In a column in today's New York Times, Floyd Norris writes about what he sees as a problem with a new Securities and Exchange Commission rule that would allow all ratings agencies, not just ones hired by a company, to get access to non-public information. Writes Mr. Norris:
The rule adopted last week says that whatever information is given to the agency hired by the issuer to rate the structured finance security must be given to other rating agencies, including those that provide analyses only to investors who pay for them.
The result will be that analysts for the other rating agencies, like Egan-Jones Ratings, will have access to information not available to the general public, and their analyses will go only to clients. Those clients will have the benefit of nonpublic information, or at least of their agent's analysis of what it means.
The answer is obvious: Cut off the inside information. The rating agencies now have an exemption from the S.E.C.'s Regulation FD, for fair disclosure. If that exemption were removed, the level playing field would be restored.
Mr. Norris may think that the "obvious" answer to this situation is to try to allow less information into the marketplace. But there's another possible solution, too -- revise or eliminate Regulation FD altogether, along with the rules against trading on what is supposedly "inside" information. Rather than trying to further restrict the flow of information, as Mr. Norris suggests, this solution would increase the flow of information and make it available not just to rating agencies but more broadly to anyone who asked and who the company wanted to answer. After all, inside information isn't necessarily that valuable -- Richard Fuld and Jimmy Cayne had lots of inside information about Lehman Brothers and Bear Stearns, yet they each lost nearly a billion dollars. And what makes the inside information valuable is the restriction on leaking it, which can make a stock price appear undervalued or overvalued compared to an upcoming earnings release. Remove the restriction and the information becomes less valuable. As this 2002 New York Sun editorial about the Martha Stewart case put it:
According to Henry Manne, whose authoritative book "Insider Trading and the Stock Market" was published in 1966, changes in stock prices routinely precede public announcements of price-moving events. This happened with both Enron and WorldCom — though not to an extent that helped most investors much. Mr. Manne argues that such leakage of information is a good thing. When insiders trade on their information they make the market more efficient, an efficient market being one in which prices immediately adjust to underlying realities. In an efficient market, outsiders are less likely to get sandbagged by developments that have yet to be factored into a stock's price. "People are relying on accounting, but accounting isn't that accurate," he said. "Insider trading is."
Sometimes, the "obvious" answer isn't the best one. Relaxing government-imposed restrictions on the flow of information may be a less "obvious" answer than trying to tighten them, but it's not obvious to me why a business journalist would want to be arguing for having less information flow to the public rather than more information. Sure, the answer that gets commonly given is that if the restrictions are lifted, only the rich and powerful will have early access to the information. The analyst at Goldman Sachs (and his clients) will find out about what is going on at a company before an ordinary small investor would. But with faster, more open information flow, at least the small investor can notice the price of his stock gradually sink and have the opportunity to sell at that point, rather than having it drop 10% or 20% in a day as the result of some bombshell public announcement that is made to everyone all at once. That's the theory, anyway.
