Proposed Rule:
Selective Disclosure and Insider Trading

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 240, 243, and 249

Release Nos. 33-7787, 34-42259, IC-24209, File No. S7-31-99

RIN 3235-AH82

Selective Disclosure and Insider Trading

Agency:   Securities and Exchange Commission

Action:   Proposed rule

Summary:   The Securities and Exchange Commission is proposing new rules to address three issues: the selective disclosure by issuers of material nonpublic information; whether insider trading liability depends on a trader's "use" or "knowing possession" of material nonpublic information; and when the breach of a family or other non-business relationship may give rise to liability under the misappropriation theory of insider trading. The proposals are designed to promote the full and fair disclosure of information by issuers, and to clarify and enhance existing prohibitions against insider trading.

Dates:   Public comments are due on or before March 29, 2000.

Addresses:   Please send three copies of your comment letter to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 5th Street, N.W., Washington, D.C. 20549-0609. Comments can also be sent electronically to the following e-mail address: rule-comments@sec.gov. Your comment letter should refer to File No. S7-31-99. If e-mail is used, include this file number on the subject line. Anyone can inspect and copy the comment letters in the Commission's Public Reference Room at 450 5th St., N.W., Washington, D.C. 20549. Electronically submitted comments will be posted on the Commission's Internet web site (http://www.sec.gov).

For Further Information Contact:   Richard A. Levine, Assistant General Counsel, Sharon Zamore, Senior Counsel, or Elizabeth Nowicki, Attorney, Office of the General Counsel, at (202) 942-0890.

Supplementary Information:   The Securities and Exchange Commission (Commission) today is proposing for comment new rules: Regulation FD,¹ Rule 181 under the Securities Act,² Rule 10b5-1,³ Rule 10b5-2,⁴ and amendments to Forms 8-K⁵ and 6-K.⁶

I. Executive Summary

Information is the lifeblood of our securities markets. Congress enacted the federal securities laws to promote fair and honest securities markets, and a critical purpose of these laws is to promote full and fair disclosure of important information by issuers of securities to the investing public. The Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act), as implemented by Commission rules and regulations, provide for systems of mandatory disclosure of certain material information in securities offerings and in periodic reports.

The antifraud provisions of the federal securities laws also play a very important role in furthering full and fair disclosure. Among other things, the antifraud provisions prohibit insider trading, or the fraudulent misuse of material nonpublic information. Unlike the law underlying the issuer disclosure requirements, which generally has been developed through statutes and rules, the law of insider trading has largely been developed through a series of Commission and judicial decisions in civil and criminal enforcement cases involving fraud charges. As a result, a few areas of insider trading law have been marked by disagreement among the courts.

Today's proposals address several issues related to full and fair disclosure of information, and insider trading law. The proposed rules are the following:

• Regulation FD (Fair Disclosure), a new issuer disclosure rule, deals with the problem of issuers making selective disclosure of material nonpublic information to analysts, institutional investors, or others, but not to the public at large. Although analysts play an important role in gathering and analyzing information, and disseminating their analysis to investors, we do not believe that allowing issuers to disclose material information selectively to analysts is in the best interests of investors or the securities markets generally. Instead, to the maximum extent practicable, we believe that all investors should have access to an issuer's material disclosures at the same time. Regulation FD, therefore, would require that: (1) when an issuer intentionally discloses material information, it do so through public disclosure, not through selective disclosure; and (2) whenever an issuer learns that it has made a non-intentional material selective disclosure, the issuer make prompt public disclosure of that information.

• Rule 10b5-1 addresses an important unsettled issue in insider trading law: whether the Commission must show in its insider trading cases that the defendant "used" the inside information in trading, or merely that the defendant traded while in "knowing possession" of the information. The Rule would state the general principle that insider trading liability arises when a person trades while "aware" of material nonpublic information, but also provides four exceptions to liability. In these four situations, where a trade resulted from a pre-existing plan, contract, or instruction that was made in good faith, it will be clear that the trader did not use the information he or she was aware of.

• Rule 10b5-2 addresses another unsettled issue in current insider trading law: what types of family or other non-business relationships can give rise to liability under the misappropriation theory of insider trading. The Rule would set forth three non-exclusive bases for determining that a duty of trust or confidence was owed by a person receiving information: (1) when the person agreed to keep information confidential; (2) when the persons involved in the communication had a history, pattern, or practice of sharing confidences that resulted in a reasonable expectation of confidentiality; and (3) when the person who provided the information was a spouse, parent, child, or sibling of the person who received the information, unless it were shown affirmatively, based on the facts and circumstances of that family relationship, that there was no reasonable expectation of confidentiality.

