Court Finds SEC´s Enforcement Action Against Siebel Systems Was "Overly Aggressive" Interpretation Of Regulation FD

In the first reported decision dismissing a Securities and Exchange Commission ("SEC") enforcement action under Regulation Fair Disclosure ("Reg FD"), the Southern District of New York has found that enforcement efforts that "excessively" scrutinize executives’ comments can have a chilling effect that runs counter to the underlying purpose of Reg FD. Reg FD was meant to encourage the public disclosure of material information, and parsing words at an "extremely heightened level" places an unreasonable burden on management and spokespersons to "become linguistic experts," according to the New York federal district court opinion dismissing Securities and Exchange Commission v. Siebel Systems, Inc. et al., 2005 WL 2100269 (S.D.N.Y. Sept. 1, 2005) ("Siebel II").

Reg. FD, which was adopted in August 2000 and became effective in October 2000, was intended to level the playing field between professional investors and the investing public. It requires that when a public company discloses material nonpublic information regarding its business or securities to such audiences as broker-dealers, investment advisers, or holders of the company’s securities when it is reasonably foreseeable the person will buy or sell based on the information, the company has to make a public disclosure, simultaneously in the case of an intentional disclosure and .promptly. in the case of a non-intentional disclosure.

The New York case was Siebel’s second go-round with the SEC over Reg FD. In 2002, in one of the SEC’s first enforcement actions ("Siebel I") under Reg FD, the SEC alleged that Siebel’s CEO had disclosed material non-public information at an invitation-only technology conference hosted by Goldman Sachs when, in answer to an analyst’s question, the CEO stated that he was optimistic because business "was returning to normal," which contrasted with his public statements three weeks earlier that times were "as tough as any" and "they will continue to be quite tough in the short term." According to the SEC, these seemingly innocuous nonpublic statements reflected the CEO.s knowledge of developments in the "sales pipeline," information that a reasonable investor would consider in making an investment decision. As support for the allegations, the SEC pointed out that several people at the conference immediately purchased Siebel stock, and that the stock closed about twenty percent higher on more than twice its average daily volume at the end of the day. That stock movement, the SEC argued, demonstrated the material nature of the CEO’s comments.

In Siebel II, the SEC alleged that six months after the cease-and-desist order in Siebel I, the company’s CFO disclosed material nonpublic positive statements by contradicting prior negative comments in meetings with an institutional investor and Morgan Stanley, again causing increased buying of the company’s stock. According to the SEC, the CFO stated that the company’s activity levels were "good" or "better," that new deals (including "some $5 million deals") were coming into the pipeline, and that an announced increase in the company’s guidance for the second quarter was not simply because deals that had slipped from the first quarter were closing. The SEC claimed that these statements contrasted materially with statements made by Thomas Siebel in conference calls in April. The SEC also named Siebel’s investment relations officer as a defendant, alleging that he attended both meetings and failed to protect the company by making the information public. Siebel had done "little to improve its compliance," failing to develop company policies, safeguards, or training in Reg FD’s requirements, the SEC concluded.

Siebel moved to dismiss the complaint under Federal Rule of Civil Procedure 12(b)(6) for failure to state a viable claim, and the District Court dismissed the case in its entirety. The Court had harsh words for the SEC. Noting that a required element of a Reg FD violation is that the subject statements were not publicly disclosed, the Court chided the SEC for "selectively" citing isolated portions of Siebel’s public statements to support its "conclusory allegation" that Siebel had not publicly disclosed the information. On a 12(b)(6) motion a court typically does not consider material outside the complaint, but since the SEC relied on the assumption of non-disclosure in the public documents, the District Court considered the full content of Siebel’s public statements, finding that they were in fact equivalent in substance with the CFO’s statements. In fact, comments in the company’s April analysts’ calls were quite consistent with statements made in the April conference calls, in which Mr. Siebel stated, "I think we’ll see lots of small deals. We’ll see some medium deals. We’ll see some deals over a million dollars. And I think we.ll see some greater than five."

The SEC argued that the CFO’s statement was in the present tense, while Mr. Siebel’s statement was in the future tense, thus making the two "factually different." The Court was not persuaded. Reg FD "was never intended to be utilized in the manner attempted by the SEC under these circumstances," the Court said. The SEC had scrutinized every word, the tense of verbs, and general syntax of each sentence; this level of scrutiny "places an unreasonable burden on a company’s management and spokespersons to become linguistic experts, or otherwise live in fear of violating Regulation FD should the words they use later be interpreted by the SEC as connoting even the slightest variance from the company’s public statements." The mere fact that the analysts who heard the CFO.s statements found the information significant "is not, standing alone, a basis to infer that Reg FD was violated."

In its Proposing Release for Reg FD, the SEC described seven categories of information likely to be deemed "material" in enforcing the regulation.¹ However, neither Reg FD itself nor the SEC has offered a definition of materiality. In Siebel I the SEC pointed to the stock movement following the statements in question as proof that the statements were material. In Siebel II, however, the Court disagreed with this assumption, noting that the "mere fact that analysts might have considered [the CFO’s] private statements significant is not, standing alone, a basis to infer that Regulation FD was violated."

Siebel II is at present just one District Court.s take on the SEC’s enforcement approach to Reg FD. However, the decision is encouraging for its finding that materiality cannot be judged by hindsight alone, based on stock movement or volume, as well as for its injection of a dose of common sense into applying Reg FD in the context of the purpose of the regulation.

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