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In the wake of recent Securities and Exchange Commissionenforcement actions and rule-making, executives and investor-relationspersonnel at public companies should focus on how they manage the”informal” flow of information to the investment community. In November2002, the SEC announced its first enforcement actions under RegulationFD, which prohibits selective disclosure of material nonpublicinformation. In January 2003, the SEC adopted Regulation G, whichestablishes the conditions under which companies may use “pro forma”financial information — i.e., data not prepared in accordance withgenerally accepted accounting principles — in public disclosures andrequires earnings releases to be filed promptly on Form 8-K. Public companies make a variety of mandatory public disclosures,most notably in periodic reports filed under the Securities Exchange Actof 1934 and in registration statements filed under the Securities Act of1933 in connection with the issuance of securities. In addition,companies communicate to their shareholders and the investment communitythough “voluntary” disclosures. Voluntary disclosures range from formalquarterly earnings announcements and presentations at investmentconferences, to informal press interviews and one-on-one discussionswith analysts or investors. Voluntary disclosures play a critical role in disseminatinginformation to investors. However, the SEC had long-standing concernsthat certain practices, such as the selective disclosure of materialfacts to analysts in private conference calls, were unfair to averageinvestors. These concerns led to the adoption of Regulation FD. Under Regulation FD, a company may not selectively disclosematerial nonpublic information to certain market participants such asbroker-dealers or investment companies, or to investors if it isreasonably foreseeable that trading will ensue. Instead, before materialinformation is disclosed to such market participants, it must generallybe broadly disclosed to the public on Form 8-K or through anothermethod, such as a press release. Conference calls and analystconferences comply if they are accessible to the public through aWebcast or a dial-in number and if the company gives advance publicnotice. The SEC has for several years had a separate concern over theunsystematic use of “pro forma” financial information. Congress, in theSarbanes-Oxley Act of 2002, provided the SEC with a legislativefoundation for rules addressing disclosure of pro forma financial data.This mandate from Congress led the SEC to adopt Regulation G. RECENT ENFORCEMENT ACTIONS The SEC targeted four companies in its first four publishedRegulation FD enforcement actions. The SEC imposed cease-and-desistorders on three and fined one of these three $250,000. The fourcompanies are Siebel Systems Inc. (Release No. 34-46896), SecureComputing Corp. (Release No. 34-46895), Raytheon Co. (Release No.34-46897) and Motorola Inc. (Release No. 34-46898). During an October 2001 quarterly earnings call with analyststhat was accessible to the general public, Siebel Systems’ CEO statedthat the market for information-technology products had been soft andwas expected to remain so. But at an investment bank-sponsored privateconference less than three weeks later, the CEO, aware that sales werein fact improving, announced that he was “optimistic” and “seeing areturn to normal behavior in IT buying patterns” in response to aquestion about the current state of the software market. Siebel’s stockprice and trading volume increased significantly during the conference,and attendees of the conference also traded in the company’s stockimmediately following the presentation. The SEC used its second action to illustrate the differencebetween “unintentional” and “intentional” disclosures. In March 2002,Secure Computing’s CEO disclosed a new significant contract on a privateconference call with a portfolio manager, mistakenly believing that thecontract had already been publicly disclosed. The next day, after theerror was discovered, the company prepared to issue a press release atthe close of business. But three hours before the press release wasissued, the CEO again disclosed the existence of the contract to anotherportfolio manager. The company’s stock price and trading volumeincreased throughout the period following the initial disclosure. The SEC used its third and fourth actions to address aparticular area of focus: one-on-one calls to analysts to comment ontheir earnings projections. In the first, the company’s CFO made callsto 11 analysts after reviewing their models and concluding that theirfirst-quarter earnings estimates were higher than the company’s ownestimates. Although the company had not provided public earningsguidance, the CFO told the analysts that most earnings would begenerated in the second half of the year, and warned a few that theirestimates were too high. Analysts contacted by the CFO lowered theirfirst-quarter and second-quarter estimates and increased their estimatesfor the second half of the year. SEEKING COUNSEL AVERTED ACTION In the second such action, Motorola