EXECUTIVE
SUMMARY | THE SEC HAS TAKEN ITS
FIRST ENFORCEMENT ACTIONS
against companies that violated
regulation FD by selectively disclosing
material nonpublic information about
themselves to certain parties, such as
investment analysts, before sharing it
with the public.
CPAs CAN PLAY AN
IMPORTANT ROLE for their
public-company clients and their
employers—if they work for an SEC
registrant—by ensuring those companies
understand what regulation FD requires
of them and how they can most easily and
effectively comply with it.
CLEAR DISCLOSURE
GUIDELINES are the starting
point for an effective strategy for
complying with regulation FD. CPAs
should advocate documentation that
spells out what kinds of information the
rules govern and to whom, when and under
what circumstances company officials are
permitted or obligated to release it.
A COMPREHENSIVE
COMMUNICATIONS REVIEW
procedure is an essential
complement to disclosure guidelines.
CPAs should recommend that such
procedures provide for knowledgeable
vetting of all company announcements to
ensure they conform with regulation FD’s
provisions and, when necessary, for
initiating corrective actions within
prescribed time frames.
COMPANIES MUST
ENSURE WIDESPREAD DISTRIBUTION
to avoid selective disclosure
when they release material nonpublic
information. CPAs can recommend several
ways to achieve this. One method is to
file a Form 8-K with the SEC. Others
include issuing a press release through
a news or wire service or hosting a
webcast—an Internet-based live or
delayed version of a sound or video
broadcast.
IF A COMPANY MAKES
A SELECTIVE DISCLOSURE of
material nonpublic information, the time
frame within which it must share those
data with the public depends on whether
the disclosure was intentional or
unintentional. If the company did it
deliberately, it must make a public
statement at the same time as the
selective disclosure. But if it
inadvertently disclosed the information,
it must make a public announcement by
the later of 24 hours afterward or the
beginning of the next trading day on the
New York Stock Exchange. |
ED McCARTHY is a
freelance writer in Warwick, Rhode Island,
who specializes in finance and technology.
His e-mail address is
edmccarthy1@yahoo.com .
|
o one knew how stringently the SEC
would apply regulation FD, which requires public
companies to share earnings data and related
information equally with all interested parties.
But last November the commission instituted its
first enforcement actions against a number of
companies and, in the process, gave many others a
wake-up call. Here’s how several CPAs, drawing on
their own experiences and those of companies
caught violating regulation FD, say you can help
keep your clients or your employer—if you work for
an SEC registrant—in compliance. (Also, see “
After Regulation FD: Talking to Your
Constituents, ” JofA , Feb.01, page
28.)
THE SEC FOLLOWS UP
This article examines
the cases of four companies (referred to below as
A, B, C and D) the SEC cited for inequitable
disclosure practices. While three were the SEC’s
first regulation FD enforcement actions, the
agency’s regional offices have been actively
monitoring potential violations. Boris Feldman, a
partner and securities litigator in law
firm Wilson Sonsini Goodrich &
Rosati’s Palo Alto, California, office,
advises publicly traded companies on
regulation FD. He reports the SEC
contacted a number of his clients with
disclosure-related questions since the
regulation became effective. “Several of
our clients received calls from, for
example, the SEC’s San Francisco regional
office saying, ‘We noticed such and such a
comment triggering a stock reaction,’”
Feldman says. “‘Would you mind bringing
the CFO in? We want to talk to her about
what happened.’” By making such
inquiries, the commission sought to
determine whether a sudden movement in
the price of a company’s stock was
precipitated by the actions of a small
group of investors to whom the
company—intentionally or not—had
selectively disclosed nonpublic material
information about itself. In instances
where this happened, a privileged few
had acted on their exclusive knowledge
and bought the company’s stock before
its price rose or sold the stock short
before its price fell. In either case
the “insiders” profited when the
information became public and the
stock’s price moved in the direction
they had anticipated, producing the
profits they had expected. |
Playing It Safe
When regulation
FD took effect in October 2000,
companies began making public
“preannouncements” or advance
statements of their earnings.
