[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
FAIR DISCLOSURE OR FLAWED DISCLOSURE:
IS REG FD HELPING OR HURTING INVESTORS?
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE, AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON
FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
MAY 17, 2001
__________
Printed for the use of the Committee on Financial Services
Serial No. 107-18
_______________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Printing
Office
Internet: bookstore.gpo.gov Phone: (202) 512-1800 Fax: (202) 512-2550
Mail: Stop SSOP, Washington DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice BARNEY FRANK, Massachusetts
Chair PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska MAXINE WATERS, California
RICHARD H. BAKER, Louisiana CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma KEN BENTSEN, Texas
ROBERT W. NEY, Ohio JAMES H. MALONEY, Connecticut
BOB BARR, Georgia DARLENE HOOLEY, Oregon
SUE W. KELLY, New York JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio MAX SANDLIN, Texas
CHRISTOPHER COX, California GREGORY W. MEEKS, New York
DAVE WELDON, Florida BARBARA LEE, California
JIM RYUN, Kansas FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina CHARLES A. GONZALEZ, Texas
DOUG OSE, California STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin HAROLD E. FORD, Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona RONNIE SHOWS, Mississippi
VITO FOSELLA, New York JOSEPH CROWLEY, New York
GARY G. MILLER, California WILLIAM LACY CLAY, Missiouri
ERIC CANTOR, Virginia STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
SHELLEY MOORE CAPITO, West Virginia BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio
Terry Haines, Chief Counsel and Staff Director
Subcommittee on Capital Markets, Insurance, and
Government Sponsored Enterprises
RICHARD H. BAKER, Louisiana, Chairman
ROBERT W. NEY, Ohio, Vice Chairman PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut GARY L. ACKERMAN, New York
CHRISTOPHER COX, California NYDIA M. VELAZQUEZ, New York
PAUL E. GILLMOR, Ohio KEN BENTSEN, Texas
RON PAUL, Texas MAX SANDLIN, Texas
SPENCER BACHUS, Alabama JAMES H. MALONEY, Connecticut
MICHAEL N. CASTLE, Delaware DARLENE HOOLEY, Oregon
EDWARD R. ROYCE, California FRANK MASCARA, Pennsylvania
FRANK D. LUCAS, Oklahoma STEPHANIE TUBBS JONES, Ohio
BOB BARR, Georgia MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, North Carolina BRAD SHERMAN, California
STEVEN C. LaTOURETTE, Ohio GREGORY W. MEEKS, New York
JOHN B. SHADEGG, Arizona JAY INSLEE, Washington
DAVE WELDON, Florida DENNIS MOORE, Kansas
JIM RYUN, Kansas CHARLES A. GONZALEZ, Texas
BOB RILEY, Alabama HAROLD E. FORD, Jr., Tennessee
VITO FOSSELLA, New York RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
GARY G. MILLER, California RONNIE SHOWS, Mississippi
DOUG OSE, California JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania STEVE ISRAEL, New York
MIKE FERGUSON, New Jersey MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
MIKE ROGERS, Michigan
C O N T E N T S
----------
Page
Hearing held on:
May 17, 2001................................................. 1
Appendix:
May 17, 2001................................................. 57
WITNESSES
Thursday, May 17, 2001
Boyle, H. Perry, Jr., CFA, Deputy Director of Research, Thomas
Weisel
Partners LLC, San Francisco, CA................................ 32
Gardner, Thomas M., Co-founder, The Motley Fool, Inc.,
Alexandria, VA................................................. 37
Glassman, James K., Resident Fellow, American Enterprise
Institute,
Washington, DC................................................. 30
Hann, Daniel P., Senior Vice President and General Counsel,
Biomet, Inc., Warsaw, IN; on behalf of the Association of
Publicly Traded Companies...................................... 42
Hunt, Hon. Isaac C., Jr., Commissioner, Securities and Exchange
Commission..................................................... 6
Kaswell, Stuart J., Senior Vice President and General Counsel,
Securities Industry Association, Washington, DC................ 45
Sweeney, Patrick D., General Counsel, Nomura Corporate Research
and Asset Management, Inc., New York, NY....................... 40
Unger, Hon. Laura S., Acting Chairman, Securities and Exchange
Commission..................................................... 4
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 64
Crowley, Hon. Joseph......................................... 58
Kanjorski, Hon. Paul E....................................... 59
Kelly, Hon. Sue.............................................. 61
LaFalce, Hon. John J......................................... 62
Boyle, H. Perry, Jr.......................................... 93
Gardner, Thomas M............................................ 101
Glassman, James K............................................ 83
Hann, Daniel P............................................... 131
Kaswell, Stuart J............................................ 141
Sweeney, Patrick D........................................... 111
Unger, Hon. Laura S.......................................... 66
Additional Material Submitted for the Record
Carey, Hon. Paul R., Commissioner, Securities and Exchange
Commission, prepared statement................................. 156
The Bond Market Association, prepared statement.................. 160
FAIR DISCLOSURE OR FLAWED DISCLOSURE:
IS REG FD HELPING OR HURTING
INVESTORS?
----------
THURSDAY, MAY 17, 2001
U.S. House of Representatives,
Subcommittee on Capital Markets, Securities,
and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, DC.
The subcommittee met, pursuant to call, at 10:20 a.m. in
room 2128, Rayburn House Office Building, Hon. Richard H.
Baker, [chairman of the subcommittee], presiding.
Present: Chairman Baker; Representatives, Ney, Cox, Weldon,
Riley, Fossella, Ose, Hart, Kanjorski, Bentsen, J. Maloney of
Connecticut, Hooley, S. Jones, LaFalce, Capuano, Inslee, Moore,
Hinojosa, K. Lucas, Shows, Ferguson, Israel and Ross.
Also present was Mrs. Kelly.
Chairman Baker. Good morning. I would like to now call the
hearing of the Capital Markets Subcommittee to order and
welcome our witnesses, and with brief explanation, explain the
purpose of this morning's hearing.
Since 1995 and the advent of online trading, we literally
have millions of individuals who are now engaging in investment
activity. I have been not surprised, but confirmed my view of
this activity as to demographic profiles of those typical
online investors with average annual incomes of about $60,000
with net worth less than $50,000.
So in fact, enormous capital flows are into the markets
today as a result of the typically described ``mom and pop''
investor. To that end, there is then a responsibility of the
Congress to ensure that the flow of information to those
individuals is balanced, fair and appropriate to make educated
investment decisions.
With the advent of regulation fair disclosure,
understanding the intent was to provide transparency and
insight into investment decisions, there was the expectation
that this would enhance the ability of that small dollar
investor to be treated in similar fashion to the sophisticated
Wall Street investor.
On first review, it would appear that that may not in fact
have been the result of a well-intentioned regulation. In fact,
looking at the potential legal liabilities of a CEO or a CFO in
making judgments particularly with regard to forward-looking
statements, it may simply just not be worth it. And therefore,
the decisions have been reached to deprive the markets of
needed information as opposed to inform the markets.
It is my view, and I think the view of many Members of the
subcommittee, that whether you are a $200 investor or a
$200,000 investor, you should be treated with equal respect and
regard, but that treating both with no information is not the
standard by which we conduct a measure of fairness.
For those reasons, the Committee this morning is looking
forward to the statements of those who will appear and will
engage in a review of this matter over the coming months to
determine what, if any, action the Congress should take with
regard to ensuring that American investors are given adequate
information to make appropriate decisions.
With that statement, I would now recognize Congressman
LaFalce who is with us. I do not know that the Congressman
would choose to make an opening statement, but I will talk for
a minute to make sure that he reflects on that decision
carefully, and I am sure off the top of his head he will come
up with an appropriate contribution to the hearing this
morning.
With that, Congressman LaFalce, welcome, sir.
Mr. LaFalce. Thank you very, very much, Mr. Chairman. Maybe
not the top of the head, but the top of my file. Thanks very
much. I think this is a very important hearing and I
congratulate you for having it. I welcome our distinguished
witnesses today to this public discussion of the Fair
Disclosure Regulation, or as it has come to be known,
Regulation FD. I think it is a very important reg.
Regulation FD was adopted to confront a serious problem.
Companies making selective and important disclosures of
material, non-public information to analysts, institutional
investors, but not to the public at large. This practice
disadvantaged the small retail investor and other market
participants who did not have the access or the privileged
relationships of analysts and powerful institutional investors.
It undermined the fundamental premise that the market is
both efficient and fair because of the broad dissemination of
meaningful information to all investors at the same time.
The Rule requires that when a senior official of a company
discloses material non-public information to a shareholder or a
market professional, then the company must: one, make all
intentional disclosures public simultaneously; or two,
promptly, for non-intentional disclosures.
In my view, FD is an important and needed step to level the
playing field for investors. And the regulation has gone a long
way in ending the practice of selective disclosure to industry
analysts and powerful institutional investors. It is possible
that FD over time may, in fact, encourage companies to
communicate directly with their investors in a more fair and
transparent way.
In addition, although FD was not precisely designed to do
so, it may also help ensure that analysts remain a truly
independent source of information for investors. The regulation
should encourage analysts who have sometimes inappropriately
become cheerleaders for the investment banking industry--and
that is all too often the case--to return to the work of
objective analysis of company fundamentals and not rely on the
privileged access that permeated the pre-FD environment.
At the same time, I am concerned about claims that FD may
contribute to market volatility and I am interested in hearing
the panelists' views on this point. The argument, as I
understand it, is that the market is often surprised by results
in the absence of analyst guidance ahead of official
information by companies. One could also argue that the price
effect of an announcement may simply be compressed into a
shorter time period rather than the several days typical under
the old regime of analyst guidance.
I am also eager to hear not only from the SEC, but our
other guests as well, about the possible chilling effects that
FD may have produced. Perhaps the SEC should consider some
specific guidance on what is material to assist companies in
their disclosure decisions.
It will also be important for our companies to understand
the SEC's enforcement posture as they evaluate their own risk
profile.
As we confront claims that the quality of disclosure has
suffered, we also must consider that this disclosure framework
is in its infancy, and there is much data yet to be gathered.
Companies, analysts and investors are clearly adjusting to the
important changes FD has brought, and in many ways companies
are learning how to communicate in an unfiltered way with their
investors, and this will take time.
Over the coming months we will look to the SEC, the
securities industry and the investors themselves to guide us on
the effects of FD. And I believe today's hearing can be an
important first step in this direction. And I again
congratulate Chairman Baker and Congressman Kanjorski for
bringing this very important and distinguished panel together
as we attempt to do our part in protecting investors and in
enhancing the efficient operation of U.S. capital markets. I
thank you.
[The prepared statement of Hon. John J. LaFalce can be
found on page 62 in the appendix.]
Chairman Baker. Thank you, Mr. LaFalce.
Mr. Kanjorski, did you have an opening statement?
Mr. Kanjorski. Mr. Chairman, I am going to put most of my
opening statement in the record. I, however, have just two
areas I wanted to talk about here. From my perspective,
individual investors on Main Street should have access to the
same information as the pros on Wall Street. The preponderance
of the preliminary evidence also indicates that the SEC's
regulations tangible and intangible benefits are increasingly
outweighing its costs.
It is, however, also too early to know for certain how the
Fair Disclosure Rule is working. With time and experience, I
expect that the industry's concerns about Reg FD will likely
fade as the marketplace becomes more comfortable with the
enforcement of the standard.
In the meantime, we should work in Congress to closely
monitor the SEC's actions to implement the Rule and
appropriately refine its enforcement approach.
I am going to insert the rest of my statement into the
record, Mr. Chairman. I just want to congratulate you for this
hearing. I think it is very appropriate at this time.
[The prepared statement of Hon. Paul Kanjorski can be found
on page 59 in the appendix.]
Chairman Baker. Thank you very much, Mr. Kanjorski.
Does any other Member have an opening statement he would
like to read? If not, I would like to proceed now to our first
panel and welcome this morning the Acting Chair of the SEC,
Laura Unger, for her comments. Thank you very much for your
appearance and participation.
STATEMENT OF HON. LAURA S. UNGER, ACTING CHAIRMAN, SECURITIES
AND EXCHANGE COMMISSION
Ms. Unger. Thank you, Chairman Baker, Ranking Member
Kanjorski and other Members of the subcommittee. I appreciate
the opportunity to testify before you today on behalf of the
Securities and Exchange Commission regarding Regulation Fair
Disclosure, which we call Reg FD.
Reg FD represents a sea change in the way----
Chairman Baker. Ms. Unger, I am sorry to interrupt. If you
could pull that mike just a bit closer, we could hear better.
Ms. Unger. Oh, sure.
Chairman Baker. Thank you.
Ms. Unger. How is that? OK. Reg FD represents a sea change
in the way issuers communicate with investors and the
marketplace. It is a very timely topic, so we commend the
subcommittee for holding today's hearing.
Commissioner Paul Carey could not be here today, but he has
submitted a written statement for the record. And Chairman
Baker, I was wondering if you could include that in today's
proceeding?
Chairman Baker. Without objection.
[The prepared statement of Paul R. Carey can be found on
page 156 in the appendix.]
Ms. Unger. Thank you. Well, even though Commissioner Carey
is not here, the subcommittee still gets a quorum of the
Commission, as I am joined here today by my colleague,
Commissioner Isaac Hunt.
Issuers selectively disclosing material non-public
information to analysts and analysts' clients trading on that
information undermine investor confidence in the fairness and
integrity of our markets. Reasonable people may differ as to
whether Regulation FD is the best cure, but no one disputes
that the problem of selective disclosure is a serious one.
I dissented from the Commission's vote to adopt Regulation
FD because of the breadth of the Rule. My dissent was not meant
to minimize the problem of selective disclosure, but I was
concerned that, in an attempt to eradicate actual trading by
clients of analysts following a selective disclosure, Reg FD
burdened the vast majority of issuers who are good corporate
citizens with new disclosure requirements.
Regulation FD embraces a broad parity of information theory
by prohibiting issuers from disclosing material non-public
information to analysts, absent a confidentiality agreement,
without disclosing it simultaneously to the rest of the world.
I was not convinced that adopting a communication rule was
the best way to cure a trading problem. I was also concerned
about the quantity and quality of information in a post-FD
world. Now that the Rule has been adopted, the Commission will
enforce Regulation FD the same way we would enforce any other
rule or regulation. But during the Commission's meeting to
adopt Regulation FD, I did pledge to monitor the Rule's impact
on information flow. And last month I convened a roundtable in
New York to discuss with the issuers, the media, analysts and
investors how the Rule is working. And your staff actually was
able to attend, Mr. Chairman.
I do plan to issue a report on the roundtable in the near
future. And the report will include the following five
observations:
Number one is the time factor. The consensus was pretty
clear that it is too soon to assess the overall effectiveness
of Reg FD.
Number two is the quantity and quality of information.
There is no question that Reg FD has increased the quantity of
information provided by issuers, but the impact on the quality
of information is a lot less clear. Some participants were
concerned that the Rule had led to a decline in the quality of
information provided, and we were told that some of the issuers
use the Rule as a shield to limit information flow.
Other issuers who are concerned about their top officials
making on-the-spot determinations of materiality that could be
second-guessed later have retreated to scripted conference
calls and other types of presentations.
The third observation would be the need for more guidance.
Many issuers at the roundtable were confused about how to deal
with questions of materiality under FD and expressed concern
that the Commission may be overzealous in its enforcement of
Reg FD. They called for additional guidance from the Commission
on how the Rule will be interpreted and enforced.
I think it is fair to say at this point that our
enforcement efforts will be focused on clear-cut violations.
Number four would be the need for more information
dissemination tools. Participants stated that the rules of the
self-regulatory organizations, especially the NYSE and NASD,
that require the dissemination of a press release, limit the
methods of dissemination otherwise allowed by Regulation FD.
And they urge the Commission to explore with the SROs other
means of achieving this dissemination and expanding the tools
available to meet the requirements of Regulation FD.
Number five, the regulation cannot be tied to current
market volatility. At this point it is impossible to draw any
direct correlation between Regulation FD and the recent
volatility in the securities markets.
It was clear from the roundtable discussion that we
probably need more time to assess the overall effectiveness of
Reg FD and whether any improvements or adjustments to the Rule
are appropriate.
Although ``FD'' stands for Fair Disclosure, and the title
of today's hearing plays on that with whether it stands for
``Flawed Disclosure.'' I think that maybe at this time we would
say that ``Few Days'' have passed and that we need ``Further
Discourse'' to figure out exactly where we need to go with this
rule.
In this regard, I can assure you that the Commission will
consider the issues raised at the roundtable and at this
hearing today in deciding what needs to be done with the rule.
Thank you, Mr. Chairman.
[The prepared statement of Hon. Laura S. Unger can be found
on page 66 in the appendix.]
Chairman Baker. Thank you very much, Ms. Unger.
I welcome now Mr. Isaac Hunt, who is a Commissioner of the
SEC, and we certainly appreciate your willingness to appear
here today, sir. Welcome.
STATEMENT OF HON. ISAAC C. HUNT, JR., COMMISSIONER, SECURITIES
AND EXCHANGE COMMISSION
Mr. Hunt. Thank you, Mr. Chairman.
Chairman Baker. And if you would pull that mike close. It
is not very sensitive. Thank you.
Mr. Hunt. Ranking Member Kanjorski and other Members of the
subcommittee, I am pleased to join my Chairwoman and to have
this opportunity to testify before this subcommittee regarding
the Securities and Exchange Commission's Regulation Fair
Disclosure.
Regulation FD was designed to eliminate selective
disclosure of material non-public information. While the goal
of Regulation FD to eliminate selective disclosure is almost
universally supported, the method employed by the Rule has been
controversial from the very beginning.
While the general public strongly supported the proposed
regulation, corporations and Wall Street saw an overbroad
regulation that would have imposed significant cost. I myself
expressed grave reservations regarding the initial proposal. I
believed that Regulation FD as it was initially proposed was
overbroad.
More importantly, however, I believed it violated one of
the basic tenets of securities regulation that President
Franklin D. Roosevelt first expressed in his letter to Congress
urging the Federal regulation of securities. Quote: ``The
purpose of this legislation is to protect the public with the
least possible interference to honest business.''
