Practical Guidance for Living with Regulation FD

Practical Guidance for Living with Regulation FD

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SEC Adopts New Selective Disclosure Rule

Regulation FD was adopted by the Securities and Exchange Commission on August 10, 2000 and will take effect on October 23, 2000. It will apply to almost all public companies, including closed-end investment companies. Regulation FD does not apply to open-end investment companies or foreign private issuers.

Regulation FD, which is short for Fair Disclosure, represents the SEC's first attempt at direct regulation of informal communications between public companies and investment professionals. Public companies will need to review, and possibly adjust, their investor relations practices in light of the new regulation. See "Practical Guidance for Living with Regulation FD" below. Regulation FD and the adopting release are available on the SEC's web site. For a litigator's perspective on new Regulation FD, see "Guidance on Guidance" below.

General Rule

Regulation FD prohibits a company from intentionally disclosing material nonpublic information to specified types of securities market professionals and stockholders unless the company publicly discloses the information simultaneously.

In addition, if a company unintentionally discloses material nonpublic information to persons covered by the new regulation, the company must publicly disclose the information promptly.

Company Representatives Subject to Regulation FD

Regulation FD only applies to disclosures made by the following company representatives:

  • directors and executive officers;

  • persons performing investor relations or public relations functions; and

  • employees and agents who regularly communicate with securities market professionals and stockholders.

Statements made by other company employees will not trigger disclosure obligations under Regulation FD, unless the employee is acting at the direction of senior management.

Recipients Triggering Public Disclosure Obligation

Under Regulation FD, only disclosures of material nonpublic information to the following classes of recipients will trigger a company's public disclosure obligation:

  • brokers, dealers and persons associated with them, such as securities analysts;

  • investment advisers, institutional investment managers, investment companies and persons associated or affiliated with them; and

  • stockholders, if it is reasonably foreseeable the stockholder will buy or sell the company's securities on the basis of that information.

Disclosures Not Subject to Regulation FD

The public disclosure obligations of Regulation FD are not triggered by disclosure:

  • to persons owing a duty of trust or confidence to the company, such as attorneys, accountants and investment bankers;

  • to persons who "expressly agree" to keep the disclosed information confidential;

  • to rating agencies, provided the information is disclosed solely for the purpose of developing a credit rating and the entity's ratings are publicly available; or

  • in connection with registered securities offerings other than "shelf" offerings.

The release adopting Regulation FD also makes clear that the new regulation is not intended to apply to ordinary-course business communications with parties such as customers, suppliers, strategic partners and government regulators.

Material Nonpublic Information

Perhaps the most difficult issue in interpreting and applying Regulation FD is what constitutes material nonpublic information.

Regulation FD does not define either "material" or "nonpublic". In the release adopting Regulation FD, the SEC stated that these terms have the meanings established in existing case law. The release, quoting from leading cases on the issue, notes that information is "material" if there is "a substantial likelihood that a reasonable shareholder would consider the information important" in making a decision to buy or sell the company's securities. Stated another way, there must be a substantial likelihood that a reasonable shareholder would view the information "as having significantly altered the 'total mix' of information" available about the company.

The adopting release states that information is "nonpublic" if it has not been disseminated in a manner making it available to investors generally.

Intentional and Unintentional Disclosures

Intentional disclosure of material nonpublic information occurs when the person making the disclosure knew, or was reckless in not knowing, that the information disclosed was both material and nonpublic. An example of intentional disclosure is knowingly including nonpublic projections on a slide shown during a private conference with analysts. Intentional disclosure of material nonpublic information is a violation of Regulation FD.

Unintentional disclosure is any disclosure that does not qualify as an intentional disclosure. An example of unintentional disclosure is an executive's off-the-cuff response to an unanticipated question posed during a private meeting with analysts which provides material information that the executive mistakenly believed had been previously publicly disclosed. Unintentional disclosure of material nonpublic information triggers an obligation on the part of the company to publicly disclose that information promptly.

"Promptly" means as soon as reasonably practicable after a director, executive officer or investor relations or public relations employee learns of the unintentional disclosure; provided that the disclosure must be made within 24 hours or, if the next trading day does not begin for more than 24 hours, prior to the beginning of the next trading day.