The number of such press
releases doubled in 2001 and has
continued to grow rapidly.
Source:
Thomson Financial/First Call,
www1.firstcall.com .
| |
When a company releases such information to
everyone simultaneously, however, the playing
field is level and no one has an advantage. Since
that was the SEC’s goal in issuing regulation FD,
companies actually or seemingly not complying may
attract the attention of the commission’s
enforcement division. So how do you avoid
regulation FD violations? Feldman and the CPAs
interviewed for this article recommend companies
create a compliance program that
Establishes clear disclosure
guidelines.
Follows a stringent communications
review procedure.
Uses multiple channels to disseminate
information.
Ensures the company responds quickly
and effectively after nonpublic disclosures.
The next four sections of the article explain
how to implement these compliance objectives.
DECIDE WHAT TO SAY
Feldman urges his
clients to adopt bright-line rules—precise
limits—that provide clear guidance to staff
members on what they safely can disclose. Such
procedures help prevent errors in judgment that
can lead to inadvertent violations during, for
instance, an unscripted conference call or
presentation. “You don’t want to have to weigh
different factors when you’re on a call with an
analyst or a reporter,” he says. “Instead, you
need red-light and green-light rules,” meaning
unambiguous instructions that indicate whether
releasing information in a given situation is
forbidden or permitted under regulation FD. “For
example, after you give your outlook in an
earnings release or in a conference call, you
could make it a standard practice that you don’t
update it during the quarter unless you find your
estimate was so far off that you have to put out
another release preannouncing a quarterly miss.
That’s a bright-line rule,” Feldman says.
Such a
precept might have prevented company A
from violating regulation FD. On two
occasions its CEO disclosed information to
two portfolio managers about a significant
sales contract the company had not
announced publicly. If the company’s
policy had prohibited the CEO from
discussing the contract until the company
had publicly announced it in a press
release, it could have avoided the
violation. But since the company had no
such protocol, it broke the SEC rule and
in November the commission issued a public
cease-and-desist order prohibiting the
company from continuing its illegal
practices but imposing no penalty.
Earnings projections between
scheduled announcements are an area
where it’s easy to violate regulation
FD. Feldman advises his clients to
provide forecasts at the beginning of
the quarter and then to avoid any
subsequent confirmation or denial of
analysts’ estimates. “Don’t give
updates, even casual ones such as,
‘We’re on track,’” he says. “If you must
provide an update, do it through a press
release.” Some experts offer
even more conservative advice. Susan M.
Barnard, a partner of law firm Sullivan
& Worcester in Boston, says her firm
tells its clients “to eliminate private
analyst calls. Now everything goes out
over a simulcast—a live broadcast on,
for example, the Web and television—or a
conference call. Our clients no longer
correct analysts’ forecasts, either,”
she adds. “They rectify errors only in
reports of historical facts.” At
Ross Systems Inc., a software developer
in Atlanta, Verome M. Johnston, CFO and
CPA, follows a procedure similar to the
one Feldman advocates. According to
Johnston, the company issues earnings
projections annually but not quarterly
and limits its quarterly press releases
to initial estimates followed by
confirmed numbers. “As soon as possible
after the quarter has ended and we have
discussed our revenues with our external
auditors, we issue a preliminary revenue
and earnings outlook in the form of a
press release,” he says. “We advise the
public that it is preliminary and
subject to a routine evaluation. After
the external auditors have completed
their review, we confirm the earnings
estimate in a detailed press release.”
|
Reg FD Tool
Kit
CPAs should ensure these
essential resources are
available for corrective action
when an official representing
their employer or client reveals
material nonpublic information.
Contact list.
Companies should
designate an emergency
response team with the
knowledge and authority to
make supplemental
announcements that can counter
the effects of a selective
disclosure. Each person on
that team and all company
officials who discuss
significant topics with
external parties should
exchange cell phone numbers
and e-mail addresses to ensure
timely communication in a
crisis.
Communications
capability.