Regulation FD as originally proposed would have interfered
with every communication by a public company where material
information was provided. It would have caused companies to
publicly disclose simultaneously any material non-public
information provided to suppliers, customers, and, yes, even
the Government. It would have applied to material non-public
disclosures made by any and every employee in a public company.
It would have inappropriately interfered in the public offering
process where companies seek to raise needed capital.
In short, I believe Regulation FD as originally proposed
would have interfered too much with honest business.
The proposals, however, brought thoughtful public comments
that helped the Commission and its staff to significantly
narrow the effects of Regulation FD. Accordingly, I believe
that Regulation FD as revised and adopted appropriately
targeted the selective disclosures that we thought presented a
problem to the integrity of our securities markets.
Specifically, we were trying to stop disclosure of material
non-public information by issuers or their representatives to
favored analysts or other market professionals who in turn
often passed this information on to their favored clients.
Those favored clients might then use such information to obtain
a trading advantage in the securities markets.
While I believe that Regulation FD as revised enhances the
integrity of our markets, which is why I voted in favor of its
adoption, I remain concerned about any unintended consequences,
specifically the chilling of communications.
At the Commission meeting adopting Regulation FD, I
requested that the Commission's Office of the Chief Economist
undertake a study to examine the effects of Regulation FD.
The study should seek to determine whether Regulation FD is
accomplishing its stated goal and whether there have been any
unforeseen consequences such as a chilling of communications or
increased market volatility.
I have been advised that any study would need somewhere
between a year and two years worth of data in order to properly
evaluate the effects of Regulation FD.
I have asked and I am hopeful that the Commission will
publish in the very near future the intended methodologies of
the study so that we can obtain thoughtful public comment and
make any necessary revisions.
Since the adoption of Regulation FD, there have been a few
surveys published regarding its effects. These surveys have
shown both positive changes and negative changes in behavior of
public companies. Some companies appear to have increased the
amount of information they provide to the market, including
most notably forward-looking information, while others appear
to have reduced the amount of information they provide to the
market.
In my opinion, all of these surveys have some shortcomings.
Although they do not provide us with any definitive judgments
on the effects of the Regulation, they do provide the
Commission with certain red flags indicating possible problems
with the Regulation.
It is now, I believe, incumbent upon us to explore and
monitor these areas. We need to evaluate the landscape to see
if these problems are anomalies related to the limited
timeframe that Regulation FD has been in effect or if these
problems are widespread and long-term. I believe the Commission
has begun this process with our recent roundtable on Regulation
FD mentioned by Chairman Unger.
On the issue of enforcement, I have publicly stated that
the Commission is not looking for a test case. This regulation
was not adopted to provide our Division of Enforcement with
another tool. In fact, I am hopeful that in time Regulation FD
will be associated more with our Division of Corporation
Finance and Disclosure Practices than with our Division of
Enforcement.
I believe that it will take companies some time to fully
adjust to this rule. After all, this rule intends to change
what has been standard practice for over 60 years. Thus, there
is an education process that must take place before we rush to
judgment.
Therefore, at this time, I personally would not support an
enforcement action in a case that I did not find to be
egregious.
Let me emphasize that, as you may know, to date the
Commission has not brought a single enforcement case under
Regulation FD. This does not mean, however, that our Division
of Enforcement will not ask questions when it becomes aware of
facts that suggest that the Regulation has been violated.
I am aware that some have suggested that the mere asking of
questions by our Division of Enforcement has in some cases
caused companies to stop releasing information out of fear of
violating Regulation FD.
I do not make light of these concerns, but in my opinion,
just as it is incumbent upon us to monitor the negative effects
of the rule, we cannot and must not ignore abuses and
violations of Regulation FD. Otherwise I believe we risk
alleviating the negative consequences of the regulation only at
the cost of eliminating our desired goal.
I would, however, like the Commission to consider all of
its alternatives when it finds cases where the rule has been
clearly violated. In order for the rule to have a prophylactic
effect, I do not believe every case requires us to seek
penalties.
In conclusion, Mr. Chairman, I believe Regulation FD is an
important and appropriate rule for maintaining the integrity of
our markets, but it must be monitored carefully to ensure that
it does not result in less information being disclosed.
It is my current opinion that it is just too early to come
to any final judgment on the rule. Companies are still becoming
familiar with it, and as they become more accustomed to its
application, I am hopeful that more, not less, information will
be disclosed.
I should note that specific guidance on any particular fact
pattern can be obtained any day by calling our Division of
Corporation Finance. Additionally, frequently asked questions
and significant telephone interpretations of the rule can be
obtained on our website 24 hours a day, 7 days a week.
Thank you again, Chairman Baker and Ranking Member
Kanjorski for permitting me to testify before you today.
Chairman Baker. Thank you very much, sir, for your
statement.
Chairman Unger, in trying to get my understanding around
this issue, it appears that timing of the flow of information
is extraordinarily important. Someone telling me today that
Edsel would go out of business is probably not financially
significant. But someone telling me that Corporation X had
secured a patent and that the medication would fix a
significant problem in society today and nobody else knows it
except me and the corporation would probably be a pretty
valuable thing.
So the delivery and timing of information to all parties is
the goal. But when I look at Reg FD--and I understand both of
you have testified that no action is warranted today until we
have better understandings of its impact--but if you look at
the construction of it, we prohibit executive-level individuals
from communicating preferentially with the market participants.
It does not prohibit mid-management. It does not eliminate the
natural ability of markets to engage in exchange of whisper
numbers.
So rather than the CEO, who has a broad view of the
condition of the company talking informally with the analyst
who is going to be coming up with the consensus earnings
projection for the next report, we now have the necessity to
abide by the law to go to mid-management, who may have a
narrower view of corporate performance, and therefore perhaps
give less reliable information to the analysts which they
manage.
And I say that with some degree of certainty that
corporation management and analysts tend to talk to one
another, because the corporation does not want to have an
earnings expectation that is too high, therefore underperform.
And I have been somewhat amazed. In the dot.com arena, a
corporation that loses 6 cents as opposed to the consensus of 8
cents has a run-up in value, while a brick-and-mortar
corporation, who earns 9 cents instead of 10 cents, has a
runoff of market cap. It just makes no sense at all.
So to make a fair disclosure about what goes on in business
practice, we do have corporate executives who share information
in advance with the analysts who are trying to come up with a
consensus estimate which needs to be a penny or two below the
whisper number so that they can then exceed market expectations
and see investors flock to this unexpected great news. How are
you going to stop that? And does not Reg FD, based on those
observations, simply complicate the ability for that mom-and-
pop investor we talked about, 800,000 trades a day, the huge
run-up in mutual fund investment, IRAs? You name the investment
strategy.
It is individual Americans, working families, that are
responsible for the enormous capital flows into the market. And
it is very difficult to look at the way the system works today
and feel like they are being treated on anywhere near an equal
footing with the professional analyst. Make me feel better,
please.
Ms. Unger. I am not sure you are making me feel better. I
think Reg FD preserved the ability of analysts to have
conversations with mid-level management in order to preserve
the mosaic theory, which means that you can communicate pieces
of information and transmit pieces of information, none of
which is material in and of itself, but taken as a whole would
lead to a material piece of information or conclusion.
Chairman Baker. But the problem with that point, something
becomes material when a person trades on the basis of that
information. So at the time of its release, it might not be in
the executive's mind material.
Ms. Unger. That is right.
Chairman Baker. But to the recipient, it becomes material.
Ms. Unger. In theory, it enables the analyst to collect the
information and have these communications. And I believe the
thinking would be that the analyst would not have the same
level of faith or confidence in a mid-level management
projection as they would in a CEO's projection. So it would
really only be a piece of the due diligence the analyst was
conducting with him.
Chairman Baker. But that in large measure is a result of
whether you lose money or make money. If you lose money, you
talk to your lawyer. It becomes material and you sue him. If
you make money, you are very happy and you go about your
business.
Ms. Unger. Well, this is part of the problem with Reg FD.
If Reg FD was originally articulated to get to the problem of
an unfair trading advantage, that is a very different problem
than a communication issue. And as you know, the Supreme Court
has rejected parity of information and has acknowledged that
the corporate management and analysts community have, I
believe, walked on the tightrope, or something along those
lines, for a number of years, and the value of that
relationship.
When you get to limiting the communications of company
management with the investment community, I think you do run
into certain risks that the information collected by the
analyst, or gathered by the analyst in the analyst's research
of the company and its earnings or whatever information the
analyst is collecting, might not be as precise as the
information the analyst was receiving before.
That is the tradeoff of Regulation FD. It requires the
analyst to consult several sources in determining an earnings
projection, for example, as opposed to just getting it from the
mouth of management. And I do not know whether we know at this
point whether that is good or bad. Obviously you have heard
many different views about that.
Chairman Baker. Thank you. I have exhausted my time.
Hopefully we will come back for another round.
Mr. Kanjorski.
Mr. Kanjorski. Following up on what Mr. Baker said, it
seems that apparently we have identified some sort of a
problem, which the regulation was put together for the purpose
of solving. Does the regulation as it is structured end up not
directing itself at the problem and do we have a solution that
is much broader than was necessary? Apparently, all publicly
traded companies must deal with FD regulations. Is that
correct?
Ms. Unger. Yes.
Mr. Kanjorski. And so even small companies on the over-the-
counter market have the same costs of going through the process
of making sure that the information is out there. Was it
intended by the Commission that there was a problem with larger
companies or with smaller or mid-size companies? What
information was getting out there that appeared to be unfair?
Ms. Unger. The problem as it was originally articulated was
that there was trading activity before or around the time of
analyst calls that revealed information about earnings and
earnings projections. That indicated to our former Chairman and
others that there was material information being conveyed
during these calls that was causing the analyst to either trade
on that information or pass that information onto his favorite
clients who then traded on that information in advance of the
marketplace having that information.
The reason the SEC could not bring a case for insider
trading under those circumstances, which you would think would
be the logical next step, is because in 1983, the Supreme Court
said there is no duty owed by an analyst to the issuer because
there is no relationship of trust and confidence between the
issuer and the analyst. The analyst, in theory, works for the
retail investors to whom they disseminate that information.
Therefore, without a duty, there can be no breach of that
duty. Additionally, the insider who provided the information to
the analyst did not breach his or her duty to the company
because he did not receive a benefit for providing the
information to the analyst. And without a breach of that duty,
there can be no passing of inside information and no violation
of Section 10(b) and Rule 10(b)(5). Is that more than you
wanted to know?
Mr. Kanjorski. Not really more than I wanted to know, but I
can see your problem in how to cure it. I am just wondering
whether----
Ms. Unger. We had two choices basically. One was to read a
duty into that relationship, or two, to prohibit the
communication of the information. Rather than read a duty into
the relationship and lay the predicate for a 10(b) violation,
we prohibited the communication. Therefore, the issuer cannot
transmit material non-public information to the analyst without
transmitting it to the rest of the world simultaneously or
within 24 hours afterwards if the disclosure is inadvertent.
Mr. Kanjorski. Why can that not be accomplished by just
requiring the firms, when they talk to analysts, to talk
publicly?
Ms. Unger. Well, I think that was the tried. And in fact,
that was part of the reason for my dissent. Why regulate
communication when, in fact, the internet is making it very
feasible for companies to make this information publicly
available. Before, you did not have the possibility of
webcasting your analyst calls. Companies can now provide a lot
more access than they could have in the past and at a
reasonable cost.
Mr. Kanjorski. How large of a problem did the former
chairman think this was? Was it 50 percent of the transactions
that had insider information? Was it 5 percent? Was it 1
percent?
Ms. Unger. You know, I do not know the percentage. Do you
know that, Commissioner Hunt?
Mr. Hunt. No. I do not think we know how to quantify that,
Mr. Kanjorski. I think many of us thought that there was a
perception in the market that there was trading on selectively
disclosed information by market participants who had access to
that information. And the purpose of the regulation was to,
insofar as possible, create a level playing field for those who
had access to such information and those who did not.
It can never be a totally level playing field, and we know
that. But it was an attempt to level it as much as we could.
Mr. Kanjorski. I come down on the side that every investor
is entitled to the same information, although I think the
difficulty is in how you accomplish that objective. I tend to
agree with you, Ms. Unger, that with the internet today, it
should be relatively easy to provide investors access to
information without a lot of expense. Thus, the person that
really is a Main Street investor could acquire important
information as soon as an analyst does.
But on the other hand, I weigh it against the burden,
particularly on smaller capitalized companies, to police this
regulation internally. Smaller companies may ultimately be put
upon, either by disclosures that were not intended by the
leadership of the company but occurred by people who are less
faithful or did not carry on their fiduciary relationship to
the company and talked to outsiders. They could later be
charged with some violation.
Moreover, it would be horribly expensive. I mean, an SEC
suit against General Motors for insider trading is a flick in
legal expenses. But, to a relatively small startup company, it
could be disastrous and put them out of business.
Ms. Unger. I just want to clarify two points. One is that
Reg FD only applies to the highest level of management. So, in
the scenario that the Chairman was laying out, again, you could
talk to middle management in collecting the information, but
the company would not be on the hook for any disclosure made by
that middle management unless senior level officials were
deliberately conveying information through middle management in
an effort to circumvent Reg FD.
And also, Reg FD is a disclosure requirement. So there is
no basis for 10(b) action or an insider trading action. And
there is no private right of action for an FD violation.
So in that regard, while the threat of litigation is still
something substantial to most companies, it is not as
substantial perhaps as a private class action case involving a
10(b) violation.
Mr. Kanjorski. But, even a lawsuit by the SEC for
enforcement to a relatively undercapitalized company could
break it.
Ms. Unger. Absolutely. We have heard a lot about that. That
is right.
Mr. Kanjorski. Thank you, Mr. Chairman.
Chairman Baker. Thank you, Mr. Kanjorski.
Mr. Cox.
Mr. Cox. Thank you. And thank you both for being here with
us this morning. Chairman Unger, is the post-Dirks concern
trading or inefficient dissemination of information?
Ms. Unger. I think the concern was first expressed as
trading. But as the alternatives to how to cure that problem,
or perhaps lack of authority, emerged, it became a
communication issue. The former chairman chose to address this
issue through disclosure requirements as opposed to, again,
reading a duty or a judiciary relationship between the issuer
and the analyst.
Mr. Cox. So as you look at this today, do you think that if
the regulation were withdrawn altogether, if you can imagine it
were just gone, that the lion's share of the problems that
would be created in that vacuum would be people acquiring
information selectively and then trading on it or disseminating
it in a way that was uneven?
Ms. Unger. I think there is nothing wrong with everybody
having equal access to information if it is feasible. But the
Supreme Court has never said that there is an absolute right to
a parity of information. And it is, in fact, unreasonable to
expect that everybody would have equal information.
Mr. Cox. Yes. I am just trying to discern what the greatest
concern is about. Is it about people acquiring information?
Ms. Unger. I think that is what it has evolved into.
Mr. Cox. About people acquiring information and then doing
what with it? Trading on it?
Ms. Unger. The problem is, it is not something--it was not
my concern, so I am having a hard time answering you only
because I am trying to read someone else's mind who is not here
at the table. But my observations are that it started out being
a problem with respect to trading and a lot of trading activity
around the time of the analyst's earnings call with the
company.
And rather than bring a case and test whether we had the
authority to say, ``OK, that information was disclosed for
improper purposes, which would take you perhaps into an insider
trading violation . . . .'' As I know, you know the case law
very well, and rather than make that test case, the idea was to
maybe cast a wider net and say, ``OK, those communications are
improper.'' Nevermind the duty. We do not even have to look to
the duty, because we are going to say that you just cannot make
that information available on a limited basis. You have to
disclose it to everyone simultaneously.
Mr. Cox. I probably should not ask such a distinguished
witness when I could ask my staff and probably get the answer.
But I am just going to display my ignorance. Has there been any
private litigation since the adoption of the regulation based
upon violation of the Reg?
Ms. Unger. No. As I mentioned to the Ranking Member, there
is no private right of action under FD, because it is a
disclosure obligation. And in fact, we made very clear, I
think, in the release that it would not be the basis for a
10(b) violation to avoid the specter of litigation.
Mr. Cox. I did hear that exchange, but in my view there is
a constitutional right to file bad lawsuits.
Ms. Unger. Right. We have talked about that.
Mr. Cox. And so oftentimes people style--they do their best
to try and at least rely upon something such as this in
constructing a cause of action that they are entitled to bring,
for example, under 10(b)(5) or in some other way. To your
knowledge, has that ever occurred?
Ms. Unger. To the best of my knowledge that has not
occurred, nor has the Commission brought an action, which you
probably heard also. We have about a half a dozen
investigations at this time, but we have not brought a case.
Mr. Cox. And so from the standpoint of the issuers, do you
believe that the entirety of their concern is Commission
action?
Ms. Unger. I think there is a lot going on. I think the
issuers or the companies are trying to do the right thing in
terms of following the rule. Nobody wants to be the first Reg
FD case. I think these are all good corporate citizens that we
are talking about when I am saying ``nobody'' and talking about
companies in general. Nobody wants to have a case brought by
the Commission saying, ``Well, you committed a securities law
violation here; you did not follow the regulatory requirements
of Reg FD. ``They do not want to be the first one. So people
are reticent to make disclosures beyond what has been scripted
or what has been specifically said or outlined that they can
say.
So I do think that is having a negative impact on the
information flow.
Mr. Cox. Well, my time has expired, but I would invite Mr.
Hunt to reply to any of these questions that arouse your
interest.
Mr. Hunt. Well, thank you, Mr. Cox. I think that my
concern--and I was in favor of the regulation and worked hard
to narrow it so that it was more reasonable. My concern was the
disclosure matter that when people got selectively disclosed
information, particularly people in the analyst profession, it
would be passed on to their favorite clients.
Their clients would trade on that information ahead of the
general marketplace knowing about that information, and that
was a clear perception in many people's minds that that gave
the people who had close relationships with these analysts who
had close relationships with the issuers a clear trading
advantage over the average investor in the marketplace today,
you know, the individual investor who has come in the market in
such great numbers in the last decade or so.
So I thought the rule was a rule to, insofar as possible,
level the playing field vis-a-vis the information available to
the general investing public.
I also want to emphasize that Regulation FD does not
prohibit one-on-one conversations between analysts and the
chief executive of a company so long as no material
nondisclosed information is not revealed in those discussions.
