2500 Valdivia Way
Burlingame, CA 94010
March 24, 2000
John G. Katz
Securities and Exchange Commission
450 5th Street, NW
Washington, DC 20549-0609
Re: File No. S7-31-99 (comments on proposed rule covering selective disclosure)
To the Commission:
I began my career as a securities analyst twenty years ago; that is, after the Dirks case but before Dirks v. SEC finally adjudicated the matter. I have watched as technology, legal opinion (e.g., Dirks) and regulation (e.g., Safe Harbor) have made companies much less cautious about offering any information for fear of legal liability, and far more open than ever before. The Internet has had a profound impact on the investments and equity brokerage business. A large number of active private investors has emerged to take advantage of the lower trading costs and the vast amount of no-cost or low-cost information that make it possible for them to participate in the securities market on far more equal terms with professionals than ever before. The very long bull market and large returns in the technology sector has also encouraged an increasing number of people to invest on their own. At the same time, today's disclosure regulations and norms were largely developed a generation ago at a time when public enthusiasm for the stock market was much lower; when a prominent business magazine even declared "The Death of Equities" on its cover.
Selective disclosure is a topic under discussion by the SEC and the investment community. As the SEC rightly points out, regulations against selective disclosure ensure that the capital markets are as fair and open as possible. There is a sense on the part of SEC that as more individuals are trading for their own accounts, the playing field is not level enough, and that to remedy this a very broad measure - Regulation FD - needs to be enacted in the public interest. I disagree. After reviewing the proposed rules included in the "Selective Disclosure and Insider Trading," I conclude:
In my judgment, the Commission needs to address a small number of issues with specific requirements of public companies. I think the proposed Regulation will have serious chilling effect on the managements of public companies. Ultimately this will reduce the useful information available to all investors, give greater market pricing influence to manipulators through rumors and tipping, and allow those with informal access to privileged information to trade advantageously on quasi non-public information.
What's the Problem?
The problem SEC is attempting to address with FD should not be that individual investors are less well informed as professional investors; the Commission's concern ought to be that individual investors are systematically excluded from timely access to material information. Contrary to the tone of the SEC's draft, I think it is clear that individuals have access to much more material information on a real-time basis than ever before on which to base their investment decisions. The problem the SEC is pointing to is that they are excluded from timely access to specific types of events.
Professionals Will Almost Always Be Better Informed
It will always be the case is that, as a class, investment professionals will have access to more information and know more than individuals by virtue of their specialization and experience. I might buy "design-your-dream-house" software and play golf avidly in my spare time, but I will never be as good as a professional architect or join the PGA tour. I also submit that the professional's advantage in sizing up a specific company at a specific time is not necessarily a result of having better access to company officials. Indeed, for those brokerage firm analysts that actually do real research (and there are far more of us than the financial press would have one believe) we may be better plugged into what is going on in an industry than the company official we are conversing with because we talk to suppliers, customers, competitors, etc. Similarly, in some instances individual investors will do a better job of sizing up some investments than many professionals because of their superior knowledge of companies or industries, and their access to purchasing managers, sales executives, etc., in their normal course of business. As has been noted many times since Dirks, the professional's advantage stems not from having material inside information, but from being able to assemble the mosaic of general facts into a coherent picture. Those on the "buy side" of the investments business benefit from their own independent research as well as having dozens of brokerage firm analysts constantly collecting relevant information and disseminating it to them.
Even so, the gap between institutions and individuals is continually narrowing. Small investors have ready access to the same research reports as multi-billion dollar pension funds, as brokerage firms with large research teams have made their research available over the Web.
Not Much Evidence of Systematic Exclusion
Now turn to the evidence presented by the SEC in the draft. Other than stating there is a problem, and quoting assertions from journalists (some with an agenda less self-serving than others), the Commission has not demonstrated there are issues that demand a new set of sweeping regulations.
For example, the SEC is "troubled by the many recent reports of selective disclosure and potential impact of this practice on market integrity." It states: "Commonly these situations involve advance notice of the issuer's upcoming quarterly earnings or sales figures..." This is either not true or, if it is, the leaking of this kind of information is already covered by insider trading laws. Revealing actual revenue and earnings ahead of the formal release is without a doubt disclosing material inside information, and both parties would have to be well aware of this. I submit this is an issue that is already addressed by existing regulations and laws.
The SEC also states "many recent cases of selective disclosure have been reported in the media." In fact, relative to the number of public companies and the volume of public offerings, the handful of reports of "improper" conduct by company officials is hardly a cause for sweeping regulatory action. The footnotes offered by the Commission cite four instances of varying seriousness. I would be willing to stipulate that there may have been a couple more incidents that have gone unreported over the past year, but there is no evidence that it is endemic and worthy of sweeping reform..
