The Securities and Exchange Commission (SEC) announced enforcement actions in October 2010 against Office Depot, Inc., and two executives for selectively communicating to analysts that the company would not meet analysts' quarterly earnings estimates. This marked the third Regulation FD enforcement action brought by the SEC within 13 months, underscoring the SEC's renewed focus on the enforcement of Regulation FD.
SEC v. Office Depot, Inc.
On October 21, 2010, the SEC filed civil injunctive actions against Office Depot, its CEO Stephen A. Odland, and its then-CFO Patricia A. McKay, for violations of Regulation FD. According to the SEC's complaint, in late May 2007, Odland alerted Office Depot's board of directors that the company was not likely to meet analysts' consensus estimate of $0.48 earnings per share for the second quarter of 2007 and that senior management was considering a strategy to avoid a complete surprise to the market. As the end of the quarter approached, Odland and McKay discussed how to encourage analysts to revisit their analysis of the company. Odland proposed to McKay that Office Depot talk to analysts and refer them to recent public announcements by two comparable companies about their financial results being impacted by the slowing economy. Odland also suggested that Office Depot point out the company's previous warnings about softening demand.
Following this discussion, and based on talking points drafted with the assistance of McKay, Office Depot conducted one-on-one calls with all 18 analysts covering Office Depot over two days late in the second quarter of 2007. By the end of the second day of calls, 15 of the 18 analysts covering Office Depot lowered their estimates, bringing the consensus earnings per share estimate down from $0.48 to $0.45. 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." Between the day Office Depot began calling analysts and the last market close before Office Depot filed its Form 8-K, the company's stock dropped 7.7 percent on increased volume.
Office Depot agreed to settle the SEC's charges by consenting to an order that enjoined the company from future violations of Regulation FD and directed it to pay a $1 million civil penalty. Odland and McKay also agreed to settle the SEC's charges by consenting to orders that enjoined them from future violations of Regulation FD and directed them to pay $50,000 each.
Takeaways
Beyond signaling that Regulation FD remains an enforcement priority, the action against Office Depot is noteworthy in that it highlights Regulation FD's reach to indirect guidance. The SEC did not allege that Office Depot explicitly told analysts that it would not meet earnings estimates. Instead, the SEC alleged this message was signaled through references to two negative earnings announcements of comparable companies and reminders of Office Depot's prior cautionary statements to investors regarding softening demand. Echoing earlier enforcement actions, such as the action against Schering-Plough in 2003, the Office Depot enforcement action demonstrates the SEC's view that indirect material communications—whether achieved through words, tone or demeanor—are covered by Regulation FD.
In addition, in both the complaint and the cease and desist order, the SEC specifically highlighted Office Depot's lack of written Regulation FD policies or procedures and its lack of any formal Regulation FD training. In contrast, the SEC's decision not to bring an enforcement action against American Commercial Lines, Inc., previously reported in our December 2009 Securities Update, highlights the benefits of a strong internal compliance program. The SEC did not pursue an enforcement action against American Commercial Lines in part because the company had established controls to prevent improper disclosures by company officials, and an executive alone was responsible for violating that policy. A strong internal compliance program, coupled with full cooperation with SEC staff inquiries, are essential to minimizing damage in connection with a potential Regulation FD violation.
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