SEC Enforces Reg FD on ‘Winks and Nods’

Regulation Fair Disclosure, the rule aimed at preventing private leaks of sensitive information about public companies, has just startled corporate compliance departments yet again.

The Securities and Exchange Commission’s recent enforcement action against Office Depot for a Reg FD violation (its third within the last 14 months) dinged the company’s CEO and CFO for selectively sharing information with analysts and institutional investors in 2007 that earnings might not be where the market had been expecting. Nothing new there. But how the executives dropped hints—via oblique references to a slowing economy and stumbling rivals—has just painted another swath of gray across compliance departments’ already murky world.

The two executives, CEO Stephen Odland and former CFO Patricia McKay, each agreed to pay a $50,000 penalty, and Odland resigned his position just four days after the announcement. Office Depot itself agreed to pay a $1 million settlement with the SEC.

Day

Reg FD actions are still fairly rare; one tally puts the number of settled cases at only nine across the rule’s entire 10 years of existence. “There are relatively few enforcement cases and a lot of gray areas, so any kind of guidance on Reg FD is helpful to provide a framework around what’s permissible and what’s not,” says Jason Day, a partner at Faegre & Benson.

The SEC did bring Reg FD enforcement actions against Presstek Corp. and its former CEO in March, and it sued the former CFO of American Commercial Lines in September 2009, although it took no action against the company. But the Office Depot case stands out because the enforcement action dealt with implied, rather than direct, statements—what former SEC chairman Arthur Levitt once called a numbers game of “winks and nods.”

According to the SEC settlement, near the end of the second quarter for 2007, Odland and McKay discussed how to talk down analysts’ earnings projections. McKay helped the investor relations staff prepare talking points for a series of one-on-one calls to analysts. During those calls, the company didn’t say it would miss expectations, but signaled as much with references to statements by comparable companies about the effect of the slowing economy on their earnings and reminded analysts of Office Depot’s own prior cautionary public statements.

Analysts promptly lowered their estimates, and Office Depot’s share price dropped. The company later filed a Form 8-K announcing that sales and earnings would suffer due to a continued soft economy.

Thomsen

Linda Chatman Thomsen, a partner at the law firm Davis Polk & Wardwell and former SEC enforcement director, says the action is “a reminder that you can’t do indirectly what you can’t do directly.” In other words, she says, “If you’re trying to do something that seems like it violates the law, it probably does.”

Get It in Writing

“If you’re trying to do something that seems like it violates the law, it probably does.”

—Linda Chatman Thomsen,

Partner,

Davis Polk & Wardwell

So how do you avoid that sort of trouble? First and foremost, have a clear, written Reg FD compliance policy in place—which Office Depot didn’t. While most companies have a policy, observers say they probably haven’t looked at it lately. “This is a great excuse for a Reg FD refresher,” Day says. “If you already have policy, open it up and see if it’s up-to-date.”

Experts say a good policy should address implied statements as well as the latest SEC staff guidance on Reg FD. The staff issued a compliance-and- disclosure interpretation related to Reg FD in June that specifically addresses ramifications of private conversations with shareholders, and suggests steps companies can take to avoid violations. Several other C&DIs were published in August 2009.

Day says companies may need to tweak their existing policies to make more explicit what’s allowed and what’s not. In particular, companies should look at how their policy treats one-on-one communications with analysts as well as communications made near the end of the quarter, which carry higher risk of violating Reg FD.

Quinlivan

OFFICE DEPOT SETTLES

The following excerpt is from the Securities and Exchange Commission press release on Office Depot’s settlement over Reg FD charges:

The Securities and Exchange Commission today announced enforcement actions against Office Depot, Inc. and two executives for violating or causing violations of fair disclosure regulations when selectively conveying to analysts and institutional investors that the company would not meet analysts’ earnings estimates. The SEC also charged Office Depot with unrelated accounting violations.

