"High quality and timely information is the lifeblood of strong, vibrant markets. It is at the very core of investor confidence. Regulation FD will bring all investors, regardless of the size of their holdings, into the information loop - where they belong." - SEC Chairman Arthur Levitt (August 10, 2000)
Communications between public companies on the one hand and securities analysts and institutional investors on the other is often characterized as a "fencing match conducted on a tightrope." This characterization, we believe, properly recognizes and succinctly demonstrates not only the legal concerns associated with providing selective disclosures to securities insiders but also the business concerns associated with the failure to do so.
In a recent study performed by NIRI (the National Investor Relations Institute), more than 25 percent of all responding companies stated that they engaged in some type of selective disclosure practices. The media has recently reported a number of cases suggestive of selective disclosure, including:
- October 14, 1999, Wall Street Journal, "Abercrombie & Fitch Ignites Controversy Over Possible Leak of Sluggish Sales Data."
- October 7, 1999, Wall Street Journal, "Webvan to Delay IPO in Response to SEC Concerns."
- March 2, 1999, Wall Street Journal, "Compaq Is Criticized for How It Disclosed PC Troubles."
Regulation FD ("fair disclosure")
In an attempt to address these types of selective disclosure issues, the SEC proposed a new regulation, Regulation FD (for "fair disclosure") on December 20, 1999. The proposing release prompted an outpouring of public comment. According to the Commission, approximately 6,000 comment letters on the proposed regulation were received by the Staff, the vast majority of which were from individual investors who urged, almost uniformly, that the SEC adopt Regulation FD. Individual investors expressed frustration with the practice of selective disclosure, believing that it places them at a severe disadvantage in the market. The SEC also received numerous comments from security industry participants, issuers, lawyers, media representatives and professional and trade associations. The regulation was revised in light of the issues raised by the commenters and, on August 10, 2000, the SEC adopted this new regulation which will become law on October 14, 2000.
In 1988, tort reform law had provided that punitive damages were to be solely awarded by the court. The Ohio Supreme Court found that unconstitutional as a violation of the right to a jury trial in Zoppo v. Homestead Insurance Co., 644 N.E.2d 397 (Ohio, 1994).
H.B. 350 had capped punitive damages at the lesser of three times the amount of compensatory damages or $100,000.00 for small defendants and $250,000.00 for large corporations.
In striking down caps on punitive damages, the court noted that allowing a jury to make determinations within a range was unconstitutional because it would deny a party a determination of the amount by a jury.
Q. Will Regulation FD require public disclosure of all significant corporate developments as they occur?
A. No. Neither Regulation FD, nor any other provision of the U.S. securities laws, impose an overarching duty on corporations to disclose events, material or not, as they happen. Such a duty, however, may arise:
- in connection with a 10-K, 10-Q or other filing under the Exchange Act;
- in connection with the public sale or purchase of securities by a corporation;
- to the extent a corporation becomes "entangled" with or otherwise "adopts" the statements of others;
- to the extent the company needs to correct misinformation previously existing in the marketplace; or
- by a stock exchange or Nasdaq rule or agreement.
Q. What does Regulation FD require then?
A. New Regulation FD requires that whenever the corporation itself or any person acting on its behalf makes disclosure of material nonpublic information to securities market professionals or holders of the issuer's securities who could be reasonably expected to trade on the information, the corporation must:
- simultaneously provide such information to the general public if the disclosure was intentional; or
- promptly provide such information to the general public if the disclosure was unintentional.
As observed by the SEC, because Regulation FD requires simultaneous and widespread disclosure of material nonpublic information, corporations will now be effectively prohibited from engaging in intentional selective disclosure.
Q. Does this mean that the new regulation is only applicable to public companies?
A. Yes. Only corporations registered pursuant to Section 12 or 15 of the Exchange Act must comply with the provisions of the new regulation. Accordingly, the new regulation will not apply during a corporation's initial public offering,kb 9t. As proposed, the regulation would have applied to "roadshows" conducted in follow-on offerings (or, offerings after the IPO). As ultimately adopted, however, the regulation expressly excludes communications made in connection with most registered offerings. In addition, the regulation does not apply to foreign issuers.
