Companies today are faced with the complex challenge of providing quality guidance to the marketplace while simultaneously avoiding the scrutiny of the SEC and the plaintiffs’ bar. The pressure to increase transparency—coupled with the threat of regulatory and shareholder litigation—means that companies must walk a fine line between disclosing too much information and providing insufficient amounts, which in turn can hamper analysts’ ability to report effectively on the company’s valuation and future prospects.

True, increased disclosure can lead to increased liability, but this doesn’t mean that companies shouldn’t be making the effort. In fact, companies that are armed with a basic understanding of the law and that enforce a few simple policies can provide quality information to the market without fear of litigation.

Enforcement Of Reg. FD: Rare But Painful

Two groups monitor public company interactions with analysts: the SEC and the private plaintiffs’ bar.

The SEC primarily looks for selective disclosures. In October 2001, Regulation Fair Disclosure took effect, barring the selective disclosure of material non-public information. If a selective disclosure is intentional, then a company must make a public disclosure simultaneously. If a selective disclosure is unintentional, then the company must disclose the information to the market promptly, usually within 24 hours or before trading opens the following business morning. Public disclosure can be made by filing a Form 8-K or any other method reasonably calculated to effect broad, non-exclusionary distribution to the public.

In the past three years, the SEC has brought only six enforcement actions charging violations of Reg. FD. Of those six, only two have resulted in monetary penalties.

Siebel Systems, for example, paid $250,000 to settle claims that its CEO revealed material, non-public information at an invitation-only technology conference. Schering-Plough Corp. agreed to pay a $1 million civil penalty, and its CEO agreed to pay $50,000 as a civil penalty, to settle charges that the company released material information on two separate occasions to a select group of analysts and portfolio managers.

While the number of SEC actions seems relatively low, the threat of enforcement nevertheless remains and is real.

Litigation Impetus Of Analyst Reports

Communications with analysts can result in private class action suits charging the company with liability for the analyst’s statements.

There are generally three activities for which companies can be held liable for statements made by analysts or other third parties:

First, a company may face liability for providing false information to an analyst with the intent that the analyst will act as a conduit to release the information publicly.

Second, companies that have significant pre-publication involvement in the preparation of analyst reports may be held liable for any false information in the published report.

And finally, companies can be held liable for endorsing or adopting analyst statements after they are published.

And the costs of a securities fraud class action can be devastating: defense costs often exceed seven figures, the average settlement value in 2003 was $19.8 million, and adverse disclosures typically devalue stock price and affect investor confidence.

Tips For Street Smart Guidance

As a result, it is essential for corporate executives to manage their communications with The Street effectively, weighing the benefits of releasing more information against the costs of potential liability for alleged misstatements that may result.

Implementing and enforcing a few simple policies can safely tip the balance and promote transparency while simultaneously preserving defenses against potential litigation.

Limit Communications.

Do not provide non-public information selectively to analysts or other third-parties. Although Reg. FD allows companies and analysts to enter into confidentiality agreements, practically, the agreements serve little purpose, can potentially cause conflicts for analysts, and increase the risk of inadvertent disclosure for companies.

A better practice is to make guidance fully accessible and non-exclusionary. If non-public information will be provided to any outside source, ensure simultaneous access to the market by filing an 8-K or using another means approved to reasonably notify the public.

Evaluate Materiality.

Courts define ‘materiality’ broadly: information is deemed material if a reasonable investor would consider it important in making an investment decision. The SEC has provided a list of factors that would typically be considered material—first on the list is earnings information.

Still, there is plenty of information that companies can provide to the market that will not trigger disclosure requirements. Information that is already public, general statements of optimism, and information concerning industry-wide factors are generally not considered material under the law.

Involve Management.

Explain disclosure policies to management and all employees who communicate with outside parties. Script presentations and conference calls, and press company officials to refrain from deviating from the script. In addition, brief management before guidance is given. The more companies communicate their policies and information internally, the less likely they are to have improper disclosures made externally.

Implement A Disclosure Policy.

Every company should have a disclosure policy that limits who can speak on behalf of the company and outlines precisely what guidance the company will provide. In addition, the policy should explain how the company intends to communicate with analysts—that the company does not comment on Street expectations and does not review forecast models or edit drafts of analyst reports.

In fact, a strict policy that does not accept models or drafts can be an effective mechanism for combating claims of entanglement. Silence is a risky strategy. Plaintiffs may argue that “no comment” implies that a company has endorsed an analyst’s evaluation; a clear disclosure policy can prevent such claims from surviving.

Do Not Distribute Analyst Reports.

Companies should not provide analyst reports to investors, nor should they provide links to reports on the company website. If an investor requests a report, be sure to include an explicit disclaimer that disavows any endorsement of the analyst’s evaluation. If the company did not check the report for factual inaccuracies, be sure to note that as well.

Utilize Safe Harbor.

The Private Securities Litigation Reform Act provides a safe harbor for forward-looking statements that a company identifies as forward-looking and is accompanied by meaningful cautionary language. Companies make a big mistake when they do not utilize this provision effectively when providing guidance to the market.

Many companies repeat the same hackneyed risk factors in every public filing. Better to provide updated, relevant risk factor information that protects companies should their projections prove inaccurate. The potential impact of such disclosures on a company’s stock price are trivial in comparison to the advantages gained should companies find themselves in litigation.

Maintain Back-up Files.

Retain all communications with analysts, including notes used or taken during analyst meetings or telephone calls, all power-point presentations, scripts of conference calls, and any electronic correspondence. In addition, maintain records to support safe harbor protection. Analysts often regurgitate earnings forecasts given by management; rarely will they cite the same cautions management raised. If companies can show that adequate risk factors were provided with management’s forecasts, then they should be protected by the safe harbor.

Support Your Guidance.

Companies must have a reasonable basis for making all projections. The ability to demonstrate with tangible evidence that a reasonable basis existed at the time a forecast was made is crucial to defeating claims of securities fraud. Maintaining files that document support for all financial forecasts will prove invaluable if companies are ever forced to defend a securities fraud class action.

Implement A Document Retention Policy.

An unambiguous and consistently applied document retention policy is an excellent way to cut costs and prevent liability. Companies that are not under investigation or defending a lawsuit will not be penalized for destroying documents in compliance with a document retention policy. On the other hand, purging files when a regulatory investigation or shareholder lawsuit is imminent can result in severe criminal and civil sanctions.

Public companies need to remain cautious, particularly as they strive to increase the amount of information released to the Street. With relatively small effort, a company can greatly enhance the potential for success should the SEC or plaintiffs’ lawyers come knocking.

This column solely reflects the views of its authors, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

What did you think of this column? If you'd like to react or respond, we urge you to write a letter to the editor.

Topics