As of Monday, October 17, 2005     

Five Years Later

Critics felt Regulation FD would choke off the flow of corporate information. Here's why it didn't happen.
October 17, 2005; Page R8

The Securities and Exchange Commission's Regulation FD, mandating equal disclosure of corporate information, is now a healthy, almost-five-year-old, but like a lot of youngsters, it has gone through a few growing pains.

Reg FD, for "fair disclosure," took effect five years ago next week, barring companies from selectively tipping off analysts and large investors about important information like earnings forecasts. The information had to be disclosed publicly, to everyone, or not at all. At the time, the rule caused much gnashing of teeth by companies and analysts, who feared the push for a level playing field would instead choke off the flow of corporate information -- companies would be so nervous of running afoul of the SEC, the thinking went, that it would be safest to disclose as little as possible.

By and large, many observers agree, those fears haven't been realized. Some concerns have proved overblown, while companies have adapted to others. Along the way, Reg FD has changed the landscape of how companies give out information and how investors and analysts get and use it: It has improved access to information for small investors, prompted companies to give out more information and improve their processes for disseminating it, and forced analysts to try some new tricks now that they no longer have an information advantage. It has led to a flurry of changes, from an explosion in public access to corporate conference calls to attempts by analysts to read executives' body language and tone when they deliver a forecast.

"My assessment after five years is that FD has worked very well," says Louis Thompson, president and chief executive of the National Investor Relations Institute, or NIRI, a group of corporate investor-relations officers.

Still, there are lingering questions, many prompted by a recent court ruling, about how far FD will or should extend, and how far the SEC will go in enforcing it. And some observers, even supporters of FD, are concerned that the goal of a level playing field for everyone has "dumbed down" the information companies disclose to the point where it isn't as detailed as it once was or should be.

"You have to talk differently when you're talking to the public," says Stephen Poss, who chairs the securities-litigation and SEC-enforcement practice at Boston law firm Goodwin Procter. Privately distributed but highly detailed information has been replaced by more public but less detailed "and potentially less useful" information, he says.

Information for All

Reg FD came about when it became clear that companies were doling out tidbits of important information to favored insiders like analysts and money managers -- often prompting stock prices to move, when small investors had no idea why. That undermined the integrity of the market and put small investors at a disadvantage, the SEC said. Under FD, companies had to tell their information to the world, in a news release, SEC filing or other public forum. If they issued information selectively by mistake -- by giving out new information in a private meeting with an analyst, say -- they had to make it right quickly, by publicly disclosing the information.

Regulation FD is the Securities and Exchange Commission's five-year-old rule requiring equal disclosure of significant corporate information to all investors. Key provisions of the rule:
 When a company discloses material, nonpublic information to Wall Street professionals like analysts and large institutional investors, it must disclose the information publicly at the same time.
 Companies may meet the public-disclosure requirement by making an SEC filing, issuing a press release or disclosing the information during a conference call, presentation or other event accessible to the public.
 If a company accidentally discloses information selectively, it must make the information public promptly, generally within 24 hours.
Source: WSJ reporting

Many companies fretted about the potential consequences of FD. It would curtail private meetings with analysts, they complained; they'd constantly live in fear of saying the wrong thing and bringing an SEC lawsuit down on them. But they did make the changes, and now they're used to it. And the SEC, which had insisted all along it would go after only clear-cut violations of Reg FD, has brought only seven enforcement cases under the regulation in nearly five years.

"Over time, [companies] have actually learned to live with it in a way that has surprised a number of people," Mr. Poss says.

One big change is that corporate conference calls, formerly the province of analysts and major investors, have been thrown wide open. Most are now Webcast online for all investors to hear, a move which all by itself has greatly increased small investors' access to information.

Biomet Inc., a Warsaw, Ind., medical-products business, is one company that started preannouncing and Webcasting its quarterly conference calls because of Reg FD. "It certainly has had lasting effects on our disclosure policies as well as all public companies'," says Dan Hann, Biomet's senior vice president and general counsel.

Many companies have also formalized and centralized how they disseminate information -- to come up with an official policy about disclosure and authorize a limited number of people to speak for the company. There's less chance of a goof under Reg FD that way. "A lot of times [before FD], companies did not even have disclosure policies," says the NIRI's Mr. Thompson.

"Investor relations is no longer considered a clerical function, it's a policy function," adds Bill Sherman, a securities lawyer with Morrison & Foerster in Palo Alto, Calif.

When FD took effect, for example, Merrill Lynch & Co. implemented a new policy that authorized only certain senior executives and investor-relations staff to discuss important information about the company with analysts. Merrill officials had no comment.

Companies Keep Talking

And there are indications that despite companies' fears, the flow of information hasn't been curtailed. Surveys by the NIRl have found that 97% of companies still hold one-on-one meetings or small-group sessions with analysts and investors, despite concerns that such meetings would dry up under FD because they'd be seen as either risky or irrelevant. According to the NIRI, 71% of companies still provide earnings guidance -- a number that's down from 79% in 2001, the year after FD took effect, but that's seen as having more to do with increased earnings volatility and the resulting difficulty in forecasting earnings than with Reg FD.

"I don't think anything remotely like the worst fears have been realized," says David Becker, a partner at the Washington law firm of Cleary Gottlieb Steen & Hamilton and a former SEC general counsel. "I don't think companies are withholding information investors want because of FD."

