Introduction

On August 10, 2000, the Securities and Exchange Commission approved the adoption of new rules to address the problem of selective disclosure by issuers of material nonpublic information. The new rules are also intended to clarify certain aspects of existing insider trading law. These rules, which will take effect 60 days after publication in the Federal Register, will impose important new obligations for publicly-held corporations in communicating with securities analysts.

The newly adopted rules are set forth in Regulation FD. This Regulation reflects the SEC’s view, expressed repeatedly over the past two years in statements by Commissioners and staff, that the practice of disclosing material nonpublic information on a selective basis to securities analysts poses a serious threat to investor confidence in the fairness and integrity of the securities markets. The SEC release setting forth the new rules notes that many corporations have had a practice of making such disclosures in conference calls or meetings that are open only to analysts and/or institutional investors and exclude other investors, members of the public and the media. In other cases, company officials have made selective disclosures directly to individual analysts. These situations commonly involve advance notice of the company’s upcoming quarterly earnings or sales figures, information that is likely to have a significant impact on the market price of the company’s securities. In a statement issued on August 10, SEC Chairman Arthur Levitt voiced concern that this practice has led some in corporate management to treat material information as a commodity which can be used to curry favor with particular analysts, leading to pressure on analysts to report favorably on companies in order to assure continuing access to selectively disclosed information.

Under current Supreme Court decisions, this type of selective disclosure to analysts does not give rise to insider trading liability unless the representative of the company relaying the information receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputation benefit that will translate into future earnings.

Prohibited Selective Disclosures

Regulation FD will apply to all corporations which are subject to periodic reporting obligations under the Securities Exchange Act of 1934. Rule 100 of Regulation FD sets forth the basic rules regarding selective disclosure. Under this rule, whenever:

1. an issuer, or person acting on its behalf,
2. discloses material nonpublic information,
3. to certain enumerated persons (in general, securities market professionals or holders of the issuer’s securities who may well trade on the basis of the information),
4. the issuer must make public disclosure of that same information,

1. simultaneously (for intentional disclosures), or

promptly, which is generally defined as within 24 hours after knowledge of the disclosure by a senior official (for non-intentional disclosures).

Disclosures to Enumerated Persons

In response to concerns over the scope of the Regulation as originally proposed, the Commission narrowed the reach of Regulation FD. The Regulation is designed to address the core problem of selective disclosure made to those who would reasonably be expected to trade on the basis of the information provided or provide others with advice about securities trading and does not apply to issuer communications with the press or ordinary course of business communications with customers and suppliers.

Rule 100(b)(1) of Regulation FD enumerates four categories of persons to whom selective disclosure may not be made absent a specific exclusion:

1. broker-dealers and associated persons,
2. investment advisors, certain institutional investment managers and associated persons,
3. investment companies and hedge funds, and
4. any holder of the issuer’s securities if the communications were made under circumstances in which it could be reasonably foreseen that the person would purchase or sell securities based on the information.

Rule 100(b)(2) sets out four exclusions from coverage:

1. communications to persons owing a duty of confidence to the issuer, or communications to "temporary insiders," such as lawyers, investment bankers and accountants,
2. communications to any person who agrees to maintain the information in confidence,
3. disclosures to entities whose primary business is the issuance of credit ratings, provided that the information is used solely for the purpose of developing a credit rating and the entity’s ratings are publicly available, and
4. communications made in connection with most offerings of securities under the Securities Act.

The final rule also expressly provides that a violation of the rule will not disqualify a company from the use of short-form registration forms under Rule 144 of the Securities Act of 1933 or affect investors’ ability to use Rule 144 for resales of the company’s securities. In addition, the rule will not apply to foreign governments or foreign issuers.

For purposes of Regulation FD, a "person acting on behalf of an issuer" includes:

1. any senior official of the issuer, or
2. any other officer, employee or agent of an issuer who regularly communicates with securities market professionals or with the issuer’s security holders.

This definition is intended to cover senior management (directors and executive officers), investor relations professionals and others who regularly interact with securities market professionals or security holders. To the extent another employee is directed to make a selective disclosure by a member of senior management, that member of senior management would be responsible for having made the selective disclosure.

