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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks Before the Rocky Mountain Securities Conference


Richard H. Walker

Director, Division of Enforcement,
U.S. Securities & Exchange Commission

Denver, Colorado

May 18, 2001

The SEC, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or the staff of the Commission.

Good afternoon, and thank you, Randy, for your kind introduction. It's a pleasure to be here with you at this Conference again this year. I've always been a big supporter of the Rocky Mountain Securities Conference. This Conference provides an excellent opportunity for SEC staff to update you on current developments at the Commission – to deliver our message first hand – and to hear from you as well. The level of interest in, and participation at, this Conference is evidence of the robust and sophisticated securities bar that continues to flourish here.

This gathering also provides a much-needed opportunity for a reality check for those of us traveling here from Washington, DC. I have no doubt that many of you, like I, have scratched your heads over happenings in Washington. At times, folks in the District become consumed with issues and concerns that the rest of the country has the good sense to quickly shrug off and move on.

I thought that the topic of my remarks today – our new Regulation FD – might be the latest manifestation of Washington myopia. In fact, when I suggested to Randy Fons that I would like to discuss Regulation FD here today, he cautioned me that there had not been much discernible interest in the topic. I must say that Randy's cautionary warning surprised me. On the East Coast, there have been dozens of programs, conferences, seminars, and, just yesterday, a Congressional hearing, devoted exclusively to the subject of Regulation FD. If anything, I thought we might have reached the saturation point on the subject. In light of Randy's concern, I considered very carefully whether the furor over FD was more apparent than real and whether I should pick a different topic. After further thought, I decided to stick to Reg FD. I reached this conclusion because Regulation FD affects so many different constituents of this thriving business community, including companies based here, attorneys, securities professionals, institutional investors, and, of course, individual investors as well – probably everyone in this room.

And so I would like to share with you some of my views, and they are only my views and not necessarily those of the Commission or its staff, on the continuing debate about Regulation FD. In particular, after recapping a bit of the history underlying the rule's adoption, I will focus on two topics: one, initial efforts to evaluate Regulation FD's impact to date, and two, my evolving perspective on enforcement of Regulation FD.

Background of Regulation FD

As you likely are aware, the Commission adopted Regulation FD less than a year ago, in August 2000. Its adoption followed a notice and comment period during which the Commission solicited the views of a wide range of parties who would be affected by the proposed rule, including issuers, Wall Street firms, investors, attorneys, and the media. Individual investors expressed overwhelming and unprecedented support for the proposal in the form of almost 6,000 comment letters urging its adoption. Nevertheless, in light of responsible comments from many issuers and securities firms, the Commission adopted a substantially narrower rule than it had proposed. The rule in place today was tailored to minimize, if not eliminate, the ill effects that FD's critics predicted would befall us upon FD's adoption.

This slimmed down version of the rule was carefully crafted to abolish the common issuer practice of selectively disclosing material nonpublic information to favored analysts and institutional shareholders, while leaving unaffected other types of issuer communications. Under the rule, in general, if an issuer makes an intentional disclosure of material nonpublic information to securities professionals or to shareholders when it is reasonably foreseeable that they would trade on the information, the issuer must simultaneously disclose that information to the public. An issuer's ordinary-course business communications – for example, to customers and suppliers – and its communications with the press are outside the scope of Regulation FD, as are communications made in connection with most registered public offerings. In addition, Regulation FD is a disclosure rule, not an antifraud rule. Accordingly, a violation of Reg FD does not provide the basis for an action – by the Commission or by private plaintiffs – under Rule 10b-5 of the Exchange Act. Indeed, there is no private right of action under Reg FD.

Though simple on its face, Regulation FD is, at the same time, arguably one of the most significant rules in the Commission's history. In the world of issuer/analyst communications, it has led to historic changes. Regulation FD takes aim at a deeply entrenched Wall Street practice that traditionally enabled analysts to obtain sensitive information from issuers – information which could be passed on to paying clients of the analysts – before such information was made available to the rest of the investing public. At the same time, selective disclosure provided issuers a mechanism to manage analysts', and thus, indirectly the market's, expectations concerning their stocks' performance. This practice disadvantaged the individual investor who was typically not a recipient of selectively disclosed information, and eroded confidence in the fairness of our markets.

In addition to the fundamental unfairness worked by such an arrangement, selective disclosure may have had other ill effects. For example, it may have caused issuers to keep sensitive information nonpublic longer – thus preserving its value to analysts. The promise of selective disclosure – or more accurately, the threat of its unavailability – may also have caused analysts to refrain from publishing negative research reports in order to maintain their access to such information.

If there is one point on which there appears to be almost unanimous agreement, both before and after adoption of Regulation FD, it is that ending selective disclosure is an appropriate, even imperative, goal. There appears to be little agreement, however, on anything else having to do with Reg FD.

