SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Release No. 46898 / November 25, 2002
Report of Investigation Pursuant to Section 21(a)
of the Securities Exchange Act of 1934:
The Division of Enforcement has conducted an investigation into whether Motorola, Inc. ("Motorola") violated the federal securities laws when one of its senior officials selectively disclosed information about the company's quarterly sales and orders during private telephone calls with sell-side analysts in March 2001. During those calls, Motorola's Director of Investor Relations (the "IR Director") told analysts that first quarter sales and orders were down by at least 25%. Previously, in a February 23, 2001 press release and a public conference call, Motorola had said only that sales and orders were experiencing "significant weakness" and that Motorola was likely to miss its earnings estimates of 12 cents per share for the quarter and have an operating loss for the quarter if the order pattern continued. Motorola decided to telephone the analysts and tell them that "significant," as used on February 23, meant a "25% or more" decline because the IR Director had seen the analysts' models and research notes and concluded that the analysts had not understood from the February 23 conference call just how disappointing the results were for the quarter. Motorola specifically decided not to issue a new press release or otherwise make any timely public disclosure of this additional information.
The conduct in question was inconsistent with the disclosure mandate of Regulation FD, which generally prohibits issuers from communicating material, nonpublic information to securities professionals without simultaneous public disclosure of the same information. We issue this Report of Investigation ("Report") pursuant to Section 21(a) of the Securities Exchange Act of 1934 ("Exchange Act")1 to provide guidance concerning Regulation FD and to highlight conduct that we believe the regulation was specifically intended to prevent. When an issuer endeavors to make public disclosure of material information -- but later learns that it did not, in fact, fully communicate the intended message, and determines that further disclosure is needed -- the proper course of action under Regulation FD is not to selectively disclose the corrected message in private communications with industry professionals, but rather to make additional public disclosure.
Here, before engaging in the conduct in question, Motorola officials sought the advice of in-house legal counsel. Counsel approved the conduct in question based on a determination that the information in question was not material or nonpublic. Counsel's determination was erroneous in both respects. Nevertheless, because it appears that counsel's advice was sought and given in good faith, and in light of the surrounding facts and circumstances, we are issuing this Report rather than bringing an enforcement action against Motorola or its senior officials.
Motorola is a Delaware corporation headquartered in Shaumburg, Illinois. The company manufactures and sells electronic and telecommunications equipment and components. Motorola derives more than 50% of its total revenues from its Personal Communications Segment ("PCS") and its Semiconductor Product Segment ("Semiconductors"), which manufacture and sell, among other things, wireless and digital radio telephones, paging and messaging devices, personal two-way radios, and semiconductors. The company's common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and trades on the New York and Chicago Stock Exchanges.
b. Motorola's Public Announcements
On January 11, 2001, Motorola held a scheduled analyst conference call, during which company officials discussed Motorola's fourth-quarter 2000 results and estimated first quarter 2001 sales at $8.8 billion and earnings at 12 cents per share. The conference call was webcast live, and a transcript of the call was posted on Motorola's website.
On February 23, 2001, however, Motorola issued a press release (the "February 23 Release") stating that "as a result of significant weakness in first-quarter order input across its business segments, the company does not expect to achieve the first-quarter 2001 sales guidance of $8.8 billion or the earnings guidance of 12 cents per share given on Jan. 11, 2001." Later the same morning, during a live, webcast analyst conference call (the "February 23 Call"), Motorola's President and Chief Operating Officer explained that Motorola's PCS was "experiencing significant weakness in orders and sales versus our expectations at the beginning of the quarter." He also stated that Semiconductors was "experiencing lower sales and significantly lower orders. All markets are down compared with the same period last year." Motorola did not define the terms "significant," "significantly," and "down" in the February 23 Release or on the February 23 Call and never indicated that it was using those terms in a specific manner or to convey particular quantitative information.
c. Direct Communications With Analysts
Following the February 23 announcements, most analysts who cover Motorola lowered their estimates. Nevertheless, after reviewing the analysts' models and research notes, the IR Director concluded that the analysts still were overstating Motorola's likely quarterly results. As a result, between March 6 and 12, 2001, the IR Director directly contacted approximately fifteen analysts to discuss their models. On these calls, the IR Director reiterated and verbally emphasized particular statements from the February 23 Release and the February 23 Call, such as the term "significant." On at least ten calls, the IR Director specifically told analysts that when Motorola uses the terms "significant" or "significantly" it intends a rate of change of 25% or more. The IR Director provided these definitions while discussing specific numbers in the analysts' models. All of the analysts directly contacted by the IR Director revised their models following the calls.2 An example of a telephone conversation between the IR Director and an analyst is detailed in Appendix A hereof.
