to investors in an efficient market, we should be sure that the analysts and the information are like Caesarís wife. The efficient market will only work if analysts are above reproach.
The question is are they? Consider that rarely do analysts issue "sell" recommendations. In fact, about 98 percent of analystsí recommendations are buy or hold.
Consider the pressure put upon analysts who must perform "star research" in order to maintain the firmís client relationship with a company it took public. A recent survey shows that 88% of senior executives who dropped their Wall Street underwriters after IPOs between 1993 and 1996 ranked better research coverage as one of the top three reasons for the switch. Consider that companies deny access to analysts who write critical reports about them. Consider also that many top analysts are paid based on their ability to bring in investment banking business.
If, under the aircraft carrierís communications proposals, research reports develop into sales documents for the retail investor, then maybe it is time to take a closer look at any conflicts of interests that may exist for analysts, to ensure that there are appropriate firewalls between analysts and the investment bankers, and to ensure that the research reports disclose any material conflicts of interest.
Increasing the quantity of timely information available to investors in the secondary market.
The Commission generally disfavors the selective disclosure of information. In a recent rulemaking involving the regulation of alternative trading systems, the Commission required high volume ATSs to display their best-priced institutional orders in the public quote stream. The Commission took the position that there should not be "hidden markets" for institutional orders. Does this drive for transparency make sense in the context of disclosing other types of information when that information gives a temporary advantage to institutional players?
The Internet may push selective disclosure by the wayside. I have to believe that eventually, the Internet will be the only means of disclosure. We can assume that, no matter how hard one may try to hide information, it will always reach the market eventually. It was Ben Franklin who said, "three may keep a secret, if two of them are dead." In Washington, D.C., of course, all three would have to be dead to keep that secret. However, we cannot assume that information always reaches all market participants at the same time.
For example, retail investors who do not use limit orders for trades placed overnight may be surprised that their execution occurred at a significantly worse price than expected due to trading by institutional investors on company news released after-hours.
Chairman Levitt has also expressed his concern with market movements caused by institutional investors during analystsí conference calls.
Despite his concerns, my guess is that issuers are probably talking more, not less, during these analyst calls as a result of legislation passed in 1995 and last year. The Private Securities Litigation Reform Act of 1995 allows issuers to disclose earnings projections or "forward-looking" statements during analyst calls without the potent threat of private securities litigation. However, the threat of securities litigation in state courts allegedly had a "quieting effect" on such projections until last year, when Congress enacted the Securities Litigation Uniform Standards Act of 1998.
I do not believe we have had sufficient time to judge precisely how this legislation will impact the type of information disseminated by issuers during analyst conference calls or meetings.
Nonetheless, the aircraft carrier release goes far to minimize the potential for selective disclosure and democratize access to information between retail and institutional investors.
For example, today, during the waiting period, issuers and underwriters oftentimes make roadshow presentations to institutional investors. Since the roadshow presentation is largely oral and visual, the conventional wisdom has been that it is not a writing, and therefore, not an unlawful prospectus used during the waiting period.
The aircraft carrier would level the playing field with respect to offering information by requiring issuers to file with the Commission written information given to investors during the offering. As a result, both institutional and retail investors will have access to any written information included during the roadshow presentations.
Noise on the Internet
I said before that I thought that eventually everything would be disseminated over the Internet. When I said that, I was thinking that information on the Internet eventually would be "sorted out" or "quieted down."
The flip side of more information is "noise" and an inability to find out exactly where the noise is coming from. For example, a marketer on the Internet can buy 12 million e-mail addresses for $300 to send mass e-mails or "spam" hyping a particular stock to unsuspecting web users. Itís no wonder that spamming is the number one customer complaint in our Office of Internet Enforcement.
So far, the Commission has brought over 60 cases for fraud online against people trying to raise money for offerings such as eel farms and coconut plantations through high tech direct public offerings.
A lot of this information, whether accurate or not, has the ability to quickly move markets. For example, recently the stock of a maker of financial analysis software almost doubled within half an hour of the market opening based on its recommendation by a stock picker writing overnight in an Internet chat room. That same stock picker made another stock of a small software manufacturer shoot up 25 percent on one day.
The Commission recently brought action against the publishers of 44 online investment newsletters for failing to disclose that they were being compensated for touting stock.
We have also seen increased incidences of "scalping" where an investment adviser buys stock, hypes it, and sells it into a rising market. We have also seen increased complaints about "cybersmears," where anonymous short sellers talk down the price of a stock through postings in chat rooms.
The ability to hype a company quickly raises an interesting question about an issuerís responsibility in the age of the Internet. What responsibility, if any, should issuers bear for this information? Should issuers have a duty to address material inaccurate information that comes to their attention?
These are some of the issues that the Commission will have to address -- hopefully sooner rather than later. The Internet can be a powerful ally to the Commission. As I mentioned, it can level the informational playing field. It can also empower investors and provide them with valuable information with the click of a mouse. Of course, everything that is good about the Internet is everything that could be bad. It could provide too much information or fraudulent and misleading information -- also with the click of a mouse. We at the Commission must find a way to integrate the Internet into our regulatory scheme in a way that makes sense.