Disclosure And Reg. FD In The Post-Flowserve Era

Frank MacInnis, the chairman and CEO of $4.8 billion EMCOR Group, recalls speaking at a conference a few weeks after the Securities and Exchange Commission handed down its decision in the case against Flowserve Corporation for violating Regulation Fair Disclosure. When asked a question about earnings guidance, MacInnis gave a deadpan delivery of the boilerplate language he is required to use when reiterating previously issued earnings guidance, drawing understanding laughter from the audience.

MacInnis

In MacInnis’s view, his routine at the conference summed up the state of investor relations as companies tighten up their efforts to comply with Reg. FD in the wake of the Flowserve decision. Reg. FD requires companies to disclose material information to all investors simultaneously, or to do so promptly if a disclosure is unintentional.

“We spend more time than necessary on carefully scripted and largely inconsequential communications with investors, making these meetings a waste of time for both sides,” says MacInnis. And as a result, the value of the communications has decreased. “Many investors are just going through the motions and don’t expect to get much of anything from these meetings because they understand the restrictions we are under.”

In fact, MacInnis turns down many opportunities to speak at investor conferences because he's ostensibly limited to repeating verbatim information that is in the company's most recent periodic report. “I am concerned that these meetings end up focusing on inconsequential things instead of matters of real substance.”

The Flowserve Effect

If Reg. FD had a chilling effect on the quantity and quality of communications between companies and the investment community, the Flowserve decision—in which the SEC found that the company violated Reg. FD by reaffirming a previous earnings guidance in a private meeting with securities analysts—seems to have cooled the dialogue a few more degrees.

Although companies have been complying with Reg. FD for nearly five years, the Flowserve decision seems to be a watershed moment for companies as they step up Reg. FD-related training and tread even more cautiously in discussions with analysts and shareholders.

However, whether companies will eliminate these types of meetings or stop issuing earnings guidance altogether remains to be seen. A survey of 527 companies released by the National Investor Relations Institute in March found that the percentage of companies providing earnings guidance declined from 77 percent to 71 percent in just over a year, while the percentage providing quarterly guidance declined from 75 percent to 61 percent (see study titled "Focusing On The Long Term," at right).

“There have been some questions about whether to issue earnings guidance at all,” says Gaston Kent, vice president of investor relations with Northrop Grumman Corporation, the $29.9 billion aerospace and defense contractor. “But companies almost have to issue guidance because that is your protection” when complying with Reg. FD.

Far from encouraging Northrop Grumman to discontinue earnings guidance and one-on-one meetings, “the Flowserve decision caused us to pay closer attention to timelines,” says Kent. That means knowing exactly what the company has disclosed, when, and in what forum, and how those disclosures might change over time. Northrop Grumman has already made it a practice to issue press releases about what will be discussed whenever company representatives meet one on one with investors or analysts. “We are not doing anything differently in those meetings and conversations,” says Kent. “But we are putting out more press releases.”

Curtis

Although the requirements of Reg. FD are clear, “where companies can get into trouble is treating one-on-one meetings differently than conference calls,” says Chris Curtis, vice president with investor relations firm Ashton Partners in Chicago. He emphasizes the importance of using the same presentation used in public meetings during one-on-one meetings, with an added disclaimer that the information in the presentation is not an update or reaffirmation of previously disclosed information.

Managing Disclosure

Compliance with Regulation Fair Disclosures, and the implications of the Flowserve decision, are causing some companies to increase Reg. FD-related training to eliminate the potential for future problems.

Feigin

Juniper Networks, for example, a $1.3 billion technology company based in Sunnyvale, Calif., has expanded its Reg. FD training beyond the senior management team, so that more individuals who might have material information about the company or its products do not violate Reg. FD unwittingly. “This includes new executives, members of the sales force, product marketing executives who are hosting roundtables about product offerings, or anyone else who could be a company spokesperson,” says Randi Paikoff Feigin, the company’s vice president of investor relations. “In some situations, even a salesperson becomes a spokesperson.”

The training at Juniper includes specific dos and don’ts about what individuals can and can’t talk about. “By no means can they talk about earnings guidance,” says Feigin. “We have become much more strict on that language since the Flowserve case. We need to educate and remind people of that when they don’t handle these issues on a daily basis.” For example, when the company was preparing to participate in a major trade show, Feigin went through the rules with the individuals who would be working in the company’s booth and could be taking questions about the company’s products. “They needed to find out who they were talking to in all cases and they needed to understand what information is material,” she says.

In some cases, Reg. FD has affected what kind of information companies disclose to their own employees. MacInnis at EMCOR Group notes that Reg. FD requirements limit his ability to discuss how the company is doing, and its strategies and overall direction. “People want to be informed and involved, but I still have to tread carefully in those conversations,” says MacInnis.

Feigin at Juniper Networks agrees with MacInnis' comments. “We have to treat employees the same way as shareholders and only tell them what is publicly available,” she says. “The content of employee communications is scrubbed to make sure all of that information is already out in the public domain.” For example, the company cannot share information like product segmentation analyses, because that information could be material and wouldn’t be available to the public. “We can’t communicate the level of detail that we did before Reg. FD,” says Feigin.

