MICHAEL S. CACCESE
Senior Vice President,
General Counsel and Secretary
Tel: 804.951.5310 Fax: 804.951.5320
August 8, 2000
Mr. Jonathan Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Proposed Regulation FD Regarding Selective Disclosure, SEC Release Nos. 33-7787, 34-42259, File No. S7-31-99
Dear Mr. Katz:
The Association for Investment Management and Research1 (AIMR) takes this opportunity to address issues (1) not specifically addressed in AIMR's April 26, 2000 comment letter relating to the U.S. Securities Exchange Commission's (SEC) Proposed Regulation FD and, in our opinion, (2) excluded from the SEC review in considering this matter.
AIMR is deeply concerned with the unintended consequences the proposed rule will have not only on equity markets (as we and other commentators have already noted), but also on (1) fixed-income primary and secondary markets (corporate bonds, asset-backed securities, municipal securities, and commercial paper), (2) credit markets such as futures and over-the-counter (OTC) derivatives, and (3) money market and short term bank collective funds.
At the core of our concerns are that the current SEC reporting systems and required financial disclosures are structured to favor equity markets. Credit and fixed-income analysts have compensated for this reporting and disclosure bias by heavily interacting with corporate issuers, debt guarantors and others in order to receive the necessary information to adequately assess credit and liquidity risks inherent to many derivative and fixed-income investments, including repurchase agreements and other short term instruments held by money market funds. This interaction helps maintain the efficiency of the derivative and fixed-income markets. More important, it enables portfolio mangers and others to be continually vigilant in their credit risk and other analysis needed to ensure that their clients do not incur any unknown risk by investing in these instruments. In addition, because of the structure of the fixed income markets, especially the short-term debt markets, where a loss of confidence and simultaneous actions by investors can have a domino effect on the deterioration of an issuer's credit, it is essential that a portfolio manger or analyst maintain a sound understanding of the details of an issuer's cash flow and liquidity. This currently only occurs through constant contact with the issuer. AIMR submits that such interaction will be severely curtailed, if not eliminated, if the Commission approves Regulation FD in its current form.
Summary of AIMR's April 26, 2000 Comment Letter
AIMR's April 26, 2000 letter asserted its support for the SEC's effort to increase and widen the dissemination of information, but expressed a strong belief that the proposal, as written, will have the opposite effect. The rule threatens to significantly reduce the flow of information between publicly traded corporations and the analyst community and undermines the role of the investment professionals in the efficient functioning of U.S. capital markets.
If Regulation FD is implemented, corporations will curtail the information flow to the market to avoid having to decide "on the spot" whether certain information will be deemed to be material after the fact by the SEC. This is supported by the results of the recent National Investors Relations Institute (NIRI) Survey of Corporations' Anticipated Response to SEC Proposed Rule Fair Disclosure. The survey results show that 53.1% of corporations will either eliminate or limit their communication practices with analysts. Specifically, the survey found that 10.6 % of companies plan to reduce or eliminate quarterly conference calls; 23.8% will eliminate or reduce the Q&A session that typically following conference calls; 33.9% will eliminate or curtail one-to-one meetings with analysts and investors; and 26.9%, 21.7%, and 31.6% of respondents will eliminate or reduce company sponsored group meetings, industry brokered investor conferences, and broker-held analyst meetings, respectively.
Consequences for Fixed Income Investors
AIMR's response focused on the chilling-of-the-market effects the proposed regulation will have primarily on U.S. equity markets. The unintended effects of curtailed corporate information flows on the fixed income markets, however, will be potentially more severe. Because corporate disclosures (such as annual reports, 10Qs and 10Ks) are traditionally written for equity shareholders, fixed-income analysts (buy-side analysts in particular) regularly contact corporate issuers and debt guarantors to obtain non-material and non-public information critical to their credit risk and other analysis of their investments.
Fixed-income analysts and portfolio managers often contact corporate issuers to address non-material and non-public information pertinent to their analysis of primary and secondary market debt securities. In addition, it is a legal obligation under Rule 2a-7 of the Investment Company Act of 19402 imposed on money market fund boards to ensure that there is thorough credit risk analysis of money market fund holdings. A keen understanding of an issuer's credit standing as well as its cash flow and liquidity positions, business practices, and market characteristics are critical to fixed-income investors and are rarely provided with the necessary detail in mainstream reports.
