by Gilbert G. Menna and Ettore A. Santucci

In adopting Regulation FD (Fair Disclosure), the Securities and Exchange Commission (SEC) made a commitment to closely monitor the rule's impact on information flow. The SEC took the first step with an April 24, 2001 roundtable held in New York. Subsequent comments by acting SEC chair Laura Unger and commissioner Isaac Hunt, both of whom have been publicly skeptical about Regulation FD, lead us to believe it is very unlikely the SEC will take action to amend it in the near future. In a speech on May 18, 2001, Richard Walker, director of the SEC Division of Enforcement, gave his views on enforcement of Regulation FD and concluded that more time is needed to assess whether the rule has had negative effects and whether amendments are necessary.

SEC Roundtable Results

The April 24 roundtable featured four separate panels comprised of company representatives, news media, securities analysts and investors. The consensus was that Regulation FD has increased the volume and frequency of disclosure, but decreased its usefulness and specificity, while curtailing access to management, reducing candor and cutting back on disclosure between conference calls. As one panelist remarked, there is "more noise, less substance and more paranoia." Most panelists requested that the SEC supplement Regulation FD to provide bright-line standards of materiality, publicize "best practices" and expand the safe harbor to cover inadvertent or immaterial disclosures. Panelists highlighted a number of legal issues and new developments:

NYSE continues to require press releases. The New York Stock Exchange has specifically declined to amend its rules to mirror Regulation FD and continues to require companies to issue a press release on material developments. Posting information on a web site, or using other acceptable FD methods will not satisfy NYSE requirements.

Mid-quarter conference calls. Mid-quarter conference calls are becoming more common, though not yet widespread. If REITs begin to adopt this practice, the whole industry may have to follow and it will be difficult to stop holding these conference calls.

Analysts and media seeking sources "further down the chain." The media and analysts often seek out company personnel who are not subject to Regulation FD and may be less aware of disclosure policies, though they acknowledged this information is potentially less reliable and less complete. REITs should have clear policies restricting who may speak to the public.

Media exploiting Regulation FD exemption. SEC representatives confirmed that Regulation FD does not apply to disclosure of material non-public information to media representatives, even if the reporter then passes the information on to an analyst for comment on the information. However, this probably violates NYSE rules.

Analysts not updating publicly available research reports. Some sell-side analysts update their reports and furnish them to clients, while leaving the outdated version of their reports in the public domain. While this practice may not be actionable under existing case law, leaving information that a financial institution knows to be stale in the public arena, while the institution and its clients trade on fresher information could lead to adverse publicity. Analysts should be aware of the SEC's focus on its role in the markets, given the Commission's stated objective of leveling the playing field. To the extent the "free market" for information continues to create disparities in access, we can expect the SEC to weigh in to change behavior.

Use of blanket confidentiality agreements. Some companies are now using broad confidentiality agreements as a condition for one-on-one meetings. Analysts view this as an objectionable practice that frustrates the purpose of the meetings. One-on-one meetings continue to be the fault line between market- driven disclosure practices (analysts demand them) and compliance with Regulation FD (heightened risk of violation).

The members of the issuer panel, representing mostly large high-tech or biotech businesses, agreed that Regulation FD had done little to change their investor relations and disclosure practices. But at the same time the panelists complained about the role that lawyers now play, which suggests there has been more change than some were prepared to admit. Issuers complained about greater volatility in market prices of securities, higher IR and compliance costs, a chilling effect on quality of information, and the difficulty of making materiality judgments under the time constraints imposed by the rule.

The media and analyst panels felt that disclosure has been "dumbed down" as a result of the one-size-fits-all disclosure requirements of Regulation FD. Some analysts believe that Item 9 Form 8-K reports are used to "conceal" disclosure of information that might adversely affect the stock price if disclosed in a press release. They also suggested that companies adopt longer archiving periods, make available transcriptions of conference call Q&As, and make sure corporate firewalls and other technical issues do not block viewing of webcasts.

