The Advent Of Regulation FD - Mandates On Managing Disclosure

Regulation FD (for Fair Disclosure) is a rule recently adopted by the U.S. Securities and Exchange Commission regarding selective disclosure of issuer material non-public information. The rule deeply affects the manner in which public company executives are permitted to communicate to members of the financial community and others. Because of the public policy concerns that the rule attempts to address, public companies would be well-advised to pay close attention to their compliance with the rule on an ongoing basis.

Regulation FD was adopted by the Commission for a number of well-intentioned reasons. The chairman at the time of adoption, Arthur Levitt, believed that the Commission should outlaw a longstanding practice by certain issuers of selective disclosure of certain types of material non-public information. This "selective disclosure" was intended to, among other things, manage analysts' expectations about the earnings prospects of a company. He perceived that such an activity was deeply offensive to the maintenance of a level playing field among investors with respect to issuer information.

In its adopting release, the Commission set forth several specific reasons for adoption of the Rule. According to the Commission, issuers have disclosed important nonpublic information before making full disclosure of the same information to the general public. Where this has happened, those who were privy to the information beforehand were ostensibly able to make a profit or avoid a loss at the expense of those kept ignorant.

The release stated that selective disclosure has led to a loss of investor confidence in the integrity of our capital markets and that it closely resembles insider trading. In both cases a privileged few gain an information edge and then allegedly unfairly profit from access to corporate insiders rather than from skill, acumen, or diligence.

The Commission stated that another threat to the integrity of the markets was the potential for corporate management to treat material information as a commodity to be used to gain or maintain favor with particular analysts or investors. Also, it found that the ability of an issuer to satisfy the requirements of rapid broad public dissemination of such information was now made easier and more affordable by recent technological advances, including the advent of the Internet.

Nevertheless, as the Commission admitted in the release, many commenters to the rule questioned whether Regulation FD was even necessary, stating, in part, that existing securities laws providing for liability were sufficient to protect the investing public. Others, including Harvey Pitt, the putative nominee for Chairman of the Commission, have been publicly critical of the rule. There is some speculation that the rule could be modified or even rescinded. The current acting Chairman, Laura Unger, actually voted against its adoption. Most recently, the Securities Industry Association released a survey that found that the new rule contributed to market volatility and reduced substantive communication between issuers and analysts. Nevertheless, for the foreseeable future, issuers will be required to comply with the provisions of the rule and must be prepared to do so.

Below is a summary of the rule that is not intended to be exhaustive. It should especially be noted that even if the rule is satisfied, an issuer and other parties may still be found to have violated other provisions of the securities laws.

Regulation FD mandates that whenever an issuer, or any person acting on its behalf, discloses any material nonpublic information regarding the issuer or its securities to certain persons, the issuer must make public disclosure of that information. Such disclosures must be made simultaneously, in the case of an intentional disclosure; and promptly, in the case of a non-intentional disclosure.

An "issuer" subject to this regulation is one that has a class of securities registered under Section 12 of the Securities Exchange Act of 1934, or is required to file reports under Section 15(d) of the Securities Exchange Act of 1934, including any closed-end investment company, with certain exceptions.

A person acting on behalf of an issuer means any senior official of the issuer (or, in the case of a closed-end investment company, a senior official of the issuer's investment adviser), or any other officer, employee, or agent of an issuer who regularly communicates with any person described in certain provisions of the rule, or with holders of the issuer's securities. Senior official means any director, executive officer, investor relations or public relations officer, or other person with similar functions. An officer, director, employee, or agent of an issuer who discloses material nonpublic information in breach of a duty of trust or confidence to the issuer is not considered to be acting on behalf of the issuer.

With certain exceptions, FD applies to the disclosure of material non-public information made to any person outside the issuer who is any of the following: a broker or dealer, or a person associated with a broker or dealer; an investment adviser, an institutional investment manager, or a person associated with either of the foregoing; an investment company, or a company that would be an investment company but for certain provisions in the Investment Company Act of 1940 or an affiliated person of either of the foregoing; and a holder of the issuer's securities, under circumstances in which it is reasonably foreseeable that the person will purchase or sell the issuer's securities on the basis of the information.

