Speech by SEC Commissioner:
Fallout from Regulation FD
Has the SEC Finally Cut the Tightrope?
Commissioner Laura S. Unger
U.S. Securities & Exchange Commission
Glasser LegalWorks Conference on SEC Regulation FD
New York, New York
October 27, 2000
Thank you for inviting me to speak before such a distinguished group today. Before I begin, let me remember the all-important disclaimer. These are my own views about Regulation FD and not those of the Securities and Exchange Commission. Considering that I voted against FD, I guess you would have figured that out.
There is much to say about Regulation FD even if the regulation itself leads most people to not say much. Regulation FD turns on its head the longstanding relationship between issuers and their analysts a liaison that has never been particularly easy. In Bausch & Lomb, the Second Circuit aptly described a corporate officialís exchange with an analyst as a "fencing match conducted on a tightrope."
Now that Regulation FD has effectively cut the communications tightrope, will issuers disseminate the same information that was previously filtered through analysts directly to the marketplace? If you believe what you read or hear, corporate officials are keeping quiet until they absolutely have to speak. When they speak, it is to the marketplace as a whole and whatever is said negative or positive is reflected by volatility in that companyís stock price. Take, for example, the New York Times recent report that Intelís stock fell 22% in one day after it announced lower than expected third-quarter revenue. If increased volatility is one of the consequences of Regulation FD, then investors and their confidence in the marketplace could be damaged.
Will issuers speak at all to their analysts now? What information can issuers impart to analysts without running afoul of Regulation FD? FD purports to leave intact the mosaic theory, but it is unclear what information company officials will actually be able to tell analysts. Proponents of the regulation argue that analysts will just have to work harder on researching their reports. If this is true, it could be at the expense of research coverage for small and mid-cap companies.
Will Regulation FD lead to less accurate company information in the marketplace? If companies disseminate information simultaneously to investors and analysts, will the market react before an analyst has a chance to put the information in context? Remember, companies will disseminate material information to the marketplace as a whole, without the benefit of having analysts "ferret out and analyze" information as the Supreme Court in Dirks described the analystís role. The Commission itself noted in the aircraft carrier release in 1998 that analysts "digest information . . . , put all of it in context, and act as conduits in the flow of information by publishing reports explaining the effect of this to investors."
In effect, investors will now be forced to perform the role previously played by analysts. Discussing the role of analysts, the Supreme Court noted in Dirks that "[i]t is the nature of [analystsí judgments about companies and their securities], and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporationís stockholders or the public generally." Yet Regulation FD seeks to accomplish exactly that result.
Will Regulation FD actually get to the root of the "evils" associated with selective disclosure? The impetus for Regulation FD was to prevent analysts from passing material nonpublic information on to others so that those individuals could trade. As we have all heard and read numerous times, the Chairman defined the issue of selective disclosure trading by analysts or their firmsí institutional clients contemporaneous with closed analyst calls or corporate meetings and called it a "stain on our markets." The Chairmanís words resonated with everyoneís sense of propriety.
Trading activity around the time of selective disclosure is offensive, even if not illegal, but Regulation FD does not expand or change the law of insider trading to address the missing link found by the Dirksí Court. Rather, it seeks to make all material information disclosed to analysts public unless a confidentiality agreement exists. If all or most material information becomes public, there can be no opportunity for insider trading, regardless of how you assign the duty to disclose or abstain from trading.
I dissented from the adoption of Regulation FD for several reasons. First, I thought the rule was unnecessary. Issuers are voluntarily opening their corporate communications to the public through the Internet. According to an August 2000 survey by the National Investor Relations Institute ("NIRI"), 61% of issuers are already webcasting analyst conference calls for access by the media and individual investors, and another 22% are planning to do so within the next year. Bestcalls.com, a company that broadcasts conference calls over the Internet for free, said that 70% of public companies that have earnings conference calls with analysts now allow individual investors to participate, up from 25% early last year.
Second, I was concerned that the rule would result in issuersí scaling back their disclosure, rather than expanding it. On one hand, companies might restrict communications because of a fear of violating Regulation FD. On the other hand, companies that did not wish to talk to analysts could use Regulation FD as cover. At a time when the Internet is making more information available, it just didnít make sense to adopt a rule that would most likely reduce the amount of information available to investors.
Third, I was concerned about the quality of the information that would be produced in response to Regulation FD. Considering the number of press releases that could be issued for intentional or inadvertent disclosures of material, nonpublic information, the webcasting of analyst calls and the instantaneous nature of these communications I was concerned that investors would not be able to process the information.
Judging from what we have heard, companies are taking Regulation FD very seriously even if they have not yet figured out how to comply with it and develop policies and procedures. NIRI indicates that 90% of U.S. public companies have reviewed their disclosure policies and procedures as a result of the adoption of Regulation FD.
Will Regulation FD provide the information investors really want and at what cost? Do the benefits of this regulation outweigh the burdens? According to my cost benefit scorecard, Regulation FD fails. Before Dirks, the SEC brought one case for selective disclosure. Since Dirks, we have brought one settled case and opened a dozen or so investigations possibly involving trading on information selectively disclosed.
I am all for more information meaningful information but ensuring parity of information is not the SECís mandate. We would have done better to preserve the integrity of the marketplace by guiding industry efforts to curtail the trading we heard about rather than cutting the tightrope of analyst/company communications.
Having said all that, here is my campaign pledge to be a watchdog for any unintended consequences of Regulation FD. I promise to:
- Monitor closely the studies by the SEC, SIA and others of the effectiveness of Regulation FD in reducing selective disclosure as well as the impact of the regulation on the "chilling" of corporate communications, market volatility and any disproportionate effect on smaller issuers;
- Encourage the staff and other Commissioners to provide more guidance regarding the practices that are of concern to the Commission and those that are not;
- Find ways to facilitate "public" dissemination of material nonpublic information through the Internet, and make sure that Regulation FD doesnít discourage the use of technology as a means of public dissemination; and
- Scrutinize staff recommendations on enforcement matters to that Regulation FD will be applied fairly and judiciously.
Pre- and post-adoption of Regulation FD, it has become easy to lose sight of what the Chairman sought to accomplish with this rulemaking. In many ways, Regulation FD exemplifies the challenges of regulating our markets. As an agency, the SEC faced two choices in addressing selective disclosure: (a) bring an enforcement case for insider trading based on selective disclosure and test a novel theory of liability; or (b) remove one of the elements of insider trading by analysts or their firmsí customers by drastically reducing their access to inside information. In making the latter
choice perhaps the more conservative choice the Commission bet the store that Regulation FD would work. But I bet my house that it wonít!