And so when we talk about the mosaic, we assume that analysts
usually have more information, more background about the
industries and the companies they follow.
There is nothing in Regulation FD that prevents that
analyst or small group of analysts from having a discussion
with a chief executive of a registrant to fill in background
material which may be more useful, is probably more useful to
the analyst because of his knowledge and sophistication, than
it would be to the general member of the investing public.
The important thing we were trying to do was to make sure
that material information was disclosed to everybody at the
same time.
Chairman Baker. You have expired your time, Mr. Cox. I
guess I would surmise this. That the goal is to provide
information. The next level may be to sue if you do not
understand it. And that would be even a more difficult
standard, I think, to meet.
Mr. Hinojosa.
Mr. Hinojosa. Thank you, Mr. Chairman. I was listening to
the pager. And I appreciate the opportunity to ask a question.
Ms. Unger, I am new to this process, and I was not here
when the Reg FD was passed. But reading the materials and
listening to your comments and answers to the questions of our
leaders, I am going to ask you, it seems that when analysts are
looking at a corporation and judging their estimates, financial
statements and so forth, they have software that they can use
to plug all that information and make a comparison of their
financial statements and disclosures.
And so they still have an advantage of being able to call
mid-management and asking them for additional information. So
it seems like the Regulation FD was one that has been in place
a short time, not long enough for us to want to do away with
it.
Is it true that in spite of having it in the last 12
months, we have had cases where large corporations have wanted
to buy another large corporation and that the information that
top management gave besides the financial disclosures were
possibly in question, and that is why the purchase of that
other company didn't take place? And then when the announcement
was made that this giant was buying another large company was
not going to through, then the smaller of the two companies
sued the large one because their stock went down.
And I don't want to disclose names, but it's in the food
industry. And the question that I ask you is, it still happens
in spite of Regulation FD. They talked to the highest of
management, and it still happens that the information
supposedly is not reliable. So would it be your opinion that
maybe we should keep this Regulation FD for a longer period to
let it be tested?
Ms. Unger. It has only been 6 months since the rule has
been implemented. I do think that was one of the findings from
the roundtable, whether people liked Reg FD or didn't like FD,
was that more time is needed to really assess the impact of FD
on the quality of information. And, perhaps it was possible for
the Commission to have more of an exchange with the corporate
community and provide more guidance informally in order to
perhaps educate people better on how to comply with the rule
and that maybe this is just a period of adjustment.
Mr. Hinojosa. Mr. Hunt, you said that when you first saw it
implemented and enacted that you felt comfortable, and now that
you're having second thoughts. Based on my comments, would you
disagree with me?
Mr. Hunt. No, sir, I don't think I quite said that. I said
when we first proposed it I expressed concern because I thought
as originally proposed it was overbroad. I think people in the
building on the staff and at the Commission level worked very
hard to narrow it, and by the time we adopted it, I thought it
was an appropriate disclosure rule that precisely got at the
selective disclosure we were concerned about and did not impair
the ability of management of a company to communicate with
others such as clients or suppliers or even the Government.
We were trying to prevent the selective disclosure of
information that we thought could affect the marketplace
because it was going to analysts and then going from analysts
to their favorite investment customers. And that's all the rule
does now is limit that information from the issuer to
investment advisors, broker/dealers and analysts who might use
that information either to trade or to allow their customers to
trade ahead of the market knowing that important material
information.
Chairman Baker. Mr. Hinojosa, your time has expired, sir.
Mr. Hinojosa. Thank you, Mr. Chairman.
Chairman Baker. If I may, I'd like to recognize Ms. Hart
perhaps for a round of questions. Ms. Hart, did you have a
question?
Ms. Hart. No.
Chairman Baker. Dr. Weldon. It would be my intent for your
series of questions to be the last before we briefly recess for
the vote. We have about 9 minutes or so remaining on the vote.
Dr. Weldon. Thank you, Mr. Chairman. I will not consume 9
minutes, I assure you. I just have a quick question.
I apologize for missing your testimony, both the witnesses.
And I don't know if you covered this in your testimony. I was
wondering about a cost benefit perspective of the rule in light
of the widespread criticism that the rule led to higher
volatility in the market and lower quality of information to
investors. What is your opinion about the cost benefit?
As I see this, this is--if you listen to both sides on the
issue, the impression that you get is that there's some good
and bad. And maybe you can't answer my question. Maybe it's too
complicated. But take a stab at it, please.
Mr. Hunt. Do you want to do it? Or do you want me to do it?
Either one.
Ms. Unger. All right. We'll both speak on this one. I think
the cost benefit analysis at the time the rule was adopted
couldn't possibly have predicted the market volatility that
we're seeing independent from Reg FD. And I don't think anyone
in this room would attribute the current market conditions
solely to Reg FD.
So I think it makes it a lot harder to determine what if
any contribution FD has had to volatility in a particular
stock. Rather than having earnings management or a sort of a
gradual introduction of information into the marketplace,
perhaps some people are seeing more abrupt earnings
announcements and failure to meet earnings projections, and
that could have some impact on a particular company's stock
volatility.
But as far as the rule overall and the impact on the
market, as Commissioner Hunt said earlier, it would take 1 to 2
years to study that impact. This is not to say that we are not
going to go ahead and do it, but it will be a little bit of
time before we really know the answer to that question.
Mr. Hunt. Mr. Congressman, I think that as Ranking Member
Kanjorski mentioned in his queries to Chairman Unger, one of
the things we are monitoring very closely on a cost benefit
analysis is the effect of this rule on smaller issuers.
When we had our roundtable in New York late last month, one
of the comments we received from several large issuers was that
complying with this rule is no problem to us. We have the
resources, we have the staff, we have the experience to make
sure that we have no selective disclosure. But we, they said,
are concerned that this rule may have unintended adverse
consequences on smaller issuers who do not have already in
place the resources and the staff to monitor very well the
disclosures that their management make to the analyst world.
So that is one of the effects of the rule that we are
trying to watch very carefully.
In terms of volatility, I agree with Chairwoman Unger that
given at the time we promulgated this rule and what was
happening in the market at this time, I don't think there's
anybody in this room who could say to what extent Regulation FD
had, or didn't have, an effect on the existing volatility in
the market.
Dr. Weldon. Thank you, Mr. Chairman.
Chairman Baker. Thank you, Dr. Weldon.
At this time, we would recess for the vote on the floor.
Members have expressed an interest in returning and asking
additional questions. So with your continuing patience, we will
resume our panel in just a moment. Thank you.
Ms. Unger. Thank you.
[Recess.]
Chairman Baker. I would like to reconvene the hearing of
the Capital Markets Subcommittee and again welcome Ms. Kelly,
who is not a Member of the Committee, to our hearing today and
recognize her at this time for her questions.
Ms. Kelly. Thank you very much, Mr. Chairman.
One of the criticisms of the rule that's been raised about
the rule is about its materiality, that its materiality
standard is amorphous. It's subject to sort of an after-the-
fact evaluation. And I'm wondering if the Commission shouldn't
address this problem.
I mean, why not formulate a bright line rule between the
material and non-material information in some other way, some
way that is perhaps more workable?
Ms. Unger. Well, Congresswoman, you know that materiality
is a concept that is well understood, maybe not well understood
in this particular context, but in the Federal securities laws.
It has been around for a number of years.
I think the biggest challenge about materiality in the
context of Reg FD is again that you are talking about
communications. Normally when we're talking about materiality,
it's in the context of a document. It is fairly easy to sit
down and examine whether something is material or not, rather
than to have a conversation and then think, ``Oh my gosh, did I
just say something material? Do I have to disclose that?''
Which is why I think we're hearing a lot of anecdotal evidence
that people are sticking to scripts or to predetermined pieces
of information in terms of what they will disclose.
In this area, one thing that I think may have sort of
confused the issue a little bit for some people is that Reg FD
included in reference to materiality a SAB, SAB 99, which is a
Staff Accounting Bulletin on materiality. And that's fairly new
to some people. So that could be part of the confusion.
We could, however, consider adopting more guidance in terms
of examples of types of information that maybe we wouldn't
consider material. And that's something I think we'll consider
in reviewing what was discussed at the roundtable in April
where we can provide more guidance on materiality.
I don't think you want a specific definition that applies
only to Regulation FD, however. Because there are many contexts
in the Federal securities laws where materiality is an issue.
Ms. Kelly. The reason that I'm here is in my capacity as
the Chairwoman of the Oversight Committee. So I'm going to ask
another question. In adopting the release, the Commission cited
its Staff Accounting Bulletin 99, which arguably casts a wider
net than the established Supreme Court cases over the scope of
the materiality.
But given that the SAB 99 suggests that the materiality may
be judged by subsequent stock price movements, does the SEC
intend to apply hindsight to issuers' materiality?
Ms. Unger. Well, the SAB 99 I did just point out to you is
a reason that people might have a little bit less certainty as
to what materiality means in this context.
And there has been a Second Circuit decision that has said
that SAB 99 and its interpretations are consistent with
existing interpretations of materiality. And the case--I
actually have it here--is Ganino v. Citizens Utility Company.
And so that has spoken to whether the SAB 99 is consistent with
previous Supreme Court interpretations of what materiality
means.
As I think Commissioner Hunt and I have both indicated
today, we don't intend to try to make an example of someone who
makes an inadvertent disclosure or a good faith mistake in
terms of complying with Regulation FD. So no, I think the
answer to your question is no.
Ms. Kelly. Good. Thank you. I'm wondering about what the
SEC is going to view as ``intentional'' statements of material
information. For example, if a corporate CEO is in the midst of
a discussion with analysts and knows that the response to a
question is material, does the CEO refuse to answer the
question? I have some problems with the fact that I think there
needs to be some more bright lines drawn, some more
information. I think people are confused about this.
You know, if you get involved in the heat of a discussion
and you're the CEO and you respond and you've got material
information that you respond with because you're involved in
this discussion and you feel that it's important to say
whatever you're saying, would the SEC prosecute the CEO for a
violation?
Ms. Unger. I think the rule as drafted--and Commissioner
Hunt might have something to add to this--is more geared toward
intentionally making a statement. You know, perhaps picking up
the phone and calling an analyst and intentionally disclosing
something that is material and non-public and not
simultaneously disclosing it to others.
If something comes up in a conversation and a CEO answers
it and then realizes, ``Ooh, that might have been material,''
there is a period of time where that CEO can disclose that
information and not be in violation of the rule. So, again,
that is a way to cure that type of inadvertent dissemination of
information.
Ms. Kelly. I understand that that is a 24-hour window only.
I'm wondering if that is enough time. I realize I'm out of
time. But I would perhaps like to talk with you a little bit
more about that. Maybe we could talk----
Ms. Unger. I think we hadn't heard so much that it was the
time that was the issue, but really, the reluctance to engage
in the dialogue. And we heard some anecdotes at the roundtable,
and there was a subsequent mirror roundtable where people were
just saying see my earnings guidance. So they weren't answering
at all. And do you lose something when that happens? I think
probably you do.
Ms. Kelly. Thank you very much, Mr. Chairman.
Chairman Baker. Thank you, Ms. Kelly.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman. Let me start out by
saying, first of all, this is a very interesting topic and
hearing. I have to say I am a little disappointed that we don't
have Mr. Levitt here since he was the originator of this rule,
and if for no other reason, to get some of the institutional
history and what his intent was behind this.
And given that I don't think Mr. Levitt--I never really put
Mr. Levitt on the consumer side of the camp. And while he
wasn't a securities lawyer, he certainly was a practitioner and
I think had a pretty good understanding of the securities
markets.
But that being said, I do think we would benefit from his
input. That being said, I think that our colleague, Mr. Cox,
started to hit on what the issues are here. And I'm not sure we
have determined whether the issue is the efficient
dissemination of information or its effect on trading. And, Ms.
Unger, you point out that the marketplace has changed, that
there's greater access to information or the ability to
disseminate information is much easier today than maybe it
was--or certainly than it was 10 years ago or 20 years ago.
I would add to that that I think the investor community,
the investor class has expanded dramatically in the last 10
years. And that the role of the securities analyst has changed
somewhat. The securities analysts are not the primary
disseminator of market information that they once were, given
those other changes.
And I think that's good. But at the same time, something
like Reg FD it would seem to me that it was designed to not
give one sector of the investor class, if you will, the benefit
to information that the other sector might not get. And it does
seem to me that public companies do talk to investors and do
want to give them information, certainly not for illicit
purposes and certainly not for insider trading purposes, but
rather to try and tell their side of the story so that that
when the analyst turns around and puts out their report that
the market will react somewhat positively to either an upside
or a downside potential.
And so, you know, I think you could look at Reg FD and say
that was the direction that it was going in.
Now I think there is another problem that exists as well,
and I think this is where Mr. Cox was going, and that is on
this vacuum. There is a vacuum as information becomes more
readily available, as the investor class grows, and as the use
of analysts is somewhat devalued, you have a gap between 10Q's
and the information that's available and a gap between offering
documents in 10Q's and who is able to get that information.
And I am curious whether you think--I haven't read your
statement. I guess what you're saying is it's too early to tell
what the impact of FD is going to be. And you had your
roundtable and there was a difference of opinion with respect
to that.
But I'm curious whether or not the SEC is looking at Reg FD
and the broader implications of the changes in the marketplace
to where we might be moving away from or beyond quarterly
dissemination of material information to even more frequent
required dissemination of material information. Now I don't
know that you can go to instantaneous at this point in time.
But, you know, maybe in 100 years or 50 years or 25 years, you
might do that.
But is the Office of Economic Analysis or is the SEC
looking at this? And do you think that's where we're headed?
Ms. Unger. I actually have thought about that particular
issue. In the era of the internet when everything is
instantaneous, what's the point of having annual reports that
have a 90-day lag time in information? By the time that
information is publicly filed, it's pretty much already out in
the marketplace in some other form or another. And what meaning
does that have?
And I have talked to the accounting industry about this
issue and the notion of having real-time information available
about companies and whether anyone's given thought to that. And
in fact the accounting industry has. And the way they approach
it is by reviewing a company's internal controls and validating
that measure of a company. That way, when that company makes
some type of disclosure, there will be a rating attributed to
their internal controls and management and the credibility of
the information then generally disseminated by that management.
That's probably a long way away. Maybe not so long. But
certainly it's not going to happen in the next year or so. And
in the meantime, I think what we're trying to do is figure out
how we can best use the power of the internet to fulfill the
mandate of the SEC, which is full disclosure and now fair
disclosure, and how we can make that information meaningful.
And the tricky part is, when you have the opportunity to
promulgate a rule like Regulation FD, well, what do you do in
terms of providing the ability for companies to disseminate the
information? Right now we say it has to be done through a press
release, but you can then point investors to the internet in
terms of where they will find the information being disclosed.
So we have many challenges involving instantaneous
information and the dissemination of information and how
investors fit into the internet age. And I guess Reg FD is just
one of the first steps. Have I answered your question?
Mr. Bentsen. Well, no, no. I was going beyond it. I was
just making a comment on FD. I do have some more questions, but
I'll wait til another round. So, thank you.
Chairman Baker. Mr. Ferguson. No questions?
Ms. Hooley.
Ms. Hooley. Thank you, Mr. Chair, and thank you for being
here to talk about this issue. One of the things you've talked
about in your testimony is, it's too soon to tell. At least
that's the reoccurring theme that I've heard, it's too soon to
tell. Can you give me some inclination as to when would be
another appropriate time to have a hearing on this and look at
some additional information that we will gather over the next 3
months, 6 months? What kind of timeframe are we talking about?
Ms. Unger. I'm not sure what Commissioner Hunt's views are,
but I would think this is something that we should continue to
monitor on an ongoing basis. We absolutely could not have
gathered any meaningful information before the 6-month period,
which is when we had the roundtable in New York. And then we
had our first set of 10Ks since then, well, since the rule was
promulgated.
As we continue to look at the information that's being
provided and seek the input of the industry, the issuers, the
analysts and the investors, we can pinpoint what if anything we
can do to improve the rule on an ongoing basis.
Ms. Hooley. Well, I think like most rules we enact, no
matter what agency or legislation we pass, there's always a
shakedown period and a time to look at what have we done right,
what have we done wrong, and how do we bring some kind of
balance to this whole situation. So I will be anxious not only
to finish this hearing but have another round in another 6
months. Thank you for your testimony.
Ms. Unger. Thank you.
Chairman Baker. Thank you, Ms. Hooley.
I again want to make another run at trying to understand
where the intent is with Reg FD. The presumption is information
ultimately affects valuation. And so that if information is
provided equally to all, everyone can make judgments about
value simultaneously. But information only becomes material if
the disclosure of that information would ultimately affect
value. So that in order to avoid a potential penalty or inquiry
from the SEC--even the inquiry is sometimes enough to make a
corporate executive think twice--the standard now becomes let's
not say anything even if it could ultimately disclose
information to the investor community that ultimately would
affect value, thereby insulating us from action so that the
safest approach is to say nothing, even if you have knowledge,
for example, that the large contract that will be the basis on
which future earnings projections are now based, has just been
canceled. Because it doesn't go to solvency of the corporation,
it's just another day at work.
If you disclosed it, however, it would have the consequence
of a significant--and let's take it both ways. It could be that
you haven't announced the new contract that will mean
significant run-up in price, or you haven't announced the loss
of the contract which would result in a devaluation, but you're
doing your job as a CEO if you simply do not disclose the
material fact based on your concern that the way in which you
disclose it may lead you to some liability.
Am I inside the CEO's head with the proper view of the
world? Is that's what's going on?
Ms. Unger. Well, I think there are a couple of things going
on with what you said. One is materiality. What is material
information? I think you've pinpointed something that everyone
would say is material. But the definition, the case law
definition, is what a reasonable investor would want to know.
When you say that it might affect the valuation, I think
you're talking about the SAB 99 interpretation. One of the
considerations is if it would move the price of the stock,
which you obviously can't really know in advance, I think.
When you talk about disclosing that information to an
analyst, you can do it in one of two ways post-Reg FD. You can
either issue a press release and announce it to the world--you
know, announce your earnings call and make it available to the
public, and announce it that way. Or, you can tell the analyst,
pursuant to a confidentiality agreement where the analyst would
then not be able to do anything with that information in terms,
I guess, of putting it into the total mix of information.
