Communications with Financial Analysts and Related Disclosure Issues

Securities analysts play a key role in securities markets, and publicly held companies as a matter of market practice regularly brief them to help them understand company results and business trends. There have been some unfortunate instances, however, in which analysts have received nonpublic information on which their clients have acted before the information was disclosed to the general public. In the wake of these cases, as well as Enron and the unanticipated and significant decline in the financial position of other public companies, the role of the securities analyst was scrutinized by Congress, the Securities and Exchange Commission (the “SEC”), state regulators and various self-regulatory organizations. The result was a heightened campaign against selective disclosure, facilitated by the SEC’s adoption of Regulation FD (Fair Disclosure) in 2000.

Although the number of Regulation FD cases has diminished in recent years, this is perhaps because compliance has become deeply ingrained in market participants. Nonetheless, given the potential for SEC enforcement action, as well as insider trading litigation, ongoing vigilance in this domain is certainly warranted. A memorandum prepared by Cleary, Gottlieb, Steen & Hamilton LLP (available here) sets out guidelines for communications between management and securities analysts in light of applicable case law and the SEC’s Regulation FD. A summary of the guidelines is included below.

The U.S. rules governing disclosure to analysts by issuers originally emerged from case law construing a basic antifraud rule, Rule 10b-5 under the Securities Exchange Act of 1934 (the “Exchange Act”). As a result, the rules are not straightforward, are at times ambiguous and, in any event, have not been applied, with one known exception, to communications between issuers and analysts. This situation led the SEC to adopt a new disclosure regime, Regulation FD, to prevent material nonpublic information from being given selectively to market professionals (broker-dealers, investment advisers and managers, and investment companies), who could use such information to their own or their clients’ advantage. Regulation FD applies to communications on behalf of the issuer with market professionals and with securityholders who may foreseeably trade on the basis of the disclosed information. Although Regulation FD does not apply to foreign issuers, they too should avoid selective disclosure of material nonpublic information both as a matter of best practice and to avoid potential liability. Ill-considered disclosure can lead to liability both for the company and for its management personally under Rule 10b-5, raise potential issues regarding correcting or updating information and have adverse market consequences.

The U.S. Supreme Court has established that there must be a breach of a fiduciary duty or other relationship of trust and confidence, or a misappropriation of information received in violation of such a relationship, before tipping or trading on the basis of material nonpublic information results in a violation of Rule 10b-5. This has led to three general principles with respect to the disclosure of corporate information to securities analysts and the public. First, Rule 10b-5 by itself does not normally require management to disclose material nonpublic information regarding the company to the investment community. Subject to certain exceptions discussed below, the timing of such disclosure is ordinarily left to the business judgment of management. Second, if a company does disclose corporate information (whether voluntarily or otherwise), Rule 10b-5 requires that those disclosures neither contain misleading statements of material information nor omit material facts necessary to make the statements made not misleading. Third, when divulging material nonpublic information, company officials may not disclose it selectively—e.g., exclusively to securities analysts—but rather must make the information available to the general public, if those officials could be found to have gained a personal benefit from the selective disclosure. Selective disclosure can lead to liability for the company and for company officials themselves for insider trading by persons receiving the disclosure. Although Rule 10b-5 might not require dissemination of material information, the New York Stock Exchange (the “NYSE”) and the NASDAQ Stock Market (“Nasdaq”) require listed companies to disclose material information promptly to the public through any Regulation FD-compliant method of disclosure, except under certain limited circumstances.

In addition, listed companies may be required to notify the NYSE or Nasdaq of the release of any such information prior to its release to the public. NYSE and Nasdaq rules, however, do not have the force of law and cannot be the basis for an implied private right of action. The Second Circuit held in State Teachers Retirement Board v. Fluor Corp. that no private right of action exists for a violation of the NYSE Listed Company Manual’s disclosure rules. The court reasoned that, given the extensive regulation in this area by Congress and the SEC, “a federal claim for violation of the [NYSE’s Listed] Company Manual rules regarding disclosure of corporate news cannot be inferred.”

In addition to annual reports on Form 10-K and quarterly reports on Form 10-Q, a domestic issuer subject to Exchange Act reporting must file current reports on Form 8-K with the SEC to disclose certain specified events. In many cases, disclosure is required within four business days of an event’s occurrence. For a foreign private issuer, Form 6-K requires submission to the SEC of all significant information that (i) must be made public under local law in the issuer’s country of incorporation or domicile, (ii) is filed with any foreign stock exchange on which the issuer’s securities are listed and made public by such exchange or (iii) is distributed to the issuer’s securityholders. Finally, when preparing disclosure responsive to the SEC’s Exchange Act reporting requirements, companies should be mindful of Rule 12b-20, which requires inclusion of any information beyond what is expressly required “as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading.” The SEC has brought enforcement actions for violating Rule 12b-20 even in the context of Form 6-K filings, where there are no express disclosure requirements.

Management should be very careful in its communications with securities analysts. Under certain circumstances, the disclosure of material information selectively to analysts can violate Rule 10b-5 and thereby generate both SEC sanctions and liability for damages to investors. Pursuant to the tests courts have fashioned to determine “materiality,” company officials should be wary of disclosing to analysts, but not to the public generally, any information (such as earnings information) that might affect the company’s share price or that a reasonable investor would deem important in deciding whether to buy or sell company securities.

