Of Competitive Environments and Selective Disclosure.

• Author: Livingston, Phil

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...