All company
spokespersons and members of
the company’s emergency
response team should have cell
phones and keep them on at all
times. E-mail can serve as a
backup communications medium,
especially when circulating
documents for review.
Procedures.
CPAs should help
their employers and clients
prepare a comprehensive plan
that clearly identifies
necessary actions, responsible
parties and deadlines for
completion. All members of
management and the emergency
team should maintain a copy of
the plan for reference.
Designated
coordinator.
The company
should identify a senior
manager—and at least one
backup person—to oversee the
ongoing appropriateness of the
emergency plan and the
readiness of those responsible
for executing it.
—Robert Tie Robert
Tie is a senior editor with
the JofA . His e-mail
address is
rtie@aicpa.org .
| |
Johnston also points out the need to control
disclosures to internal audiences. “In the past,
during a company-wide meeting, we might have given
some casual indications of our current financial
performance. But we’ve definitely curtailed that
practice and now treat all parties the same. We
disclose any new information in a press release,
and we disseminate it through the proper channels
to make sure we comply with regulation FD.”
Besides sending information to the SEC, companies
can distribute their announcements through
Business Wire (
http://home.businesswire.com ) and other
services that deliver corporate press releases to
the media, financial markets, investors and other
public audiences.
LOOK BEFORE YOU SPEAK
With the help of
compliance experts, a company can review its
internal and external communications practices—to
see whether they comply with regulation FD—and
reduce the likelihood of its violating the rule,
as company B did. During a public conference call,
the CEO said the company had a negative business
outlook. But three weeks later, at an
invitation-only technology conference, he
presented attendees with a positive view of the
company’s prospects, and the price of its stock
immediately rose 20%. In fining the company
$250,000, the SEC said the public did not have
access to the technology conference and was unable
to benefit from the information disclosed there.
Clearly, if a process—for example, a prior review
by in-house counsel—for vetting the CEO’s planned
remarks had been in place, it might have revealed
the discrepancy and saved the company a quarter of
a million dollars. At Ross Systems,
Johnston’s staff members collect data—such as
descriptions of recently added customers—for use
in reports and news releases. The company then
combines the information with that from other
departments and makes an announcement. If
management believes the announcement is
nonmaterial—for example, a routine statement about
a new account or employee—it is reviewed
internally only. But notices regulators might
consider material, such as the loss of a major
account, undergo an external review as well. “In
those cases we also let our accountants, corporate
counsel and securities-law attorneys take a look
at them,” Johnston says. W.R. Grace &
Co., a chemical products manufacturer in Columbia,
Maryland, also follows a thorough communications
review procedure. The company circulates draft
press releases by e-mail through its financial,
executive and legal groups, the last of which
includes SEC counsel. “This gives key managers and
each division a chance to contribute to the
document’s language,” says Robert M. Tarola, CFO
and CPA. “We don’t send anything outside the
company without going through that process. We can
accomplish this within hours if necessary, but it
usually takes a few days when the release is about
a complex subject such as quarterly earnings.”
SPREAD THE WORD
Many of the violators
made the same mistake: Each of their cases
involved a material disclosure from corporate
management to a select audience via private
conversations or an invitation-only meeting. For
example, the SEC cited company C for material
nonpublic disclosures to securities analysts
following one of its investor conferences. The
commission said the company’s CFO selectively had
disclosed quarterly and semiannual earnings
projections during one-on-one talks with analysts
about the accuracy of their estimates of the
company’s first-quarter earnings. Following these
discussions, the analysts revised their
calculations to align them more closely with the
company’s estimates—the outcome management had
sought so that the company’s performance would be
consistent with expectations and its shares would
appear to be safe investments. Like company A,
company C discontinued such illegal
practices, settled with the SEC and
received no penalty. Since regulation
FD prohibits behind-the-scenes
maneuvers, CPAs should advise companies
to simultaneously communicate all
potentially material information through
many different channels. Toward that end
CPA Thomas A. Nardi, CFO of Peoples
Energy Corp., a distributor of natural
gas based in Chicago, says that his
company now files Form 8-K more
frequently with the SEC (for a list of
the most common corporate filings, go to
www.sec.gov/info/edgar/forms.htm
). In addition Peoples conducts its
quarterly earnings conference calls by
means of webcasts—Internet-based live or
delayed versions of sound or video
broadcasts—which it then archives and
makes available for replay by interested
parties. According to Nardi, the company
still meets face-to-face with analysts;
but, he says: “We’re careful to operate
within the requirements of regulation
FD. We don’t disclose any material
information that has not been publicly
disseminated.” |
The Easiest Way to
Comply
A lthough the
SEC cited four companies for
violating regulation FD, its
actions toward them varied. What
lay behind the SEC’s different
treatment of these companies?
