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Washington-A California business-software company will face off with the Securities and Exchange Commission in a New York federal court next month over the boundaries of the federal agency’s authority to regulate corporate speech. At the center of the clash between the SEC and San Mateo, Calif.-based Siebel Systems Inc. is Regulation Fair Disclosure, more commonly known as Regulation FD, which requires firms that disclose material, nonpublic information to securities market professionals, such as analysts, to disclose the same information simultaneously to the public. The SEC has brought six enforcement actions charging violations of the regulation since its controversial promulgation in 2000, but none has gone into litigation until Siebel, facing a second charge, decided to fight. SEC v. Siebel Systems Inc., No. 04 Civ. 5130 (S.D.N.Y.). Calling the stakes in the litigation “substantial,” the company not only disputes the factual basis for the alleged violation, but it also levels a broadside at the agency’s authority to issue the regulation itself. And it raises a rare First Amendment challenge to the securities regulation that some legal experts say is long overdue. Siebel’s lead counsel, John C. Dwyer of Cooley Godward in Palo Alto, Calif., has brought into the litigation noted constitutional scholar Kathleen M. Sullivan, former dean of Stanford Law School. The company also has attracted amicus support from the U.S. Chamber of Commerce. “The SEC has often behaved as if there is a securities exception to the First Amendment,” said Sullivan, who recently became counsel to Los Angeles firm Quinn Emanuel Urquhart Oliver & Hedges. “That’s a mistaken view of the law because although there are different rules for commercial speech, the Supreme Court has really defined commercial speech very narrowly to mean advertising for goods or services. It doesn’t mean anything motivated by commercial efforts or emanating from the corporate mouth.” But publicly held companies are subject to an extremely wide range of regulation, said securities scholar Larry D. Soderquist of Vanderbilt University Law School. “The SEC has been given extensive authority to regulate in the public interest with respect to these companies, and most of that regulation relates to disclosure,” said Soderquist. “The idea that the First Amendment may somehow trump these regulations is to me a very long stretch. They have a massive mountain to climb.” Mountain climbing The SEC, which refused to comment on the litigation, said in its opposition to the company’s motion to dismiss the enforcement complaint that Regulation FD was promulgated with the specific purpose of “leveling the playing field” for all investors. Many companies frequently met with market professionals in private or industry meetings in which they provided information not available to the public. Analysts often received guidance about future earnings and other important indicators during the meetings. The private disclosures, according to some securities experts, benefited the market in two specific ways: The information and guidance became the basis for analysts’ reports on which many investors rely, and providing guidance reduced price volatility. But critics countered that the practice of selectively disclosing important corporate information put some investors, particularly smaller ones, at a disadvantage. In some cases, it also led to insider trading. Siebel settled the first enforcement action for violating Regulation FD in 2002 by paying a $250,000 fine and without admitting or denying the SEC’s charges. The SEC filed the second complaint last year, naming the company, its chief financial officer, Kenneth Goldman, and its former director of investor relations, Mark Hanson. The complaint focuses on statements made by Goldman at a one-on-one meeting with Alliance Capital Management and a private dinner sponsored by Morgan Stanley & Co. on April 30, 2003. The SEC contends that Goldman on that date “made positive comments about the Company’s business activity levels and transaction pipeline.” Those statements, according to the SEC, “materially contrasted” with negative public statements made by Chairman Thomas Siebel in the three weeks before the private meetings. “Recipients of this information promptly acted on it either by trading or by further disseminating it to selected investors,” said the SEC, and there was no public disclosure. An example of the materially contrasting statements, according to the SEC, is the following: On April 23, Thomas Siebel publicly stated, “We’ll see a number of deals over a million dollars. And I suspect we’ll see some greater than five [million dollars].” Goldman in his private meetings stated that $5 million deals were in the pipeline. “Thomas Siebel’s use of the future tense and the word ‘suspect’ demonstrates that his statements were not fact but rather were forward-looking,” said the SEC in its brief. “In contrast, Goldman’s statements were in the present tense and constituted a factual statement of what the Company was seeing in its pipeline.” Siebel Systems has chosen to litigate, said Sullivan, because, “whatever the proper application of this law might be-and we think it’s void on its face-this is egregious overreaching on speech far from concern of regulators.” The regulation is unusual, she said, in the way it uses compelled disclosure as a “club” to inhibit both the regulated speech and “the vast universe of corporate speech” spoken beforehand and to which it might be compared. But there have been few enforcement actions, which