On November 5, 2001, the CEO of Siebel Systems, Inc. (Siebel) stood in an invitation-only technology conference in California and commented on Siebel’s performance and positive outlook. The problem with this seemingly harmless disclosure was that Siebel had made a public conference call conveying negative prospects on the company just three weeks prior. People at the conference took swift actions; that day’s trading volume doubled, and Siebel’s stock price closed at 20 percent higher than the prior day’s close. This event resulted in the first-ever SEC charge of a Regulation Fair Disclosure violation, which resulted in a $250,000 civil penalty and a cease-and-desist order for those violations.
Public companies bear many unique regulations and public scrutiny, and Reg FD certainly is one of them. While private companies may disclose information at their own discretion, public companies must be cautious about disclosing any material information; violation of Reg FD may bring lead to regulator charges, a drop in stock price, damage to the company’s public reputation, and a loss of investor confidence. This article aims to introduce Reg FD, its basic principles, and methods to mitigate violation risk.
Reg FD Defined
Reg FD prohibits public companies from disclosing material non-public information to certain investors or securities professionals without also disclosing that information to the public. Prior to Reg FD, many institutional investors or security professionals often received inside information from management before management publicized it, giving the first-learners an unfair advantage to make investment decisions before the rest of the market could react. To remedy this problem, the SEC established Reg FD to put market insiders and retail investors on an even playing field.
For the purpose of Reg FD, material information is any information that a reasonable investor would deem relevant in deciding whether to buy or sell a company’s securities. According to SEC guidance, material information includes, but is not limited to, the following:
- Financial results or guidance
- Major transactions (e.g., merger and acquisition or strategic alliance)
- Significant operational or research developments
- Imminent change of corporate officers or directors
- Legal contingencies and their developments
- Financing decisions (e.g., stock issuance, repurchasing plans)
Two types of disclosures exist in Reg FD: intentional and unintentional disclosure.
Intentional disclosure pertains to planned activities where companies specifically make prepared announcements on material, non-public information, such as earnings calls or conference calls with analysts. Reg FD stipulates that in the case of intentional disclosure, companies must make simultaneous disclosure of the same information to the public, which is typically done by press release, webcast, or a Form 8-K. For instance, public companies generally provide information about the time of the earnings call and the methods by which the public can access the call well in advance. The entire conversation is broadcast live via designated platforms such as YouTube.
An unintentional disclosure happens when public company insiders accidentally provide material non-public information to selective people without simultaneous disclosure to the public. In such cases, the company has the chance to solve the problem by publicizing the information (usually via press release or filing an 8-K) by the later of 24 hours or the moment the New York Stock Exchange reopens.
Note that a material disclosure does not have to be an explicit statement, and the SEC has charged companies for Reg FD violations merely for hinting or alluding to non-public material information in the presence of outsiders. For example, in 2010 the SEC penalized Office Depot, Inc. for $1 million and two executives for $50,000 each for Reg FD violations. Interestingly, the two executives never explicitly revealed material information to outside analysts. According to the SEC’s statement, “[Office Depot] did not directly state that it would not meet analysts’ expectations, but rather this message was signaled with references to recent public statements of comparable companies about the impact of the slowing economy on their earnings. The analysts also were reminded of Office Depot’s prior cautionary public statements.” This cautionary tale illustrates how stringent the SEC is in finding and charging Reg FD violators. Therefore, public companies should implement proper measures to prevent Reg FD violations.
Reg FD Violation Prevention
C-suite executives, investor relations (IR) personnel, and public relations personnel (PR) are the officers most likely to cross the line on Reg FD, despite their many years of professional experience. Thus, no matter how experienced a company’s officers may be, the volume of SEC charges against Reg FD violations indicates that companies still should deploy preventive procedures for Reg FD compliance. The following are some common preventive measures used by public companies:
- Review and amend current disclosure policies (especially policies on disclosing information to financial market professionals).
- Conduct periodic Reg FD trainings.
- Designate a compliance officer and build a disclosure committee including legal, IR, and finance experts to establish disclosure protocols and review important disclosures.
- Prepare detailed scripts when making quarterly earnings calls.
- Make all analyst calls public.