Manner of Required Public Disclosure

There are two ways in which a company can make the public disclosure required by Regulation FD. The first is by filing a Form 8-K with the SEC. The SEC has amended Form 8-K by adding a new Item 9 and providing that disclosure required by Regulation FD may be included under either existing Item 5 or new Item 9. Information disclosed under Item 9 is not considered filed for purposes of the provisions of the Securities Exchange Act of 1934 imposing liability for inaccurate or misleading statements in filings under the Exchange Act. Information disclosed under Item 9 also is not automatically incorporated into registration statements filed under the Securities Act of 1933.

The second means of satisfying Regulation FD's public disclosure requirement is by disseminating the information by a method or combination of methods "reasonably designed to provide broad, non-exclusionary distribution of the information to the public." A press release distributed through widely circulated news or wire services is generally sufficient, although the SEC noted in adopting Regulation FD that if the company knows its press releases are routinely not carried by major business wire services, the company should use other or additional means of public dissemination. In addition, disclosure of information in a conference call open to the general public, through a webcast and dial-in number, is also generally sufficient, provided the public is given adequate notice of the call and the means of accessing it. Information about the call should be included in a press release and posted on the company's web site.

Merely posting information on the company's web site is not, by itself, sufficient dissemination.

Liability and Enforcement Issues

In response to concerns that potential liability under Regulation FD would have a "chilling effect" on disclosures by companies and lead to less information in the marketplace, the SEC has taken several steps to mitigate the potential liabilities for breaches of Regulation FD. The failure to make a public disclosure required by Regulation FD:

  • is not a breach of the anti-fraud provisions of Rule 10b-5 - as a result, there is no private right of action for violations of Regulation FD;

  • has no effect on a company's eligibility to use short-form registration statements under the Securities Act, such as Form S-3 or Form S-8;

  • has no effect on whether a company is in compliance with the current public information requirements of Rule 144; and

  • will not result in a loss of the availability of the "safe harbor" protections under the Private Securities Litigation Reform Act of 1995.

The principal enforcement mechanism for violations of Regulation FD will be enforcement actions brought by the SEC against issuers and their responsible officials.

Practical Guidance For Living with Regulation FD

Following are suggested guidelines for various situations commonly confronted by public companies. While these guidelines are intended to help ensure compliance with Regulation FD, many of the guidelines were sound corporate policies even before the adoption of Regulation FD. Thus, for many companies, adherence to these guidelines should not represent a significant departure from their current practices.

Conference Calls with Investment Community

We recommend that companies observe the following guidelines regarding conference calls with securities analysts and investors, such as the calls that typically follow quarterly earnings releases:

One-on-One Calls or Meetings with Analysts and Investors

The legal risks inherent in this practice have been exacerbated by Regulation FD. A properly arranged conference call, to which the investing public is given access, will constitute public disclosure of the statements made by the company during the call. However, material nonpublic statements made in one-on-one or other limited-access situations are clearly selective disclosure. The intentional disclosure of any material nonpublic information in such a setting is a violation of Regulation FD. If any material nonpublic information is unintentionally disclosed in such a setting, the company must publicly disclose that information promptly.

Some public companies have stated that they will no longer meet or speak with securities analysts in one-on-one situations. While that is certainly a safe course of action from a legal perspective, for most companies this will not be a realistic option. Moreover, in the adopting release, the SEC explicitly acknowledged that Regulation FD is not intended to eliminate all analyst communications:

"[A]n issuer is not prohibited from disclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer, that piece helps the analyst complete a 'mosaic' of information that, taken together, is material. Similarly, since materiality is an objective test keyed to the reasonable investor, Regulation FD will not be implicated where an issuer discloses immaterial information whose significance is discerned by the analyst. Analysts can provide a valuable service in sifting through and extracting information that would not be significant to the ordinary investor to reach material conclusions. We do not intend, by Regulation FD, to discourage this sort of activity."

