How Fair Disclosure Rules Reinvented Wall Street Chatter

 

Takeaway

  • In 2000 the SEC began requiring firms to disclose earnings info to all investors at once rather than giving early access to a select few
  • As a result, many companies have become more transparent in their reporting
  • Smaller firms, which once could lure individual investors by feeding them information, are now having a harder time attracting capital

Before October 23, 2000, it was harder to be a little guy on Wall Street.

That was the day the U.S. Securities and Exchange Commission implemented Regulation FD, shorthand for Fair Disclosure. A simple but far-reaching rule, it aimed to flatten the information highway for investors large and small. Under FD, if a company discloses material information to one investor or analyst, it has to disclose it to the general public at the same time.

“The whole idea was to try and make it a more even playing field,” says accounting professor John Robinson at the McCombs School of Business. “You can’t be benefiting one group of investors over another.”

As the rule approaches its 14th anniversary, how well has it achieved that goal? When Robinson went looking for research on its effects, he found dozens of studies. What he didn’t find was any study that compared them and made sense of their differing conclusions.

“I discovered an enormous literature on FD, but there were really not any summaries or reconciliations of the discoveries in this literature,” says Robinson.

In a September article, Robinson took on the job, along with colleagues Adam Koch and Craig Lefanowicz of the University of Virginia. Surveying more than a decade of research, they found that FD had indeed leveled the landscape for small investors. But it had also changed securities markets in less predictable ways. Some of their key findings:

Bumps in the playing field. The fair disclosure regulation has prompted some public companies to release more information into the markets. In one study, firms after FD were found to have doubled the amount of earnings guidance they put out ahead of official earnings announcements. Another study found 96 percent of companies switched from closed conference calls with just a few analysts and investors, to open ones, in which anyone could listen in.

But for two kinds of corporations, FD seems to have had an opposite effect. Small firms and technology companies appear to be making less information available to the markets. Several studies suggested investors were demanding higher returns from smaller companies, to compensate for getting less news from them.

That can be a hardship for a small firm with a low profile, says Robinson. Before FD, it could attract key investors by feeding them tidbits of information. Now, he says, “If you limit that ability to selectively disclose, there’s less information about the firm in the market, and consequently less trading and less liquidity. Maybe some firms are not being as well-capitalized because of this.”

Analysts: We try harder. When all investors are getting the same news from a company, analysts have to make stronger efforts to discover unique information. They end up covering fewer stocks, and their forecasts are more likely to differ from one another.

“Having less information means analysts have to work harder, to focus in on certain companies, to do more with whatever information was public and dig deeper for its implications,” says Robinson.

New forms of inside information. FD prohibits a company from playing favorites with material information, the kind that will move its stock price. But it leaves room for executives to disclose subtler kinds of information, which well-informed investors and analysts can use to get an edge on the market. Since FD took effect, events like invite-only investor conferences have multiplied, allowing a few investors to pay for private access to executives.

“These are not market-moving sorts of disclosures,” Robinson explains. “The average investor, given the information disclosed, wouldn’t see anything to trade on. But these guys know so much about an industry, in a specialized field, that a little more information from one company can allow them to analyze several companies. It has beneficial effect in that the information gets impounded into the price of stocks, and the market becomes more efficient.”

So far, notes Robinson, the SEC has done little to discourage such activity on the fringes of the rule. When he spent a year there as an academic fellow, the agency didn’t take a single enforcement action related to FD.

He notes that the agency pays closer attention to a different kind of selective disclosure. In the past year, it’s investigated financial news services like Bloomberg and Thomson Reuters, which send data to some clients a few minutes, or even a few seconds, ahead of the general public. Those extra seconds, say some observers, are enough for computerized high-speed traders to get a jump on the market.

For the most part, though, the agency seems content to have discouraged the most blatant kinds of selective disclosures.

“The SEC has a pretty good excuse for not doing a lot of FD enforcement,” Robinson says. “The idea is to eliminate some disclosure, but not to eliminate all the information moving around in the market. You do that, and the market becomes very inefficient. Like all public policies, there’s a balancing act going on.”

 

Faculty in this Article

John Robinson

Professor of Accounting McCombs School of Business, The University of Texas at Austin

John R. Robinson is the C. Aubrey Smith Professor in Accounting, in the Department of Accounting. He has taught at the University since 1985. John...

About The Author

Steve Brooks

In a quarter-century as a journalist, Steve Brooks has won two Neal awards for excellence in trade reporting and a Press Club of New Orleans award...

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