On October 21, 2010, the Securities and Exchange Commission announced enforcement actions against Office Depot, Inc. and two executive officers for violating Regulation FD by selectively conveying to analysts and institutional investors that Office Depot would not meet analysts' earnings estimates.
The Violation
According to the SEC complaint, Office Depot's CEO and then-CFO were concerned that analyst estimates for the then current quarter were too high. They considered issuing a press release to provide the company's lower internal guidance, but were concerned because internal estimates were incomplete at that point. Instead, they directed employees to conduct one-on-one calls with analysts designed to cause analysts to revise their estimates downward by referring to recent public statements of comparable companies that cautioned of the slowing economy's impact on earnings. The CFO assisted in preparing the following talking points for the calls:
- Haven't spoken in a while, just want to touch base.
- At beginning of quarter we've talked about a number of head winds that we were facing this quarter including a softening economy, especially at small end.
- I think the earnings release we have seen from the likes of [Company A], [Company B], and [Company C] have been interesting.
-
- On a sequential basis, [Company A] and [Company B] domestic comps were down substantially over prior quarters.
- [Company C] mentioned economic conditions as a reason for their slowed growth.
- Some have pointed to better conditions in the second half of the year – however who knows?
- Remind you that economic model contemplates stable economic conditions – that is midteens growth
Office Depot's director of investor relations notified the
CFO that an analyst expressed concern over the lack of a press
release and indicated that several of his clients were also
surprised. Nonetheless, the CFO instructed the director of investor
relations to call Office Depot's top twenty institutional
investors and relay the prepared talking points to them, which he
did.
Six days after the calls to analysts began, Office Depot filed a
Form 8-K publicly disclosing, among other things, that its earnings
would be "negatively impacted due to continued soft economic
conditions."
The Market Reaction
Between the first day Office Depot began calling analysts to
the last market close before Office Depot filed its 8-K, Office
Depot's stock dropped 7.7%.
SEC Civil Charges and Settlements
The SEC brought and settled on the same day enforcement actions
on the Regulation FD violation and an unrelated financial
restatement. Office Depot agreed to settle the SEC's charges
without admitting or denying the findings and allegations, and
agreed to pay a $1 million penalty. The CEO and CFO also agreed to
settle the Regulation FD charges against them without admitting or
denying the findings, and each agreed to pay a $50,000
penalty.
Noteworthy Implications
This enforcement action is noteworthy because Office Depot and its
CEO and CFO were charged not with explicit communication
of material, non-public information, but with implicit
communications designed to lead analysts to a conclusion that
matched material, non-public information.
This is the first Regulation FD action involving indirect
communications since a U.S. District Court dismissed the SEC's
complaint against Siebel Systems, Inc. in 2005. In the Siebel
Systems case, the SEC alleged that the CEO of Siebel Systems
selectively disclosed material, non-public information at private
meetings with analysts when he made statements such as
"business activity levels were 'good' or
'better' and that its sales pipeline was
'building.'" Such statements were similar to prior
public statements made by the CEO, but had somewhat different
wording and context, which the SEC alleged were understood by the
listeners to convey material, non-public information. The District
Court took issue with the SEC's scrutinizing of the particular
words, verb tenses, and syntax of the CEO's statements. The
District Court also stated that Regulation FD does not prohibit
persons speaking on behalf of an issuer from providing "mere
positive or negative characterizations, or their optimistic or
pessimistic subjective general impressions, based upon or drawn
from the material information available to the public."
This enforcement action signals that the SEC remains committed to
applying Regulation FD to implicit as well as explicit statements.
A significant difference between the Office Depot action and the
Siebel Systems action is the evidence that Office Depot's
executives intended for the selective conversations to communicate
material, non-public information. No such evidence appears in the
SEC's complaint in the Siebel Systems action.
What should you do now?
The Office Depot is the third Regulation FD enforcement action
brought since September 2009. The action is a reminder that
companies need to be vigilant about Regulation FD compliance. We
advise public companies to adopt written Regulation FD compliance
policies, to update such policies and procedures regularly and to
conduct periodic Regulation FD training for executives and company
spokespersons.
Regulation FD issues and related questions about updates to prior
public disclosures can be complex and often require significant
legal and business judgment. Executives and company spokespersons
should consult with legal counsel whenever non-public information
is proposed to be communicated privately to analysts, brokers or
investors and whenever private conversations might occur with
analysts, brokers or investors while the speaker is aware of
material, non-public information.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.