It’s a tad unlikely that when the Founding Fathers wrote the Bill of Rights that they foresaw a legal use for it in defending corporate executives more than 200 years later.
On March 15, however, a U.S. Southern District Court of New York judge will hear arguments by Siebel Systems that the First Amendment’s right to free speech protects its CFO and an investor relations officer against a Securities and Exchange Commission complaint that alleges the company—for the second time—violated Regulation FD.
The defendants, who include Siebel CFO Kenneth Goldman, argue in court documents that Regulation Fair Disclosure is “an unprecedented and remarkably sweeping infringement of corporate speech in violation of the First Amendment.” The defendants also argue that the statute “both restricts and compels speech on the basis of its content, triggering the strictest constitutional scrutiny.”
Reg FD, which took effect in 2000, bans U.S. public companies from selectively disclosing “material nonpublic” information to investors, analysts, and company outsiders unless they make that information available to the public simultaneously or promptly.
Interestingly, Siebel already paid a $250,000 civil penalty and agreed to a cease-and-desist order against further Reg FD violations in a 2002 SEC settlement. Its chief executive had told analysts, institutional shareholders, and other attendees at a Goldman Sachs invitation-only conference that he was “optimistic” about business returning to normal, just three weeks after management made more pessimistic utterances publicly. And the position was not more broadly disseminated to the public.
Then six weeks after Siebel agreed to the cease-and-desist, the SEC claims the company violated Reg FD again. But this time Siebel will put up a fight in court.
The SEC now claims that Siebel violated Reg FD when Goldman disclosed “material nonpublic” information during a “one-on-one” meeting with institutional investor Alliance Capital Management and an invitation-only dinner hosted by Morgan Stanley—private events he attended with investor relations director Mark Hanson, also a defendant in the case, on April 30, 2003.
Positive statements from Goldman that Siebel’s sales transaction pipeline apparently contrasted with company Chairman Thomas Siebel’s depiction of an “apocalyptic economic environment” during a Deutsche Bank conference weeks earlier, according to court documents. (Through a company spokesperson, Goldman said he would have no comment for this story.)
The commission also notes that within roughly four trading hours after Goldman and Hanson met with Alliance representatives, Alliance converted its 108,200 share short position in Siebel stock into a 114,200 share long position. What’s more, at least two of the attendees at the Morgan Stanley private dinner bought Siebel stock on the morning after.
Countering the SEC’s claim, Siebel and its executive defendants argue that the disclosures at issue were not material and had been revealed by the company in its prior public statements.
In case that argument fails, Siebel is also asking the court to dismiss the complaint because it believes that: (1) the Commission lacked statutory authority to promulgate Reg FD in the first place; (2) it’s an infringement of corporate speech that violates the First Amendment, and (3) it’s “unconstitutionally vague” and violates the Due Process Clause of the Fifth Amendment.
To date, there have been only six enforcement actions charging violations of Reg FD, two of which have been against Siebel. And this case is the first contested action ever brought by the SEC seeking to enforce Reg FD. The rest have settled.
Securities lawyers give the First Amendment argument little if any chance of helping Siebel’s case, let alone killing Reg FD or changing the way the rule is enforced. At the same time, Treazure Johnson, SEC senior assistant chief litigation counsel, acknowledges the precedence and significance of the Siebel case. But she told CFO.com that she is “very confident” the commission will prevail.
“We are going to remain consistent with the enforcement,” says Johnson. “If [Reg FD] were to be declared unconstitutional, of course, that would have an impact.”
Daniel Posin, professor of law at Tulane University, also supports Reg FD’s defensibility. He explains that its roots are in rule 10b-5, promulgated under the Securities and Exchange Act of 1934, which prohibits trading on insider information.
Indeed, the SEC noted in a securities fraud rule called “Selective Disclosure and Insider Trading” that selective issuer disclosure “bears a close resemblance” to ordinary “tipping” and insider trading. “In both cases, a privileged few gain an informational edge—and the ability to use that edge to profit—from their superior access to corporate insiders, rather than from their skill, acumen, or diligence,” the agency said.
Asked about Siebel’s First Amendment defense, Posin said that “free speech only goes so far.”
If the Siebel case goes to a higher court, however, there could be trouble for the SEC, some observers say. Simon Frankel, a partner with Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco, notes that the Supreme Court has recently increased its scrutiny of restrictions on commercial speech, increasingly recognizing First Amendment protections for such speech.
Bruce Packard, a partner with Davis Munck, P.C., contends that it’s unlikely that Reg FD could be voided on First Amendment grounds, however. “When faced with a restriction on commercial speech, which this regulation is, the court will rarely, if ever, throw out the entire regulation,” he says.
The worst-case scenario for Reg FD, Packard says, is that the court could limit the rule to a specific time period or add a requirement to it that information must be made public soon after the non-public statements. It could also otherwise provide regulatory guidance for the SEC, he said.
What’s more, the record on Constitutional challenges to the securities laws doesn’t appear to be in Siebel’s favor. “Just ask Richard Scrushy, currently being prosecuted for fraud at HealthSouth Corp,” says Posin. “He challenged the constitutionality of the Sarbanes-Oxley Act and got his head handed to him on a plate by the federal district court judge.”