Fair Disclosure Or Flawed Disclosure

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

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

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 Û.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.

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