d. Motorola's Reliance on Counsel
Prior to making the phone calls to analysts, the IR Director sought and obtained the advice of Motorola's in-house legal counsel responsible for SEC reporting and disclosure issues. Counsel specifically advised the IR Director that he could contact selected analysts, reiterate the information that had been disclosed on February 23, and provide quantitative definitions for certain qualitative terms that had been used in the February 23 announcements. Counsel based that legal advice on the conclusion that providing a quantitative definition for the term "significant" was not material. Counsel also concluded that Motorola's particular definition of the word "significant" was public for Regulation FD purposes.3
* * *
Ultimately, certain Motorola officials harbored a mistaken belief that Regulation FD allowed them to communicate quantitative details just to analysts. The IR Director testified that Motorola's use of qualitative terms to convey quantitative information was
quite familiar to the sell side and to the buy side, and that our longstanding view was that it was the sell side's responsibility to communicate information, to act as the vehicle for communicating information from the company to many investors. And that as long as they understood what we were saying, it was their role in this process to communicate that information to the general public at large. That was the thought pattern going back quite a number of years in terms of how the company chose to use th[e] adjective [significant].
That view, which contemplates the selective disclosure of information, is plainly contrary to the mandate of Regulation FD, where the relevant information is material.
Regulation FD prohibits issuers with a class of securities registered under Section 12 or required to file reports under Section 15(d) of the Exchange Act,4 from selectively disclosing material nonpublic information to securities professionals. Regulation FD generally provides that when an issuer, or person acting on its behalf, discloses material nonpublic information to certain enumerated persons (in general, securities market professionals and holders of the issuer's securities who may well trade on the basis of the information), it must make public disclosure of that information, simultaneously for intentional disclosures, or promptly for non-intentional disclosures.5
Motorola selectively disclosed material nonpublic information covered by Regulation FD when the IR Director told analysts during private telephone calls in March 2001 that Motorola's sales and orders were off by 25% or more for the first quarter of 2001.6
In reaching this conclusion, we make the following observations:
1. The information selectively disclosed by Motorola clearly was material. Although the Commission has stated that "issuers will not be second-guessed on close materiality judgments,"7 we believe that the information conveyed in the IR Director's telephone calls to analysts clearly was material. There is a substantial likelihood that a reasonable investor would consider it important that Motorola's sales and orders were down by 25% or more for the quarter even though the company already had explained that sales and orders were experiencing "significant weakness."8 Counsel erred in concluding that the IR Director would not be communicating material nonpublic information by providing a quantitative definition for the term "significant." Counsel testified that the term significant means "very large," which, in counsel's view, was no different from saying "25% or more." This mechanical approach, however, failed to take into account the relevant circumstances of this situation. Most notably, this type of language parsing failed to consider the context of what the IR Director was planning to do, or why he was planning to do it. The fact that the IR Director believed it necessary to call analysts to guide them to a "25% or more" conclusion demonstrates that, regardless of what Motorola originally intended to communicate by the term "significant weakness," the IR Director subsequently discovered that it had not been understood to mean "25% or more." Similarly, the IR Director's plan to call analysts seriatim demonstrated that he considered it quite important to communicate this specific quantitative figure, at this level of detail, to those analysts. As such, these circumstances demonstrate - and should have demonstrated to counsel - that the specific quantitative figure was important information that had not previously been made public.9
2. Senior officials of issuers should be particularly cautious during private conversations with analysts. Although Regulation FD does not prohibit private discussions between investor relations officers and analysts, it does prohibit the communication of material, nonpublic information during those discussions. The Adopting Release underscored that selective disclosure of corporate earnings, in particular, during private conversations will likely violate Regulation FD. Moreover, this is not a case where the topic came up unexpectedly during a discussion with an analyst about other issues. The IR Director deliberately initiated a series of telephone calls to analysts specifically to bring this information to their attention.
3. After-the-fact private communications of material, nonpublic information to securities professionals are not a proper way to supplement a prior public disclosure that the issuer determines to have been misunderstood or misinterpreted. We adopted Regulation FD out of concern that issuers were "disclosing important nonpublic information, such as advance warnings of earnings results, to securities analysts or selected institutional investors or both, before making full disclosure of the same information to the general public."10 If an issuer becomes aware, as Motorola did here, that information it is trying to convey to the public has not in fact been conveyed, and the issuer determines that further disclosure is necessary, the proper course of action under Regulation FD is to make additional public disclosure. We are particularly troubled that in this case, after Motorola knew that even securities professionals had failed to understand the message Motorola purportedly was trying to convey, the company chose to contact selected analysts only, rather than make broad public disclosure.