Reflecting the complexity of the
circumstances prompting the
enforcement actions, the five
SEC commissioners were unable to
agree on whether a fine was
appropriate as part of each
case. The vote was 4-1
against a penalty for company
A and company C and 3-2 in
favor of one for company B.
The commission unanimously
opposed enforcement action
against company D. Since it’s
so difficult to predict the
SEC’s reaction to a particular
form of disclosure violation,
the moral for CPAs and CFOs is
to advise clients and/or
employers that it’s easier and
less expensive to be
conservative. In short: When
in doubt, issue a press
release. —Robert Tie
| |
Webcasts are gaining in popularity—and for good
reason. Feldman says that since many investors
have Internet access, almost every company he
advises uses the Internet-based programs to
publicize the announcements and presentations they
make at analyst meetings and investor conferences.
He wholeheartedly endorses the practice because
webcasts distribute information immediately to
everyone and allow it to be saved for future
reference. Plus, “they give the company a cushion
if, for example, its management says too much in
response to an analyst’s question,” Feldman says.
“Because the webcast is out there for the world to
see, it can prevent the company’s disclosure from
being selective and violating regulation FD.”
DAMAGE CONTROL
If an SEC registrant
releases nonpublic material information, it must
act quickly to correct its error. The SEC requires
that in such a case the company “must publicly
disclose the information promptly after it knows
(or is reckless in not knowing) the information
selectively disclosed was both material and
nonpublic.” The time frame within which the
company must make a public announcement depends on
whether the selective disclosure was intentional
or unintentional. If it was deliberate, the press
release or other public statement must be
simultaneous with the nonpublic disclosure. But if
it was unintentional, the regulation allows the
company 24 hours to recognize the violation and
disseminate the inadvertently disclosed
information through public channels. To
take effective action within 24 hours, the company
must have a corrective procedure in place. “You
need a clear chain of command in the
communications channel,” Feldman says. “The key is
being able to track down a spokesperson, such as
the company’s CEO, CFO, investor relations officer
or attorney.” And while it’s important to
have “backup” contact staff, together they must
deliver a coordinated message. “Determine who will
say what,” Barnard advises. To that end, the CPA
should ensure that company officials with the
knowledge and authority to make public
announcements work together as part of a
well-thought-out communications strategy. In this
way they can address an unintentional disclosure
on a timely basis. The case of company A
demonstrated the importance of having a plan for
rapid corrective action. The company’s CEO,
working from his home, participated in a
conference call with a portfolio manager and a
salesperson from an investment advisory group.
From her office, the company’s director of
investor relations also took part in the
conversation. During the call, the director
realized the CEO unwittingly disclosed nonpublic
information, but she didn’t interrupt him. As soon
as the conference call ended, she tried to reach
him by telephone but was able to leave him only a
voice-mail message expressing her concern over his
inadvertent selective disclosure. Not until an
hour later did the CEO get her message. He then
asked the other call participants to keep the
information confidential, but took no further
action that day.