is evidence that companies have adjusted well, said Vanderbilt’s Soderquist. “I believe most issuers are happy because this relieved them of pressure being put on them by financial analysts and reporters and so on,” he said. “It says to treat everybody the same.” Unusual but constitutional? The Supreme Court has generally skirted the issue of the First Amendment’s application to securities laws, said securities scholar Larry Ribstein of the University of Illinois College of Law. “One reason the courts are reluctant to get into it is that once you start applying the First Amendment to securities laws, where do you stop?” he said. “The securities laws are all about speech. What’s troubling the courts is they would have to get into a significant review of a major body of federal legislation and lay down standards for review.” Courts also generally like what the SEC does, and don’t have a lot of respect for commercial speech, said appellate litigator Eric S. Jaffe of Washington. Add to that the fact that “no major company in its right mind” wants to “poke a stick in the eye” of its primary regulator, he said, and the SEC generally escapes serious constitutional challenges. No one in the Siebel case argues that the securities laws in general are unconstitutional on speech grounds. But Ribstein and Jaffe agree with Sullivan that there has to be some First Amendment scrutiny of what the SEC does. “I think Regulation FD is a good place to start,” Ribstein said. “When you’re talking about discouraging or impeding truthful speech, that’s possibly problematic.” When it comes to the First Amendment, Regulation FD is different from the typical securities regulation in two respects, said Gary Orseck of Washington’s Robbins, Russell, Englert, Orseck & Untereiner, who drafted the U.S. Chamber of Commerce’s amicus brief. The typical securities case is brought under Section 10 of the Securities Exchange Act of 1934 or under Rule 10b-5, he said. “It is absolutely true nobody would even dream of trying to bring a First Amendment claim in that context and the reason is Section 10 is really a regulation of conduct more than pure speech,” he said. “It says you may not employ or manipulate a deceptive device in connection with the purchase or sale of securities. There has to be an act. Regulation FD is entirely different. It is not at all tied to conduct. All it says is if you release information to the nonpublic, you have an affirmative obligation to make the same speech to the public at large.” The second difference, he added, is the regulation falls under the category of compelled speech. “If you do X, then you must make further speech,” Orseck said. “The Supreme Court’s cases are pretty emphatic that compelling speech-no matter what the subject matter is-typically is subject to very heavy scrutiny.” The SEC, however, argues that the regulation is not content-based, but instead regulates the manner in which disclosures of important corporate information are made to the public. “It is directed only at selective disclosure of material information to a defined group of persons in circumstances where there is a reasonable likelihood that the information will be used for trading,” said the agency in court papers, adding that companies are free to make selective disclosures as long as the recipient expressly agrees to keep the information confidential. The agency, whose lead attorney on the case and briefs is Treazure R. Johnson of Washington, also contends that the regulation addresses commercial speech, which gets “less extensive” First Amendment protection than private speech. But the regulation passes even the most searching scrutiny, added the agency. There is ample evidence that selective disclosure is an important problem affecting the integrity of the securities markets, according to the SEC, and preserving confidence in the markets and preventing insider trading are compelling governmental interests. Orseck disagreed. “Before the SEC can justify a speech regulation like this, the evidence has to be much, much more. Even if there were a terrible problem in the markets, this is a blunt instrument, not at all narrowly tailored.” Avoiding the issue U.S. District Judge George B. Daniels, who will hear arguments on a motion to dismiss the case on March 15, could avoid the First Amendment issues if he agrees with Siebel and the chamber that the SEC lacked authority to issue Regulation FD in the first place. The SEC contends in its brief that Regulation FD was issued pursuant to the agency’s authority under Section 13(a) of the 1934 Exchange Act to require current disclosures by corporate issuers. “In order to protect the investing public, Section 13 grants the SEC broad authority to determine the scope of continuing disclosure required of the issuers of publicly traded securities,” said the SEC. But Siebel counters that Section 13(a) only authorizes rules requiring updates to information contained in registration statements and applications. “Congress has considered and rejected the idea of a continuous disclosure obligation,” said Sullivan. “It has never thought it appropriate to put the burden on corporate officers of continuous disclosure all the time of everything, which is just Orwellian.” Sullivan and others noted that unlike the First Amendment context, courts have not been reluctant to examine the SEC’s rulemaking authority and to rein in the agency when it has overreached. “The SEC has to have specific authority,” said Sullivan. “It doesn’t have carte blanche to do anything it wants to make markets more fair.”

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