The SEC’s Battle Against Selective Disclosure

Sometimes a situation seems so obviously wrong that you can’t believe it’s allowed to continue. Then someone–like, say, the Securities and Exchange Commission–comes along and says the situation won’t be allowed to continue, and a host of opponents spring up to say, unbelievably, “Things are just fine the way they are.” To which the only reasonable response, of course, is to say, “Who are these people?”

This is pretty much the story of the SEC’s battle against the selective disclosure of significant financial and business information by companies to investment bank analysts and large institutional investors, who routinely get looks inside companies and notifications of changes in future outlooks long before everyone else does. SEC Chairman Arthur Levitt has been publicly on the attack against selective disclosure for the past 18 months, and yesterday the SEC issued a remarkably measured proposal, Regulation FD, that simply stated in essence that companies would not release any “material information” privately. Instead of applauding the regulation, Wall Street looks ready to fight it.

From one perspective, of course, this is hardly surprising. Investment banks and brokerage houses built their businesses around their access to information, and their ability to get that information to their clients before it reached anyone else. And while in theory that information could be–and sometimes is–the product of especially dedicated digging or sharp analysis, it’s often the product of a phone call to a chief financial officer, or comes from a vice president who lets slip that the fourth quarter is looking especially good. If you give up selective disclosure, and create a truly free flow of information between companies and all of their investors, then the possibility of making easy profits (either by getting in before everyone hears the good news, or getting out before everyone hears the bad) disappears.

That’s hardly an argument even Wall Street could use to defend itself. So instead what you hear is the classic “this will lead to a general chill on information” argument, which says that since companies don’t want to put out press releases all the time, they’ll stop talking to analysts at all, for fear that they’ll be breaking the law. And since markets function best when there’s more information, the market will work less well if Regulation FD is ratified.

The truth is, it’s not clear that there would be any damage done at all if companies stopped having private conversations with analysts. The privileged position of the analyst, after all, is a vestige of the days when just about all investors had accounts with the major brokerage houses. In today’s world, with the profusion of online brokerages, that’s an unnecessary privilege. At the same time, if you look at analysts’ estimates for companies’ quarterly earnings, they tend to be quite similar, which suggests that they’re the result not of aggressive independent research but rather of company guidance. If that’s the case, then let the company give its guidance publicly, in a conference call accessible to the public, broadcast on the Internet, and transcribed on the company’s Web site. The same should be the case with any disclosure of material information.

Regulation FD will work, though, only if it’s followed up with a loosening of the rules on the kinds of public statements companies can make without fear of running afoul of either the SEC or minority-shareholder lawsuits. Even today, the SEC continues to limit the kinds of forward-looking statements companies can make, out of a desire to protect individual investors–whom it considers less serious and financially responsible–from potentially deceptive statements. And the ability of lawyers to sue every company executive who makes a prediction that doesn’t come true obviously keeps executives from making predictions that would be of great use to investors. Both of these phenomena are legacies of Depression-era laws passed when Wall Street was purely an insider’s game and individual investors really were at a radical disadvantage in terms of separating truth from lies. But protecting individual investors today has the ironic effect of perpetuating their informational disadvantage. If we’re going to have full disclosure, then we have to accept the risks that go along with it. So let companies speak and investors listen and decide from themselves, and cut out the middle men.