On August 10, 2000, the Securities and Exchange Commission (SEC) adopted Regulation FD (Fair Disclosure), a regulation that prohibits public companies from selectively disclosing material information to analysts and institutional investors before making the same disclosures to individual investors and the general public. In the same release, the SEC also adopted Rules 10b5-1 and 10b5-2 that clarify certain principles of insider trading.
Regulation FD is intended to prohibit the selective disclosure practices that have been observed by the SEC and other participants in the capital markets. The SEC believes that selective disclosure, and the related problems of "tipping" and insider trading, diminish investor confidence in the capital markets. In addition, the SEC believes that the new rules will reduce the conflict of interest faced by analysts who have an incentive to report favorably about companies in order to maintain their access to corporate insiders.
Regulation FD and the new rules regarding insider trading became effective on October 23, 2000.
Prohibition of Selective Disclosure
The General Rule
Regulation FD requires a public company to disseminate all material nonpublic information publicly and not only to select persons. The regulation requires companies to make intentional disclosures of material information immediately available to the public through an SEC filing or other means reasonably designed to provide broad, non-exclusionary distribution of the information. Companies must make similar public disclosure of unintentional disclosures of material nonpublic information within 24 hours of discovering the selective disclosure.
The SEC believes that technological developments allow companies to make broad dissemination of information and eliminate the need for companies to rely on analysts to disseminate information. Press releases, internet webcasting and teleconferencing enable companies to communicate directly with the public. Access to the internet permits individual investors to conduct independent research online and obtain information in "real time" without the assistance of an intermediary.
Issuers Subject to the Regulation
Regulation FD will apply to all issuers that file periodic reports with the SEC, including closed-end investment companies. The regulation does not apply to other investment companies, foreign governments or foreign private issuers.
Communications Covered by the Regulation
Regulation FD applies to communications made by or on behalf of an issuer to the following four categories of persons and persons associated or affiliated with those persons:
- investment advisers and certain institutional investment managers;
- investment companies and their hedge funds; and
- holders of the issuer’s securities under circumstances in which it is reasonably likely the recipient will trade on the basis of the information.
The rule excludes ordinary-course business communications, such as communications with the media, customers or suppliers and government agencies. In addition, the regulation expressly excludes the following four types of communications:
- communications with temporary insiders, such as attorneys, investment bankers and accountants;
- communications with persons who expressly agree to maintain the information in confidence;
- communications with credit rating agencies who make their credit ratings publicly available; and
- communications made in connection with most registered securities offerings.
If an issuer intends to rely on a person’s agreement to maintain information in confidence, it should discuss documenting the agreement in writing with counsel even though the SEC indicates that an express oral agreement will suffice.
Disclosure by a Person Acting on an Issuer’s Behalf
Regulation FD only covers communications made by persons acting on an issuer’s behalf. This includes the following persons:
- senior officials of an issuer (executive officers, directors, investor and public relations officers or other employees performing similar functions); and
- any other officer, employee or agent of an issuer who regularly communicates with securities market professionals or securities holders.
The regulation covers communications by senior management and investor relations professionals; however, these persons cannot escape the regulation by telling non-covered persons to make the disclosures. The regulation also states that issuers are not liable for selective disclosures made by persons who breach a duty to the issuer, such as an issuer’s employee disclosing information in violation of a confidentiality agreement.
Material Nonpublic Information
The regulation does not define the terms "material" or "nonpublic," but rather relies on the definitions that have been established by case law. Based on these definitions, information is material if a reasonable investor would have considered it important and likely to have significantly altered the total mix of information available. Information is nonpublic if it has not been disseminated in a manner making it available to investors generally.
Many of the comments received by the SEC expressed concern about the ability of companies to make prompt determinations about whether information is material under this definition. The SEC explained that it was unable to state an adequate bright-line rule for something that is unique to each issuer, but stated that the following types of information and events should be carefully considered by issuers as potentially being material:
- earnings information;
- mergers, acquisitions, tender offers, joint ventures or changes in assets;
- new products or discoveries or developments regarding customers or suppliers (such as an acquisition or loss of a contract);
- changes in control or management;
- changes in auditors or notification by an issuer’s auditor that the issuer may no longer rely on the auditor’s audit 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.
In particular, the SEC warned that private discussions by an issuer’s official with an analyst giving direct or implicit guidance on the analyst’s earnings estimates will likely violate Regulation FD.
Intentional disclosures of material nonpublic information must be made simultaneously to the public. Intentional selective disclosures occur when the issuer or a person acting on behalf of the issuer knows or is reckless in not knowing that the information is both material and nonpublic.
The circumstances under which the disclosure was made are relevant for determining whether the person making the disclosure was reckless in knowing something was material. For example, materiality judgments made during preparation of a written statement may be more likely to be found reckless than if the same judgment was made in response to an impromptu question.