Under Regulation FD, selective disclosure is "intentional" when the individual making the disclosure either knew prior to making the disclosure, or was reckless in not knowing, that he would be communicating information that was material and nonpublic. Intentional selective disclosure must be accompanied by simultaneous public disclosure. Non-intentional selective disclosure must be followed promptly by public disclosure. For these purposes, "promptly" means as soon as reasonably practicable (but in no event after the later of 24 hours or the commencement of the next day's trading on the New York Stock Exchange) after a senior official of the company knows or is reckless in not knowing of the non-intentional disclosure.

Rule 101 defines the type of public disclosure required by Regulation FD. Issuers can meet this requirement either by filing a Form 8-K with the SEC or by disseminating information through any other method of disclosure that is reasonably designed to provide broad, non-exclusionary distribution of the information to the public. Generally, press releases distributed through a widely circulated news or wire service, or announcements made through press conferences or conference calls that may be attended or accessed by interested members of the public, and other electronic means of transmission (including broadcasting over the Internet) will satisfy the "public disclosure" requirement of Regulation FD so long as the public is given adequate notice of the transmission. The SEC suggests the following model for planned disclosures of material information:

1. issue a press release, distributed through regular channels, containing the information,
2. provide adequate notice, through a press release and/or website posting, of a scheduled conference call to discuss the information, giving investors the time and date of the call, as well as instructions on how to access the call, and
3. hold the conference call in an open manner, permitting investors to listen either via telephone or the Internet.

Regulation FD clearly states that it does not create liability for fraud solely as a result of a selective disclosure violation, nor will a company which violates the rule be exposed to lawsuits from the investing public under Regulation FD. When the Regulation is violated, the SEC could bring an administrative proceeding seeking a cease and desist order or a civil action seeking an injunction or other civil penalties. Any misstatements in public disclosures made pursuant to Regulation FD would subject the company to civil liability.

The rule does not contain any explicit definition of materiality. Traditional materiality concepts will apply, so that information will be considered to be material and thus subject to the rule if there is a substantial likelihood that a reasonable shareholder would consider it important, or if it would significantly alter the total mix of information made available. The SEC has laid out the following as examples of types of information or events that should be reviewed carefully to determine whether they are material:

1. earnings information,
2. mergers, acquisitions, tender offers, joint ventures or changes in assets,
3. new products or discoveries or developments regarding customers or suppliers,
4. changes in control or management,
5. changes in auditors or notification that the issuer may no longer rely on the auditor’s report,
6. events regarding the issuer’s securities, and
7. bankruptcies or receiverships.

The SEC release proposing Regulation FD makes the point that the practice of non-publicly giving guidance or express warnings to analysts or selected investors about upcoming earnings or sales figures, including whether the company’s anticipated earnings will be higher than, lower than or the same as analysts’ forecasts, would be likely to violate Regulation FD. Such information, in the SEC’s view, will frequently have a significant impact on the company’s stock price, and thus should be viewed as material.

Clarification of Existing Rules on Insider Trading

The release which announced the adoption of Regulation FD also announced the adoption of two new rules under Section 10(b) of the Exchange Act: Rules 10b5-1 and 10b5-2. These new rules clarify two issues in current insider trading law on which various courts have disagreed.

Rule 10b5-1 provides that insider trading liability will generally attach whenever a defendant trades when aware of material nonpublic information acquired by misappropriation or in breach of a fiduciary duty, without proof that the information was actually used in the trade. The rule also sets forth several affirmative defenses or exceptions to liability which permit individuals to trade in certain specified circumstances where it is clear that the information of which they are aware is not a factor in the decision to trade. Examples of these circumstances include trades made pursuant to a pre-existing plan, contract or instruction that was made in good faith.

Rule 10b5-2 clarifies what types of family and other non-business relationships can give rise to liability under the misappropriation theory of insider trading. The misappropriation theory’s application is most clear in cases involving misappropriation of confidential information in breach of an established business relationship, such as lawyer-client or employer-employee. Under this new rule, family members and others having a non-business relationship with a provider of inside information would owe a duty of trust and confidence, and thus would be liable under the misappropriation theory when:

1. the person agreed to keep the information confidential;
2. the person involved in the communication had a history, pattern, or practice of sharing confidences that resulted in a reasonable expectation of privacy, or

the person who provided the information was a spouse, parent, child or sibling of the person who received the information, unless it is shown affirmatively, based on the facts and circumstances of that family relationship, that there was no reasonable expectation of privacy.