Regulation Fair Disclosure
By: Paul R. Carey
Commissioner, U.S. Securities & Exchange Commission
Before the Capital Markets, Insurance
and Government Sponsored Enterprises Subcommittee
of the House Financial Services Committee
U.S. House of Representatives
May 17, 2001
Chairman Baker, Congressman Kanjorski, Members of the Committee, thank you for asking me to share my views on Regulation FD with you. I regret that I am unable to appear before you today, but appreciate the opportunity to submit my thoughts for your consideration.
Like many, both in the industry and at the Commission, I was initially skeptical about how well Regulation FD would work in practice. Regulation FD signalled a significant sea change in how public companies would disseminate material information. The old system, where company insiders shared earnings and other important information with a small circle of analysts and institutional investors, had existed for a long time. After the Commission proposed Regulation FD, we heard from thousands of securities industry participants, many of whom predicted negative consequences to the markets were FD to go effective. While many of the arguments these commenters put forward were well reasoned and persuasive, I found it difficult, however, to refute the underlying premise of FD: that all investors, large and small, should have equal access to material information about a public company at the same time. How could we as a regulatory body continue to justify favoring a privileged few with advance notice of material news like earnings declines, new lines of business or dividend surges? Why should a few investors have the opportunity to trade on the news before it reached the market? With these principles in mind, I voted for Regulation FD, but agreed with my colleague, Commissioner Hunt, that we should closely monitor how well FD worked in practice.
How well is Regulation FD working?
As you know, the rule went effective in October. It is now May. So, what can we say about the effect of Regulation FD? From my perspective, I think we have seen many positive signs that the rule is working and is working amazingly well. But, I also firmly believe that it is too soon to draw too many conclusions. I think we need at least a full year's experience with Regulation FD before we can really evaluate its strengths and weaknesses and determine whether any modifications are needed.
The Commission recently held a roundtable on FD, inviting representatives from issuers, analysts, information disseminators and investors to share their experiences with us. Depending on whom you asked, FD has either resulted in qualitatively and quantitatively more, or less, disclosure. And both answers likely are correct. But, as many panelists frankly admitted, both answers seem more drawn from anecdotal experiences than hard data. Representatives from the newswire services say they have seen the flow of news from public companies increase dramatically, commending the Commission for democratizing the disclosure process through FD. Since FD went into effect, the number of press releases issued, webcast announcements posted, web conferences and conference calls opened to the public and Form 8-Ks filed with the Commission appears to have risen considerably.
Analysts, however, will tell you that they must now work harder to obtain company information, and that companies are more reluctant to comment on analyst models or assist analysts in making or confirming their predictions. I do not think that it necessarily is a bad thing that analysts are researching more before publishing predictions. But, we certainly want analysts to have enough reliable information upon which to base responsible commentary. We've seen nothing yet to suggest that the quality of analysts' work has declined as a result of FD, but we need more experience with how company practices evolve in response to FD before we can fairly evaluate the impact of FD on the role of the analyst, or on the markets overall.
Institutional investors, like portfolio managers, tell us that they, too, have noticed a difference in how they obtain information from issuers. So far, they tell us that they still do their jobs well. Clearly, FD was meant to increase, not staunch, the flow of reliable material information to any segment of the investing community. Not surprisingly, individual investors, who now are accessing issuer conference calls and web conferences in unprecedented numbers, seem to like Regulation FD.
We also have heard concerns, as you must have as well, that FD may be contributing to some of the market volatility we have seen in recent months. Volatility is a complex issue, and we all can identify many factors that may have contributed to recent price fluctuations. What we have heard about FD's possible contribution to volatility is largely based on instinct rather than empirical research, but should not be idly dismissed. We have seen the market undergo change in recent months. No one is surprised to see the market, or a segment of the market, move downward in reaction to news that companies have failed to hit earnings targets. One panelist at our roundtable suggested that decimalized trading helped lower spreads and perhaps increased volatility, as had block trading in the sixties, program trading in the eighties and day trading in the nineties. This panelist advised that we do nothing, and wait for the market to sort things out as it has done well so many times in the past. As this panelist noted, volatility is not a new thing; we saw volatility before FD, and we, no doubt, will see it again long after the controversy surrounding FD has faded.
Obviously, we will want to explore the volatility issue further once we have more experience with the rule. But, I think it is also important to step back and examine how this rule could lead to volatility, and, if it did, whether a return to the practices of the past would be advisable. Does anyone really believe that it would be preferable to allow a class of analysts and large investors to learn of good or bad news and trade accordingly, in advance of the rest of the market, in order to more gradually move the market up or down? Does anyone really believe that these privileged few should be able to profit by trading before the market, and the retail investor, have a chance to learn and absorb the new material information?
