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In Praise of Regulation Fair Disclosure

By Amey Stone It has been easy to criticize Regulation Fair Disclosure, or Reg FD, as it's known. The controversial Securities & Exchange Commission rule, which went into effect last October, essentially requires that public companies release information to all investors (large and small) at the same time. Arguably the most significant rule the SEC has passed in years, it was bitterly opposed by much of the professional investment community, which feared it would cause companies to clam up on the outlook for profits and capital-spending plans.

The truth is, Reg FD has been a blessing in disguise for the securities industry. With the dot-com bubble bursting and bellwether tech stocks plunging, the confidence of individual investors in the integrity of financial markets has been seriously challenged. Now consider this: The whole episode could have been far worse if Reg FD hadn't been around.

Think how individual investors might have behaved in the market meltdown of the past year without FD in place. They would've had to rely on information from Wall Street analysts, most of whom maintained buy recommendations on stocks even as they were losing 50% or more of their value. Without direct access to information from the companies, more people (some do now) might have become convinced the markets were stacked against them -- that Wall Street was intentionally leaving them holding the bag as stocks plummeted.

BROADER IMPACT. "It's extremely important for the broad public to have confidence in the markets as a fair place that doesn't favor those with the most money," says Chuck Hill, director of research at First Call. "The public's perceptions are important. If that means some of us have to work a little harder, we shouldn't lose sight of that goal, which I think is the most important one."

The critical public benefit of FD at a time of near-unprecedented volatility in the markets became apparent at an Apr. 24 day-long roundtable on Reg FD called by SEC Acting Chairman Laura Unger. She originally dissented from the rule and promised to monitor its consequences -- intended and unintended -- closely.

Mid-way through the meeting, she commented that Reg FD was having a much broader impact on the flow of information than originally intended. The rule had a pretty narrow goal -- to prevent companies from releasing information to favored analysts first, a practice known as selective disclosure. "We tried to get at the trading, and we got at communications," she said. That turned out to be a far more important outcome in a time of such market confusion.

THE RIGHT TECHNOLOGY. Of course, Unger and the packed auditorium in downtown Manhattan still heard the requisite mild criticism from much of the professional investing community. But groups representing individual investors had plenty of high praise. John Markese, president of the American Association of Individual Investors, said he never talked to a small investor who didn't like the rule -- in fact most couldn't believe it wasn't already the law in the first place. Perhaps some of that praise should have been coming from the analysts and professional investors.

What the advocates for the small investor like best is that Reg FD has opened up to the general public the conference calls companies hold with analysts following important news releases. Technology was on their side. The Internet made it possible to broadcast the overwhelming majority of these calls on the Web. In 1999, 80% of companies excluded individuals from listening in on calls, says Mark Coker, president of the conference call information site In the most recent quarter, 4,300 open calls were held, up from 1,300 just a year ago, Coker says.

While typical attendance at a Webcast is about 250, storage equipment king EMC (EMC) had 17,000 at its last call. Companies were moving to allow open access to conference calls before Reg FD, but it's clear that prompting from the SEC, which actually started long before the rule went into effect, got the ball rolling.

CONFUSION AND ANGST. During these calls, senior executives openly discuss problems their businesses are encountering and make forecasts about the coming year. In 2001, as Corporate America's technology spending stalled, management at these companies have had occasion to throw up their hands and say they don't know what the future will bring. For the public to be able to hear directly the confusion and angst that has tormented tech execs this year has likely gone a long way toward creating public understanding of the nature of this slowdown. The speed and intensity of the downturn surprised veteran market participants and cost them and many individuals serious money.

By opening conference calls, FD has also opened to the public the process by which analysts get much of their information -- spoonfed by the companies themselves. "A lot of investors thought analysts were working for them," said Alan Cleveland, special legal counsel to the New Hampshire Retirement System. Now they know better. Coker said analysts formerly were a "choke point" in the flow of information. With the help of the Internet, "We're entering the age of the transparent corporation," he says.

In this light, it's hardly surprising that professional investors and analysts don't like the rule. Some claim that it's adding to market volatility (since information hits the market all at once instead of going first to analysts, then to the business press, then the public). Truth is, it's impossible to judge the rule's effect on volatility given that its implementation coincided with the tech slowdown and consequent turbulent markets.

LIVING WITH IT. Mostly analysts and professional investors complain that they get less candor and receive information of lower quality when they meet one-on-one with executives. "It feels like a lot of reliance on just the script," said Morgan Stanley's research director Michael Blumstein. Fidelity's General Counsel Eric Roiter described an "orchestration effect."

But SEC commissioners don't seem impressed by these arguments. "Analysts are just going to have to go out and do their job, and not sit around and talk to the [chief financial officer] and say 'I have the inside scoop,'" says SEC Commissioner Isaac Hunt.

The rule may be causing some companies to be less candid in discussing their business. But this will be resolved over time as public companies -- or rather, their lawyers -- get used to the new rule. And, as Keefe, Bruyette & Woods analyst David Berry told the SEC, analysts are learning to get along. "We can live with anything," he says. Ultimately, the rule should improve the quality of securities analysis, believes Cleveland.

Rather than simply tolerating it, Wall Street should be applauding Reg FD for its key role in preserving public confidence in the markets. They might not appreciate it now. As Coker says, "We all will underestimate the impact of Reg FD for decades to come." But in hindsight, this significant piece of legislation will ultimately prove a major positive for all investors, large and small. Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column.

Questions or comments? Join in the discussion at our Ask Amey Stone interactive forum

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