Is Regulation Fair Disclosure working?
That question has emerged periodically since the rule first went into effect 14 years ago. While some critics are calling for the Securities and Exchange Commission to amend or even scrap its rule for preventing material company information from being handed to a small group of investors, others who deal with the rule on a regular basis defend it and say adapting to new challenges is more the responsibility of companies themselves than the SEC.
The latest critic to stir the pot is Steven Davidoff, a professor at the Michael E. Moritz College of Law at Ohio State University. Earlier this month, in a New York Times column, he asked: “Do we even need such a broad rule anymore in today’s information age? If the rule was done away with, might not companies be much more willing to release information, information that would improve how markets trade? Given what is going on right now, it doesn’t seem like small investors are benefiting at all from this ‘equal access’ to information, instead losing out because of small issuers being denied capital and analyst coverage.”
Davidoff argues that activist investors and hedge funds leverage their large positions to demand direct access to the CEO and other executives, and that the rule can’t prevent such meetings from happening.
Last October, for example, Apple CEO Tim Cook agreed to a three-hour dinner with activist investor Carl Icahn, who was pushing for Apple to conduct a $150 billion share buyback and acquired a large stake in the company. Was the dinner merely a “get to know you” breaking of bread? Or, was potentially material, market-moving information—of the very sort Reg. FD is intended to make available to a broader audience—on the menu?
If It Ain’t Broke …
Not everyone agrees with Davidoff that Cook’s meeting with Icahn is evidence of Reg. FD’s failings. “In my view, remembering the pre-FD world and looking at the post-FD world, I think it definitely works pretty well and has proven to be useful to the markets,” David Lynn, a partner in the Washington D.C. Office of Morrison & Foerster, says. “It creates a lot of hand-wringing among people like me and at companies about when and how they have to disclose things, but it has worked very well.”
Others say it hasn’t constricted the flow of information from public companies, as some feared. “There was a lot of discussion when Reg. FD was enacted about whether it was going to cause less information to be disclosed by public companies simply because of fear of running afoul of it,” Thomas Aldrich, a partner in the law firm Thompson Hine’s Corporate Transactions & Securities practice group, says. “I haven’t seen that at all.”
Aldrich does concede that the current investor relations landscape gives companies cause for concern. “One of the basic issues you are dealing with is that, from a Wall Street standpoint, information is the same thing as money,” he says. “You have a constant arms race between people trying to find out things about companies that nobody else knows and the SEC committed to the idea of a level playing field.”
Maureen Wolff, president of Sharon Merrill, an investor relations and corporate communications consultant and a past chairman and board member of the National Investor Relations Institute, also agrees that Reg. FD has worked well despite occasional challenges. Rather than tinker with the rule itself, or toss it aside, what is needed is for companies to strategize their approach to compliance, she says.
“Engaging in dialogue with an activist investor is the same as you would any investor,” Wolff says. “The content of your discussion must be limited to previously disclosed material information. The key to staying on the right side of Reg. FD in such a high-risk meeting situation is to be extremely well prepared. That means spending a significant amount of time on Q&A preparation and rehearsal to ensure your answers don’t get you in trouble. “
It is also helpful, Wolff says, to disclose, in a public conference call or other SEC-compliant manner, as much information as possible on what is expected to be discussed in upcoming investor meetings, especially if those topics include growth strategy and expectations, capital allocation, and capital structure plans. “If there is information that you would like to disclose, or believe that an activist will ask about in a particular meeting, you do have the option to file a Form 8-K prior to the meeting,” she says. “Keep in mind that meetings with activist investors are excellent opportunities to do more listening than talking. It gives management a chance to uncover the activist’s specific areas of interest or concern and gauge the perceptions of other shareholders.”
Wolff underscores the importance of Reg. FD training, especially in light of recent SEC enforcement actions. Last year, the SEC charged Lawrence Polizzotto, a former investor relations executive for First Solar, with violating Reg. FD by disclosing details of a government loan to a select group of analysts and investors during 2011 phone conversations.
While the executive agreed to pay $50,000 to settle the SEC's charges, the company itself was let off the hook because of what was described by the SEC as “extraordinary cooperation” with the investigation, the fact that it quickly self-reported the matter, and its commitment to employee training on disclosure matters.