Furthermore, companies should take precautionary measures in advance to avoid selective disclosure. Prophylactic procedures include the scripting of presentations to analysts, the pre-meeting review of the proposed presentation by counsel and officials familiar with the issues to be discussed and a debriefing of the officials after the presentation to verify that no material nonpublic information has been disclosed, as well as a limitation on the number of company officials responsible for giving such presentations. Management should also consider maintaining a “no comment” position if it wants any particular issue to remain confidential. Finally, less formal communications with analysts should also be conducted in accordance with procedures designed to minimize inadvertent disclosure of material information and to provide the company with evidence to defend potential allegations of intentional selective disclosure. When a domestic company discloses material nonpublic information to analysts or other market professionals, or to its securityholders when it is reasonably foreseeable they will trade, the disclosure regime established by Regulation FD requires that the company must make the disclosure broadly to the investing public too. Although Regulation FD does not apply to foreign issuers, foreign issuers should continue to take into account best practices and avoid selective disclosure of material nonpublic information out of concern for potential liability under Rule 10b-5.

Regulation FD requires that if material nonpublic information is inadvertently disclosed to analysts or others to whom selective disclosure is restricted by the regulation, the company must promptly (and, in any event, generally within 24 hours) make public disclosure of that information. Public disclosure for purposes of Regulation FD can be made by filing or furnishing a Form 8-K or by disseminating the information through a method or combination of methods that is “reasonably designed to provide broad, non-exclusionary distribution of the information to the public,” such as a press release. The NYSE and Nasdaq also require listed companies to disclose material information promptly to the public through any Regulation FD-compliant method of disclosure. In addition, listed companies must notify the NYSE or Nasdaq of any such information prior to its release to the public in certain circumstances. Management should also avoid participating to a significant extent in the preparation of analysts’ reports to minimize potential 10b-5 liability. Specifically, company officials should not “entangle” themselves with the creation of such reports to the extent that the information they contain can be attributed to the company. Accordingly, any participation by the company should be limited to reviewing the report for factual accuracy (which is all a U.S.-based analyst is permitted by applicable SRO rules to request), with care being taken in any event not to comment on any forecasts or other judgmental statements made by the analyst. Similarly, a policy of not commenting on analysts’ projections can prevent the company from being required to correct or verify market rumors on the grounds that such rumors cannot be attributed to the company.

While Rule 10b-5 liability can arise from selective disclosure of accurate information, it is important to note that liability can also attach if such disclosure, made selectively to analysts or generally to the public, contains a materially misleading statement or omits a material fact necessary to make the statement made not misleading. Even if a company’s statement is accurate when made, if intervening events render the disclosure materially misleading, management may have a duty to update the prior comment. Finally, management should institute a process for identifying all non-GAAP financial measures contained in any public disclosure by the company, accompanying that disclosure with the most directly comparable GAAP financial measure and quantitative reconciliation of the two measures. To minimize the impact of these rules on public presentations of non-GAAP financial measures disclosed orally, telephonically, by webcast or broadcast, or by similar means, the company should also consider maintaining a reconciliation of these non-GAAP financial measures, for at least a 12-month period, on its website under the section dedicated to investor relations and set forth the location of the website in the public presentation in which the non-GAAP financial measure is used. In particular, for information disclosed in conjunction with the company’s earnings conference call, management should furnish the earnings press release to the SEC under Item 2.02 of Form 8-K before the conference call, include a statement identifying where the call will be archived on the company’s website and distribute the announcement through a widely
circulated news or wire service.

Guidelines for Communications with Analysts

• 1. Designate one company executive to communicate with analysts.
• 2. Make each presentation to analysts on the basis of a prepared text that has been reviewed by senior executives and by counsel.
• 3. Do not disclose material nonpublic information to analysts unless you disclose the information to the public at the same time; this can be done by permitting the public, on reasonable advance notice, to participate in any call with analysts during which material nonpublic information may be discussed.
• 4. Refrain from responding to analysts’ inquiries in a nonpublic forum unless you are certain that the response does not include material nonpublic information.
• 5. If you are asked about a matter that is not ripe for disclosure, simply say “no comment.”
• 6. If requested by an analyst to review a research report, do not comment except to correct errors of fact. Do not comment in any way on an analyst’s forecasts or judgments, including by saying you are “comfortable” with them, that they are “in the ballpark” or other words to similar effect. Do not distribute analysts’ reports or hyperlink to them on the company’s website.
• 7. Avoid favoring one analyst over another.
• 8. Review public statements to identify any non-GAAP financial measures. If disclosure contains non-GAAP financial measures, include a presentation of the most directly comparable financial measure calculated and presented in accordance with GAAP and a quantitative reconciliation of the two measures. To avoid reconciliation of non-GAAP financial measures in public presentations given orally, telephonically, by webcast or broadcast, or by similar means, provide the most directly comparably GAAP financial measure and the required reconciliation on the company’s website and include the location of the website in the presentation. If materials distributed (electronically or in hard copy) during a public presentation contain non-GAAP financial measures, provide the most directly comparable GAAP measures and provide the required reconciliations in close proximity to the non-GAAP financial measures.
• 9. Do not make specific forward-looking statements, unless (a) you set out the assumptions on which the forecast is based, (b) you indicate the factors that could prevent the forecast from being realized, (c) you make the statements to the public at the same time and (d) you are always prepared to evaluate the need to update the statement when circumstances change. The steps contemplated by (a) and (b) can be effected by referring to a filed document that contains the relevant information.

Edward F. Greene is a partner at Cleary Gottlieb Steen & Hamilton LLP where he specializes in corporate law matters.