Disclosure Committees

Thompson

When it comes to Reg. FD compliance, investor relations executives are front and center. “The Flowserve decision made it clear that the SEC considers investor relations executives to be the chief compliance officer when it comes to Reg. FD,” says NIRI President Louis Thompson Jr. “They must be the expert on Reg. FD and what the company can and cannot do.”

But most companies have established working groups or committees to assist or in some cases handle disclosure-related issues. The establishment of a "disclosure committee" has been recommended, but not mandated, by the SEC.

Cole

Myogen, a small biopharmaceutical company based in Westminster, Colo., has established such a committee that reviews all company disclosures for materiality. Myogen's committee meets as needed and is made up of the CEO, CFO, controller, the director of investor relations, and the heads of its business divisions. Other individuals in the company are included in the group as needed, including the heads of commercial development and research and the regulatory general counsel. An added benefit to this approach is that the committee “also helps to make sure that senior management is looking at long-term strategic communication issues,” says Derek Cole, the company’s director of investor relations.

As a small cap company, Cole believes Myogen must tread especially carefully when conducting one-on-one meetings because above-normal trading activity can have a much greater affect on stock performance. “The SEC’s perception of that activity worries us the most, so we make sure we stick to scripted responses during these meetings,” says Cole. After all, an investor acting on information from a meeting, even if that information has not been improperly disclosed, could still create trading activity outside the norm and catch the SEC’s attention.

Peters

Aftermarket Technology Corp., a $395.6 million auto parts company based on Downers Grove, Ill., relies on a similar compliance group made up of its CEO, CFO, corporate controller, general counsel, and vice president of investor relations to plan and manage disclosure. “We have a comprehensive policy on how to deliver market moving information,” says Todd Peters, the company’s CFO.

According to Peters, the group scripts answers to potential questions that might be asked during conference calls, investor conferences, or one-on-one meetings. Once those meetings are over, the group reviews what was said during these Q&A sessions to make sure the company revealed no material information that had not previously been disclosed. “It is all about preparation,” says Peters.

This group at Aftermarket Technology also helped the company navigate some unique Reg. FD-related challenges when the company made a new stock offering earlier this year to replace 30 percent of the company owned by a private equity firm. “We wanted to attract investors for those shares and we had to craft our story for the market,” says Peters. Doing so was difficult, however, because the management team could not disclose information about the company to new and potential investors that was not already available in the public domain.

“We needed to communicate our message consistently among new and existing shareholders who do not have the same level of knowledge about the company or its business,” says Peters. For example, the company’s existing shareholders tend to ask more probing questions during conference calls, even though the management team has to stick to its prepared script for those conversations. The management team then used those questions and concerns to craft the company’s investor relations message that it could share with all shareholders. “If something is a concern to an existing shareholder, it is also likely to be a concern to new shareholders,” says Peters. The management team addressed those issues in future Q&A scripts and press releases in order to provide that information within the compliance requirements of Reg. FD.

Tension With Wall Street

Inevitably, Reg. FD has created some tension in relationships between Wall Street and public companies. After all, companies must abide by the requirements of Reg. FD or face severe penalties, but Wall Street analysts and investors face no sanctions if they manage to get an executive to provide previously undisclosed material information. “Three weeks before an earnings announcements, analysts still call to ask how things look,” says NIRI’s Thompson. “There is no liability for them to ask that kind of question and they are still trying to get a wink or a nod or some body language that will tell them something.”

At least one institutional investor has even trained its analysts on how to read executives’ body language during meetings and one-on-one conversations in an effort to glean information on which to trade. “They still try to get you to flinch because it will be the company that gets in trouble, not them,” says Feigin of Juniper Networks. “It’s very frustrating.”

At the same time, companies, particularly smaller ones, cannot afford to scale back on the information they disclose, lest they lose analyst coverage. “If a large company like Microsoft scales back on what it says to analysts and investors, that would have no impact on its ability to attract analyst coverage,” says Myogen’s Cole. “We need to gain analyst attention by reaching out to the business community. Analysts don’t have to cover small cap companies.”

Murphy

Even if a company does not disclose material information, there is still plenty to talk about with analysts and investors—investor communication goes well beyond what is material. “We discuss the company’s strengths, strategy, discovery and development efforts, and areas where we are building competency,” says Pamela Murphy, vice president of investor relations and corporate communications with druge discovery and development firm Incyte Corp. “It is fairly clear what is material and not material at this point.”

But, while complying with Reg. FD is obviously important, practitioners say too much emphasis on compliance can get in the way of effective communication. “As companies comply with the letter of the law, they should not forget context,” says Curtis of Ashton Partners. “It is still important to package information so that the market can see what and how the company is doing.” For example, if the company is going to close facilities, the company can provide information about the closing and why it is happening.

And though it has its complexities, Thompson at NIRI argues that—from a compliance perspective—Reg. FD has been a success. That's because, even though companies hold thousands of conversations with investors and analysts every year, there have been only about 70 enforcement cases related to Reg. FD—only six have resulted in enforcement actions. “Reg. FD has leveled the playing the field so that investors and analysts are getting the same information in a nonselective way,” he says.

Related coverage of Reg. FD issues, studies, guidelines, and commentary are available from the box above, right.