had stated publicly that itsfirst-quarter sales and orders were experiencing “significant weakness.”The company’s investor relations (IR) director reviewed analysts’first-quarter estimates and was concerned that analysts did notappreciate just how bad the first-quarter results would be. He placedone-on-one telephone calls to analysts to clarify that “significantweakness” meant that the company’s sales and orders would drop by atleast 25 percent. Before doing so, however, he sought and received clearance fromthe company’s in-house counsel, who concluded that providing aquantitative definition of the term “significant” was not material. Thecompany’s stock price dropped by more than 15 percent after these calls, andtrading volume increased significantly at the firms contacted by the IRdirector. Although the SEC determined that the company’s counsel gaveincorrect advice, it declined to take formal action against the companybecause the IR director sought and relied upon legal advice beforemaking the selective disclosure. The SEC noted that the legal advice,although erroneous, was given in good faith. These enforcement actions make clear that corporate officersshould use caution — and stick to public information — in private calls withanalysts. The actions show that the SEC is highly attuned to one-on-onecalls to analysts. The SEC views with suspicion calls to analysts thatpass along information that has not been disclosed publicly. Even aclarification or “pointing out” call to analysts can move the stockprice and appears to be material in hindsight, so a company shouldconsider critically whether private communications to analysts wouldinvolve disclosure of material nonpublic information. If so, the companyshould issue a press release or file a Form 8-K before or in lieu ofcalling analysts. Corporate officers should also presume forward-looking financialinformation is material. The selective disclosures in many of theseactions involved earnings guidance or new trends identified bymanagement. The SEC is likely to view as material any informationrelated to future performance or trends. In addition, management should consider market reaction inassessing materiality. In these actions, the SEC assessed materiality inhindsight by looking at the changes in a company’s stock price andtrading volume during the period immediately following the selectivedisclosure. In evaluating materiality, management should consider howthe public disclosure of information would affect the company’s stockprice. If the market reacts to selective disclosure initially thought tobe immaterial, the company should re-evaluate its materiality analysisand consider making prompt public disclosure. STICK TO THE SCRIPT Management should always follow the script. In the actionagainst Siebel, the investment-conference organizer gave the company anadvance copy of the questions to be asked at the conference, and its IRdirector had prepared “talking points” for the CEO to follow. Thetalking points did not address company trends. Talking points areeffective only if spokespersons actually use them and confine theircomments to identified, publicly disclosed information. It is also crucial to remedy unintentional disclosures promptly.In the Secure Computing action, the SEC concluded that the CEO’s firstdisclosure of the contract’s existence was unintentional, requiringprompt public disclosure. However, the SEC concluded that the CEO’ssecond disclosure was intentional because he knew at the time that thecontract had not been publicly disclosed. If information is selectivelydisclosed unintentionally, a company must promptly disclose theinformation publicly, and before any further private communication ofthe information. Officers should also act in good faith and seek good counsel.The SEC concluded that Motorola had selectively disclosed materialnonpublic information. Yet, because the spokesperson consulted withinside counsel and followed counsel’s advice, the SEC declined to pursuean enforcement action. But there are common-sense limits: Relying oncounsel won’t work if the officer knows that the information would beimportant to a reasonable investor, or when consultation with counselinvolves only counsel’s recitation of the legal standard formateriality. Companies use a variety of pro forma measures to calibrate theirperformance internally and with the street that do not incorporategenerally accepted accounting principles (GAAP). Among the most commonlyused pro forma metrics are EBITDA (earnings before interest, taxes,depreciation and amortization) and “free cash flow.” The SEC adoptedRegulation G because it believes that the use of these and othernon-GAAP financial measures have the potential to confuse investors byobscuring GAAP results or making more difficult “apple-to-apple”comparisons between companies and even between reporting periods of thesame company. Regulation G, which will become effective on March 28, requirescompanies that include non-GAAP measures in public communications (suchas earnings releases) also to provide: The most directly comparable GAAP measures and A clearly understandable reconciliation of