Speech by SEC Commissioner:
26th Annual Cleveland Securities Law Institute on Securities Regulation
by Commissioner Isaac C. Hunt, Jr.
U.S. Securities & Exchange Commission
February 18, 2000
Good afternoon, itís a pleasure and honor to be here today. But before I begin I am obligated to give you the usual disclaimer that Commission members must make when speaking publicly; which is that the views I express here today are my own and do not necessarily reflect those of the Commission, other Commissioners, or the Commissionís staff.
I would like to speak to you about selective disclosure. As you know, last December, the Commission issued for public comment rule proposals that attempt to reduce selective disclosure in our markets. At that time I expressed grave reservations about the effect of those proposals, but having always felt that the Commission benefits from open discussion and comment about major issues affecting our markets, I voted to approve the release of the proposals. Today, however, I would like to use this time to explain in more detail my reservations about the proposals.
Before I begin, however, let me make this absolutely clear; while I have reservations about the means the proposals would use, the goal of reducing selective disclosure I support one hundred percent. Moreover, I believe that selective disclosure is a problem in our markets that the Commission must address. We can no longer ignore it.
Two years ago this March, the Chairman, in a speech at our annual SEC SPEAKS conference, attracted national attention when he called for companies to end selectively disclosing material information. I, too, have spoken out about the problem of selective disclosure. Regulation in this area was not our first choice. It was both our hopes that alerting the market to the inherent unfairness would have been sufficient to end this problem. Atlas, we were wrong. Speeches were not enough.
Many of you, however, may be asking "why now?" Our capital markets are among the most efficient and liquid in the world. Selectively disclosing information to analysts and large institutional investors has been common corporate practice for decades. In fact, one of the understood benefits of an efficient market is that the price of a security will reflect information that is not necessarily universally known to every participant in the market. In this regard, companies, generally, have felt comfortable disclosing material information to analysts and large institutions knowing that such information will be reflected quickly in its stock price. For most companies, this selective disclosure was not done with the intention of bestowing some valuable benefit, but rather as a cost effective way to get the information reflected in its stock price as rapidly as possible.
This method of dissemination works, in part, because large institutional investors and the analystsí brokerage firms have the necessary capital to buy and/or sell securities in sufficient quantities to affect their prices. Accordingly, while material information may not have been personally disclosed to an investor, that investor will not be disadvantaged if at the time he or she purchases or sells the security such material information is reflected in the securityís price.
The Commission, itself, recognized the benefits of efficient markets when it adopted the integrated disclosure system. Under the integrated disclosure system, large companies are not required to deliver all material information to the investor. Even the courts, with their acceptance of "fraud on the market," recognize that information need not be directly conveyed to the investor to be reflected in the price of the security.
If the Commission itself has recognized the benefits of efficient markets then why is it so concerned about material information being selectively disclosed to analysts and large institutional investors? The short answer is: our markets are changing. Institutions and analystsí brokerage firms are no longer the primary means by which our markets achieve efficiency. Moreover, the costs of universal disclosure have substantially decreased in the last decade.
In this regard, I believe we are seeing the beginnings of a new phenomenon; the power of the small retail investor. Whether through day-trading or personal investing, small retail investors are having a large impact on our equity markets. For evidence of their impact, one only needs to look at the IPO market. While institutions may still be setting the price at which the underwriter initially sells the security, it is the retail market, those small investors that appear to be determining the price at which the security will trade at in the aftermarket.
Now please donít misunderstand me. I believe institutional investors and analysts will continue to play major roles in the efficiency of our markets. I also believe, however, that we can no longer ignore the impact that retail investors are having on stock prices. The mechanisms by which our markets become efficient are changing. If information is selectively disclosed to those that cannot or will not affect the price of a security, then the market for that security will not be efficient with regard to the selectively disclosed information. That information will not be reflected in the price of the security unless it is disclosed to those whose purchases and sales affect the price of that security. Today, retail investors through their purchase and sales of securities are affecting the price of those securities. Therefore, they must be made aware of the material information.
