United States: The SEC's New Selective Disclosure Rules Under Regulation FD

After extensive public comment from investor activists, market professionals, academicians and the corporate and securities bar, on August 15, 2000, the Securities and Exchange Commission ("SEC") adopted Regulation FD (fair disclosure) to redress the practice by issuers of selectively imparting material, non-public information to securities analysts, institutional investors and other market participants.

Regulation FD provides the SEC with a direct remedy against exclusionary disclosure practices of public companies. The regulation is not intended to impose a new general requirement on issuers to publicly disclose material corporate developments as and when they occur, nor is it intended to chill the orderly flow of corporate information into the marketplace or obstruct conversations between issuers and analysts that do not confer an informational advantage vis a vis the general investor public. Rather, it constitutes an SEC disclosure (and not an antifraud) rule designed to level the corporate informational playing field.

The new rules, which become effective on October 23, 2000, generally require public companies to make widespread, non-exclusive disclosure of material, non-public information that (i) previously was disclosed on a selective and unintentional basis or (ii) that is intentionally disclosed on a selective basis. In the case of an unintentional disclosure (e.g., an "off-the-cuff" disclosure to a securities analyst of information that the issuer’s spokesperson mistakenly believed was already in the public domain), corrective public disclosure must be made "promptly" (i.e., within the later of 24 hours or commencement of the next NYSE trading day) after discovery by a senior official of the wrongful selective disclosure. In the case of an intentional selective disclosure (i.e., where the disclosing person either knows or is reckless in not knowing that the information being disclosed is both material and non-public), the remedial public disclosure must be disseminated simultaneously with the intentional selective disclosure.

Notably, the rules do not cover information disclosed by senior officials to (i) the issuer’s investment bankers (e.g., in connection with a pending or proposed underwritten securities offering or M&A transaction, or in connection with a similar confidential financial advisory engagement); (ii) so-called "temporary insiders" - - persons who owe a duty of confidence or trust to the issuer (e.g., lawyers, accountants or other professional advisors); or (iii) persons who otherwise have entered into express confidentiality agreements with the issuer (e.g., a business combination candidate or creditors’ committee representatives participating in an issuer debt restructuring). While communications made in the context of an underwritten registered offering, other than shelf registrations, are excluded, such exclusion does not extend to private placements (e.g., Regulation D or Rule 144A debt offerings, or offshore offerings pursuant to Regulation S).

Moreover, the rules are not applicable to disclosures made to the general media, public and governmental authorities, ratings agencies (such as Moody’s and S&P - - if the disclosure is made solely to facilitate development of a rating and the ratings are publicly available), customers and suppliers, and strategic business partners.

Regulation FD applies only to public reporting companies (i.e., issuers with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or who otherwise are required to file periodic reports with the SEC pursuant to Section 15(d) of the Exchange Act), but the Regulation does not apply to foreign private issuers. Regulation FD does not apply to communications made by any issuer-employee. Rather, it only covers communications made by "senior officials" (i.e., any director, executive officer, investor relations or public relations employee, or any other officer, employee or agent of the issuer who regularly communicates on behalf of the issuer with market professionals, investors and other categories of information recipients within the ambit of the Regulation).

Those "recipients" covered by the rule include broker-dealers, investment advisors, investment companies, hedge funds and securityholders of the issuer as to whom it is reasonably foreseeable that they will trade on the basis of the imparted material, non-public information.