So in that respect, you don't have the time for the analyst
to take that piece of material information and somehow allow
management to manage the earnings of the company or to soften
the blow of the disclosure of that information. You either have
to disclose it pursuant to a confidentiality agreement, which I
guess means that it remains non-public, or you have to disclose
it to the whole public at once. And the question is, well, what
does that do then to the price of your stock? And is that what
management wants to do? Do they want to tell everyone at once
or not? But those are your two options basically.
Chairman Baker. Mr. Hunt, if you were on the other side of
the table as a CEO for a corporation sitting in front of your
Commission, what would you say to the Commission about your
view of how this should function?
Mr. Hunt. Given my view of the rule, Mr. Chairman, I think
that I would say that companies have always been under an
obligation to disclose either the gain or loss of a company
that's going to totally change the financial statement for the
next quarter or half-year or year.
Chairman Baker. But let's move the bar just a little closer
in, and instead of something that's a significant financial
impact, it would enable you--let's take the positive side. It's
a really good contract. It's going to improve your bottom line.
It may not double your stock value, but it's going to be an
improvement. So somebody may want to trade on that information
and benefit from that 4, 5, 6 percent increase, being quite
happy with that news. And you don't disclose that.
I don't know of anything in current law that requires you
to make that disclosure. And if you choose not to disclose it
because you're worried about the mechanism by which you make
that information available impairing someone, is that really
what we want to be doing?
Mr. Hunt. Well, I think actually there is something in the
current law. The Supreme Court case that we based most of our
materiality standard on, in addition to Accounting Bulletin 99,
which says that if something is material, a reasonable investor
would want to know it, and it doesn't necessarily have to move
the market, but it has to be something that would change the
total mix of information that a reasonable investor would want
to know.
Now if the company is putting out a document, a proxy
statement, a registration statement, a press release in that
time when the new contract comes in, then you might have to
make that materiality judgment that it's got to be disclosed in
one of those documents.
And I think there's a lot of discussion about Regulation FD
perhaps chilling the communication--I know you're going to hear
that from the second panel--chilling communication between the
issuer and the investment community.
Our information so far--and it's very preliminary--is that
some companies are putting out more information, some are
putting out less. Some are putting out the same. I recognize
that some people could suddenly hide behind FD and say I'm not
going to say anything to anybody anymore. But I think we are
finding that most people are not reacting to this regulation
that way.
Chairman Baker. Thank you, sir.
Mr. Kanjorski.
Mr. Bentsen, do you want to come back again?
Mr. Bentsen. Yes. Let me follow up on that, because it also
brings up another point I wanted to make in my last round.
First of all, the law requires that public companies have
to disclose material items quarterly or registration----
Mr. Hunt. Or even more.
Mr. Bentsen. Pardon?
Mr. Hunt. We encourage them to disclose material
information more often than that. If it happens between
quarters, then disclose it.
Mr. Bentsen. But this argument, and Ms. Unger, in your
testimony you raise this I think as one of the reasons of your
dissent--that some companies might just choose not to disclose
anything.
Now ultimately they're going to have to disclose, though.
Even if upon the encouragement of the Securities and Exchange
Commission that they don't want to disclose in an interim
period, they have to disclose in a registration. They have to
disclose in an offering document or they have to disclose in a
10Q or 10K.
And so it's just a question that they wouldn't disclose
necessarily in the interim period because they figure they
might trip over FD in some way and not conducting simultaneous
disclosure to the public. Is that your concern?
Ms. Unger. The only thing I would add to the disclosure
requirements that you just enumerated is the Form 8K which has
a number of items that do have to be disclosed intraquarter.
And there's Item 5, which covers certain material events. And,
without having Regulation SK in front of me, I can't remember
exactly what they are. And then there's a change in auditors
and things like that.
So we've identified some material information that must be
disclosed intraquarter. But you're right. There's still a whole
host of information out there that we don't say you have to
disclose that might not be disclosed as a result of the fear of
repercussions.
Mr. Bentsen. But what would be the motivation? I mean,
first of all, I don't think stock analysts necessarily or
market analysts necessarily, I mean, they're a conduit of
information, but they basically are not a conduit from the
standpoint of Acme Corporation sends them a press release and
they publish the press release in their report that they send
to their investors. They are an analyst of information,
theoretically, and they take that information and make their
judgment as to what it means.
But what would be the motivation of someone to only provide
information to certain parties in an interim period as opposed
to providing it across the spectrum?
Ms. Unger. Why would companies do that do you mean?
Mr. Bentsen. What would be their motivation, yes.
Ms. Unger. I think the concern was that companies would
provide the information to curry favor with the analysts so
that they would receive good coverage in the research reports.
The articulated problem is that they could give the information
to the analysts, curry favor in some respects by letting the
analyst have that information; and the allegations in some
cases were that the analysts would take--the way they'd curry
favor is to allow the analyst to have that information and to
pass it on to the favored clients, who would trade. Not
necessarily the analyst him or herself, but the clients of the
firm that the analyst was employed by.
Mr. Bentsen. And why would we want anybody to do that?
Ms. Unger. I think everyone in the room would agree that's
not a good thing. The question is, how do you get at that
problem? And that's a problem of insider trading, but not the
type of insider trading to come within the traditional
articulation of the rule.
Mr. Bentsen. I'm not a lawyer, but I think what the court
said, there was no trust, whether legal or illicit----
Ms. Unger. No duty.
Mr. Bentsen. ----that would cause some sort of insider
trading activity. And I don't want to use this term, but I
guess I can't think of another one. There is the potential for
manipulation, which we would call ``spin'' in Washington, to
say that we're going to provide to some analysts that we want
to curry favor with or we want to make something sound a little
bit better than it might be, I mean, why not provide it to
everyone?
Now I assume that if you were a company that had very good
news--and companies seem to do this all the time--you'd want to
put it out to the world because you hope it would pump your
stock price.
But I guess, you know, this is maybe the devil's advocate
to my friend from Louisiana's question. But why would this--I
mean, if this chill--I don't understand why this would chill
communications between public companies and analysts who follow
their stock or follow their companies. And why would we be
concerned that that might happen when at the same time the law
is pretty specific that the companies have to provide the vast
majority of this information?
Ms. Unger. Well, companies have always been allowed to give
information previously. You could provide information to the
analysts, and it wasn't a violation of anything, even if it was
material non-public information. And frankly, because of the
case law, that was true even if the analysts passed that
information onto someone else who traded. Well, people thought
it certainly presented an appearance problem--that a company
could pass material non-public information onto an analyst who
could then pass that information on to clients who trade.
That's the problem. Not having material non-public
information. That has never been a violation before. You could
always possess the information. You could have it and the rule
was always you had to disclose it or abstain from trading. Now
we're saying the company can't give you that information unless
there's a confidentiality agreement or the company discloses
that information to the investing public.
Mr. Bentsen. With the Chairman's indulgence.
Mr. Hunt. Mr. Congressman, if I could add something. In the
post-promulgation era, I am not concerned about companies
spreading the word of positive information. They're always
going to have a reason to do that. I'm concerned about whether
there would be any chill on giving out negative information.
Not that you won a big contract, but that you lost a big
contract.
Mr. Bentsen. Right.
Mr. Hunt. And that under FD, the company will decide, I'm
not going to say anything until I have to in a 10K or something
like that, but I'm not going to say it right now. They'll
always find a way to get the positive news out to the
investment community.
Mr. Bentsen. And that's a fair point, but it has to be
clear for the record that there are very limited periods of
time in which they are shielded from having to disclose that
information.
Mr. Hunt. But the market can move instantaneously.
Mr. Bentsen. I understand that also. But the other thing,
the point is, you are giving information, again, you're giving
information to an analyst and the analyst is not, she is not
just taking that information and reprinting it and putting it
out under the name of, you know, Bentsen Securities or
whatever. It is something that they are taking that information
and they are theoretically putting out their own interpretation
of that information. They are adding value to that information.
Mr. Hunt. It depends on who you talk to, Mr. Congressman.
Mr. Bentsen. I understand. But that's the theory of the
job. And the question is, so why--I mean, even if you want to
curry favor with the analyst and give them the information, I
mean, why wouldn't you do that because you know that they're
going to--if it's an analyst who happens to like your company,
then maybe they're going to put something out saying the fact
that they lost that contract isn't all that bad because of all
these other things that are going on, and so forth, and so
forth. And you have to put it out to everybody else.
I mean, I still don't understand why we would want to
protect one specific group as a conduit for information, good
or bad, as opposed to opening it up to everyone else. Because
that one specific conduit puts their own spin on it
theoretically.
Mr. Hunt. Well, I think the theory behind the rule as
articulated is that there was a perception that the
information, good or bad, was being given to a small group,
maybe only one analyst who follows the registrant, the issuer,
and that that analyst would pass it onto his or her favored
customers, and those favored customers would be able to
successfully trade on the basis of that new material
information before the rest of the market knew it and could
absorb it and trade on it as well.
And so the disadvantage we saw in the existing state of the
law, that there might be a time period between which there
wasn't any obligation to disclose because it wasn't time for a
10K or you had so much time before you put it in an 8K. And so
if it was given to a small number of investors, they would have
the advantage over the marketplace in their knowledge both of
the information from the issuer and from the analysis that the
analyst did before passing it on.
Mr. Bentsen. And nobody would want that to happen?
Mr. Hunt. No, I would hope not.
Mr. Bentsen. But in your opinion, will FD help preclude
something like that happening?
Mr. Hunt. We hope FD will preclude some people having an
information advantage over other people in the market. We know
I think realistically that you can never completely level the
playing field. Some people are more sophisticated. Some people
are more knowledgeable. Some people have more experience in the
market. So we're never going to be able to level it completely.
But we hope that this certainly levels it some and helps
alleviate the appearance of disadvantage that some people have
vis-a-vis other people in the market.
Mr. Bentsen. And was there any alternative?
Chairman Baker. Mr. Bentsen, I'm sorry. Your sophistication
is taking advantage of the other Members of the subcommittee.
Mr. Bentsen. I appreciate there are others. Thank you, Mr.
Chairman.
Chairman Baker. Thank you, Mr. Bentsen.
Mr. Ferguson.
Mr. Ferguson. Thank you, Mr. Chairman. And I thank the
panel for being here. Very briefly, I was not here the whole
time. I came in late, so I apologize if this has been covered
already. But I just had a quick question for the panel. And I
appreciate your patience with us this morning.
My question is why does Reg FD not provide safe harbor for
analysts from ensuing liability or derivative liability? I
mean, if our goal is transparency, it seems to me that may be
one course we'd want to look into. Could you maybe just address
that very briefly for me?
Ms. Unger. Well, Reg FD is a disclosure requirement, and
there is no private right of action for a violation of Reg FD.
Only the Commission could sue. So if we gave a safe harbor from
suit by the Commission, then nobody could sue.
So I'm not sure if that's what you're talking about, or are
you talking about the safe harbor for forward-looking
projections?
Mr. Ferguson. It just seems to me if we're trying to
promote transparency, we should be looking into many avenues to
see what we can do to promote that. So that's why. I just had a
question. And again, I apologize I wasn't here the whole time.
Mr. Hunt. Mr. Congressman, I think that we think that--the
liability for the analyst is what you asked about--is an
extended liability. The rule is mostly aimed at the issuers,
the registrant.
There is a possibility, a theoretical possibility of
analyst liability if they aid and abet an issuer, for example,
in making an unfair disclosure by getting the information and
then passing it on to their clients when they know it's
material and otherwise nondisclosed information.
So there is a possibility of liability under FD for members
of the analyst community, but it's an extended, it's a
collateral liability. It's not a direct liability which mostly
would rest on the shoulders of issuers and their
representatives.
Ms. Unger. Right. Because it's the company's obligation to
make the disclosure.
Mr. Ferguson. Sure. Thank you. Thanks, Mr. Chairman.
Chairman Baker. Mr. Ferguson, let me jump in here on this
point, though. We are now creating with Reg FD a standard. And
if I take action against an issuer based on what I believe to
be fraudulent conduct, then I can point to the disparate
disclosure standards pursuant to Reg FD as a material fact to
substantiate the fraudulent conduct of the corporation.
So I'd think, notwithstanding the fact there are or are not
currently pending issues of litigation, certainly this body of
law creates something that a creative attorney can pursue in
evidence of a 10(5)(b) violation.
You would I think agree with that observation?
Mr. Hunt. I think creative securities lawyers can always
find a way to use whatever information they have.
Chairman Baker. Depending on the charge per hour, I'm sure.
Mr. Hunt. Yes.
Ms. Unger. I think we did consider that issue, and there
was a concern by the Commission that that would be a problem,
that we would somehow inadvertently create the basis or a new
basis for a 10(b) claim. In fact, we tried to address that in
the adopting release. We stated that a violation of FD would
not be the basis for a 10(b) claim.
Chairman Baker. And to date, we have no knowledge that that
in fact has occurred?
Mr. Hunt. No, sir. But I think we would concede that there
is certainly a possibility that even though there's no private
cause of action under Reg FD itself, it is possible to take
something that was said in the FD context, constructed with
other things, possibly to make a plausible violation under
Section 10(b) or Rule 10(b)(5), but not under Regulation FD in
and of itself.
Chairman Baker. Understood. It's not an actionable cause on
its own basis.
Mr. Hunt. Yes, sir.
Chairman Baker. Mr. Fossella, did you have a question?
Mr. Fossella. Thank you, Mr. Chairman. I apologize for
being late, but I have a hearing across the hall on Commerce. I
wish I were here for the earlier part of the testimony and
questioning. So if I ask a question that's been asked already,
accept my apology.
It's been said that Regulation FD has done more harm to
small investors as opposed to prior to Reg FD, because the
amount of information has actually decreased, and therefore a
small investor is not as sophisticated as those who perhaps
could engage or contract with analysts or whatever the case
might be, are now at a disadvantage prior to the implementation
of Regulation FD. Do you agree with that?
Ms. Unger. I think the focus has been on the quality of
information, whether there is good information being disclosed
post-FD and that there has been perhaps an increase in the
number of disclosures made, but not in what those disclosures
are in terms of the actual information provided.
And so the question is whether that's good or bad for the
marketplace is I think what you're asking. And that's something
that we are monitoring very closely, because obviously that
would be a very unintended consequence. If the idea was to
provide more information to the marketplace, then certainly it
would not be accomplishing that objective if investors were
receiving less information.
But I don't know. I don't know that we know other than
anecdotally exactly what it's done. And there have been a
number of studies in terms of the quality of information, but I
think nothing definitive yet.
Mr. Hunt. Yes, sir. I think that clearly the little
investor was at a disadvantage, at least a perceived
disadvantage, in the pre-FD era when sophisticated, large
institutional investors, for example, could receive information
from analysts and trade on that information before the rest of
the market knew about it.
If the consequence of Reg FD is there's less information
going out to the general investing public now than was going
out before, then that's a negative consequence of Regulation
FD, and we would have to address that.
As the Chairlady said, of the polls and the surveys that
have been done so far in this preliminary 6-month stage, some
indicate that more information is going out because of FD, some
indicate the same amount of information is going out, and some
indicate that issuers are giving out less information.
We're going to have monitor this very closely to see what
the overall effect of FD is as to the quantity and quality of
information going to the general investing public.
Mr. Fossella. So in a yes or no answer, I guess, you have
not drawn a conclusion.
Mr. Hunt. No, sir. We have not drawn it. I think companies
and their counsel are still in the learning curve. How do we
react to FD, you know? How soon do we get this material
information out? Do we judge materiality in the same way we
judge offering documents or the proxy material that the
companies put out? I think they're in a learning curve. And I'm
hopeful that the information will get better in both quantity
and quality as we go down the road.
Mr. Fossella. Is there a timeframe in mind at which point
you will say, you know what, we're going to assess and realize
that perhaps----
Mr. Hunt. We're trying to assess it all the time. We're
going to do a study certainly within the next year of the
effects of this regulation. We promised at the public hearing
where we promulgated it that we would do a study and study its
consequences. And, of course, other people whom you will hear
from today are also monitoring and doing surveys on the effects
of this regulation.
Ms. Unger. But what's interesting about FD is that the
individual investor thinks they love the rule without really
knowing what impact it's had on the information. So if you were
to poll individual investors, they would say FD is the best
thing that ever happened. And the other part of it is, they
never thought that it was legal to engage in this type of
information dissemination pre-FD.
So you have this perception that FD is a panacea to
individual investors without them really understanding the
impact it's had on information flow. So I think there would be
a very strong reaction from the individual investor community
if we were to do something like repeal FD.
So at this point I think maybe we're just trying to improve
the effect of the rule.
Mr. Fossella. But doesn't the issuer try to do what's right
regardless of what the investor may or may not feel? I'm just
trying to get a sense. If those who are correct in saying that
Reg FD has had a negative impact on small investors, regardless
of what they may feel if asked a question in a poll, if indeed
it's wrong or it's been detrimental to the small investor, what
is the SEC's position and when will it make a decision to
modify or potentially abolish something like Reg FD?
Ms. Unger. If I had to answer today whether it's had a
negative or a positive impact on information flow, I would say
a negative impact on the quality of information and a positive
impact on the flow of information generally.
Mr. Fossella. Like it's raining outside? That's more
information, but who cares?
Ms. Unger. Exactly. Exactly. Based on what I've heard and
what people have said during the various roundtables, that
would be my conclusion.
Mr. Hunt. I'm not ready to reach that conclusion yet. I
think clearly there has been more frequent information. I'm not
yet ready to make a determination on the quality of information
vis-a-vis information that was given out pre-Reg FD.
I mean, one of the contexts to put this in is that there is
so much more information about the financial world on TV these
days because of all the business networks that, in some ways,
the small investors are already inundated with information
about what's going on in the marketplace. But I just would
withhold the judgment yet on whether the quality of the
information has increased or decreased under the FD regime.
Chairman Baker. Thank you, Mr. Fossella.
Mr. Fossella. Thank you.
Chairman Baker. I'd like to recess the hearing briefly for
the pending vote, but conclude this panel if appropriate. We do
have a significant participation in the second panel.