If a company wishes to engage in conversations with analysts or investors in one-on-one or other limited-access settings, it is critical that the company not disclose any material nonpublic information. Materiality judgments are inherently fact-specific, and there is no bright-line standard or list of items that can define materiality in all cases. In order to make materiality judgments on a real-time basis, company officials must be fully versed about the company, its prior public statements and the applicable legal rules.

We recommend that companies engaging in one-on-one or other limited-access conversations with analysts or investors adhere to the following guidelines to help minimize the risk of disclosing material nonpublic information:

Earnings Guidance

One particularly problematic situation is providing analysts or investors with information or "guidance" on the company's projected operating results. In the release adopting Regulation FD, the SEC bluntly stated:

"When an issuer official engages in a private discussion with an analyst who is seeking guidance about earnings estimates, he or she takes on a high degree of risk under Regulation FD. If the issuer official communicates selectively to the analyst nonpublic information that the company's anticipated earnings will be higher than, lower than, or even the same as what analysts have been forecasting, the issuer likely will have violated Regulation FD. This is true whether the information about earnings is communicated expressly or through indirect 'guidance,' the meaning of which is apparent though implied. Similarly, an issuer cannot render material information immaterial simply by breaking it into ostensibly non-material pieces."

It is arguable whether the SEC's position here is fully supported by applicable law since it does not appear to take into account the materiality of the information communicated in a particular situation.

However, in light of the SEC's statement quoted above, we recommend that companies give guidance on analysts' models or projections only in the public conference call following an earnings release, and not in limited-access settings. If guidance is given in a limited access setting, such as an investor conference, the company should issue a press release containing that guidance prior to the conference. Even in public settings, however, revenue and earnings guidance involves risks under anti-fraud and other securities laws, and must be carefully crafted. Providing guidance on expected operating results is inherently risky and difficult, and we encourage companies to consult with counsel before doing so.

Reviewing Analyst Reports

Reviewing and commenting on a report of a securities analyst prior to its publication creates a serious risk that the company's comments on the draft report will impart material nonpublic information to the analyst. Accordingly, we recommend that the company not review and comment on draft analyst reports. Company officers sometimes remark that when they see a factual error in a draft analyst report, they feel compelled to correct it, and worry that they may have liability for failing to correct obvious errors. To avoid this conundrum, it is best to inform the securities analysts covering the company that it is the company's policy not to review draft reports in advance of their publication, and to request that no such draft reports be sent to the company.

A company that nevertheless insists on reviewing analyst reports in advance of publication should take the following two steps, which should reduce, but not eliminate, the attendant risks:

Other Common Forums for Disclosure

There are a variety of situations in which companies present information about themselves to a relatively large audience that includes securities analysts, institutional investors and/or other stockholders. Companies often tend to think of these settings as public forums and may therefore be less vigilant about selective disclosure issues. However, unless those settings provide for broad, non-exclusionary distribution to the public of the information disclosed by the company, the disclosures by the company are not considered to have been publicly made, and will instead constitute selective disclosures. Accordingly, the risks and guidelines described above for one-on-one conversations are equally applicable to disclosures in these settings.

Examples of forums in which the presentation of information by companies generally will be subject to the prohibitions against disclosure of material nonpublic information include:

A company may be able to comply with Regulation FD by turning some of these situations into forums for true public disclosure by providing the public with sufficient notice of and access to the event, in a manner similar to our recommended approach for investor conference calls, or by issuing a press release containing the text of the company's presentation. However, this is not likely to be feasible for all such settings.

Interviews with News Media

Regulation FD does not apply to disclosures to members of the press or other news media - that is, disclosure of material nonpublic information to members of the media will not trigger a company's public disclosure obligation. However, care must still be taken in dealing with the media for the following reasons:

We recommend that public companies treat the media as if they are subject to Regulation FD. This means, for example, that if a company wishes to provide advance information of an impending transaction to a reporter so that a more in-depth article may be published concurrently with the public announcement of the transaction, the company should obtain an express agreement from the newspaper to hold the information in confidence until the authorized release date.

Securities Offerings

The public disclosure requirements of Regulation FD are not triggered by communications made in connection with most registered securities offerings, including the registered issuance of securities in connection with M&A transactions. As a result, road show and sales force presentations after a registration statement has been filed are not subject to Regulation FD.