The SEC’s adopting release for the Regulation does not contain a "litmus test" for determining materiality. Rather, the release makes reference to the ostensibly objective (but functionally subjective) standard announced by the courts in a seminal antifraud case: i.e., information is material if "there is a substantial likelihood that a reasonable [person] would consider it important in making an investment decision, or if it would significantly alter the total mix of information made available [to investors]." That said, the SEC has indicated that earnings information would always be deemed material and that information pertaining to extraordinary corporate transactions and events (i.e., mergers, business combinations and joint ventures; the loss or attainment of a material contract; changes in relationships with significant customers or suppliers; the receipt, lapse or revocation of material regulatory approvals; changes in management and in control of the issuer; bankruptcy and receivership events; impending or past defaults on securities; recapitalizations, stock splits and dividend payment events; changes in assets, financial condition and outside auditors; and the like), while not per se material, should raise a "red flag" for issuers and their senior officials because there is a strong presumption of materiality. Of course, many of these parenthetical illustrations involve events that give rise to Form 8-K (Current Report) disclosures and mandatory disclosures pursuant to stock exchange listing requirements, not to mention disclosure simply as a matter of sound information dissemination practice.

Whether information is material is an issuer-specific case-by-case analysis. It, therefore, is important for issuers to properly educate their authorized spokespersons regarding the categories of information which, if discussed selectively, might inadvertently lead to violations of Regulation FD.

Regulation FD counsels that material information must be disseminated by methods which are "reasonably designed to achieve broad, non-exclusionary distribution of information to the public."

There are two principal means of satisfying this requirement. First, the filing of a Current Report on Form 8-K containing the material information will always satisfy the Regulation. In practice, if Form 8-K is used, the issuer can elect to "submit" (without filing) the Form 8-K or file the Form 8-K with the SEC under the Exchange Act. The distinction is important in terms of potential liability - - in that a "filed" report subjects the contents of the Form 8-K to the various strict liability and antifraud provisions of the Securities Act of 1933, as amended (the "Securities Act") and the Exchange Act. By contrast, a "submitted" report is not deemed filed under the Exchange Act and, therefore, is not incorporated by reference into any of the issuer’s other SEC filed documents (including its Securities Act registration statements and Exchange Act periodic reports). The second means of public disclosure is the issuance of a press release via Dow Jones, Reuters, Bloomberg, the Associated Press or a similar news service of widespread dissemination.

If the issuer’s news accounts are not routinely tracked and redistributed by the leading wire services, the issuer needs to supplement its press release with additional means of widespread communication (e.g., filing or submitting a Current Report on Form 8-K, distribution through the general media, posting the information on the issuer’s website, or using a news service that republishes the press release through other media sources and/or retains the press release).

No. Significantly, the SEC has admonished that merely posting disclosures on the web, without more, is not adequate public dissemination for purposes of Regulation FD. (As technology evolves and the web becomes a more widely used and accepted source of investor and securities market information, the SEC has noted that issuers whose internet sites are extensively followed by the marketplace might be able to rely on website postings alone - - but the SEC observed that this stage has not yet been reached.)

Generally, issuers announce their quarterly earnings by means of press release with a prompt follow-up analysts’ calls to respond to street queries and often to provide certain forward-looking information (in the form of earnings "guidance" or otherwise) that is not included in the four corners of the earnings release.

With the adoption of Regulation FD, issuers will now have to examine this practice more carefully to avoid exclusionary disclosure of material, non-public information during the analysts’ call. In its adopting release, the SEC offers a disclosure model - - namely, issuers may continue to publish press releases as an initial means of disclosure, followed by an analysts’ call during which "additional material details related to the original disclosure" are disclosed. Unfortunately, the SEC offers no definition of what "related" details means and has not addressed the extent to which the disclosure of additional unrelated information might violate the Regulation’s non-selective dissemination mandate.

Providing as much advance notice (to media representatives and potential investors) of the analysts’ call as practicable, together with at least a "heads up" indication of the topics proposed to be discussed during the call (and, if applicable, the fact that certain forward-looking information is intended to be disclosed) should help demonstrate that good faith attempts were made by the issuer to provide adequate notice and to maximize participation in the call.