I would express my appreciation to you for your long-
standing participation today. No one would have expected the
hearing would have gone on quite this long. But in the course
of the morning, we've had in excess of 22 Members come in and
express an interest in this matter.
It also is a beginning for us, not the end. We will
continue our examination of this and related matters throughout
the rest of the year and look forward to perhaps when the
Commission has reached some preliminary findings, revisiting
the issue.
I just recently refinanced, and at the closing had 68 pages
of required information. Just the Fannie and Freddie
disclosures were 18 pages. And I took the closing agent through
a very painful exercise of going through every page, a closing
he will not soon forget.
But if I had had 88 pages as opposed to 68, it would not
have improved the quality of either of our lives. So I'm not
sure that the flow of information is in itself a valuable item.
It is more important to have a quality instrument. A one-pager
that told me what I needed to know would probably have been a
very helpful thing on that morning.
And my concern is that FD, although well-intended, may be
turning the firehose on a little heavy and that the quality of
the useful result is somewhat questionable, at least in my mind
at the moment.
But we are not reaching conclusions here today. We are only
trying to understand, and we appreciate your courtesy in
participating in the hearing. We'll stand in recess for about
10 minutes.
Mr. Hunt. Thank you, Mr. Chairman.
Ms. Unger. Thank you, Mr. Chairman.
[Recess.]
Chairman Baker. I'm reasonably confident there will be
Members returning here in a moment. We probably have another
hour before we are again interrupted. But I think it
appropriate to go ahead and get our second panel initiated.
Few would have predicted we would be starting the second
panel at 12:35. So I would express my appreciation to each of
you for your participation, make you aware that your statements
will be included in the record as received, and would encourage
you to summarize your views in order to maximize the ability of
Members to be able to ask questions of the panel.
Our first witness in this panel is Mr. James Glassman,
Resident Fellow, American Enterprise Institute, and we welcome
you, Mr. Glassman. And if we can get you a microphone, I guess
we'll get you started. And you do need to pull that thing very
close. It's not all that sensitive. So thank you very much,
sir.
STATEMENT OF JAMES K. GLASSMAN, RESIDENT FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Glassman. Thank you, Mr. Chairman. It's an honor to be
here today to discuss this very important issue.
While the purpose of Executive Regulation FD was to help
small investors, it has actually hurt them. Since the
regulation was enacted, the volatility of markets has
increased, making them scarier places for the public, and
increasing the cost of capital for corporations.
The regulation has certainly led to a lower quality of
information emanating both from those companies and from the
analysts who cover them. Warnings abounded before Reg FD was
approved and even advocates admitted that higher volatility was
a likely result. For example, in an Op Ed piece in the New York
Times shortly before the approval of the regulation, Daniel
Gross, a supporter of the rule, admitted the obvious.
Regulation FD, quote: ``will surely bring greater volatility.''
Two surveys have now shown that 90 and 71 percent of
analysts believe that FD has increased volatility. Obviously,
we don't know for sure. There are too many other factors
involved. But it stands to reason that FD has increased
volatility.
Did the SEC believe that these adverse consequences were
simply the price that had to be paid to achieve more important
objectives? Fairness, through the elimination of special
advantages enjoyed by analysts and professional investors; and
objectivity, through the elimination of a system that could
reward analysts with access if they gave favorable reports.
That seems likely. My own view, however, is that high
volatility and degraded information quality have been far too
high a price for small investors to pay for a particular vision
of fairness promulgated by regulators.
And I speak as someone who has devoted much of his
professional life to educating small investors and advocating
policies to help them. For nearly 20 years I've been writing
about finance and economics, while in recent years I have also
served as a Fellow at the American Enterprise Institute in
Washington and have run a website, TechCentralStation.com, that
focuses on the nexus among technology, public policy and
finance.
My strong belief is that for most Americans, the stock
market is the only route to the kind of wealth necessary for a
comfortable retirement. So understanding the market and
investing wisely are not a luxury, but a necessity.
I have generally applauded the work of the SEC during the
tenure of Chairman Arthur Levitt, Jr. Mr. Levitt was my
business partner from 1987 to 1993 when we were co-owners of
Roll Call, the Congressional newspaper that I edited. But at
times the Commission's appropriate concern has led to
inappropriate policy, mainly because of a lack of faith in free
markets and the competitive process. Reg FD is a prime example
of a top-down regulatory policy that tries to manage an often
messy process which produces better results for small
investors.
Is it fair that corporate executives share information with
some analysts and not others or with some analysts and not the
public at large? Well, fairness is in the eye of the beholder.
The Supreme Court in Dirks says that fair or not, it is indeed
constitutional.
Let me ask a different question. Is it fair that elected
officials, including many Members of Congress here today, and
certainly even Commissioners of the SEC, share information with
selected journalists and not with others, or with some
journalists and not the public at large? That would seem to be
even less fair than selective sharing by corporate executives
since public officials by definition serve the public. Yet
selective sharing by politicians happens every day and
undoubtedly works not only to promote good policy but also to
promote the financial well being of journalists and their
publications.
Certainly selective sharing of information by politicians
is a way to put more information and analysis into circulation.
Without that sharing, the information might not come out at all
and might not be understood.
So what is the best way to encourage the dissemination of
information, financial information? Not Government rules, but
open competition. Competition driven by consumer choice is the
key to abundance and variety in the marketplace both of goods
and services and of ideas.
Analysts compete. They work to get information about
corporations because that information, plus subsequent
judgments that they draw from it, gives them an edge over other
analysts. As my colleague, Kevin Hassett, an economist at the
American Enterprise Institute, has written, ``Analysts do this
hard work because they or their firm's clients will profit if
they are a little bit smarter than the next guy.''
It is the potentially asymmetrical nature of the
distribution of information that triggers the competition from
which all investors benefit, whether they are clients of the
analysts with the initial edge or not. If information by law is
relayed to all analysts and in fact to all citizens at the same
time and in the same way, then the incentive for hard work by
analysts declines sharply. Less information comes out, and
small investors suffer.
Now while the internet offers the technology to make vast
amounts of information about companies available to investors,
the role of analysts remains critical. Raw numbers don't help
most investors who have a hard time telling an income statement
from a balance sheet. More than ever they need analysts to
analyze, to tell them what the numbers mean and to ask
corporate managers to find out.
In addition, according to several surveys, Regulation FD
has led skittish companies simply to disclose less information.
With information limited by this regulation, investors have
often been shocked, for example, by quarterly earnings results
about which they may have learned in a more gradual, less
abrupt way in the preceding months. These shocks almost
certainly led to increased volatility and high volatility led
small investors especially to make poor decisions about the
stocks they hold and may acquire.
Also, press releases and earnings announcements present
information in a less contextual manner in a post-FD world.
So what should be done about Regulation FD? Don't study it
for 2 years, as has been just suggested earlier, and in fact,
don't even fix it, as many issuers and securities industry
officials have argued. Abolish it.
Regulation FD is simply the latest manifestation of an
approach to regulation that is harmful to consumers, because it
denies them the benefits of free market competition. Just as
companies compete for the favor of customers they will, given
the chance, compete for the favor of investment analysts, their
clients and investors at large. How? In part by trying to gain
an edge on competitors by offering what analysts and investors
want most: Information.
A company that can be relied on for timely, abundant and
thorough business data placed in a truthful context is a
company that will attract more capital, all else being equal.
Investors don't like being kept in the dark. And for that
reason, 83 percent of companies now conduct conference calls
and four-fifths of them open those calls to the public. We
don't need regulators telling companies how to do what is in
their best interest.
What Regulation FD reveals, in conclusion, is a misguided,
often destructive regulatory mentality. The hubristic notion
that regulators stand between investors and chaos, that is
simply untrue. Orderly markets in goods and services flourish
without the heavy hand of regulation about disclosure. Markets
in financial information, given half a chance, will do the
same.
Thank you.
[The prepared statement of James K. Glassman can be found
on page 83 in the appendix.]
Chairman Baker. Thank you, Mr. Glassman.
Our next witness is Mr. Perry Boyle, Chief Financial
Officer and Deputy Director of Research for the Thomas Weisel
Partnership. Mr. Boyle.
STATEMENT OF H. PERRY BOYLE, JR., CFA, DEPUTY DIRECTOR OF
RESEARCH, THOMAS WEISEL PARTNERS, LLC
Mr. Boyle. Thank you. I appreciate the opportunity to
convey my views on Reg FD to the subcommittee. My name is Perry
Boyle. To correct the record, I'm not the Chief Financial
Officer, but I am a founding partner of Thomas Weisel Partners
and currently serve as the Deputy Director of Research. I've
been an equity analyst since the middle of 1992, covering a
variety of sectors, starting with transportation stocks,
business services stocks, and most recently, marketing services
stocks. And I think I'm one of the few analysts that the
Commission has actually talked to directly on this subject.
To clarify my general position on Reg FD--and I believe you
can view me as a typical analyst in this--I support the same
ends as the Commission on selective disclosure. Good analysts
do favor a system that provides broad, nondiscriminatory
dissemination of quality information.
I also note that from a sell-side position, Reg FD, by
reducing the flow of quality information, increases the value
of good analysts in the marketplace, so it would be
disingenuous of me to rail against the regulation despite how
strongly I agree with Mr. Glassman in principle.
However, from a public policy perspective, the regulation
does have costs that have not been adequately quantified, and
it's questionable whether the benefits of the regulation merit
those costs.
I listened appreciatively to the Commissioners' plans to
study and measure the costs, but I'm still relatively clueless
on what they actually plan to study and measure.
I'd like to address some of the questions posed by the
Committee in its letter inviting me to testify. First, whether
there was a need for Regulation Fair Disclosure prior to its
promulgation. I don't believe there was.
It's always been my understanding that selective disclosure
was impermissible prior to Reg FD, and one might interpret FD
as a rather inarticulate rewrite of previous law that's created
much confusion and very little clarity. I don't recall reading
in the popular press a groundswell of public demand for a new
Fair Disclosure regulation until the SEC raised the issue. The
U.S. capital markets are globally recognized as the freest and
fairest in the world. Issuers from around the globe flock to
our market.
Indeed, I doubt that the vast majority of America's 90
million investors even know about the rule or have any
practical use for it, given that almost all of them depend on
professionals such as fund managers or stockbrokers to manage
the bulk of their accounts.
On the plus side, to the degree that Reg FD has raised
public confidence in the capital markets, that would be
laudatory. I've seen no study that supports that conclusion.
But a reasonable person might presume that that is the case.
From an analyst's perspective, Reg FD does not change our
fundamental role, nor does it introduce a new moral or ethical
duty on selective dissemination. But it does create more
uncertainty about what the definitions surrounding selective
dissemination are and how companies and analysts will be
prosecuted for sharing information. It has injected uncertainty
in the marketplace with an unreasonable definition of
materiality and a lack of clarity on how the rule will be
applied and enforced.
As a general rule, most of us involved in the capital
markets believe that regulations that encourage efficient
markets are good, and regulations that impede market efficiency
are not good. This is based on our education and experience
that over time, securities prices reflect all available
information about that security.
In that context, the short-term impact of Reg FD in my
experience has been to reduce the flow of useful information
from issuers to the investment community. Longer term, as we
all learn how to live with it, the restrictive impact is likely
to abate. In the information age, with the plethora of media
channels, it's hard to keep the lid on interesting news.
Now that the Commission has dealt with the fair disclosure
issue, perhaps the next priority should be more on full
disclosure. In the normal course of filings under SEC
regulations usually generally accepted accounting principles,
issuers exclude massive amounts of information that could be
presumed material in making an informed investment decision
about a company.
The simple fact is that investors will always be making
investment decisions based on a combination of imperfect
information, varying degrees of analysis, experience, intuition
and luck. That's what makes a market.
I think it's instructive to look at who wins and who loses
under the regulation. Winners include previous SEC
commissioners for a positive public relations move, lawyers
engaged by issuers to ensure compliance with the regulation,
investor relations and public relations personnel who have much
more work to do, the members of the public who were concerned
about fairness of information disclosure, the financial media
who have more press releases to make sound bites of, the
business wires and webcast service companies, day traders who
have more press releases to trade off of, market makers, who
actually benefit from increased volatility, and good analysts,
who have always cultivated a variety of sources of information
other than top management of issuers.
Losers include issuers and their shareholders who have to
bear the cost of the compliance, investors, who bear the cost
of increased market volatility, which I do believe can be
measured, and bad analysts, who merely reported what they heard
from management.
Contrary to some of the rhetoric we heard this morning,
analysts are generally prohibited from short-term trading in
the stocks that they cover. Trading activity in advance of
anticipated announcements of earnings, which often you see
spikes in volume, are people making educated bets, not
necessarily on inside information held by analysts. And I would
like to see the SEC's data on their concerns on that.
My concern is that Reg FD was designed to attack anecdotes
of insider trading rather than attack a documented problem.
Also to Commissioner Hunt's concern. We do not dole out
information to select clients. That is prohibited by any number
of rules. All our clients get it at the same time. I believe
the SEC may not have a very rich view of the role of the
analyst. While I'm certainly not asking for sympathy, there are
only three things that I know every day when I go to work:
First, I'm wrong. If I was right all the time, I wouldn't be
doing sell-side research, I'd be talking to you ship-to-shore.
Secondly--I'm going to upset somebody today--I'm paid to
have an opinion. Often that opinion will be contrary to the
opinion of others, including my clients, which can be upsetting
to them. If I don't have an opinion, I'm not doing my job.
And third, I'll be lied to all day by just about everybody
I talk to, especially the management teams of the companies I
cover.
Our job is to anticipate trends and figure out which
companies will capitalize on those trends to the benefits of
their shareholders over the long period of time. By reducing
the information flow available to the analyst community through
poor definitions of materiality and liability, with few safe
harbors for the analyst community, the value of the analyst
community, which the SEC itself recognizes is necessary to the
preservation of a healthy market, is diminished.
How are those affected by FD, adjusting to Reg FD regime in
terms of policies, practices and trends? On the positive side,
it's created a renewed commitment to what we call primary
research. That's where we gather input from customers, vendors,
competitors, employees, and so forth, to create a mosaic of
information regarding a company's prospects.
On the negative side, it's increased an adversarial
relationship between management and analysts. Many issuers now
believe that they need to protect themselves from analyst
interactions. Many issuers are not particularly happy that
analysts are poking more deeply into their relationships with
customers, suppliers and even their lower-level employees, but
that's a fact of life they need to learn to live with.
Not all of those sources, though, can replace the lost
quality of information that was often available from direct
interactions with top management, particularly surrounding
longer-term strategies and estimate guidance.
In the post-Reg FD world, analyst interaction with top
management is far more likely to occur in a highly scripted
manner with management's only discussing information that has
been scrubbed and sanitized by lawyers and investor relations
personnel. These interactions lack spontaneity and a depth of
color that existed pre-Reg FD.
There have been numerous articles on Reg FD in recent
media, including a May 11th article on page C-1 of the Wall
Street Journal talking about the Progressive Company and
lauding the fact that post-Reg FD, they're now publishing
operating statistics on a monthly basis instead of only quarter
end. Well, that's clearly positive.
But prior to Reg FD, many companies in a variety of
industries already released monthly operating data, and still
the data provided by Progressive is historical in nature. They
still refuse to give forward guidance on how they believe the
company will perform.
The same article notes that Gillette announced earlier this
year that it would no longer provide short-term earnings
guidance. And a New York Times article last Saturday talked
about how Wal-Mart will no longer share its detailed sales data
with third parties.
The April issue of CFO Magazine has a survey done by
Thompson Financial. In response to the question, ``What changes
have you made due to Reg FD?'', 21 percent of respondents said
they provide more info on earnings and releases. But 21 percent
also say they no longer give earnings guidance. Thirty-two
percent say that they have limited the flow of information, and
22 percent say they are more cautious in discussing earnings
estimates.
The key problem with the regulation is the lack of clarity
on what is material versus what is not. In the absence of that
clarity and with a new degree of liability, many issuers have
chosen to take the safe road of reducing the flow of quality
information. So while the regulation may have had positive
impact on fairness of information dissemination, it's had a
negative impact on the fullness of information dissemination.
I could go through a litany of examples here, but I'm just
going to pick one. Post-Reg FD, many issuers will refuse to
comment in any way on an analyst's report prior to publication.
That's a common but not universal practice for an analyst to
send a preview copy to an issuer. The intent is not to have the
issuer rewrite the report but rather to comment on factual
errors and to rebut any unflattering arguments made by the
analyst. It's a courtesy.
On the SEC's website, item number seven on the phone
supplement page, ``Can an issue ever review and comment on
analyst's model privately without triggering Reg FD's
disclosure requirements?'' And I quote, ``Yes. It depends on
whether in so doing the issuer communicates material non-public
information.''
In the interest of time, I'm just going to get to the
bottom line. ``It would not violate Regulation FD to reveal
this type of data even if, when added to the analyst's own font
of knowledge, it is used to construct his or her ultimate
judgment about the issuer. An issuer may not, however, use the
discussion of an analyst's model as a vehicle for selectively
communicating either expressly or in code material non-public
information.''
I would posit that it's impossible for an issuer to
determine what the Commission means by ``seemingly
inconsequential data'' in that section, and the last two
sections of that guidance are clearly contradictory. So when in
doubt, say nothing. So analysts lack the nuance and color they
may have previously gotten.
On the issue of volatility, I believe that in addition to
the cost of compliance, the primary cost of the regulation has
been increased volatility in the market. I disagree with
observers who state that that cannot be measured.
Chairman Baker. Mr. Boyle, if you can, begin to wrap up for
me, please.
Mr. Boyle. OK. It can be, if you look at the CBO Volatility
Index or VIX, it clearly indicates an increase in market
volatility since the introduction of the prospects of Reg FD
early last summer.
I'll skip to how can the regulation be improved,
materiality and liability.
Materiality. In general, reducing liability for
disseminating information should improve the quality of
information disseminated. Therefore, clarification of the
definition on materiality would be helpful.
Also, on enforcement, it's unclear to how the regulation
will be enforced. While the Commissioners state that they're
not looking to enforce it, at the same time they have six
ongoing investigations, and actions do speak louder than words.
I believe there should be the same kind of safe harbor for
security analysts as there are for representatives of the media
under Reg FD. The burden should be on the issuer and not on the
analyst.
