Speech by SEC Commissioner:
Corporate Communications Without Violations: How Much Should Issuers Tell Their Analysts and When
Laura S. Unger
Commissioner, U.S. Securities & Exchange Commission
At the 19th Annual Ray Garrett Jr. Corporate and Securities Law Institute
April 23, 1999
Thank you, Herb. Itís a privilege to be invited to participate on not one, but two panels at the Ray Garrett Institute.
Before I begin my remarks, Iíll dispense with the standard SEC disclaimer, which youíll thankfully only hear once today, as Iím the only Commission speaker on the program: the remarks I am about to give are my own, and do not necessarily reflect the views of the Commission, its staff, or the other Commissioners.
I thought I would begin by talking about a corporate information issue that is receiving increased attention from the Commission today: issuer/analyst communications and potential insider trading liability. Iíll follow this up with some remarks on how a favorite subject of mine -- the Internet -- impacts corporate information practices.
Dealing with Analysts and Institutional Shareholders/Insider Trading Policies
Securities analysts play a critical role in contributing to efficient securities markets. With the deluge of information available to market participants today, the value of an analystís opinion -- both to investors and issuers -- is greater than ever before.
It is in an issuerís best interests to be responsive to inquires by analysts following their stocks. It is also in investorsí interest for issuers to do so. Unless, of course, the issuer selectively discloses material non-public information to analysts.
SRO policies governing issuer relations with analysts attempt to strike the difficult balance between encouraging issuers to provide access to analysts that benefits investors and the markets and discouraging selective disclosure. For example, the NYSE Listed Company Manual recommends that an issuer observe "open door" policies with analysts, but pointedly adds that an issuer should not reveal material information to analysts that it hasnít given to the press for publication.
I would guess that issuers are probably talking more these days during their analyst calls as a result of private securities reform legislation passed in 1995 and 1998. This legislation encourages certain issuers to disclose earnings projections or "forward-looking" statements during analyst calls by giving a safe harbor from private securities litigation.
At the same time, itís just as important for analysts to maintain good relationships with issuers. The value of a piece of significant information about an issuer amidst all the "noise" in todayís markets heightens competition among analysts to seek out whatever informational advantage they can get. Moreover, a recent survey found that 88% of the senior executives of issuers that dropped their underwriters after IPOs between 1993 and 1996 ranked better research coverage as one of the top three reasons for the switch.
Obviously, there is pressure on analysts to provide favorable coverage. Some issuers deny access to analysts who write critical reports. Some analysts are compensated based on the investment banking business they bring in. Both Chairman Levitt and I have previously expressed concerns about the potential issues such an environment raises for analysts. I wonít repeat those concerns here, but you can read them at your leisure on our website -- www.sec.gov.
The recent concerns expressed by the Commission and its staff on selective disclosure have centered on a scenario where there is suspicious market-moving trading activity occurring shortly after, or even during, analyst calls. At the very least, such activity may undermine the confidence of investors in the fairness of our markets.
Iíd like to mention another scenario involving issuers and analysts that I believe may raise similar concerns. You may have read the news stories late last year describing conferences investment banking firms hold for their clients. In the typical example, an investment banking firm flies in clients and company representatives to a luxury resort, where they are wined and dined and perhaps treated to shows by well-known entertainers. These festivities are organized around exclusive meetings between firm clients and companies, where company representatives give presentations about their prospects and business plans.
Of course, legally there is nothing necessarily wrong with companies participating in such conferences and giving exclusive presentations to firm clients -- as long as they do not include material non-public information. Regardless whether the information can be deemed material or not, when these presentations are accompanied by a spike in trading activity in the companyís stock, the Commission should be concerned.
Taking a slightly different angle, whatís the recourse to investors if a company happens to let slip some previously undisclosed material information during one of these presentations? According to SRO guidelines, if a company makes a substantive disclosure during a discussion with analysts, it should simultaneously release the information to the public.
This might not be an adequate curative step in todayís marketplace. First of all, if material information happens to slip out, itís too late for simultaneous release. Moreover, given todayís technology, where participants can relay trades from their seats either by their cell phones or even by wireless units that some brokerage firms offer, itís probably too late to prevent the rest of the market from being disadvantaged.
What recourse would the Commission have against the issuer representative in such an instance? Bringing an insider trading case against the company insider? Since the Dirks decision in 1983, the Commission has had to show some benefit flowing back to a corporate insider for insider trading liability to attach to the insider for providing material, non-public information to analysts. While the benefit need not be monetary, a reputational benefit will suffice, this requirement has posed a hurdle for the Commission to overcome in bringing certain insider trading cases against issuers.
So that leads us to question whether we can quantify a benefit to the company insider in the typical conference call scenario? What if an issuerís corporate relations official provides material non-public information to curry favor with a particular analyst, in hopes that it will be reflected in the analystís next rating of the issuer? Is that a sufficient reputational benefit, or is it too attenuated? Can we more likely deem it a benefit if a part of the representativeís compensation is based on the companyís stock performance?
What about an investment bank conference scenario? Say a company insider -- feted by an investment banking firm -- blurts out some material non-public information during a client meeting. Does the fact that the meeting is wedged between his round of golf and dinner paid for by the firm sufficiently establish a benefit?
The case law since Dirks is not exactly replete with instances where weíve brought actions against issuers for selective disclosure to analysts and institutional investors. Of course, I am certain that the threat of Commission enforcement actions is having the appropriate deterrent effect, causing issuers to exercise discretion in their dealings with analysts. But as you can tell from some of the questions I raised about the benefit analysis, this remains an area with some legal uncertainty for the Commission.