Unintentional disclosures of material nonpublic information must be publicly disclosed promptly after a senior official of the issuer learns of the disclosure and knows, or is reckless in not knowing, that the disclosure is both material and nonpublic. "Promptly" means as soon as reasonably practicable, but in no event after the later of 24 hours or the commencement of the next trading day on the NYSE after a senior official learns of the selective disclosure.
Method of Public Disclosures
The regulation gives issuers significant flexibility to determine the appropriate method for disseminating information to meet the public disclosure requirement. The public disclosure requirement can be satisfied by filing a Form 8-K, circulating a press release or by another method or combination of methods of disclosure that are reasonably designed to provide broad, non-exclusionary public access. This flexible approach is designed to give issuers the ability to use current technology, such as webcasting of conference calls. Conference calls and electronic transmissions are acceptable methods so long as the public has adequate notice and means of accessing the disclosure. Providing public access to a conference call, however, does not require that the issuer permit everyone to speak or ask questions during the call.
Issuers choosing to file information on a Form 8-K may either file a report under Item 5 or furnish it under new Item 9. Information filed under Item 5 will be subject to liability for any misleading statements contained in the report and will be automatically incorporated by reference into registration statements and therefore subject to liability as part of a prospectus or registration statement. If the information is merely furnished under Item 9 instead of filed under Item 5, it will not be subject to such liability unless the disclosure is specifically incorporated in a filed report, proxy statement or registration statement. All disclosures on Form 8-K remain subject to the antifraud rules. The regulation specifically provides that filing information on Form 8-K will not be considered an admission of its materiality.
The SEC suggested the following model for a planned disclosure of material information, such as a scheduled earnings release:
- First, issue a press release distributed through regular channels;
- Second, provide adequate notice through a press release, including time, date and access instructions, of a scheduled conference call to discuss the information; and
- Third, hold the call providing for public access.
The SEC has indicated that an issuer’s determination of whether a method of communication is reasonably designed to provide broad, non-exclusionary public distribution will be evaluated in light of the relevant facts and circumstances, such as compliance with or deviations from usual practices or knowledge that the issuer’s press releases are not generally carried by major business wire services. Posting information on an issuer’s website is not currently a sufficient means of public disclosure, but may be used in combination with other methods designated to provide public disclosure. The SEC also advised issuers disclosing information on a webcast or conference call to make the information available for a long enough period of time to enable people to access the information even if they miss the initial announcement.
Disclosure Made During a Securities Offering
The SEC determined that sufficient protections already exist under the mandated disclosure requirements of the Securities Act to prevent selective disclosure in connection with a registered offering. As a result, Regulation FD does not apply to disclosures made in connection with a registered securities offering, unless the registered offering is an ongoing and continuous registered shelf offering, such as a debt securities shelf or an employee benefit plan registration. The rules specify when different types of registered public offerings are considered to have commenced and terminated for purposes of the regulation.
Because the same public disclosure protections and sources of liability do not exist for unregistered offerings, Regulation FD will apply to disclosures made in connection with unregistered offerings. Public companies should have the parties to unregistered offerings agree to keep the information confidential or be prepared to make public disclosure of any material nonpublic information provided during the offering. The SEC noted that public disclosure of such information during an unregistered offering may conflict with the private offering exemption upon which the issuer may be relying for the unregistered offering.
Liability for Violations of Regulation FD
Failure to comply with Regulation FD may result in SEC enforcement actions seeking a cease-and-desist order or civil actions seeking injunctive or civil monetary penalties. The SEC also may bring an action against the individual responsible for the violation as "a cause of" the violation or as an aider or abettor. The SEC expressly stated that failure to comply with Regulation FD will not create antifraud liability or private rights of action; however, disclosures made under Regulation FD containing false or misleading information, or omitting material information, will not be protected from traditional antifraud liability.
The SEC received comments in response to the proposed release from issuers who were concerned about the liability that could result from the SEC second-guessing their materiality judgments. In response to these concerns, the SEC has specifically indicated that the regulation only applies if the person making the disclosure knows or is reckless in not knowing that the information is both material and nonpublic.
In addition, a failure to file a Form 8-K when no other public disclosure has been made will not result in a loss of eligibility to use short-form registrations or prevent the issuer’s shareholders from reselling their securities under Rule 144.
The regulation does not obligate issuers to develop policies to avoid violations, but the SEC expects that most issuers will adopt policies for complying with the regulation. In the proposing release, the SEC suggested the following policies for preventing selective disclosure:
- limit the number of persons authorized to speak to analysts and investors;
- keep a record of communications with analysts;
- defer answering sensitive questions until the speaker has an opportunity to consult with counsel and determine the materiality of the response; and
- seek time-limited "embargo" agreements from analysts, in which the analysts agree not to use or publish certain information.