The U.S. Securities and Exchange Commission's (SEC's) Regulation Fair Disclosure, also commonly referred to as Regulation FD or Reg FD was an SEC ruling implemented in October 2000. It mandated that all publicly traded companies must disclose material information to all investors at the same time.
The regulation sought to stamp out selective disclosure, in which some investors (often large institutional investors) received market moving information before others (often smaller, individual investors).
Regulation FD changed fundamentally how companies communicate with investors, by bringing better transparency and more frequent and timely communications, perhaps more than any other regulation in the history of the SEC.
Most of the corporate announcements are issued in press releases or during the conference calls and are summarized at websites such as EarningsWhispers.com.
FSA penalizes bond traders for trading on non-public information
- Source: UK rulings narrows “accepted practice” loophole for traders, Reuters, October 12, 2009
LONDON, Oct 12 (Reuters) - The UK Financial Services Authority (FSA)’s decision to censure two Dresdner Kleinwort traders for trading while in possession of inside information about a forthcoming issue of floating rate notes by Barclays has implications that go far beyond the offence of trading ahead of a formal announcement. By censuring the traders, the FSA is attempting to establish a precedent about how it will deal with the defence of “accepted market practice” in future, restricting it significantly, in a move that will force a wider re-examination of entrenched practices across the financial markets in London.
The actions at the centre of the FSA’s probe were not seriously in dispute. On Thursday March 15, 2007, at 1002, the traders at Dresdner Kleinwort were given “a very early heads up” to gauge their appetite for a possible forthcoming note issue by Barclays Capital acting as agent for Barclays PLC.
At that point Barclays Capital indicated the new issue would probably be announced the following Tuesday. Following the call the Dresdner unit in which the two traders worked sold $30 million of similar maturity securities already held in its book.
Later that day, in another call at 1340, Barclays Capital indicated the timetable might be accelerated and “we might in fact just go ahead and just announce it today”. The traders sold a further $35 million of similar securities a few minutes later at 1406. The new issue was formally announced an hour afterwards at 1516.
While the facts were not seriously in dispute, the construction put upon them proved much more controversial. The traders raised a number of defences, but the two most interesting were:
(1) An early heads up about a possible future issue could not constitute the type of specific, price-sensitive information covered by insider trading laws. The telephone conversations were about a potential new issue with no certainty or even reasonable expectation it would materialise.
“Premarketing sounding out or book building prior to formal deal launches were standard market practice and occurred regularly … [T]he established view of market participants at the time was that until a deal closed, no information could be specific or price sensitive”.
(2) Credit markets were different from equity markets. In the view of colleagues and other practitioners “it was perfectly acceptable to trade ahead of new issues in the market” and “fair and common practice to sell ahead” of a new issue.
Both of the key defences were rejected by the FSA’s Regulatory Decisions Committee:
(1) The FSA noted that “absolute certainty” was rarely present in the issue process, but the fact that information was provided by Barclays Capital about a potential issue by its parent the following week should have been sufficiently to give the Dresdner traders a “reasonable expectation” an issue would be announced and alerted them to the risk of dealing ahead. Information about a potential future issue could, in these circumstances, be sufficiently precise that it made the traders insiders to the transaction.
(2) The FSA accepted that the two traders did not believe they had received inside information and were acting in line with accepted market practice (AMP). But it rejected this belief as unreasonable and held they should have considered whether it constituted inside information “regardless of market practice” and guidance from the bank’s compliance department.
It was the decision to reject the “accepted market practice” defence that marks the really important aspect of the case, because it helps resolve one of the key uncertainties at the heart of the market abuse and insider trading regimes.
The general rules covering market abuse and insider trading are fairly clear (EU Directive 2003/124/EC as transposed into UK law at Section 118 of the Financial Services and Markets Act). The prohibition on trading while in possession of inside information is set out in unambiguous terms.
The directive also warns about other potential forms of abuse resulting from trading in substantial volumes affecting the price of a financial instrument; large orders in a concentrated time span causing price movements that are subsequently reversed; and orders around a specific time when reference prices, settlement prices and valuations are calculated that have an effect on those prices or valuations.
Unfortunately, the general prohibition has been muddied and undermined by the exemption for “accepted market practices” (EU Directive 2004/72/EC, transposed into UK law at Section 123 (2)).
This creates the problem of what happens when an “accepted market practice” directly contradicts the general prohibitions on insider trading and market abuse. The safe harbour for accepted practices has created a loophole a mile wide for potentially abusive practices to continue because they are hallowed by ancient practice and custom and would be expected with a shrug by other regular market users.
It also creates inconsistency. What constitutes “market abuse” in one market can be “accepted practice” in another. The issue of consistency as envisaged by the original directive, which notes laconically: “there might be circumstances in which a market practice can be deemed acceptable on one particular market and unacceptable on another comparable market within the [EU]“.
This rather elastic definition of market abuse has been a recipe for confusion. It is a bit like saying theft is a crime in some circumstances but not in others.
More importantly, it has allowed some very dubious practices to continue unchecked, with practitioners able to argue that although they might seem to be abusive they are in fact quite normal and accepted by everyone and therefore should not be changed.
It is this loophole the FSA has sought to narrow. In rejecting the Dresdner traders’ “accepted market practice” defence, the authority has ruled that even if trading ahead was quite normal in the credit market, it could not justify behaviour which seemed to contravene the general market abuse rules so directly and blatantly.
The Dresdner case does not change the law. But it does subtly shift the balance between the general prohibitions and the AMP defence in favour of the former. It is a warming that market participants will have to be much more careful in relying on accepted practices in future to protect themselves from an accusation of abusive trading.
The FSA’s decision to let both traders off with a public rebuke, at the very low end of the scale of sanctions, rather than fine them or seek to bar them from the industry, is an implicit admission the state of the law about accepted practices was not clear.
The sanctions and report will have been, in some sense, “negotiated” with lawyers acting for the traders. This is an “accepted” settlement. The authority notes that both traders have opted not to exercise their right to appeal the matter to the (independent) Financial Services and Markets Tribunal (where the FSA has lost before). The authority may have been nervous about allowing the traders to press their accepted practice claim and what the consequences if it had been accepted.
Moreover, the FSA explicitly accepted the two traders “believed” they had not received inside information and that “no clear guidance” had been provided to either the credit markets in general, or to the traders in particular. This case remedies that lack of guidance. No one else will be able to rely on the accepted practice defence in quite the same way in future.
As the FSA concludes sternly, if either trader had been found “to have acted deliberately, recklessly or in breach of compliance department guidelines, the FSA would have imposed a higher penalty, including prohibition. This would have called into question his fitness and propriety … and would have resulted in a more severe penalty, including a financial penalty and prohibition”.
CESR's "insiders list" requirement for issuers
- Source: Market Abuse Directive Level 3 – Third set of CESR guidance and information on the common operation of the Directive to the market Committee of European Securities Regulators, May 15, 2009
"1.2 Relevant articles of the Directive
6. Article 6 (3) of the Directive 2003/6/EC states that “Member States shall require that issuers, or persons acting on their behalf or for their account, draw up a list of those persons working for them, under a contract of employment or otherwise, who have access to inside information. Issuers and persons acting on their behalf or for their account shall regularly update this list and transmit it to the competent authority whenever the latter requests it.”
7. Article 5 of the Directive 2004/72/EC implementing Directive 2003/6/EC as regards accepted market practices, the definition of inside information in relation to derivatives on commodities, the drawing up of lists of insiders, the notification of managers' transactions and the notification of suspicious transactions states that:
- “For the purposes of applying the third subparagraph of Article 6(3) of Directive 2003/6/EC, Member States shall ensure that lists of insiders include all persons covered by that Article who have access to inside information relating, directly or indirectly, to the issuer, whether on a regular or occasional basis.
