After-hours news releases hurt stock owners

Investors could lose big when market can’t react to new information

This stark preference for releasing news outside of market hours is not new, but neither has it always been the case. Researchers have traced its origins to the enactment of Regulation Fair Disclosure in 2000 and of the Sarbanes-Oxley Act in 2002, both of which encouraged senior executives of issuers to pay more attention to the fairness of news releases. While neither law required out-of-session news releases, executives (or their lawyers) concluded that giving small investors more time to digest new information was fairer.

This logic might have been sound in 2002, but a couple of fundamental changes in in-session market quality since then cast significant doubt on the wisdom of continuing to announce material news outside of market hours.

First, electronic market makers have entirely replaced their human predecessors. In 2002, it was a challenge for a floor specialist to process the heightened volume of order flow that accompanies news announcements. When news hit in session, floor brokers couldn’t keep up, and favored institutional clients often got orders filled at the expense of smaller investors.

Today, with the exception of the New York Stock Exchange’s open and close, all order matching is done electronically, and at any given moment during market hours, electronic market makers compete to narrow spreads, populating the order book with quotes that provide a cushion against volatile movements. As the unprecedented order volume of Aug. 24 demonstrated, all-electronic exchanges do a better job of timely processing all orders than their human counterparts at the NYSE. There is no longer a danger of overwhelming the order matchers during market hours.

Second, single-stock circuit breakers (known as limit up/limit down) now automatically halt stocks that move up or down more than certain allowed limits for five minutes, to give traders time to digest relevant data. With a couple of corner-case exceptions, this has generally done an effective job of dampening price swings. When news changes the fundamental value of a stock, limit up/limit down gives investors a timeout to arrive at a new valuation, and when traders overreact to less important news, limit up/limit down limits the damage to jittery sellers.

While electronic market makers and limit up/limit down both effectively moderate the impact of news, both of them switch on at 9:30 a.m. and switch off at 4 p.m. Issuers announcing negative news outside of those hours are not protected by either mechanism, and their stocks are vulnerable to violent price swings. Two recent examples illustrate this issue.

On Dec. 29, Anavex Life Sciences Corp., a small drug company specializing in Alzheimer’s research, filed its 10-K around 8 a.m. Buried within that document was a disclosure that the company had recently received a subpoena from the Securities and Exchange Commission. The stock had closed the previous session at $7.03, but as traders got wind of the subpoena disclosure, it dropped all the way to $5.35 at 8:42 a.m. This 24% drop was more than what limit up/limit down would have permitted during market hours. When market makers arrived at 9:30 a.m., the stock recovered somewhat and eventually closed for the day at $6.28, down only about 10% from the previous close.

AVXL on Dec. 29. Note the abrupt decline at 8:30 a.m. as sellers read the company’s disclosure of a new SEC subpoena. The decline would have been arrested by limit up/limit down had Anavex delayed its filing until 9:30 a.m. Credit: Trillium Surveyor

Also consider Yahoo! Inc. on Dec. 8. After an uneventful session featuring penny spreads and 20,000-share average price tiers, Yahoo’s market makers shut off for the day at 4 p.m. At 4:28 p.m., with the spread now 7 cents and price tiers thinned to 100 shares, Yahoo announced it was changing its strategy on its critical tax-efficient spinoff of its hoard of Alibaba Group Holding Ltd. shares. With no market makers around to absorb errant orders, Yahoo dipped 4% and then bounced up 8% within a minute of the announcement.

YHOO on Dec. 8. Note the thick red and green order book graphs disappearing at 4 p.m., and the news announcement and sudden price movement 28 minutes later. Credit: Trillium Surveyor

The trading in both of these examples was unnecessarily disruptive. Sellers at the bottom of these unconstrained moves lost a lot of money.

Our current market structure has some robust safeguards to tame wild price swings, but those safeguards are only on duty from 9:30 a.m. to 4 p.m. Enjoying the benefits of those safeguards ought to be a far more relevant consideration in deciding what time to announce news than it currently is. n

Michael Friedman is general counsel and chief compliance officer of Trillium Management LLC, New York.


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