4. When communicating with securities industry professionals, issuers may not use "code" words to selectively disclose information that they could not selectively disclose expressly. Issuers may not evade the public disclosure requirements of Regulation FD by using "code" words or "winks and nods" to convey material nonpublic information during private conversations.11 What is particularly troubling about this case is that Motorola communicated to the public using general terms such as "significant," and then engaged in private discussions with analysts to provide a more detailed quantitative definition of the code word "significant."
5. In issuing this Report rather than commencing a formal enforcement action, we are crediting Motorola's reliance on counsel in the context of this case concerning Regulation FD issues because we understand that legal advice was sought and given in good faith. We encourage honest, carefully considered attempts to comply with Regulation FD. In this case, it appears that Motorola acted based on advice of counsel that, although erroneous, was sought and given in good faith. We caution, however, that reliance on counsel will not necessarily provide a successful defense in all future cases. The availability of any reliance on counsel argument turns on all the facts and circumstances of the case. Clearly, in cases where relevant facts are concealed from counsel, or where counsel's advice was not faithfully given and followed, there will not be a valid reliance on counsel argument.12
In addition, in a case where the officer knows that the information to be selectively disclosed would be important to the reasonable investor, he or she cannot seek out and rely on counsel's consent as a shield against liability. In many cases, an issuer's chief financial officer or investor relations officer may have a keener awareness than company counsel of the significance of information to investors. Consultation with counsel will not relieve the officer from responsibility for disclosure of information that he or she personally knows, or is reckless in not knowing, is material and nonpublic.13
Finally, in concluding that Motorola should not be the subject of a formal enforcement action, we also note that, having now issued this Report, we would be less likely in future cases to credit reliance on counsel for the advice rendered here.
We issue this Report to remind issuers of their obligations under Regulation FD not to selectively disclose material and nonpublic information to securities professionals. In this case Motorola's IR Director communicated material nonpublic information to selected analysts when he quantified earnings information that had been previously disclosed only in vague qualitative terms. This type of selective communication is inconsistent with the disclosure mandate of Regulation FD.
By the Commission (Chairman Pitt, Commissioner Glassman, Commissioner Goldschmid, Commissioner Atkins, Commissioner Campos).
The following is a partial transcript of a telephone conversation between the IR Director ("IRD") and an analyst ("A") at a major financial institution, and a summary of the actions the analyst took to revise his model following the call:
IRD: I want to review for you the things that we said on that conference call. I've had conversations with a number of analysts over the last several days to review things we said on that conference call because I don't believe that in your case, or in the case of some other people, you've adequately taken into account the things that we've said.
IRD: Let me begin by reminding you what our guidance was at the beginning of the quarter. At the beginning of the quarter we guided people toward $8.8 billion in sales.
A: Yes, yes.
IRD: And earnings per share of 12 cents.
A: I remember, yes.
IRD: Right. Now your current model is showing sales of $8.375 billion.
IRD: So it's only a 5% decline from our original guidance.
A: Correct. Yes.
IRD: Now I think the things that we said segment-by-segment would indicate a much larger level of decline than that.
IRD: Let's review them. All right. In our Personal Communications Segment, in January we gave guidance that that segment would have lower sales and operating profits than the first quarter of 2000.
IRD: And lower than in the fourth quarter of 2000.
IRD: All right. Two weeks ago we said that orders and sales in this segment were expected to be significantly lower than the guidance at the beginning of the quarter.
IRD: So what was already a down quarter should have been dropped significantly further.
IRD: Now when Motorola uses the word significantly, maybe you're not familiar with this, but it's a longstanding approach that we have, we are referring to a rate of change of 25% or more.
IRD: Okay so.
A: From the guidance down.
IRD: From the guidance at the beginning of the quarter which was already lower than the guidance from the year before. So your model for that segment is - and let me go to that right now - your model for that segment is showing 2 billion 830 million, that's only down twelve and one half percent.
IRD: Okay. So there's one place right away where your sales assumption is more optimistic than we indicated it should be two weeks ago.
A: Thank you.