Advancements in technology, combined with changes in the media industry, have significantly reduced the costs associated with widespread or universal disclosure. The Internet alone provides a low cost alternative for issuers to disseminate information to millions around the world. In the past, small investors were unlikely to have daily access to material financial information. It was too expensive for companies on a continuous basis to attempt to disclose information directly to them.
Today, however, with a click of a mouse or the touch of a remote, small investors everywhere can access a wealth of financial information. The availability of this information has empowered record numbers of small investors to participate in our markets. These investors provide additional sources of liquidity to our markets and funds to our corporations. The availability of this financial information, however, appears to have merely wet their appetites. These investors are no longer content to have access to information, they want timely access. They want to be treated fairly and equally, and I believe they deserve no less.
Finally, we can no longer fail to notice that selective disclosure attacks the very soul of our markets. While we may not be able to make our markets 100% fair for all investors, we should never stop trying. Our securities laws are premised on the fact that investors should be treated fairly. They were enacted in era when the standards of fairness, honesty, and prudent dealing were the exception rather than the rule. How many of you would return to a market that you believe did not treat you fairly?
Now that I have told you why I think now is the time to end selective disclosure, let me review for you how proposed Regulation FD, (Fair Disclosure) would achieve that goal.
Proposed Regulation FD would provide that whenever an issuer, or any person acting on its behalf, intentionally discloses material information regarding the issuer or its securities, it must simultaneously make public disclosure of that information. In the event that disclosure of the material information was non-intentional, the issuer must make public disclosure of that information promptly, but in no event no more than 24 hours after a senior official becomes aware of the non-intentional disclosure. The only exception to publicly disclosing the material information is if the initial disclosure is made to a person who owes a duty of trust or confidence to the issuer or has expressly agreed to maintain such information in confidence.
Proposed Regulation FD would provide three methods to publicly disclose material information:
- An issuer may file a Form 8-K or, in the case of a foreign issuer, a Form 6-K, with the Commission disclosing the material information;
- An issuer may disseminate a press release through a widely circulated news or wire service that discloses the material information; and
- An issuer may disseminate the material information through any other method of disclosure that is reasonably designed to provide broad public access to the information and does not exclude any member of the public from access.
Now let me outline some of my reservations regarding proposed Regulation FD. First, as you can see, proposed Regulation FD is very broad in its scope. It would affect nearly every business communication by a corporation. It is likely that companies will have to continuously review their communications to determine whether any material information is being disclosed and thereby subject to Regulation FD. For example, communications with customers, suppliers and yes, even regulators, absent a confidentiality agreement, may be subject to simultaneous public disclosure. I am unaware, however, of any widespread problems involving trading on material non-public information by a companyís customers, suppliers, or regulators.
Consequently, I believe Regulation FD, as proposed, violates one of the basic tenants on which our securities laws are premised. That is, as President Roosevelt stated in his letter to Congress in 1933: "the purpose of the legislation . . . is to protect the public with the least possible interference to honest business." If we have problems with communications with analysts and presentations of road shows then we should limit Regulation FD to them. In my opinion, we have neither the mandate nor the authority to regulate every business communication.
Second, I am concerned about the impact of liability on corporations. While proposed Regulation FD is quite clear that it does not create a private right of action, I am concerned that it might provide the plaintiffís bar with evidence that certain disclosures are per se material. For example, in connection with the quarterly release of earnings, companies ordinarily will issue a press release disclosing their earnings before their analystsí conference call. If the company discloses information in compliance with proposed Regulation FD, can this compliance be used as evidence that the initial press release was materially misleading? I hope not. I am concerned, however, that some will argue that the companyís compliance with Regulation FD is an admission that the initial press release omitted material information that was necessary not to make it misleading.
I also have reservations from the investorsí standpoint. First, does proposed Regulation FD actually reduce selective disclosure? Most companies, today, believe that material information is not presented or discussed in an analyst conference call. Companies have argued that any material information, such as the statement of earnings, is provided in the initial press release, not during the conference call. If there is a material effect on the companyís stock price is it because of the initial press release or because the information provided in the conference call was combined with other information that an analyst had discovered through other sources? In the event that the information disclosed in the conference call actually results in a material change in the securityís price, a company may simply claim it was non-intentional and follow up with a press release 24 hours later --after the information has already affected the market. Now how does that protect investors?