Still, a significant minority feels that while companies may be releasing more information in the wake of FD, the quality of the information may have suffered. In a 2003 survey by the Association for Investment Management and Research -- now the CFA Institute -- only 45% of members surveyed gave companies a grade of "A" or "B" on the quality of information they disclosed, down from 61% in 1999.

Ashok Kumar, a semiconductor analyst from Raymond James, says companies are releasing "probably more" information because of Reg FD. "I'm not sure necessarily it's better," he adds.

Into the Field

As for analysts, they've gone in two different directions. Some simply take a company's public guidance and repackage it, the same way they did when it was in the form of private advance tipoffs.

But the better analysts, market-watchers say, are returning to some of the practices they used many years ago, before companies started spooning out guidance to them in advance of the rest of the market. They're getting out into the field, talking to customers and suppliers, gathering their own information and crunching their own numbers to inform their analysis, instead of simply relying on the company's latest earnings target.

"You have to do your homework," says Mr. Sherman, the Morrison & Foerster lawyer. With everyone getting the same information from the companies, he says, those analysts and investors who are best prepared will be best able to act on and benefit from the same information everyone is getting. "You've got to be smarter about the same information and quicker about trading on it."

Dick Bove, a banking analyst with Punk Ziegel & Co., says he spends "a lot less time with management" than he used to, and more time analyzing industry trends and data. "There's far more value in financial statements than in talking to management," he says. "I find it much more helpful to know what the shape of the yield curve is."

Some analysts and money managers have even taken to trying to decipher nonverbal cues given off by corporate executives. Reg FD prohibits the proverbial conscious "wink and a nod" by executives to convey information, but there's nothing to prevent company watchers from trying to read significance into executives' body language or the tone of their voice as they deliver an earnings forecast.

"That's what gives you the edge," Mr. Kumar adds. If an analyst is familiar with the way an executive typically behaves, "you can always measure any deviation from that normal behavior."

Not everyone has so sanguine a view of trying to analyze unspoken tip-offs. "It's absurd," Mr. Thompson says. "I've had some of my people say they've had a cold and had the [analyst] say, 'Well, you don't sound like you usually do.' "

In addition to the continuing concerns about the quality of the information flow, this year two SEC enforcement cases under Reg FD have raised issues about the rule's scope.

One poses the question of when a company's reaffirmation of previous financial guidance becomes material, new information itself. In March, the SEC settled a Reg FD case against Irving, Texas-based Flowserve Corp. and two of its executives over allegations that they had violated the rule in a private meeting with analysts in November 2002 by reaffirming guidance that they issued about a month before. The SEC's rationale was that by reaffirming guidance too late in a reporting period -- Flowserve's actions came only 42 days before the end of the quarter and year -- a company may essentially provide information about how it actually performed during that period, and that constitutes new, material information that should be disclosed to everyone if it's disclosed at all.

But Mr. Thompson says the effect will be to discourage companies from reaffirming existing guidance under any circumstances, unless they do it publicly. "Nobody wants to take a chance," he adds.

The other case, involving Siebel Systems Inc., of San Mateo, Calif., was the first instance in which a company contested an SEC enforcement case under Reg FD and resulted in the rule's first major court test -- a test that did not go well for the commission.

In September, a federal judge threw out an SEC lawsuit against Siebel that had alleged the company violated Reg FD in private comments it made to investors in 2003. The judge agreed with Siebel's contention that the comments essentially did nothing but repeat what the company had previously said publicly; he also said the SEC was being too aggressive in parsing and dissecting Siebel's statements, and that "places an unreasonable burden on a company's management and spokespersons to become linguistic experts" in order to avoid violating Reg FD.

Analysts and investors don't expect the ruling to have much effect on how companies disseminate information, however, especially since the judge left the regulation itself in place -- he ruled on the basis of facts specific to the Siebel case, and didn't address Siebel's larger arguments that the rule itself is unconstitutional.

"I think most executives have accepted FD as a pretty good way of doing business," says Arthur Levitt, who championed FD when he was SEC chairman. The ruling, he says, "leaves the principles of FD pretty much intact."

Mr. Thompson thinks the ruling might at least prompt companies to relax a bit, instead of constantly looking over their shoulder and worrying they're going to say the wrong thing in a one-on-one discussion with an analyst. "It does give investor-relations people and whoever else is speaking for companies a little more flexibility," Mr. Thompson says.

A Chastened SEC?

The most noteworthy effect of the ruling may be on the SEC, which might be prompted to set the bar higher when deciding whether to bring a Reg FD enforcement case. That would be too bad, says Jill Fisch, a Fordham University law professor who was among a group of securities-law experts who filed a friend-of-the-court brief in the Siebel case supporting the SEC.

"I am concerned the SEC will feel the court has slapped it down and will feel more reluctant to enforce the regulation, and ultimately that's going have an effect on corporate conduct," she says.

Still, Mr. Poss cautions against any company thinking that the ruling gives it license to start giving out information selectively to favored insiders once again.

"The SEC, in order to vindicate itself, is liable to be looking for a new test case, a new example," Mr. Poss says. "And you don't want to be that example."

--Mr. Rapoport is a special writer for Dow Jones Newswires in Jersey City, N.J.

Write to Michael Rapoport at