Regulation FD – The First Decade P resentation at a Meeting of the Securities Subsection of the...

Regulation FD – The First DecadePresentation at a Meeting of the Securities Subsection of the Colorado Bar Association on 1/20/2011

Daniel F. Shea

January 2011

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History, Purpose and Effect of Regulation FD

• Regulation Fair Disclosure, commonly referred to as Regulation FD, was adopted by the SEC in August 2000.

• Purpose is to prohibit selective disclosure of material non-public information to investment professionals and institutional shareholders of public companies.

• Only authorized enforcement actions by the SEC; no private rights of action were created.


Regulation FD

To what communications does Regulation FD apply?

• Regulation FD applies to the disclosure of material non-public information by public companies and persons acting on their behalf to:

• Broker-dealers (in particular their research analysts)• Investment advisers and managers• Investment companies• Hedge funds• Pension funds• Any other investor under circumstances in which it is reasonably

foreseeable that such person would buy or sell the securities on the basis of such information


Regulation FDTo what communications does Regulation FD not apply?

Selective disclosure of material non-public information may be made to:

• Persons who owe a duty of trust and confidence to the company (e.g., an attorney, investment banker, or accountant engaged by the company)

• Other persons who agree to keep the information confidential

• Persons who receive the information in connection with a registered public offering (e.g., during a roadshow presentation) except for certain continuous offerings (e.g., resales, dividend reinvestment plans, employee benefit plans, direct stock purchasing plans, and exercises and conversions)

• Media outlets

• Existing and potential customers and vendors


Regulation FD

To whom does Regulation FD apply?Persons deemed to be “acting on the company’s behalf” include:• Any senior official defined to include any Section 16 officer, director,

Investment Relations (IR) director, Public Relations (PR) director, and any other person having such a role

• Any other officer, employee, or agent of the company who communicates with market professionals or stockholders (e.g., employees in the investor relations or public relations departments)

• Investor and/or public relations firms used by the company


Regulation FDDoes Regulation FD apply only to affirmative communications?

Regulation FD applies with equal force to affirmative statements and reactive remarks:

• Affirmative statements are much more likely to be deemed intentional • Reactive remarks, while less likely to be deemed intentional, are

nonetheless covered by Regulation FD• Company officers and employees therefore should avoid reacting

extemporaneously to rumors. Rumors related to information that is material should not be quashed selectively; rather, the company should adopt and follow a policy for determining which rumors should be quashed and do so by publicly disseminating the company’s refuttal of the rumor


Regulation FD

Examples of types of disclosures likely to deemed public:• Widely disseminated press releases• Investor conference calls preceded by adequate notice• In limited circumstances, postings on a company’s website

(see SEC’s August 2008 guidance regarding Use of Company Websites)


Regulation FD

Intentional Disclosures• Disclosures will be deemed “intentional” only when person making the

disclosure knows, or should know, that the information is material and non-public

• Intentional disclosures must be made “simultaneously” to all shareholders so company should take prompt action to make broad public disclosure once it learns of any selective disclosure of material non-public information to market professionals

• Recognizing that materiality is sometimes an elusive concept, then Enforcement Director Walker stated in November 2000 that SEC was “not going to second-guess close calls regarding the materiality of a potential disclosure.” Thus, according to Walker, for the SEC to allege that a selective disclosure was intentionally made, the act must be an “extreme departure from standards of reasonable care”


Regulation FD

Non-Intentional Disclosures• Non-intentional disclosures are those made inadvertently (for

example, where the company spokesperson believes that the information is immaterial or has already been disclosed publicly or where the statement is made extemporaneously, such as in response to a question posed by an analyst)

• Non-intentional disclosures must be cured “promptly” meaning “as soon as reasonably practicable” but no later than 24 hours after the statement was made or before the start of trading on the next business day


Regulation FD

Publication of Corrective Disclosures• The methods of public disclosure can vary, so long as they are “reasonably

designed to effect a broad and non-exclusionary distribution of information to the public”

• Best practice is to issue press release that is incorporated in a Form 8-K filing


Regulation FD

Non-public: • Information that has not been widely disseminated to the public

Material:• There is a substantial likelihood the information would be important to a

reasonable investor in making an investment decision


Regulation FD

What is material information?• Short answer = nearly all non-public information, particularly given

that any disclosure will likely be judged with the benefit of hindsight• Long answer = too many items to commit to memory


Regulation FD

Regulation FD lists certain information as presumptively material:

• Earnings information

• Mergers, joint ventures, acquisitions, tender offers, or significant changes in assets

• New products or discoveries in R&D area• Developments regarding customers or suppliers, particularly new or

terminated agreements• Changes in control or management• Change in auditors• Notification from auditor that prior audit report can no longer be

relied upon• Events regarding the company’s securities (ex: stock splits, stock

dividends, sales of additional securities, or defaults on senior securities)