Regulation FD does apply to disclosures made in connection with "shelf" public offerings and all unregistered offerings made by public companies, including Rule 144A and Regulation S offerings, "PIPE" transactions and traditional private placements. Public companies conducting unregistered offerings must either publicly disclose any material information disclosed non-publicly to investors or obtain express confidentiality agreements from the investors. In addition, disclosures during road shows in connection with those offerings are subject to Regulation FD, and companies must therefore be careful about statements made in those meetings.

The exception for registered public offerings applies only to statements made "in connection with" the offering. For example, Regulation FD does not exempt statements made in a nonpublic conference call that happens to occur during the course of a registered offering.

Companies that have shelf registration statements on file must carefully consider the means by which they make any public disclosures required by Regulation FD. In particular, the company should consider whether the information needs to be incorporated by reference into the shelf registration statement, in which case filing the information under Item 5 of Form 8-K would be the recommended approach.

Other Recommended Disclosure Practices

Now more than ever, the combination of Regulation FD with other existing legal requirements places a premium on consistent adherence to the following good disclosure practices:

Insider Trading Rules Expanded

Concurrently with the adoption of Regulation FD, the SEC adopted new Rules 10b5-1 and 10b5-2, which will also take effect on October 23, 2000. These rules are designed to address two problems that have made it difficult for the SEC to bring some insider trading cases. Both rules clarify and expand the prohibition against insider trading.

Rule 10b5-1 -Trading "on the basis of" material nonpublic information

It is a violation of the anti-fraud provisions of Rule 10b-5 for a corporate fiduciary to buy or sell securities "on the basis of" material nonpublic information. Before the enactment of Rule 10b5-1, courts had been split on whether insider trading liability required proof that a trader actually "used" material nonpublic information or whether mere proof that a trader was in "knowing possession" of such information at the time of a trade was sufficient.

Rule 10b5-1 resolves this question by providing that a person has traded "on the basis of" material nonpublic information if the person was "aware" of the material nonpublic information when making the purchase or sale. No proof that the trader used or was otherwise influenced by the information in making the trading decision is necessary.

The rule also sets forth several affirmative defenses or exceptions to liability. A person who trades while being aware of material nonpublic information avoids liability if he or she took any of the following steps prior to becoming aware of the material nonpublic information:

These exceptions permit persons to trade in specified circumstances where it is clear that the information of which they are aware is not a factor in the decision to trade.

Rule 10b5-2 - Duties of trust or confidence in misappropriation cases

The misappropriation theory of insider trading provides that a person violates Rule 10b-5 by misappropriating and trading on inside information in breach of a duty of trust or confidence. The theory applies most clearly in cases involving misappropriation of confidential information in breach of an established business relationship, such as attorney-client or employer-employee.

New Rule 10b5-2 extends the misappropriation theory to non-business relationships. It deals with a breach of trust or confidence within a family or other non-business relationship. Under this rule, a person receiving confidential information under the following circumstances owes a duty of trust or confidence, and thus would be liable for insider trading under the misappropriation theory when:

Guidance on Guidance: A Litigator's Perspective

Last month, after much comment and some controversy, a divided Securities and Exchange Commission promulgated Regulation FD (meaning Fair Disclosure).

While gathering our thoughts on the topic, we could not avoid bemusement at the instant reaction of some of our colleagues who variously proclaimed the end of one-on-one conversations with analysts, the end of commenting on analysts models, the end of participation in broker-dealer sponsored events and indeed the end of guidance from issuers to the analyst community.

The reality is that companies will continue to offer access to the analyst community in exchange for coverage by that community, although guidance relating to earnings will likely be dramatically curtailed. Our view is that most corporate officers have long been law-abiding citizens, and what Regulation FD threatens them with is not a sudden burst of investigative energy from the SEC but rather an enhanced duty of caution in their daily lives - a duty which good counsel, outside directors knowledgeable about and respectful of Regulation FD, and an adroit use of technology can help them discharge.

