New SEC Regulation Prohibiting Selective Disclosure
Under the banners of "restoring fairness" to the system and protecting the "integrity of our markets," the Securities and Exchange Commission adopted new rules last month addressing the selective disclosure of material, non-public information by public companies. SEC Release Nos. 33-7881, 34-43154, IC-24599 (August 10, 2000). Regulation FD (Fair Disclosure) takes effect on October 23, 2000.
Regulation FD was promulgated under the premise that the dissemination of important company information should be made to all investors at the same time. The rule requires any intentional disclosure of material information to be done by means of public disclosure. Selective disclosure is prohibited. If non-intentional disclosure of material information is made, prompt public disclosure of the same information must follow.
The basic rule provides that when an issuer, or person acting on its behalf, discloses material nonpublic information to certain enumerated persons (in general, securities market professionals and holders of the issuer's securities who may well trade on the basis of the information), it must make public disclosure of that information: (a) simultaneously (for intentional disclosures), or (b) promptly (for non-intentional disclosures). Under the regulation, the required public disclosure may be made by filing or furnishing a Form 8-K (through new Item 9), or by another method or combination of methods that is reasonably designed to effect broad, non-exclusionary distribution of the information to the public.
"Issuers" can disseminate material non-public information through parties such as officers, directors, employees or agents of the company while acting within the scope of their authority. The "person acting on its behalf" language addresses the situation when an agent of the issuer, who is authorized to speak with the media, analysts, and/or investors, makes selective disclosures and not to the case where the agent discloses such information for his own benefit.
The regulation does not define the terms "material" and "nonpublic." Instead, it relies on existing definitions of these terms established in case law. Information is material if "there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision. To fulfill the materiality requirement, there must be a substantial likelihood that a fact "would have been viewed by the reasonable investor as having significantly altered the ‘total mix' of information made available." Information is nonpublic if it has not been disseminated in a manner making it available to investors generally.
"Enumerated persons" include securities market professionals (e.g., broker-dealers, investment advisers, certain institutional investment managers, investment companies and hedge funds) and any holder of the issuer's securities, under circumstances in which it is reasonably foreseeable that such person would purchase or sell securities on the basis of the information. Specifically excluded from the definition are persons who owe the issuer a duty of trust or confidence (e.g., attorneys, investment bankers and accountants), persons who expressly agree to maintain the information in confidence (i.e., those who are privy to material nonpublic information for legitimate business purposes), persons whose primary business is the issuance of publicly available credit ratings and persons with whom communication is made in connection with most offerings of securities registered under the Securities Act.
Under the regulation, a selective disclosure is "intentional" when the issuer or person acting on behalf of the issuer making the disclosure either knows, or is reckless in not knowing, prior to making the disclosure, that the information he or she is communicating is both material and nonpublic. Thus, in the case of a selective disclosure attributable to a mistaken determination of materiality, liability will arise only if no reasonable person under the circumstances would have made the same determination.
"Promptly" means "as soon as reasonably practicable" (but no later than 24 hours or the commencement of the next day's trading on the New York Stock Exchange) after a senior official of the issuer learns of the disclosure and knows (or is reckless in not knowing) that the information disclosed was both material and non-public. "Senior official" is defined as any executive officer of the issuer, any director of the issuer, any investor relations officer or public relations officer, or any employee possessing equivalent functions. (The release cites a number of ways in which technology allows issuers to disseminate information "simultaneously.")
Issuers can make public disclosure for purposes of Regulation FD by filing a Form 8-K, or by disseminating 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." (e.g., press releases distributed through a widely circulated news or wire service, or announcements made through press conferences or conference calls that interested members of the public may attend or listen to either in person, by telephonic transmission or by other electronic transmission - including use of the Internet.)
Regulation FD applies to all issuers with securities registered under Section 12 of the Securities Exchange Act and all issuers required to file reports under Section 15(d) of the Securities Exchange Act.
Issuers who fail to comply with Regulation FD will be subject to an SEC enforcement action alleging violations of Section 13(a) or 15(d) of the Exchange Act and Regulation FD. The SEC could bring an administrative action seeking a cease-and-desist order, or a civil action seeking an injunction and/or civil money penalties. In certain cases, the SEC could also bring an enforcement action against an individual at the issuer responsible for the violation, either as "a cause of" the violation in a cease-and-desist proceeding, or as an aider and abettor of the violation in an injunctive action. The new regulation expressly provides that failure to make a public disclosure required solely by Regulation FD shall not be viewed as a violation of insider trading rules.
The new regulations adopted by the SEC will have a direct impact on the way in which most public companies release information to the market. Of particular note, one-on-one sessions between senior officers and market analysts now give rise to potential liability under Regulation FD. In addition, companies should refrain from indicating earnings projections in any format other than a public setting.
SEC rulemaking is ordinarily followed by focused enforcement. Clients should be prepared to see increased SEC enforcement in the areas of selective disclosure and insider trading.
In order to avoid intentional and unintentional selective disclosure problems, issuers should do the following:
- Limit the number of persons who are permitted to make disclosures to, or respond to inquiries from analysts, investors or the media.
- Keep a record of the substantive information that is disclosed during private communications with investors or analysts.
- Inform analysts and investors of the following: (1) the name of the person who the issuer has authorized to make disclosures; (2) that responses to inquiries will not be made until the issuer can consult with others; and (3) that any information disclosed in private communication remain confidential until after the issuer has had an opportunity to review and assess the record of the discussion.
- Use confidentiality agreements to protect communications in the context of business combinations or other transactions that the issuer expressly does not want disclosed to the public.