It also may be difficult for the Commission to prove a violation of proposed Regulation FD. How does the Commission prove that the information disclosed in the call to analysts was material when the company only hours earlier had released related material information. Which information moved the market? Did the earnings release affect the stockís price or was it the information disseminated in the conference call? This is complicated by the fact that the market absorbs information about different companies at different speeds.
For all of the reasons I have just mentioned, I am afraid that we may be establishing an uneven playing field, as some companies will attempt to comply with the spirit of the regulation while others will not.
I also am concerned about proposed Regulation FDís methods of public disclosure. First, I believe it is unlikely that any company will comply with Regulation FD by filing a Form 8-K or Form 6-K. Why would any company want to take additional liability? Unlike a press release or the opening of a conference call to the public, a Form 8-K filing would be subject to Section 18 liability under the Exchange Act. It would also be subject to Section 11 liability under the Securities Act if it is incorporated by reference into a registration statement. Therefore, I think it is very unlikely that information disclosed pursuant to proposed Regulation FD will ever be available on the Commissionís web site.
The lack of a filing requirement I find to be problematic. Our recent experience with Internet chat rooms has resulted in the Commission advising investors to review the information a company files with us before acting on what they may have read in a chat room. If material information that the company has publicly disclosed is not available on our web site that advice might be misleading. Moreover, I believe it is a significant benefit to investors to be able to look in one area for material information that companies, themselves, have disclosed publicly.
Proposed Regulation FD also would allow companies to comply by issuing a press release through a wire service. While this may work very well for the Fortune 500 companies, what about the Fortune 5,000 company? While the material information may be reported in the Fortune 5,000 companyís local newspaper, it is unlikely that any major newspapers will pick up the material disclosure. Consequently, the material information is unlikely to be available on a timely basis to the general public.
The next alternative is to grant the public access to the analystsí call, either by personal attendance, telephonic or electronic transmission. This may be the best solution for most companies, but how does one provide the general public with effective notice of the call? What happens when the analyst calls at 5:30 and wants to talk about a rumor he or she heard? In order to talk with the analyst, must the company first issue a press release or post a notice on its web site of when the call will occur? Would posting a notice on the web site even be enough? How much advance notice of the call must the company give?
Again, I believe to effectively make the material information available to the public there must be some type of filing requirement. The two alternative means of disclosure, while better than what occurs today, still leave much to be desired. The proposing release solicits comment on requiring a Form 8-K or Form 6-K filing two days after the information is publicly disclosed. While this may not be perfect for all investors or for all companies, I believe it provides an appropriate balance. Companies would have the necessary time to review the disclosure with their attorneys before filing with the Commission and it ensures that investors will be able to locate the information. I look forward to reading your comment letters on this issue.
Now while I have been critical, perhaps overly critical, of the proposals, I want to make it clear that I think the Commissionís Office of General Counsel did an incredible job. It would have been easy for them to just thrown up their hands and say it is impossible to eliminate selective disclosure. No one ever said life would be fair, so why should small investors expect equal treatment. But that is not what government service is about; it is about helping others when no one else will. They have worked extremely hard on proposing these rules. They have attempted to balance the interests of corporations and investors. Clearly, it is impossible to make everyone happy. While I may have reservations about the proposals, they have provided us with the opportunity to have an educated discussion and hopefully find a satisfactory way to address the problem of selective disclosure.
In closing, I would like to leave you with one more disclaimer: I am expressly reserving the right to get smarter. These proposals are likely to generate a record number of insightful comment letters. I suspect many of these letters may address my concerns and raise new issues that I had not considered. I am excited and eagerly looking forward to reading your comment letters, and perhaps becoming a little bit smarter along the way.
Well, thank you, again, for allowing me the opportunity to speak with you today about this important issue.