Of Competitive Environments and Selective Disclosure.

The SEC's recently released rules on selective disclosure are receiving generally favorable reviews. The new guidelines take some tough problems and provide practical guidance for front-line financial executives. Two key points stand out. If a company plans to release new material information and use a conference call with institutional investors to put the news in context, the company must simultaneously issue a press release containing the news. Second, if information is released in an unplanned, inadvertent situation, the company should level the playing field and issue a release within 24 hours.

An increasingly worrisome investor trading mentality and the increased speed with which information travels created the need for these rules. It may be that our market conditions are changed forever and these rules level the playing field by forcing fast, even disclosure, but the real issues seem more structural in nature and bigger than these new requirements imply.

The baby boomer generation's huge inflow of funds into the equity markets during their prime saving years has driven a lucrative and extremely competitive environment for investment-fund managers. Whether they're managing a large mutual fund, pension plan assets or an individual account, these managers face constant measurement and quick replacement if they under-perform. Rightfully so, these market pressures have been transferred to greater demand on corporations to deliver superior performance. In turn, the turnover rate of today's chief executives and chief financial officers is up dramatically. Management teams widely embrace this performance culture and accept the higher risk/return tradeoff.

But the more intense competitive environment has also introduced some marketplace practices that aren't healthy. One is the widespread use of stock price momentum as a fundamental investment criterion. One economist recently told an FEI gathering that over half of the models he constructed for institutional investors use price momentum as the highest-weighted independent variable. And it's not just the so-called momentum funds that are piling on with the herd that run up stock prices to unreasonable levels. It's a widespread practice in the biggest funds. A major investment bank recently studied this issue and found that the pressure not to miss out on exploding sectors causes many institutional investors to rush in regardless of the lack of fundamental valuation analysis support.

The pressure to outperform the market indices also has increased the importance of information advantages. Especially troubling for companies with small to medium market capitalization, major investors can use their importance to smaller companies with constant inquiries about short-term results. The problems arise when investors press for management's view of analysts' estimates close to quarter ends. Companies must be disciplined and avoid unfair disclosure advantage. Correspondingly, investors must respect formal quiet periods and times when management essentially knows the unpublished results. At times, these conversations cross from tough to rude and inappropriate.

The lack of sunshine rules and accountability on short-seller research shops is another problem. It's common practice for such groups to notify their narrow client base of an upcoming report in advance of publication. These groups then proceed to concoct incredible collections of possible negative information and scenarios. Sometimes they possess a single bit of inside information they then try to bury in a pile of bad news. One correct fact seems to legitimize the entire story. These groups usually pester the companies' largest shareholders with contrived negative information, trying to force them to sell, thereby driving down the stock price to their clients' gain.

Much has been written about the role of day trading and investor bulletin boards. While these vehicles have the potential for abusive impact in very small market capitalization companies, it's unlikely these practices are really affecting the overall market levels or values of mainstream stocks. Investor education and a buyer-beware mentality are more important in addressing these problems.

Our economy continues to boom ahead, and the value of the underlying companies should follow. But the systemic issues of this highly charged marketplace need to viewed within the context of the pressures on all the players and the dynamics among them.