The SEC Addresses Selective Disclosure With Proposed Regulation FD

With the rapid growth of public companies in today's e-commerce and technology driven economy, the need to quickly disseminate material information to investors and potential investors has never been more critical. Moreover, the full and fair disclosure of material information to the investing public is paramount to the operation of efficient capital markets.

The SEC states that the best disclosure practice is the prompt public disclosure of material information. Generally, however, public companies are not required to disclose all material information simultaneously with its occurrence. Rather, companies are required to file periodic reports (Forms 10-K, 10-Q and 8-K) after the event has occurred.

A company will often make a voluntary initial disclosure of an event prior to the required filing of a periodic report. With these releases, known as selective disclosures, a company retains control over the content and audience of the release, often targeting a select group of analysts to receive, as an example, earnings updates prior to dissemination to the general public.

While "whispering" these earning numbers has a predictable and significant impact on a company's shares, the practice has received critical attention from the SEC. The SEC, in its Selective Disclosure and Insider Trading Proposed Rule (proposed "Regulation FD"), comments that "the current practice of selective disclosure poses a serious threat to investor confidence in the fairness and integrity of the securities markets. We have recognized that benefits may flow to the markets from the legitimate efforts of securities analysts to 'ferret out and analyze information' based on their superior diligence and acumen. But we do not believe that selective disclosure of material nonpublic information to analysts--or to others, such as selected investors--is beneficial to the securities markets." Furthermore, "the impact of such selective disclosure appears to be much greater in today's more volatile, earnings-sensitive markets." Clearly, the SEC perceives an inequity.

In an attempt to curb this practice of selective disclosure, the SEC, on December 15, 1999, proposed new Regulation FD (Fair Disclosure). In summary, Regulation FD would require that:

• when a public company intentionally discloses material information, it does so through public disclosure, not through selective disclosure;
• and whenever a public company learns that it has made an unintentional material selective disclosure, the public company makes prompt public disclosure of that information.

Regulation FD would not require a public company to disclose all material events simultaneously with their occurrence, but rather, when a company voluntarily releases material nonpublic information, the dissemination must be to the broad public and not to a select group of investors or analysts. If a company does intentionally release information to a select group of investors or analysts, then it must simultaneously release the same information to the broad public.

In the alternative, when a company learns of an unintentional disclosure of material information to a select group, then the company must promptly disseminate the same information to the broad public. The SEC defines prompt as, "as soon as practicable (but no later than 24 hours)" after any executive officer, director, investor or public relations officer knows or should know of the unintentional disclosure.

Regulation FD governs both formal and informal statements of the company. Therefore, a company is responsible "for the disclosures of company officials, employees, or agents who are properly authorized or designated to speak to the media, the analyst community, and/or investors," but not for statements made by this group of individuals for their own personal benefit. These latter statements would be governed by securities fraud rules.

Although the materiality standard is not specifically defined in Regulation FD, the SEC has stated that, for Regulation FD, an event is material if "there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision, or if it would have significantly altered the 'total mix' of information made available."

At present, Regulation FD has not been adopted and, in its present form, has received formal opposition from the Securities Industry Association, American Electronics Association, Futures Industry Association, Institute of International Bankers and the Bond Market Association. Regardless of this opposition, it appears clear that the SEC intends to address the issue of selective disclosure. Therefore, public companies should be aware of the issues created by selective disclosure and should consider the creation of a formal process to prevent these selective intentional non-public material releases and have steps in place to correct selective releases when they unintentionally occur.