When Regulation Fair Disclosure was enacted 12 years ago, Facebook creator Mark Zuckerberg was in high school and the first Twitter message was still six years off.
Since then, the entire way that people communicate and how news is disseminated has changed, thanks to social media and other technologies. But the rules of Reg FD haven't changed a lick. Maybe it's time for some revisions.
In a September 1998 speech before the New York University Center for Law and Business, then Securities and Exchange Commission Chairman Arthur Levitt condemned the “game of nods and winks” between companies and financial analysts which he described as a common practice in which companies played “the numbers game” in an attempt to manage earnings expectations to achieve a consensus among selected analysts. This speech set in motion the SEC's effort to write a new rule that would eliminate this practice in favor of providing full and fair disclosure of material information to all investors, individual and institutional.
First, let's take a closer look at the early thinking that went into Reg FD. When the SEC began considering new disclosure rules, I served on Chairman Levitt's Investor Advisory Committee, and in my role as CEO of the National Investor Relations Institute, my board urged me to work with the SEC staff in an effort to craft rules companies could live with. At the time, the “technology” for disseminating corporate earnings news was primarily a press release transmitted by the major wire services.
I urged the SEC staff to consider the Internet and fully accessible telephone conference calls as additional avenues for full disclosure. Initially, the staff pushed back saying that fewer than half of American adults had Internet access. I provided research conducted by Iowa State University in 1998 of members of the National Association of Investors Corp.—comprised mostly of investment club members around the country—showing that more than 80 percent used the Internet and rated corporate Websites as a primary and credible source for making investment decisions.
Moreover, the staff believed it was not possible for a corporate official to engage in a one-on-one discussion about corporate performance or earnings without giving away selective material information. I brought in Debbie Kelly, a member of the SEC's 1978 disclosure task force and a former financial analyst with experience in corporate investor relations along with NIRI Chairman Jane McCahon, an experienced investor relations officer to demonstrate, through role-play, how a corporate spokesperson could have a one-on-one discussion with an analyst about corporate performance without revealing new material information.
When the final rule passed in October 2000 the SEC embraced a fully accessible corporate conference call using an “800” number that investors could call or access the live call through the company's Website as means for full and fair disclosure. The SEC required companies to provide “adequate notice” through a press release in advance of a conference call containing the access information. And, with cautionary warnings, the rule accepted the practice of one-on-one discussions between a corporate official and individual analysts or investors. The road to the adoption of Reg FD was filled with potholes created by various powerful interest groups such as the Chartered Financial Analyst Institute (then the AIMR), the American Bar Association's Securities Law division and the Investment Company Institute, representing the major investment funds—all claiming the rule would stifle the flow of information between companies and analysts and institutional investors.
Seven years later, Harvard University Business School professor Paul Healy, who had conducted the most extensive academic review of Reg FD, published a paper “How Did Regulation Fair Disclosure Affect the U.S. Capital Market? A Review of the Evidence,” showing these concerns to be unfounded. In fact, he said, “Overall, the findings suggest that Reg FD was accompanied by an increase in public disclosure by managers and a decline in the value of sell-side analyst information. The findings therefore suggest that regulator concerns about weakened investor confidence from selective management disclosure and critics concerns about the impact of the new rules on market information were both over-stated.”
The early success of Reg FD was further buoyed by the small number of documented violations. Between 2003 and 2010, the SEC brought only about a dozen enforcement actions against company officers for breaking Reg FD. In none of these cases was technology for disseminating material non-public information a major issue. They were all based on senior company officials selectively disclosing material, non-public information to analysts or investors. The first case involved the chief financial officer of Raytheon, who after a quarterly earnings conference call and ignoring his IRO's advice, made individual calls to all but one of the company's analysts to make his case why each should lower his or her published estimates. The analyst who didn't get a call went to the Wall Street Journal and exposed what the CFO had done. That news triggered an SEC investigation and the CFO lost his job over the enforcement action.
In another case, Siebel System's CEO selectively disclosed at a private, invitation-only investor conference, material information about the company's outlook that was different from what had been previously disclosed. In a subsequent case Siebel's CEO again selectively disclosed material information that differed from what had been publicly released, but in the second case the IRO was also sanctioned for not having adequate disclosure controls in place to avoid these situations.
Also, in the early life of Reg FD, Shering-Plough's CEO and his IRO met in Boston over two days with four of its major mutual fund investors and told each that third-quarter published earnings were too high, resulting in the company's share price dropping significantly within hours after the meetings. The company after waiting several days, finally issued a news release saying the following year's earnings would be “terrible.” But, it was too late for corrective action. The damage had been done. The CEO paid a civil fine of $50,000 and Shering-Plough paid a $1 million penalty. The CEO subsequently lost his job and the IRO, who should have immediately issued a press release containing the newly disclosed information, moved on.
So, with all previous cases involving selective disclosure between company officials and a select audience of analysts or investors, is the SEC going to open the door into the new media environment where social media are considered means for full and fair disclosure?
After a four-year drought in Reg FD cases, the SEC cited Office Depot's IRO in 2010 with selectively disclosing material earnings guidance to certain analysts. The Commission brought administrative and civil actions against the company and Office Depot paid a $1-millon fine.
None of these cases involved the channel or technology that company officials used to convey the information. They were almost all clear-cut cases of selectively disclosing information to favored investors or analysts, whether the executives whispered the news in their ears or provided the information in a phone call.
In a recent development, however, the SEC issued a “Wells Notice” informing Netflix and its CEO, Reed Hastings, that it intends to bring a civil enforcement action for violating Reg. FD last July when Hastings announced on his Facebook page that Netflix had streamed a billion hours of videos in during the prior month. The issue, in part, is whether that information disseminated to 200,000 subscribers was material. Hastings contends it was not and said his Facebook disclosure was functionally equivalent to disclosure in a public securities filing or press release. He also suggests that the SEC needs to update its disclosure rules to account for social media such as Facebook, LinkedIn, Twitter, or even The Motley's Fool's Blog Network as means for disclosure.
So, with all previous cases involving selective disclosure between company officials and a select audience of analysts or investors, is the SEC going to open the door into the new media environment where social media are considered means for full and fair disclosure? No longer are we talking about corporate officials discussing material, non-public information with a select audience. The audience today may be all of those who have access to the social media. Not only is the SEC dealing with a materiality issue with Netflix, but more broadly, what constitutes an adequate audience for full disclosure.
Realistically, when information disseminated through authorized means today—namely a press release delivered over a wire service—the number of investors who actually access this information probably pales when compared with the number who can be reached through social media. Another factor the SEC needs to consider is that a number of recent surveys show IROs are reluctant to consider social media as part of their news dissemination process for fear of violating Reg FD.
It's time for the SEC to consider revising Reg FD, keeping the basic components of the rule that defines selective disclosure between companies and their analysts or investors, and now consider what constitutes an adequate audience for “full” disclosure in view of the large number of investors and analysts who use social media as means for gathering information to make investment decisions or developing earnings estimates.