- Lists of insiders shall state at least:
- the identity of any person having access to inside information;
- the reason why any such person is on the list;
- the date at which the list of insiders was created and updated.
- Lists of insiders shall be promptly updated (a) whenever there is a change in the reason why any person is already on the list; (b) whenever any new person has to be added to the list; (c) by mentioning whether and when any person already on the list has no longer access to inside information.
- Member States shall ensure that lists of insiders will be kept for at least five years after being drawn up or updated.
- Member States shall ensure that the persons required to draw up lists of insiders take the necessary measures to ensure that any person on such a list that has access to inside information acknowledges the legal and regulatory duties entailed and is aware of the sanctions attaching to the misuse or improper circulation of such information.”
CESR's Suspicious Transaction Reporting
- Source: Market Abuse Directive Level 3 – Third set of CESR guidance and information on the common operation of the Directive to the market Committee of European Securities Regulators, May 15, 2009
2.2 Relevant articles of the Directives
20. Article 6 (9) of the Directive 2003/6/EC states that “Member States shall require that any person professionally arranging transactions in financial instruments who reasonably suspects that a transaction might constitute insider dealing or market manipulation shall notify the competent authority without delay.
21. Articles 7 to 11 of the Directive 2004/72/EC implementing Directive 2003/6/EC as regards accepted market practices, the definition of inside information in relation to derivatives on commodities, the drawing up of lists of insiders, the notification of managers' transactions and the notification of suspicious transactions state that:
Article 9 - Content of notification
1. Member States shall ensure that persons subject to the notification obligation transmit to the competent authority the following information:
- description of the transactions, including the type of order (such as limit order, market order or other characteristics of the order) and the type of trading market (such as block trade);
- reasons for suspicion that the transactions might constitute market abuse;
- means for identification of the persons on behalf of whom the transactions have been carried out, and of other persons involved in the relevant transactions;
- capacity in which the person subject to the notification obligation operates (such as for own account or on behalf of third parties);
- any information which may have significance in reviewing the suspicious transactions.
2. Where that information is not available at the time of notification, the notification shall include at least the reasons why the notifying persons suspect that the transactions might constitute insider dealing or market manipulation. All remaining information shall be provided to the competent authority as soon as it becomes available.
Article 10 - Means of notification
Member States shall ensure that notification to the competent authority can be done by mail, electronic mail, telecopy or telephone, provided that in the latter case confirmation is notified by any written form upon request by the competent authority.
Article 11 - Liability and professional secrecy
1. Member States shall ensure that the person notifying to the competent authority as referred to in Articles 7 to 10 shall not inform any other person, in particular the persons on behalf of whom the transactions have been carried out or parties related to those persons, of this notification, except by virtue of provisions laid down by law. The fulfilment of this requirement shall not involve the notifying person in liability of any kind, providing the notifying person acts in good faith. 2. Member States shall ensure that competent authorities do not disclose to any person the identity of the person having notified these transactions, if disclosure would, or would be likely to harm the person having notified the transactions. This provision is without prejudice to the requirements of the enforcement and the sanctioning regimes under Directive 2003/6/EC and to the rules on transfer of personal data laid down in Directive 95/46/EC. 3. The notification in good faith to the competent authority as referred to in Articles 7 to 10 shall not constitute a breach of any restriction on disclosure of information imposed by contract or by any legislative, regulatory or administrative provision, and shall not involve the person notifying in liability of any kind related to such notification.
Sigtarp investigates insider trading of TARP banks
- Source: US banks face insider probe FT Alphaville, February 1, 2010
Neil Barofsky, the special inspector-general overseeing US financial rescue efforts, is to probe allegations of insider trading among bank executives and their associates. Eight of the largest US banks received between $2bn and $25bn in late 2008. Dozens more institutions followed and Barofsky, who oversees the Tarp scheme, is examining whether information was improperly conveyed to trading rooms as the government and banks exchanged information.
SEC proposes expansion of Rule 163
- Source: SEC Proposes Rule Amendments to Facilitate Access to Capital Markets SEC, 2009-273, Dec. 22, 2009
The Securities and Exchange Commission today announced that it has proposed amendments to Rule 163 under the Securities Act to further facilitate the ability of certain large companies to communicate with broader groups of potential investors and gauge the level of interest in the market for their securities offerings.
The proposed amendments would apply to companies that are "well-known seasoned issuers" (WKSIs) and would allow them to authorize an underwriter or dealer to communicate with potential investors on their behalf about potential securities offerings prior to filing registration statements for such offerings. Under the current Rule 163, only WKSIs are permitted to communicate directly with potential investors before filing a registration statement.
A WKSI is an issuer that is current and timely in its Exchange Act reports for at least one year and has either $700 million of publicly-held shares or has issued $1 billion of non-convertible securities, other than common equity, in registered offerings for cash in the preceding three years.
As proposed, an underwriter or dealer could act as an agent or representative of a WKSI if the following conditions are satisfied:
- The underwriter or dealer receives written authorization from the WKSI to act as its agent or representative before making any communication on its behalf.
- The WKSI authorizes or approves any written or oral communication before it is made by an authorized underwriter or dealer.
- Any authorized underwriter or dealer that has made any authorized communication on behalf of the issuer in reliance on Rule 163 is identified in any prospectus contained in the registration statement that is filed for the offering to which the communication relates.
- Proposed Changes May Facilitate “Wall-Crossed” Offerings Harvard Law School Forum on Corporate Governance and Financial Regulation by Eduardo Gallardo, Gibson, Dunn & Crutcher LLP, on 1/15/10
Selective disclosure of analyst information to trading clients
Source: Goldman's Trading Tips Reward Its Biggest Clients WSJ, August 24, 2009
"Goldman Sachs Group Inc. research analyst Marc Irizarry's published rating on mutual-fund manager Janus Capital Group Inc. was a lackluster "neutral" in early April 2008. But at an internal meeting that month, the analyst told dozens of Goldman's traders the stock was likely to head higher, company documents show.
The next day, research-department employees at Goldman called about 50 favored clients of the big securities firm with the same tip, including hedge-fund companies Citadel Investment Group and SAC Capital Advisors, the documents indicate. Readers of Mr. Irizarry's research didn't find out he was bullish until his written report was issued six days later, after Janus shares had jumped 5.8%."
Source: Report: Goldman providing tips to certain clients AP via Investment News, August 24, 2009
"...Clashing short-term and long-term opinions from the same firm is an issue the securities industry's self-regulating body, the Financial Industry Regulatory Authority, is currently reviewing as part of its rule requiring "fair dealing" with clients.
A Finra spokesman said the group is currently reviewing comments about a proposed rule that would clarify disclosure obligations allowing firms more flexibility in how they provide views on a stock.
"It's more of a gray area than a black-and-white area," said John Coffee, a professor of securities law at Columbia University.
The "fair dealing" rule for investment firms "hasn't really been applied very strictly," Coffee said. To make a case that the meetings violated rules, regulators would have to show that a firm "systematically" ensured that certain clients received the information before others, he said.
The tips at Goldman come out of meetings, called "trading huddles," the Journal report said. However, very few of Goldman's thousands of clients who get written research from the bank receive recommendations from the huddles, according to the Journal.
The Journal said, citing participants of the huddles, that the meetings can last up to about an hour. At the meetings, analysts bring trading ideas and Goldman's traders talk about financial markets and what could trigger movements in specific stocks.
Employees then call and provide the information to top clients, while in-house traders cannot use the tips until after they've been given to customers, the report said.
Recommendations from the meetings usually remain in effect for a week, according to the Journal.
A Goldman spokesman didn't return messages seeking comment. A spokesman from the SEC had no immediate comment."
Finra expands probe of "trading huddles"
- Source: Finra Probes Wall Street's Trade Huddles Wall Street Journal, December 18, 2009
The Financial Industry Regulatory Authority has launched a broad inquiry into how Wall Street firms disseminate stock ratings and research, people familiar with the matter said.