Much More Information Available to All
What is also missing from the proposal is any acknowledgement that the amount and timeliness of the information easily available to all interested parties has increased significantly over the past decade. There is a vast amount of information readily available to individual investors. They no longer have to go to a regional SEC office to pore through microfiches (as I once did) and pay ten cents per page if they wanted a printed copy. They need not request documents from a company and wait weeks for them to appear in the mail. All of this is available for free instantly on the Internet, along with press releases that were once accessible only if you paid high fees for a "broad tape," real time/near real time quotes, and so on. Moreover, all investors now benefit from far more timely warnings on earning disappointments than was the case a decade ago. The weeks just before and after the calendar quarter are now referred to as the "pre-announce season" to reflect the common practice today of quickly making public statements and issuing press releases as soon as it is clear to management that results will differ significantly from expectations. Until the 1990s it was common for companies to sit on this information until the earnings were officially released. Then, the predictable result was that some of the time a favored few (e.g., the friend of the neighbor of the western sales manager) found out that a company had a blockbuster quarter and was able to trade on that information.
The Potential for a Severe Chilling Impact Is Real
Today's regulatory and legal climate fosters the free flow of information to investors in a way that was certainly not the case before Dirks was resolved by the Supreme Court and the "Safe Harbor" provisions were passed by Congress. In that earlier period brokerage firm analysts and company officials had to worry that even in assembling the mosaic one became liable because that final piece that completed the picture might be deemed material inside information. Companies are now much more willing to discuss their prospects than ever before.
The Commission notes the potential for the chilling impact, and proceeds - without the benefit of evidence or the practitioner's experience - to trivialize them. As a practitioner I am alarmed by the SEC's naïve assessment of the potential for FD to cause the flow of information to all investors to be severely constrained. In the real world it is far easier for a company official to beg off answering all but the most basic questions by citing selective disclosure concerns. Corporate counsel has exactly zero incentive to encourage officers to say anything more than what is already available in public documents and press releases. Going to counsel for guidance will ensure the official will clam up . Materiality judgments may be difficult, as the SEC notes, but in my experience not making them and not saying anything is very, very easy. In the bad old days, when faced with having to provide even a minor point of clarification, I frequently found CEOs and CFOs unwilling to provide them because of the potential for being charged with violation of selective disclosure rules.
In its cost/benefit calculations the SEC indicates its belief that FD will result in, on average, only five more submissions per year. In my opinion, that is likely to be the case either because the "problem" today is relatively minor, or because companies will be disseminating less information, or (more than likely) both.
Rifle Shot, Not Blunderbuss Regulation
I suggest that the problems enumerated by the SEC can be addressed through more rigorous enforcement of existing rules, and some specific changes to its requirements for issuers to reflect today's conditions (i.e., more individual investors and new communications technologies).
As to enforcement, I am not an securities attorney, but it strikes me that some of the problems that the SEC mentions - disclosure of earnings information prior to the release of this information to the public; material information passed on during an IPO roadshow that is not disclosed in the prospectus or included in broadly disseminated press releases - ought to be the subject of vigorous prosecution under existing laws. Has the commission even looked for remedies and been systematically frustrated by the courts?
On the regulatory side I suggest the SEC enumerate the following specific requirements for issuers:
- A number of the newspaper articles cited by the SEC complained that individuals and the press were denied access to the conference calls that companies now routinely hold after they release their periodic financial results. I suggest that the SEC simply mandate that companies provide a simultaneous means of access to any interested party to a specific set of meetings through a telephone hook-up, or over the Internet, or any other communications medium readily accessible by interested parties in the United States. That specific set of meetings would include any organized by the company itself specifically to discuss information that is subject to a 10-K, 10-Q, or 8/6K filing. Access should not be equated with participation, however. As a citizen of this country, I should expect to be able to watch or listen to a Presidential news conference, but the White House press corps would strenuously object if I insisted on being able to ask questions at that event. Selection of those allowed to ask questions, and those given "listen-only" connections should remain at the discretion of the company holding the meeting.
- The Commission notes in the proposal that it is "aware than many, if not most, issuers already have policies and procedures regarding disclosure practices, the dissemination of material information, and the question of which issuer personnel are authorized to analysts, the media or investors." If the SEC believes there is a process issue that needs to be addressed, why not simply require all issuers to have policies and procedures governing who does the disseminating, rather than what gets disseminated.
- The SEC notes that "our staff is currently engaged in a more comprehensive review of the regulatory issues raised by `roadshows.'" Public offerings indeed are a special case. Existing regulations were born in an age when far less information was readily available to investors, and the problem facing the Commission was limiting the issuers' and underwriters' ability to over-promote the security. The desire for fair and equal access to these events reflects a different set of issues. Today, since investors have ready access to contextual information that will enable them to evaluate claims by issuers, the restriction of information itself is turning into a problem. Why not mandate that issuers that hold roadshows have at least one of these presentations available in some form; say on the Web? (However, it would be onerous if the issuing company and its underwriters were required to make all of the meetings held in conjunction with the offering accessible in this fashion.) Also, why should brokerage firms still wait for weeks before issuing a research report with an investment opinion?
Conclusion: Little Benefit, Much Harm from FD
In my judgment, the proposed Regulation FD ultimately will be counterproductive to free and fair dissemination of information. The SEC is attempting to remedy a problem with sweeping new regulatory authority that can be addressed more appropriately through better enforcement and clarification of the existing measures. In the end, I submit enacting FD will result in less information available to investors, less disclosure through proper channels, an increase the volume and weight of rumors (particularly those generated ad hoc on "chat boards"), and a subsequent increase the volatility of the equity markets. It will disadvantage the "little guys" the SEC hopes to protect.
Very truly yours,
Robert D. Kugel, CFA