Q. What is a "person acting on behalf of the issuer?" Will we be responsible when one of our employees improperly trades or tips?
A. No. Although the regulation as originally proposed contemplated subjecting any person who spoke on behalf of the company to the rigors of the rule, the regulation was narrowed to define "a person acting on behalf of the issuer" to refer to only the corporation's senior management, its investor relations professionals and others who regularly communicate with market professionals and security holders. Obviously, a corporation and those acting on its behalf will not be able to avoid liability by merely directing a non-covered employee to make the selective disclosure. In these cases, the corporation and/or the directing member of management will be responsible to the same extent as if it or he made the disclosure personally.
Q. How do I know if the information disclosed is material?
A. This may be the most difficult question to analyze in connection with public company disclosure issues. Unfortunately, the new regulation provides little guidance. The good news that the rule has not attempted to modify the definition used under the federal securities laws historically. Consequently, information will be deemed material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision or if it would have significantly altered the total mix of information available.
Although the Commission has long resisted any list that attempted to enumerate those situations that are likely to be deemed material to a public company, it did suggest as part of the adopting release to Regulation FD that the following items should be reviewed carefully to determine whether they are material:
- earnings information;
- mergers, acquisitions, tender offers, joint ventures, or changes in assets;
- new products or discoveries, or developments regarding customers or suppliers (e.g., the acquisition or loss of a contract);
- changes in control or in management;
- changes in auditors or auditor notification that the issuer may no longer rely on an auditor's report;
- events regarding the issuer's securities (e.g., defaults, on senior securities, calls of securities for redemption, repurchase plans, stock splits or changes in dividends, changes to the rights of security holders, public or private sales of additional securities); and
- bankruptcies or receiverships.
Although many questions of materiality are clear, we suggest that clients contact us any time a question potentially falls in the "gray area."
Q. We frequently disclose information to our analysts on an earnings call that is not included in the relevant press release or 10-Q. Could this type of disclosure be deemed nonpublic under the provisions of the new regulation?
A. Yes. In order for information to be disseminated publicly, it must be available to all investors and other interested parties at the same time. Accordingly, disclosures such as that described are exactly the type intended to be captured by the rule.
Q. Does this mean we can never disclose sensitive information to merger partners, investment bankers, or other third parties on a selective basis?
A. Remember, the rule is intended to cover only disclosures to securities professionals (such as broker-dealers, investment advisers, certain institutional investment managers, investment companies, hedge funds and, in each case, their affiliated persons) and holders of the company's common stock to the extent it is reasonably foreseeable that such persons will trade on the information. We note that the "reasonably foreseeable" qualifier only modifies security holders, not securities professionals generally.
Accordingly, the regulation will not apply to communications with the media generally, other insiders or ordinary course business communications with customers or suppliers.
New Regulation FD also provides express exclusions of coverage for communications with the following additional groups of persons:
- temporary insiders - i.e., any person who owes the issuer a duty of trust or confidence (such as attorneys, accountants, or investment bankers);
- any person who expressly agrees to maintain the information in confidence; and
- any entity whose primary business is the issuance of credit ratings, provided the information is disclosed solely for the purpose of developing a credit rating and the entity's ratings are publicly available.
Difficult questions can arise when a bank provides both investment banking and coverage services to a particular company.
Q. When will disclosure be deemed intentional?
A. When the individual making the disclosure either:
- had actual conscious awareness that the information was material and nonpublic; or
- was reckless in not knowing that the information was material and nonpublic.
As stated by the Commission in the adopting release, "this will provide additional assurance that issuers will not be second-guessed on close materiality judgments. Neither will we, nor could we, bring enforcement actions under Regulation FD for mistaken materiality determinations that were not reckless." The Commission further observed, "[t]hat a materiality judgment that might be reckless in the context of a prepared written statement would not necessarily be reckless in the context of an impromptu answer to an unanticipated question."
Q. To the extent information is disclosed unintentionally, what definition is the SEC providing for the concept of "promptly?"