II. Selective Disclosure: Regulation FD

A. Background

Full and fair disclosure of information by issuers of securities to the investing public is a cornerstone of the federal securities laws. In enacting the mandatory disclosure system of the Exchange Act, Congress sought to promote disclosure of "honest, complete, and correct information"⁷ to facilitate the operation of fair and efficient markets.⁸

Despite this well-recognized principle, the federal securities laws do not generally require an issuer to make public disclosure of all important corporate developments when they occur. Periodic reports (e.g., Forms 10-K and 10-Q) call for disclosure of specified information on a regular basis, and domestic issuers are additionally required to report some types of events on a Form 8-K soon after they occur. However, in the absence of a specific duty to disclose, the federal securities laws do not require an issuer to publicly disclose all material events as soon as they occur. While we encourage prompt disclosure of material information as the best disclosure practice,⁹ and self-regulatory organization (SRO) rules often require this,¹⁰ issuers retain some control over the precise timing of many important corporate disclosures.

In practice, issuers also retain control over the audience and forum for some important disclosures. If a disclosure is made at a time when no Commission filing is immediately required, the issuer determines how and to whom to make its initial disclosure. As a result, issuers sometimes choose to disclose information selectively – i.e., to a small group of analysts or institutional investors – before making broad public disclosure by a press release or Commission filing.

Many recent cases of selective disclosure have been reported in the media.¹¹ In some cases, selective disclosures have been made 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. Commonly, these situations involve advance notice of the issuer's upcoming quarterly earnings or sales figures – figures which, when announced, have a predictable and significant impact on the market price of the issuer's securities.

We are troubled by the many recent reports of selective disclosure and the potential impact of this practice on market integrity. As the Supreme Court has recently emphasized, promoting investor confidence in the fairness of our securities markets is an "animating purpose" of the Exchange Act.¹² Clearly, one critical component of that mission is protecting investors from the prospect that others in the market possess "unerodable informational advantages"¹³ obtained through superior access to corporate insiders.

In our view, the current practice of selective disclosure poses a serious threat to investor confidence in the fairness and integrity of the securities markets. We have recognized that benefits may flow to the markets from the legitimate efforts of securities analysts to "ferret out and analyze information"¹⁴ based on their superior diligence and acumen. But we do not believe that selective disclosure of material nonpublic information to analysts – or to others, such as selected investors – is beneficial to the securities markets. As a recent academic study indicated, selective disclosure has the immediate effect of enabling those privy to the information to make a quick profit (or quickly minimize losses) by trading before the information is disseminated to the public.¹⁵ Indeed, while issuer selective disclosure is not a new practice,¹⁶ the impact of such selective disclosure appears to be much greater in today's more volatile, earnings-sensitive markets. Accordingly, we think that a continued practice of selective disclosure by issuers inevitably will lead to a loss of public confidence in the fairness of the markets.

Even apart from the issue of fundamental fairness to all investors, selective disclosure poses other real threats to the health and integrity of our securities markets. Corporate managers should be encouraged to make broad public disclosure of important information promptly. If, however, they are permitted to treat material information as a commodity that can be parceled out selectively, they may delay general public disclosure so that they can selectively disclose the information to curry favor or bolster credibility with particular analysts or institutional investors.¹⁷

Moreover, if selective disclosure were to go unchecked, opportunities for analyst conflicts of interests would flourish. We are greatly concerned by reports indicating a trend toward less independent research and analysis as a basis for analysts' advice, and a correspondingly greater dependence by analysts on access to corporate insiders to provide guidance and "comfort" for their earnings forecasts.¹⁸ In this environment, analysts are likely to feel pressured to report favorably about particular issuers to avoid being "cut . . . off from access to the flow of non-public information through future analyst conference phone calls" or other means of selective disclosure.¹⁹ This raises troubling questions about the degree to which analysts may be pressured to shade their analysis in order to maintain their access to corporate management. We believe that these pressures would be reduced if issuers were clearly prohibited from selectively disclosing material information to favored analysts.

