Enacted in October of 2000, Regulation Fair Disclosure (“Reg FD”) was designed to level the informational playing field among investors by ensuring that issuers publicly disclose material information to the entire market and not just to a select few. Specifically, Reg FD requires that if a firm privately discloses material information, they must promptly disseminate that information publicly to all market participants. While the efficacy and legality of Reg FD have been widely debated over the last two decades, one thing remains abundantly clear: Selective private disclosure remains alive and well in financial markets.
The practice of privately disclosing material information to a select few individuals creates a two-tiered system of information dissemination, where privileged investors and analysts are given an advantage over other market participants. Naturally, these selective private disclosures prompt concerns for average investors about their risk of trading at an informational disadvantage. However, by its very nature, market participants cannot observe selective private disclosure. Therefore, a firm’s public dissemination of privately disclosed information through Reg FD filings (Item 7.01 of Form 8-K) could inform market participants about the firm’s selective private disclosure activity, allowing them to better price-protect against that risk when trading in the firm’s underlying stock.
Examining 176,124 Reg FD filings from over 9,000 firms between January 2005 through December 2020, I attempt to answer the following questions: (1) What do firms’ Reg FD filing patterns look like? (2) Do Reg FD filings inform market participants about firms’ selective private disclosure activity?
What do firms’ Reg FD Filing Patterns Look Like?
Specifically designated for Reg FD disclosures, Item 7.01 of Form 8-K represents 15% of all 8-K items filed. This makes Reg FD filings the third most frequent 8-K Item filed over this time period, behind only earnings announcements (Item 2.02) and “other” material events (Item 8.01). This also speaks to the ongoing prevalence of selective private disclosure in financial markets, implying that at least 15% of all material information publicly disclosed by firms is first disclosed privately.
Although Reg FD filings constitute a significant and growing portion of 8-K disclosures on average, it appears that the intensity of Reg FD filings varies widely across firms. Despite their broad prevalence, I find that 44.8% of the firm-years in my sample have no Reg FD filings at all. Further, I document that a firm’s Reg FD filing activity in any given year is highly predictive of its filing activity in the subsequent year. As depicted in the transition matrix below, this effect is strongest in non-Reg FD filing firms and suggests that firms adopt a relatively sticky strategy with respect to Reg FD compliance.
Figure 1: Reg FD Filing Frequency Transition Matrix
While the absence of Reg FD filings could reflect that these firms did not have any selective private disclosure activity to disclose in those years, that seems highly unlikely given that select analysts and investors often meet privately with management several times a quarter (Soltes, 2014; Solomon and Soltes, 2015). Therefore, it is unclear whether Reg FD filings credibly reflect a firms selective private disclosure activity.
Do Reg FD filings inform market participants about firms’ selective private disclosure activity?
Yes. Using a naïve expectation of selective private disclosure activity associated with informed trading, I document a “U” shaped pattern in investors’ price-protecting behavior whenever Reg FD filings deviate (positively or negatively) from that expectation. Intuitively, investors price-protect more when Reg FD filings exceed their expectations, consistent with greater-than-expected Reg FD filings being interpreted as an indication of higher selective private disclosure activity. Interestingly, I also find that investors price-protect more when Reg FD filings fall short of their expectation. This suggests that market participants do not interpret lower-than-expected Reg FD filings as a signal of lower selective private disclosure activity, but rather as an indication that the firm has not transparently disclosed that activity.
To corroborate my interpretation of the findings, I perform additional analyses exploiting variation in the value of a firm’s private information. Using the amount of firm specific information in the firm’s stock price and the average market reaction to the firm’s release of voluntary information as proxies for the value of the firm’s private information, I expect the results to be stronger when the ex ante value of a firm’s private information is higher. This is because selective private disclosure of more valuable information would put market participants at a greater informational disadvantage and thus would elicit stronger price-protecting behavior. Consistent with that prediction, I find that market participants’ reaction to Reg FD filings is significantly larger when the value of the firm’s private information is higher.
Finally, given that incentives for firms to reduce selective private disclosure activity hinge on their ability to credibly communicate with investors, I exploit variation in firm reporting credibility to examine whether firms are able to signal the reduction of selective private disclosure activity through the absence of Reg FD filings. To the extent that market participants view a firm’s disclosures as credible, I expect lower-than-expected Reg FD filings to be viewed as credible reductions of selective private disclosure activity and thus associated with a reduction in price protecting behavior in highly credible firms. I find market participants’ reaction to lower-than-expected Reg FD filings is attenuated for high credibility firms, while their reaction to higher-than-expected filings does not change.
The lack of a significant relation between market participants’ price protecting behavior and lower-than-expected Reg FD filings suggests that highly credible firms are able to avoid penalties for a perceived lack of transparent disclosure. However, this also indicates that these same firms are still not able to credibly signal a reduction in selective private disclosure activity through the absence of Reg FD filings, as lower-than-expected Reg FD filings still do not result in a significant decrease in price protecting behavior.
Implications
These results present two distinct weaknesses of the current Reg FD disclosure regime. First, market participants believe that a significant portion of firms’ selective private disclosure activity goes unreported. This inference is consistent with the large disparity between the documented importance of private communication with management (Bushee et al., 2011; Soltes, 2014) and the 44.8% of firm- years in my sample that contain no Reg FD filings at all. Even if these firms are complying with Reg FD through unidentifiable channels, my findings demonstrate that the lack of clear disclosure regarding their selective private disclosure activity creates significant market frictions by increasing market participants’ perceptions of adverse selection risk. In the event these firms are eschewing compliance entirely, they are failing to mitigate informational advantages from their selective private disclosure activity. Given the profitability of privately informed trades occurring around selective private disclosure activity that is disclosed in Reg FD filings (Campbell et al., 2020), the absence of these disclosures could generate a far larger cost to uninformed investors.
Second, my results suggest Reg FD filings do not allow firms to credibly signal a reduction in selective private disclosure activity. Without a way to credibly signal a reduction in their selective private disclosure activity, firms have no incentive to reduce that activity ex ante. The results from Campbell et al. (2020) suggest that Reg FD, in its current form, is not effective in fully mitigating the costs of firms’ selective private disclosure activity for market participants. Therefore, a reduction of selective private disclosure activity is necessary to achieve the regulatory goal of “levelling the playing field.”
I contend that strengthening the informativeness and credibility of Reg FD filings may help regulators more effectively level the informational playing field as they originally intended. Specifically, my results suggest a requirement to clearly label all disclosures made in compliance with Reg FD would be beneficial. This would allow market participants to more accurately identify firms’ selective private disclosure activity, providing an incentive for firms to reduce that activity ex ante. Further, it would also make it easier for regulators to identify the absence of Reg FD filings, which could improve the enforcement of the regulation and further raise the informativeness and credibility of the filings. The economic consequences suggested by my analyses should be of significance to academics, regulators, and market participants.
Anthony Joffre is Ph.D. student of Business Accounting at the University of Miami.
This post is adapted from their paper, “Selective Private Disclosure: Is Silence Golden?” available on SSRN.
