Photographer: Daniel Acker/Bloomberg

Hunting the Next Bear Stearns

Here's how the fight between companies and their regulators is about to change

A council of U.S. regulators led by Treasury Secretary Jack Lew is going to tell companies sooner when it's assessing whether the companies should be labeled critical to the smooth functioning of the financial system, a badge they're resisting because it means they'll be subjected to Federal Reserve oversight.

The change was approved yesterday by the Financial Stability Oversight Council, an alphabet soup of banking and market regulators, including the FDIC and SEC, that was formed after the 2008 financial crisis. It means the fighting between companies and regulators is going to start earlier. The council, or FSOC, will notify companies when it is analyzing them in the second stage of review, possibly months earlier than they are now, in the third and final stage.

Yesterday's move is likely to change the behavior of the companies, regulators, and investors. Here's how:

Publicly traded companies will probably disclose the news earlier to shareholders

Although disclosure isn't required under any specific Securities and Exchange Commission rule, companies won't want to be accused later of hiding material information, said Donald Langevoort, a securities law professor at Georgetown University. John Olson, a securities lawyer at Gibson Dunn in Washington, said he thinks "any notification of potentially systemically important status from the FSOC is potentially material to investors, and companies that receive a stage 2 notice would certainly want to consider public disclosure.''

Investors might have to make buy/sell decisions with less information

So far, entering stage 3 has been akin to being designated systemically important. All four publicly traded companies that have gone to stage 3—American International Group, Prudential Financial, General Electric's finance unit, and MetLife—ended up being designated. All made a public disclosure when they were told they were in the third stage. Investors at that time were able to make decisions with confidence that the company would be subject to tougher Fed standards on capital, leverage, and liquidity. Companies in the second stage aren't as far along in the process and therefore are less likely to be designated. So an investor told that a company is in stage 2 can't be certain it will be designated.

FSOC could be more cautious in moving companies along

If companies tell the world when they are in the second stage, regulators might think twice before putting them there. Knowing that their actions will become public sooner and have an earlier impact on investors, regulators such as Lew and Fed Chair Janet Yellen might take more time and move more deliberately in the designation process.