Lots has recently been said and talked about investor confidence or the lack thereof that is hurting the stock market. Before I go any further, let me briefly outline the different types of investors. First, institutions that include mutual funds, pension funds, etc. Second, individuals who invest in the market as part of their financial planning goals and finally the speculators. Here where I say “gaining back investor confidence” I am addressing the second type, i.e., individual investors. I will call them “traditional investors.” The traditional investors are convinced that certain groups of people are trading on material “non-public” information and hence their erosion of confidence in the capital market. We all know that those with insider information and special access can take unfair advantage of the general investing public. Although trading on insider information may lead to short-term profit, in the long-run, individuals and the professionals as a whole suffer as investors avoid a capital market perceived to be “rigged” in favor of the knowledgeable insider.
What is material “information”? Its disclosure would have direct effect on the price of the stock and a potential investor would want to have the information prior to their investment decisions.
Issues of selective disclosure often arise when a corporate insider provide material information to an analyst or selected individuals either by a briefing, conference call or special meeting before that information is released to the public. If the recipient of the selective disclosure did not act to buy or sell stocks, there is no harm done. It is when the group upon receiving the information acts to buy or sell, thus negatively impacting the market, which by the way is a criminal act under the CMA regulation and is punishable by both jail term and hefty pecuniary penalty.
The company by disclosing selective information does not violate any law. This is mainly because professional money managers need the information in order to make their clients aware about the future direction of the company and therefore its stock price. Financial analysts and individuals who are privy to such information are aware that a disclosure made to a room full of analysts or group of individuals does not necessarily make the disclosure information “public.”
Analysts and others are fully aware that such information they receive are material non-public information the company provides as a guidance or interpretation of publicly available financial statements and regulatory filing.
The company should invite analysts and the professionals to provide guidance on a regular interval. It is a pro-active process and helps the general public better understanding of the company’s future growth and a reflection of its stock price. Such actions only gain confidence among future investors in the company.
Financial analysts and other receiving non-public information usually do not use this information for personal trading. In fact they are forbidden to do any personal trading. What they do is create is a “mosaic theory”; blending their access to “non public” information with public information and make proper recommendations to their clients about the company and its future stock price. A service very valuable to the general investor as they rely on such research to make their investment decision.
So how do we get the investor confidence back? We all know trading on insider information is illegal. At the same time many investors are investing with access to no or very little research on the company.
Individuals cannot purchase stock directly thought the exchange, but has to go through their broker, despite the fact that order can be placed through the Internet. I think it is in the best interest of the financial community in cocoordination with listed companies to provide better information and guidelines to prospective investors. One possibility could be that every time an investor makes an order request to buy or sell; and before the final decision is made, the ordering system may request the individual to review the company research. The buyer and seller then have a choice to either read or skip the company research. This gives the investor a high level of confidence and better choice mechanism for investment decisions. Of course at the end it is up to the individual investor to make the ultimate decision. At least professional money managers provide the investor an opportunity for an educated decision and therefore confidence in the system. The brokerage community should proactively provide company research voluntarily. This can be accomplished by cooperating research efforts. I would not be surprised if sometimes in the future such services are made mandatory. Such service is already mandatory in some exchanges in the West.
As long as the profession is proactive and listed companies are transparent and investor friendly, I think sooner than later the level of confidence among the investors will rise and ultimately benefit us all along with the market.
(Faisal Alsayrafi is president & CEO of Financial Transaction House.)
