If former SEC chairman Arthur Levitt could have been a fly on the wall at Tuesday’s SEC-sponsored meeting on the impact of Regulation FD (Fair Disclosure), he would have been fairly satisfied.
The rule, which was designed to prohibit selective disclosure of material information, was one of his pet projects during his tenure as Wall Street’s top cop.
But in the six months it’s been on the books, Reg FD has indeed put the brakes on selective disclosure. CFOs and other financial executives have sharply curtailed their communications with Wall Street analysts, and the analysts are not too happy about it.
The analysts exhibited their displeasure during a panel discussion as part of a daylong event that was part of the SEC’s first public meeting on the rule since its enactment last fall.
Levitt resigned his post as SEC chairman at the end of February, but in one of his last official speeches he told a group of individual investors, “You are now privy to the same information, and at the same time, as analysts, investment bankers, and every other professional on Wall Street.”
While Levitt clearly viewed the rule as part of his legacy, it is one inheritance many analysts on Wall Street would rather do without.
“There is information that is clearly not material that we just can’t get anymore,” said David Berry, research director at Keefe, Bruyette and Woods. “There is less [quality] information to play with than before.”
In response to this comment and others like it, SEC Acting Chairman Laura Unger, who moderated the discussion with Commissioner Isaac Hunt, Jr. stressed that meetings between analysts and corporate executives remain permissible under FD, so long as material information is not disclosed.
“The depth of information has become an issue,” said Michael Blumstein, a managing director at Morgan Stanley. Companies have stopped disclosing nuanced information, he said, and now rely more on boilerplate scripts from their investor relations departments.
Blumstein also complained that companies no longer allow analysts to go on plant and company tours for fear of violating the regulation.
The regulation’s broad definition of materiality, and the gray areas that arise as a consequence, was a recurring theme throughout the daylong discussion. During several of the event’s discussions, panelists recommended that the SEC rethink its definition of materiality, and they urged the commission to provide more guidance in this area in the meantime.
But Unger’s words did little to reassure the analysts.
“The competitive advantage of the analyst is to ferret out data and put together a mosaic that helps them form investment recommendations,” said Patricia Walters, a senior vice president for professional standards with the Association for Investment Management and Research (AIMR). The trade group sponsors training and certification programs for securities analysts.
But Walters said Reg FD has hindered analysts’ ability to piece together information from a variety of sources. The end result compromises the quality of research that analysts produce.
Keefe, Bruyette’s Berry lamented that “So how’s the quarter going?” conversations are now strictly prohibited, referring to the wide- ranging discussions between corporate executives on one side and institutional shareholders and sell-side analysts on the other. Such talks had once been a staple for analysts in developing their earnings guidance for the companies they cover. Without them, analysts have been scurrying to devise new tactics for developing their earnings estimates.
Berry said quarterly conference calls are becoming key sources of information for analysts. “They are more important than ever because we have nothing else,” he commented.
Morgan Stanley’s Blumstein said, “We are concerned about corporate paranoia. No company wants to be the first test-case.”
On average, he said, corporate managers have made themselves less accessible, and have refused to disclose any information, including non- material information to analysts.
This was a dangerous trend, Blumstein contended.
“My concern,” he said, “is that uncertainty leads to volatility, which increases the cost of capital, which in turn dampens the economy.”
Although most analysts conceded that it was difficult to prove the effects of the regulation on market volatility, the majority did claim that there was a correlation between the two.
Because there is less information out there, investors act on scanty tidbits without the benefit of analysis and context, said Berry.
But the complaints were not unanimous.
Chuck Hill, director of quantitative research for Thomson Financial First Call, a data service that compiles earnings forecasts from analysts, said, “No matter how you slice it, FD has not been responsible for the increase in [earnings] warnings.”
Hill said that the notion is “absolutely untrue.” The timing of the regulation’s enactment was unfortunate, since it coincided with the market volatility of the last six months. That’s allowed critics to blame market gyrations on the regulation itself.
Opponents have argued that FD makes the market more volatile by eliminating a corporation’s ability to disseminate earnings guidance to analysts, thus exacerbating the impact of earnings surprises when they occur.
“Ultimately Reg FD will be irrelevant,” for analysts said Perry Boyle, a research director at Thomas Weisel Partners. “We can live with anything,” he stated.
But Morgan Stanley’s Blumstein was not as flip about the long-term consequences of the regulation on the securities analyst industry. He expressed concern that Reg FD’s chilling effect will negatively impact the development and training of a next generation of analysts, since a core part of their training involves working closely with corporate management to gain first-hand knowledge of business fundamentals.
Not surprisingly Commissioner Hunt, who has been a Reg FD champion from the start, had a positive take on Reg FD’s effects on the quality of sell-side analysis.
“The regulation was intended to help the good analysts,” he said, claiming that those that simply parrot information from the CFO do not add value.
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