Given that the goal of Regulation FD is almost universally accepted as beneficial, why do some parties continue to voice such fierce opposition to the rule? I think the answer is relatively simple. Anytime a regulator seeks to uproot a longstanding practice that benefits powerful constituencies, that regulator is in for a fight. This is so even where, as here, the rule in question leaves issuers with unfettered discretion to disclose whatever they choose, subject to existing disclosure requirements. While Regulation FD undeniably works a significant change in practice, it places no new disclosure obligations on issuers. Unlike most Commission disclosure rules, Regulation FD does not require an issuer to make known any new item of information, detail of its operations, anticipated event, or emerging risk factor. Regulation FD merely directs that when an issuer itself elects to disclose material nonpublic information, it make that disclosure publicly, not selectively.

The Rush to Judge Regulation FD

In the almost seven months since Reg FD went into effect, there has been intense interest in the rule and a lively debate concerning how it is being implemented, how issuers are adjusting to it, its effects on analysts, and numerous other aspects of the transition process. There has been a virtual stampede to declare it a success or a failure, much like the networks' efforts to project a winner in a presidential election even before the polls have closed. Parties on all sides of the debate are rushing to publish studies, surveys, and purportedly objective analyses of FD, perhaps in the belief that whoever speaks first will gain an advantage in controlling future debate. One analysis of the rule, which itself consists of a few short pages, runs almost 70 pages in length and dissects the rule almost word by word.

In one sense the results of the surveys released to date are not surprising. Surveys sponsored by organizations that opposed the rule reveal more negative effects than positive effects. Surveys sponsored by other organizations tend to reveal just the opposite. Most of the surveys to date are hampered by small sample sizes and general questions designed to elicit opinions rather than empirical facts. Further, extreme market conditions and changing disclosure practices surely have confounded the ability of survey respondents to separate cause from effect.

These limitations have resulted in dramatically conflicting findings. On any number of points, different surveys reach opposite conclusions. For instance, a survey by Thomson Financial/Carson found that 22% of issuers felt their stock had become more volatile since adoption of FD. The Association for Investment Management and Research (AIMR), on the other hand, reported that 71% of analysts thought FD had contributed to market volatility at least a little.

In another example, a survey by PricewaterhouseCoopers (PwC) found that 57% of respondents have not incurred any incremental compliance costs in connection with Regulation FD. Of the 43% who have incurred such costs, 90% reported that the costs were moderate or low. In contrast, a study by the Securities Industry Association (SIA) finds that Regulation FD imposes "significant costs . . . well in excess of those originally estimated by the SEC."

So which is it – a costly rule contributing to volatility, or a low-cost rule that has no impact on volatility? My own views are pretty clear: there's simply no credible evidence at this point to tie volatility in the markets to Regulation FD. Nevertheless, the surveys suggest that at least some people, particularly analysts, believe there is a correlation between the two.

Let me give you some additional examples of what I'll call the survey swamp. Thompson's, PwC's, and NIRI's surveys report that under Regulation FD most issuers are providing the same or more public disclosure of material information as they did before FD was adopted. But the SIA asserts, based on its study, that "Reg. FD has a 'chilling effect' on the quantity of information disseminated by certain issuers."

As a final example, 74% of NIRI's respondents reported conducting the same number of one-on-ones with the investment community post-FD, while a majority of analysts polled in the AIMR study reported that private sessions with executives had declined.

There are conflicting findings relating to virtually every aspect of the Regulation FD debate. While it is unclear to me whether the costs and benefits of Regulation FD will ever be reliably quantifiable, it is self-evident that surveys based only on preliminary experiences with the rule enlighten us very little concerning the long-term success of Regulation FD.

The current climate is very reminiscent of the early days following the enactment of the safe harbor for forward-looking statements back in 1995. Then, as now, there was an impassioned debate, both before and after passage of the safe harbor, as to its effectiveness and its impact. There were claims, on the one hand, that the safe harbor did not go far enough and that companies would simply not risk providing forward-looking information.

Sound familiar?

On the other hand, there were dire predictions that the safe harbor would provide a license to commit fraud.

One of the first tasks I faced in 1996 when I became General Counsel of the Commission was to prepare for the President a report on the new statute that included the safe harbor. Even after a year of operating under the safe harbor, we found that it was much too early to draw meaningful conclusions about its impact. Today, however, nearly 4-1/2 years later, the safe harbor is, I believe, widely accepted and almost universally used to provide vital information to investors. The parade of horribles that was threatened when the law was enacted has simply not eventuated. I suspect the same will be said about Reg FD when we look at it several years down the road.

