Cramer: New SEC Rules

N E W   Y O R K, Oct. 30, 2000 -- — It’s time to confront the reality of the new government regulations that govern the timely disclosure of information.

It’s time to evaluate what the Securities and Exchange Commission’s rule has done and recognize that it has made the stock market into a much larger game of chance than ever before.

And, as a totally unintended beneficiary, it has made financial journalists ludicrously indispensable because analysts now know no more than reporters and at the same time can’t be as honest as reporters, because of the usual institutional constraints on the investment banking side as well as a whole host of protocol that makes it tough to favor one client (the broker customer) over another (the corporate client who pays a much larger bill).

Money Made by Some, Not All

First, understand that the SEC meant well when it stopped the conduit, the back channel, between favorite analyst on the sell side (broker side) and the financial people at the companies. Before the rule, there was an informal process by which information was dispensed. Let’s say National Gift Wrap was worried that Remarc Brothers, a major brokerage firm, was carrying too high an estimate for next quarter. National Gift’s chief financial officer could call the analyst and say, “Hey, shade that down a penny or two, will you? You’re too high.”

Then, within the healthy confines of a reiteration of a buy, the analyst would cut numbers a bit, or shade them by a penny, which would allow the stock to go down gently over time. It was a terrific process for smoothing the volatility of a stock to the downside when something minor had gone wrong. But it got abused.

Some of the analysts called their favorite buy-side customers (mutual and hedge funds) and gave them a heads-up that they would be cutting numbers for the National Gifts, and the buy-side customers would have a crucial heads-up to be short the stock, or bet against it, and money would be made by some but not all.

That was the basis of selective disclosure and the government thinks, correctly, that selective disclosure is bad because it makes the playing field unlevel.

A Funny Thing HappenedBut a funny thing happened on the way to the level playing field.

We’ve now shut down information altogether. On conference call after conference call during this earnings season, chief executive officers said they would no longer be communicating intraquarter with investors. There’s a total cutoff between companies and shareholders through the analysts. No information is getting passed through. Which means that stocks will trend wildly intraday on every rumor and every raid. Which means that companies will no longer be able to defend themselves from those who want stocks lower.

Before, rumors pushed down National Router’s stock two or three points. The insiders at National Router called their favorite analysts and said “hogwash.” The analysts reiterated buy and the stock calmed down.

Now, however, the bad guys spread rumors that National Router’s quarter is light and finished badly and the companies say nothing. The analysts get nothing. And the stock gets manipulated down and stays down.

Divorced From Fundamentals

And when things are actually bad, in that estimates are a penny or two too high, there’s no cushion, no helpful analyst supporting the stock with a careful reiteration couched in a number cut.

So we have a miraculous change in volatility for the worse. Talk about a major change! And analysts have been the biggest losers in this change. They’ve now been shut down and have no more insight than the rest of us. Uninformed stock investors doing macro homework are the biggest winners because they’re no longer less informed than everyone else in the know! And the stock market becomes more of a crapshoot than ever, more easily manipulated by rumor and more easily brought down by those who would try to raid stocks.

James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.