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A new Securities and Exchange Commission rule could create a compliance minefield. “Analysts are kind of on pins and needles really figuring out if their lines of communication are going to shut down,” says David Prince, general counsel for Robinson-Humphrey Co. in Atlanta. The new rule, announced by the SEC last week and scheduled to become law in less than 60 days, is aimed primarily at analysts. The agency feels that analysts and institutional investors have enjoyed a monopoly on market-moving information. Under the latest draft of Regulation FD, which stands for “fair disclosure,” companies are forbidden from selectively disclosing information to analysts. The SEC says all “material” information should go out at the same time to everyone. And what’s “material?” In light of all information available to an investor, material information is anything that would cause the investor to change an investment decision, says SEC General Counsel David Becker. While the new rule is similar to Rule 10b-5, it has some major differences. Rule 10b-5 is an anti-fraud rule, and Regulation FD is not. It is only a disclosure rule. As such, it broadens the context in which a public company or its executives could be liable for selective disclosure and fills a gap in existing law. For example, under Rule 10b-5, to trigger liability, information generally had to be disclosed in the context of the purchase or sale of securities, or with the likelihood or knowledge that disclosure would influence or cause such a transaction. AN UNCLEAR AREA Paul, Hastings, Janofsky & Walker securities partner Walter E. Jospin says it was unclear under Rule 10b-5 whether cases where the information was given out just to educate an analyst, for example, were actionable. The SEC lost cases it pursued in this context, he adds. Under Regulation FD, however, even information given just to educate an analyst is likely to trigger liability. The new regulation also closes a gap in securities law, says Troutman Sanders securities partner W. Brinkley Dickerson Jr. The gap was left open by a U.S. Supreme Court case, Dirks v. SEC, 463 U.S. 646 (1983). Dickerson says the case dealt with securities analyst Raymond Dirks, who learned that a public insurance company was committing fraud. He reported his findings to the SEC and a newspaper, but they ignored him. So Dirks told his clients. When they unloaded their shares, the company’s stock value plummeted, and the SEC sued the analyst for insider trading. The SEC lost, because the court decided the analyst’s intent wasn’t to help his clients, but to make the information public. “The SEC has hated that case ever since it was applied,” says Dickerson. Under Regulation FD, the analyst might have been liable. Now, selective disclosure of anything deemed material could violate the rule. The new regulation does allow companies to cure inadvertent selective disclosures by making the information public in 24 hours, through an 8-K form, a press release, or some other means. SEC officials say that a Webcast alone may not be sufficient. DEFINITION UNCHANGED Becker and Stephen Cutler, deputy director of the agency’s Division of Enforcement, stressed that the definition of what is material has not changed. Among potentially material events Becker listed are mergers, acquisitions, tender offers, developments regarding customers or suppliers, high-level management changes, and bankruptcy or receivership. Those examples are “no-brainers,” says Dickerson. The problem comes when a company doesn’t disclose material information, but a smart analyst puts two and two together and comes up with it anyway. And in this age of fast Internet communication, “just about anything is prone to move the markets,” notes Robinson-Humphrey’s general counsel Prince. That means there’s the risk of a substantial chilling effect on analysts’ communication with public companies. “Historically, research analysts have had a very close relationship with companies they follow, with weekly or even daily contact,” Prince says. He fears that will change. “If they are tipped by a company, can they use that? We’re hoping for some guidance,” he says. RANKING STOCKS Now, says Prince, most analysts know how competitors are ranking stocks because so much information is on the Web. It’s not uncommon for an analyst who has priced a stock at $100 a share, for example, to learn online that most competitors are pricing it at $80. Then the analyst calls a company executive for guidance. Those days may be at an end, he says. Analysts may need to start doing more independent research — for example, visiting the branches and warehouses of a retail company to see how it’s doing. “What the people who’ve been around a long time say is, it’s really going to push analysts to focus more on individual analysis,” he says. Troutman’s Dickerson says he knows of one food company that has already refused to participate in a Merrill-Lynch conference set up for the industry and analysts unless the event is simulcast. INVESTIGATION THREAT Companies are skittish because a violation could lead to an investigation in which the company will have to prove it didn’t disclose material information. “An SEC investigation is a nightmare for a public company, as well as for a company in the financial services industry like a broker-dealer,” says Jospin. Not only do lawyers stay busy answering the SEC’s questions, but if the market learns of the investigation, the company’s stock price may be affected. And that can trigger investor suits. “I would liken it to an IRS audit or maybe a star chamber,” Jospin says. Regulation FD also is different from Rule 10b-5 in that it does not provide a private right of action. Under the new rule, only the SEC may pursue malfeasors. That could be an advantage for companies. According to Dickerson, companies worry most about private suits. A class action is expensive, whether the company is right or wrong, he says. Still, he adds, the public could pursue the company through state law claims or other fraud remedies. And the penalties for violating the rules are the same, says Jospin. Under both rules, the SEC may seek a cease and desist order in an administrative proceeding or an injunction or fine in federal court. The amount of the fine, the SEC’s Cutler said, would be at the judge’s discretion. Also, a company’s reporting responsibilities technically are not increased. It still must produce 10-K and 10-Q forms but has no duty to release material information to the public in the middle of a reporting period, says Jospin. If it does disclose material information, however, the disclosure must be made to everyone and not a select few. SIX THOUSAND PUBLIC COMMENTS Until the rule is released — and tried — lawyers and analysts won’t know exactly how it will affect them and the market. It is, says Dickerson, one of the most controversial rules in a long time, generating more than 6,000 public comments in an arena that usually generates 50 or 60. He says adequate enforcement of Rule 10b-5 might have been a substitute for Regulation FD. “I’ve never seen the SEC subpoena the records of an analyst and investigate how he got them and from whom for an offense like this,” Dickerson says. “I don’t think their enforcement in this area has been particularly strong.” Jospin likes the concept of the rule. “I think that the markets ought to have access to information at the same time,” he says, noting that because of full disclosure, the United States has the most efficient and effective capital market in the world. On the other hand, he says, there’s the view that a small minority of SEC staffers are “overzealous and they really want to push the envelope to make law and to make a name for themselves.”

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