The industry-funded regulator of securities firms doing business in the U.S. recently sought information from Citigroup Inc., J.P. Morgan Chase & Co. Morgan Stanley and other firms, including details of any meetings where unpublished research opinions or trading ideas were disclosed to nonresearch employees or clients.
The probe follows an article in The Wall Street Journal in August about gatherings at Goldman Sachs Group Inc. known inside the company as "trading huddles." During the meetings, Goldman analysts gave short-term tips to traders, followed by big clients. The tips sometimes differed from Goldman's long-term research.
Finra's examination of the trading huddles at Goldman was expanded last month to include about 10 other firms, according to people familiar with the situation. Responses were due earlier this month.
Such meetings highlight the demands on research analysts as trading desks become even bigger engines of revenue and profits for Wall Street firm. While large clients routinely get extra attention and service, Finra officials want to determine if the gatherings give an unfair advantage to certain customers.
Securities laws require firms to engage in "fair dealing with customers." Analysts are prohibited from issuing opinions that are at odds with their actual beliefs about a stock. It is permissible for analysts to have different short- and long-term views on a stock.
Critics of Goldman's trading huddles have complained that distribution of such tips to in-house traders and major clients hurts other Goldman customers who aren't given the opportunity to trade on the information and could be relying on the firm's longer-term research to make investment decisions.
Goldman doesn't disclose the existence of the huddles to nonparticipants but has said that any information discussed in the firm's huddles is consistent with its long-term research reports.
In its letter to securities firms, Finra asked for lists of all meetings held since July 2008 where "any non-published research opinion and/or information … regarding a company under research coverage by the Firm was disclosed … to non-research personnel or current or potential customers of the firm."
The information requested by Finra includes dates and minutes of meetings, names of attendees and the names of clients who might have received the information.
Use of material nonpublic information by hedge funds
- Source: Renewed case peers at hedge fund Boston Globe, September 6, 2009
For years, unusual trading by hedge funds, particularly such trading that takes place in advance of major corporate announcements, triggered alarms in computers for the New York Stock Exchange and Nasdaq that are set to detect signs of illegal trading. When exchange officials consider the evidence strong, they forward the information to the SEC for investigation. Although the exchanges pass these alerts to the SEC, the agency to date has taken action in only a handful of cases, nearly all of them small.
Hilton Foster, a retired veteran SEC enforcement lawyer, faults the agency for not having devoted more resources to investigate hedge funds. He said the hedge funds’ personnel mainly come from investment banks and have close ties to knowledgeable insiders all over Wall Street, so they have access to nonpublic information and strong temptation to trade on it to boost their funds’ returns. “So you’d have to be naive to think it wasn’t happening,’’ he said.
Testimony and other records released with a Senate report show the SEC had been receiving warnings for years of possible insider trading by Pequot, but didn’t act. From 1999 through 2004, exchanges sent the SEC at least 17 alerts to possible insider trading and market manipulation by Pequot. A 2007 report by the Senate finance and judiciary committees, which jointly investigated the SEC’s handling of the inquiry, found that for years the agency had logged alerts but took no action to investigate.
In September 2004, the enforcement division decided to look at Pequot. It handed the case to the enforcement division’s newest, least experienced investigator, Gary Aguirre. While new to the SEC, Aguirre had spent decades as a private lawyer in San Diego, where he had won more than $200 million in a long chain of local environmental and real estate lawsuits. At age 64, he decided to devote the last part of his career to public service, ending up at the SEC.
He focused on two bursts of trading by Pequot that occurred just before announcements of major corporate news. One involved a pending 2001 earnings announcement by Microsoft that would significantly surpass analysts’ expectations. Loading up on Microsoft stock and options before the announcements, Samberg made an estimated profit of $12 million once Microsoft announced its earnings and its stock price shot up, SEC records show.
Aguirre found 2001 e-mail records, which have been made public, in which Samberg asked for Microsoft performance information from David Zilkha, a midlevel Microsoft executive who had been offered a job by Samberg. The e-mails show Samberg asked Zilkha for “tidbits’’ about Microsoft, and after hearing back from him he began rapidly amassing stock in the company.
The original SEC investigation didn’t turn up replies from Zilkha, although it did find an e-mail message Zilkha sent to Samberg months later in an attempt to dissuade Samberg from firing him. In it Zilkha noted that he had given Samberg profitable Microsoft information on April 9, 2001, which was when Samberg had begun buying large amounts of stock in advance of the company’s earnings announcement."
Use of material nonpublic information by private equity
- Source: SEC Says Defendants Timed Their Trades Wall Street Journal, November 2, 2009
"...On Feb. 7, 2008, the complaint says, Mr. Tang learned his firm was looking into buying a "market-moving" chunk of Tempur-Pedic shares. The SEC alleges that after a Feb. 11 meeting, the private-equity firm hadn't made a decision on the purchase, but advised employees of a blackout on trading in Tempur-Pedic shares until further notice.
Questions about the blackout were referred to Mr. Tang, the SEC said.
Between Feb. 7 and Feb 13, the SEC says, Mr. Tang conveyed in telephone conversations non-public, material information about the possible transaction to two of his friends, Ming Siu and Joseph Seto, co-defendants. From Feb. 10 through Feb. 12, Messrs. Siu and Seto -- but not Mr. Tang -- bought and sold through various accounts Tempur-Pedic stock and options, the SEC says.
On March 12, 2008, the complaint says, Mr. Tang learned Tempur-Pedic was going to pre-announce it would miss its earnings forecast. Friedman Fleischer, which had a managing director on Tempur-Pedic's board, planned to buy its shares by March 19, two days after Tempur-Pedic's announcement, so they could get them for a lower price. Tempur-Pedic policy requires insiders to wait two days after material announcement events before buying shares.
On March 12 and March 13, after Mr. Tang learned of the planned missed earnings announcement and his firm's plan to buy afterward, the SEC alleges "a flurry of phone calls" took place between Mr. Tang and his trading partners. Through various accounts, Mr. Tang and several of the associates allegedly engaged in short-sales and the buying of "put" options on Tempur-Pedic shares, both of which are bearish bets on a company's stock price.
On March 17, 2008, the day of the pre-earnings announcement, Tempur-Pedic shares closed at $10.50, down 37.7% from the previous close. From March 17 to March 18, Mr. Tang and his associates closed all their short positions, the complaint says.
On March 19 and March 20, Friedman Fleischer & Lowe bought about 4.3 million Tempur-Pedic shares for approximately $49.7 million, and Tempur-Pedic's shares rose 18%. Between March 17 and March 20, Mr. Tang and three of his associates -- Messrs. Seto and Siu as well as Zisen Yu -- were also buying Tempur-Pedic shares, and also options, according to the complaint.
A lawyer for Mr. Seto on Friday said he hadn't yet reviewed the complaint; he didn't respond to a request for comment Sunday. Lawyers for the other four defendants either didn't respond to requests for comment or didn't comment on Sunday.
By March 24, 2008, the SEC says, the defendants' remaining positions were closed, with the defendants realizing nearly $2 million in profits through the long and short positions.
Mr. Tang's alleged trading in the shares of Acxiom followed from his relationship with his brother-in-law Mr. Yee. Mr. Yee allegedly told Mr. Tang in April 2007 that his firm was considering a deal for Acxiom, information that the SEC says Mr. Tang passed on to other defendants. On April 24, the SEC complaint says, Mr. Yee's firm submitted its bid for Acxiom. From April 23 to May 16, through various accounts, these six defendants bought Acxiom stock and options, the complaint says. Mr. Yee didn't buy any shares.
On May 16, 2007, Acxiom announced publicly it was being bought by ValueAct and another private-equity firm. The stock increased 18% the next day. The SEC alleges that by the end of August 2007, Mr. Tang and the five other co-defendants who traded had sold the Acxiom shares they had bought after the announcement, at profits of $5.1 million."