Following the call, the analyst published an updated research note and model that accounted for the definition of "significantly" that he had learned from the IR Director. In particular, the analyst lowered his PCS revenues from $2.830 billion, a decline of 12.5% year-over-year, to $2.330 billion, a decline of 28% year-over-year.14
|| Section 21(a) of the Exchange Act authorizes the Commission to investigate violations of the federal securities laws and, in its discretion, to "publish information concerning any such violations." This Report does not constitute an adjudication of any fact or issue addressed herein. Motorola has consented to the issuance of this Report without admitting or denying any of the statements or conclusions herein.|
|| Between March 6 and March 12 - the period of the phone calls at issue - the price of Motorola stock declined from $17.70 to $15.00, a drop of more than 15%. There were also significant increases in trading volume of Motorola stock at most of the firms where analysts were contacted.|
|| Counsel based that conclusion on three factors: (1) Motorola had purportedly used the term "significant" to convey a rate of change of 25% or more for a long time and the usage was generally "out there;" (2) Motorola representatives had, on a couple of occasions, stated in response to analyst questions on earlier conference calls that when Motorola used the term "significant" it "generally" meant to indicate a rate of change of 25% or more; and (3) Motorola had periodically defined the term in so-called "Order Detail" documents. These factors, however, should not have caused counsel to conclude that Motorola's usage of "significant" was public. The IR Director himself conceded that the ordinary investor would have no way of recognizing that Motorola used the term to convey particular quantitative information. The response of analysts to the February 23 announcements reveals that they also did not understand the quantitative meaning that Motorola purported to place on the term "significant." Moreover, Motorola's "Order Detail" document did not publicly disclose any general usage by Motorola of the term "significant." Order Details are one-to-two page summaries issued quarterly by Motorola to outline orders received by the company's various business segments. Since the second quarter of 1999, the quarterly Order Details have used the term "significant" and contained a footnote defining that term to mean a rate of change of 25% of more. The Order Detail, however, is a stand-alone document: it is not contained in or incorporated by reference in any of Motorola's press releases, earnings reports, conference calls, or public filings. There is nothing in the Order Detail that indicates that its definitions might apply in other contexts. Neither the February 23 Release nor the February 23 Call made any mention of the Order Detail. |
|| Rule 101(b)17 C.F.R. § 243.101(b) (defining "issuer").|
|| 17 C.F.R. § 243.100. Final Rule: Selective Disclosure and Insider Trading, Exchange Act Release No. 34-43154, 65 Fed. Reg. 51,716 (Aug. 15, 2000) ("Adopting Release").
|| Regulation FD applies to communications by investor relations officers, such as the IR Director, to securities professionals such as sell-side analysts ( Rules 100(b)(1)(i)17 C.F.R. § 243.100(b)(1)(i) (defining covered recipients to include brokers, dealers, or persons associated with a broker or dealer), 101(c)17 C.F.R. § 243.101(c) (defining "person acting on behalf of an issuer"), and 101(f)17 C.F.R. § 243.101(f) (defining "senior official")). A selective disclosure of nonpublic information is "intentional" when the person making the disclosure knows, or is reckless in not knowing, that the information he is communicating is both "material" and "nonpublic" ( Rule 101(a)17 C.F.R. § 243.101(a)).|
|| Adopting Release at 51,718. Adopting Release at 51,736 ("a reasonable, but mistaken, determination that information was not material will not be second-guessed").|
|| Information is material under Regulation FD if there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision and if the information would significantly alter the total mix of available information. , 485 U.S. 224, 231-32 (1988); , 426 U.S. 438, 449 (1976).|
|| Further confirming evidence is provided by the fact that the analysts contacted changed their models, and by the contemporaneous price and volume changes discussed at n. 2. |
|| Adopting Release at 51,716.|
|| Adopting Release at 51,721 (warning against the selective disclosure of earnings information during private conversations with analysts "whether the information about earnings is communicated expressly or through indirect guidance,' the meaning of which is apparent though implied"). |
|| We note further that in some cases counsel's advice may provide the officer with a good faith basis for making the disclosure at the time the advice is received, but the officer later learns additional information that puts him or her on notice that the information being disclosed is material and nonpublic, notwithstanding counsel's prior advice. For example, after making a selective disclosure that he or she believes in good faith is not material, an officer may become aware of a very significant market reaction and may learn facts indicating that this reaction was a result of the selective disclosure. At that point, even though the officer's original selective disclosure was not intentional, the issuer has learned that it has made a non-intentional selective disclosure and must make the prompt public disclosure required by Regulation FD. 17 C.F.R. 243.100(a)(2) and 243.101(d). Moreover, if the issuer makes any additional selective disclosures of the information thereafter, these disclosures would be intentional under the Regulation. |
|| In particular, if consultation with counsel merely results in counsel reciting the legal standard for materiality and asking the chief financial officer's or investor relations officer's opinion whether a reasonable investor would consider the information significant, then the resulting judgment is really the company officer's, not counsel's. In addition, in some cases the conduct of the company officer may provide sufficient evidence that, notwithstanding the asserted reliance on counsel, the officer knew, or was reckless in not knowing, that investors and securities analysts did in fact consider the information material.|
|| Year-over-year refers to a change from the actual revenues for the same quarter of the previous fiscal year.|