FD does not apply to a disclosure made to a person who owes a duty of trust or confidence to the issuer (such as an attorney, investment banker, or accountant); to a person who expressly agrees to maintain the disclosed information in confidence; to an entity whose primary business is the issuance of credit ratings, provided the information is disclosed solely for the purpose of developing a credit rating and the entity's ratings are publicly available; or, with certain exceptions, in connection with a securities offering registered under the Securities Act.

Except as otherwise provided, an issuer must make the "public disclosure" of information required by the rule by furnishing to or filing with the Commission a Form 8-K Current Report disclosing that information. Disclosures must be made simultaneously, in the case of an intentional disclosure; and promptly, in the case of a non-intentional disclosure.

A selective disclosure of material nonpublic information is "intentional" when the person making the disclosure either knows, or is reckless in not knowing, that the information he or she is communicating is both material and nonpublic.

Under the rule, "promptly" means as soon as reasonably practicable (but in no event after the later of 24 hours or the commencement of the next day's trading on the New York Stock Exchange) after a senior official learns that there has been a non-intentional disclosure by the issuer or person acting on behalf of the issuer of information that the senior official knows, or is reckless in not knowing, is both material and nonpublic.

An issuer will be exempt from the requirement to furnish or file a Form 8-K if it instead disseminates the information through another method (or combination of methods) of disclosure that is reasonably designed to provide broad, non-exclusionary distribution of the information to the public.

No failure to make a public disclosure required solely by the rule will be deemed to be a violation of Rule 10b-5 under the Securities Exchange Act. Such a failure will also not affect the availability of certain short-form registration statements or be part of a determination whether there is adequate current public information about the issuer for purposes of Rule 144(c).

Regulation FD applies to disclosures of "material nonpublic" information about an issuer or its securities. Information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision. There must be a substantial likelihood that the fact would be viewed by the reasonable investor as significantly altering the total mix of information available.

A veritable cottage industry has sprung up with respect to the offering of legal professional services in this area, and for good reason. The Commission itself estimated the total paperwork burden for issuers to comply with FD will be $49,562,500 per year. The Securities Industry Association recently estimated the cost to be more in the neighborhood of $250 million to $400 million.

One prudent place to look for guidance with respect to a new rule is the administrative guidance contained in the "release" that adopts the final rule.

The Commission listed in its adopting release the following types of information or events it feels should be reviewed carefully to determine whether they are material: (1) earnings information; (2) mergers, acquisitions, tender offers, joint ventures, or changes in assets; (3) new products or discoveries, or developments regarding customers or suppliers (e.g., the acquisition or loss of a contract); (4) changes in control or in management; (5) change in auditors or auditor notification that the issuer may no longer rely on an auditor's audit report; (6) events regarding the issuer's securities -- e.g., defaults on senior securities, calls of securities for redemption, repurchase plans, stock splits or changes in dividends, changes to the rights of security holders, public or private sales of additional securities; and (7) bankruptcies or receiverships.

The Commission left little doubt as to its original intent under the rule. Notwithstanding its protestations to the contrary in response to critics that felt the rule inordinately chilled issuer-analyst communications, the Commission advised in the release that when an issuer official engages in a private discussion with an analyst seeking guidance on earnings estimates, he or she is engaged in activity that is highly risky under Regulation FD.

The following suggested model for disclosure under FD was set forth by the Commission in the release. It uses a combination of methods 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.

The Commission also repeated several suggestions to mitigate concerns over the ongoing management of disclosure under FD, including: (1) designating a limited number of persons who are authorized to make disclosures or field inquiries from investors, analysts, and the media; (2) keeping a record of communications with analysts; (3) declining to answer sensitive questions until issuer personnel could consult with counsel; or (4) seeking time-limited "embargo" agreements from analysts in appropriate circumstances.

It is beyond the scope of this article to set forth a complete set of the ramifications of, or the history behind, Regulation FD. Suffice it to say that it contains more than a few traps for the unwary. The rule has encountered substantial criticism and may, sometime in the future, undergo further modification. Nevertheless, a clarion call has been sounded by the Commission that activities that could be characterized as "selective disclosure" are now going to undergo a higher level of enforcement scrutiny. Issuers, and their leaders, would be well-advised to heed that call.