Since its adoption in 2000, Regulation FD has transformed the way US public companies communicate with the market.  The SEC has spurred this transformation on by bringing six Regulation FD enforcement actions against companies, their officers and IR personnel (Raytheon and Secure Computing in 2002, Siebel Systems in 2002 and again in 2004, Schering Plough in 2003 and Flowserve in 2005) and by publishing one investigative report which did not result in a complaint being filed (Motorola in 2002).

In September 2005, a federal district court handed the SEC its first defeat in FD enforcement by dismissing its 2004 enforcement action against Siebel Systems and by rebuking the SEC for an overly aggressive FD enforcement posture.  SEC v. Siebel Systems, Inc. (SDNY September 1, 2005).

The full impact of the recent Siebel Systems decision is not yet clear.  But it is unlikely to change dramatically the Regulation FD lessons taught by previous enforcement – lessons that no US public company can afford to ignore.

Regulation FD

Regulation FD bans US public companies from selectively disclosing material nonpublic information to securities analysts, certain other market professionals or their security holders (where it is foreseeable that they will trade on such information).  Regulation FD requires that an issuer making an “intentional” disclosure of material, nonpublic information to such persons do so in a manner that provides simultaneous disclosure to the general public.  If an issuer makes a “non-intentional” selective disclosure of material information, it must “promptly” (generally within 24 hours) make public disclosure.

Public disclosure under Regulation FD requires inclusion of information in a Form 8-K or dissemination by press release or other means of broad, non-exclusionary distribution to the public.  Posting information on a company’s web site or announcing information at a meeting at which representatives of the press happen to be in attendance does not, by itself, constitute public disclosure under Regulation FD.

Lessons Learned

1. One-on-one communication with analysts, shareholders and other Regulation FD triggers is extremely risky, especially impromptu Q&A.

Every one of the enforcement actions involved an officer speaking in a nonpublic setting to analysts or investors followed by a market reaction (high-volume trading and price movement or change in analyst recommendation).  One-on-one communication with analysts or investors is not illegal under Regulation FD.  Although a few public companies used the occasion of Regulation FD’s adoption to announce that they would discontinue one-on-ones completely, that has not been viewed as an option for many.

When officers or IR personnel venture into one-on-ones, they can avoid Regulation FD problems (absent a confidentiality agreement) only if they refrain from disclosing anything that is material and nonpublic.  So, the idea is that they will only be repeating or clarifying information that is already public or adding new, but nonmaterial information.

This is tricky for two reasons.  First, it is nearly impossible to have any certainty up front that what you say or otherwise communicate – whether it is intended as repetition, clarification or new information – is not “material.”  Information is “material” for purposes of Regulation FD if a reasonable shareholder would find it important in making an investment decision – if it adds significantly to the total mix of information available.  The SEC maintains that quantitatively insignificant information may still be qualitatively material.  But whether quantitative or qualitative, materiality is in the eye of the beholder.  Market reaction is an after-the-fact indicator that what you said must have been “material.”

Second, analysts and investors presumably do not attend one-on-ones to hear something they already know or something new but unimportant.  So, the officer’s legitimate agenda and that of the attendees at one-on-ones are somewhat at loggerheads, and it all comes to a head in unscripted Q&A.

2. Beware of one-on-one “clarification” of previous public statements.  Even one-on-one “repetition” can amount to a Regulation FD violation where word choice variations, demeanor or body language is viewed as adding significantly to the total mix of available information.

Some of the enforcement actions alleged what appeared to be intentional additions of new information.  In each of the two proceedings against Siebel Systems, the company had made public statements painting a somewhat negative picture of near-term results, and the CEO and CFO subsequently made observations about the order “pipeline” building to analysts in a nonpublic setting.  In the Secure Computing case, the CEO talked one-on-one about major, previously unannounced, OEM agreements.

But in other cases, the one-on-one communications were at least intended to be only repetition or clarification of previously disclosed information.

  • The CFO of Raytheon intended to clarify that the annual projected earnings he had announced publicly would be back-end loaded when he had IR staff make one-on-one calls to analysts to talk them down on their first quarter and first half projections.
  • Motorola was trying to clarify one-on-one to out-of-line analysts that when it talked publicly about “significant” weakening of performance it meant a 25% decrease.
  • Schering Plough’s CEO and IR officer probably believed they were essentially just repeating publicly announced information about the adverse impact of Claritin going off patent when they did a series of one-on-ones and responded to questions. But the language chosen in these repetition or clarification sessions (words like “terrible,” “hard hit,” “very, very difficult”), even the body language, downbeat demeanor and expressions on their faces, prompted analysts to change their reports and moved the market.

All these clarification or repetition cases involved company officials who wanted to help analysts get their projections in line with the company’s own projections by repeating or clarifying previously publicly announced information on a one-on-one basis.  This has been a formula for Regulation FD problems.  If the analysts react as desired, it proves to the SEC that whatever was communicated privately must have materially altered the total mix and violated Regulation FD.