The Galleon affair - All at sea
- Source: The Galleon affair - All at sea October 22, 2009, The Economist
"The largest insider-trading case in decades snares a giant hedge fund
MILTON FRIEDMAN argued for legalising insider trading on the grounds that it benefited all investors by quickly disseminating new information. These days such leave-it-to-the-market views are unfashionable. Regulators, lambasted for snoozing through the bubble, are keen to be seen rooting out manipulation. The case they have brought against Raj Rajaratnam, co-founder of Galleon, a big hedge-fund group, and five alleged co-conspirators could do much for their credibility.
At $25m, the ring’s alleged profits were not unusually large. More shocking is the breadth of companies and the seniority of the individuals involved. Mr Rajaratnam, who is accused of soliciting and trading on non-public information but denies wrongdoing, is a well-known investor in technology stocks. Those said to have passed on tips about deals and upcoming earnings news at various public companies include a senior executive at IBM and employees from Moody’s, a rating agency, McKinsey, a consultancy, and Intel, a chipmaker.
The intricacy of this web highlights how many firms have access to privileged information from large companies. Rating agencies, for instance, are told about pending deals so they can be ready with upgrades or downgrades when the announcement comes. In this case a Moody’s analyst, who has not been charged, allegedly received $10,000 for letting slip that Hilton Hotels was about to be bought by Blackstone, a private-equity firm.
Insider trading can be hard to prove. The recipient of information must be shown to have encouraged or known about a breach of fiduciary duty. The line between legitimate research and ill-gotten information is fuzzy. There are other quirks. An insider-trading case against Mark Cuban, owner of the Dallas Mavericks, a basketball team, was dismissed in July because he had not promised not to trade on sensitive information.
Nailing hedge funds can be particularly difficult. Many trade in and out of stocks so frequently—Galleon might do so more than 1,000 times a day—that it can be hard to link wrongdoing to specific transactions. Front-running takeovers is just one concern. Funds can exploit small price movements, often caused by mundane news—about, say, product development—and use derivatives to magnify gains.
The case against Mr Rajaratnam is based in part on the novel use of wiretaps, a technique previously reserved for blue-collar criminals such as mobsters and terrorists. According to the complaint, he was taped telling a co-conspirator to “buy and sell and buy and sell” shares in AMD, a technology firm, to avoid drawing attention to illicit trades. Galleon’s traders were encouraged to sail close to the wind—as one put it, you “get an edge or you’re gone”. Investors are now flocking to pull their money out, prompting Mr Rajaratnam to say on October 21st that he would wind down Galleon’s funds. The affair even rocked share prices in his native Sri Lanka.
Regulators are looking to gain an edge, too, by stepping up their data-mining efforts. The Galleon case benefited from the detection of suspicious trades by the New York Stock Exchange’s systems. They are also looking for help from poachers-turned-gamekeepers, such as the Goldman Sachs man hired to help shake up the Securities and Exchange Commission’s enforcement division. Officials warn of more big cases to come. Friedman would not be amused, but many will be only too happy to see more Wall Street grandees in cuffs."
SEC settles its third Reg FD action
- Fair Warning on Fair Disclosure! SEC Settles Its Third Regulation FD Action Perkins Coie, November 4, 2010
The SEC recently settled a Regulation FD action against Office Depot and several of its executives. This Update summarizes the key issues addressed in this action and offers practical guidance.
Background on the Office Depot Enforcement Action
The SEC charged that the CEO and then-CFO of Office Depot, in an effort to encourage analysts to revise downward their sales and earnings forecasts for the second quarter of Office Depot's 2007 fiscal year, arranged private calls with eighteen analysts who followed the company. During those calls, begun just eight days before the end of the quarter, the director of investor relations referred the analysts to recent earnings statements by comparable companies that discussed the effect of the slowing economy, and reminded them of statements made by Office Depot at the beginning of the quarter that referenced the softening economic climate. Although Office Depot was careful not to state directly that it would not meet analysts' expectations for the quarter, the SEC took the position that Office Depot's statements nevertheless communicated that very message.
Following the conversations, 15 of the 18 analysts lowered their earnings expectations for the quarter. After several analysts expressed concern about the lack of a company press release regarding earnings, the CFO asked the director of investor relations to provide the company's top institutional investors with the same talking points given to the analysts. Six days after the initial calls, Office Depot filed a current report on Form 8-K with the SEC in which it announced reduced expectations for sales and earnings. Between the time of the first calls and the filing of the Form 8-K, Office Depot's stock dropped almost 8%.
More Active SEC Enforcement of Regulation FD. This SEC action, the third in little more than a year, should serve as an additional reminder that the SEC has become more aggressive in policing potential Regulation FD violations. A few takeaways from the Office Depot case include:
It's Not Just What You Say, It's Also How You Say It. Though the Office Depot executives were careful not to say anything about earnings directly to the analysts, the message was clearly communicated. As the SEC made clear in its Schering-Plough enforcement action, companies cannot evade the requirements of Regulation FD by using code words or phrases to convey material nonpublic information.
Have a Regulation FD Policy—And Train Your Team To Know It. Office Depot did not have written Regulation FD policies or procedures at the time of this violation, and the company had never conducted any formal Regulation FD training prior to June 2007. Companies should be sure to have a Regulation FD policy in place and to conduct training frequently.
Use Extreme Caution In Private Conversations Near the End of the Quarter. Be especially cautious when the discussions relate to financial results and earnings guidance. In this case, the calls with analysts were near the end of the quarter, a particularly sensitive period. If your company needs to provide advance warning of earnings results or otherwise update its financial disclosures, do it first in a press release or with a Form 8-K filing. Don't try to "talk down" Wall Street on earnings expectations without a public disclosure.
Seek Legal Counsel. In this case, there is no indication that the CEO or CFO ever asked inside or outside counsel about either arranging these analyst calls or the talking points used by the director of investor relations. A brief consultation with an attorney regarding these types of communications can help prevent inadvertent Regulation FD violations. Additional Information
You can find a copy of the SEC's press release regarding this enforcement here.
SEC develops data mining techniques to map insider trading
- Source: U.S. Said to Target Wave of Insider-Trading Cases After Galleon Bloomberg, October 19, 2009
"Federal investigators are gearing up to file charges against a wider array of insider-trading networks, some linked to the criminal case against billionaire hedge-fund manager Raj Rajaratnam that shook Wall Street last week, people familiar with the matter said.
The pending crackdown, based on at least two years of investigation, targets securities professionals including hedge- fund managers, lawyers and other Wall Street players, the people said, declining to be identified because the cases aren’t public. Some probes, like the one that focused on Rajaratnam, rely on wiretaps. Others stem from a secret Securities and Exchange Commission data-mining project set up to pinpoint clusters of people who make similar well-timed stock investments.
Investigators have struggled for years to build cases against large institutional investors such as hedge fund managers, who often deflect regulatory queries about suspiciously timed bets, arguing they’re statistical flukes amid their millions of trades. The case against Rajaratnam, built on recorded conversations within a web of alleged conspirators, offers a glimpse of how U.S. investigators are using more aggressive tactics to cut through the blizzard of trading and trace the flow of information.
“If you’re going to shoot the king, you better shoot to kill,” said Bradley Bennett, a partner at Baker Botts in Washington who formerly focused on insider-trading cases as an SEC investigator. “If they’re going to take on a billionaire, they need to have the strongest possible cases. The defendant’s own words are the strongest possible evidence.”
SEC spokesman John Nester declined to comment, as did Alejandro Miyar, a spokesman for the Justice Department.
Intel, McKinsey, IBM
Rajaratnam, who founded the Galleon Group hedge fund in 1997, was arrested with five alleged conspirators on Oct. 16 in what prosecutors called the biggest insider-trading ring targeting a hedge fund. Prosecutors said he and his firm reaped as much as $18 million by investing on tips from a hedge fund, a credit-rating firm and employees within companies including Intel Capital, McKinsey & Co. and IBM Corp.
