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‘Full disclosure’ makes investing harder for individuals
An SEC regulation makes more information available to individual investors, but increases the advantages for money managers.
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Over the past decade, the individual investor has become an extremely important element in the stability and success of the U.S. equity markets. Concerns about how well the individual investor can compete with large institutions and professional money managers who have existed for years have recently escalated.
Regulation Fair Disclosure, or Reg. FD, was adopted by the Securities and Exchange Commission (SEC) to address the problem of selective disclosure of information by companies to their “elite” investors or analysts. We believe that Reg. FD has actually increased the disparity between the individual investor and the institutional side of Wall Street, having brought unintended negative effects on the individual investor.
Selective disclosure
The SEC implemented Reg. FD in October 23, 2000, eliminating “selective disclosure.” Selective disclosure occurs when companies release material nonpublic information to certain individuals before disclosing the information to the general public. Before Reg. FD, companies commonly disseminated to analysts and institutional investors news relating to an upcoming earnings warning or event that would have stock price implications. The result was a material advantage for those who were privy to the undisclosed information.
The goal of Reg. FD was to eliminate this information gap and level the playing field for all investors. Further, the belief was that as an ancillary benefit, confidence in our markets would rise on the heels of regulation that forced companies to provide information to the general public in concert with the institutional circles. Again, we believe that Reg. FD has adversely affected the individual investor and increased the time and resource requirements to compete with money managers.
Inferior information
Requiring companies to release all material news in an approved public medium has led to information that is inferior in quality, as well as in quantity. Many companies have greatly reduced the quantity of information that they release surrounding their business for fear of violating Reg. FD. According to a Securities Industry Association survey, “About one-quarter of issuers feel they communicate less to the public, and analysts estimate that nearly two-thirds of the companies they follow communicate less.”
This “chilling effect” on information has made it harder for an individual investor to thoroughly research companies and obtain information that will produce an informed investment decision. An additional problem is that the information released by companies post-Reg. FD is raw in nature and has little analysis. This creates a true quality-of-information predicament.
The same Securities Industry Association study cited above found that “72% of analysts interviewed feel that information communicated by issuers to the public is of lower quality than information made public prior to implementation of the regulation.”
Reg. FD does not apply to communications with the press, which places the media in a position to be the primary vehicle for the delivery of information. Because many individual investors rely on CNBC, newspapers, magazines and free Internet sites, they are actually hurt if they do not have the aptitude and experience to put press releases in context and analyze the raw data that is provided.
The paucity of skilled analysis or explanation in company press releases has placed an individual investor, who does not have a deep grasp of a company’s business model and fundamentals, at a severe disadvantage. Companies now issue very generic press releases, and the burden of analysis falls in the hands of individual investors. This problem is exacerbated by the fact many investors make uninformed buy or sell decisions on pieces of news that may appear a certain way.
An example
A good example of this costly type of investor misinterpretation was the recent sell-off in Chico’s on an announcement that appeared negative on its surface.
On Oct. 29, 2001, Chico’s (NYSE: CHS) closed at $27.82 a share. Chico’s, a private label women’s clothing retailer, announced before the open of trading on Oct. 30 that it would run its television advertisements during the last 2 weeks of November instead of the usual first 2 weeks of December.
The stock sold-off on the announcement on Oct. 30 because it may have appeared that Chico’s was having a poor quarter and was moving up its scheduled advertising because of weaker sales. The fact was that Chico’s had looked carefully at studies that revealed shoppers tend to respond to commercials roughly 1 week after they are aired. Management was actually being more analytical in its decision to air the ads earlier, a decision they had already stated they were considering on previous conference calls. The press release did not refer to their prior consideration, and the media’s lack of analysis or context of the announcement put an irrational cloud over the stock.
That day, Oct. 30, the stock traded down as low as $22.72, a loss of 23%. Seven days later, on Nov. 7, Chico’s announced that October sales had risen 29.2%, which should not have surprised any investor who had been tracking their weekly same-store sales or earlier releases on sales trends. Our firm used the misinformed selling as an opportunity to acquire Chico’s, and from its low on Oct. 24, the stock is up 39% to $31.50 (as of Dec. 3, 2001). However, to take advantage of the confusion, it was critical to have extensive research into the decision to move the ad campaign, as well as the surprising strength in October sales.
Inordinate burden
The fact is that Reg. FD has placed an inordinate burden on the individual investor to monitor all news releases during the trading day, in addition to daily conferences, mid-quarter conference calls and subsequent earnings releases. This barrage of unorganized avenues for companies to release pertinent and germane news is too broad for an individual investor to monitor and scrutinize.
Yes, Reg. FD has made information accessible to all investors, but the extensive time and resource elements have given the professionals a leg up in our ability to act on the information while the doctor, lawyer, architect or teacher is working hard at their full-time occupation.
Complicating matters for an individual investor is that more companies are releasing material information on newswires or at speaking engagements during normal trading hours. With the market’s increased volatility, it is indispensable that a money manager has a team of analysts constantly examining company filings with the SEC, as well as news releases.
It has become common for key executives to issue business updates, or make changes to guidance at conferences or analysts’ days. These presentations are available through Webcasts on a company’s Web site or via conference calls. An investor who understands the company’s business and can place guidance relative to sales or margins into immediate context is often rewarded with a window to act before the news is dissected by the general public.
A good example of acting on information from a conference call was Action Performance.
On Nov. 7, 2001, Action (NASDAQ: ACTN), the leading distributor of motorsports merchandise, closed at $25.34 per share. The next morning, they had a conference call pertaining to their fourth quarter earnings. The call was quite good and they actually surprised us by raising earnings guidance when discussing their expectations for 2002. Having the knowledge that Wall Street’s consensus estimates were well below the company guidance that was provided, we were able to buy the stock aggressively before the news filtered through to the newswires and other media like CNBC.
By the time the news on their positive outlook had become pervasive, the stock had climbed nearly 16% intra-day to over $29 per share. It is imperative to participate in the conference calls of the companies you own so you are aware of any information released that changes the fundamentals or outlook for the future.
Disparity magnified
There are many examples that illustrate how news now made available under Reg. FD has catalyzed sharp swings in stock prices and associated profits or losses. Reg. FD would have leveled the playing the field if the playing field were simply access to information.
However, the playing field has become even more uneven, giving an even greater performance advantage to money managers who have the time and resources to inspect every news release, company filing and presentation that a company can throw at them. Further, the advantage is magnified because of the lack of analysis that is now integrated in communications from companies to the general public, placing the analytical responsibility on the investor.
Reg. FD has inadvertently ensured that consistent outperformance will be determined by the talent and the ability of an investor to sift through the barrage of information. It will be those investors and money managers who have the time, patience and discipline to carefully gather and evaluate information in order to make prudent investment decisions that will excel more so now than ever.