Regulation FD requires that when issuers disclose material nonpublic information, they must make broad public disclosure of that information. The SEC’s orders find that as they neared the end of Office Depot’s second quarter for 2007, CEO Stephen A. Odland and then-CFO Patricia A. McKay discussed how to encourage analysts to revisit their analysis of the company. Office Depot then made a series of one-on-one calls to analysts. The company did not directly state that it would not meet analysts’ expectations, but rather this message was signaled with references to recent public statements of comparable companies about the impact of the slowing economy on their earnings. The analysts also were reminded of Office Depot’s prior cautionary public statements. Analysts promptly lowered their estimates for the period in response to the calls. Office Depot did not regularly initiate these types of calls to all analysts covering the company.

Office Depot agreed to settle the SEC’s charges without admitting or denying the findings and allegations, and will pay a $1 million penalty. Odland and McKay also agreed to settle the Regulation FD charges against them without admitting or denying the findings, and will pay $50,000 each.

“Office Depot executives selectively shared information with analysts and the company’s largest shareholders in order to manage earnings expectations,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “This gave an unfair advantage to favored investors at the expense of other investors and, as today’s action shows, is illegal.”

“Talking Wall Street down from its earnings projections whether done expressly or through signals is prohibited,” said Eric I. Bustillo, Director of the SEC’s Miami Regional Office. “Regulation FD is designed to level the playing field so that all investors receive the information at the same time.”

The SEC’s administrative orders find that Odland, in an attempt to get analysts to lower their estimates, proposed to McKay that the company talk to the analysts and refer them to recent public announcements by two comparable companies about their financial results being impacted by the slowing economy. Odland further suggested that Office Depot point out on its calls what the company had said in prior public conference calls in April and May 2007. McKay then assisted Office Depot’s investor relations personnel in preparing talking points for the calls.

According to the SEC’s orders, Odland and McKay were not present during the calls but were aware of the analysts’ declining estimates while the company made the calls. They encouraged the calls to be completed. Office Depot continued to make the calls despite McKay being notified of some analysts’ concerns about the lack of public disclosure among other things. Six days after the calls began, Office Depot filed a Form 8-K announcing that its sales and earnings would be negatively impacted due to a continued soft economy. Before that Form 8-K was filed, Office Depot’s share price had significantly dropped on increased trading volume.

In addition to their $50,000 payments, Odland and McKay consented to the entry of administrative orders requiring them to cease and desist from causing any violations and any future violations of Regulation FD and Section 13(a) of the Exchange Act.

Source

SEC Press Release on Office Depot (Oct. 21, 2010)

“Most of the Regulation FD enforcement cases have been related to private conversations with analysts,” notes Stephen Quinlivan of Leonard Street & Deinard. “Whenever you have one-on-one conversations like that, you’re on thin ice.”

Companies should also consider having one-on-one calls from CEOs and CFOs to analysts or large institutional investors monitored by legal staff. “Counsel may want to chaperone those calls,” says Day. Companies may also want to think about instituting a “quiet period” that bars executives from speaking to investors and analysts for the last few weeks of a quarter until the company’s earnings are issued. “A quiet period is a great way to prevent Reg FD slipups,” he says.

Besides instituting a policy, companies also have to ensure they’re conducting regular training on that policy for any employees authorized to speak on the company’s behalf, including the CEO, CFO, investor relations staff. Media relations and communications professionals are often unaware of the rules. It’s also a good idea to expressly limit that circle, which allows the company to “better control the message,” Day says.

Salter

A crisis team should also be put in place to respond to any possible violations of Reg FD, says Dean Salter, of law firm Holme Roberts & Owen.

In fact, the SEC is likely to look more favorably on companies that have policies in place covering Reg FD. In 2009, the Commission let American Commercial Lines off the hook for Reg FD allegations partly because the company was able to show that it had a strong policy, regularly trained employees on that policy, and took prompt remedial action to correct the violation when its then-CFO talked out of turn.

Preventative measures can keep a company out of trouble “even if someone goes rogue,” says Day. “Office Depot could’ve saved $1 million by having a written Reg FD policy and spending some time on training.”

Any time the company plans to communicate information to analysts, says Quinlivan, “They should ask the Reg FD question, ‘Are we doing something that’s out of bounds?’”