• Bankruptcies or receiverships


Regulation FD

Form 8-K instructions list other information as presumptively material:

• Costs associated will exit or disposal activities• Material impairments• Notice of delisting from exchange• Unregistered sale of securities• Material modifications to rights of securities holders• Amendments to Articles of Incorporation or Bylaws• Change in fiscal year• Acquisition or disposition of significant assets• Events that trigger an acceleration or increase in direct financial

obligation or obligation under off-balance sheet arrangement• Material agreement or change in agreement regarding

compensation of certain highly compensated officers


Regulation FD

Examples of other information that might be deemed material:

• A change in a business plan or operations, including any decision to operate, or cease operations, in a new segment

• A change in segment revenues or earnings • Concerns about loan covenants or liquidity generally• Impending rating upgrade or downgrade


Regulation FD

Earnings guidance is area of greatest risk• Earnings guidance is primary area of SEC concern (8 of

10 enforcement actions to date deal with such guidance)• Discussions with sell-side and buy-side analysts are

particularly risky, particularly when discussing modeling• Prior public earnings guidance should not be affirmed later

in quarter or year except by way of a public disclosure• No company officer or employee should communicate with

any analyst or institutional investor about earnings or guidance during any quiet period


Regulation FD

SEC Enforcement ActionsRaytheon (2002)

• SEC instituted a settled cease-and-desist proceeding against Raytheon and its CFO

• Raytheon provided only annual earnings-per-share guidance, but CFO called sell-side analysts only to provide then with quarterly guidance. CFO also told the sell-side analysts that their estimates of the company’s earnings were too high, resulting in the subsequent lowering of estimates by analysts and a 6% decrease in the price of the company’s stock

• The SEC concluded that the disclosures were intentional

• Civil money penalty of $50,000 was imposed on CFO but no penalty was imposed on Raytheon


Regulation FD

SEC Enforcement Actions (continued)Secure Computing (2002)

• SEC instituted a settled cease-and-desist proceeding against Secure Computing and its CEO

• CEO made inadvertent disclosure concerning an important new contract during calls with two institutional investors

• Following this disclosure, trading volume and the price of the company’s stock increased sharply

• Company management determined that a press release should be issued to disclose information about the contract

• Prior to the issuance of the press release, the CEO reactively confirmed to an additional institutional investor that the rumor about the new contract was true

• SEC concluded that the initial disclosure was inadvertent but that the second was intentional

• No civil money penalty was imposed on Secure Computing or its CEO


Regulation FD

SEC Enforcement Actions (continued)Siebel Systems, Inc. (“Siebel I”) (2002)• SEC instituted a settled cease-and-desist proceeding against Siebel

Systems• At an “invitation-only” analyst conference sponsored by an investment

bank, Siebel’s CEO disclosed that company was optimistic that business was returning to normal. On day of conference, the company’s stock price rose 20% and trading volume doubled

• Such conferences with senior management were normally broadcast to the public, so CEO was unaware that comments were not being disseminated to the public. The company’s director of investor relations knew, however, that the conference was not being broadcast

• The SEC concluded that the company’s selective disclosure was intentional

• Civil money penalty of $250,000 was imposed on Siebel Systems


Regulation FD

SEC Enforcement Actions (continued)Schering Plough (2003)

• SEC instituted a settled cease-and-desist proceeding against Schering-Plough and its CEO

• At several meetings over four days with institutional investors and sell-side analysts immediately after the end of the third quarter, CEO indicated that analysts’ estimates were too high and that earnings the next year would be terrible. By the end of the fourth day, the price of the company’s stock had dropped about 20% on four times normal trading volume

• Company issued a press release at the end of the fourth day revising downward its earnings guidance

• SEC concluded that the selective disclosures were intentional• Civil money penalties of $1 million and $50,000 were imposed on

Schering-Plough and its CEO


Regulation FD

SEC Enforcement Actions (continued)SEC v. Siebel Systems (“Siebel II”) (2004)

• SEC filed a civil injunctive action against Siebel Systems, including for allegedly violating the prior cease-and-desist order

• At a meeting with an institutional investor and a subsequent meeting with additional institutional investors and investment bank, CFO made comments about business activity levels being “good” or “better” and about a “growing” and “building” transaction pipeline. The meetings were at the end of the first month of the quarter. The next day, the price of the company’s stock rose 8% on increased trading volume

• The company made no corrective disclosure after the general counsel questioned CFO and another officer who had attended the private sessions


Regulation FD

SEC Enforcement Actions (continued)SEC v. Siebel Systems (“Siebel II”) (2004)• Federal district court dismissed the SEC’s complaint, concluding that

CFO did not disclose material, non-public information because the essence of what was said had been communicated by the company in public disclosures earlier during the first month of the quarter. In this regard, the court indicated that Regulation FD’s focus is on what is said by the representative of the issuer, not whether a keen analyst discerns some meaning from his or her particular perspective. Nor was linking the company’s performance to the performance of the economy as a whole violative of Regulation FD, for Company had previously stated this and Regulation FD does not prohibit company representatives from repeating a prior public statement in a private conversation.


