City X is working on an advance refunding of its outstanding Series 1995 Bonds, but the plan is not known outside the City "family". The Bonds are now rated A, but if advance refunded will be eligible for rating upgrade to AAA based on the portfolio of government securities to be held in escrow until the 1995 Bonds become callable in 2005. An institutional investor is considering the purchase of a large block of the 1995 Bonds and makes a "due diligence" call to the Finance Director. Should the Finance Director tell the prospective investor about the possible advance refunding?
The answer to questions like that one can be tricky under the securities laws, but the SEC's position on such issues became clearer on August 10, 2000. That's the day it adopted a new rule, designated Regulation FD for "Fair Disclosure", to combat the practice known as "selective disclosure" which occurs when issuers make material information available to a limited number of persons, such as our inquiring institutional investor in the advance refunding example, before disclosing it to the general public. Regulation FD appears in Securities Act Release No. 33-7881 and is effective on October 23, 2000.
The new rule reflects the SEC's increasing concern about the practice of public companies disclosing material information to securities analysts or selected investors before making it available to the general public. Originally proposed in December, 1999, the new rule prompted more than 6,000 comment letters, an unusually high number, with most coming from individual investors concerned about fairness in the markets. Of course, they supported the SEC's proposal or some variation of it.
Regulation FD applies only to issuers which have securities registered with the SEC or have a duty to file periodic reports with the Commission and, therefore, does not apply to governmental issuers. Nevertheless, those issuers and conduit borrowers in public finance transactions will find Regulation FD instructive for everyone having to deal with unintended leaks or inquiries from investors and analysts.
The new rule is intended to "level the playing field" for all investors by providing generally for the immediate public disclosure of material information if that information is made available, whether intentionally or inadvertently, to specified securities market professionals who are not restricted from acting on it.
What is "material information"? The word "material" is not defined in the regulation, so the currently accepted legal meaning would apply. Information is generally considered material if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to buy, sell or retain the security. In the advance refunding example, wouldn't the resulting rating upgrade be of great interest to an owner or purchaser of those 1995 Bonds?
The new FD rule is no different than other rules in one respect: it has some exceptions. The following activities would not trigger the public disclosure requirement: discussions with a rating agency incident to obtaining a rating; disclosure made to professional advisors who have a duty of trust or confidence to the issuer; and disclosures made to a person who expressly agrees to maintain the information in confidence.
Regulation FD raises many interesting issues: What is non-public information? What triggers a public disclosure requirement? When and how is "public disclosure" made? What are the sanctions for violating the rule? We will address those and other interesting aspects of the new rule in future commentaries. In the meantime, our City X Finance Director ought to consider the implications of Regulation FD before discussing that proposed advance refunding with the inquiring institutional investor.
These materials are intended to furnish general information and should not be relied upon as advice in specific situations.
Robert J. Jones
Saul Ewing LLP
Centre Square West
1500 Market Street, 38th Floor
Philadelphia, PA 19102
(215) 972-7802 fax:(215)-972-1856
e-mail: rjones@saul.com
web: www.saul.com