With that, I'll wrap up. Thanks.
[The prepared statement of H. Perry Boyle Jr. can be found
on page 93 in the appendix.]
Chairman Baker. Thank you, Mr. Boyle.
Our next witness is Mr. Thomas Gardner, Co-Founder--and I'm
very careful in making the introduction, Mr. Gardner, to say
you're Co-Founder of The Motley Fool, making no inference at
all. Thank you. Welcome.
STATEMENT OF THOMAS M. GARDNER, CO-FOUNDER, THE MOTLEY FOOL,
INC.
Mr. Gardner. Thank you. Good morning. It's a pleasure to be
before the subcommittee to talk about what equal access to
information means to all investors. My name is Tom Gardner. I'm
Co-Founder of The Motley Fool, and a fool myself.
The Motley Fool is a multimedia personal finance company
headquartered across the river in Old Town, Alexandria,
Virginia. Our business was founded upon and is driven by the
belief that average people can and do benefit from taking a
more active interest in the management of their money.
However, before individuals take control over these
matters, they need education, they need information, they need
an opportunity for dialogue, and they need an open platform for
their questions and for answers. And that's where we come in.
We teach people the fundamentals of long-term financial
management. We help them find the resources they need to
budget, save and invest, and we provide a forum for a thriving
online community. Our services today reach more than 20 million
investors each month.
I am not here, however, as a business owner. I'm here
because The Motley Fool represents a vibrant, powerful
community of individual investors who go to work, who earn
money, and who make decisions about the financial path that
their lives will take.
Over the past 8 years we've heard from them again and again
about the importance of access to simple information, whether
that's information about Einstein's miracle of compounding
growth, information about the real after-fee and after-tax
returns of managed mutual funds, information about any public
company's quarterly earning result, and for investors, access
to information means that in a public market this information
must be available to all investors at the same time.
Every day, millions of investors put their money in the
stock market and become part-owners of companies and businesses
that they believe in. Over the last 100 years, the stock market
has been the best place for long-term investment, returning
average annual returns of around 11 percent, returns that have
allowed us to put downpayments on homes, to pay for our kids'
educations, to retire comfortably. And along the way, this
public market has financed some pretty impressive businesses
and led to the creation of products that have changed our
lives.
A company like Johnson & Johnson improves the lives of
millions of people each year and has done so for more than 100
years, due in large part to its access to capital in the public
markets.
The problem, however, is that selective disclosure is
threatening the public market system in the U.S. and has been
for years. Through selective disclosure, professional investors
on Wall Street have increasingly tried to turn the public
markets into private markets of information that benefit
themselves and their firms. The net result of this is that
smaller investors reduce their investments. Thinking that the
game is rigged, they pull back or simply move into index funds
and pay fees to mutual fund managers because they feel they
have no other option.
They recognize that selective disclosure leads to
investing, if it is investing, that is not based on analysis,
that is not based on hard work and intelligence, but instead on
who you know or how much money you have to invest--the very
things that compel public companies and have in the past to
privately, illegally share privileged information with select
investors and analysts.
If we were establishing a capital market system today from
scratch, I think we'd all agree that we'd want to make sure
that the soccer mom who's putting $100 a month into a divided
reinvestment plan for her child's college education would have
access to the same information at the same time as the fund
manager wearing a nice suit, carrying a bottle of Mylanta, the
guy who has to decide or the gal who has to decide where to put
his or her million dollars of the fund. I can't imagine wanting
any sort of other public market in a free country.
Selective disclosure, a common practice on Wall Street for
years, is a direct violation of the spirit and the law of our
public markets, and it undermines equal access. It's a
violation that should be of the highest concern to those who
oversee the market, the SEC and the U.S. Congress.
In creating the SEC, Congress mandated that the SEC protect
investors. Under this mandate, the SEC is obliged to protect
all investors--tech investors in Silicon Valley, long-term
investors in Omaha, Nebraska, the small business owner that
invests from Port Allen, Louisiana, as well as investors on
Wall Street. Any SEC action that contravenes this duty would
naturally force us to ask why American citizens would pay tax
money to fund a regulatory agency that might not protect those
citizens' best interests.
Let's talk specifically about Regulation FD. Regulation FD
dramatically changed the financial landscape by making
information available to all investors simultaneously. Those
who oppose Regulation FD are not fighting it based on its
fairness. Regulation FD is not Regulation Full Disclosure, it
is Regulation Fair Disclosure. The criticisms do not come from
those who think it is unfair. That's precisely the problem. It
is fair. It promotes fairness. And thus it undermines Wall
Street's unfair advantage. And that unfairness is an enormous
commercial advantage to the big investment firms on Wall
Street, which I have to say--and controversy is part of the
game--the SIA and other organizations are funded to protect
that commercial interest.
Let's consider some of the arguments specifically noting,
as I believe it was noted yesterday, that many of the
complaints are supported by studies carried out by those who
object to Regulation Full Disclosure.
First, as an individual investor, I am taken aback by the
implication that I'm not smart enough to flesh out the
information; that I need someone else's help. To claim or even
imply that individual investors need interpreters takes us back
to the Middle Ages, back before we had printing presses, when
common folks were forced to rely on experts and aristocrats to
interpret texts like the Bible for them. They were not
permitted for a number of years after the printing press even
to have a Bible on their bedside table or any other textbook.
Similarly, the internet now allows individual investors to
access, analyze and act on financial information. I certainly
don't see a need for a professional investors to earn an
illegal information advantage in order to then translate that
information on delay for the rest of the marketplace.
Second, the evidence indicates that this claim of analyst
objectivity simply isn't true. We know that analysts are not
objective sources for individual investors. They work for
commercial firms that broadly seek underwriting deals with
public companies, and that renders them very subjective players
in the context of the public markets. That's the main reason
that Forbes Magazine, in an article earlier this year, reported
that only 1 percent of all analysts' recommendations from sell-
side analysts last year were sell recommendations.
While we're talking about analysts, I'd like to know
exactly what an analyst is and why I, as an individual
investor, can't call myself one. Who determines which analysts
without Regulation FD get to sit on illegally exclusive
quarterly conference calls? Who determines which analysts get
to gain access to private, illegal closed-door meetings with
company executives? Who determines which analysts get unlawful
earnings guidance from CFOs directly before the general public
hears of them? I would like to know that, because if the SEC is
not going to enforce Regulation FD or is going to repeal it, I
can tell you that I and tens of millions of other American
investors would officially like to sign up to become analysts.
If we don't have Regulation FD, we should eliminate all
insider trading laws. We should pursue a perfectly free
competitive market and have no insider trading laws whatsoever
and allow me, along with everyone else, to try and play golf
with company insiders so that we can get information and trade
in advance of the rest of the marketplace.
What about the claim of stock market volatility? Opponents
of Regulation FD will argue that it has increased stock market
volatility. I don't think that there's any clear evidence that
this exists. If a company, however, releases bad news
simultaneously to everyone--and I suggest in this example,
let's really look at the volatility studies before we just
accept them.
If a company releases bad news simultaneously to everyone
and its stock falls from $30 a share to $25 a share, is this
any more volatile than if the company selectively releases
information to professionals on Wall Street, the stock falls
from $30 to $27, then the information gets released to the
general public, who sells it down to $25. If we're going to
accept volatility studies, we have to keep our eyes focused on
the time periods that are being studied.
Finally, opponents of full disclosure will also argue that
Regulation FD has somehow stifled corporate disclosure. Let's
be clear. It has chilled the distribution of illegal
communication of privileged information in a public market.
Last week's Wall Street Journal reported that Progressive
Insurance plans to distribute information monthly.
Progressive's CFO saw Regulation FD as an opportunity for us to
open up more to investors.
But even if Regulation FD stifles the flow of information,
would we want more information in a public market if that
information were protected for a privileged group of Wall
Street investors? In a free country, which sort of public
market would operate more effectively, one with less
information delivered fairly, or one with more information
delivered illegally?
Regulation FD is Regulation Fair Disclosure not Full
Disclosure. The aim is fairness of distribution of information,
not the quality or the quantity of that information.
I'd like to close by praising the SEC for having brought
this issue and created policy on it. I'd like to praise the
subcommittee for having conversations about it. And I call on
Congress and the SEC to enforce Regulation Full Disclosure or
to strike it from the record. Let's not do either/or. Let's
either enforce it or let's eliminate it so that every investor
knows what sort of marketplace we operate in.
I'll close with SEC Chairman Arthur Levitt's quotation
which explains why he believes that preserving the public
nature of our markets is extremely important to the integrity,
confidence and efficiency of those markets. Chairman Levitt
said: ``Simply put, the practices of selective disclosure defy
the principles of integrity and fairness. We teach our children
that a person gets ahead through hard work and diligence, that
through equal opportunity, everyone has a chance to succeed.
America's marketplace should be no exception to that principle.
Instead, it should serve as its beacon.''
I couldn't agree with Chairman Levitt any more, nor could I
agree any more with Warren Buffet. And I guess I will close
with Warren Buffet's quote about Regulation Full Disclosure:
``The fact that this reform came about because of coercion
rather than conscience should be a matter of shame for CEOs and
their investor relations departments.'' It's good to see that
the greatest investor in American history is a supporter of
fair disclosure.
Thank you for having me today.
[The prepared statement of Thomas M. Gardner can be found
on page 101 in the appendix.]
Chairman Baker. Thank you, sir.
Our next witness is Mr. Patrick Sweeney, General Counsel of
Nomura Corporate Research and Asset Management. Welcome, Mr.
Sweeney.
STATEMENT OF PATRICK D. SWEENEY, GENERAL COUNSEL, NOMURA
CORPORATE RESEARCH AND ASSET MANAGEMENT, INC.
Mr. Sweeney. Good afternoon, Chairman Baker, Ranking Member
Kanjorski and Members of the subcommittee.
Chairman Baker. And if you would pull that a little bit
closer, we can hear you better.
Mr. Sweeney. My name is Pat Sweeney. I am the General
Counsel of Nomura Corporate Research and Asset Management,
which is more commonly known as NCRAM. NCRAM is a registered
investment adviser and a member of the Investment Company
Institute.
NCRAM's clients are mutual funds organized and sold to
retail investors in the United States and other major capital
markets. While mutual funds themselves are correctly viewed as
institutional investors, they are typically offered to the
public retail investor markets and draw capital investments
from millions of retail investors.
Like many other buy-side investment managers, NCRAM employs
its own team of research analysts to support all investment
decisions made on behalf of its advisory clients. NCRAM
continually engages in a fundamental analysis of the business
and financial risk of each corporate issuer in which it has
invested or proposes to invest.
As part of this fundamental analysis, NCRAM evaluates the
issuer's management experience, market position, cost
structure, historical track record and cashflow generating
ability.
This process involves not only a review of the company's
published financial information, but also incorporates one-on-
one visits with company management, discussions with industry
analysts, visits to company facilities and consultation with
third-party experts as appropriate.
The protocols of investor relations communications between
corporate issuers and buy-side investment managers have been
carefully structured over the years to limit communications to
nonmaterial information which can be used by buy-side analysts
to structure proprietary investment models for corporate
issuers. This practice is consistent with the long-recognized
mosaic theory which enables an investment manager to develop
and implement independent investment decisions based upon its
analysis of discrete, nonmaterial pieces of information
provided by the corporate issuer.
The ability of NCRAM and of many other buy-side investment
managers to conduct fundamental investment analysis is a key
variable in the quality of investment services provided to
retail investors in mutual fund advisory accounts. Fundamental
analysis on behalf of mutual funds provides a significant
investment benefit which most retail investors would be unable
to achieve with their own resources.
And it's from these perspectives that I'm pleased to have
the opportunity today to make the following comments on Reg FD.
First, a widespread, ongoing practice of selective disclosure
of material information by corporate issuers would in fact
erode public confidence in the fairness of the securities
markets and should be corrected by an appropriate regulatory
response.
Second, the broad scope of Reg FD is premised upon the
existence of widespread and abusive selective disclosure of
material information by corporate issuers.
Third, in assessing whether Reg FD appropriately responds
to the problem of abusive selective disclosure, consideration
should be given to the potentially adverse impact of the
regulation upon the fundamental analysis conducted by buy-side
investment managers.
Fourth, by persistently linking the rationale and
methodology of Reg FD to insider trading concepts, the
Commission appears to have provoked a conservative and overly
cautious response on the part of corporate issuers to
regulatory compliance.
Fifth, Reg FD has already affected the quantity and
timeliness of information provided by corporate issuers, and
the adverse impact of the regulation on the fundamental
analysis process may progressively worsen as analytical
investment models become outdated.
Sixth, the negative impact of Reg FD on market transparency
is most apparent in the case of financially stressed or
distressed corporate issuers which frequently cite Reg FD
restrictions in refusing to respond to demands for
accountability by investment managers.
I'd like to close my statement today with two
recommendations. First, Reg FD should be re-evaluated
generally, taking into account whatever empirical data may be
obtained in determining the scope of the selective disclosure
problem, as well as the potential detrimental impact of the
regulation on the buy-side fundamental analysis process and
other legitimate market processes.
And second, public disclosure requirements imposed on
corporate issuers by Reg FD should be based upon the objective,
itemized reporting methodology of Section 13 of the Securities
and Exchange Act, rather than upon subjective and ambiguous
determinations of materiality similar to those employed in
determining liability for insider trading under Rule 10(b)(5).
NCRAM has appreciated this opportunity to testify before
the subcommittee.
[The prepared statement of Patrick D. Sweeney can be found
on page 111 in the appendix.]
Chairman Baker. Thank you very much, Mr. Sweeney.
Our next participant is Mr. Daniel Hann, Senior Vice
President and General Counsel, Biomet. Welcome, sir.
STATEMENT OF DANIEL P. HANN, SENIOR VICE PRESIDENT AND GENERAL
COUNSEL, BIOMET, INC., WARSAW, IN; ON BEHALF OF THE ASSOCIATION
OF PUBLICLY TRADED COMPANIES
Mr. Hann. Thank you. Good afternoon, Chairman Baker,
Ranking Member Kanjorski, and Members of the subcommittee.
Thank you for the opportunity to testify today on behalf of
hundreds of mid-cap and small-cap companies that make up the
Association of Publicly Traded Companies. I am Daniel Hann,
Senior Vice President and General Counsel of Biomet.
Biomet is in the business of manufacturing and marketing
medical devices used primarily by orthopedic surgeons and is
headquartered in the industrial heartland of northern Indiana.
Biomet has been a member of APTC for many years, and our
President and CEO, Dr. Dane Miller, who was recently recognized
as one of the top five CEOs in the country for delivering
shareholder value, serves on the board of APTC.
The APTC's position on the specific issues before the
subcommittee is guided by a belief that issuers, investors and
all market participants benefit from governmental policies that
are designed to maximize the flow of quality information to the
capital markets.
Last month I had the opportunity to participate in the Reg
FD roundtable held by the Commission in New York City. The APTC
applauds the efforts of Acting Chairman Unger and the other
Commissioners to understand the full impact of Reg FD and their
willingness to provide guidance to market participants.
As a general matter, the Association views Reg FD as
reflecting two policy choices made by the Commission. First,
the decision not to create a private right of action was a
crucial and essential policy choice for Reg FD, and we commend
the Commission for this wise decision.
Second, the Commission decided that the benefits of a more
level playing field for information outweighed the possible
cost of restricting selective disclosure as it can be argued
that any restrictions on the quantity and quality of
information could negatively impact the efficiency of the stock
markets.
Insofar as Reg FD has some positive aspects for issuers
that may offset the additional burden of compliance, we as
issuers remain relatively neutral. For investors, however,
especially long-term buy-and-hold investors, Reg FD is a mixed
bag.
With my remaining time, I will briefly focus on four of the
questions posed for today's hearing in Chairman Baker's
invitation letter.
First, what impact has Reg FD had on the quantity and
quality of information? The overall quantity of information has
not changed according to two recent surveys. We believe this is
probably true because companies are issuing more press releases
as a shield against the risk that a non-public disclosure could
prove in hindsight to have been material.
However, we believe that the quality of information has
been adversely affected by the requirement for public
disclosure of all material information. Such a requirement
encourages issuers to limit disclosures to more general
information that is less likely to become the basis of a
private securities class action lawsuit if the company stock
hits a downdraft.
While we are unaware of any effort to measure it, we
suspect that the quality of information going to the markets
has suffered. I will offer a suggestion later as to how this
may be mitigated.
A second question posed by the subcommittee is what
particular benefits or problems result from Reg FD? The real
benefit of Reg FD inures to the benefit of people like me--
namely, lawyers. We now have a rule to reference when we
caution others to avoid certain means of communication in
disclosing certain types of information. We, the lawyers, are
now more important and more necessary than ever in publicly
traded companies.
Seriously, the primary problem is one of uncertainty. No
company wants to serve as the enforcement test case for Reg FD.
While we appreciate the recent statements from the Commission
that it will not prosecute good faith mistakes, the vagueness
of the materiality standard calls for caution. There is a
natural inclination to err on the side of caution pending some
clarification as to where the Commission will draw the line on
materiality.
A third question I would like to address is whether there
are any specific ways to improve Reg FD. We believe it can be
improved and offer two suggestions. Our first proposal focuses
on the problem that the legal definition of ``materiality'' is
vague and fact-specific. Because materiality is the basis for
enforcement, companies are generally responding by providing
less information in non-public communications and providing
more information of a general nature in a more structured
public format.
The decline in more specific information probably harms the
overall quality of information in the market. The flow of
information to the markets might well continue abated despite
the new risk of enforcement if the rule were made clear and the
risks were more well-defined.
Our second recommendation is that the Commission can
promote the flow of information by supporting the statutory
safe harbor for forward-looking statements or by promulgating a
broader and deeper safe harbor under the authority granted in
the Private Securities Litigation Reform Act of 1995.
Companies are now very cautious about making the types of
specific forward-looking statements that will be most useful
for individual investors. Currently, companies that wish to
communicate their expectations about their futures must do so
very carefully. Despite reform litigation, private securities
class action lawsuits are still quite common.
In addition, the safe harbor for forward-looking statements
is still a work in progress by the Federal courts. The
commission could be a positive force for improving the quality
of forward-looking disclosures if it supported a more expansive
interpretation of the safe harbor and acted as a friend of the
court.
