The Securities and Exchange Commission is in danger of becoming the Dept of Silly Walks.
Let me explain why I’m calling the SEC Monty Python. And it matters to you, public companies and investors.
Speaking of disclosure: I’m on the NIRI National Ethics Council, and we’re debating this matter. What I’m saying here is, as usual, my own view.
So back in the go-go late 1990s, “sellside” analysts like Henr
y Blodget and Mary Meeker were the superstars of research. Public companies could be seen groveling at sellside thrones.
And simultaneously, sometimes tens of thousands of retail investors would join a new-fangled communication tool public companies were using, the earnings-call webcast.
And insider-trading was the hottest of buttons for regulators. They were concerned companies were telling sellside analysts and big institutional investors things before the little guys would hear them. The disturbing spectacle of the Big Guys getting an edge over the Little Guys.
Nothing smokes the cigar of regulators faster than that.
So in August 2000, the SEC passed Regulation Fair Disclosure requiring public companies not to tell some people stuff that could alter valuation or stock-performance without telling everybody else.
In enacting the rule, the SEC said:
As reflected in recent publicized reports, many issuers are disclosing important nonpublic information, such as advance warnings of earnings results, to securities analysts or selected institutional investors or both, before making full disclosure of the same information to the general public. Where this has happened, those who were privy to the information beforehand were able to make a profit or avoid a loss at the expense of those kept in the dark.
Step forward to 2021. The SEC last week brought a Reg FD enforcement against members of the investor-relations team at AT&T for supposed material nonpublic disclosures to analysts and big investors five years ago.
AT&T is contesting these findings in a tartly worded missive.
So now we get to the Ministry of Silly Walks and how it’s dragging its gangly limbs about in comic fashion. First, if it takes you five years to figure out enforcement is needed, you’ve already made a mockery of the process.
Now, consider the stock market in 2000. Almost 90% of investment assets were actively managed – overseen by people finding what would set one company apart from another and lead to better investment returns. And 80% of volume was Active. And market intermediaries like Citadel Securities barely existed.
And in 2000, stocks were not decimalized. Markets were not connected electronically and forced to share prices and customers and stock-listings so that everything trades everywhere, all the time.
In 2021, about 65% of investment assets are now passively managed using models. Over $5 trillion in the US alone resides in Exchange Traded Funds (ETFs), stock substitutes backed by cash and securities that trade in place of actual stocks.
And trading machines using lightning-quick techniques from collocating servers right next to the exchanges’ to microwaves and fiberoptics drive over 50% of volume.
And guess where selective disclosures and informational advantages reside now? You got it. ETFs. And Fast Traders. ETFs know which direction the supply and demand for shares is moving, and they transact off-market with a handful of Authorized Participants in giant blocks called Creation Units.
Imagine if big investors gathered with big companies and traded information in smoky backrooms. It would at minimum violate Reg FD. It would no doubt prompt outrage.
So, why is it okay for ETFs and their brokers to do this at the rate of $500 billion per month? It’s an insurmountable advantage harming non-ETF fund managers.
Second, Fast Traders buy retail stock orders so us little guys can trade for free and in fractional shares. But Fast Traders can see the limit-order pipeline. Nobody else can. That’s material nonpublic information, and it permits them to profit at others’ expense.
Why is it okay for the quickest firms to have a first look? Notice how the operators of big traders own sports teams and $100 million houses? There’s a reason. It’s called Informational Advantage.
Third, as I’ve said repeatedly, automated market-makers, a fancy name for parties between buyers and sellers, can short shares without locating them, and they don’t have to square books for more than 30 days. As we described, it’s how GME went up 1,000%.
Finally, next week indexes and ETFs will have to rebalance, and a raft of options and futures expire. And about ten big banks handle all that stuff – and know which direction it’s going.
A handful have a massive advantage over everybody else – the very thing regulations are meant to prevent. Sure, we get free trading, cheap ETFs and the appearance of liquidity.
But it’s not a fair market – and that’s why this AT&T case is silly. It’s cognitively dissonant and hypocritical to permit rampant market exploitation while culling a five-year old file from the last regime to score political points.
Reg FD is a quaint relic from a time that no longer exists. Maybe the SEC should regulate to how the market works now?