When Regulation Fair Disclosure took effect in October 2000, finance executives felt some trepidation that their own words might eventually hang them. As a company’s main spokesperson on matters financial, after all, a CFO is in the precarious position of routinely answering analysts’ and shareholders’ questions—especially about earnings prospects.
The initial wariness has eased a bit. Reg FD’s effort to standardize the flow of corporate information to all interested parties has resulted in only five completed federal investigations of violations so far. Four became public in November 2002, and the latest, involving pharmaceuticals giant Schering-Plough Corp., emerged this past September (see “Recapping a Reg,” at the end of this article). There’s also been just one high-profile CFO casualty: Raytheon Co.’s Franklyn Caine resigned in December 2002, a few weeks after the Securities and Exchange Commission named him in a selective-disclosure action.
But the SEC is still watching. “We’ve got a number of active investigations in the pipeline,” SEC enforcement director Stephen Cutler recently told a group of lawyers at Georgetown University. And Boris Feldman, a securities lawyer with Wilson Sonsini Goodrich & Rosati in Palo Alto, California, says the SEC’s regional bureaus are busy “reviewing Reg FD violations” and questioning CFOs about unexplained stock movements.
Still, the enforcement actions taken to date—which Gordon McCoun, senior managing director of New Yorkbased investor-relations firm Financial Dynamics, says target the “most visible and the most obvious transgressions”—are instructive. Feldman, in fact, finds them “quite interesting from an anthropological perspective,” and likens the SEC to Talmudic scholars who “have set markers out there.” And in response, companies continue to reshape their communication strategies, says McCoun.
In fact, says Robert Profusek, a partner at the New York office of law firm Jones Day, taken together, the SEC’s actions have put companies on notice that they can no longer make selective disclosure errors—a conclusion especially obvious after the recent sanction against Schering-Plough. “It’s very clear that the incidents [investigated] so far were mistakes, not intentional bad behavior,” he explains. But under today’s more mature Reg FD, he says, the SEC has zero tolerance for any “accidental” missteps.
Between the Lines
There’s no question that companies are now taking a more uniform approach to dealing with the external flow of material information. “Reg FD codified what would be fair and balanced disclosure,” says R. Kevin Matz, a senior vice president at $4.5 billion Emcor Group Inc., and a spokesman for the Norwalk, Connecticut, company. Moreover, the rule “has achieved its main objective&it has leveled the playing field,” says Chuck Hill, director of research at First Call. “It’s forcing analysts to get back to the basics of analysis.”
For companies, the new procedures are now almost habit, says Matz. An April survey by the National Investor Relations Institute found that of the 92 percent of companies that conduct earnings conference calls, all use Webcasts or teleconferencing. And in June, NIRI found that one-on-ones and small group meetings with analysts and investors seem to be as popular as ever—an indication that companies are comfortable staying within the confines of the rule.
That doesn’t mean everyone is happy with the information being provided. Indeed, Wall Street, which vigorously opposed Reg FD, continues to fume. The Securities Industry Association, its trade group, declares that “the regulation has had the impact the association feared: less information, lower quality, higher costs, and greater volatility.”
And Wall Street is particularly upset with the parade of companies that have stopped giving guidance. The trend really started last December, when the Atlanta-based Coca-Cola Co. vowed not to provide quarterly or annual guidance, and companies like McDonald’s and AT&T followed suit. They may not be the last. The April NIRI survey found that, overall, 28 percent of companies are considering eliminating guidance.
The stated idea behind restricting guidance, of course, is to refocus analysts on long term rather than quarterly results. But CFOs know that it also means material slips are less likely to occur. Material revelations have been at the root of the actionable cases to date. So, it’s little wonder that in a poll of finance executives two years ago, PricewaterhouseCoopers found that 68 percent wanted the SEC to issue specific guidelines about which information is material and requires disclosure, and which is not.
Some slipups under Reg FD represent seemingly obvious breaches, however. In one case, against Siebel Systems Inc., CEO Thomas Siebel allegedly disclosed material information at an invitation-only technology conference, assuming that it would be Webcast. Last November, Siebel became the first company to pay a fine—of $250,000—to settle a Reg FD case. It promised not to selectively disclose again, but the real message—one CFOs should take to heart, says Feldman—is that Siebel “wouldn’t have gotten into trouble if it had Webcast.” (As CFO went to press, Siebel revealed in its third-quarter financials that the SEC was investigating it for a second Reg FD violation.The potential enforcement action reportedly involves statements made by CFO Ken Goldman at an April 30 dinner with analysts.)
The message in the Raytheon case is that material breaches can also get personal. Former CFO Caine didn’t give quarterly guidance during an initial conference call in February 2001. Then, shortly thereafter, he allegedly made calls to individual analysts, telling them their estimates were too high. According to the SEC’s enforcement action, the problem leading to the sanction was Caine’s knowledge that “Raytheon had provided no public quarterly earnings guidance for 2001” when he made those calls.