the non-GAAP measuresto GAAP measures. These requirements will apply to both historical financialinformation and guidance on future results, although GAAP reconciliationfor forward-looking non-GAAP information need only be provided “to theextent available without unreasonable effort.” Recognizing that it could be awkward for a company to have toinclude Regulation G-mandated disclosures in an oral presentation, suchas an earnings call that discusses non-GAAP financial measures, the SECallows a company to satisfy the requirements of the rule by providingthe required GAAP information and reconciliation on its Web site andinforming the audience of the Web site address during the presentation. At the same time as the SEC adopted Regulation G, it amendedForm 8-K to require companies that publicly disclose material nonpublicinformation about historical operating results or financial condition(such as earnings releases) to furnish such information to the SEC on aForm 8-K within five business days, whether or not the earnings releasecontains non-GAAP financial measures. The Form 8-K amendment is meant toimplement in part Sarbanes-Oxley’s requirement that materialdevelopments be disclosed on a “rapid and current basis.” (In additionalrules adopted together with Regulation G, the SEC set conditions on theuse of non-GAAP financial information in SEC filings that are notdiscussed in this article.) TIPS FOR COMPLIANCE To comply with Regulation G, a company should carefully vet alldisclosures containing financial information. Regulation G applies toany public disclosure of non-GAAP financial information — not justearnings releases — including communications publicly disclosed in orderto comply with Regulation FD. Personnel from a company’s finance andlegal departments should carefully scrutinize all company communicationsthat are intended for the public or will likely find a way into thepublic domain, identify any non-GAAP financial information and ensurethat the communication contains the required comparable GAAP informationand GAAP reconciliation. A company should also get its Web site ready. The SEC allowscompanies to exclude Regulation G-mandated information from oralpresentations that include non-GAAP measures if that information isavailable on the company’s Web site and the Web site address isdisclosed during the presentation. Therefore, legal counsel or IR personnel should ensure that theinformation regarding comparable GAAP measures and GAAP reconciliationis posted on the company’s Web site before an earnings call or a similarpublic presentation and to make sure executives who are involved in thepresentation disclose the Web site address to the audience. In the case of quarterly earnings calls, this requirement can besatisfied by posting a Regulation G-compliant earnings release on theWeb site and including a reference to the Web site’s URL in theintroductory portion of the call. The SEC encourages companies toprovide Web site access to these postings for at least a 12-monthperiod. Again, management should stick to the script and beknowledgeable about the Regulation G disclosures that have been postedto the company’s Web site. Unscripted use of non-GAAP financialinformation on public conference calls or in public speeches can resultin a violation of Regulation G if it turns out that comparable GAAPmeasures are not posted on the company Web site. In addition, management should give GAAP numbers their due.Regulation G prohibits companies from presenting non-GAAP financialinformation in ways that are misleading to investors. Companies shouldavoid giving non-GAAP measures greater prominence in their publiccommunications than the GAAP measures required by Regulation G orburying the required GAAP measures in a way that will not get noticed.(Companies are expressly prohibited from doing this in earnings releasesthat now must be filed on Form 8-K.) For example, if the header of an earnings release contains a proforma measure, the most comparable GAAP measure should be included there,too. In addition, care should be taken to ensure that non-GAAP measuresdo not obscure the import of GAAP measures. For example, companiesshould avoid presenting a non-GAAP financial measure that excludesone-time or noncash charges in a way that makes it difficult forinvestors to comprehend GAAP results or the trends such results mayportend. Finally, management should explain the use and purpose ofnon-GAAP measures. Companies should consider disclosing the reasons whymanagement believes the use of a non-GAAP financial measure providesuseful information to investors; indeed, the SEC now expressly requiresthis in connection with earnings releases that must be filed on Form8-K. Eric DeJong is a corporate finance partner, Paul Sassalos is acorporate finance associate, and Stewart Landefeld is a partner and thechairman of the corporate finance practice in Seattle-based PerkinsCoie ( www.perkinscoie.com). The firm’s corporate finance practice focuses on corporategovernance, public offerings, venture capital, securities regulation andmergers and acquisitions. 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