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In August 2000 the Securities and Exchange Commission adopted Regulation Fair Disclosure to ensure that all market participants, from small individual investors to large institutional investors and securities professionals, would have equal and simultaneous access to material information concerning publicly held corporations. While the SEC’s stated purpose was to level the playing field and encourage the flow of information to investors, the result has been quite the opposite: Regulation FD has apparently chilled communications to investors. Concerned about incurring the SEC’s wrath and aggressive enforcement, corporate executives are appropriately reluctant to do little more than regurgitate their corporation’s carefully scripted public statements. This September, in SEC v. Siebel Systems Inc., however, the SEC suffered a setback in its Regulation FD enforcement efforts. In the first litigated case under Regulation FD, the SEC complaint was decisively dismissed. MATERIAL AND NONPUBLIC Regulation FD, 17 C.F.R. §234.100, et seq., applies to issuers of registered securities. It also applies to any person acting on behalf of an issuer, including senior officers, investor relations personnel, and others who communicate with securities holders and market professionals on a regular basis. It prohibits these issuers from selectively disclosing material, nonpublic information to securities professionals or certain investors before making such disclosures to the general public. While Regulation FD does not define “nonpublic” or “material,” it adopts definitions from other securities jurisprudence. Thus, “nonpublic” refers to information that has not been disseminated in a manner sufficient to ensure its availability to the investing public. And “material” means “there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision. Examples of likely material information include earnings information, mergers and acquisitions, new products or discoveries, developments regarding customers or supplies, changes in control or management, negative auditor notifications, and a range of events concerning the issuer’s securities. Any intentional disclosure of nonpublic, material information to analysts and institutional investors requires simultaneous disclosure of the same information to the public. Prohibited intentional selective disclosure occurs when the issuer or 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. Non-intentional selective disclosure can be cured with prompt public disclosure. Under Regulation FD “prompt” means “as soon as reasonably practicable (but no later than 24 hours or the commencement of the next day’s trading on the New York Stock Exchange) after a senior official of the issuer . . . learns that there has been a non-intentional disclosure by the issuer or person acting on behalf of the issuer of information that the senior official knows, or is reckless in not knowing, is both material and nonpublic.” Recognizing that private liability could contribute to a chilling effect on issuer communications, the SEC has emphasized that Regulation FD contains no private right of action. NO LINGUISTIC EXPERTS In Siebel Systems, a case in the U.S. District Court for the Southern District of New York, the SEC brought Regulation FD charges against Siebel Systems and Kenneth Goldman, its chief financial officer. The SEC alleged that Goldman had commented positively on the company’s business activity and sales transaction pipeline in a private meeting with an institutional investor and at an invitation-only dinner hosted by an investment bank. Those who attended the meetings subsequently made substantial purchases of Siebel Systems stock. The SEC argued that Goldman’s statements “materially contrasted” with allegedly more cautious public statements made by Thomas Siebel, the company’s founder and chairman, in conference calls earlier the same month. On Sept. 1, Judge George Daniels rejected the SEC’s claims, dismissed the complaint, and admonished the SEC for “scrutiniz[ing], at an extremely heightened level, every particular word used in the [defendant's] statement, including the tense of verbs and the general syntax of each sentence.” For instance, the court pointed to the SEC’s distinguishing between Goldman’s private statement that the company had $5 million deals in the pipeline and Siebel’s earlier statement that “We’ll see a number of deals over a million dollars. And I suspect we’ll see some greater than five.” The SEC argued that Goldman’s statement was in the present tense and, hence, factually different from Siebel’s forward-looking remark. Daniels further criticized the SEC’s approach for placing “an unreasonable burden on a company’s management and spokespersons to become linguistic experts, or otherwise live in fear of violating Regulation FD should the words they use later be interpreted by the SEC as connoting even the slightest variance from the