I do not mean to suggest that the drive to evaluate Reg FD now is not an important and worthwhile endeavor. It is. But we must be careful not to lean too heavily on the experience of the first six months under FD when we attempt to draw long-term conclusions about the rule. Not only does six months of data provide an extremely limited sample, the data is drawn from a unique six-month period in the life of the rule. Many of the effects observed and costs incurred during this transition will be non-recurring. Everyone acknowledges there are start-up costs associated with compliance, such as employee training and development of new procedures. In addition, as the market grows accustomed to new disclosure practices prompted by Reg FD – such as preannouncements of earnings – market reaction is likely to moderate. As a result, it probably would be difficult to pick a less-representative six-month period for study than the six-month period that has just ended. Our Office of Economic Analysis estimates that any meaningful study would require one to two years worth of data.

Reasons for Optimism About Regulation FD

Notwithstanding limited available data, I believe the post-FD landscape looks very positive. In general, I believe issuers are embracing Regulation FD. They are adopting new disclosure policies, training their covered employees, putting out more press releases, and web casting their quarterly earnings announcements. My clear impression is that most issuers are acting responsibly and in good faith to comply with the letter and spirit of the new rule.

In addition, despite their limitations, many of the studies and surveys released to date provide hopeful signs that Reg FD is functioning as intended. For instance, according to the NIRI survey, almost all issuers (89%) are providing earnings guidance during open quarterly conference calls. The PwC survey found that the vast majority of respondents (85%) understand what they can and cannot disclose under FD moderately well, well, or very well. These results are consistent with what I have learned anecdotally based on talking with lawyers, issuers, and analysts about FD – and believe, me, there has been a lot of talking about this subject.

There is also reason for optimism that Regulation FD will promote ever-greater disclosure in the marketplace and better financial analysis. In what a recent Wall Street Journal column termed "one of the boldest moves of the post-Regulation FD era," auto insurer Progressive has decided to begin reporting detailed financial data on a monthly, instead of quarterly, basis. Others have confirmed giving more information than ever before as well. And a Bloomberg study shows that analysts' track records may also be improving post-FD. The study finds that analysts, on average, missed fourth-quarter earnings by 22%, while the average whisper number missed by 30% for the same period. In a similar Bloomberg study in mid-1999, analysts were off by 44% and whispers by only 21%. The future looks very, very bright, indeed.

Enforcement of Regulation FD

Regardless of what surveys show, I suspect that most commentators' views on the rule will be shaped in large part by how it is enforced. If people conclude that the Commission's enforcement actions are reasonable and well articulated, I'm confident many of the fears and anxieties about the rule will vanish.

Less than ten days after Regulation FD became effective, I outlined publicly, in a speech before the Compliance and Legal Division of the Securities Industry Association, my philosophy on enforcement of the new rule. That speech is available on our web site, but let me reiterate what I said at that time. Regulation FD was not designed as a trap for the unwary. We do not plan to frustrate the intent of the rule – which is to encourage disclosure – by proceeding overzealously against issuers who make mistaken but reasonable judgments about materiality. In addition, we recognize that the rule grants substantial discretion to issuers regarding the means of making public disclosures. We do not intend to crowd issuers' reasonable, good faith exercise of that discretion.

When I spoke to the SIA, I cautioned then – and I reiterate now – that our measured approach should not be mistaken for reluctance to enforce Regulation FD. I have heard some suggest that there should be a grace period during which the Commission should take no action against violators of Regulation FD. I reject that position. Regulation FD has been part of the public dialog since its proposal in December 1999. After its adoption in August 2000, the staff engaged in extensive outreach efforts to provide guidance on FD, including publishing Frequently Asked Questions & Answers and providing telephonic interpretations. Advising issuers on FD compliance has become a cottage industry for securities lawyers. Under these circumstances, no issuer can credibly claim to have been blind-sided by the requirements of this much-heralded rule. Besides, nothing about complying with this rule is any more or less difficult than complying with any other Commission rule – think, for instance of the net capital rule or the order handling rules.

I also disagree with the suggestion by some that Regulation FD should be enforced only if there is trading on the basis of the selectively disclosed information. While it is true that selective disclosure in many ways resembles insider trading, Reg FD was designed to get at the problem in a different way than Rule 10b-5. Rather than prosecuting an insider for trading after the fact, FD works as a prophylactic rule by preventing the transmission of the material nonpublic information that could lead to unfair trading. To try to convert Reg FD into a trading rule after the fact would work a great unfairness since issuers who may be charged under the rule cannot control whether another party trades on the information selectively disclosed. As a result, if FD were enforced only against issuers whose FD violations led to trading, similarly situated issuers would be subjected to different treatment based entirely on chance. Thus, I reject the suggestion that Regulation FD should only be enforced as a trading rule.