These concerns about selective disclosure are widely shared, as reflected both in stock exchange listing standards and in "best practices" guidelines of investor relations and analyst groups. The New York Stock Exchange Listed Company Manual and the NASD Rules both require listed issuers to disclose promptly "to the public" information about material developments.²⁰ The National Investor Relations Institute (NIRI) guidance in this area also states that an issuer "should not disclose in selective situations – such as conference calls and analyst meetings – information that it is unwilling to make available for general public use."²¹ Similarly, the Association of Investment Management and Research Standards of Practice Handbook states that if an analyst selectively receives disclosure of information that he deems material, "the member must encourage the public dissemination of that information and abstain from making investment decisions on the basis of that information unless and until it is broadly disseminated to the marketplace."²²

Finally, revolutions in communications and information technologies have made it much easier for issuers today to disseminate important information broadly and swiftly. A generation ago, issuers may have relied on conferences attended by a handful of interested parties, or news releases that led to delayed, indirect retransmission of information to the public. Lacking effective means to communicate directly to large numbers of investors, issuers may have relied on analysts to serve as information intermediaries. In the last few years, however, new, effective methods for mass communications have become widely available. Today, issuers can – and many do – use a variety of these new methods to communicate with the market, including: live transmissions of annual meetings and news conferences on the Internet or closed circuit television; listen-only telephone transmission of meetings and analyst conferences; and company websites.²³ With the availability of these new technologies, issuers can much more easily reach a wide investor audience with their disclosures, and do not need to rely on analysts as heavily as in the past to serve as information intermediaries.²⁴

Nevertheless, issuers are continuing to engage in selective disclosures of material nonpublic information, perhaps due in part to the uncertainty in current law about when selective disclosures are prohibited. For at least the past 30 years, the issue of potential liability for selective disclosure has been addressed under the principles of fraud law, particularly the law of insider trading. Under early insider trading case law, which appeared to require that traders have equal access to corporate information,²⁵ selective disclosure of material information to securities analysts could lead to liability.²⁶

This changed with the Supreme Court's decisions in Chiarella v. United States²⁷ and Dirks v. SEC.²⁸ In Chiarella, the Court rejected the "parity of information" approach, which considered trading to be fraudulent whenever the trader possessed material information not generally available. The Court instead held that there must be a breach of a fiduciary or other relationship of trust and confidence before the law imposes a duty to disclose information or refrain from trading.

In Dirks, the Supreme Court addressed the disclosure, or "tipping, " of material nonpublic information by an insider to an analyst.²⁹ The Court rejected the idea that a person is prohibited from trading whenever he knowingly receives material nonpublic information from an insider. Instead, it stated that a recipient of inside information is prohibited from trading only when the information has been made available to him "improperly" – that is, in breach of the insider's fiduciary duty to shareholders. To determine whether a breach of duty occurred, "courts [must] focus on objective criteria, i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings."³⁰

After Dirks, there have been very few insider trading cases based on disclosure to, or trading by, securities analysts. In some situations, an insider's selective disclosure can be viewed as improper, because the disclosure was motivated by a desire for some type of personal benefit.³¹ In other cases, however, the evidence to support the "personal benefit" argument under Dirks is less clear. As a result, many have viewed Dirks as affording considerable protection to insiders who make selective disclosures to analysts, and to the analysts (and their clients) who receive selectively disclosed information.³²

Although the antifraud provisions of the securities laws do not require that all traders possess equal information when they trade, we believe that our disclosure rules should promote fair treatment of large and small investors by, among other things, giving all investors timely access to the material information an issuer chooses to disclose. Therefore, we are today proposing new rules, which use a different legal approach, to address selective disclosure.

The approach we propose does not treat selective disclosure as a type of fraudulent conduct or revisit the insider trading issues addressed in Dirks. Rather, we propose to use our authority to require full and fair disclosure from issuers, primarily under Section 13(a) of the Exchange Act, as a basis for proposed Regulation FD. This Regulation is designed as an issuer disclosure rule, similar to existing Commission rules under Exchange Act Sections 13(a) and 15(d).³³ We believe this approach would further the full and fair public disclosure of material information, and thereby promote fair dealing in the securities of covered issuers.

B. Description of Proposed Regulation FD

Rule 101 of Regulation FD sets forth the basic rule regarding "selective disclosure." Under this Rule, whenever:

(1) an issuer, or any person acting on its behalf,

(2) discloses material nonpublic information

(3) to any other person outside the issuer,

(4) the issuer must

(a) simultaneously (for intentional disclosures), or

(b) "promptly" (for non-intentional disclosures)

(5) make public disclosure of that same information.