Moreover, the SEC has observed that the call or conference must be open to all potential investors and media representatives either by telephone or real-time webcast. If this method is used in conjunction with other disclosure mechanisms, the SEC suggests that issuers should consider making recorded webcasts or scripts of analysts’ calls and press conferences available for a limited time period of time (e.g., one week or less) following the conclusion of the call or conference to enable non-real time participants to review the information disclosed in the real time session.

In sum, factors including the adequacy of notice of the call, the number and character of the call participants and conference invitees, whether replays and scripts are made available for a reasonable time after the live disclosure event, whether additional topics discussed during the call are germane and logically incidental to the original press release disclosure, and the issuer’s past custom and practice with respect to earnings disclosure, will be determinative when assessing compliance with Regulation FD.

In all cases, distribution of the earnings press release should precede the analysts’ call or conference.

The adopting release for Regulation FD notes that "if a [senior official] communicates selectively to the analyst nonpublic information that the [issuer’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."

The foregoing is a flat prohibition against exclusionary "earnings guidance" practices, including talking street estimates up or down or issuing confirmatory statements. Reviewing analysts’ models and draft reports also will subject the issuer to potential liability to the extent the issuer’s comments are deemed (often with hindsight) to impart material, non-public information or provide "soft" guidance that enables the analyst to more accurately project the issuer’s earnings.

In view of the SEC’s heightened scrutiny of earnings guidance (and other analogous forms of corroborative communications), the watchword here may well be "total abstinence." As a practical matter, however, because such guidance can serve legitimate corporate and marketplace interests, issuers will need to reexamine their procedures for providing earnings guidance and craft methods to achieve widely disseminated communications.

The adopting release warns against inconsistent disclosure practices. Where, for example, an issuer typically releases earnings information in a particular form and at a particular time following the end of the fiscal quarter but preceding the filing of its Form 10-Q or Form 10-K, as applicable - - any deviation from past custom and practice could be viewed with skepticism by the SEC and carefully scrutinized under the Regulation. Accordingly, issuers should design a tailor-made program for compliance with Regulation FD and strictly adhere thereto without modification, except under compelling circumstances.

As noted above, Regulation FD is not an antifraud rule. Accordingly there is no private right of action for violations. The Regulation does, however, empower the SEC to bring direct enforcement proceedings against violators, and in such cases the SEC would have the burden of demonstrating that a selective disclosure of material, non-public information was either reckless or intentional.

Compliance with Regulation FD does not immunize an issuer (or its senior officials) from private causes of action and SEC enforcement proceedings under Exchange Act Rule 10b-5 (including newly adopted Rules 10b5-1 and 10b5-2).

Moreover, of significance, failure to comply with Regulation FD will not affect the issuer’s ability (if otherwise eligible) to utilize short-form Securities Act registration statements (e.g., Forms S-2, S-3, and S-8) or the issuer’s compliance with the "current public information requirements" of Securities Act Rule 144.

To address uncertainty in the U.S. federal circuit courts as to the appropriate standard of liability for insider trading, concurrently with the adoption of Regulation FD, the SEC adopted new Exchange Act antifraud Rules 10b5-1 and 10b5-2 which are designed to help clarify the instances where specified persons are deemed to have engaged in insider trading practices.

The new antifraud rules, which become effective on October 23, 2000, provide for "awareness" (i.e., where a person trades in securities while aware of material, non-public information) and "misappropriation" (i.e., where the person trading on material, non-public information misappropriated the information by violating a duty of trust or confidence) standards of liability and afford the SEC a more well-defined enforcement tool against violators.

By virtue of Regulation FD, public companies will need to design and self-police strict disclosure practices and procedures - - lest they risk being held responsible by the SEC for (recklessly or intentionally) making exclusionary releases of material, non-public information.

A carefully planned and proactive posture is vitally important to avoid potential SEC enforcement proceedings under the Regulation. Early consultation with and the involvement of experienced outside corporate and securities counsel will be useful in this process to help the publicly traded issuer design appropriate internal compliance policies and procedures for public disclosures.

© 2000 Greenberg Traurig