He hasn’t yet entered a plea. Rajaratnam’s lawyer, Jim Walden, said last week that prosecutors are misconstruing the evidence against his client and that the case isn’t as strong as prosecutors allege.
U.S. senators including Pennsylvania Democrat Arlen Specter have pressed regulators for years to more aggressively scrutinize hedge funds. Some of those concerns were spurred by the SEC’s decision in 2006 to close an insider-trading probe of Pequot Capital Management Inc., once the world’s biggest hedge- fund manager, after investigators said they lacked evidence to bring the case.
The SEC later reopened part of the inquiry focusing on whether Pequot abused information from a former Microsoft Corp. employee. In August, Pequot and founder Arthur Samberg, 68, said they may be sued by the agency. Insider-trading claims would be “without merit,” they said.
Many cases begin when stock exchanges send the SEC reports on traders who place profitable bets shortly before corporate announcements. Someone who rarely trades may have difficulty explaining later what prompted an uncharacteristic investment. Hedge funds, on the other hand, can more plausibly attribute their windfalls to skill or chance.
To overcome that hurdle, the SEC began using computer software about two years ago to sift hundreds of millions of electronic trading records, known as blue sheets, attached to the stock exchange reports about suspicious incidents, according to people familiar with the project. By looking for patterns in the library of data, they identified groups of traders who repeatedly made similar well-timed bets.
Once investigators find a cluster of correlated trades, they tap other sources of information to unravel how its members obtain and share tips, the people said. For example, if a group profits on trades before a series of corporate takeovers, the SEC may check so-called league tables listing which investment banks or law firms advised the deals. If one firm was involved in all of them, an employee there may be the source of the leak.
The data-mining strategy yielded one of its first cases in February, when the SEC and U.S. prosecutors charged takeover advisers at UBS AG and Blackstone Group LP with taking part in an $8 million insider-trading case, people familiar with the inquiry said. Authorities used a “novel” technique to detect the scheme, the SEC’s lead investigator on the case, Daniel Hawke, said at the time, without elaborating.
While the investigation of Rajaratnam didn’t stem from the data-mining project, it did start with the SEC’s identification of suspicious trades, people with knowledge of the case said.
SEC to focus on derivatives as insider probes expand
- SEC to Focus on Derivatives as Insider Probes Expand Bloomberg, November 23, 2009
"The U.S. Securities and Exchange Commission will focus on financial instruments such as derivatives as it broadens a crackdown on insider trading by hedge funds, enforcement director Robert Khuzami said.
“The days of insider-trading scrutiny being focused almost solely on the equity markets are now gone,” Khuzami said today at a New York legal conference on hedge-fund regulation. After bringing its first insider trading case tied to credit default swaps in May, the SEC will “roll back the curtain on those markets and look at patterns across all markets,” he said.
Insider trading has become “systemic” behavior in the hedge-fund industry and the SEC is working with criminal authorities to ferret out misconduct, Khuzami said this month. Billionaire Raj Rajaratnam and his New York-based Galleon Group are among more than 20 people and firms the agency has sued since Oct. 16 in its probe of hedge funds.
The SEC brought its first insider-trading case tied to credit-defaults swaps in May, when it sued a Deutsche Bank AG salesman on claims he illegally fed information on a bond sale to a hedge-fund money manager. Prices on credit-default swaps, which insure investors against bond defaults, have surged before corporate takeovers in recent years, fueling speculation that traders are abusing inside information. The SEC has said since at least 2007 that it’s examining the trades..."
Recent enforcement of Reg FD
- The Perils of Implied Messages for Reg FD Harvard Law School Forum, October 26, 2010
- Remarks of Robert Khuzami at November 5, 2009 Press Conference SEC
- SEC Steps Up Insider-Trading Probes Wall Street Journal, December 1, 2009
- Source: United States: Recent Regulation FD Enforcement and Guidance Mayer Brown, October 16, 2009
The US Securities and Exchange Commission recently brought a Regulation FD enforcement proceeding against Christopher A. Black, the former chief financial officer, and designated investor relations contact, of American Commercial Lines, Inc. (ACL), alleging that Mr. Black violated the SEC's rules prohibiting selective disclosure. In settlement of the proceeding, Mr. Black, without admitting or denying the SEC's allegations, agreed to pay a $25,000 penalty and consented to an order directing him to cease and desist from violating Regulation FD and Section 13(a) of the Securities Exchange Act of 1934. See the SEC's order 34-60715 (the "Order"), dated September 24, 2009, available here.
This case is notable in two respects. First, it demonstrates that the SEC does monitor compliance with Regulation FD, notwithstanding that the SEC has not initiated many Regulation FD actions recently. Second, and perhaps more significantly, the SEC did not commence enforcement proceedings against ACL; rather the SEC brought the action only against the corporate officer that the SEC believed had violated Regulation FD.
The SEC complaint alleged that on Monday, June 11, 2007, ACL issued a press release revising its prior annual earnings guidance for 2007, projecting annual earnings per share in the range of $1.45-1.65. The press release also included general earnings guidance for the second quarter of 2007, stating that the company expected the "2007 second quarter results to look similar to the first quarter." ACL's first quarter 2007 earnings per share were $0.20.
On Tuesday, June 12, 2007, through Thursday, June 14, 2007, Mr. Black and ACL's CEO traveled together to meet with analysts who covered the company. Upon their return, Mr. Black proposed to send an email to all of the analysts, summarizing the information that had been discussed in their meetings. ACL's CEO agreed, and asked for the email to be sent by the close of business on Friday, June 15, 2007. According to ACL's CEO, the CEO directed Mr. Black to provide a draft of the email to outside counsel before sending it.
Mr. Black was unable to finalize the email on Friday. Instead he sent it from his home on Saturday to just the eight sell-side analysts who covered the company. Mr. Black did not have counsel review the email and he did not notify anyone else at ACL that he was sending it. In the email, Mr. Black stated that he wanted to provide "some additional color" regarding the June 2007 earnings guidance and that the company expected "EPS for the second quarter will likely be in the neighborhood of about a dime below that of the first quarter ...."
On Monday, June 18, 2007, the first trading day after Mr. Black's email, ACL's stock price dropped 9.7 percent on usually heaving trading volume. ACL's CEO learned of the email on that Monday morning. ACL filed a Form 8-K to disclose the content of Mr. Black's email at the end of the trading day on that Monday afternoon. For further information about the facts in this case, see the Order referenced above and the SEC's complaint, available here.
The SEC issued Litigation Release No. 21222 on September 24, 2009, available here, in which it explained several factors that made it decide not to commence enforcement proceedings against ACL:
- Before the date that Mr. Black sent the email in question, ACL had "cultivated an environment of compliance" in which it provided training on Regulation FD requirements and adopted policies implemented controls to prevent violations;
- In this matter, Mr. Black was responsible for the violation and he did so outside of the systems of control that ACL had adopted to prevent improper disclosures;
- On the day that ACL discovered that Mr. Black sent the email to certain analysts, it filed a Form 8-K to publicly disclose the information;
- ACL self-reported the selective disclosure to the staff of the SEC on the day after it discovered that the email had been sent;
- ACL provided "extraordinary cooperation" with the SEC staff's investigation; and
- ACL took remedial measures to address the improper conduct, which included the adoption of additional controls aimed at preventing future Regulation FD violations.
There are a number of important lessons that public companies can learn from this enforcement case. First, companies should implement controls to prevent selective disclosure, and should revise and update those controls as necessary to be sure that they work as intended. As the ACL situation emphasizes, a strong on-going compliance program can be an extremely effective tool in deterring government action against a company in the event an employee violates both company policy and Regulation FD.