The commission could also use its statutory authority to
create a safe harbor that is clear enough that both issuers and
investors can make good use of information.
A final question today deals with how companies are
adjusting to Reg FD. Please make no mistake about it, Reg FD
has significantly changed the way issuers deal with the
investment community. In my experience, issuers have made a
bona fide attempt to comply with the new rule. In recent
months, issuers have worked very hard to implement new policies
and procedures and have taken steps to educate directors,
officers and employees as to their respective obligations and
duties under the rule.
One consequence of the new rule is that issuer press
releases, as we have heard today, tend to be longer and more
detailed. Unfortunately, this may make it difficult for the
average investor now to separate the wheat from the chaff.
In closing, the APTC believes that with the Commission's
continued openness to change and the adoption of the APTC's
proposed solutions, there is opportunity to substantially
improve Reg FD.
Once again, I would like to thank you for the opportunity
to appear before this subcommittee and share the views of the
APTC on Reg FD. Thank you.
[The prepared statement of Daniel P. Hann can be found on
page 131 in the appendix.]
Chairman Baker. Thank you very much, Mr. Hann.
Our final witness today is Mr. Stuart Kaswell, Senior Vice
President and General Counsel for the Securities Industry
Association. Welcome, Mr. Kaswell.
STATEMENT OF STUART J. KASWELL, SENIOR VICE PRESIDENT AND
GENERAL COUNSEL, SECURITIES INDUSTRY ASSOCIATION
Mr. Kaswell. Thank you, Mr. Chairman. Chairman Baker, Mr.
Kanjorski and Members of the subcommittee. My name is Stuart
Kaswell and I am General Counsel of the Securities Industry
Association.
With me today is my colleague, Frank Fernandez, SIA's Chief
Economist and Director of Research. SIA's nearly 700 member
firms are active in all U.S. and foreign markets and account
for the overwhelming majority of all securities-related
business in North America. About 50 million Americans hold
accounts with our firms. SIA commends the subcommittee for
holding this hearing. I deeply appreciate the opportunity to
testify.
SIA strongly believes that vibrant securities markets
require a vigorous flow of information from issuers to the
marketplace. We think there is a broad consensus on that simple
but important point. The only debate has been over the best
means for encouraging that flow of information. Investors and
issuers as well as the economy as a whole will suffer if
issuers face obstacles in disclosing information.
Regulation FD is a bold experiment in which the SEC has
tried to ensure that information flows to the markets on a
broad basis. SIA was a critic of the rule. Our principal
concern then as now is that the rule would reduce the quality
and quantity of information flowing to the markets.
Now that we have had a short period of experience with the
rule, we think it is entirely appropriate for this subcommittee
to consider whether the rule has had the desired effect.
After the adoption of Regulation FD, SIA undertook a study
of the effect of the rule. We interviewed 30 buy- and sell-side
analysts, interviewed 25 general counsels of issuers, conducted
a random telephone survey of 505 individual investors, and
conducted a survey of 94 SIA member firms. Although 6 months is
not a lot of time, the results are revealing. We are releasing
a copy of that study to the subcommittee today.
SIA's study shows the following. The good news is that
Regulation FD has produced a benefit of accelerating the
healthy trend toward communicating material information to the
public and securities professionals simultaneously. It may also
have enhanced the public's perception of the fairness of our
markets.
We should note, however, that only 14 percent of investors
surveyed seek the information that issuers communicate directly
to the public.
Unfortunately, there is also some bad news. The vast
majority of analysts feel that the quality of information put
out by companies is inferior to the information that reached
the market before Regulation FD was adopted. Regulation FD is
costing much more to implement than the SEC predicted. These
costs include recurring expenses and are not just transitional
costs.
Ninety percent of the analysts surveyed believe that
Regulation FD contributions to stock price volatility. However,
SIA cannot quantify the impact that FD has had on volatility.
In light of these results, SIA wants to work with all
interested parties to ensure that the goals of Regulation FD
may be more fully realized with fewer side effects.
Let me be clear. We do not seek repeal of Regulation FD.
SIA would like to offer ideas that will help ensure a vigorous
flow of information from issuers to the markets.
We have two primary suggestions that we believe would be
helpful. First, we suggest developing a more concise definition
of ``materiality'' for Regulation FD. The current amorphous
definition leaves issuers in a quandary as to whether many
facts are material or nonmaterial. A clearer definition under
this rule would ease those concerns and encourage more
disclosure.
Second, we suggest that persons receiving information
should not be subject to derivative liability. A senior member
of the SEC staff has said it is OK to be persistent and dogged.
It is not OK to be abusive and threatening. The problem is that
analysts who seek to probe for information should not be
subject to an after-the-fact assessment of whether he or she
has crossed the line from persistent to abusive. It is the
analyst's job to gather information on behalf of investors. But
Regulation FD makes it risky to ask penetrating questions. We
do not think that the risk of derivative liability serves
investors. Indeed, we think it is counterproductive.
Our written statement expands on these ideas and offers
some others as well. SIA appreciates the opportunity to share
the results of its study and to offer suggestions for improving
Regulation FD.
SIA hopes it can make a positive contribution to this
debate and can help ensure that American investors receive the
information they need to make good investment decisions,
whether they rely on professional analysts or do their own
research.
Thank you very much.
[The prepared statement of Stuart J. Kaswell can be found
on page 141 in the appendix.]
Chairman Baker. Thank you, Mr. Kaswell.
For the purposes of a complete record, I have been asked to
include a statement provided by the Bond Market Association
which will be included as a part of the official record.
[The information referred to can be found on page 160 in
the appendix.]
Chairman Baker. Mr. Sweeney, help me understand a
practicality. NCRAM used to do certain things pre-Reg FD that
it now does not do. Give me an example of what you would advise
corporate management to steer clear of that previously would
have been behavior that was not subject to concern.
Mr. Sweeney. Well, Chairman Baker, it is very difficult to
give corporate issuers advice in the context of the current
rule because of the uncertainties as to what they can and
cannot tell us in the traditional one-on-one interviews.
Those uncertainties to a large extent were compounded by
some fairly aggressive language in the SEC's adopting release
in which the SEC specifically, and I would say went out of
their way, to warn corporate issuers about speaking with
securities analysts seeking guidance concerning earnings
forecasts.
The SEC stated that whenever an issuer official engages in
a private discussion with an analyst who is seeking guidance
about earnings estimates, he or she takes on a high degree of
risk under Regulation FD. With that type of interpretation of
the regulation, one can understand how most corporate issuers
and their counsel would be extremely conservative about giving
any information to a buy-side analyst that the analyst could
then apply to his own earnings model.
And what has in fact happened is that although one-on-one
calls and group investor calls continue, less information is
provided on those calls. Corporate issuers have traditionally
assisted buy-side analysts in the construction of investment
models for the issuers by providing historic building block
components of revenue, expense and margin data, none of which
would be considered material non-public information at the time
the issuer shared it, because it would be historic.
In our experience, a significant number of corporate
issuers have either discontinued or curtailed this practice.
Chairman Baker. Of revenue expenditure and market data? Is
that which is now being withheld? That is what I am trying to
get to. What is it that executives are being counseled to be
very careful in exercising disclosure that previously would not
have been?
Mr. Sweeney. Typically, a buy-side analyst looking at a
corporate issuer would construct his own investment model for
that issuer on a going-forward basis from many sources--from
his analysis of the industry, from macro research input that he
might get from the sell-side, but also very critically, in one-
on-one discussions and group investor calls with the issuer.
Now what the analyst would like to obtain on those calls is not
a flat statement or a flat wink in the eye about what the next
earnings results are going to be.
What they are expecting to obtain are, for example, segment
information from different segments of the company's business;
information pertaining to revenues or expense trends in various
segments, many times simply on a historic basis, referring, for
example, to financial statements that have already been filed
with the public on a Form 10K; trying to break them down into
greater detail so that for the future, the buy-side analyst can
construct his own model to project how this issuer is going to
perform in the future. That kind of data is now being withheld.
Chairman Baker. Wouldn't there be some concern from your
perspective when you counsel the CEO to be careful with regard
to X, Y and Z and it perhaps has been disclosed in pre-FD era,
there may be an attachment of liability for your refusal to
disclose it now because you are trying to avert contravention
of Reg FD, and it is something that the investor could allege
at a later time, had they known, they would have made different
judgments about the advisability of the investment?
I mean, no matter which way you go here, isn't there some
attachment of liability?
Mr. Sweeney. Well, there is certainly a lot of concern
about liability.
Chairman Baker. And let's talk about some other company. I
certainly wouldn't----
Mr. Sweeney. There is certainly a lot of concern about
liability that is untested at this point. But when you see
statements like the one that I cited in the adopting release,
it certainly heightens the concerns of corporate issuers and
their counsel.
I do not advise issuers. I am on the buy-side asking for
the information.
Chairman Baker. I get the sense people in the market are
sort of waiting for the first victim to be selected to find out
just how bad this really is or how good it could be. If
materiality is clarified, if the manner in which notice is
established as being the way to insulate yourself, perhaps
industry executives could find a way to live with FD. But it is
the uncertainty of knowing how the rules will be interpreted at
the moment that appears to be creating the biggest problem. Is
that fair?
Mr. Sweeney. That is true, Mr. Chairman. And I would also
revert back to a comment you made earlier today with
Commissioner Unger in your comparison of some earnings releases
that caused stock prices to go up and some earnings releases
that caused stock prices to go down. Of course, what you left
out is that some earnings releases don't affect stock prices at
all. And the fact of the matter is, stock price movements in
our complex capital markets tend to be the result of many
different factors. And it is somewhat difficult to deal with a
materiality standard that has been directly tied to the
accounting bulletin release that referred to the impact on
trading prices. That is, in particular, a very troubling aspect
of the interpretation to date.
Chairman Baker. Yes. The only certainty in the market is if
I own it, it's going to go down.
Mr. Kanjorski.
Mr. Kanjorski. No, I do not agree. It is if I own it, it
goes down.
Boy, the six of you have really confused the heck out of
me. I was trying to keep score. The only thing I have to ask my
friend Mr. Glassman is why do you disagree with your former
partner so much? He obviously put this rule together.
Mr. Glassman. Well, he didn't ask me before, you know. I
agree with him on many things, and I think he did an excellent
job as Chairman, and I think his focus on small investors,
educating investors having town meetings and so forth, was
excellent. I just think this is a misguided attempt to do
something which is admirable but really which is causing much
more harm than good.
Mr. Kanjorski. Do you get the sense--all six of you,
whoever wants to pick up on this point--that somebody felt that
there was insider trading and tried to fix it, and this
regulation is the result? And when I ask, was there that much
insider trading that it was a big problem? Was this too much of
a fix?
Mr. Kaswell. Mr. Kanjorski, I would argue that Regulation
FD is not supposed to be an insider trading remedy. We felt
that the SEC had plenty of authority to proceed on the case of
Rule 10(b)(5) to go against insider trading. We don't think
there is a lot of insider trading out there. But we want the
SEC to prosecute those cases vigorously. We argue they had
authority.
Regulation FD tries to turn the securities laws into a
parity of information standard, because the SEC couldn't
proceed on an anti-fraud theory.
Mr. Kanjorski. But wouldn't the prior testimony of the
Commissioners that they had a perceived insider trading problem
suggest this rule was one of the solutions? Yes?
Mr. Boyle. I agree with what you are saying, Congressman.
If insider trading is the aim, Reg FD is not the weapon to
address that. And I haven't seen any studies through this
process on how big a problem insider trading was to warrant
this kind of an issue. And I would say that that the
regulations prior to Reg FD were very adequate to address that.
Mr. Kanjorski. You know, it puts me in a quandary. And, I
am not the only one. You are not going to find many politicians
up here that aren't going to take a position that we want as
much information as possible provided to the public and the
best-educated investors. But, I tend to agree with whomever
made the statement that a lot of this information really isn't
usable and that we probably have a pretty strong free flow of
information occurring through the old practices. Moreover, the
only reason you would go to this absolute fairness provision is
if you felt there was insider trading. But that may not be
correct. I appreciate Mr. Gardner's position that you feel this
is the best thing since sliced cheese, I assume.
But I am in a quandary that we don't understand enough. We
have such a diverse recommendation here from the six witnesses.
For instance, Mr. Glassman said not to study it, but just to do
away with it. I am not sure we are even in a position to make
that conclusion at this time. I appreciate all the testimony,
and it clearly sets forth to me that this subcommittee probably
has to do a lot more study, Mr. Glassman, before we could
decide to do away with it. But, it may eventually warrant that
result.
I am just a little sensitive to the new, inventive smaller
companies that are coming along. I am worried about the
terrible burden we may be putting on them and the cost of
getting involved in these sorts of things. It is so nice to
have regulations. It is so nice to appear to have absolute
fairness. But sometimes economic fairness isn't there because
of size, experience and the ability to direct the assets in one
way or another.
Can somebody make a compelling argument of something really
good and important that has come out of the regulation that
should automatically keep us on it? OK, Mr. Gardner.
Mr. Gardner. Well, I think part of the challenge for the
Commission is to hear from individuals. Because the broadest
constituency in our public market is the individual investor,
whether that is the person in investor club, investment club,
somebody managing their own money.
I mean, we have a tremendous collection of bright people
out there, and I think, unfortunately, the knee-jerk assumption
is that the individual investor is somehow ignorant or can't do
this themselves or shouldn't be given the same information,
because they will misunderstand that information.
What I think is most laudatory that has come out of
Regulation FD is the recognition that there was unfair
disclosure of information. And I believe we are in an
adjustment period today where there is less information and
lower quality information but that over time companies will
learn what they can deliver and when they can deliver it.
I simply resubmit that what has really been chilled here is
the selective disclosure of information that should be illegal
in a public market. We have chilled the distribution of
information from a corporate executive to curry favor of an
analyst to distribute that information to his clients
simultaneously within their firm but not to anyone else.
Mr. Kanjorski. Mr. Boyle does not look like that kind of
guy.
Mr. Boyle. I wish corporate managements were trying to
curry my favor. And I use The Motley Fool site. I think it is a
fantastic site. But as the Chairman said earlier, the average
investor in the market is $60,000 and only $50,000 of net
worth. And you really have to question whether we should be
encouraging people to speculate in the market based on those
kind of financial standards. And I know you would argue with
that.
Second, the sad fact is that most individual investors when
trading individual stocks rely on the media for information
with very little analysis. And so when you replace the role of
an analyst with the role of a talking head who is chosen more
for ratings potential than in-depth analysis, you have to
question that economic impact on the market and whether the
public wins in that situation.
Mr. Kanjorski. Do I hear the call letters ``CNBC'' with
your comments?
Mr. Boyle. Well, and then selective dissemination. I would
love to hear more from Mr. Gardner on what his analysis of the
issue and problem was other than a perception issue, because my
experience is that it was the exception rather than the rule
and that most analysts are deathly afraid of receiving
selective information because they don't want to have the
liability for it.
Mr. Gardner. I would just say that there are so many pieces
of evidence pre-Reg FD where you had quarterly conference calls
that were exclusive to a privileged group of Wall Street
analysts and you would see that stock move in after-hours
trading. You would have a quarterly conference call at 5:00
p.m. There would be only 10 analysts allowed on the call, no
individual investors allowed on the call, and you would see the
stock go up 20 percent or down 20 percent before the market
even opened the next day. I don't understand how that could
happen unless there was some series of investors operating in
the after-hours market that simply did not have access to that
but were speculating that that information might have happened
on the call.
I think it is pretty clear that the people who were on the
call were in some ways participating directly or indirectly,
and I think it is far more indirect participation, in the
movement of that stock in after-hours.
I mean, the simplest way to look at this that I see is, we
may only have one smart individual investor out there. Maybe
the rest of them are idiots. All these people out there that
are trying to buy stocks are foolish with a small ``f''. They
are relying on the media. They are making all of the old
mistakes and they are losing fortunes in front of our eyes.
But if there is one investor out there, a single individual
investor that is bright enough, that has the resources, that it
is important enough to her to be following an individual
company that she is a part-owner of, I believe the law of the
public market should protect that investor's right to get
information at the same time as any big Wall Street firm would
get it.
Chairman Baker. Thank you, Mr. Kanjorski.
Mr. Bentsen.
Mr. Bentsen. Thank you, Mr. Chairman.
Mr. Glassman, in your testimony you talk about a free
market--that FD takes us away from a free market approach for
analysts. But on the other hand, isn't there some form of
arbitrage that occurs among analysts, that some analysts are
privy to information and other analysts are not? That there is
an inefficiency in the marketplace? That an analyst at Solomon
Smith Barney may have an in to certain information because of a
relationship that an analyst at Merrill may not?
I am not sure that that is completely a free market. And I
am not sure that analysts are in part reporters, I guess. But
they are also in part editorialists. Because they are providing
an analytical viewpoint on data that is available.
Second of all, I am surprised that full disclosure is now
somehow perceived as disruptive to the market. That full
disclosure of information is somehow bad for the marketplace
when I would think you would want in a free and open and
competitive marketplace for investors to have as much data as
available. What investors do with it and whether they make
money or lose money is their problem. But generally, in a free
market system, I would think you would want everybody to have
access to the same tools.
Mr. Glassman. I think that what you want in a free market
system is as much information as possible. And in fact, the
journalistic model is a good one. I mean, if the only way the
journalist had to get information was the dissemination of
press releases, then I don't think that Americans would know as
much as they know today because we have a vigorously
competitive press, which uses all sorts of means to find things
out.
Mr. Bentsen. But if I could interrupt you for a second. And
I have to move through here quickly. But we also know in the
press world, and I will use a political analogy, that in some
cases, some will give information to the New York Times as
opposed to the Wall Street Journal because they think that they
can control the story better through the New York Times than
they can if they delivered it to everybody in the Wall Street
Journal and the LA Times and everybody else who was dealing
with that.
Mr. Glassman. That is exactly right. But that means that
there is more information out there. Once the information gets
out, and it might not have gotten out at all if it had not been
for the selective dissemination of the information, then more
journalists get onto it, there is more discussion about it. And
that is actually a very good analogy with what is going on
here.