Several definitional and other provisions in the Regulation establish the scope and effect of the general rule. As a whole, the Regulation would require that whenever an issuer makes an intentional disclosure of material nonpublic information, it must do so in a manner that provides general public disclosure, rather than through a selective disclosure. In the case of an unintentional selective disclosure, the issuer must make full public disclosure promptly after it learns of the selective disclosure. Regulation FD does not mandate that issuers make public disclosure of all material developments when they occur. What it does require, however, is that when an issuer chooses to disclose material nonpublic information, it must do so broadly to the investing public, not selectively to a favored few.

The key provisions of the Regulation are discussed in greater detail below.

1. Disclosures by "An Issuer or Person Acting on its Behalf"

Regulation FD applies to all issuers with securities registered pursuant to Section 12 of the Exchange Act, and those issuers required to file reports under Section 15(d) of the Exchange Act, including closed-end investment companies but not including other investment companies.³⁴ It would apply not only to a selective disclosure formally made in the name of the issuer, but also to a selective disclosure made by a "person acting on behalf of an issuer." This term is defined by Rule 101(c) as any officer, director, employee, or agent of the issuer who discloses material nonpublic information while acting within the scope of his or her authority.

The definition of "person acting on behalf of an issuer" distinguishes between cases where a properly authorized employee or agent of the issuer makes a selective disclosure, and cases where an employee or agent discloses material nonpublic information for his or her own benefit – i.e., provides a "tip" that would violate Rule 10b-5 if securities trading ensued. This distinction means that the issuer would not automatically be liable under Regulation FD (or be responsible for making simultaneous or prompt public disclosure) whenever one of its employees or agents improperly trades or tips.³⁵ The Rule also would not apply if an official disclosed information to another person who owed him or her a duty of trust or confidence – such as a medical professional. By focusing on employees and agents acting within the scope of their authority, the Rule would make an issuer responsible only for the disclosures of company officials, employees, or agents who are properly authorized or designated to speak to the media, the analyst community, and/or investors.

We request comment on this approach. Is the definition of "person acting on behalf of an issuer" appropriate? Should it be narrower – for example, limited to executive officers and directors, and persons acting on their behalf? Or should it be broader, to prevent evasion – for example, covering any person authorized to act on behalf of the issuer?

2. Disclosure of Material Nonpublic Information

Regulation FD addresses the selective disclosure of "material nonpublic information." The Regulation does not define the term "material, " but instead relies on the same definition as is generally applicable under the federal securities laws: information is material if "there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision, or if it would have "significantly altered the 'total mix' of information made available."³⁶

We recognize that materiality judgments can be difficult. Corporate officials may therefore become more cautious in communicating with analysts or selected investors, or may feel compelled to consult with counsel more frequently about their ability to respond to questions from analysts and investors. We understand that these communications take many forms, including unrehearsed question-and-answer sessions, and responses to unsolicited inquiries. We are mindful of the potential burdens of requiring instant materiality judgments to be made by those put in the position of responding immediately to questions.

We believe that these concerns are significant but can be mitigated in several ways, many of which involve practices already in place at many issuers.³⁷ First, issuers can designate a limited number of persons who are authorized to make disclosures or field inquiries from analysts, investors, or the media. Second, issuers can make sure that some record is kept of the substance of private communications with analysts or selected investors – for example, by having more than one person present during these contacts or by recording conversations. Third, issuer personnel can decline to answer questions that raise issues of materiality until they have had an opportunity to consult with others. Fourth, issuer personnel can secure the agreement of analysts not to make use of certain information for a limited time until they have had the opportunity to review their notes of the conversation and engage in whatever consultation they deem necessary to reach a conclusion as to materiality;³⁸ then, if the issuer determines that public disclosure of the information is necessary, it can do so. Finally, and most importantly, as described in greater detail below, the Regulation recognizes that issuers may sometimes unintentionally make a selective disclosure of material nonpublic information, and it treats such unintentional disclosures differently from cases in which the issuer makes a planned selective disclosure.

We also believe that a heightened awareness of materiality issues may well have overall benefits to the disclosure process. Senior corporate officials who are responsible for dealing with analysts, investor relations, and disclosure issues already should be sensitive to materiality questions. When particularly difficult issues arise, responsible officials should seek the advice of counsel. Though it is likely that this Regulation will require corporate officials to consider more thoughtfully precisely what to disclose, it is unlikely, given the robust, active capital market, that the flow of information to the market will be significantly chilled.

