Securities regulation is one of the most harmonized fields of business law. Observing disclosures about cross-border transactions between public corporations traded in the United States and the European Union seems to confirm this belief. Cross-border transactions are typically announced at the same time by the parties even when the parties are traded in different stock markets and regulated by different disclosure regimes. We grow so accustomed to the picture of two CEOs shaking hands that we never stop to think about the nontrivial ability to synchronize disclosures across different jurisdictions. As we explain in our recent article ‘More JoMo Less FoMo: The Case for Voluntary Disclosure of Uncertain Information in Securities Regulation,’ this is a false perception, especially regarding the disclosure of uncertain future corporate events, such as negotiations involving a potential transaction.
The US and EU have different legal systems overseeing the disclosure of unfolding events. These two jurisdictions differ from each other in two important aspects: (1) the definition of materiality; and (2) the existence of an obligation to disclose material information.
Materiality plays a key role in both disclosure obligations and insider trading prohibitions. Corporate insiders are prohibited from trading in the company’s securities until material information is made public, often referred to as the ‘disclose-or-abstain’ rule.
While in the US, materiality of information regarding unfolding events is determined by a relatively complicated test, which takes into account both the magnitude of an event and its probability, the EU bright-line rule utilizes a probability threshold (‘more likely than not’) for determining materiality. Often, these two disclosure regimes yield different outcomes. For example, under the US ‘probability/magnitude’ test, information pertaining to future corporate events of significant magnitude may be considered material at a relatively early stage in their development, whereas information about future corporate events of smaller magnitude may become material earlier under the European regime.
Additionally, the US and EU disclosure regimes differ from each other with respect to whether there is a mandatory obligation to disclose material information regarding unfolding, yet uncertain, future events. The US voluntary disclosure regime rarely mandates companies to disclose these types of events, relying instead on market-based incentives to generate disclosure. In contrast, the EU mandatory disclosure regime requires companies to disclose the intermediate stages of these unfolding events as soon as they become material. Nevertheless, the EU allows companies to delay disclosure when there are justifications for doing so, such as when early disclosure would pose harm to the company.
The architecture of the EU disclosure system puts European investors at a disadvantage compared to their US counterparts. We show that, as it pertains to information about developing corporate events, the US voluntary disclosure regime is superior to the E.U. mandatory disclosure regime in several crucial ways.
First, corporate insiders in the US have a strong incentive to voluntarily disclose information regarding high-magnitude events at a relatively early stage in order to trade on this information without breaking insider trading prohibitions. Moreover, given that corporate insiders are more inclined to voluntarily disclose private information when they intend to trade on the basis of such information, these insiders also have an incentive to disclose only information that they subjectively believe will affect the company’s stock market price. As a result, this method of voluntary disclosure is valuable in highlighting relevant information for investors. While the literature usually emphasizes that insider trading prohibitions are important for mandatory disclosure regimes, this reasoning explains why voluntary disclosure of uncertain information in the US is driven by insider trading prohibitions in a way that increases financial market efficiency.
Second, the EU mandatory disclosure regime dilutes particularly important information with a deluge of relatively unimportant news and thus is likely to cloud the ability of investors to notice valuable information. In contrast, the US voluntary disclosure helps declutter the total mix of information provided to investors. This allows investors to focus on important and useful information.
Third, the US voluntary disclosure regime is socially more cost-efficient than the European regime. Under the European rule, more future events of smaller magnitude may be considered material, making the EU regime more work-intensive, while also inflicting high compliance costs on companies.
The design of EU securities regulation seems to be driven by the ‘fear of missing out’ (‘FoMo’). Our analysis shows that the ‘joy of missing out’ (‘JoMo’) is a superior driver. Imagine the investor as a person trying to find her way to a particular destination (the best investment) in the dark. A small light is often sufficient to expel the darkness and reveal the contours of the obstacles on the road leading to the destination. A beacon of light emanating from the destination would be even better. However, a fusillade of lights and torches would only blind the person and cause her to stumble.
Ido Baum is an associate professor of law (senior lecturer) at the Haim Striks Faculty of Law, College of Management-Academic Studies (Colman), and academic director of the Rina and Meir Heth Center for Competition and Regulation.
Dov Solomon is an associate professor of law (senior lecturer), head of the Commercial Law Department, and academic director of the LL.M. program at the College of Law and Business, Ramat Gan Law School.