In short, we expect issuers and others to conform their conduct to the requirements of Reg FD, and if they do not, we will take steps to make them do so. Our Acting Chairman, Laura Unger, made this clear yesterday in testimony before a House Subcommittee when she said, "Regulation FD will be enforced just as any other Commission rule or regulation."

We are particularly likely to take enforcement action if we discover clear-cut violations suggesting disregard for the rule. In that regard, we are troubled when, seven months after FD has become effective, we see evidence that the conduct of some issuers has not changed. Just like in the advertisements for those amazing diet shakes, we should see a marked difference between the "before" picture and the "after" picture. Unfortunately, this is not always the case.

Anyone who followed the FD rulemaking process is aware of the numerous press reports regarding instances of apparent selective disclosure that, in part, prompted the Commission to propose Regulation FD, and mobilized investors and others to support the proposal in record numbers. Let me give you a flavor for what the "before FD" picture looked like.

According to one pre-FD report, a Chief Financial Officer of a dot.com company called the four analysts who covered the company to discuss disappointing trends at the company and delays in developing a rapidly growing sales force. Based on the conversations, all four analysts concluded in subsequent published reports that the company was unlikely to meet Wall Street's revenue targets for the second quarter.

According to another pre-FD report, a top official of a retail clothing chain alerted an analyst to slower-than-expected sales, prompting the analyst to activate his firm's sales force to contact top clients. By 3:00 the next day, the stock had dropped about $8. It was not until the following week, a full five days after the analyst had been tipped, that the company announced publicly that sales in certain stores had increased less than Wall Street had predicted.

What is troubling to me is that we continue to see reports of conduct that echo the ones that moved the Commission to act in the first instance. In the "after FD" picture, we still read of top corporate officials calling multiple analysts to review prior announcements, resulting in the analysts lowering their earnings estimates. We also hear of senior officers making serial calls to analysts and talking them down from their earlier assumptions. And we learn of senior officials who, late in the quarter, confirm to a single analyst guidance given publicly months earlier when market conditions were very different. These kinds of stories will almost certainly trigger an enforcement inquiry. Conduct that flouts the rule or that looks uncomfortably like the "before FD" picture will be scrutinized thoroughly.

Let me add several additional observations to my earlier comments on the enforcement perspective. The first relates to our enforcement process itself. When we learn of a situation that suggests a violation of FD has occurred, we will react – and quickly. You can expect the staff to come knocking on the doors of issuers and analysts to collect the information we need to assess a situation. But in more than one instance, after asking preliminary questions concerning potential FD violations, we have determined that full investigations were not warranted. Mindful of complaints about the potential chilling effect of our inquiries, we have decided, when possible, to make determinations about whether to pursue a full investigation as early as feasible in the process. The mere fact that we have inquired about a small number of situations should not deter issuers from making lawful and responsible disclosures. There are roughly 14,000 public companies making disclosures, sometimes on a daily basis. We are currently looking at fewer than ten situations involving potential FD violations. In these circumstances, it is hard to credit claims that the threat of an enforcement action lowers the FD thermostat to the point where communication is chilled.

Let me turn from process to an issue of substance. We continue to receive reports of public presentations or open conference calls by companies followed by closed or private sessions that are restricted in attendance. Regulation FD does not prohibit small group or one-on-one meetings with analysts. We recognize that these settings may provide excellent opportunities to discuss nonmaterial mosaic information. We share the view that such exchanges are fully lawful. However, companies should be aware that when we see reports that company-sponsored public meetings or calls are followed, sometimes immediately, by sessions that exclude all but selected analysts, and there is evidence suggesting that material nonpublic information may have been provided at such a session, we will take a closer look.

Furthermore, we are not the only ones who will do so. Two constituencies that strongly supported adoption of Regulation FD – individual investors and the press – have emerged as energetic watchdogs for potential violations of the rule. You've undoubtedly noticed how eager the press is to document instances when it is excluded from meetings. Not only do we read news reports of such company-initiated restricted meetings, we also receive complaints from investors who, while on a public earnings call hear reference to a subsequent invitation-only session from which they are excluded. Companies should be cognizant of the appearances they create and the suspicion and ill will they generate when they sponsor selective gatherings like these. They also should keep in mind that when an issuer controls the circumstances and setting of a communication, we naturally assume that issuer will have had the opportunity to carefully analyze whether particular disclosures are material.


In closing, let me reiterate that I believe there is substantial room for optimism concerning the future of Regulation FD. We should not forgo an opportunity to remedy a problem that is so clearly important to individual investors and to the health and integrity of our markets out of fear of the unknown. If we are patient, and if we continue to work together in good faith to find our way in the new FD world, I am confident that the Commission's wisdom in adopting Regulation FD will stand the test of time.

Thank you.


Modified: 05/24/2001