Regulation Fair Dis closure (FD) is having a "chilling effect" on Wall Street. It is hurting the quality and quantity of information provided by public companies to analysts.
Those are some of the conclusions of a recently released study by the Securities Industry Association.
The study, which surveyed analysts, said FD's inhibiting effects include a decline in the quantity of information disseminated by public companies, and a reduction in the dialogue between analysts and officials of public companies.
Nevertheless, FD has many defenders on Wall Street and among consumer groups. They argue that – prior to FD – companies leaked information to a favored analyst or two. That was unfair to the investing public and those analysts who were not close to a company. Requiring that material information must be released in a public forum has promoted a fairer market, FD defenders say.
"We think it is working quite well. If anything, I would say it is doing better than we would have expected," said Charles Hill, a director of research at Thomson Financial. "We're publishing a lot more information and are able to give a lot more guidance," according to Glen Meakem, chairman and chief executive officer of Freemarkets, which runs a business-to-business e-market firm in Pittsburgh. FD was vitally needed, said one of its authors.
"The problem was with a CEO or a CFO walking into a room – knowing sales are down, knowing revenues are down, knowing the stock is going to tank next week – and simply providing the hard material to a favored analyst. Then it was used by the analyst and his large [brokerage] firm for their customers," said Professor Harvey Goldschmid, a Columbia University law professor. "That, no matter how you think about it, was an evil."
Goldschmid noted that those at the end of the information chain were hurt by this system. "It was a stain on the market," Goldschmid said, quoting former SEC Chairman Arthur Levitt, a strong proponent of FD.
Goldschmid said that FD is not designed to have a chilling effect on the flow of information, which he said has increased since the rule went into effect. However, the controversy about whether FD is a success or not, is over the quality, as well as the quantity, of information. Has the information flow improved and have discussions between professionals and analysts been hindered because business leaders are now fearful of triggering regulatory penalties? The SIA survey contended that the answer is yes.
"Survey participants say the regulation has had a chilling effect on the quantity and quality of information released by public companies, and could well be a factor influencing the near-record levels of volatility the market has experienced lately," according to Frank Fernandez, chief economist and senior vice president of research for the SIA. He said 90 percent of analysts surveyed complained that increased emphasis on the release of information directly from the company to the public produces an "announcement effect" as markets react to the news.
But Goldschmid argues that means the role of the analyst is changing. Short-term information is now much more available from many more sources. So an analyst's value is now in seeing long-term trends.
"No longer do we need analysts in general just for information. Information is everywhere all over the net. The trick now is for the analyst to take that information and interpret it and project out and use a longer time frame in general," he added.
Goldschmid warned analysts that, under FD, "You are not playing an important role for me if you're projecting earnings two weeks ahead. If you're looking hard at that management strategy and you're working out longer term, that is your key strategy in the future," he noted.
Supreme Court
Although Goldschmid contended that FD was "a moderate" approach to the problem of disclosure, he warned that the U.S. Supreme Court might have imposed a draconian remedy if the regulators hadn't intervened with this rule.
However, Michael Blumstein, a Morgan Stanley research official, said the rule still has outstanding legal questions.
"FD says the company is responsible if the company feels it has breached the rule to get an announcement out, but there is a little bit of contradiction there in terms of our responsibility if we come across material of non-public information," warned Blumstein, director of North American research at MSDW. He complained that many of his firm's analysts had been close to companies before FD and that has to change. And he said that many companies are now "reluctant to do investor conferences or do one-on-one interviews" because of FD. Companies are more nervous about "moving off their scripts," he said.
Still, Hill, the Thomson analyst, argues there was much fear before FD went into effect, but the reg has had little negative effect.
"Since the implementation [of FD], the only industry where I see a fair amount of grousing from the analysts about not getting the information is the banking industry," he added. Hill said there is a problem in that sector, but outside of that there have been "minimal complaints."
He said that more companies are conducting conference calls because of the regulation. He conceded some of the openness can be credited to improved technology, but FD still has "accelerated" this openness. He said that the investing environment is now fairer for individuals as well as smaller institutions. There is no longer a paucity of places for investors to obtain information, but another problem is developing, Hill added.
"The problem now is what you're going to listen to. There's so much information now available that wasn't there before. The bigger decision now is where I draw the line on what I'm going to listen to," Hill noted. Blumstein said that there is "lots of noise, lots of chatter, but less substance coming out of companies." He said that Morgan Stanley is trying to concentrate more on proprietary research as well as a company's "long term strategic position."
Fewer Surprises
Hill still praised FD, saying, "It has lessened the short-term focus on what the current quarter's estimates are going to be." The diffusion of information and information channels is going to mean the spreads on earnings estimates will decline and there will be "fewer surprises when companies actually report," according to Hill.
"Analysts are going to have to work a lot harder under rule FD," Meakem said. The best thing about FD is that it will wean out "the non-analysts," Hill said. He said that, over the past 15 years or so of bull markets, too many analysts have done little more than echo what the company told them would be their earnings. In a consistently bull market, it's not too difficult to survive this way. "That game is over now," he announced.
Today, with some signs possibly pointing to a bear market and with FD in effect, analysts like that won't survive, Meakem warned.