Although materiality issues do not lend themselves to a bright-line test, we believe that the majority of cases are reasonably clear. At one end of the spectrum, we believe issuers should avoid giving guidance or express warnings to analysts or selected investors about important upcoming earnings or sales figures; such earnings or sales figures will frequently have a significant impact on the issuer's stock price. At the other end of the spectrum, more generalized background information is less likely to be material. We request comment on whether use of the procedures discussed above or similar procedures can significantly reduce the risk of "chilling" the flow of corporate information to the marketplace.

The Regulation also does not specifically define the term "nonpublic." It is well established that information is nonpublic if it has not been disseminated in a manner making it available to investors generally.³⁹ In order to make information public, "it must be disseminated in a manner calculated to reach the securities market place in general through recognized channels of distribution, and public investors must be afforded a reasonable waiting period to react to the information."⁴⁰ The Regulation does specify means by which "public disclosure" is to be made.⁴¹ We request comment on whether to rely on existing standards for the term "nonpublic." Should we provide further guidance, or is the specific definition of "public disclosure" provided in Rule 101(e) sufficient?

3. Selective Disclosure "To Any Other Person Outside the Issuer"

Rule 100(a) covers selective disclosures made to "any person or persons outside the issuer." Therefore, the Rule would not apply to communications of confidential information by officials and employees of issuers to each other. Only selective disclosures to outsiders, such as analysts or selected investors, are covered by the Regulation.

To make clear the scope of the Regulation, paragraph (b) of Rule 100 expressly states that the Rule does not apply to disclosures of material information to persons who are bound by duties of trust or confidence not to disclose or use the information for trading. Paragraph (b) expressly refers to several types of persons whose misuse of the information would subject them to insider trading liability under Rule 10b-5: (1) "temporary" insiders of an issuer – e.g., outside consultants, such as its attorneys, investment bankers, or accountants;⁴² and (2) any other person who has expressly agreed to maintain the information in confidence, and whose misuse of the information for trading would thus be covered either under the "temporary insider" or "misappropriation" theory.⁴³

This approach recognizes that issuers and their officials may properly share material nonpublic information with outsiders when those outsiders agree to keep the information confidential. This would permit issuers to discuss confidential strategies or plans with outsiders, as necessary for business purposes, without need to make public disclosure under this Rule. For example, issuers could share material nonpublic information with other parties to a business combination transaction or with a purchaser in a private placement without having to make public disclosure if the party receiving the information agrees to hold the information in confidence. Similarly, if it served an issuer's corporate interests to make disclosure of material information to selected analysts – for example, to give the analysts sufficient time to analyze complex information before its public release, or to solicit analysts' views on a business strategy under consideration – it could do so, provided that the recipients of the information expressly agreed not to use the information and to keep it confidential prior to public disclosure. Such a confidentiality agreement would also include an agreement not to trade on the nonpublic information.

We request comment on whether the proposed Regulation covers the appropriate categories of persons. Should other types of persons be enumerated in Rule 100(b) as proper recipients of material nonpublic information? By permitting disclosures to outsiders who agree to confidentiality requirements, does the Regulation adequately permit issuers to engage in legitimate business communications with customers or suppliers, potential co-venturers, and others? Would purchasers in private offering who receive material nonpublic information be willing to sign confidentiality agreements? How would this affect the resale market for private offerings and the flow of information in these transaction? Would the proposals reduce liquidity in the 144A market? How should the Regulation account for practices in this market? Should we require that confidentiality agreements take any specific form – i.e., be written – or include certain required provisions?

4. Timing of Public Disclosure Required by Regulation FD

An important provision of Regulation FD is that the timing of required public disclosure differs depending on whether the issuer has made an "intentional" or a "non-intentional" selective disclosure.

When an issuer makes an "intentional" disclosure of material nonpublic information, Rule 100(a)(1) requires the issuer to publicly disclose the same information simultaneously. In effect, this requirement for simultaneous disclosure means that issuers cannot engage in an intentional selective disclosure consistent with the terms of Regulation FD.

Under the definition provided in Rule 101(a), a 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 or she would be communicating information that was material and nonpublic. This definition would cover, for example, situations where an issuer official determined to hold a conference call or meeting that excluded the public, or selectively contacted a particular analyst or investor, to disclose material nonpublic information. The individual making the disclosure must know (or be reckless in not knowing) that the information he or she is going to disclose is both material and nonpublic. Thus, for example, a communication would not be "intentional" under this Rule if it was disclosed inadvertently through an honest slip of the tongue, or because the individual mistakenly (but not in reckless disregard of the truth) believed that the information had already been made public.