A. The regulation requires corrective disclosure as soon as reasonably practicable after an executive officer, director or investor relations officer of the corporation (or any employee possessing equivalent functions) learns of the unintentional disclosure and knows (or is reckless in not knowing) that the information disclosed was material and nonpublic. In this area, the Commission has provided some needed delineation. Specifically, they have provided that the outer limits of prompt disclosure shall be the later of 24 hours or the commencement of the next day's trading on the New York Stock Exchange (whether or not the stock is actually traded on the NYSE). As an example, therefore, if a senior official discovers a non-intentional selective disclosure of material nonpublic information after the close of markets on Friday, the company will have until the beginning of trading on the NYSE on Monday to widely disseminate the same information.
Q. Should we alter the way we currently "talk the street down?"
A. Possibly. New Regulation FD provides that when companies disclose material nonpublic information, they must do so broadly. Consequently, because the SEC clearly views a corporation's inability to make upcoming quarterly earnings estimates as material, this information must be disclosed to the public and Wall Street simultaneously through a press release or other comparable avenue. To the extent your company has adopted a policy of providing information to a select group of analysts (either directly or by implication) concerning whether or not the company will make its numbers, we recommend that you review this policy in light of the new regulation.
The SEC has offered the following as a model for these types of disclosures:
- First, issue a press release, distributed through regular channels, containing the information.
- Second, provide adequate notice, by a press release and/or website posting, of a scheduled conference call to discuss the announced results, giving investors both the time and date of the conference call, and instructions on how to access the call.
- Third, hold the conference call in an open manner, permitting investors to listen either by telephonic means or through Internet webcasting.
Q. If we are required to disclose material information, what methods of disclosure will satisfy the SEC?
A. The SEC acknowledges that there is more than one method of broadly disseminating information to public shareholders at the same time. In this regard, the new rule disclosure by:
- "filing" a Current Report on Form 8-K under Item 5;
- "furnishing" a Current Report on Form 8-K under new Item 9;
- dissemination of a press release; or
- dissemination through any other method that is reasonably designed to provide broad public access and does not exclude access to members of the public (examples include webcasts or telephonic conference calls in which investors generally can participate).
Currently, a website posting, without more, is likely to be insufficient. The Commission has that as technology evolves and as more investors have access to and use the Internet, some issuers whose websites are widely followed by the investment community could potentially use such a method.
Q. What is the difference between "filing" an 8-K under Item 5 and "furnishing" one under Item 9?
A. There are two ways to submit a Current Report on Form 8-K to the SEC, each of which will satisfy Regulation FD disclosure requirements:
- "Filing" on 8-K under Item 5 (which is used for optional reporting of any information not required by one of the other items) subjects the information to liability under certain provisions of the Exchange Act and will permit automatic incorporation by reference into the issuer's Securities Act registration statements.
- "Furnishing" an 8-K under new Item 9 will not subject the information to liability under the Exchange Act and (unless specifically so provided) will not be incorporated by reference into previously filed Securities Act registration statements.
Importantly, Regulation FD provides that either filing or furnishing information on Form 8-K will not, by itself, be deemed an admission as to the materiality of the information. However, all disclosures on Form 8-K, whether filed or furnished, will remain subject to the antifraud provisions of the federal securities laws.
Q. What are the consequences for failure to comply with Regulation FD?
A. Importantly, Regulation FD does not provide a private right of action to shareholders or others. As a result, no private liability can arise under the new regulation from a corporation's failure to file or make required public disclosures. However, if a public corporation does not comply with regulation FD, the SEC could bring:
- an administrative action seeking a cease and desist order;
- a civil action seeking an injunction and/or civil money penalties; and/or
- an enforcement action against the controlling persons responsible for the violation.
It is also important to recognize that Regulation FD does not mitigate or otherwise affect traditional bases of liability under Rule 10b-5, Section 18, Section 11, or founded on a duty to update or duty to correct theory. Additionally, communications with analysts may continue to result in liability under the "entanglement" or "adoption" theories.
Q. Will a violation of Regulation FD disqualify us from use of the short form registration process permitted by Form S-3 or restrict our insiders from their ability to sell under Rule 144?
A. No. The SEC has clarified that a violation of the disclosure provisions of Regulation FD cannot affect either S-3 status or the availability of 144 resales.
Q. What should we do now?
A. As we indicated, some public companies may need to modify their disclosure policies in light of Regulation FD, while others may not. Contact an attorney to review the specific implications of this new regulation on your business.