Did Regulation FD Prevent Selective Disclosure?

The Securities and Exchange Commission proposed Regulation Fair Disclosure (Reg FD) on December 20, 1999. The motivation behind the proposal was concern that an informational advantage provided by selective disclosures to certain market participants was resulting in a loss of confidence in the integrity of capital markets. Thus, the SEC’s stated intention with Reg FD was to “level the playing field” for all market participants.

The proposal was met with a strong reaction by market participants, with over 6,000 comment letters issued in response, and the reaction was mixed. On the one hand, individual investors generally supported the proposal, expressing concern that selective disclosure placed them at a significant disadvantage. On the other hand, analysts and institutional investors were concerned that an unintended consequence of the proposal would be firms reducing their overall disclosure levels, ultimately resulting in less efficient markets.

Early research suggested that Reg FD was effective at reducing selective disclosure without reducing firms’ overall levels of disclosure. However, these studies suffered from significant design weaknesses, and none were able to provide direct evidence that selective disclosure was fully mitigated by Reg FD. Furthermore, the SEC only pursued 10 enforcement actions due to Reg FD violations in the seven year period following its passage, leaving open the possibility that the law has not been well enforced and that selective disclosure could therefore still be taking place.

More recent research on Reg FD overcomes design weaknesses from prior studies and more directly tests whether Reg FD was fully effective at mitigating selective disclosure. We currently have a research study (Campbell, Twedt and Whipple 2016) that uses intraday trading volume and stock returns around Reg FD Form 8-K filings and find that, despite Reg FD’s goal of providing information to all investors simultaneously, disclosure provided pursuant to the regulation appears to be selectively disclosed to subsets of investors beforehand. Specifically, we offer the following set of results. First, we find significant increases in abnormal trading volume during the trading hour immediately prior to the first public release of Reg FD disclosures. In fact, we find that 20 percent of the abnormal volume reaction over the two hour window surrounding Reg FD disclosures occurs during the hour before the disclosure. Second, this pre-disclosure increase in trading volume is larger when the information is of greater consequence to the market. Finally, stock returns during the trading hour immediately prior to Reg FD filings predict returns during the trading hour immediately after the filings, but only for the disclosure of consequential, negative information.

We also find that selective disclosure prior to Reg FD filings is larger for firms with more growth opportunities and weaker information environments. Further, we provide evidence that corporate insiders and large traders appear to be significant beneficiaries of these selective disclosure releases. Specifically, these two groups collectively account for about 50 percent of the abnormal trading volume in the hour leading up to Reg FD filings. However, these results also suggest a role for small traders. While small traders could be unsophisticated investors benefiting from selective disclosure, they could also be large traders splitting up their trades to take advantage of their inside information.

Although our results stand in contrast to those of earlier research on the effectiveness of Reg FD, they are more in line with an emerging literature suggesting that the regulation has not been effective at mitigating selective disclosure. For example, recent studies show that, even after Reg FD, managers have ongoing communication with subsets of investors and that this communication is associated with changes in analyst stock recommendations, abnormal stock price movements, higher trading volume and changes in institutional ownership (Bushee, Jung, and Miller 2011; Green, Jame, Markov, and Subasi 2012; Bushee, Gerakos, and Lee 2012). A limitation of these studies is that they cannot distinguish whether these private communications provide material information that would be a violation of Reg FD, or whether these communications simply provide non-material information that completes the mosaic for these analysts and are thus not a violation of Reg FD. In a literature review of the research on Reg FD, Koch, Lefanowicz, and Robinson (2013) call for studies that are capable of distinguishing between these two explanations. We answer this call by identifying a setting where we know with certainty that the firm intended to disclose information specifically to comply with Reg FD, and we find strong evidence consistent with selective disclosure in this setting.

REFERENCES

Bushee, B., J. Gerakos and L. Lee. 2012. Corporate Jets and Private Meetings with Investors. Working paper, University of Pennsylvania, University of Chicago and Boston College.

Bushee, B., M. Jung and G. Miller. 2011. Do Investors Benefit from Selective Access to Management? Working paper, University of Pennsylvania Wharton School, New York University and University of Michigan.

Campbell, J., B. Twedt and B. Whipple. 2016. Did Regulation Fair Disclosure Prevent Selective Disclosure? Direct Evidence from Intraday Volume and Returns. Working paper. University of Georgia and Indiana University.

Green, T., R. Jame, S. Markov and M. Subasi. 2012. Access to Management and the Informativeness of Analyst Research. Working paper, Emory University, University of New South Wales, University of Texas at Dallas and University of Missouri.

Koch, A., C. Lefanowicz and J. Robinson. 2013. Regulation FD: A review and synthesis of the academic literature. Accounting Horizons 27: 619-646.

This post comes to us from Associate Professor John L. Campbell and Assistant Professor Benjamin C. Whipple at the University of Georgia’s Terry College of Business and from Assistant Professor Brady J. Twedt at Indiana University’s Kelley School of Business. It is based on their paper, “Did Regulation Fair Disclosure Prevent Selective Disclosure? Direct Evidence from Intraday Volume and Returns,” which is available here.