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Can Arthur Levitt Jr. and 1,000 investors be wrong? The Securities & Exchange Commission chairman has stirred up a blizzard of e-mail -- 1,000 and counting -- supporting his newest effort to make the markets safe for small investors. The proposed rule, Regulation FD for "fair disclosure," would crack down on companies that divulge important information to selected audiences -- especially Wall Street analysts -- before announcing the news to the rest of the world. "The behind-the-scenes feeding of information from companies to analysts is a stain on our markets," Levitt declares.
Indeed, it is -- when it happens. But the SEC hasn't proved that selective disclosure, by design or mistake, is common. "It's a pernicious practice, but I don't know that it's pervasive," says Laura S. Unger, one of two SEC commissioners who have expressed doubts about the proposed regulation. Given that the SEC hasn't tried to prosecute such a case since 1991, it's not at all clear that corporate tip-offs are a widespread problem.
What is clear is that the SEC's proposed solution could create a legal minefield for corporate executives. The regulation would require companies to put out press releases immediately when they deliberately divulge "material" information or to make an announcement within 24 hours of an "inadvertent" disclosure of important news.
MORE SHOCKS.
If executives misjudge what "material" or "important" means, they risk fines, sanctions, and lawsuits when they talk to analysts, reporters, company vendors, or even ordinary shareholders. In all probability, corporate lawyers will tell executives not to talk at all. Regulation FD would chill the flow of information, give investors less informed insight into corporate news, and create more -- not fewer -- shocks in stock prices. Investors would be the poorer for it.
To be sure, the question of who gets what information when is vital in today's hyperactive markets. Even a small earnings surprise can send stock prices ricocheting. In such an environment, it's unfair for companies to discuss earnings, products, and prospects in closed meetings with analysts and institutional investors before that information is released to the public.
But the proposed regulation goes too far in trying to stamp out unintentional disclosure of material information. The trouble comes in trying to define what "material" means. Big insights can arise when a smart analyst or reporter combines small bits of information that, taken separately, aren't significant at all. For a $2 billion company, a two-week delay in starting a production line isn't material news. But to an analyst, that tidbit might provide the final tile in a mosaic of information about problems with the company's new products. Under Regulation FD, the executive who discussed the problems could be guilty of selective disclosure.
LAWYERS WIN.
Companies say the proposed regulation will put them in a trap. "The SEC will have the benefit of 20-20 hindsight," says Louis M. Thompson Jr., president of the National Investor Relations Institute, "but companies will have to decide in real time what they can say and what they can't."
Executives who miscalculate will face not only the SEC's wrath but also private lawsuits. Indeed, the biggest beneficiaries of Regulation FD could be plaintiffs' attorneys, who will get a new tool for hauling companies into court. To prevent that from happening, executives are likely to take extreme measures. "What you'll get is Presidential press conferences -- scripted answers and no real probing," says Stuart J. Kaswell, general counsel of the Securities Industry Assn. "It will choke off information that's critical and analytic."
What should the SEC do instead? On deliberate selective disclosure, Levitt should declare victory: Thanks in part to his use of the bully pulpit, 82% of companies that have conference calls have opened them to reporters and ordinary investors, according to a NIRI survey. The Web helps: 48% of companies are broadcasting calls over the Internet.
CORPORATE WHISPERS.
The SEC should bolster these moves by making Internet posting an official form of disclosure, since far more investors have access to corporate Web pages than to financial wire services.
Other forms of corporate whispering are tougher to eliminate. While most investors are turned off by companies' efforts to manage expectations about earnings, the fact is their guidance to analysts helps smooth trading in stocks and prevent shocks. In the rare cases when corporate executives violate their positions of trust for personal gain, the SEC has vast legal powers and can prosecute.
But unless the agency can show that corporate tip-offs are widespread and dangerous, it ought to steer clear of rules that will gag the vital flow of information and analysis that all investors need.
McNamee covers the SEC for Business Week in Washington
EDITED BY BETH BELTON
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