By all accounts, this earnings season will go down in the books for its sheer brutality.

Tuesday's Coverage

Getting a Handle on the Wireless-Handset Slowdown

Previously

Why This Earnings Season Has Been So Brutal

Earnings Burned Investors, but the Tech Fire Remains

With No Catalyst, Stocks Rumbling and Stumbling Through February

For the first time in 11 years,

Microsoft

(MSFT) - Get Report

warned that it would

miss earnings and revenue expectations. Keeping it company were leading names like

Intel,

(INTC) - Get Report

Dell Computer

(DELL) - Get Report

and

Home Depot

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. And though it didn't issue a formal preannouncement,

Cisco Systems

(CSCO) - Get Report

caused bedlam when it missed estimates after years of beating them by a penny.

There's no question that both the preannouncements and outright misses on estimates reflect a weakening economy, with both business and consumers cutting back spending. But while the economy gets all the attention, there's another change that marks this earnings season out from previous ones: Under a new rule known as

Regulation FD

(for "fair disclosure"), companies are no longer allowed to furtively guide down numbers by leaking bad news to analysts or favored shareholders.

The rule, which went into effect last October, was hailed as a way to level the playing field for small investors.

But on the downside, could all that blunt honesty also have played a role in this season's surge in negative preannouncements? Analysts think so, though they disagree about whether Reg FD has increased market volatility by forcing companies to stop sugar-coating the truth, or whether it's actually

decreased

volatility for essentially the same reason.

Certainly, Reg FD seems to have shifted the timing of news, pushing it up from actual earnings reports to preannouncements. "The real surprises were more in the preannouncements than in the actual reports," says Chuck Hill, director of research at

First Call/Thomson Financial

.

That's a big change from the past, when companies would try to shift expectations behind the scenes. "Previously for a company to preannounce a bad quarter was like a nuclear blast; they normally would try to walk the Street down and cushion the blow," says Jared Kopel, a partner with the law firm of Wilson Sonsini Goodrich & Rosati. "But now

preannouncing is what the

SEC

wants companies to do," says Kopel, in an effort to give clear guidance about the state of their businesses.

According to First Call/Thomson Financial, negative preannouncements are up 79% over a year ago. The current earnings season has set a record for negative preannouncements, with 781 so far compared with the previous high of 554 in the fourth quarter of 1998. First Call predicts the number of negative preannouncements could top 800 by the end of the season.

Granted, it's impossible to separate the effects of FD from the toll taken by a faltering economy. But the regulation probably played some role in the pro-active stance companies took by preannouncing.

Reg FD may have played a role in missed estimates, too. Of course, companies ran into business trouble because of a general economic slowdown, but in some cases they may have missed estimates because analysts' numbers weren't grounded in reality. Analysts, who used to be able to take their cues from the companies they covered, can no longer rely on them for clear guidance.

Case in point: Cisco. The company disappointed even though it was widely reported that CEO John Chambers had been trying to guide down investor expectations in his public appearances. As columnist

Adam Lashinsky

has

reported, in the days before Reg FD, it would have been customary for the investor relations folks to call up and enlighten analysts whose numbers were on the optimistic side. Now they're not allowed to.

Under Reg FD, says Andy Engel, senior research analyst at the

Leuthold Group

, "I think we will have more surprises because companies are less likely to guide the analysts. Rationally, I think you could make the case that the regulation is increasing the volatility."

That view is seconded by Joseph Kalinowski, equity strategist for First Call/Thomson Financial. "I do think it contributed to volatility and to the actual total number of preannouncements for the fourth quarter," he says. "In terms of volatility, in the past the analyst community acted as a buffer to the individual investor. Now, when you just have public dissemination of all this data, it may initially be information overload for individual investors. The fact is that corporate managers can't communicate directly to the analyst in order to maybe massage the consensus down," he says.

On the other hand, some argue that the new rule has had a stabilizing influence on markets precisely because analysts no longer get special access to information.

With all analysts presumably receiving the same information, the disparities among earnings estimates on the Street already have shrunk, says First Call's Hill, which has the effect of discouraging speculation and its accompanying volatility.

The incidence of "on-targets," or cases in which companies exactly meet estimates, is up 41% from last year, according to First Call - an indication that companies are divulging more information about their businesses, or at least sharing it more equitably.

As a corollary, analysts no longer will be able to talk up the prospects of companies they cover (or underwrite for), then gradually edge down their estimates as it becomes clear they've been too optimistic. "It will be difficult for an analyst to say how it will be a great quarter when it turns out not to be, because companies have provided more public guidance," says Hill.

By some accounts, Reg FD also may eventually lessen the short-term focus on whether companies meet earnings estimates, as companies issue more realistic projections and find ways to give more guidance, within the rules, on whether they can meet them. But expect more volatility in the short term, as companies adjust and individual investors get a grasp on how Reg FD works.

Plus, the first-quarter confession season is already shaping up to be an ugly one, with negative preannouncements likely to match or exceed those of the fourth quarter. "I think we will get all the bad news out in the first quarter, then be very conservative for the year," says Kalinowski. By doing that, companies will lessen the risk that they'll have to issue more preannouncements later in 2001.