Regulators vs. truth in securities

Today's WSJ reports:

The Securities and Exchange Commission's Regulation Fair Disclosure, or "Reg FD," said in 2000 that a company releasing market-moving information to anyone had to disclose it publicly. New York State Attorney General Eliot Spitzer last year reached a settlement with brokerage firms designed partly to stop them from favoring privileged investors. The 2002 federal Sarbanes-Oxley law also takes a crack at analyst conflicts of interest by seeking to separate analysts from investment bankers. And both the New York Stock Exchange and the National Association of Securities Dealers have stiffened their efforts to stanch information leakage in recent years.

But these efforts have not so much blocked the flow of valuable nonpublic information as shifted the channels. One venue that has risen in importance: Meetings that corporate executives often hold with small groups of investors -- where useful nonpublic information sometimes slips out, inadvertently or otherwise. Brokerage firms give special treatment to big investors who pay the most commissions, and that includes inviting them to those meetings with corporate executives.

In other words, although corporate insiders can't talk to analysts the way they used to (because of Regulation FD), they still let information slip to hedge funds. Information wants to be free.

Enron focused attention on the problem of securities fraud -- companies appearing to be something very different from what they are. The solution to that is obviously robust securities markets in which information flows freely. It is therefore helpful to keep in mind how much of securities regulation is aimed at the suppression of true information -- from insider trading laws, to takeover regulation (which forbids takeover-related tips), to Regulation FD, to prohibitions against pre-IPO publicity.

That is not surprising. The securities markets are awash in money, and regulation can channel that money, producing big payoffs for the beneficiaries. I discussed this recently in connection with the gun-jumping rules. So, too, laws that close one insider trading channel simply open another. If executives can't trade on what they know, the profits go to those in the securities industry who are next in line, as Haddock and Macey discussed in A Coasian Model of Insider Trading, 80 Nw U L Rev 1449 (1986). And, as today's WSJ discusses, there were winners as well as losers from Reg FD.

Of course the regulation doesn't come dressed in interest group clothes -- it presents itself in the guise of "fairness." No one ever explains why it's "fair" for one person to have information and not another. We do seem to know that there's something fishy about somebody making a lot of money simply because he knows something others don't. Yet this money provides an incentive to get information about how companies are really doing into the market and to flush out the lies. In other words, fairness is antithetical to market efficiency.

So we need to decide: Do we want less envy of those with the information, or less fraud?