Friday, October 06, 2006

Cloaking Device

Star Trek fans probably remember with fondness how the Klingons maneuvered through the universe undetected with the aid of a “cloaking device.” U.S. public companies have a cloaking device of their own - Reg FD. By most accounts Regulation FD or the Fair Disclosure Rule promulgated by the SEC in 2000, has been successful in reducing selective disclosure of material information to the disadvantage of other investors. That was its intended purpose.

Unfortunately, Reg FD has had unintended consequences. Like all good rules it sometimes gets broken and twisted to the advantage of management. I hear Reg FD invoked as a means to avoid answering tough and sometimes even benign questions about performance. “We do not talk about that because of Reg FD.”

Even before passage of Reg FD, public companies were, and still are, subject to rules relating to leakage of material, non-public information. The SEC is fairly diligent about enforcing insider trader trading prohibitions found in Rule 10b-5 and comes up with about four dozen enforcement actions a year after an untold number of investigations. Just ask Sam Waksal and Martha Stewart.

I don’t think Reg FD was ever intended to limit the content of a company’s communications, just make certain that revelations of material information are disseminated fairly. That means using communications channels such as SEC filings, press releases or conference calls that can be easily accessed by any interested party.

So what happens when management is contacted by telephone or receives a visit from a single interested party such as an analyst or portfolio manager? If the Company has a well thought out investor relations policy and its reporting practices generate highly transparent SEC filings, it will probably be a highly informative conversation well within the rules.

However, in the case of companies seeking to traverse Wall Street like a Klingon ship, undetected by inquisitive analysts and traders, such cogent communications policies and practices are usually not in place. Almost any question will lead to a Reg FD issue.

So who is at a disadvantage then? It is the individual investor, the same little guy who was supposed to be protected by Reg FD, who again gets left out in the cold. This individual does not have the resources or the time to make dozens of phone calls to suppliers, customers and competitors to learn about industry or company trends.

Company silence is like a one of those mysterious black holes in space left by imploding stars. Black holes are defined by their gravitational pull into nothingness. They are so compact even the speed of light cannot escape.

I do not recall a Star Trek episode invovling the Enterprise getting lost in a black hole - probably owing to the skillful maneuvering of Captain Kirk. Shareholders who buy stocks in “cloaked” companies with voids in their communications policies, should likewise navigate carefully.

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