company’s public statements.” The court found that, when viewed in context, the defendants’ public and private disclosures “did not add, contradict, or significantly alter” the material information available to the general public. It rejected the SEC’s syntactic parsing of those disclosures: “Fair accuracy, not perfection, is the appropriate standard.” The court concluded that Regulation FD does not require that corporate officials “only utter verbatim statements that were previously publicly made.” Nor does it prohibit persons speaking on behalf of an issuer “from providing mere positive or negative characterizations, or their optimistic or pessimistic subjective general impressions, based upon or drawn from the material information available to the public.” So long as the private statement communicates the same material information that the public statement conveyed, the court concluded that Regulation FD is not implicated. ‘OVERLY AGGRESSIVE MANNER’ The court clearly believed that the standard argued by the SEC in Siebel was inconsistent with the underlying purpose of Regulation FD to provide the public with a broad flow of investment information. The court did not, however, go so far as to adopt the position put forward in the U.S. Chamber of Commerce’s amicus brief, which argued that Regulation FD should be invalidated as a violation of corporate executives’ right to free expression and association. The court held that applying Regulation FD in “an overly aggressive manner” does not actually give companies any clear guidance. Instead, the court said, “excessively scrutinizing vague general comments has a potential chilling effect which can discourage, rather than encourage, public disclosure.” A more demanding standard might drive companies to end any spontaneous communication at all. Siebel is not an isolated example of the SEC’s aggressive enforcement of Regulation FD. In April 2005, just months before the Siebel decision was issued, the SEC entered into a settlement with the Flowserve Corp. and its CEO in another Regulation FD enforcement action. There, the SEC alleged that Flowserve’s CEO privately reaffirmed to analysts previous public guidance on Flowserve’s earnings. The following day one of the analysts reported the CEO’s reaffirmation. Flowserve then filed a Form 8-K on the third day, acknowledging the reaffirmation. Despite the small delay between public and private disclosures and the fact that the CEO’s private statements seemed merely to repeat previous public disclosures, the SEC hit Flowserve with a corporate penalty of $350,000 and its CEO with an individual penalty of $50,000. TIME TO STEP BACK It remains too early to predict whether the Siebel decision should provide comfort to issuers. Based on the SEC’s pursuit of the Flowserve and Siebel cases, issuers should expect regulators to continue to parse every apparent discrepancy or delay between an issuer’s public and private statements. But given Siebel‘s rejection of this approach and the court’s admonishment of the SEC for scrutinizing language too closely, the SEC itself should pause and consider whether aggressive enforcement of Regulation FD remains appropriate. Indeed, the SEC needs only to revisit its own public statements to see how Regulation FD should be enforced. When adopting the regulation, the SEC assured issuers that they “need not fear being second-guessed by the Commission in enforcement actions for mistaken judgments about materiality in close cases.” In Siebel, seeking to dismiss concerns about its aggressive enforcement, the SEC argued that “liability under Regulation FD will ensue only on the clearest cases.” It should be noted that since the Flowserve and Siebel cases were filed, two new commissioners have been appointed, and that the agency did not appeal from the Siebel decision. One hopes that the SEC’s previous reassuring statements truly will guide all future enforcement efforts for Regulation FD. Nonetheless, regardless of how it may adjust its enforcement, the SEC will still expect issuers to take Regulation FD seriously. It will continue to judge companies on whether they provide Regulation FD training, establish compliance protocols and policies, and implement disclosure controls to ensure that corporate executives do not unintentionally disclose material information solely to securities professionals. And the SEC will continue to bring enforcement actions when it believes that issuers have selectively disclosed material, nonpublic information. As always, prudence dictates that it is better for issuers to err on the side of caution when it comes to disclosure.
Thomas A. Zaccaro, the former regional trial counsel in the SEC’s Pacific regional office, is a partner in the Los Angeles office of Akin Gump Strauss Hauer & Feld. Jesse Z. Weiss is a counsel in the firm’s Austin, Texas, office, and Chad Stegeman is an associate in the firm’s San Francisco office.

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