Second, it is important to train employees on the compliance requirements of Regulation FD, to periodically refresh that training and to document that such training occurred. Pointing out the personal penalties that Mr. Black incurred may serve as a graphic reminder to employees of the importance of refraining from selective disclosure of material nonpublic information about the company.
Finally, this case provides a roadmap of meaningful steps that can be taken to head off government prosecution of the company should an employee violate Regulation FD. These steps include promptly filing a Form 8-K, as required by Regulation FD; self-reporting the violation to the SEC; cooperating with any SEC investigation; and reviewing and improving internal controls in an effort to improve future compliance.
When considering how to implement Regulation FD compliance, public companies should note that the SEC published Compliance and Disclosure Interpretations (CDIs) for Regulation FD on August 14, 2009. See .
Many of these CDIs reflect the SEC's prior telephone interpretations, but there have been some revisions and clarifications. For example, Question 102.01 specifies that the adequate advance notice under Regulation FD must specify the subject matter, as well as the date, time and call-in information for a conference call. Question 102.05 provides that a shareholder meeting that is open to the public but is not otherwise webcast or broadcast by electronic means is not a method of disclosure "reasonably designed to provide broad, non-exclusionary distribution of information to the public."
And, Question 102.06 states that the mere presence of the press at an otherwise non-public meeting attended by persons outside of the issuer does not render the meeting public for the purposes of Regulation FD. Question 102.07 has been added to reference Exchange Act Release No. 58288, (available here, which discusses the circumstances under which information posted on a company website is considered public for the purposes of Regulation FD. For a further description of that interpretive release, see our Securities Update, titled "SEC Issues Updated Guidance on Company Web Sites," available here.
The CDIs on Regulation FD, taken together with the SEC's interpretative release mentioned in the CDIs, serve as important reference tools that public companies should consult as questions about Regulation FD compliance arise.
Background on Reg FD
Before the 1990s, most individual investors followed the progress of their stock holdings by receiving phone calls from their broker, by reading annual or quarterly reports mailed to them by the company, by reading news in newspapers or financial publications, or by calling the company with questions. Most investors relied primarily upon full service brokers, such as Merrill Lynch, for trading advice.
During the 1990s, Internet usage became widespread and online discount brokers such as Charles Schwab, E-Trade and Ameritrade allowed individual investors to trade stocks online at the push of a button. At the same time, these investors began using the Internet to research stocks and make timely, more informed trading decisions. The Internet placed a plethora of rich research information into the hands of investors, who became more empowered than ever to make their own informed investing decisions. As these investors learned the joys of real-time stock quotes and near-real-time access to press releases, they began to demand even more access.
By 1999, individual investors became more aware of quarterly analyst conference calls, where a company's management would disclose the results of the quarter and answer analyst questions about the company's past performance and future prospects. At the time, most companies did not allow small investors to attend their calls.
One small investor, Mark Coker, founded a company called Bestcalls.com, a directory of conference calls open to all investors, to help persuade public companies to open up all their calls . Coker campaigned in the press to educate individual investors about the benefits of conference call attendance as a fundamental research tool, and worked constructively with the SEC to educate them about the pervasiveness of selective disclosure on earnings conference calls. At the same time, companies such as Broadcast.com, Vcall.com, Shareholder.com and Thomson Financial offered webcasting technology and services that made it more practical, and more affordable, for companies to allow all investors to listen in.
In December 1999, the SEC proposed Regulation FD. Thousands of individual investors wrote the SEC and voiced their support for the regulation. But support was not unanimous. Large institutional investors, accustomed to benefiting from selectively-disclosed material information, fought vigorously against the proposed regulation. They argued that fair disclosure would lead to less disclosure. In October 2000, the SEC ratified Regulation FD.
The principles of Regulation FD
Source: United States: The SEC Staff Updates Regulation FD Guidance August 27, 2009, Morrison & Foerster LLP
Regulation FD prohibits selective disclosure of material nonpublic information to specified persons. Two key principles underlying Regulation FD are:
- Selective disclosure of material information that has previously been adequately publicly disseminated will not violate Regulation FD; and
- Unless an exclusion to Regulation FD applies, a company is required to publicly disclose any material nonpublic information that it discloses selectively to the persons enumerated in Regulation FD.
Regulation FD provides that material nonpublic information can be publicly disclosed by either filing or furnishing a Form 8-K or by disseminating 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."
Confirming Prior Guidance
Regulation FD C&DI Question 101.01 addresses the extent to which a company may permissibly confirm prior public guidance to analysts or investors on a selective basis. The staff notes in the interpretation, as it had in the past in a telephone interpretation, that whether Regulation FD's reporting requirement is triggered depends on the materiality of the company's confirmation of the guidance. In assessing the materiality, the company must consider the extent to which the confirmation (including the related circumstances and context around the confirmation) conveys additional material information.
In examining these circumstances, the staff notes in the interpretation that the amount of time that has elapsed since the original guidance was given and the extent to which there have been intervening events since that time may be relevant factors. For example, the confirmation of quarterly guidance at the end of a quarter may be material, while confirmation in the middle of the quarter may not be deemed as material, given differing inferences that could be drawn based on the relative timing of the confirmations. Further, intervening events may also render the confirmation of guidance material. The interpretation provides an example where an intervening loss of a customer since the publication of the original guidance may make a subsequent confirmation of the original guidance material.
The interpretation has now been expanded to address the types of language that might be deemed to be confirming prior guidance. In this regard, it is noted that a statement by the company that it has "not changed" or that it is "still comfortable with" prior guidance is the same as providing a direct confirmation of the prior guidance. Further, the interpretation notes that merely a reference to the prior guidance may imply confirmation of that guidance. In the event that a company does not wish to confirm the prior guidance, the interpretation notes that the company could say "no comment." Further, a company could make clear when referring to prior guidance that the guidance was provided as an estimate as of the date it was given, and that it is not being updated at the time of the subsequent statement.
With the variability of financial results driven by the recession and the financial crisis, executives may increasingly find themselves in situations where they risk violating Regulation FD by providing selective disclosure with respect to prior guidance. Analysts or investors may press for information as to management's level of comfort with prior guidance, and, as noted in Regulation FD C&DI 101.01, there is potential for violations of Regulation FD depending on the circumstances in which these discussions arise. Companies should consider whether it is prudent to implement a "no comment" policy regarding confirmation of prior guidance, particularly in those situations where there is a heightened risk for selective disclosure regarding prior guidance.
In the current economic environment, many companies have also considered whether to suspend their prior guidance or to otherwise change their guidance practices, given the many uncertainties that they face. In general, any change to guidance practices, including the suspension of current guidance, should be announced in a manner that complies with Regulation FD, preferably in the same manner in which the company typically provides the guidance itself.
Press Involvement in a Non-Public Meeting
Regulation FD C&DI 102.06 notes that the mere presence of members of the press at an otherwise non-public meeting attended by persons covered by Regulation FD (e.g., analysts and investors) would not make the meeting public for the purposes of Regulation FD.
In restating this interpretation, the SEC staff removed a discussion of the facts and circumstances that might have been relevant to a determination, including when, what and how widely the press reported on the meeting.
Under C&DI 102.06, the presence of the press will not now be considered to be sufficient for establishing public disclosure under Regulation FD, even if the members of the press ultimately report on the meeting in a public manner.
Communications with financial analysts
- Communications with Financial Analysts and Related Disclosure Issues Harvard Law School Forum on Corporate Governance and Financial Regulation, Edward F. Greene, Cleary Gottlieb Steen & Hamilton LLP, November 21, 2009
This post is an abridged version of a Cleary Gottlieb Steen & Hamilton LLP client memorandum, excluding footnotes; the complete memorandum is available here.
