Greater Public Disclosure, Other Tips to Dodge Reg FD

The Securities and Exchange Commission provided some long-overdue guidance in August about proper interpretations of Regulation Fair Disclosure—the first interpretive guidance for Reg FD since the rule went into effect in 2000. It’s a must-read for investor relations and corporate communication officers as well as corporate counsel.

To my thinking, no rule affects the day-to-day lives of investor relations officers more than Reg FD, especially when one remembers that in the landmark SEC enforcement against Flowserve Corp. in 2005, the IRO was cited and fined along with Flowserve’s chief executive for violating the rule. The pair met with a small group of analysts, and the director of investor relations remained silent while his CEO reaffirmed previously disclosed earnings guidance near the end of the company’s reporting period.

The SEC said because the company had been revising its earnings estimates downward over the course of the year, reaffirming the previous guidance was considered selective disclosure of material, non-public information—exactly what Reg FD prohibits. The CEO was fined $350,000, the IRO, $50,000.

The lesson here is that the IRO or someone else intimately familiar with the company’s disclosure record should be present at any meeting with analysts or investors, to put their foot on the brake if a company spokesperson unintentionally starts to reveal material, non-public information. (Or if that information is revealed, then promptly issue a news release or file a Form 8-K containing the information.)

So what has changed in the last nine years since Reg FD went into effect? Start with the SEC’s primary concern in creating the rule: to stop company officials from selectively disclosing earnings information and guidance to certain analysts as a way to curry favorable coverage and relationships. In a 1998 speech before the New York chapter of the Financial Executives Institute, then-SEC Chairman Arthur Levitt declared war on the “game of winks and nods” between company officials and selected analysts over earnings-related information; the SEC’s initiative to create Reg FD was launched.

Clearly, in the context of the rule, the SEC said that anytime a company executive covered by the rule engaged in a one-on-one discussion about earnings, that person was in jeopardy of violating the rule. This decade has seen the number of sell-side analysts and the number of companies providing earnings guidance both plunge, cutting off a valuable source of earnings information. That has caused an increase in the number of institutional investors demanding greater access to senior management through one-on-one meetings. These meetings are ripe for selective disclosure if company officials are not careful.

Done right, however, such meetings can also be opportunities to communicate important public information about the company’s strategy to enhance shareholder value, along with a discussion of non-financial and financial performance measures that are either non-material or have been publicly disclosed if they are material. And these one-on-ones are a valuable way for investors to get a sense of the quality of management—a key factor in making an investment decision and one that isn’t covered by Reg FD because it’s a perceptual conclusion on the part of the investor.

To avoid the risk of selective disclosure, companies would be wise to issue as much material information as possible through earnings releases, annual reports, management speeches and presentations at investor conferences, the company’s Website, and SEC filings (Forms 10-K, 10-Q, and 8-K). By expanding public disclosure of material information, company officials have greater latitude in discussing issues and factors affecting company performance in one-on-one meetings.

Obviously, institutional investors are looking for information that will give them an investment edge over competitors. Using the “mosaic theory,” they can assemble information from the company and from their other sources and come to a material conclusion, so long as they are not using material, non-public information from the company.

By expanding public disclosure of material information, company officials have greater latitude in discussing issues and factors affecting company performance in one-on-one meetings.

The other major factor that has changed since Reg FD went into effect is the SEC’s expanded permission to let a company Website serve as a vehicle for full disclosure. Companies can now use their Website for issuing earnings releases if they believe that method is sufficient to reach a broad range of investors. When Reg FD was first adopted, the only reference to the company’s Website was to allow a fully accessible conference call or investor presentation to be a real-time means for full disclosure if proper notice was provided to investors.

The SEC’s new guidance arrives in the form of question-and-answer content published in its latest batch of Compliance and Disclosure Interpretations, which are published on the SEC’s Website to illuminate agency thinking on a variety of issues. The Reg FD guidance addresses both timing of a proper notice and availability of information following a live call or presentation. In that context, the SEC urges companies to put a transcript of the Webcast on its site and tell investors how long the record will be retained there.

Here are some of the C&DI highlights:

An issuer can selectively confirm a previous public forecast so long as the confirmation does not convey information above and beyond the original forecast and whether that additional information is material. One must also consider the timing of the confirmation. To do so near the end of a reporting period might indicate the company’s actual performance. That could constitute a material disclosure, triggering the rule’s public reporting requirements. A statement that the forecast “has not changed” or “we’re still comfortable with the prior forecast” is the same as a confirmation.

Reg FD itself does not create a duty to update, as the rule does not change existing law regarding a duty to update.

While some securities lawyers discourage companies from reviewing or commenting on draft analyst reports, the SEC says that you may do this so long as you don’t convey material non-public information in the process. Sticking to correcting historical facts is a relatively safe practice. It would not be a violation of Reg FD for the reviewer to share “seemingly inconsequential data which, pieced together with public information by a skilled analyst with knowledge of the issuer and the industry, helps form a mosaic that reveals material non-public information.”

An issuer may provide material non-public information to analysts and investors so long as there is a confidentially agreement that they will not use the information until the issuer makes it public.

An issuer may disclose material non-public information to employees (even if they are company shareholders) without disclosing the information publicly.

If an issuer has a disclosure policy that limits which senior officers are authored to speak for the company, disclosures by unauthorized senior officers are not subject to Reg FD; they could, however, be subject to existing insider-trading law.

An issuer need only confirm that material non-public information contained in a filing or furnished report has been accepted and is publicly available on EDGAR before discussing it in a non-public meeting.

A company official covered under Reg FD cannot, in response to questions in a non-public meeting, intentionally convey material non-public information believing that a follow-up release of that information would avoid a Reg FD violation. An intentional disclosure is when the official either knows or is reckless in not knowing that the information is both material and non-public.

The presence of the media at a non-public meeting does not protect a company official from violating Reg FD if that person discloses material non-public information.

There are other issues addressed in the interpretations of Reg FD, and anyone in a company who is responsible for disclosure issues and policy should carefully read and understand the August C&DIs.

To put Reg FD in perspective, the rule has been in force for almost nine years with only seven enforcement actions, one of which was overturned by a federal district court judge. Those who opposed the adoption of Reg FD expressed grave concern that companies would substantially reduce their disclosures. This did not happen, according to Harvard Business School professor Paul Healy.

In his 2007 paper “How Did Regulation Fair Disclosure Affect the U.S. Capital Market? A Review of the Evidence,” he said: “Overall, the findings suggest that Reg FD was accompanied by an increase in public disclosure by managers and a decline in the value of sell-side analyst information. However, there was little discernable change in investor behavior. The findings suggest that regulator concerns about weakened investor confidence from selective management disclosure and critics concern about the impact of the new rules on market information were both over-stated.”