Which is why our Office of General Counsel is currently reviewing insider trading law to determine whether it should recommend that the Commission propose rulemaking to address a number of insider trading-related topics, including selective disclosure by issuers to analysts and institutional investors.
Of course, there are many factors we need to consider in the context of deciding whether rulemaking is the best solution. After all, weíve been having so much luck with the Courts of Appeal. Leaving some legal uncertainty in an area such as this can always work to the Commissionís advantage since we can rely on counsel to advise clients that situations raising the spectre of selective disclosure should be avoided for fear of potential liability.
In drawing bright lines by rulemaking, we always run the risk of legitimizing conduct falling just below the line -- conduct that we may still find to be unpalatable. Finally, in any rulemaking the Commission may undertake, we must maintain the balance between encouraging the free flow of appropriate communications between issuers and analysts and discouraging selective disclosure of material non-public information.
However, it appears that the issue of selective disclosure has risen to such a level of concern that rulemaking may indeed be necessary. Outside of the insider trading review (as you may be aware from yesterdayís Aircraft Carrier panel discussion about expanding free writing during the offering period), the Commission is considering whether selective disclosure can be cured by requiring issuers to file free writing materials with us.
In the interim, I would stress that issuers should pay close attention to this issue. As you know, given a compelling set of facts, we would not necessarily be adverse to testing our legal theories in this area through an enforcement action.
Web Site and Internet Issues
Turning to the Internet and corporate communications, Iíve been asked on a number of occasions whether the Internet should be deemed an alternative means for a company to disseminate material information to the market. SRO rules govern the particulars of the release of material information by listed companies. For example, NYSE policies require that listed companies must disseminate press releases on material developments by the "fastest available means." At a minimum, listed companies have to provide press releases to the three major news services: Dow Jones, Reuters, and Bloomberg.
The foundation is being laid for the Internet to become an appropriate dissemination channel for corporate news developments. I would guess that the majority of publicly-traded companies have websites. Virtually all professional market participants have access to the Internet. In addition, over 77 million people in the U.S. have Internet access. However, these 77 million people only translate into slightly over 20 percent of all U.S. households.
The Internet has any number of websites devoted exclusively to financial news. Several websites focus on providing corporate news developments to registered users or the general public. Financial portals and online brokers provide news services to individual investors, who can set up their accounts so that they are immediately notified of news developments in particular companies or industry sectors.
But it is still a bit premature for the Commission or SROs to anoint the Internet as an acceptable alternative outlet for companies to publicly disseminate material news. There are two reasons why I think this is so. First, as I mentioned earlier, only about 20 percent of U.S. households have Internet access. Itís hard to consider that public, even though Iíve read some surveys that have noted a strong correlation between households with Internet access and those owning securities.
The second reason is the relative immaturity of tools on the Internet for getting information from company websites to Internet users. You wouldnít consider information in a newspaper to necessarily be publicly disseminated before the papers have been delivered. The same holds true for press releases posted on a companyís website. Without a means of distribution, it would be hard to argue there is public dissemination. Of course there are any number of search engines, but these donít function on a continuous basis to bring information to users. The commercialization of intelligent agents, or "bots," that investors could send out over the web to bring them corporate news developments from company web sites in close to real time may be one potential solution to the distribution issue.
This view of the limited access by a large segment of investors to the Internet and the immaturity of the Internet as a distribution channel is reflected in the revisions to NASD Rule IM-4120-1 approved by the Commission earlier this month. Specifically, the revised policy states that any dissemination of material press releases over the Internet is appropriate as long as it is not made available over the Internet before the same information is transmitted to, and received by, traditional news services.
I see no reason why the Internet couldnít eventually become an alternative channel for news dissemination by issuers, given rapid advances in technology and falling PC costs that will accelerate the penetration of the Internet into U.S. households. At some point, the Commission and the SROs will have to confront this issue. In fact, I can even easily envision an SRO seeking to designate its own website as an acceptable channel through which listed companies can disseminate material news.
Addressing Inaccurate or Fraudulent Information on the Internet
One issue of more immediate concern to corporate information officers is how to address the potential fallout from the dissemination over the Internet of inaccurate or fraudulent information about their companies. The number one subject by far on Internet chat rooms and bulletin boards is companies and their stocks. With online brokerage, individual investors have the ability to act almost immediately on this information. This creates an environment where a companyís stock is susceptible to moving very quickly on unconfirmed rumors or fraudulent information.
Companies should not necessarily begin patrolling chat rooms and bulletin boards, responding in real time to inaccuracies in postings about their companies. But it does point out that companies need to be aware of the positive and negative impacts of the power and speed of the Internet. From a business perspective, the Internet requires companies to be prepared to respond more quickly than ever to rumors or inaccurate or fraudulent information, for the consequences are all the more serious in todayís market.
The Commission is well aware of these consequences. Weíve tried to gear up to respond rapidly to fraudulent activity occurring on the Internet in order to both protect the integrity of the markets and to maximize the deterrent effect of our actions. For example, on Wednesday we filed a complaint in federal district court alleging antifraud violations in connection with the stock of PairGain Technologies.
As most of you probably know, two weeks ago an Internet bulletin board posting was made that led investors via hyperlink to a phony, but very real-looking, Bloomberg news webpage with a false press release on an Israeli companyís acquisition of PairGain. PairGainís stock rose over 30 percent within 90 minutes of the posting, but rapidly declined approximately 20 percent after the story was revealed to be a hoax.
Hopefully, by bringing such actions quickly, weíll get out the message that the Commission intends to maintain a strong presence on the Internet and will not tolerate securities-related fraud on this or any other medium.