Customs Street Advisors is a full service investor relations firm based in Lagos, Nigeria.

Where there is no RegFD: How selective disclosure hurts issuers and investors on the Nigerian Stock Exchange.

Financial markets thrive on uniform access to information for all interested parties. When access is discriminatory it gives a significant and unfair advantage to those who enjoy such access. Such partial dissemination creates a number of severe problems. Over time, the mispricing of securities by 'non-insider' traders, who are the majority by definition, make markets less efficient due to the misallocation of resources. A second insidious effect is that when there is a widespread belief that market prices are set by those with subterranean access to non-public material information, investors tend to abandon the careful study of a company's merit, and instead allocate resources based on rumour and unverifiable expectations of excess returns at payoff. A final implication of such practices is that they compromise the integrity of those intermediaries and companies which engage in such practices, building distrust between them and investors.

In 1999, the US Securities and Exchange Commission (SEC), made the radical suggestion that rather than focus on a catch-all definition of insider trading, markets would be better served if there were unambiguous guidelines on disclosure. This simple but revolutionary idea, which eventually came to be known as Regulation Fair Disclosure would transform US markets by removing the barriers of privilege that had denied retail investors access to company information at the same time as more endowed investors and analysts. In this post we will examine the effects on investors and companies which trade in markets with dense subterranean information networks.

Regulation Fair Disclosure (Reg FD) addresses selective disclosure among issuers. It provides that when a public company or its representative discloses material nonpublic information to certain persons who may trade for benefit on the basis of that information the company is under obligation to make public disclosure of that information without delay. According to the SEC,

Issuer selective disclosure bears a close resemblance in this regard to ordinary ‘tipping’ and insider trading. In both cases, a privileged few gain an informational edge and the ability to use that edge to profit from their superior access to corporate insiders, rather than from their skill, acumen, or diligence. Likewise, selective disclosure has an adverse impact on market integrity that is similar to the adverse impact from illegal insider trading: investors lose confidence in the fairness of the markets when they know that other participants may exploit ‘unerodable informational advantages’ derived not from hard work or insights, but from their access to corporate insiders. – From the US SEC Final Rule on Selective Disclosure and Insider Trading, October 2000.

For a long time, selective disclosure was tolerated as a necessary evil because the technology to support widespread uniform dissemination was simply not available or too expensive. The ubiquity of  telecommunications and internet access in the late nineties rendered the argument for exclusive access untenable.

While a lot of the debate on Reg FD has focused on the means of ensuring fair disclosure, such as universal access to webcasts, conference calls and roadshows, the essence of the rule extends beyond the provision of access points via technology.

Since some of these technologies and events are not widely available to companies and investors in Nigeria, we would rather lay emphasis on the substance of fair disclosure. By this we mean requirements on companies to ensure timely dissemination of material information via the media, SMS  alerts and RSS feeds on their websites to investors.

When companies are under no obligation to disclose material information within a stipulated period, nor publicly acknowledge that certain parties have had access to such information and may abuse it, it rigs the system in their favour.

Many company executives feel that they need to provide favoured access  to some intermediaries (stock brokers, analysts, investment bankers), who control important sharetrader constituencies. They erroneously believe that these intermediaries can help them spin bad earnings or other unfavourable news into acceptable narratives for investor consumption.

Since there are no restrictions on these intermediaries’ exploitation of such information, and often a tacit complicity that they will exploit it as a quid pro quo, a disservice is done to the general investor welfare.

Eventually, the true situation always leaks out. At that point, investors will connect the dots between periods of heavy trading pressure on the company’s stock and when the event took place with the realization that they were excluded from the loop.

Recent experience shows that the spread of affinity communities of investors on stock market fora like NigeriaVillageSquare.com, NairaLand.com, StockMarketNigeria.com, NaijaLoWa, Twitter and Facebook means that neither companies nor intermediaries can control discussions, hypotheses, rumours and opinions on these reputational networks. They have become the premier locations for discussions on companies.

These sites and others like them have become fertile ground for guerrilla narratives. The best way to deal with these is by releasing information to the markets at the same time and on the same terms. After releasing the information, the company must respond in a responsible manner and without discrimination to requests for clarification unless bound by law not to do so.

For those companies that insist on continuing with the old methods of privilege, they place themselves  at the risk of a loss of credibility. For instance, the public outcry over allegations of insider trading on the shares of six companies listed on the Nigerian Stock Exchange by the SEC in 2008 showed just how much companies can suffer serious reputational damage at the slightest perception of sharp practices in the trading of their shares.  The SEC investigation, and the lack of co-ordination with the NSE, brought to the fore the urgent need for both regulators to work closely to ensure that market abuses are stamped out, and offenders severely punished.

The past few months have been painful for Nigerian investors, as they have been for investors across the world. Still, the market turmoil has created an opportunity for the SEC and NSE to introduce investor protection policies that will reassure them that their interests are foremost on the agenda.

To achieve these, both the NSE and SEC need to act now to draw up rules on disclosure for Nigerian companies.  For example, the Canadian Securities Administrators has drawn up a comprehensive guide that may serve as a framework for issuers on the Nigerian Stock Exchange. In particular, as many investors now use the internet to research information,  all Nigerian companies must be required maintain regularly updated websites with user friendly intuitive navigation. The US SEC has published a helpful set of guidelines too. Another pressing matter is irregular reporting schedules by some public companies. Investors need to know when companies are expected to report results.

Finally, both the SEC and NSE need to allocate more resources and personnel to policing disclosure practices among companies, including soliciting public information on suspicions of improper disclosure or misuse of information.

All the above would go a long way in reinforcing investor confidence in the fairness of markets as well as infusing their trust that prices reflect publicly accessible information.

Related posts:

1. Lux fiat: A diagnosis of the implications of SEC’s Proposed Draft Rule B4(3) on Earnings Guidance for corporate issuers on the Nigerian Stock Exchange In his 2000 annual letter to Berkshire Hathaway shareholders, Warren...
2. Quis custodiet ipsos custodes? A timely discussion on the independence, professional standards and competence of analysts covering companies on the Nigerian Stock Exchange. Speaking in an November 2007 interview with the Times of...
3. Lost in translation, apples and oranges, or tomahto to tomayto?: The need for companies on the Nigerian Stock Exchange to carry the investment community along in the transition to International Financial Reporting Standards (IFRS). On April Fool’s Day, First Bank, a foremost Nigerian bank,...
4. One thousand ways to say ‘I Connect’: How companies on the Nigerian Stock Exchange can use social media (2). What is social media? Are social media and social networks...
5. One thousand ways to say ‘I Connect’: How companies on the Nigerian Stock Exchange can use social media (1). What is social media? Are social media and social networks...