IPOHub learned in an interview with the CFO of Pluralsight (a publicly-traded online technology skills development company) that one of the most effective preventive measures his company has adopted is to make sure the earnings calls and guidance are as comprehensive, transparent, and insightful as they can be, so that whatever management says to outsiders privately would simply be a repeat instead of a disclosure of new, non-public information.
Steve Albrecht (CPA, PhD, CIA, CFE), who has served on the board of directors for several public companies, suggested to IPOHub that although the common internal practice of black-out periods1 prevents insider trading, it also serves as a protection against Reg FD violation. As stated earlier, Reg FD violation does not have to occur through explicit statements but can occur through signals or gestures, which includes insiders’ decisions on trading the company’s securities. Thus, black-out periods can help a company avoid signaling to the market material non-public information through insider security transactions. Some public companies take even more caution by only allowing executives to trade on a 10b5-1 plan2, thus eliminating the possible accusation of insider trading or Reg FD violations.
Reg FD Violation Correction
Despite a well-designed preventive control environment, Reg FD violations may still occur. Almost always, violations are in the form of an unintentional disclosure. Best practice dictates that legal counsels participate in communications, including disclosures to outsiders, especially non-public communication with analysts, financial institutions, and securities professionals. As discussed above, companies have at least 24 hours to amend an unintentional disclosure through a press release or filing an 8-K, as such an immediate review of disclosures may catch potential violations and make timely correction possible. Of course, as much as internal experts should monitor disclosure activities, management should also actively report those activities and invite internal experts to participate. Indeed, a transparent and cooperative culture between the Reg FD experts and the personnel disclosing company information to outsiders is perhaps the best way to prevent and correct Reg FD violations.
If a Reg FD violation is detected after the 24-hour grace window, one strategy that companies have followed is to voluntarily report to the SEC and cooperate with investigation. In 2001, First Solar, Inc. (First Solar), an Arizona-based solar energy company, discovered a negative development regarding a financing situation. The head of investor relations at the time made selective disclosure to several sell-side analysts and institutional investors, who promptly sold large quantities of First Solar’s stock. Upon identifying the situation, First Solar decided to self-report the misconduct to the SEC. The result, as demonstrated by the SEC’s press release below, shows First Solar’s effective violation mitigation:
The SEC has determined not to bring an enforcement action against First Solar due to the company’s extraordinary cooperation with the investigation, among several other factors. Prior to [the head of investor relation]’s selective disclosure on September 21, First Solar cultivated an environment of compliance through the use of a disclosure committee that focused on compliance with Regulation FD. The company immediately discovered [the] selective disclosure and promptly issued a press release the next morning before the market opened. First Solar then quickly self-reported the misconduct to the SEC. Concurrent with the SEC’s investigation, First Solar undertook remedial measures to address the improper conduct. For example, the company conducted additional Regulation FD training for employees responsible for public disclosure.
Though the head of investor relations was personally fined $50,000, the company escaped both criminal and civil charges. This case illustrates the benefits of effective preventive measures combined with timely corrective measures. Essentially, good compliance environments and procedures can positively reduce the adverse consequence of Reg FD violations.
Business personnel considering an IPO should understand the seriousness of Reg FD and be prepared to implement a Reg FD compliance environment throughout the company. With the aid of competent legal, IR, and financial experts, companies that have well-defined preventive and corrective measures can best avoid triggering Reg FD violation and enjoy sound investor relations and reputations.
- First Solar Reg FD Case
- Forbes’ article on the Rise and Fall of Reg FD
- Frequent Q&A on Reg FD by Morrison & Forester LLP
- Mayer Brown’s Guide on Reg FD
- Office Depot Reg FD Case
- WSGR Slide Deck on RegFD
- Black-out periods are common internal policies that prohibit insiders (usually management) from altering investment plans for a certain amount of days before certain announcement dates, such as earnings calls or financial statements filing dates. Black-out periods typically range from 3 to 60 days.
- A 10b5-1 plan allows shareholders to trade a predetermined number of shares at predetermined timing intervals or when the stock price is at a predetermined price. For example, an executive could put a 10b5-1 plan in place to sell 500 shares of her company’s stocks when the price rises or falls to $20 per share or to immediately effect a sell order whenever new stock is awarded to her in order to pay taxes. In this case, she is not restricted to the black-out periods since she does not actively participate in the timing of the trading and therefore is not sending signals to the public or participating in insider trading.