It may well be that there is something that is select. I do
not believe it should be illegal. But certainly the notion that
some analyst gets an edge on another analyst I don't think is
bad for the total amount of information that people are gong to
get through a system like that. That is what I am saying.
But that is almost an extreme case. Let me just give you
one example, because I think we are----
Mr. Bentsen. If you could hold up for a second, because I
want to follow up on that point.
Mr. Glassman. Sure.
Mr. Bentsen. I understand the presumption that you are
making, and there is nothing wrong with that presumption,
assuming that it turns out that way. But let me ask Mr. Boyle
or Mr. Sweeney, you all prepare analyst reports on corporations
that you are following. Maybe Mr. Sweeney in funds, you are
doing it differently. Those reports, when you issue a report
that says Acme Corp. has lost a big contract and you now have a
sell recommendation on it, generally will be picked up in the
financial press over time, assuming because you are a watched
analyst, let's say.
But do you all, when you publish that report, who do you
distribute that report to? Do you distribute it to your
clients, or do you put it out available to anybody who wants
it? Who gets that report first?
Mr. Boyle. We write our research for our clients. The way
it is distributed is that we have agreements with wire services
such as First Call, Multex and others that whenever we make a
material change, which is typically to find there is a change
in estimates or a change in recommendation or a change in price
target on a stock, we will issue what is called a first call
note that goes to those wire services.
Most institutional investors are subscribers of those
services. We also as a matter of practice--and I believe it is
the practice of most investment banks--disseminate the research
at that same time to many--it is literally at a push of a
button. It goes to all our targeted services. It goes out to
our clients, it goes out to these services, and in many cases,
it goes to the media as well. We distribute our research to
multiple layers in the media: Bloomberg, Wall Street Journal,
New York Times, some websites. There are actually some website
aggregators that we provide information to.
And I think if you just went to cbsmarketwatch.com before
the open of the market, you would see a whole raft. Morgan
Stanley changing estimates on this, Thomas Weisel Partners
downgrading that. It gets to the market pretty darn fast.
Mr. Bentsen. But it is a discretionary action on the part
of the analyst or the firm that the analyst is employed by?
Mr. Boyle. It is a discretion--to provide it to the mass
media is a discretionary item, yes.
Mr. Bentsen. Mr. Sweeney.
Mr. Sweeney. Yes. If I may respond to that. This highlights
one of the major differences between buy-side and sell-side
analysts. Buy-side analysts do not issue reports. Buy-side
analysts take in information from the company in these one-on-
one meetings. They take in information from many sources,
analyze it for purposes of refining their investment models for
a corporate issuer, and then making an investment decision for
their managed accounts, their accounts being the mutual funds
that the soccer moms and other retail investors invest in.
So it is a very different dynamic on the receiving end with
the buy-side investor.
Mr. Boyle. I had one important qualification to what I just
said. I'm cheating. I'm reading Tom's notes as he's writing
them. We are prohibited from trading for our own account before
the notes go out, OK?
Mr. Bentsen. Right. No, I understand.
Mr. Boyle. So I just want to make sure that people
understand that front running is against the law.
Mr. Bentsen. No, I understand that. I understand that.
Chairman Baker. If I may, I would like to get Mr. Fossella
in and try to conclude the hearing before we go for this vote.
Mr. Fossella.
Mr. Fossella. Thank you, Mr. Chairman. And I guess we can
all agree we want to make more Americans investors. The
question is, how do we do it as it relates to this regulation?
And one example of how we can draw two different
conclusions from the same event, two of you, Mr. Gardner and
Mr. Boyle, reference an article that appeared in the Wall
Street Journal on May 11th regarding Progressive. Mr. Gardner
said that Progressive's CFO saw Regulation FD as an opportunity
for us to open more to investors.
Mr. Boyle, you sort of said the same thing, but then went
on to say Progressive will now issue monthly statistics. This
may force its competitors to do the same. Clearly positive. But
still the data provided by Progressive is historical. They
still refuse to give forward guidance on how they believe the
company will perform. And even prior to Reg FD, Progressive had
moved toward having quarterly earnings conference calls.
The article also mentions how Progressive is not giving any
commentary or analysis on their operating statistics and won't
report investment incomes and tax rates. And you further go on
to say how in the New York Times article how Wal-Mart will no
longer share its detailed sales data with third parties.
So I guess my question really is, given that, to Mr.
Gardner, it seems that some folks want to abolish FD. Some feel
that it has growing pains. Some feel that there is clearly room
for improvement, like Mr. Boyle cites materiality and perhaps a
carve-out and a safe harbor for analysts. Do you see any room
for modifying Reg FD to provide some guidance, for example, on
issues like materiality?
Mr. Gardner. I think that there are opportunities to modify
Reg FD. I don't think now is the time to do so, because I don't
believe there is enough evidence out there after a 6-month
period.
I would say that in the case of Progressive, there are
going to be a lot of companies that will make a decision about
whether or not to release forward-looking statements, some of
them companies that Mr. Buffett supports generally refuse to
make forward-looking statements because there is a high level
of speculation there that sometimes doesn't come true, and that
can come back to bite a company.
So there are different reasons that Progressive would
choose to release different pieces of information, but they did
state clearly that they support Regulation FD, and this is an
action in support of it, and their belief that they should
communicate to all investors at the same time.
So in terms of modifications, I think that there are safe
harbor opportunities. But I think essentially the one-on-one
call that a buy-side analyst would have, while generally my
interests lie with the buy-side analysts. They are doing
research to try and figure out how well a company is doing.
But should a buy-side analyst get a timing advantage on the
answer to their question to another buy-side analyst who may
have less money, be less consequential to the CEO of that
company, companies can release this information and answer
these questions in public conferences and via press releases,
and I think there will be an opportunity to carve out safe
harbors within Reg FD to give them that public opportunity to
have a more thoroughgoing discussion about their prospects.
Mr. Fossella. Let me throw it out to Mr. Glassman to jump
in to respond in a way. What if--I think you were saying that
the companies themselves are going to re-engineer and figure
out a way to disseminate this information and work within the
existing Reg FD, subject to maybe a minor modification. What if
they don't? And what if ultimately the unintended consequence
is to penalize the person I think you genuinely want to help?
What if there is no modification? What if everybody sorts of
sits back and holds back material information because they
don't have any guidance as to what is material and what isn't?
And maybe I will just throw it to Mr. Glassman.
Mr. Glassman. Well, this is already happening. And it's
interesting that Mr. Gardner should say that in fact we are
getting less, we appear to be getting less good information.
Let me just give you another example. And I think this
might be more to the point. On the very day that Reg FD went
into effect, the Wall Street Journal ran an article about
Matthew Burler, a Morgan Stanley Dean Witter analyst, who tried
to ask a Georgia-Pacific executive for his usual guidance on
Mr. Burler's spreadsheets, which cover--and I know that Mr.
Gardner likes to denigrate analysts--but Mr. Burler's
spreadsheets cover 887 financial factors regarding the company.
This time, however, he got no help from Georgia-Pacific,
which was worried about violating Reg FD. As a result, said Mr.
Burler, there is a greater chance for error. Now I cannot see
for the life of me how it is beneficial to the average small
investor who uses The Motley Fool or any other source that
these corporate executives won't even make a comment on a
conscientious analyst's spreadsheet of 887 financial factors.
And that is a real life example. That is actually what really
does go on with analysts.
So there is no doubt that we will get a degradation of
information and the quality of information, and that is the
reason why I wanted to respond to Congressman Kanjorski. The
reason I say don't study it, because, you know, we just heard
the SEC say we ought to study it for 2 years. Well, by then,
maybe companies won't be able to adapt, as you say, and
certainly we will have more volatility.
We already have problems right now. And I think this is not
a time to wait another 2 years to do something.
Mr. Fossella. Did you want to add to that at all, Mr.
Gardner?
Mr. Gardner. I don't think it is the Government's
responsibility to protect the quantity or the quality of
information in the public markets. I think it is the
Government's responsibility to protect the fairness of the
marketplace for investors.
So if it means a temporary reduction in the quantity and
quality of information as companies determine how they can
communicate with all of their owners fairly, simultaneously, it
is a tradeoff that I know millions of individual investors are
willing to make. And that is in evidence on our site and
basically in any forum that individual investors----
Mr. Glassman. Even though, as you know, Tom, it is not just
a tradeoff. It basically means higher volatility and a
degradation of information, essentially means that the price of
stocks will go down as a result. The cost of capital will
increase. The price of stocks will go down. And frankly, I
don't think that is a tradeoff that most Americans would want
to see.
Mr. Boyle. I would also add that it would be very good for
the market makers under that rule. More volatility is good for
market makers, bad for investors. And I was actually a little
surprised to hear from each according to his abilities to each
according to his needs logic there.
Mr. Hann. In that regard, I would add that all the
regulation in the world will never level the playing field. And
I think that is a point the Commission alluded to this morning.
And Chairman Baker, one of your initial questions today was, is
this really essentially a misplaced insider trading rule?
This is a disclosure rule, but I think because of the
perceived shortcomings of the Dirks decision that the
Commission also addressed this morning, we do have a misguided
rule, and we have one that is trying to accomplish indirectly
what it could not do directly, and that is namely, try to push
analysts on the insider trading issue.
Mr. Kaswell. As long as we seem to be running down the
line.
Chairman Baker. Please, if you'd like.
Mr. Kaswell. It seems to me, too, that by punishing
analysts for trying to ask the hard questions, if we are going
to be in a Regulation FD environment, if an analyst pushes too
hard and actually succeeds in getting information, not because
he is trying to encourage the issuer to break the law, but just
because he is being probing as a good reporter would be
probing, that is a good thing for investors that the analyst is
representing. And therefore, the analyst should not be subject
to a sort of Monday-morning quarterbacking test of whether or
not he was too aggressive in that setting.
The other point I would just like to make is putting the
full burden on particularly small issuers to ensure that the
information they get out, they have that full responsibility.
And it isn't, it seems to me that it is easy for a larger
corporation to ensure their story is being told, but for a
smaller corporation, that puts a very difficult burden on them
and perhaps there are other ways to address that by filing a
procedural AK.
Chairman Baker. I want to thank all the members of the
panel for your patience and participation. I think it has been
a very informative hearing for the Members of the Committee. We
have had a significant number of Members in and out during the
course of the day.
Suffice it to say, I think there are some areas of concern
that have been raised. This is only our first view of the
subject. We will take additional action over the coming weeks.
We would encourage each of you as you have further thoughts or
inclinations to please forward them for the Committee review.
I do have concern that the Dirks holding and the fiduciary
responsibility relationship as the trigger for liability has
indeed clouded the landscape a bit. And I do think there is
general agreement by everyone on the Committee, transparency is
a good thing, flow of information is a good thing.
But we don't in the pursuit of transparency and flow of
information want to create a new cause of action that
apparently is gong to have adverse consequences on the investor
being appropriately informed.
So I think we all generally want to pursue the goal. I
think we need to do a careful analysis of whether this
mechanism is achieving that end, and are there ways perhaps
from repeal to modification to taking another look at the whole
issue of are there advantaged people in the market who are
trading on information to the distress of the smaller,
independent investor?
A very difficult subject. Despite admonitions to move
today, I suspect we will take a day or two and examine it more
thoroughly. But I do want to express my appreciation to all of
you for your participation.
Our hearing is adjourned.
[Whereupon, at 2:00 p.m., the hearing was adjourned.]
A P P E N D I X
May 17, 2001
[GRAPHIC] [TIFF OMITTED] T2723.001
[GRAPHIC] [TIFF OMITTED] T2723.002
[GRAPHIC] [TIFF OMITTED] T2723.003
[GRAPHIC] [TIFF OMITTED] T2723.004
[GRAPHIC] [TIFF OMITTED] T2723.005
[GRAPHIC] [TIFF OMITTED] T2723.006
[GRAPHIC] [TIFF OMITTED] T2723.007
[GRAPHIC] [TIFF OMITTED] T2723.008
[GRAPHIC] [TIFF OMITTED] T2723.009
[GRAPHIC] [TIFF OMITTED] T2723.010
[GRAPHIC] [TIFF OMITTED] T2723.011
[GRAPHIC] [TIFF OMITTED] T2723.012
[GRAPHIC] [TIFF OMITTED] T2723.013
[GRAPHIC] [TIFF OMITTED] T2723.014
[GRAPHIC] [TIFF OMITTED] T2723.015
[GRAPHIC] [TIFF OMITTED] T2723.016
[GRAPHIC] [TIFF OMITTED] T2723.017
[GRAPHIC] [TIFF OMITTED] T2723.018
[GRAPHIC] [TIFF OMITTED] T2723.019
[GRAPHIC] [TIFF OMITTED] T2723.020
[GRAPHIC] [TIFF OMITTED] T2723.021
[GRAPHIC] [TIFF OMITTED] T2723.022
[GRAPHIC] [TIFF OMITTED] T2723.023
[GRAPHIC] [TIFF OMITTED] T2723.024
[GRAPHIC] [TIFF OMITTED] T2723.025
[GRAPHIC] [TIFF OMITTED] T2723.026
[GRAPHIC] [TIFF OMITTED] T2723.027
[GRAPHIC] [TIFF OMITTED] T2723.028
[GRAPHIC] [TIFF OMITTED] T2723.029
[GRAPHIC] [TIFF OMITTED] T2723.030
[GRAPHIC] [TIFF OMITTED] T2723.031
[GRAPHIC] [TIFF OMITTED] T2723.032
[GRAPHIC] [TIFF OMITTED] T2723.033
[GRAPHIC] [TIFF OMITTED] T2723.034
[GRAPHIC] [TIFF OMITTED] T2723.035
[GRAPHIC] [TIFF OMITTED] T2723.036
[GRAPHIC] [TIFF OMITTED] T2723.037
[GRAPHIC] [TIFF OMITTED] T2723.038
[GRAPHIC] [TIFF OMITTED] T2723.039
[GRAPHIC] [TIFF OMITTED] T2723.040
[GRAPHIC] [TIFF OMITTED] T2723.041
[GRAPHIC] [TIFF OMITTED] T2723.042
[GRAPHIC] [TIFF OMITTED] T2723.043
[GRAPHIC] [TIFF OMITTED] T2723.044
[GRAPHIC] [TIFF OMITTED] T2723.045
[GRAPHIC] [TIFF OMITTED] T2723.046
[GRAPHIC] [TIFF OMITTED] T2723.047
[GRAPHIC] [TIFF OMITTED] T2723.048
[GRAPHIC] [TIFF OMITTED] T2723.049
[GRAPHIC] [TIFF OMITTED] T2723.050
[GRAPHIC] [TIFF OMITTED] T2723.051
[GRAPHIC] [TIFF OMITTED] T2723.052
[GRAPHIC] [TIFF OMITTED] T2723.053
[GRAPHIC] [TIFF OMITTED] T2723.054
[GRAPHIC] [TIFF OMITTED] T2723.055
[GRAPHIC] [TIFF OMITTED] T2723.056
[GRAPHIC] [TIFF OMITTED] T2723.057
[GRAPHIC] [TIFF OMITTED] T2723.058
[GRAPHIC] [TIFF OMITTED] T2723.059
[GRAPHIC] [TIFF OMITTED] T2723.060
[GRAPHIC] [TIFF OMITTED] T2723.061
[GRAPHIC] [TIFF OMITTED] T2723.062
[GRAPHIC] [TIFF OMITTED] T2723.063
[GRAPHIC] [TIFF OMITTED] T2723.064
[GRAPHIC] [TIFF OMITTED] T2723.065
[GRAPHIC] [TIFF OMITTED] T2723.066
[GRAPHIC] [TIFF OMITTED] T2723.067
[GRAPHIC] [TIFF OMITTED] T2723.068
[GRAPHIC] [TIFF OMITTED] T2723.069
[GRAPHIC] [TIFF OMITTED] T2723.070
[GRAPHIC] [TIFF OMITTED] T2723.071
[GRAPHIC] [TIFF OMITTED] T2723.072
[GRAPHIC] [TIFF OMITTED] T2723.073
[GRAPHIC] [TIFF OMITTED] T2723.074
[GRAPHIC] [TIFF OMITTED] T2723.075
[GRAPHIC] [TIFF OMITTED] T2723.076
[GRAPHIC] [TIFF OMITTED] T2723.077
[GRAPHIC] [TIFF OMITTED] T2723.078
[GRAPHIC] [TIFF OMITTED] T2723.079
[GRAPHIC] [TIFF OMITTED] T2723.080
[GRAPHIC] [TIFF OMITTED] T2723.081
[GRAPHIC] [TIFF OMITTED] T2723.082
[GRAPHIC] [TIFF OMITTED] T2723.083
[GRAPHIC] [TIFF OMITTED] T2723.084
[GRAPHIC] [TIFF OMITTED] T2723.085
[GRAPHIC] [TIFF OMITTED] T2723.086
[GRAPHIC] [TIFF OMITTED] T2723.087
[GRAPHIC] [TIFF OMITTED] T2723.088
[GRAPHIC] [TIFF OMITTED] T2723.089
[GRAPHIC] [TIFF OMITTED] T2723.090
[GRAPHIC] [TIFF OMITTED] T2723.091
[GRAPHIC] [TIFF OMITTED] T2723.092
[GRAPHIC] [TIFF OMITTED] T2723.093
[GRAPHIC] [TIFF OMITTED] T2723.094
[GRAPHIC] [TIFF OMITTED] T2723.095
[GRAPHIC] [TIFF OMITTED] T2723.096
[GRAPHIC] [TIFF OMITTED] T2723.097
[GRAPHIC] [TIFF OMITTED] T2723.098
[GRAPHIC] [TIFF OMITTED] T2723.099
[GRAPHIC] [TIFF OMITTED] T2723.100
[GRAPHIC] [TIFF OMITTED] T2723.101
[GRAPHIC] [TIFF OMITTED] T2723.102
[GRAPHIC] [TIFF OMITTED] T2723.103
[GRAPHIC] [TIFF OMITTED] T2723.104
[GRAPHIC] [TIFF OMITTED] T2723.105
[GRAPHIC] [TIFF OMITTED] T2723.106
[GRAPHIC] [TIFF OMITTED] T2723.107
[GRAPHIC] [TIFF OMITTED] T2723.108
[GRAPHIC] [TIFF OMITTED] T2723.109