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Reg FD's fallout
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November 14, 2000: 7:36 a.m. ET
Access to company guidance will be good in the long run. Short-term unclear
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - First online brokerages made it cheaper for Main Street to take on Wall Street. Now, it gets easier. With the advent of the Securities and Exchange Commission's Regulation FD, regular investors have the same earnings guidance from companies as market professionals.
But is that a good thing? The financial world is divided. Perhaps not surprisingly, Wall Streeters who once enjoyed the privilege of cozy chats with CEOs aren't happy to see them disrupted.
Other investment pros fear a "chilling effect," where companies clam up rather than get into trouble. The SEC and investment-relations professionals are still trying to sort out what's acceptable.
Not everyone agrees there was a problem in the first place. But most agree equal access will be positive in the long run.
Reg FD "certainly provides the opportunity for individuals to obtain the same information, at the same time, as professional stock analysts," James Cloonan, chairman of the American Association of Individual Investors, said when Reg FD started. Then again, "it will only help if the individual investor uses the information effectively," he said.
Companies get edgy
Regulation FD – or Fair Disclosure -- went into effect Oct. 23. But the SEC adopted the rule back in August, and many companies started adjusting how they released information for the third quarter.
Its goal is to prevent "selective disclosure," where companies convey important performance information to chosen sources. So-called "material" statements have to be made publicly if they are made at all.
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It will only help if the individual investor uses the information effectively.
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James Cloonan
American Association of Individual Investors |
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Wall Streeters say the adjustment has been a mixed bag so far. Certain companies reacted sooner, or have gone further. Some analysts say they need another six months to see how companies respond.
For the time being, Reg FD has left executives at many companies very edgy about what they can – or more importantly, can't – say.
Often they make more guidance broadly available than they have in the past. But analysts say company officials have drastically scaled back their contact with them, which often went into greater depth.
Executives also used to review analysts' earnings models. They would then "guide" the analyst as to where the model could be improved to predict the company's results. That practice – and much one-on-one conversation -- has more or less stopped in light of FD, analysts say.
At the start of this month, the SEC's director of enforcement clarified several points in a speech to the Securities Industry Association. The SEC will only go after egregious violations, with "reckless" or "intentional" selective disclosure, Richard Walker said, or deliberate attempts to skirt the regulation.
Walker also noted that the regulation doesn't cover mid-level and junior employees and isn't a fraud law, meaning investor's can't sue under FD.
A greater number of announcements
At face value, companies are being a lot more talkative. The number of companies preannouncing earnings in the fourth quarter of 2000 was up dramatically from the same quarter in 1999. All told, 55 percent more companies guided early, close to half of them guiding investors down.
But it's hard to tell whether the increase stems from Regulation FD. The economy is weaker. The markets have lacked direction. Both factors create uncertainty, which may prompt companies to give guidance.
"I would have expected, even without FD, to see more preannouncements this quarter," said Chuck Hill, director of research at earnings tracker First Call. "Things are worse out there."
Negative surprises grew by half, according to First Call, as the Federal Reserve's rate raises took hold. But positive surprises rose even more dramatically, doubling to 111.
More companies revealed they were on target this year than last, too. So guidance rose across the board.
More guidance, less guiding
Hill notes that Alcoa (AA: Research, Estimates) warned on its third-quarter earnings on Sept. 18. He can't remember when Alcoa ever warned before.
As a metals company, Alcoa's earnings are volatile, depending on energy costs and demand from economically sensitive sectors. But the Dow component had resisted explicit warnings in the past.
An Alcoa spokeswoman said the company acted differently because of high energy costs and softening markets like construction, not because of Reg FD. But she could not recall prior guidance from Alcoa, up or down, either.
When Nortel Networks (NT: Research, Estimates) announced its earnings Oct. 24, it also gave guidance for the following quarter and next year. A week later, on Nov. 1, it took the unusual step of reiterating that it expected to earn 16 cents a share in the fourth quarter and that revenues and earnings would grow 30 to 35 percent for 2001.
"It just seemed like there were more questions this time," spokesman John O'Connor said. "It was just simply a reinforcement of what our guidance is."
