U.S. GOVERNMENT PRINTING OFFICE

72–723 PS WASHINGTON : 2001

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
(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

BARNEY FRANK, Massachusetts

PAUL E. KANJORSKI, Pennsylvania

MAXINE WATERS, California

CAROLYN B. MALONEY, New York

LUIS V. GUTIERREZ, Illinois

NYDIA M. VELA ́ ZQUEZ, New York

MELVIN L. WATT, North Carolina

GARY L. ACKERMAN, New York

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missiouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director
(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman

CHRISTOPHER SHAYS, Connecticut

CHRISTOPHER COX, California

PAUL E. GILLMOR, Ohio

RON PAUL, Texas

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

BOB BARR, Georgia

WALTER B. JONES, North Carolina

STEVEN C. LATOURETTE, Ohio

JOHN B. SHADEGG, Arizona

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

VITO FOSSELLA, New York

JUDY BIGGERT, Illinois

GARY G. MILLER, California

DOUG OSE, California

PATRICK J. TOOMEY, Pennsylvania

MIKE FERGUSON, New Jersey

MELISSA A. HART, Pennsylvania

MIKE ROGERS, Michigan

PAUL E. KANJORSKI, Pennsylvania

GARY L. ACKERMAN, New York

NYDIA M. VELA ́ ZQUEZ, New York

KEN BENTSEN, Texas

MAX SANDLIN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

FRANK MASCARA, Pennsylvania

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

BRAD SHERMAN, California

GREGORY W. MEEKS, New York

JAY INSLEE, Washington

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

STEVE ISRAEL, New York

MIKE ROSS, Arizona

(V)

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

(1)

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
2

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, nonpublic 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 com-
3

pany 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.
4

[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.
5

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 secondguessed 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.
6

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.
7

Specifically, we were trying to stop disclosure of material nonpublic 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.
8

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
9

report, we now have the necessity to abide by the law to go to midmanagement, 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 commu-
10

nication 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-thecounter 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.
11

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 nonpublic 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 ex-
12

penses. 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.
13

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, par-
14

ticularly 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 midmanagement 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
15

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?
16

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
17

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
18

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
19

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?
20

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
21

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 runup 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
22

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 halfyear 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——
23

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
24

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.
25

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.
26

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 cre-
27

ates 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,
28

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 preFD.

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
29

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.
30

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
31

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
32

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
33

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.
34

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.
35

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 preReg 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.
36

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.
37

[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 CoFounder 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
38

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
39

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 closeddoor 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
40

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.
41

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.
42

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 Com-
43

missioners 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 buyand-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-pub-
44

lic 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.
45

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.
46

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
47

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 nonpublic 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
48

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 antifraud theory.
49

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.
50

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
51

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——
52

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
53

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
54

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 GeorgiaPacific 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
55

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.
56

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.]
(57)

A P P E N D I X

May 17, 2001
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