By Gene Marbach
Regulation FD has been in place since 1999 and, as most investor relations professionals know, it was adopted to address the problem of selective disclosures of material non-public information by publicly-traded companies.
The news of late has been filled with cases of insider trading such as the major case involving the hedge fund Galleon Group. In addition, there was a highly-publicized matter involving the leak of internal memos at computer giant Hewlett Packard ahead of the release of the company’s quarterly earnings report, which caused HP to issue its financial report a day earlier than originally planned.
Violations of Reg. FD can result in serious sanctions by the SEC not to mention the loss of corporate reputation. We offer some insights into how to avoid problems.
Office Depot Case Highlights Need for Written Policy
According to a cease-and-desist order adopted by the SEC issued in October 2010, Office Depot's CEO and ex-CFO prepared talking points for one-on-one calls with selected analysts in the second quarter of 2007.
During these calls, Office Depot signaled to analysts that it would not meet expectations.
It did this by drawing the analysts' attention to prior cautionary statements by Office Depot and recent public statements by peer companies regarding the slowing economy and decreased earnings.
As a result of these calls, analysts quickly lowered their earnings estimates for Office Depot.
Office Depot continued these calls despite the analysts' concerns about the lack of public disclosure.
Upon being advised of these concerns, the CFO instructed the director of investor relations to call the company's top 20 institutional investors to relay the same talking points to them.
The company did not make a public disclosure announcing the lowered earnings expectations until it filed a Form 8-K, six days after the calls to selected analysts began.
Office Depot Inc. and the SEC announced a settlement of enforcement actions against the company, its CEO, and its ex-CFO. Office Depot agreed to settle the action for $1 million. The two executives also agreed to pay $50,000 each. Clearly, the one-on-one calls with selected analysts and investors violated Regulation FD and Section 13(a) of the Securities Exchange Act of 1934.
The Office Depot matter highlights the need for all issuers to ensure that all personnel who communicate with the public are aware of the requirements of Reg. FD. According to the Commission, Office Depot did not have written Reg. FD policies in place at the time. In addition, Office Depot had never conducted any formal Reg. FD training prior to the discovery of these alleged violations. Such policies and training should be essential parts of any issuer's compliance program.
Foster a Culture of Compliance
Corporate managers and investor relations pros need to remain vigilant to insure that disclosure regulations are being followed to safeguard the company’s reputation by fostering an “environment of compliance.”
Take the case of American Commercial Lines Inc. The company’s former CFO, Christopher A. Black, agreed to pay the U.S. Securities and Exchange Commission a $25,000 fine to settle allegations of providing inside information to securities analysts.
In agreeing to the penalty, Black did not admit or deny the allegations, according to the SEC release. The agency added that it will not take any enforcement action against the company.
The fine results from a June 16, 2007 e-mail that Black allegedly sent from his home to eight sell-side analysts who covered the company. In the e-mail, Black alerted the analysts that American Commercial Lines’ (NASDAQ: ACLI) earnings per share would likely “be in the neighborhood of about a dime below that of the first quarter.”
This took place after ACLI had issued a press release projecting second quarter earnings in line with the company’s first quarter earnings of approximately $.20 per share on June 11, 2007.
The complaint also alleged that Black's selective disclosure and resulting analysts' reports caused a significant drop in ACLI's stock price, which, on Monday, June 18, the first trading day after Black's e-mail to analysts, dropped 9.7% on unusually heavy volume.
In determining not to bring an enforcement action against the company, the SEC cited the following factors:
- Prior to the selective disclosure the company had cultivated an “environment of compliance” by providing Reg. FD training and implementing controls to prevent Reg. FD violations;
- The former CFO’s actions were taken without authorization, outside of the control systems of the company;
- The company took prompt action to publicly disclose the information by filing a Form 8-K the same day it discovered the violation;
- The company self-reported the violation to the SEC and provided “extraordinary cooperation” in the SEC’s investigation; and
- The company took remedial measures, including the adoption of additional controls, to prevent future violations.
HP's 'Memogate' Demonstrates Need for Crisis Planning
Shortly before the release of the company’s earnings, a number of memos meant for internal eyes only at Hewlett Packard leaked out and received considerable coverage.
One of the memos in question was written by HP chieftain Leo Apotheker. The memo noted that HP was bracing for "another tough quarter" in the May-July period, and that management needed to "watch every penny and minimize all hiring."
HP’s “Memogate” highlights an issue that every company faces these days.
Those of us in the communications business know that information travels at the speed of a mouse click and, within the few seconds, a corporate reputation can be jeopardized.
Not to mention, the mad scramble such an occurrence could touch off as the company takes steps to remedy the situation as HP did by moving up the date of its earnings release.
IROs with the aid of their outside counselors should review their companies’ Reg. FD compliance programs to make sure they are up to date with the latest developments and that their compliance programs are being safeguarded through both ongoing training efforts and control systems.
Companies are also advised to have in place an emergency plan for responding to potential Reg. FD violations, one that establishes responsibilities and procedures for determining the proper corrective actions.
In addition to preserving the company’s reputation, a commitment to Reg. FD compliance not only helps prevent violations from occurring but also cultivates the “environment of compliance” that the SEC deems significant when deciding whether to bring enforcement action against the company.
Keep in mind ...
- No nods and winks. Though the Office Depot executives were careful not to say anything about earnings directly to the analysts, the message was clearly communicated. As the SEC made clear in previous cases, companies cannot evade the requirements of Reg.FD by using code words or phrases to convey material nonpublic information.
- Codify your Reg. FD Policy. As noted earlier, Office Depot did not have written Reg. FD policies or procedures at the time of this violation, and the company had never conducted any formal Reg. FD training prior to June 2007. All publicly-traded companies should have a Reg. FD policy in place and to conduct training frequently.
- Be careful when dealing with “the Street” at the end of the quarter. Be especially cautious when the discussions relate to financial results and earnings guidance. In the Office Depot case, the calls with analysts were near the end of the quarter, a particularly sensitive period. If your company needs to provide advance warning of earnings results or otherwise update its financial guidance, do it first in a press release or with a Form 8-K filing. “Jawboning” analysts to change their estimates will only lead to trouble.
- Check with legal. In the matter of Office Depot, there is no indication that the CEO or CFO ever asked inside or outside counsel about either arranging these analyst calls or the talking points used by the director of investor relations. A brief consultation with an attorney regarding these types of communications can help prevent inadvertent Reg.FD violations.
- Crisis Planning. Inadvertent disclosure equals crisis – Check your crisis plan. Does it cover inadvertent disclosure? If it doesn’t now is the time to add that to the list of likely events and prepare accordingly.
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Gene Marbach is group vice president at Makovsky + Company in New York. |