Regulation FD

SEC Enforcement Actions (continued)Flowserve (2005)

• SEC instituted a settled cease-and-desist proceeding against Flowserve and its CEO and IR Director

• At a late November meeting with sell-side analysts, CEO in response to a question, reaffirmed the company’s previous guidance. IR director was present and heard CEO’s response. The next day, one of the analysts issued a report referencing CEO’s reaffirmation, and the price of the company’s stock increased 6% on increased trading volume

• More than two days after the selective disclosure, and more than 24 hours after the one analyst reported in the reaffirmation, Flowserve filed a Form 8-K with the SEC disclosing that it had reaffirmed its guidance

• The SEC concluded that the selective disclosure by Flowserve’s CEO was intentional

• Civil money penalties of $350,000 and $50,000 were imposed on Flowserve and its CEO; no penalty was imposed on IR Director


Regulation FDSEC Enforcement Actions (continued)Electronic Data Systems (2007)• SEC instituted a settled cease-and-desist proceeding against EDS for

several violations, including of Regulation FD• Non-officer employees of the company selectively disclosed in two

conversations with sell-side analysts that a lender required the company to settle certain derivative obligations totaling $225 million

• EDS, while publicly disclosing that it had settled the derivative obligations a day following the second conversation, did not disclose the cost of the settlement until about two months later

• No civil money penalty was imposed on EDS


Regulation FDSEC Enforcement Actions (continued)Christopher Black (2009)

• SEC instituted a settled cease-and-desist proceeding against former CFO of American Commercial Lines but chose not to institute an action against the company

• CFO sent e-mail from home computer on Saturday to sell-side analysts only reducing (by a dime) the quarterly guidance publicly announced by the company earlier that week and the price of the stock dropped 9.7% the next business day on three times average trading volume

• CEO learned of CFO’s e-mail on Monday and caused company to issue Form 8-K that day disclosing contents of CFO’s e-mail

• Commission found that disclosure was intentional but that company should not be sanctioned because it had an effective FD policy in place, took prompt corrective action, self-reported the violation, and provided extraordinary cooperation during the Staff’s investigation

• Civil money penalty of $25,000 imposed on former CFO


Regulation FD

SEC Enforcement Actions (continued)SEC v. Presstek, Inc. and Edward J. Marino (2010)

• SEC filed a civil injunctive action against Presstek and its former CEO, with Presstek consenting to the injunctive relief sought

• SEC alleges that CEO during last week of a quarter selectively disclosed information about Presstek’s quarterly financial performance to the manager of a large institutional investor. The manager, who initiated the call, made notes indicating that the CEO stated, among other things, that the summer had not been “as vibrant as expected”

• Presstek’s stock price declined 19% that day, with the institutional investor selling nearly all of its shares

• Presstek agreed to pay $400,000 civil money penalty


Regulation FD

SEC Enforcement Actions (continued)Office Depot, Inc., Stephen Odland and Patricia McKay (2010)• SEC initiated settled cease-and-desist proceeds against Office Depot and its

CEO and former CFO• CEO and CFO directed head of investor relations to call each sellside analyst

during the last two weeks of the second quarter to refer them to pessimistic statements made publicly by the Company earlier in the quarter and current results just announced by two other companies in the retail sector and Federal Express, viewed by many as a bellwether of the economy. After learning of concerns, from some sellside and buyside analysts, the CFO directed the investor relations representative to call selected buyside analysts as well.

• Commission found that CEO and CFO had selectively signaled to analysts that Office Depot would not seek earnings targets forecasted by the analysts, causing the price of the stock to drop by 7.7% on increased trading volume.

• Civil money penalty of $1 million was imposed on Office Depot in parallel civil action; CEO and former CFO undertook to pay penalties of $50,000 apiece.


Regulation FD

SEC Section 21(a) Report of InvestigationMotorola, Inc. (2002)• SEC, with consent of Motorola, published a report to provide guidance

regarding the circumstances in which a company can privately amplify remarks made in an earlier public statement.

• Motorola issued an announcement midway through its second quarter of 2001 indicating that it would not meet prior earnings guidance because of “significant” weakness in order flow. Analysts called the IR Director for amplification of the term “significant” and he told them that Motorola meant 25% or more, causing the price of the stock to drop by 15%. Before speaking with the analysts, the IR Director had consulted with in-house counsel who advised that the term could be quantified in private discussions with analysts.

• The SEC, stating that the legal advice was erroneous, but concluding that Motorola’s officers reasonably relied on the advice, indicated that quantifying in private an ambiguous qualitative term violated Regulation FD.

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