Current financial disclosures, for example, for new issues are limited in terms of content (the information provided is contained in two-pages or less) and are officially made only a few days before investors must commit to purchase. Potential investors rely heavily on information provided in conversations with management to adequately assess the overall risks characteristics of the security prior to the commitment date. Privately placed debt issues will be further affected as indenture terms are often negotiated, a process that frequently reveals non-public information to potential investors. The same is true with debt instruments backed by guarantees which require legal counsel for the portfolio manager and the guarantor to discuss in detail the legal documents supporting the guarantee for a full understanding of the risks in purchasing and holding such instruments.
Corporate bonds, asset backed securities, corporate municipal securities, and commercial paper have unique and independent characteristics, which can differ greatly from one another. Investors that hold these securities have exclusive information needs depending on the protections afforded to them in the indenture agreement and the inherent risk profile of the security itself. For example, asset backed securities investors must consider certain cash flow risks to which corporate bondholders have no exposure, such as the uncertainty of the timing of principal cash flows. Commercial paper investors must carefully review the adequacy of the lines of credit backing-up the program. Municipal bond investors must assess the federally tax-exempt status of their holdings. All three examples require significant interaction with the corporate issuer to obtain the necessary information to adequately assess the overall risk characteristics of these investments. Regulation FD as proposed will prevent, or at least significantly curtail, these critical interactions between issuers, guarantors, and portfolio managers and fixed income analysts.
Consequences for Credit Markets
In addition to the many risks shared with equity and fixed-income securities, derivative securities are very sensitive to counter-party and liquidity risks. As in the case with fixed-income securities, the necessary information to assess these risks is not contained in any of the mainstream financial reports. Rather, market participants have traditionally relied on the information management supplied during individual conversations. Such information has little use to those not party to the transaction and is, therefore, habitually excluded from annual reports, SEC filings, quarterly performance reports, and press releases.
Regulation FD will weaken an investor's ability to assess these risks thereby greatly decreasing the attractiveness of using OTC derivative products by stifling communication with portfolio managers and analysts. The need for interaction with the counter-party is critical to determining the counter-party risk when holding OCT derivatives. Counter-party credit research is a critical operation of portfolio managers who use OTC derivatives. Regulation FD will deter this essential tool of credit research thereby curtailing the appeal of the OTC derivative markets, which is the flexibility of their contracts and whose end-users are subject to considerable counter-party risks since exchanges no longer act in a clearing-house capacity.
AIMR believes that as written, proposed Regulation FD will disadvantage the very people the rule intends to protect. In its current form, the rule will have a detrimental effect on all markets (equity, fixed-income, and derivative markets) by encouraging companies to limit the quality, quantity, and frequency of corporate communications with analysts and investors. The rule, though well intended, fails to recognize the likely consequences to all financial markets and their participants: investors, portfolio managers, and analysts alike. AIMR is additionally concerned that the fixed-income investor, including money market funds, will incur increased credit risk and increased market volatility as a result of the inability for a portfolio manager and fixed income analyst to receive the necessary information to analyze the credit risk of their investments.
As stated in our original response to the proposed Regulation FD, AIMR strongly recommends that the SEC empanel a Blue-Ribbon Task Force representing all market participants (analysts, portfolio managers, and institutional and retail investors participating in equity, fixed income, and derivative markets) with the charge to (1) evaluate the current disclosure practices, (2) work to narrow the definition of "materiality," and (3) establish a body of "best practices" for corporate communications with the investment community and the general public. Only once of pertinent issues have been identified and considered could any possible remedy truly be in the best interests of the investing public at large.
Should you have any questions or request further elaborations of our views, feel free to contact me by phone at (804) 951-5310, by fax at (804) 951-5320, of by e-mail at email@example.com.
Michael S. Caccese
Senior Vice President and
cc: The Honorable Arthur Levitt, Chairman
The Honorable Isaac C. Hunt, Commissioner
The Honorable Paul R. Carey, Commissioner
The Honorable Laura S. Unger, Commissioner
Mike Eisenberg, Esquire
Douglas Scheidt, Esquire
Paul F. Roye, Esquire
AIMR's Selective Disclosure Task Force
Tom Bowman, President and Chief Executive Officer, AIMR
bcc: Patricia Doran Walters, Vice President, Advocacy, AIMR
Linda Rittenhouse, Associate, Advocacy, AIMR
Maria J.A. Clark, Associate, AIMR
G:\Legal\Administration\Ltr. Katz SEC 08 08 00.doc
8/8/2000 1:17 PM by Polly Johnson
1 The Association for Investment Management and Research is a global, not-for-profit organization of over 100,000 investment professionals in 135 countries. Through its headquarters in Charlottesville, Virginia, and more than 95 Member Societies and Chapters throughout the world, AIMR provides global leadership in investment education, professional standards, and advocacy programs.
2 See Revisions to Rules Regulating Money Market Funds, December 17, 1993.