Even when the SEC only issues a report instead of taking enforcement action, there are lessons. In the case of Motorola Inc., the company said during a conference call that it was experiencing “significant weakness” in sales. The IR officer later allegedly told some analysts the decline in sales would be about 25 percent, after the general counsel advised him that the number was not material. The SEC’s decision against taking an enforcement action reflected its finding that the advice, while unsound, was given in good faith. The take-away? “When in doubt, check with a lawyer,” says Feldman, with a chuckle.
Experts’ views on possible lessons from the latest Reg FD case are mixed. Feldman believes the Schering-Plough case “dwarfs the prior enforcements” and “may signal a policy shift, because it now is not just what you say, but how you say it.” At issue is one line in the September enforcement action against the $10 billion company and former CEO Richard Kogan. There, the SEC noted that Schering-Plough violated Reg FD “through a combination of spoken language, tone, emphasis, and demeanor”—a phrase that has sent some lawyers searching for duct tape.
Still, if you read the complaint, says Louis Thompson Jr., NIRI’s CEO, “what Kogan said was more than adequate” to constitute a material breach of Reg FD. In fact, during the 2002 meetings cited—an initial closed-door meeting with three big shareholders and a follow-up meeting with analysts and investors—Kogan allegedly said that the company’s 2003 earnings would be “terrible,” among other things. That led the stock to fall more than 17 percent. (Troubles at Schering-Plough also led to the departure of CFO Jack Wyszomierski in November.)
But it was the SEC’s reaction to the downbeat way the remarks were delivered that has given companies and general counsels the most pause. “Body language is a tough legal standard,” says Stuart Kaswell, a partner with Dechert LLP in Washington, D.C. To be on the safe side, says Feldman, CFOs and CEOs should guard against looking “depressed when they talk to analysts.” And since that may be impossible to do, Feldman advises companies to reevaluate the form in which they choose to communicate to Wall Street. The ruling “could be the death knell for one-on-ones,” he says.
Such advice is leading to something of a standoff between lawyers and IR professionals. “There’s a natural tug-of-war between communications and legal anyway,” says McCoun. The Schering-Plough case, however, has led to “a tendency to retreat and say we are not going to give one-on-ones,” he says.
At Emcor, Matz says that smaller meetings are necessary, and that the company has done a good job of self-policing its comments there. For one thing, Matz limits the number of communicators as a way of guarding against Reg FD violations. “I don’t think FD is out there to trick people,” he says. But by limiting Emcor’s spokesmen to CEO Frank MacInnis and himself, the former treasurer says, the company doesn’t “deviate from protocol” and “keeps the information standard.”
Limiting the time spent communicating is another way companies avoid accidental transgressions. “But the best bright-line rule is to have a permanent quiet period except for one day per quarter,” says Feldman. That is when a company releases earnings. Then, it should “give guidance with enough variables for analysts to draw conclusions”—and say no more. He calls this the only “viable and secure approach for a CFO.”
Other safeguards continue to evolve. While most companies Webcast their own earnings announcements, for example, many now insist that outside investor-conference sponsors offer the Webcast. In fact, the June NIRI survey found that 21 percent of companies refuse to participate in such events unless they are Webcast in that manner. That approach, says Feldman, should extend to the breakout sessions at those conferences, which he terms the “Wild West” of investor relations.
The main guideline from the Reg FD violations: “If business will not meet expectations, don’t do [any] meetings,” says McCoun. “Or if you still do the meeting, don’t do it until you put out a new set of expectations.” Reg FD is not meant to clamp down on information, he says. Instead, it formalizes “what the best communication practices are.”
Those policies are still subject to SEC scrutiny, however. And as far as enforcement is concerned, Feldman says, “the end point of the journey is not clear yet. We’re just on the bleeding edge.”
Lori Calabro is a deputy editor at CFO.
Recapping a Reg
Disclosure decisions made by the SEC to date.
|Company||REG FD Infraction||SEC Action|
|In February 2001, CFO Franklyn Caine allegedly gives Q1 and full-year guidance to selected analysts .||Cease-and-desist order issued November 25, 2002. Caine resigns shortly thereafter.|
San Mateo, CA
|On November 5, 2001, CEO Thomas Siebel allegedly discloses positive information at invitation-only technology conference. Siebel’s stock price rises 20%.||After November 25, 2002, cease-and-desist order, company agrees to pay $250,000 fine, the first levied under Reg FD.|
San Jose, CA
|In March 2002, CEO John McNulty allegedly discloses material nonpublic information about a contract to two portfolio managers.||Cease-and-desist order issued November 25, 2002.|
|Company IR director, told by general counsel that specifics of its sales reduction weren’t material, tells analysts “significant” weakness means “25% or more.”||“Report of an Investigation” (instead of enforcement action) says that the “legal advice, however erroneous, was sought and given in good faith.”|
|Former CEO Richard Kogan, through “spoken language, tone, emphasis, and demeanor,” discloses negative info in private analyst meetings. Stock falls 17%.||After September 9, 2003, order, company pays $1 million civil penalty. Kogan pays $50,000, the first time an individual REG FD penalty is assessed.|