Did Netflix CEO's Facebook Post Violate Reg. FD?

When is a Facebook status update from a corporate CEO a dissemination of material non-public information? How about when it pushes the stock price up 13 percent, adding $542 million in market value in one day?

Those are questions that Netflix and its CEO, Reed Hastings, are currently grappling with. Last Tuesday after the market closed, Hastings used one of his three personal Facebook accounts to share the following missive: “Congrats to Ted Sarandos, and his amazing content licensing team. Netflix monthly viewing exceeded 1 billion hours for the first time ever in June. When ‘House of Cards' and ‘Arrested Development' debut, we'll blow these records away. Keep going, Ted, we need even more!”

The next trading day after the July 4th holiday, the stock jumped from $72 to more than $81 as traders digested the news. Now some are questioning if Hastings' Facebook post violated the Securities and Exchange Commission's Regulation Fair Disclosure (Reg. FD) rule, which prohibits selective disclosure of material non-public information.

A challenge for corporate leaders in the age of social media is pinning down the distinction between permissible executive chatter and official company communications that must adhere to the compliance demands of fair disclosure rules.

Reg. FD was added to the books in 2000 as a way to ensure that companies weren't picking and choosing insiders and favored analysts to communicate potentially market-moving news. In theory, it is meant to ensure that all investors get full and relevant information, rather than having it disclosed piecemeal or to a select group.

Hastings' Facebook post raises numerous questions: How many Facebook friends are needed to pass the threshold to be considered as a “recognized channel” and are a CEO's followers a select subset of investors that could be considered insiders? Even if the statement was made on the company's own Facebook page, would that information channel satisfy regulators the same way a traditional, widely circulated press release would have? Does the stock spike mean that the company should react accordingly with a prompt, “official” release, something it had not done as of Monday? Is promising to “blow these records away” ahead of quarterly earnings later this month crossing a line for Netflix into pumping up the stock?

These questions, and others, underscore the challenges of navigating the new playing field created by sites like Facebook, LinkedIn, Twitter, and StockTwits. And Hastings isn't alone in getting tripped up by them. In May, Gene Morphis, the CFO of the women's retailer Francesca Holdings, was fired after posting in March potentially “non-public” company information on Twitter. He wrote: “Board meeting. Good numbers=Happy Board.”

As conversational and generic as the tweet may have appeared, the company saw the post as a violation of Reg. FD that was likely attracting unwanted attention from the SEC, especially as it took place in the quiet period prior to earnings. The company learned that Morphis repeatedly made similar announcements, even though his Twitter account was unofficial and not well known to the larger community of investors.

Communications by company leaders on social media could open a new area for the SEC to focus a rule that has rarely resulted in enforcement actions. The SEC has brought actions under Reg. FD against just 11 companies and 12 associated individuals since 2000; none have been related to social media. In the 2005 case of SEC v. Siebel Systems Inc., a judge rejected the SEC's claim that dinner party conversation by executives constituted the selective disclosure of material non-public information. The case was dismissed on the grounds that the shared information lacked the specificity needed to prove a violation of the regulation.

ALTERNATIVE METHODS OF PUBLIC DISCLOSURE

Below is an excerpt from the SEC's final rule on selective disclosure regarding alternative methods for disclosure.

We are recognizing alternative methods of public disclosure to give issuers the flexibility to choose another method (or a combination of methods) of disclosure that will achieve the goal of effecting broad, non-exclusionary distribution of information to the public.

As a general matter, acceptable methods of public disclosure for purposes of Regulation FD will include press releases distributed through a widely circulated news or wire service, or announcements made through press conferences or conference calls that interested members of the public may attend or listen to either in person, by telephonic transmission, or by other electronic transmission (including use of the Internet). The public must be given adequate notice of the conference or call and the means for accessing it. The regulation does not require use of a particular method, or establish a "one size fits all" standard for disclosure; rather, it leaves the decision to the issuer to choose methods that are reasonably calculated to make effective, broad, and non-exclusionary public disclosure, given the particular circumstances of that issuer. Indeed, we have modified the language of the regulation to note that the issuer may use a method "or combination of methods" of disclosure, in recognition of the fact that it may not always be possible or desirable for an issuer to rely on a single method of disclosure as reasonably designed to effect broad public disclosure.

We believe that issuers could use the following model, which employs a combination of methods of disclosure, for making a planned disclosure of material information, such as a scheduled earnings release:

First, issue a press release, distributed through regular channels, containing the information;

Second, provide adequate notice, by a press release and/or Website posting, of a scheduled conference call to discuss the announced results, giving investors both the time and date of the conference call, and instructions on how to access the call; and

Third, hold the conference call in an open manner, permitting investors to listen in either by telephonic means or through Internet Webcasting.

By following these steps, an issuer can use the press release to provide the initial broad distribution of the information, and then discuss its release with analysts in the subsequent conference call, without fear that if it should disclose additional material details related to the original disclosure it will be engaging in a selective disclosure of material information. We note that several issuer commenters indicated that many companies already follow this or a similar model for making planned disclosures.

