Please ensure Javascript is enabled for purposes of website accessibility

Why the SEC's New Disclosure Rule Hurts Investors

By Jon Friedman - Apr 8, 2013 at 1:33PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Companies may now be able to sidestep public scrutiny.

The Securities and Exchange Commission's new rule allowing companies to distribute information on social media will wind up doing more harm than good for Main Street investors. Now, investors potentially haven't got the same access to pertinent company information as their Facebook-savvy neighbors. Plus, this makes it easier for public companies to escape the typical glare of the media. A win-win? Hardly.

Yes, it's commendable that the SEC, by acknowledging the ascent and prominence of Facebook, Twitter, and the rest of the new-media genre, is showing its willingness to join the 21st century. Of course, a skeptic might ask, with much justification: Well, what kept you? 

It's reasonable to assume that the Commission is being dragged, kicking and screaming, into the digital age. As The New York Times put it in its coverage of the story: "With the decision, the SEC is playing catch-up to the new era of social media."

On April 2, the SEC detailed new disclosure regulations that explain how companies can employ Facebook, Twitter, and additional social networks to distribute information.

The decision came about largely because Netflix CEO Reed Hastings had such remarkable success when he took the pioneering move of communicating Netflix news on Facebook. Hastings was rather shrewd. As it turned out, he got beat up pretty badly in the mainstream business media. He was accused of everything from insensitivity to outright arrogance when he instituted a price increase in the summer of 2011.

In retrospect, the price hike was a modest one and probably shouldn't have caused such a furor among journalists. But Hastings exhibited, above all else, a terrible sense of timing. The United States was in the grip of an oppressive economic downturn. It seemed piggy of a company to raise its prices at that sensitive point in history. 

No matter; Hastings figured he'd roll the dice and turn to social media as a distribution system. Since then, Netflix has gone on to become one of the hottest stocks around, crushing the results of the benchmark S&P 500 during comparable time frames.

The biggest problem I have with the idea is that it makes it possible for public corporations, which seldom willingly 'fess up about their mistakes unless they're cornered, to sidestep public scrutiny. Usually, it is the prying eyes of the business media that do the dogged research necessary to unearth a company's sins. Now, the companies can communicate directly to you without any filter. The SEC's decision threatens to minimize the role of journalists acting as watchdogs of publicly held companies.

Unfortunately, most individual investors aren't savvy enough from the jump to understand that a savvy social-media director can pull the wool over their eyes by issuing an announcement on Twitter, which has a 140-character limit for a message.

When a CEO takes his or her message to Facebook or Twitter, the individual investor community could wind up suffering. Someone who reads a CEO's message on a social-media outlet is likely to accept it at face value, which gives the corporation an immediate advantage in controlling the message. With a traditional press release, the mainstream media could initially interpret for investors and openly ask questions about it. Yes, journalists still have this ability, but their inquiries will inevitably lack the same teeth. 

In December, the SEC warned Netflix that it could face a reprimand for a 43-word message that Hastings had placed on his personal Facebook page. He essentially complimented his staff on Netflix's surpassing 1 billion hours of video viewed in a single month. In hindsight, it could be argued that the Hastings initiative smacked of gimmickry and a triumph of effects. The "1 billion" figure looked sexy, and by presenting it on the very trendy Facebook, it probably seemed to have even more immediate meaning. But it worked, as Netflix's stock climbed.

The SEC rightfully took issue with the Hastings announcement and questioned whether it ran afoul of the Regulation Fair Disclosure (Reg FD), which orders a company to offer material findings to all investors at one time. Even though Hastings boasted some 200,000 Facebook followers.

The SEC was correct to fret about the violation to the sanctity of Reg FD. What about the investors who don't often go on Facebook and don't tweet -- particularly senior citizens who don't even have accounts on the social-media innovations and leave it to their grandchildren to tell them all about the new media? The crowd that cares more about CNBC than Facebook would surely be at a loss.

Certainly, it could be argued that the major media outlets would publish or broadcast Hastings' revelation, too. But the point is that investors who saw it come over on Facebook would have a decided advantage as time passed. They could invest on Hastings' news more quickly than those who weren't Facebook buffs.

Plus, if Hastings had taken the traditional but more fair-minded path of issuing a press release, he would have encountered nettlesome questions from the business media. They might have asked: Is this really such a big deal? Yes, it sounds impressive, on the face of it -- but, ultimately, so what?

But Hastings didn't have to worry, for a bit, about those kinds of points. He had beaten the system and looked smart for doing so, as Netflix's stock soared that day.

Hastings wins because he looks like a pioneering genius, and helps to repair his damaged public image. The SEC wins, too, because it looks like a with-it regulator. Facebook and Twitter et al win because their importance in our society is proven once again.

Who loses? The individual investor.

link

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
322%
 
S&P 500 Returns
116%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/25/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.