The Securities and Exchange Commission last month for the first time found that a company violated Regulation Fair Disclosure by reaffirming a previous earnings guidance in a private meeting with securities analysts.
Regulation FD prohibits issuers from selectively disclosing material, nonpublic information to securities analysts, broker-dealers, investment advisers and institutional investors before disclosing the same information to the public.
In announcing that Flowserve Corp. had agreed to pay a $350,000 civil penalty to settle the charges, the Commission also cited the company’s lack of cooperation with SEC staff. The company’s chief executive officer, C. Scott Greer, agreed to pay a $50,000 penalty.
“Issuers cannot pick and choose the recipients of material information,” said Paul Berger, associate director of the SEC’s Division of Enforcement. “If issuers disclose material information to market professionals, then Regulation FD requires that they disseminate the same information to the marketplace.”
Berger told Compliance Week that the company’s lack of cooperation with the Commission involved initial denials by CEO Greer and Michael Conley, the company’s director of investor relations, that a reaffirmation had occurred at the private meeting with analysts. Berger declined to speculate as to what impact the denials had on the SEC’s consideration of the matter.
Landefeld
Stewart Landefeld, a securities lawyer with Perkins Coie in Seattle, said the lack of cooperation may have resulted in a larger penalty for the company. “Clearly something happened to anger the SEC. [The penalty was] larger than it probably would have been if the SEC hadn’t felt there was a failure of cooperation,” he said.
The Flowserve case highlights the fact that “private discussions with analysts are very dangerous territory. They’re the no-man’s-land that the SEC talked about when first proposing [Regulation FD],” said Landefeld, who noted that—had the Commission tried the Flowserve case rather than settling—the SEC would have likely “used an FD failure like this as evidence of failure of internal controls. Here, the company had the correct policy and yet failed in some way to follow that policy.”
Earnings Guidance Reaffirmed
Flowserve, an Irving, Texas-based maker of pumps, valves and mechanical seals, began 2002 forecasting annual earnings per share in the range of $1.90 to $2.30. In July 2002, however, the company revised that estimate to $1.70 to $1.90 per share. On Sept. 27, Flowserve lowered its earnings estimate to $1.45 to $1.55 per share, which the company reaffirmed in its Form 10-Q filed on Oct. 22, 2002. The $1.45 to $1.55 range represented more than a 30 percent decline in earnings per share estimates since the beginning of the year.
On Nov. 19, 2002, 42 days before the end of Flowserve’s fiscal year, CEO Greer and investor relations director Conley met with securities analysts. At the meeting, one of the analysts asked about the Flowserve’s earnings guidance for the year, according to the SEC. Neither Conley nor Greer gave the response required by the company’s policy—that the earnings guidance was effective on the date given and would not be updated until the company made a public announcement. The SEC said that Conley did not caution Greer before Greer answered the analyst’s question and that Conley remained “altogether silent.” In response to the question, Greer reaffirmed the Oct. 22 public guidance and thus “provided additional material nonpublic information,” the Commission stated.
The following day, an analyst who attended the meeting issued a report stating that Flowserve had reaffirmed its earnings guidance. On Nov. 21, Flowserve’s closing stock price was some 6 percent higher than the closing price the day before. In addition, the trading volume of Flowserve’s stock increased by 75 percent. After the market closed on Nov. 21, Flowserve filed a Form 8-K with the Commission acknowledging that it had “reaffirmed its full year 2002 estimated earnings per share.”
The Commission charged Flowserve, Greer and Conley with violations of Reg. FD and Section 13(a) of the Securities Exchange Act of 1934. Without admitting the Commission’s allegations and findings, the company and Greer consented to the entry of a final judgment in federal court that would require them to pay civil penalties totaling $400,000 and result in the issuance of a cease-and-desist order.
In a prepared statement, Flowserve said it was eager to resolve the matter so it could concentrate on its business operations. "The company and its officers and directors continue their commitment to the objective of Regulation FD—full and fair disclosure to all members of the investing public," the press release stated.
Siebel Challenging Constitutionality Of Reg. FD
The Flowserve case is the first in which the SEC has brought an enforcement action in which an executive, in a private setting, has said there is no change to projections, said Landefeld of Perkins Coie. He said the handful of prior Reg. FD enforcement actions have involved private statements involving changes to projections.
The largest penalty to date was paid by Schering-Plough Corp., a pharmaceutical company, which agreed in September 2003 to pay a $1 million to settle the SEC’s allegations that the company had disclosed to analysts in private meetings negative and material, nonpublic information regarding Schering’s earnings prospects.
The SEC has twice charged Siebel Systems Inc., a software company based in San Mateo, Calif., with violations of the fair disclosure rule. Siebel agreed in November 2002 to pay a $250,000 penalty to resolve one of the cases.
The second complaint, filed by the Commission in June 2004, is still pending. In that case, Siebel is challenging Regulation FD in the U.S. District Court for the Southern District of New York on ground that it violates free speech rights guaranteed by the U.S. Constitution. A hearing was held in the case in March before Judge George Daniels. A group of nearly two dozen prominent law professors have filed a friend-of-the-court brief supporting the SEC’s authority to promulgate Regulation FD.
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