The importance of Reg. FD training for employees and executives is also shown in a 2009 enforcement action against American Commercial Airlines. The SEC filed a civil action against the former chief financial officer of the company when its chief financial officer e-mailed eight analysts from his home to let them know earnings-per-share would be lower than forecasted guidance. The SEC declined to bring an enforcement action against the airline because the rogue action conflicted with its efforts to “cultivate an environment of compliance” by training employees on Reg. FD and implementing controls to prevent violations. Prompt self-reporting of the violation was also cited as a mitigating factor.
“Public companies should provide training on Reg. FD and insider trading for management and their employees on a regular basis,” Wolff says. “Also, companies should have a disclosure committee and policy in place. This includes having clear guidelines and procedures for quickly and broadly disseminating information if an inadvertent disclosure takes place as well as a ‘no comment’ policy for specific questions, such as M&A. Cultivating an environment of Reg. FD compliance is an important focus of the SEC. As a result, we’re seeing a much higher demand to provide training for management, the board, and employees.”
THE LAST REVISION
During the 14 years Regulation FD has been on the books, the Securities and Exchange Commission has occasionally stepped in to offer guidance and revisions intended to adapt it to emerging technology. The following is from a 2008 revision related to company Websites.
As we have developed EDGAR to facilitate and promote electronic availability of information, we also have encouraged companies to make their Commission filings and other company information available on their Websites. We believe that company disclosure should be more readily available to investors in a variety of locations and formats to facilitate investor access to that information. Although our rules do not require reporting companies to establish or maintain Websites, our rules do promote and, in some cases require, companies to use Websites to make required disclosures. A company’s Website is an obvious place for investors to find information about the company, and a substantial majority of large public companies already provide access to their Commission filings through their Websites.
Technological advances, and the reduced costs associated with the implementation of technologies over time, now allow companies to include more “interactive” and current information on their Websites than was the case previously, thereby moving Websites away from the filing cabinet or “static” paradigm to a “dynamic” paradigm, one shaped by the market’s desire for more current, searchable and interactive information.
We recognize that allowing companies to present data in formats different from those dictated by our forms or more technologically advanced than EDGAR may be beneficial to investors. Indeed, because we recognize the enormous potential for the Internet to promote the goals of the federal securities laws, we wish to continue to encourage companies to develop their Websites in compliance with the federal securities laws so that they can serve as effective information and analytical tools for investors. Enhanced company Website presentation of information can benefit investors of all types by enabling them to gather information about a company at a level of detail they believe is satisfactory for their purposes.
Ahead of a meeting with shareholders, Aldrich would urge executives to brush up on Reg. FD and try not to speak off-the-cuff. “You carefully script these conversations and prepare the things you want to talking about in advance,” he says, suggesting that a company lawyer also take part in the conversation. “It is not that hard to avoid falling off the tightrope as long as you’re well-counseled and willing to learn the dos and don’ts.”
Executives might also want to reconsider the very idea of having a dinner similar to the Cook and Icahn summit. “I would advise clients not to have three-and-a-half-hour dinners with someone like Carl Icahn, because if you are not talking about material non-public information, what in God’s green earth can you be talking about for hours?” Aldrich says. “When you get involved with an aggressive activist, you face the question of whether every contact you have with him, and whether the fact that you are even having contact with him, is something that could potentially move the stock and you need to be saying something publicly.”
Richard Truesdell, co-head of the law firm Davis Polk’s global Capital Markets Group, agrees that most large companies are well-acquainted with the ins-and-outs of Reg. FD. “Just because it’s hard, and people make mistakes, doesn’t mean it’s not the right rule and the right system,” he says.
A challenge, however, is making on-the-fly determinations of materiality. This can be especially difficult because SEC guidance opines that you can give people “individual immaterial tiles, even if they then piece them together in a mosaic that is material,” he says. “The hard part is gauging whether this tile or that tile is material and in hindsight, lots of time, people are surprised.”
Truesdell suggests that companies offer, at least once-a-year, refreshed training for the CEO, board members, and their investor relations team on interacting with shareholders. In many ways, the occasional flurry of media attention that erupts around Reg. FD can be a good thing, he says. “The directors of companies read those articles and call up the general counsel to ask what their policy is and what training they have done,” he says. “Everybody gets focused on it for a period of time.”
One wrinkle that Aldrich plans to watch closely: the SEC’s ongoing review of its disclosure regime and the possibility of real-time disclosure at some point. “I think a lot of the future utility of Reg. FD is going to depend on what the future of securities regulation itself is going to look like,” he says.