Analysts noted they are less likely to ask detailed questions in public because they might lose an information advantage over their competitors. At the same time, Regulation FD has virtually eliminated opportunities for one-on-one discussion of meaningful information, unless it previously has been publicly disclosed. This suggests that issuers largely are choosing not to disclose information that would fit within the "mosaic" theory discussed in the Regulation FD adopting release. Analysts also noted that in many cases disclosure now comes abruptly, which contributes to greater volatility in market prices and trading volume.

The one lawyer who offered legal commentary on Regulation FD stated it would be impossible for the SEC to formulate a more specific definition of materiality than the Supreme Court has done and urged a return to a general standard. He was skeptical of "bright line" materiality standards and suggested that the list of information that might be material contained in Regulation FD raises too many red flags and has effectively nullified the "mosaic" theory. He also reiterated that, insofar as Regulation FD had done nothing to eliminate concerns about "duty to update," issuers are unlikely to provide more forward-looking information until well-known conflicts among federal circuit courts on this issue are resolved.

Enforcing Regulation FD

In his speech on May 18, Walker stated that his SEC Division of Enforcement staff actively investigates possible Regulation FD violations, including those reported by the media or investors, and companies should be particularly careful about closed-door meetings with analysts and/or investors. He also concluded that industry studies have yet to prove a connection between market volatility and Regulation FD. The Enforcement Division has a policy of not frustrating the intent of the rule—to encourage disclosure—by proceeding overzealously against issuers who make mistaken, but reasonable, judgments about materiality, and not curtailing the substantial discretion the rule grants issuers regarding the means of making public disclosures. However, this measured approach should not be mistaken for reluctance to enforce Regulation FD.

Walker specifically disagreed that Regulation FD should be enforced only if there is trading on the basis of selectively disclosed information. He pointed out that while selective disclosure resembles insider trading, Regulation FD is designed to prevent the transmission of the material non-public information that could lead to unfair trading. He stated that the SEC expects issuers and others to conform their conduct to the requirements of Regulation FD, and if they do not, the Enforcement Division will take steps to make them do so whether or not there is insider trading after the fact.

Clear-cut violations suggesting disregard for the rule and a continuation of pre-FD behavior are prime targets for enforcement. As an example, Walker pointed to the widespread pre-FD practice of discussing disappointing trends with selected analysts. The analysts then published reports that the company was unlikely to meet Wall Street's targets, leading to a sharp fall in the stock price days before the company made any public announcement. He said he is still aware of top corporate officials calling analysts to review prior announcements. Some of these calls have resulted in the analysts lowering their earnings estimates, making serial calls to "talk analysts down" from their earlier assumptions, or confirming, late in the quarter, a single analyst's guidance given publicly months earlier. These kinds of stories would almost certainly trigger an enforcement inquiry, he added.

Walker specifically addressed the issue of one-on-one meetings with analysts. He acknowledged that Regulation FD does not prohibit small group or one-on-one meetings with analysts, which provide excellent opportunities to discuss non-material mosaic information and are fully lawful. However, he warned that his staff will investigate reports that company sponsored public meetings or conference calls are followed, sometimes immediately, by sessions that exclude all but selected analysts if there is any evidence that material non-public information may have been provided at such sessions.

Individual investors and the press have emerged as energetic watchdogs for potential violations of Regulation FD. The Division of Enforcement hears from investors or press who, while on a public earnings call, hear reference to a subsequent invitation-only session from which they are excluded. Walker warned companies not to underestimate the suspicion and ill will these selective gatherings generate. He also warned that his staff would not give executives the benefit of the doubt on materiality judgments and inadvertent dis closure when information is shared in a non-inclusive setting.

These comments reinforce our perspective that one-on-one meetings, while necessary in practice and lawful in theory, must be planned and conducted with extreme care, and should be followed by a candid assessment of whether any follow-up public disclosures are required based on what actually transpired at the meeting.