At the time the CEO learned
of his disclosure error, he had 24 hours
to publicly disseminate the material
information. That much time was available
because his selective release was
unintentional . But that time
frame became irrelevant the next day, when
the CEO again selectively disclosed—this
time intentionally —the material
information without issuing a press
release. He divulged the news only to
analysts because he wanted them to know of
a large purchase order his company had
won, but he didn’t issue a statement to
the public because the buyer wanted to
gather more information before it
consented to a company A press release
announcing the deal. Unfortunately for the
company and the CEO, his second disclosure
triggered a more stringent regulation FD
requirement. Under it, his intentional
selective disclosure had to be accompanied
by a simultaneous public
announcement. But the company did not meet
this requirement. Instead, it issued a
press release three hours later and thus
violated the rule. By then its stock had
risen nearly 15% since the CEO’s first
nonpublic disclosure. Still, the company’s
effort to comply, albeit tardy, may have
been a factor in the commission’s decision
not to impose a fine as part of its
ensuing enforcement action. |
PRACTICAL TIPS TO
REMEMBER
To simplify compliance
with regulation FD, CPAs
should recommend that their
clients or their employer—if
they work for an SEC
registrant—have a compliance
program that
Establishes
clear guidelines for
determining the extent of
disclosure required.
Entails
rigorous review of
disclosures by a team
formally identified,
properly qualified and fully
empowered to perform it.
Requires the
use of several mass
communications media,
including submissions to the
SEC, press releases and
Internet-based sound and
video presentations.
Provides
resources and procedures
necessary to take
appropriate corrective
action as soon as possible
after a selective disclosure
of nonpublic material
information.
| |
Although W.R. Grace hasn’t had any problems
related to regulation FD, its management has
implemented a corrective procedure. According to
Tarola, in the event of a suspected violation, the
company would convene a review team of executives,
attorneys and other professionals and then decide
on the method and content of the follow-up
communication. “We would execute the correction
within the day, consulting or advising our board
of directors if the matter warranted their
advanced attention,” he says.
TWICE AND YOU’RE OUT
Of the four companies
the SEC cited for violating regulation FD, company
D was the single one for which the commission
issued only a Report of Investigation, a less
serious enforcement action than it took against
the others. The company started off on the
right foot when it issued a press release
announcing “significant” weakness in its quarterly
sales and orders. Soon afterward, the company’s
investor relations director decided that, based on
equity analysts’ research notes he had seen, the
analysts had not understood the true extent of the
decline in business. So, he selectively informed
them “significant” meant “25% or more.” The
director did so with the approval of in-house
counsel, which concluded that his clarification
was not material and had already been announced to
the public. Consequently, the company did not
issue a second press release when it recontacted
the analysts, and it thus violated regulation FD.
Despite this infraction, the SEC determined
the company’s counsel had made an honest error in
viewing the director’s clarification as
nonmaterial and previously publicized. So the
commission issued the report as a reminder of the
company’s obligations under regulation FD. At the
same time the SEC said it would no longer be as
lenient in similar situations.
LOOKING AHEAD
Although the number
of enforcement actions is small, financial
executives, in general, don’t treat regulation FD
lightly. One CPA and CFO who requested anonymity
characterized the commission’s actions as warning
shots. “The SEC wanted to remind us it’s actively
enforcing these rules,” he said. “I’m sure we’ll
hear more.” But that’s no reason for
pessimism. “It’s not that difficult to stay out of
trouble with regulation FD,” Barnard says. “Make
sure your spokespersons understand the rules and,
whenever possible, prepare your comments in
advance.” An SEC official declined to
offer advice on avoiding violations of the
disclosure rules. He said the regulation itself
and recent enforcement actions related to it
provide sufficiently clear guidance. And so, a
word to the wise: To help their clients and
employers stay out of disclosure-related trouble,
CPAs should advise them to retain legal counsel
who follows the SEC’s regulation FD-related
activities. The days are over when a good-faith
effort is enough to avoid a substantial fine.
Learn More
For additional
give-and-take on financial reporting
requirements, attend the AICPA Spring
Business and Industry Conference in Las
Vegas, June 19-20, 2003, or the AICPA Fall
Business and Industry Conference in Lake
Buena Vista, Florida, October 13-14. To
register go to
www.cpa2biz.com and click on the CPE
& Conferences tab. | |