Not able to clarify a point
Companies may be reticent to attribute guidance to Reg FD because they don't want to appear to have released information selectively in the past. But Jim Parmelee, telecom-equipment analyst at CS First Boston, said Nortel is being more precise with guidance, and is not alone.
"Their view was, we have to be more explicit, not just with the coming quarter but with the quarter after that," he said. "Pretty much the entire industry is grappling with how to implement this."
He thinks Nortel decided to reiterate because it had less opportunity to interpret earnings for analysts. Nortel's third-quarter news was causing its stock to plummet, but its executives weren't able to dispel doubts about its future without another statement. Its price has been steady since.
"The flipside of FD in terms of disclosure is that it can also create more uncertainty," Parmelee said. "The companies can't respond to urgent changes and rumors."
Open analysts meetings
On Nov. 3, Sprint (FON: Research, Estimates) laid out its anticipated earnings not only for the rest of the year but also for next year. While it used to give such guidance in its annual analysts' meeting, it didn't used to publish it publicly.
Its analysts' meeting was also closed. This year, Sprint broadcast the meeting via the Web and invited 30 reporters who cover its financials, both new moves. Around 20 reporters showed up.
Sprint doesn't have a handle on how many investors listened in via the Web. But it has also started Webcasting its earnings, with its third-quarter release on Oct. 17.
Mark Bonavia, a Sprint spokesman, called the new approach "a sea change." Sprint needed to explain why its earnings on its phone side would decline, he said. It attributes the drop to capital investments it was making.
But it now has to make that information available in different ways. Webcasts and media access will be important for Sprint from here on, he said.
"You just have to consider that if there's information that needs to be told to the Street, it has to be told to others as well," Bonavia said.
Less information leads to challenges
Webcasts will be increasingly common, market watchers think, because they are cost effective. Smaller companies may be able to rely on phone conferencing.
But Lou Thompson, president and CEO of the National Investor Relations Institute, said smaller companies will also find it hard to guide on earnings. While they might have been able to help an analyst on one point, they may lack the ability to map their whole earnings, particularly if they are in a volatile sector like technology, he said.
But companies can't afford to stay silent, and give up marketing. Thompson said the net effect is that equal access is traded for quality information.
The Securities Industry Association also does not like the new regulation. Frank Fernandez, SIA director of research, expects analysts to be wrong more often. Companies will lack feedback from analysts on what they're doing right, he said, and not want to reveal as much information in open session.
Others agree companies will be more reticent. "Everybody is going to know the same, but it's going to be less," said Hugh Johnson, chief investment strategist at First Albany. "The disclosure of information becomes more carefully managed than the Federal Reserve manages the disclosure of information."
Like many, he thinks Reg FD will increase volatility around earnings announcements, in an already volatile year. "We'll have some bewildering rises and some bewildering, if not shocking, declines," Johnson said.
With all investors able to respond to earnings forecasts and releases at the same time, many more retail investors may be tempted to trade. But market professionals warn that uninformed investors may get caught in sudden swings, selling at inappropriate times or on information they misunderstand. Big institutions are more likely to have the resources to interpret earnings and respond rapidly, they say.
A new kind of analysis
But some analysts think Reg FD will have the positive effect of encouraging investors and analysts to think longer term. Without a premium on forecasting earnings, analysts will be freed – or forced -- to mull companies' long-term picture, as well as develop industry overviews. Others suggest they will need to be better stock pickers, predicting the winners in an industry.
"It will allow you to distinguish yourself," Parmelee said. Analysts will have to know their industry and do their homework, he said.
They and investors may end up with explicit, regular information a company didn't give before, though that's debated.
Analyst Greg Smith, who covers online brokerages for Chase H&Q, notes that Ameritrade (AMTD: Research, Estimates) has just begun releasing monthly information on its trading volumes and new accounts.
"Before, you could call and get a better idea. Now you don't get that guidance. Instead you're getting the information," he noted. So his ability to get casual guidance has been swapped for more-concrete, regular data. Greater transparency might in fact reduce volatility, he said.
He thinks private-company contacts will also become important sources. Reg FD "makes the job of an analyst more difficult," Smith said. Then again, "It was absolutely wrong for companies to tell specific information only to a few individuals." 
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