|In October 2000 the SEC implemented Regulation FD (Fair Disclosure). The goal of the rule is to level the information playing field for all investors by barring company executives from selectively disclosing material information to market professionals. If a company has material information to release, it must release the information in the form of an official press release or a company meeting. If we examine recent earnings reports, it is clear companies have to communicate forward expectations to analysts in a public forum, something they have not done before. While this is good for a small investor because he no longer needs to rely on a stock analyst for information, the information now comes out in big "clumps" with an information vacuum in between the clumps. These sometimes-surprising clumps of information have triggered increased instances of disorderly trading, contrary to the SEC's goal of ensuring that market makers and specialist maintain an orderly market. This lack of order may have much greater implications too.|
|Before Reg FD, analysts could communicate with company executives on a regular basis, enabling them to keep tabs on the company and expectations going forward. If the analysts sensed a change they could raise or lower earnest estimates, or even the actual rating on the stock. If there were materially significant changes at a company then there would be multiple changes in analysts' earnings and ratings over a period of time. The company's stock price would ultimately reflect the changes, and by the time the company confirmed the material changes in a public forum, the stock price would already reflect the changes. |
But all of this could happen without analysts actually making any public changes in estimates or ratings. Before Reg FD the information that analysts passed on to selected clients would be undisclosed to the a small investor, but could be enacted upon by institutions.
|The release of material information is likely to trigger a bigger reaction than before Reg FD. Institutions drive stock prices, we all know and accept this. But in today's information vacuum-- the period between corporate releases-- there is little reason for institutions to take action. Reg FD has altered the technical landscape too, and for those who rely on technical analysis to assess a stock's potential this is could be devastating. One of the primary ideas behind technical analysis is to discern subtle trends created by institutional moves and to use that information take an advantageous position. With Reg FD in place, investment professionals who handle most small investors' money, are forced to operate in a different manner. This is becoming evident in chart patterns. The only reassurance they can get on a position they hold or want to hold has to come from the company itself, but that happens in front of everyone. Before Reg FD a trend could emerge. But today, a material change will be more likely to cause disruption in the marketplace. A simple review of stock openings reveals that, since the inception of Reg FD, the number of stocks opening more than 5% above or below their previous close has increased by over 100% from their average during the 90s. An increase in volatile gap openings is bad for all market participants and tells us that the market is less orderly now than it was before Reg FD. Therefore Reg FD is having an impact.|
|More importantly, Reg FD is affecting the quality and continuity in the flow of information. Today companies have to talk to analysts in an open forum, and it is human nature to be less revealing in a publicly open forum than in a closed one limited to one topic. This aspect of human nature inherently reduces the quality and quantity of information ultimately presented, but that is not as important as the disruption in the continuity of the information stream. Most small investors have their money in a mutual fund and are not individual stock owners. Investment professionals run funds, and funds take huge positions which they constantly monitor. Under the old paradigm if an investment profession became uncomfortable or concerned with a situation he could call his favorite analyst to get an update. The analyst would talk with company executives and discern the validity of the investment professional's concerns. At this point the analyst would report back to the investment professional and confirm or deny the concern. With Reg FD in place this is not possible, putting the investment professional in a very awkward position. Concern without reassurance leads to worry and in time this will undermine the confidence of both investment professionals and mutual fund holders. History clearly shows that when folks lose confidence in financial institutions very bad thing happen.|
|Reg FD has leveled the playing field, but the cost is too high. Reg FD is ultimately undermining the confidence of major stock market participants, the latter of which actually represent a significant portion of the investing public. Since the implementation of Reg FD the market has seen greater volatility and has been less informed. Company announcements are now more likely to disrupt markets, causing large opening gaps, and repeated large gaps will further undermine confidence in a market. Until the repeal or significant change of Reg FD, markets will continue losing confidence. As long as Reg FD remains as is, we should expect significantly lower returns and with the possibility of a total loss of confidence the probability of a catastrophic event is much greater. Reg FD has leveled the information playing field, but ultimate cost is market confidence. Does the end justify the means?|
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