When the cure's worse than the disease

Phillip Rueppel explains that a new SEC regulation designed to foster a more even playing field is falling far short of its ambitions.

3 min read
Rules and laws almost invariably have unintended consequences--and the recent Securities and Exchange Commission regulation FD (for Fair Disclosure) is no different.

I don't know anyone who can fault its intent. The idea is to level the playing field with regard to information for investors, and prevent the misuse of material news. But I think the remedy has been much worse than the ailment because we now have less information to operate from than before.

In order to comply with the regulation, companies now err on the side of caution. They often prefer to not release new information--the new rules require a company to ensure broad dissemination of any information--even when most people would view many of the "nuggets" as immaterial.

Quality control out the window?
In my view, the result is more innuendo floating around the market, more unqualified people analyzing company performance, and the inevitable reporter making a story without the help of anyone; I would argue this has all created more, not less, volatility in stocks. Information flow has now been reduced to the lowest common denominator.

When I was a research analyst, I worked hard to uncover new information. Patching together multiple sources of data and information, I spent a lot of time digging for clues that might indicate a company's future performance. Then I would reach conclusions based on my experience.

Did I find out things the average individual investor didn't know? Of course, but I devoted a lot more time to searching out the information.

Did I have strong relationships with company management? Yes, but they were built over time and nurtured by mutual respect. I didn't waste their time asking questions that could be answered elsewhere or asking questions they couldn't answer. Was this information useful? It always helped provide a piece of the puzzle. Did I ever get material, insider information from management that wasn't going to be broadly disseminated? No.

If I believed Asian manufacturing was going to be important to a company's future, I took my time to track the progress and would get that information. Often nobody else was interested. But if my prediction proved correct, and the company's costs declined as they ramped production, my groundwork would pay off and I would have valuable information to disseminate.

But under Reg. FD, that kind of research is now close to impossible.

Striking a balance
We need to strike a balance between protecting investors and preventing those who dig up more knowledge about companies from benefiting from that work. To be fair, most--though not all--analysts operate this way. At least all the ethical and good ones do.

And Reg. FD does expose the "reporters" masquerading as analysts--those not doing the work--and over time will eliminate them. The problem is that it also handcuffs the good analysts and the danger is that there soon will be little to differentiate anybody's opinion.

As far as disclosure goes, my job was to broadly disclose and publish views and the information behind those views. To be sure, only clients had immediate access. But increasingly, more investment houses are opening up their research to individuals. The press now systematically reports major "calls" made by analysts. Again, Reg. FD hasn't really changed this structure; it has just made the access to information by analysts more difficult.

Now I'm not blaming all the recent volatility in the stock market on Reg. FD. To be fair, it's often being lumped together with the economic downturn, a subject few management teams want to talk much about anyway. But the regulation certainly allows companies to hide and not disclose weakening trends until the writing on the wall is so clear, they have no alternative but to issue a press release documenting the severity of the downturn.

There is a difference between information and valuable information. If asked whether we get more information today than in the past, many of us might raise our hands. I think this is the result of better distribution and dissemination, not less selective disclosure. But if asked whether I have access to more valuable information--data that was analyzed and prioritized for importance, the answer is sadly no. That's why Reg. FD isn't helping anyone here.