Securities analysts play a key role in securities markets, and publicly held companies as a matter of market practice regularly brief them to help them understand company results and business trends. There have been some unfortunate instances, however, in which analysts have received nonpublic information on which their clients have acted before the information was disclosed to the general public. In the wake of these cases, as well as Enron and the unanticipated and significant decline in the financial position of other public companies, the role of the securities analyst was scrutinized by Congress, the Securities and Exchange Commission (the “SEC”), state regulators and various self-regulatory organizations. The result was a heightened campaign against selective disclosure, facilitated by the SEC’s adoption of Regulation FD (Fair Disclosure) in 2000.
Although the number of Regulation FD cases has diminished in recent years, this is perhaps because compliance has become deeply ingrained in market participants. Nonetheless, given the potential for SEC enforcement action, as well as insider trading litigation, ongoing vigilance in this domain is certainly warranted. A memorandum prepared by Cleary, Gottlieb, Steen & Hamilton LLP (available here) sets out guidelines for communications between management and securities analysts in light of applicable case law and the SEC’s Regulation FD. A summary of the guidelines is included below.
The U.S. rules governing disclosure to analysts by issuers originally emerged from case law construing a basic antifraud rule, Rule 10b-5 under the Securities Exchange Act of 1934 (the “Exchange Act”).
As a result, the rules are not straightforward, are at times ambiguous and, in any event, have not been applied, with one known exception, to communications between issuers and analysts. This situation led the SEC to adopt a new disclosure regime, Regulation FD, to prevent material nonpublic information from being given selectively to market professionals (broker-dealers, investment advisers and managers, and investment companies), who could use such information to their own or their clients’ advantage.
Regulation FD applies to communications on behalf of the issuer with market professionals and with securityholders who may foreseeably trade on the basis of the disclosed information. Although Regulation FD does not apply to foreign issuers, they too should avoid selective disclosure of material nonpublic information both as a matter of best practice and to avoid potential liability. Ill-considered disclosure can lead to liability both for the company and for its management personally under Rule 10b-5, raise potential issues regarding correcting or updating information and have adverse market consequences.
The U.S. Supreme Court has established that there must be a breach of a fiduciary duty or other relationship of trust and confidence, or a misappropriation of information received in violation of such a relationship, before tipping or trading on the basis of material nonpublic information results in a violation of Rule 10b-5.
This has led to three general principles with respect to the disclosure of corporate information to securities analysts and the public.
First, Rule 10b-5 by itself does not normally require management to disclose material nonpublic information regarding the company to the investment community. Subject to certain exceptions discussed below, the timing of such disclosure is ordinarily left to the business judgment of management.
Second, if a company does disclose corporate information (whether voluntarily or otherwise), Rule 10b-5 requires that those disclosures neither contain misleading statements of material information nor omit material facts necessary to make the statements made not misleading.
Third, when divulging material nonpublic information, company officials may not disclose it selectively—e.g., exclusively to securities analysts—but rather must make the information available to the general public, if those officials could be found to have gained a personal benefit from the selective disclosure. Selective disclosure can lead to liability for the company and for company officials themselves for insider trading by persons receiving the disclosure.
Although Rule 10b-5 might not require dissemination of material information, the New York Stock Exchange (the “NYSE”) and the NASDAQ Stock Market (“Nasdaq”) require listed companies to disclose material information promptly to the public through any Regulation FD-compliant method of disclosure, except under certain limited circumstances.
In addition, listed companies may be required to notify the NYSE or Nasdaq of the release of any such information prior to its release to the public. NYSE and Nasdaq rules, however, do not have the force of law and cannot be the basis for an implied private right of action. The Second Circuit held in State Teachers Retirement Board v. Fluor Corp. that no private right of action exists for a violation of the NYSE Listed Company Manual’s disclosure rules. The court reasoned that, given the extensive regulation in this area by Congress and the SEC, “a federal claim for violation of the [NYSE’s Listed] Company Manual rules regarding disclosure of corporate news cannot be inferred.”
In addition to annual reports on Form 10-K and quarterly reports on Form 10-Q, a domestic issuer subject to Exchange Act reporting must file current reports on Form 8-K with the SEC to disclose certain specified events.
In many cases, disclosure is required within four business days of an event’s occurrence. For a foreign private issuer, Form 6-K requires submission to the SEC of all significant information that
- (i) must be made public under local law in the issuer’s country of incorporation or domicile,
- (ii) is filed with any foreign stock exchange on which the issuer’s securities are listed and made public by such exchange or
- (iii) is distributed to the issuer’s securityholders.
Finally, when preparing disclosure responsive to the SEC’s Exchange Act reporting requirements, companies should be mindful of Rule 12b-20, which requires inclusion of any information beyond what is expressly required “as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading.” The SEC has brought enforcement actions for violating Rule 12b-20 even in the context of Form 6-K filings, where there are no express disclosure requirements.
Management should be very careful in its communications with securities analysts. Under certain circumstances, the disclosure of material information selectively to analysts can violate Rule 10b-5 and thereby generate both SEC sanctions and liability for damages to investors. Pursuant to the tests courts have fashioned to determine “materiality,” company officials should be wary of disclosing to analysts, but not to the public generally, any information (such as earnings information) that might affect the company’s share price or that a reasonable investor would deem important in deciding whether to buy or sell company securities.
Furthermore, companies should take precautionary measures in advance to avoid selective disclosure. Prophylactic procedures include the scripting of presentations to analysts, the pre-meeting review of the proposed presentation by counsel and officials familiar with the issues to be discussed and a debriefing of the officials after the presentation to verify that no material nonpublic information has been disclosed, as well as a limitation on the number of company officials responsible for giving such presentations.
Management should also consider maintaining a “no comment” position if it wants any particular issue to remain confidential. Finally, less formal communications with analysts should also be conducted in accordance with procedures designed to minimize inadvertent disclosure of material information and to provide the company with evidence to defend potential allegations of intentional selective disclosure.
When a domestic company discloses material nonpublic information to analysts or other market professionals, or to its securityholders when it is reasonably foreseeable they will trade, the disclosure regime established by Regulation FD requires that the company must make the disclosure broadly to the investing public too. Although Regulation FD does not apply to foreign issuers, foreign issuers should continue to take into account best practices and avoid selective disclosure of material nonpublic information out of concern for potential liability under Rule 10b-5.
Regulation FD requires that if material nonpublic information is inadvertently disclosed to analysts or others to whom selective disclosure is restricted by the regulation, the company must promptly (and, in any event, generally within 24 hours) make public disclosure of that information. Public disclosure for purposes of Regulation FD can be made by filing or furnishing a Form 8-K or by disseminating the information through a method or combination of methods that is “reasonably designed to provide broad, non-exclusionary distribution of the information to the public,” such as a press release.
The NYSE and Nasdaq also require listed companies to disclose material information promptly to the public through any Regulation FD-compliant method of disclosure. In addition, listed companies must notify the NYSE or Nasdaq of any such information prior to its release to the public in certain circumstances. Management should also avoid participating to a significant extent in the preparation of analysts’ reports to minimize potential 10b-5 liability. Specifically, company officials should not “entangle” themselves with the creation of such reports to the extent that the information they contain can be attributed to the company.
Accordingly, any participation by the company should be limited to reviewing the report for factual accuracy (which is all a U.S.-based analyst is permitted by applicable SRO rules to request), with care being taken in any event not to comment on any forecasts or other judgmental statements made by the analyst. Similarly, a policy of not commenting on analysts’ projections can prevent the company from being required to correct or verify market rumors on the grounds that such rumors cannot be attributed to the company.
While Rule 10b-5 liability can arise from selective disclosure of accurate information, it is important to note that liability can also attach if such disclosure, made selectively to analysts or generally to the public, contains a materially misleading statement or omits a material fact necessary to make the statement made not misleading. Even if a company’s statement is accurate when made, if intervening events render the disclosure materially misleading, management may have a duty to update the prior comment.