In the Proposing Release, we stated that an issuer's posting of new information on its own Website would not by itself be considered a sufficient method of public disclosure. As technology evolves and as more investors have access to and use the Internet, however, we believe that some issuers, whose Websites are widely followed by the investment community, could use such a method. Moreover, while the posting of information on an issuer's Website may not now, by itself, be a sufficient means of public disclosure, we agree with commenters that issuer Websites can be an important component of an effective disclosure process. Thus, in some circumstances an issuer may be able to demonstrate that disclosure made on its Website could be part of a combination of methods, "reasonably designed to provide broad, non-exclusionary distribution" of information to the public.

We emphasize, however, that while Rule 101(e) gives an issuer considerable flexibility in choosing appropriate methods of public disclosure, it also places a responsibility on the issuer to choose methods that are, in fact, "reasonably designed" to effect a broad and non-exclusionary distribution of information to the public. In determining whether an issuer's method of making a particular disclosure was reasonable, we will consider all the relevant facts and circumstances, recognizing that methods of disclosure that may be effective for some issuers may not be effective for others. If, for example, an issuer knows that its press releases are routinely not carried by major business wire services, it may not be sufficient for that issuer to make public disclosure solely by submitting its press release to one of these wire services; the issuer in these circumstances should use other or additional methods of dissemination, such as distribution of the information to local media, furnishing or filing a Form 8-K with the Commission, posting the information on its Website, or using a service that distributes the press release to a variety of media outlets and/or retains the press release.

We also caution issuers that a deviation from their usual practices for making public disclosure may affect our judgment as to whether the method they have chosen in a particular case was reasonable. For example, if an issuer typically discloses its quarterly earnings results in regularly disseminated press releases, we might view skeptically an issuer's claim that a last minute Webcast of quarterly results, made at the same time as an otherwise selective disclosure of that information, provided effective broad, non-exclusionary public disclosure of the information. In short, an issuer's methods of making disclosure in a particular case should be judged with respect to what is "reasonably designed" to effect broad, non-exclusionary distribution in light of all the relevant facts and circumstances.

Source: SEC.

W. Randy Eaddy of Kilpatrick Townsend & Stockton says that “social media is not recognized by the SEC as constituting public dissemination channels for Reg FD purposes, although he sees “potentially strong arguments that it should be.”

Last month, his firm delved further into the topic with a client advisory on its Website. “The exploding popularity of social media—with its temptations to make flippant and less than thoughtful comments, even though they are blasted out to a universe of recipients—should make public companies and their employees leery of using such channels to say anything about their companies,” the firm wrote.

Brian Wassom, a commercial litigator in Southeast Michigan and chair of the Social, Mobile, and Emerging Media Practice Group at the law firm Honigman Miller Schwartz and Cohn, cited 2008 guidance issued by the SEC that suggests corporate Websites can potentially qualify as a vehicle for public release under Reg. FD, “if the Website is recognized by the public and media as a channel of distribution, and it actually provides such information in a public manner,” he wrote in a blog post.

‘No Clear Guidance'

“But Websites are passive resources that a user must visit, as opposed to the more proactive nature of social media sites, which ‘push' information into a user's news feed,” he says. “Therefore, there is no clear guidance on whether and how social media sites can be compliant means of distributing financial information.”

That a company may be inclined to selectively post only positive information about itself on social media, could create an obstacle for the SEC approving them as distribution channels under Reg FD. “Often, the employees responsible for posting to social media are not trained in regulatory compliance,” Wassom says “They may need to be trained, and perhaps monitored, by counsel. Companies that engage in social media, especially if they do so for investor relations purposes, should consider evaluating and updating their insider training and corporate communication policies in light of the unique opportunities and challenges that these sites present.”

Amy Greer, a partner with law firm Reed Smith, says she initially focused on whether a CEO's Facebook page can be a recognized channel for reaching investors. She thinks the more relevant question, specifically regarding Netflix, is the nature of what was posted.

“The gist of the post was about how great their content is now and that they are getting more people to watch,” she says. “You sort of wonder whether the information that was in that post was something that would require an 8-K in the first place. I wont deny the fact that this bit of good news was helpful to their stock price. But the question is whether every bit of good news that a company experiences is something that warrants the filing of an 8-K.”

Large or exclusive contracts that might have a material impact on a public company's bottom line would fall into the realm of traditional 8-K announcements, Greer says. Had Netflix announced an increase in subscriber numbers, that would lead to the need for disclosure more clearly than merely crossing a viewing threshold for the customer base it has clearly accounted for.

“This seems to me to be in the realm of the kind of stuff you would expect from Netflix, the same as a supermarket serving its millionth customer or any of those kinds of things,” she says. “It is just on a grander stage.”

“Is it something the SEC might look into anyway? Maybe,” Greer adds. “But only because they have had so many tugs and pushes at what is an appropriate and recognized channel for disclosing information. I suspect that this is chasing a sprite, really. [Regulators] are never really going to catch up with the changes to technology. Good for them if they keep trying, but I suspect that it is never going to be perfect. Attempting to capture for all of the different types of companies what is the type of news that requires [the disclosure] of either good or bad news is difficult to identify around the edges.”