Regulation FD prohibits selective disclosure of material information to investment professionals while not bothering to define materiality. The Commission's commentary to the regulation does, however, provide a list of topics which are presumptively material and at the top of the list is earnings. The Commission's stark language bears quoting:

"One common situation that raises special concerns about selective disclosure has been the practice of securities analysts seeking 'guidance' from issuers regarding earnings forecasts. When an issuer official engages in a private discussion with an analyst who is seeking guidance about earnings estimates, he or she takes on a high degree of risk under Regulation FD. If the issuer official communicates selectively to the analyst nonpublic information that the company's anticipated earnings will be higher than, lower than, or even the same as analysts have been forecasting, the issuer likely will have violated Regulation FD. This is true whether the information about earnings is communicated expressly or through indirect 'guidance,' the meaning of which is apparent though implied. Similarly, an issuer cannot render material information immaterial simply by breaking it into ostensibly non-material pieces.

"At the same time, an issuer is not prohibited from disclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer, that piece helps the analyst complete a mosaic of information that, taken together, is material. Similarly, since materiality is an objective test keyed to the reasonable investor, Regulation FD will not be implicated where an issuer discloses immaterial information whose significance is discerned by the analyst." (emphasis supplied.)

These words inspire contradictory reactions in us. We can't quarrel with the Commission's seeking to put an end to the selective guiding of analysts up or down. We are a little surprised, however, that the Commission may now be prohibiting private expressions of comfort with analysts' estimates. It may be that private discussions with investment professionals concerning earnings prospects are now simply taboo. Indeed, a majority of the public companies responding to a recent National Investor Relations Institute survey said they will probably limit their communications with analysts and investors as a result of Regulation FD. Our suspicion, however, is that one-on-one meetings and attendance at investor conferences will still continue, but subject to the new rules of engagement outlined elsewhere in this Corporate Advisor.

Our experience with the SEC has been that the Commission does not bring frivolous proceedings and that appeals to the Commission's common sense - whether in an informal dialogue or in formal written submissions - prove constructive a high percentage of the time. So our disquietude is somewhat muted.

That said, we have two concerns, quite apart from the difficulty inherent in changing the folkways of Corporate America. First, selective disclosure cases will be tempting ones for Commission lawyers seeking quick victories. Unlike revenue recognition cases which require painstaking discovery and a mastery of accounting rules, a selective disclosure case only needs an otherwise unexplainable trading blip which the market surveillance cops are already very effective in identifying. Thereafter, the case is merely what corporate official said what to what analyst when. A potentially easy score.

Second, we want to return to the Commission's quotation we italicized earlier.

"This is true whether the information about earnings is communicated expressly or through indirect 'guidance,' the meaning of which is apparent though implied."

That sentence seems mildly ominous. True, we are already accustomed to seeing people trade and suffer the consequences for shrewd deconstruction of oblique words. The reassurance that "your bunny has a very good nose" prompted a senior banker a decade and a half ago to quickly and profitably close out a position - and to spend 109 days in a Club Fed for the pleasure of having done so.

We also can understand the Commission pursuing an issuer for some officer's intentional winks, blinks, nods or body language which spoke words about that corporate officer's state of mind. Imagine, however, a CFO who in response to an analyst's query "How's the quarter going?" promptly assumes - quite involuntarily - the bereaved air of the nephew who just discovers his well-off maiden aunt has died, leaving everything to her Siamese cats. Suppose further that the analyst observes this change in demeanor and gets his clients out of the shares. Will the Commission bring an enforcement action based simply on the emotional transparency of the CFO?

Polonius instructed his manservant "by indirections find directions out." No community has ever taken Polonius' instructions more to heart than the analyst community. If the SEC takes too seriously its prohibition on "apparent though implied" guidance, private meetings with analysts really will have to cease. We hope the Commission will not push a good point too far.

This Corporate Advisor was written by

Daniel H. Haines

Patrick J. Rondeau

David A. Westenberg
[email protected]

Jonathan Wolfman
[email protected]

"Guidance on Guidance: A Litigator's Perspective" was written by

Jeffrey B. Rudman
[email protected]

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