In the fall of, the US Securities and Exchange Commission issued a new rule meant to combat the problem of selective disclosure among public companies and their favorite investors. Regulation Fair Disclosure (Reg FD) mandated that any time a publicly traded company shared material information with anyone, it must make that information public to everyone.
“Place yourself in the position of a hedge fund manager. Why would you spend all this energy seeking to meet with the CEO if it didn't help to significantly inform you in some way?”
But today, over a decade since Reg FD went into effect, senior management at public firms still spends a lot of time in private powwows with hedge fund managers at corporate headquarters, road shows, or conferences—an average of 17 to 26 days per year for each executive, according to a 2010 survey by Cross Border. A whopping 97 percent of CEOs at publicly traded firms entertain occasional meetings with private investors, according to a 2009 survey by Thomson Reuters. For both the investors and the executives, this can mean spending tens of thousands of dollars annually on plane tickets and other related expenses, not to mention the considerable opportunity cost of their time. Yet by law, such meetings are not allowed to convey material information.
"There seems to be a disconnect," says Eugene F. Soltes, an assistant professor in the Accounting & Management Unit at Harvard Business School. "If these meetings followed the spirit of what the regulation wanted—a level playing field of information for all market participants--no sophisticated investor would want to spend much time having these meetings. Place yourself in the position of a hedge fund manager. Why would you spend all this energy seeking to meet with the CEO if it didn't help to significantly inform you in some way?"
In a new study, Soltes and David H. Solomon suggest that private meetings indeed help investors make better trading decisions, giving them an advantage and therefore thwarting the objective of Regulation FD.
Who's Meeting Whom?
Soltes and Solomon, a professor at the USC Marshall School of Business, had two main objectives in researching their study, titled "What Are We Meeting For? The Consequences of Private Meetings with Investors." One, they wanted to determine whether certain types of investors were more likely to score private meetings with executives. Two, they wanted to determine whether these meetings actually affected the success of the investors' trades.
The duo began their research by obtaining detailed investor meeting records from a mid-cap company traded on the New York Stock Exchange, under the condition that they would not reveal the firm's identity in their paper. "The firm was kind enough to give us access to very detailed records about which executives met with which investors," Soltes says.
“If a handful of people meet with management at the same time, and they all happen to make the same decision—buy or sell—it suggests a connection.”
The data included information about which members of the senior management team attended each meeting (the CEO, CFO, IRO [investor relations officer], and COO); the location of the meeting (corporate headquarters, a company road show, or an investor conference); and the names of the investors who met with the firm. The records spanned a six-year period between 2004 and 2010, in which a total of 340 investors held 935 meetings with company executives. Of those 935 meetings, the IRO was present at 858, the CEO at 831, the CFO at 511, and the COO at 74. On average, each executive had nearly 10 investor meetings per quarter.
The researchers found that hedge fund managers and large block holders were especially likely to gain frequent access to the firm's management. Some 56 percent of the investors in the study met with firm executives only once during the six-year sample period, while only 13 percent scored at least one meeting per year. But seven investors in the sample met at least 15 times during the six-year period; of those, four managed hedge funds and three represented large buy-side investor firms. Investor firms with high turnover of holdings also were especially likely to meet with executives frequently. Additionally, higher turnover of a firm's stock increased the likelihood that an investor could secure a meeting with all three of the firm's top C-suite executives.
"The regularity of these meetings for certain investors seems to indicate that these meetings offer more than just an opportunity to receive an introduction to management," the authors state in the study.
The Impact Of Meetings
In analyzing the trading behavior of investors, Solomon and Soltes found a strong correlation between meetings and the direction of subsequent stock trades. As a group, investors who met with management were more likely to all buy or all sell the firm's stock in any given quarter, compared with investors who did not meet with executives. A meeting, on average, changed the probability of increasing or decreasing a fund's position by 21 percent.
"If a handful of people meet with management at the same time, and they all happen to make the same decision—buy or sell—it suggests a connection," Soltes says.
More disturbing to the spirit of Reg FD, the research showed that private meetings apparently led to smarter trades. Investors who met with management were more likely to increase their position before periods of high returns and decrease their position before periods of low returns, compared with investors who didn't meet with senior management. For those investors who met with at least one senior manager, a 10 percent increase in the next quarter's stock was associated with a 33 percent increase in the size of the investor's position.
During those quarters when an investor met with a firm executive, the trades that followed those meetings performed significantly better, the research showed. This indicated that it was the meetings, rather than the skills of the individual investors, that affected the success of the trade.
“Frankly, it's very fuzzy. What's material to you may not be material to me, and vice versa.”
Soltes hastens to note that the study is not necessarily suggesting that investors who meet frequently with executives are actively breaking the rules of Regulation FD. Rather, he is suggesting that the SEC may need to spend more time determining what constitutes material information. For an astute observer, simply observing a CEO's emotions during a series of meetings may be enough to convey clues about a company's performance.
"Frankly, it's very fuzzy," Soltes says. "What's material to you may not be material to me, and vice versa. If the CEO tells you he's skipping his family vacation for the first time in years, is that material or immaterial? Clearly something may be wrong at the firm if he's skipping his vacation. Or what if the CEO is in an unusually bad mood? Does the CEO have to speak in a monotone voice during a meeting to avoid showing that he's upset and, therefore, possibly conveying potentially material information?"
In their paper, Soltes and Solomon suggest that investors who meet frequently with company executives might be able to collect enough nonmaterial information from these meetings to piece together an actionable thesis, thus forming an informational "mosaic" that includes notes from both private meetings and public reports. Thus, private meetings may ultimately violate the spirit of Regulation FD, even if a firm does not actively convey material information in a meeting. Note that in his insider trading trial, former hedge fund manager Raj Rajaratnam tried to argue that his $7 billion firm, the Galleon Group, used a "mosaic" of publicly available information to make informed trading decisions about various firms. (Nonetheless, he was convicted of securities fraud and conspiracy in May 2011.)
Soltes also hopes that the study will shed light on the fact that executives at publicly traded companies spend a significant amount of time in investor meetings—which, while it might benefit investors, might not always benefit the companies themselves. (Indeed, a recent study of CEO daily activity showed that time spent meeting with company insiders correlated with increases in a firm's profits, while time spent with outsiders—such as investors—does not.)
"I think a lot of firms fall into this difficult situation. They have to manage a delicate balance of who they should meet with, how much time they should spend [in meetings], and 'what's the benefit for us?' " Soltes says. "Most executives understand the need to meet with key investors, but it's difficult for them to enjoy these meetings. They're bombarded with questions, and they have to maintain a delicate balance of being helpful to investors while not violating Reg FD. In the end, the significant amount of time spent meeting investors one-on-one takes executives away from the job they enjoy most—running their firms."