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E-MailKevin S. Haeberle is Assistant Professor of Law at University of South Carolina School of Law and M. Todd Henderson is Professor of Law and Aaron Director Teaching Scholar at the University of Chicago Law School. This post is based on an article authored by Professor Haeberle and Professor Henderson.
Over the past few years, regulators have repeatedly decreed that they would end what was quickly becoming a routine practice: the release of market-moving information to high-speed traders just prior to the time at which it was being made available to the entire public. The most prominent examples of regulatory efforts in the area during this period involved New York State Attorney General Eric Schneiderman. He termed these types of practices “Insider Trading 2.0” and vowed to end them.
The question of how to regulate how and when market-moving information is disseminated to the investing public is not just political fodder. In 2000, the SEC promulgated Regulation Fair Disclosure (Reg FD), which requires public companies to make material information available to all investors at the same exact time when first disseminating it beyond the firm. Indeed, the agency’s parity-of-information approach in this context has been explicit since at least as early as the seminal Dirks insider-trading case in the early 1980s.
The primary rationale behind all of these efforts is “fairness.” The sacred tenet of the SEC (and other regulators) is that ordinary, long-term investors should, within reason, be put on as level of a playing field as possible with sophisticated speculators when it comes to the ability to make a profit in securities markets.
In our recent Article, Information-Dissemination Law: The Regulation of How Market-Moving Information Is Revealed, we put these fairness arguments to scrutiny, examining the actual effects of government-mandated simultaneity on ordinary investors. Applying insights from market-microstructure economics, we find that policymakers have no basis for claiming that these initiatives protect ordinary investors. In fact, our analysis reveals that efforts to make securities markets fairer for these investors may in fact be doing the opposite. At least for the many individuals who trade directly through retail-level brokerage houses, the simultaneity rules likely make them worse off than they would be without such rules. We show that some efforts, like Reg FD, are ambiguous, while others, like the NYAG’s crack down on early access to information, are unambiguously bad for investors.
The main insight of the Article can be illustrated briefly by thinking about Reg FD and its effects on information asymmetries among participants in the stock market. Reg FD has two distinct, and opposite, effects on ordinary investors that have been overlooked in the securities-law literature. The regulation prohibits firms from engaging in the once‑common practice in which they reveal new information to selective audiences hours, days, or even weeks before announcing it to the entire public. For that reason, throughout sustained periods leading up to the release of new corporate information, it reduces the risk that some select group of traders will have superior information that others lack. The ultimate result is that the welfare of ordinary investors who trade in these relatively long pre-release periods is improved. However, that improvement is only slight as a general matter because the ratio of informed trading to all other trading during these periods would generally have likely been quite low for the great majority of publicly traded stocks. Ultimately, then, Reg FD improves ordinary-investor wellbeing during those prolonged pre-release periods—but only slightly so because the information asymmetries it eliminates would generally have only imposed a slight negative effect on each member of the enormous herd of ordinary investors in the market during those periods.
But, in brief post-release periods, Reg FD does something very different: It dramatically increases and concentrates this same information asymmetry. In the seconds after new information is made publicly available, those who want to capture a trading profit based on this information must trade on it immediately, lest the competition beats them to the punch. Ordinary investors who trade in this period are made markedly worse off as the execution of their orders to buy and sell stock are far more likely to be affected by better-informed pros in those periods than they would be without the legal intervention.
Stepping back, it becomes clear that the issue of whether ordinary investors are helped or harmed by Reg FD’s simultaneity mandate depends mainly on whether the small gains from trading in the sustained pre-release periods that are slightly safer exceed the large losses from trading in shorter, now far more dangerous post-release periods. No empirical study has aimed to quantify these gains and losses, and the SEC has not supported the rule with any analysis other than a plea to “fairness.”
More generally, we show that equal access does not automatically generate “fairness.” For example, we demonstrate that the fairness rationale for “Insider Trading 2.0” is completely unjustified. All this effort does is move periods of intense informational asymmetry from a few seconds before the release to a few seconds after. And, given the undeniable and unremediable advantage investment pros have in executing trades in those brief time periods, this cannot help ordinary investors. In fact, by suggesting markets are “fair” (not to mention that ordinary investors should be trading on changes in information), these efforts encourage ordinary investors to act irrationally.
Still, you might say, simultaneous-dissemination rules (like Reg FD) were motivated by an additional concern: one relating to the bias in stock-price analysis that arose because of the practice of selective disclosure. But we believe that this type of simultaneity-focused information-dissemination regime was suboptimal, and that the lumping together of the price-accuracy and fairness concerns impedes the law from coming up with more innovative ways to address the former problem. Accordingly, we offer some alternative regulations that could better achieve the fairness ends of Reg FD without requiring equally timed access to information—while also potentially better furthering not just unbiased analysis, but the generation of accurate stock pricing more generally.
The full article is available here.
