The Securities and Exchange Commission (the "SEC") recently proposed new rules intended to (1) address "the problem of issuers making selective disclosure of material nonpublic information to analysts, institutional investors, or others, but not to the public at large;" and (2) resolve certain "unsettled issues" in current insider trading law. Securities Exchange Act Release No. 42259 (the "Release"). Comments on the proposed rules must be submitted to the SEC no later than March 29, 2000.
- Proposed Regulation FD
The chairman of the SEC has called "selective disclosure" a "stain on our markets" and "an insult to fair and public disclosure." The Release cites no evidence of actual abuse in this area but states that "selective disclosure" is in the SEC's view "a serious threat to investor confidence ... in the fairness of the markets." It recognizes, however, that "selective disclosure" seldom amounts to "insider trading" or "tipping" or conduct that violates the antifraud provisions of the federal securities laws.
Issuers subject to the new rule. Proposed Regulation FD would create a new reporting obligation for all public reporting companies, including closed-end investment companies but not including other investment companies.
New reporting obligation. Under the proposed rule, a company that disclosed material nonpublic information to any person outside the company would be required to make public disclosure of that information. The requirement would not apply if the person making the disclosure is not acting on behalf of the company or if the person to whom the disclosure is made is someone who owes the company a "duty of trust or confidence," e.g., a lawyer, investment banker or accountant, or a person who has expressly agreed to maintain the confidentiality of the information. On the other hand, the rule applies equally to disclosures that a company makes to securities analysts, the financial press and institutional investors.
In the case of an intentional disclosure, the company would have to make public disclosure simultaneously with the "selective" disclosure. In the case of a non-intentional disclosure, the company would have to make public disclosure as soon as reasonably practicable (but in no event more than 24 hours after a senior official of the company knows, or would be reckless in not knowing, of the non-intentional disclosure).
The required public disclosure could be by means of a Form 8-K, a press release "disseminate[d] ... through a widely circulated news or wire service" or any other method of disclosure that is "reasonably designed to provide broad public access ... and does not exclude any members of the general public ..., such as announcement at a press conference to which the public is granted access (e.g., by personal attendance or by telephone or other electronic transmission)."
The Release encourages companies to post this type of information on their websites, but it emphasizes that a website posting would not by itself be a sufficient means of complying with the rule's requirement of public disclosure.
No private right of action under Regulation FD. As proposed, Regulation FD is intended only to create duties under Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 30 of the Investment Company Act of 1940, as amended (the "Investment Company Act"). The Release specifically notes that the proposed regulation is not intended to create antifraud liability under Section 10(b) of the Exchange Act or any other provisions of the federal securities laws, nor is it intended to provide a private right of action or private liability.
"Gun-jumping" and M&A concerns. The Release notes that a required public disclosure under the new rule might conflict with a company's obligations under the Securities Act of 1933, as amended (the "Securities Act"), at a time when it is making a registered public offering. The Release therefore proposes a new rule under the Securities Act to the effect that a public disclosure pursuant to new Regulation FD after the filing of a registration statement would not have to meet the usual requirements for a "prospectus." It asks for comment on the "more difficult situation" where the required public disclosure is to be made before the filing of a registration statement or where the "selective disclosure" takes place in the context of business combinations.
Foreign companies. The proposed rule would apply to foreign companies that have registered their securities for purposes of being traded on the NYSE or Nasdaq. As the Release acknowledges, the requirement could be triggered by what foreign companies might view as "normal communications with major shareholders, analysts, the press, labor unions, and other constituencies" and would be the SEC's first imposition on foreign companies of a substantive disclosure requirement between the filing of their annual reports.
Potential effects of proposed rule. The SEC proposed the new rule notwithstanding its receipt of objections to the effect that the public disclosure requirement would strongly inhibit communications between companies and analysts.
- Proposed Rules 10b5-1 and 10b5-2
The SEC also has proposed new Rules 10b5-1 and 10b5-2 under the Exchange Act, which are intended to address certain "unsettled issues" in the law of insider trading.
Proposed Rule 10b5-1 would address the "use" versus "possession" debate relating to insider trading liability. Specifically, Rule 10b5-1 would establish the general principle that insider trading liability arises whenever a person effects a securities transaction while "aware" of material nonpublic information (i.e., essentially the rule deems a securities trade to be made "on the basis of" the material nonpublic information if the person trading was aware of the information at the time the trade was made).
The proposed rule would, however, contain four affirmative defenses for persons who traded while in possession of, but not on the basis of, such information (e.g., if the individual who traded while in possession of the material information can demonstrate that the transaction was part of a preexisting contract or plan made in good faith). A person trading while aware of material nonpublic information would be permitted to raise an affirmative defense under the proposed regulation if, prior to becoming aware of the information, the person had in good faith:
- entered into a binding contract to purchase or sell the security in the amount, at the price, and on the date that the person purchased or sold the security;
- provided instructions to another person to execute a purchase or sale of the security for the instructing person's account, in the amount, at the price, and on the date that the purchase or sale was executed;
- adopted, and had previously adhered to, a written plan specifying purchases or sales of the security in the amounts, and at the prices, and on the dates at which the person purchased or sold the security; or
- adopted, and had previously adhered to, a written plan for trading securities that is designed to track or correspond to a market index, market segment, or group of securities, and the amounts, prices, and timing of the purchases or sales actually made were the result of following the previously adopted plan.
Proposed Rule 10b5-1 also contains one additional affirmative defense for institutional traders (i.e., persons other than natural persons). In the case of such an institutional trader, the purchase or sale of a security will not be deemed to be have been made "on the basis of" the material nonpublic information if the person demonstrates that:
- The individual making the investment decision on behalf of the institution was not aware of the information; and
- The institution had implemented reasonable policies and procedures, taking into consideration the nature of the institution's business, to ensure that individuals making investment decisions would not violate the laws prohibiting trading on the basis of material nonpublic information.
Proposed Rule 10b5-2 would address the scope of persons potentially liable under the misappropriation theory of insider trading liability by identifying certain personal relationships that would be deemed to create a "duty of trust or confidence" to the person communicating the information. Under the proposed rule, a person receiving material nonpublic information would be considered to owe a duty of trust or confidence, and thus could be liable under the misappropriation theory, in the following circumstances:
- The person agreed to keep the information confidential;
- The persons involved in the communication had a history, pattern, or practice of sharing confidences that resulted in a reasonable expectation of confidentiality; or
- The person who provided the information was a spouse, parent, child, or sibling of the recipient of the information, unless the recipient of the information can affirmatively demonstrate, based on the facts and circumstances of the family relationship, that there was no reasonable expectation of confidentiality (e.g., by demonstrating that the parties had neither a history, pattern, or practice of sharing confidences, nor an agreement or understanding to maintain the confidentiality of the information).
The proposed rule does not purport to provide an exclusive list of those persons that may owe a duty of trust or confidence. Accordingly, relationships and circumstances other than those identified above also may give rise to liability under the misappropriation theory.
Request for comments. The SEC requests comments on all aspects of proposed Rules 10b5-1 and 10b5-2. In particular, the SEC seeks comments as to the propriety of the proposed affirmative defenses to Rule 10b5-1, including the institutional trader defense, and whether additional affirmative defenses should be available. The SEC also requests comment as to whether the affirmative defenses premised upon a preexisting plan or instruction should be further conditioned upon the plan or instruction being in writing and/or approved by counsel. With respect to proposed Rule 10b5-2, the SEC is particularly interested in comments as to other, non-enumerated relationships in which a duty of trust or confidence may arise.
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