What more should the Commission be doing?
While I cannot stress enough that it is too soon to fully and fairly evaluate the viability of Regulation FD, I do not mean to suggest that the Commission or its staff should sit idly by waiting for FD data to collect. The Commission and its staff have been actively seeking input from the industry at conferences and at forums like the recent Commission roundtable. Our Corporation Finance staff has been fielding telephone calls from industry participants seeking guidance or clarification about how the rule should work in practice. Corporation Finance has twice published answers to frequently asked questions so that the whole industry can benefit from the telephone interpretations the staff has been giving. I would expect and anticipate that this practice would continue. Many roundtable participants asked for additional guidance on issues such as: what constitutes an intentional disclosure for purposes of the rule; and what types of dissemination would satisfy the rule. Through our continuing dialogue with the industry, we hope to provide further assurance about how to comply with this rule.
Is the threat of an FD Enforcement action chilling communication?
In the interim, we have heard issuers voice concern about the specter of facing an FD enforcement action. In speeches and as part of our industry outreach on FD, we have assured the industry that the Commission does not intend to bring an enforcement action against an issuer who is making a good faith, reasonable effort to comply with the rule. FD is not meant to be a trap for the unwary.
Clearly, we do not want the fear of an enforcement action to chill dissemination of information. The rule was designed to enhance, not inhibit, disclosure of material information. To those who continue to doubt that we mean what we say regarding enforcement, look at our record. We have yet to bring an FD enforcement action. And, I, for one, at this early stage in our collective experience with Regulation FD, would be very reluctant to support an FD enforcement action based on a mere technical violation where an issuer made a good faith, reasonable attempt at compliance.
What type of dissemination should satisfy FD?
I have saved for last an issue that I feel very strongly about and that is: what method of dissemination should satisfy the FD disclosure requirement? The rule text allows issuers to use a combination of methods reasonably designed to achieve a broad, non-exclusionary distribution of the information to the public. I have two points to make on this issue. First, the digital divide still exists; it would be an anomalous result if a rule designed to democratize the flow of information to all investors resulted in disenfranchising one or more categories of investors. Second, this is one area where I do not believe that one size fits all. In other words, there is not one method of dissemination that will work equally well to satisfy the rule for all issuers.
With respect to the digital divide issue, some securities industry participants have advocated for web-only disclosure. The FD release is clear that we did not intend to supplant stock exchange rules that require issuers to disclose certain material information in a press release. Thus, information that the stock exchanges customarily have required to be disseminated in a press release, like earnings information, should continue to be disseminated in a press release. Additional material disclosures made in a follow-up conference call or webcast that has been well noticed and made accessible to the public do not have to be included in a press release, but the information that traditionally has been included in a press release should continue to be so included. Clearly, computer access and web access are the waves of the future. One day soon, I hope that all investors will have ready access to the Internet. Each year, the numbers of American households owning computers and having the ability to access the Internet increase. But, computer ownership and/or web access are not yet universal. A recent Commerce Department survey reports that 41.5% of U.S. households have Internet access. We will get there; we simply aren't there yet. And I, for one, am not comfortable disenfranchising the less well-heeled investor or the less-technologically advanced investor. I do not believe that the questionable burden of continuing the earnings press release disclosure is sufficient to outweigh the benefits that it provides to investors. I view the continuation of the earnings press release disclosure as transitional, but necessary, disclosure.
As for my second point, when the digital divide narrows, webpage-only disclosure may never be adequate for certain companies. Website disclosure made by the large, well seasoned issuer with a large analyst or news media following will be picked up and absorbed rapidly by the market. The same absorption is unlikely to occur for the small, start-up company with little or no analyst or news media following. One commentator recently analogized the start-up companies' webpage-only disclosure to the tree that fell in the forest with no one around to hear the fall. This means that newer, smaller companies may have to undertake a combination of efforts to disseminate material information until they have a sufficient following to use a more streamlined disclosure process. This disclosure approach is not unprecedented. It is somewhat similar to our registration process: larger, more seasoned issuers are able to use the more streamlined shelf registration process, while newer smaller companies must use a more extensive registration document.
Thank you again for allowing me to share my views with you. Again, I apologize that I could not attend this hearing in person. I would be happy to respond to any questions or comments from any members of the Committee.