Retail investors hunt out – and act on – SEC ‘comment letter’ disclosures

Retail investors take a more sophisticated approach to monitoring key market information about their portfolio than previously thought, new research suggests.

Researchers focused on how investors using the Robinhood platform, which does not charge commission or fees, responded to ‘comment letters’ (CLs) from the U.S. Securities and Exchange Commission (SEC) about companies they held stock in.

They found that the typical retail investor can process such complex, unscheduled financial disclosures and make fast trading decisions in response.

Comment letters were seen as a good tool to test investor sophistication because, unlike periodic company filings, they are unscheduled and unstructured and therefore require active monitoring and significant skill in processing their content. They can also spark a decline in a stock’s price, which should motivate investors to pay attention when the SEC publishes them.

The study team included Pawel Bilinski, Professor of Accounting at Bayes Business School, Dr Ruby Brownen-Trinh, Senior Lecturer in Accounting at the University of Bristol and Dr Joe (Joonghi) Cho, Assistant Professor in Accounting at Inha University, South Korea. They found that serious comment letters in particular often prompt traders on Robinhood to sell stock quickly in the expectation of a slide in share price.

Key findings include:

• Comment letters prompt a spike in Google searches for company information – particularly when the comment letters address serious financial issues. This result suggests that retail investors are aware of comment letters and search for information that will help them interpret their content.
• Severe comment letters led retail investors to promptly sell stocks in the affected companies – suggesting that investors correctly anticipate potential declines in stock prices following disclosure of the comment letter.
• Comments on revenue recognition and other accounting issues raised by the SEC seem to correlate with a higher level of stock sales by retail investors.

Professor Bilinski said:

“Brokers, institutional investors and regulators sometimes suggest that investors on Robinhood are largely driven by speculation, hype and social media chaff. The time commitment and knowledge involved in seeking out and responding to complex regulatory disclosures such as comment letters suggests that perception may be misplaced.

“We accounted for the impact of factors such as analyst recommendations, insider dealing and social media posts and the results remained consistent. That reinforces our key conclusion that retail investors actively process and act on comment letter disclosures.

“It’s clear that many people on Robinhood are very well-informed, diligent and canny investors. That has implications for how market participants and policymakers should interact with them and how they can encourage more people to invest in equity markets."

The team looked at 626 comment letters issued on firms’ 10-K reports. The 10-K reports provide a description of a company's financial activity during a fiscal year – including reporting of risks, legal descriptions, corporate agreements and financial performance.