The court in the recent Siebel Systems case criticized the SEC for being too aggressive in this regard.  In dismissing the SEC’s complaint, the court found that the subsequent private statements to analysts were sufficiently anticipated by the earlier public remarks that the court could not conclude the subsequent remarks added materially to the total mix, even if they did apparently generate a market reaction.  The court said the SEC was parsing the public and private statements too closely and making conclusory allegations about the materiality of minor differences:

"Such an approach 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. . . .  Regulation FD does not require that corporate officials only utter verbatim statements that were previously publicly made." (emphasis added)

The court noted that such an extreme approach was inconsistent with Regulation FD’s underlying purpose of encouraging the free flow of information into the market.  In a footnote, however, the court reaffirmed that even where subsequent private statements are verbal equivalents to previous public statements, "tacit communications, such as a wink, nod, or a thumbs up or down gesture" may materially add to the total mix and give rise to a Regulation FD violation.

3. Intentional does not mean premeditated or even intended.

Selective disclosure is intentional if a company spokesperson knew or was reckless in not knowing that he or she disclosed material nonpublic information.  The offending comment may be completely unplanned and unpremeditated.  The spokesperson may know immediately that he or she just made a mistake.  It is still intentional.  If the company cannot get the analysts or investors to agree to confidentiality, there is no way to put the toothpaste back in the tube.  The violation has already occurred, since simultaneous public disclosure was not made.

In the Flowserve action, the company had a flat policy against confirming in nonpublic settings previously announced earnings guidance.  Nevertheless, the CEO answered a question on previous guidance in a way that analysts viewed as tantamount to confirmation at a one-on-one meeting 28 days after the original guidance had been publicly announced.  Both he and the IR director who witnessed the violation must have known it was a mistake to answer in any way other than “no comment.”  According to the SEC, his violation was still intentional.

4. Penalties are ratcheting up and getting personal.

In the first four Regulation FD actions, announced in 2002, only Siebel Systems had to pay a monetary penalty ($250,000).  Raytheon and Secure Computing (and their offending spokespeople-officers) agreed to cease-and-desist orders.  Because of mitigating circumstances, Motorola was only the subject of a published investigative report.  These were warning shots across the bow.

In 2003, Schering Plough had to pay a $1,000,000 civil penalty, and its CEO had to pay $50,000.  The 2005 Flowserve case resulted in a $350,000 penalty payment by the company and a $50,000 payment by the CEO.

5. IR professionals must take charge and be assertive.

In the Flowserve case, the SEC excoriated the IR officer, who was in attendance at the one-on-one meeting with analysts, for not doing more to prevent the violation.  The SEC suggested that he should have announced the ground rules (including the company’s rule against confirmation of guidance) up front and that he should have jumped in and stopped the CEO from responding when the confirmation question was asked.

IR professionals can no longer be passive.  They must take charge.  They must be responsible for training, briefing and reining in the CEO, CFO and other spokespeople.  They need to disabuse them of misconceptions regarding the meaning of “intentional” and “material” as well as their practical ability to repeat, clarify or otherwise dance around previous public statements without creating Regulation FD problems.  They need to make sure spokespeople understand that word choice, demeanor and body language can get them in trouble. They also need to make sure they understand that unilateral imposition of confidentiality (e.g., “this is off the record”) is ineffective for purposes of Regulation FD.  There must be bilateral agreement.

The Flowserve case also suggests that IR personnel, if they are not doing some kind of ground-rules reminder at the beginning of sessions, ought to strongly consider adopting the practice and also be ready to jump in when a bad question is asked.

All of these cases suggest the need for disciplined procedures, sticking to a script whenever possible, rehearsing and being exceedingly wary of impromptu Q&A.  Pre-submission of written questions has important advantages.

6. Be ready to remediate.  Get your story straight and everyone on the same page.

In the Secure Computing case, company personnel had concluded that a Regulation FD violation had occurred when the CEO mentioned the previously unannounced OEM agreements during a nonpublic analyst call.  They immediately began preparation of a Form 8-K filing to make such information public.  Before they could get the Form 8-K on file, however, the CEO mentioned the OEM agreements on a second analyst call.

In Flowserve, company personnel also concluded that a violation had occurred after the CEO responded to a guidance confirmation question in a nonpublic meeting.  When the SEC called to inquire about what happened at the meeting, the CEO and IR personnel maintained that they had not really confirmed guidance in their response, even though the company had, by then, filed a Form 8-K admitting that guidance had been confirmed.

These two cases illustrate the wisdom of post-mortems after analyst or investor meetings and the need to be ready to remediate quickly.  They also illustrate the need to have everyone on the same page and cooperating with the SEC staff, not making their problems worse.  IR personnel must work with legal counsel to take charge of this effort as well.

Grace Period Is Over

Regulation FD is now a fixture in the corporate-communications landscape.  US public companies have taken it very seriously.  The vast majority have adopted written Regulation FD compliance policies, trained spokespeople and eliminated most problematic practices.  But SEC enforcement to date illustrates that mistakes still happen and that compliance requires ongoing discipline and continuing vigilance by everyone involved.  The SEC’s tolerance is diminishing, and the stakes of noncompliance are increasing.

If it is not overturned on appeal, the recent Siebel Systems decision may blunt somewhat the aggressiveness of the SEC’s enforcement program, requiring it to be more circumspect in choosing which companies to pursue when market reaction follows private conferences or meetings with analysts or investors.

The Siebel Systems case will not, however, make it much easier for executives and IR personnel.  Private conferences and meetings with analysts and investors remain a very tricky proposition, especially impromptu Q&A.  Predicting when a change in the way something is said may result in market reaction remains very difficult, and litigating against the SEC to the point of vindication in federal court may be a Pyrrhic victory.

Originally published under the title "Bad Idea: Chatting With Analysts" in the November/December 2005 issue of Executive CounselUsed with permission.