Finally, management should institute a process for identifying all non-GAAP financial measures contained in any public disclosure by the company, accompanying that disclosure with the most directly comparable GAAP financial measure and quantitative reconciliation of the two measures. To minimize the impact of these rules on public presentations of non-GAAP financial measures disclosed orally, telephonically, by webcast or broadcast, or by similar means, the company should also consider maintaining a reconciliation of these non-GAAP financial measures, for at least a 12-month period, on its website under the section dedicated to investor relations and set forth the location of the website in the public presentation in which the non-GAAP financial measure is used.
In particular, for information disclosed in conjunction with the company’s earnings conference call, management should furnish the earnings press release to the SEC under Item 2.02 of Form 8-K before the conference call, include a statement identifying where the call will be archived on the company’s website and distribute the announcement through a widely circulated news or wire service.
Guidelines for Communications with Analysts
- Designate one company executive to communicate with analysts.
- Make each presentation to analysts on the basis of a prepared text that has been reviewed by senior executives and by counsel.
- Do not disclose material nonpublic information to analysts unless you disclose the information to the public at the same time; this can be done by permitting the public, on reasonable advance notice, to participate in any call with analysts during which material nonpublic information may be discussed.
- Refrain from responding to analysts’ inquiries in a nonpublic forum unless you are certain that the response does not include material nonpublic information.
- If you are asked about a matter that is not ripe for disclosure, simply say “no comment.”
- If requested by an analyst to review a research report, do not comment except to correct errors of fact. Do not comment in any way on an analyst’s forecasts or judgments, including by saying you are “comfortable” with them, that they are “in the ballpark” or other words to similar effect. Do not distribute analysts’ reports or hyperlink to them on the company’s website.
- Avoid favoring one analyst over another.
- Review public statements to identify any non-GAAP financial measures. If disclosure contains non-GAAP financial measures, include a presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP and a quantitative reconciliation of the two measures. To avoid reconciliation of non-GAAP financial measures in public presentations given orally, telephonically, by webcast or broadcast, or by similar means, provide the most directly comparably GAAP financial measure and the required reconciliation on the company’s website and include the location of the website in the presentation. If materials distributed (electronically or in hard copy) during a public presentation contain non-GAAP financial measures, provide the most directly comparable GAAP measures and provide the required reconciliations in close proximity to the non-GAAP financial measures.
- Do not make specific forward-looking statements, unless
- (a) you set out the assumptions on which the forecast is based,
- (b) you indicate the factors that could prevent the forecast from being realized,
- (c) you make the statements to the public at the same time and
- (d) you are always prepared to evaluate the need to update the statement when circumstances change.
The steps contemplated by (a) and (b) can be effected by referring to a filed document that contains the relevant information.
Edward F. Greene is a partner at Cleary Gottlieb Steen & Hamilton LLP where he specializes in corporate law matters.
The use of websites for Regulation FD purposes
Regulation FD C&DI 102.07 reminds companies that the SEC has provided guidance on the use of corporate websites, including the extent to which information posted on websites would be considered "public" for the purposes of the applicability of Regulation FD and whether the information would be deemed to satisfy Regulation FD's "public disclosure" requirement.
In Release No. 34-58288 (August 1, 2008), the SEC provided three considerations for determining whether information posted on a corporate website is considered "public":
- Is a company's website a "recognized channel of distribution"?
- Is information posted in a manner calculated to reach investors?
- Is information posted for a reasonable period of time so that it has been absorbed by investors?
In the context of whether a website posting satisfies the public disclosure requirement of Regulation FD following the selective disclosure of material, non-public information, the guidance from the Release indicates that companies must consider whether website postings are "reasonably designed to provide broad, non-exclusionary distribution of the information to the public." In conducting this analysis, a company must examine the first two factors referenced above, and also must consider whether its website is capable of meeting the simultaneous and prompt timing requirements under Regulation FD once a selective disclosure has been made.
Companies have continued to struggle with applying the SEC's guidance in practice, given the difficulty in making judgments about the nature of a company's website. As a result, practices have not significantly changed in terms of how information is disseminated in order to make the information public or to comply with Regulation FD's public disclosure requirement. More guidance from the SEC or the staff on this topic would be welcome.
Google moves to web disclosure for Reg. FD
Google moves to web disclosure for Reg. FD] IRWebReport.com, April 16, 2010 (By Dominic Jones)
GOOGLE INC. (NASDAQ:GOOG) will begin making announcements about its financial performance solely through its investor relations website, making it the most prominent company to take advantage of the U.S. Securities and Exchange Commission’s (SEC’s) guidance on using company websites for disclosure under Regulation FD.
Almost all North American public companies currently distribute their earnings announcements and other investor disclosures through paid PR wire services that syndicate full-text releases to hundreds of media and Internet outlets. They do so even though the SEC ruled in August 2008 that postings on company websites alone can meet its fair disclosure requirements if they abide by certain standards.
Google broke with the PR wire service distribution tradition for its April 15 earnings release when it issued a short advisory via a paid PR wire service informing investors to visit the company’s investor relations website to obtain the full earnings announcement. The advisory release approach, which we first recommended in 2007, has been adopted by at least two three other U.S. companies, BGC Partners (NASDAQ:BGCP), Reis, Inc. (Nasdaq:REIS), and Expedia, Inc. (NASDAQ:EXPE), which plans to use the process again April 29.
Google’s IR website has long been “recognized channel”
However, Google also announced in its advisory release that it “intends to make future announcements regarding its financial performance exclusively through its investor relations website.” This suggests the company will no longer issue advisory releases and instead rely solely on its recently revamped investor relations website as a disclosure channel.
- SEC proposes Reg FD SEC
- SEC ratifies Reg FD SEC
- SEC analyzes impact of Reg FD SEC
- Examining Reg FD impact Wharton
- American Enterprise Institute
- Reg FD Disclosure wire (North America & UK)
- The 10b-5 Daily
- Recent SEC Enforcement of Regulation FD: Office Depot, Inc. Drinker Biddle, January 17, 2011
- The insider trading crackdown and Reg FD Truth on the Market, December 17, 2010
- Recent SEC Enforcement of Regulation FD: Lessons to be Learned Andrews Kurth LLP, December 14, 2010
- Kinnucan: How to Tell an Investment Bank from an “Expert Network” CNBC, December 9, 2010
- SEC Enforcement Action Under Regulation FD For Implicit Communications To Selected Analysts Sheppard Mullin, November 22, 2010
- Do Hedge Funds Trade On Non-Public Information; The Gray World Of "Tiered" Ultra Premium Media Access ZeroHedge, July 9, 2010
- (MoneyTech) Google and Twitter v the investment banks FT Alphaville, June 22, 2010
- Did Warren Buffett & Berkshire Sell A Million Shares Of Moody's Based On Inside Information? The Daily Bail, May 11, 2010
- France to Use Intelligence Agency in Rumor Crackdown CNBC, May 7, 2010
- USA Vs. GS - Pot Calls Kettle Black? ZeroHedge, April 26, 2010
- Image Is Everything: SEC Brings Second Regulation FD Action in Six Months Perkins Coie, April 1, 2010
- Big Clients Keep Their Head Start New York Times, March 22, 2010
- Ashes to Ashes, Dust to Dust (Except Where Prohibited by Law) ZeroHedge, March 22, 2010
- Banks Stifle First Amendment, Attempt To Create A Tiered Market Of "Clients" And "Everyone Else" ZeroHedge, March 18, 2010
- Banks Win Ban on Flyonthewall Instant News of Reports Bloomberg, March 18, 2010
- Corporate crooks face tougher penalties The Age, January 28, 2010
- Director Engagement With Shareholders Without Fearing Reg FD Harvard Law School Forum, Dec 20, 2009
- Commentary: Give 'Fair Disclosure' Time to Work Businessweek, January 18, 2001
- Full Disclosure for All Business Week, September 18, 2000