SEC adopts regulation FD prohibiting selective disclosure of material information

Attorney-CPA, The, 2000 by Goelzer, Daniel L

On August 10, 2000, the Securities and Exchange Commission, by a 3-1 vote,1 adopted Regulation FD (Fair Disclosure) prohibiting public companies from making selective disclosure of material, nonpublic information to market professionals or shareholders. While the Commission rejected securities industry arguments that Regulation FD would chill disclosure and inhibit the free flow of information,2 it narrowed the scope of the proposal originally published by the Commission in several respects.3 At the same time as it adopted Regulation FD, the Commission also adopted two new rules clarifying the law of insider trading.4 The new rules become effective on October 23, 2000. This paper summarizes Regulation FD and its impact on public companies.

The SEC's Crusade Against Selective Disclosure

During the past several years, SEC Chairman Levitt and other members of the Commission and its senior staff have been critical of public company disclosure practices that they view as favoring analysts and other industry professionals. Release No. 7881 states that "many issuers are disclosing important nonpublic information, such as advance warnings of earnings results, to securities analysts or selected institutional investors or both, before making full disclosure of the same information to the general public." The Commission has concluded that these practices lead "to a loss of investor confidence in the integrity of our capital markets." Regulation FD is intended to address this problem by establishing "a clear rule prohibiting unfair selective disclosure" and encouraging "broad public disclosure."

Requirements of Regulation FD

Regulation FD applies whenever an issuer, or "any person acting on its behalf (as defined in Regulation FD), discloses material, nonpublic information regarding the issuer or its securities to certain types of recipients. Rule 100(a) of Regulation FD provides that, when such a disclosure occurs intentionally, the issuer must simultaneously make public disclosure of the information; if the selective disclosure occurs unintentionally, public disclosure must be made "promptly" after the selective disclosure comes to the attention of a senior official of the issuer. There are, however, some important limitations on this obligation, as described below.

A. What Disclosures Trigger the Requirements of Regulation FD?

As proposed, Regulation FD would have applied to any disclosure by a public company to any person outside of the company who was not required to keep the information confidential. However, as adopted, Regulation FD is narrower - only disclosures to securities industry professionals, or to company shareholders that are likely to trade, are within the rule. Further, only disclosures by senior officials or members of the investor relations staff are covered.

* Selective disclosure recipients. The Rule 100(a) disclosure obligation is only triggered by a disclosure to a securities broker-dealer (or associated person); an investment adviser or institutional money manager (or associated person); an investment company (or affiliated person); or a holder of the issuer's securities "under circumstances in which it is reasonably foreseeable that the person will purchase or sell the issuer's securities on the basis of the information." Regulation FD does not apply to disclosures to persons who are themselves bound by duties of trust or confidence not to disclose the information or to use it for trading. This includes "temporary insiders" (such as the company's investment bankers), persons who have expressly agreed to maintain confidentiality, and credit rating agencies. As a result of these limitations, Regulation FD does not apply to most ordinary course of business disclosures, such as to employees, customers and suppliers. Communications with the press are also outside the rule.

* Selective disclosure sources. Regulation FD is only triggered by disclosures from a "person acting on behalf of the issuer." This phrase is defined narrowly, to include a "senior official" of the issuer, or any other officer, employee, or agent of the issuer who regularly communicates with securities market professionals or shareholders. "Senior official" in turn, means a director, executive officer, investor relations officer, or "other person with similar functions." Therefore, only top company officials and members of the investor relations staff can expose an issuer to the requirements of Regulation FD.5

B. When Must Public Disclosure Be Made?

When a selective disclosure subject to Regulation FD is "intentional," public disclosure must be made simultaneously with the selective disclosure; when a selective disclosure is non-intentional, public disclosure must be made "promptly."

* Intentional. A selective disclosure is intentional when the person making the disclosure either knows, or is reckless in not knowing, that the information he or she is communicating is both material and nonpublic.

* Promptly. Public disclosure following a nonintentional selective disclosure is "prompt" if it is made as soon as is reasonably practicable. However, a disclosure must be made no later than (i) 24 hours or (ii) the commencement of the next day's trading on the New York Stock Exchange, after a senior official of the issuer learns of a non-intentional disclosure that the senior official knows, or is reckless in not knowing, is both material and nonpublic.