Under Rule 100(a)(2), when this type of "non-intentional" disclosure of material nonpublic information occurs, the issuer is required to make public disclosure promptly. In this situation, because the disclosure was unplanned, the Rule does not require simultaneous public disclosure. Instead, the Rule requires "prompt" public disclosure, with "promptly" defined to mean "as soon as reasonably practicable" (but no later than 24 hours) after a senior official of the issuer knows (or is reckless in not knowing) of the non-intentional disclosure.⁴⁴ "Senior official" is defined as any executive officer of the issuer, any director of the issuer, any investor relations officer or public relations officer, or any employee possessing equivalent functions.⁴⁵

By creating a separate requirement for "prompt" public disclosure in the case of a non-intentional selective disclosure, the Rule recognizes that corporate officers may sometimes make mistakes without the intent to selectively disclose material nonpublic information. When mistakes are made, absent intent or recklessness, we do not believe that the issuer should be held in violation of Regulation FD for not having made simultaneous public disclosure.⁴⁶

If, however, an inadvertent selective disclosure of material information occurs, the issuer must take prompt "corrective" action when it knows (or is reckless in not knowing) that the disclosure of material information has occurred. The requirement to take corrective action arises when a senior official of the issuer (as defined above) becomes aware of the selective disclosure.⁴⁷ When that occurs, the issuer is required to act "as soon as reasonably practicable" to make full public disclosure of the information that has been selectively disclosed.⁴⁸

We request comment on the distinction between "intentional" and "non-intentional" disclosures for purposes of the timing of public disclosure. Does the proposed definition of "intentional" disclosure draw the appropriate distinction? Does the definition of "promptly" provide an appropriate time period for the required public disclosure? Should the time period be shorter (e.g., same trading day); or longer (e.g., next business/trading day or 48 hours later)? Is the definition of senior official appropriate, or should it be narrower (e.g., executive officers only) or broader (e.g., all employees)?

5. Definition of "Public Disclosure"

Rule 101(e) defines the type of "public disclosure" that will satisfy the requirements of the Regulation. This definition provides issuers with considerable flexibility in determining how to make the required public disclosure.

In general, the Rule states that issuers can comply with the "public disclosure" requirement by filing a Form 8-K with the Commission containing the information (or, in the case of foreign private issuers, by filing a Form 6-K). ⁴⁹ We are proposing to add a new Item 10 to Form 8-K for disclosures made under Regulation FD. Should we permit issuers to make Regulation FD disclosures on existing Item 5 of Form 8-K as an alternative to proposed new Item 10? Item 5 is not confined to material disclosures; accordingly, if a registrant used Item 5 it would not acknowledge that the information disclosed was necessarily material. Is this a preferable approach?

As alternatives to making a Commission filing, the Rule permits an issuer to choose other methods of public disclosure. Under Rule 101(e)(2), an issuer will be exempt from the filing requirement if it uses one of the following alternative methods of public disclosure:

• First, an issuer could make public disclosure by disseminating a press release containing the information through a widely circulated news or wire service. Under current practice and SRO rules, corporate issuers typically provide press releases to services such as Dow Jones, Bloomberg, Business Wire, PR Newswire, or Reuters. Any of these services would continue to be a satisfactory means of making public disclosure.
• Second, an issuer could make public disclosure by disseminating information through any other method of disclosure that is reasonably designed to provide broad public access, and does not exclude access to members of the public – such as announcement at a press conference to which the public is granted access (for example, by personal attendance or by telephonic or electronic transmission). In order to afford broad public access, an issuer must provide notice of the disclosure in a form that is reasonably available to investors.

As noted above, current technology provides various means that issuers can use to transmit announcements and press conferences to the public. The Rule would not require use of any particular technological means, but would give issuers their choice of any method that did not limit public access to announcements and conferences.

An additional method for issuer dissemination of material information is posting the information on the issuer's website.⁵⁰ We encourage issuers who maintain websites to post information on their websites whenever they make public disclosure through one of the means described above. However, the proposed Rule would not consider a website posting by itself to be a sufficient means of public disclosure.⁵¹ Will this limitation make issuers less willing to post information on their websites?

We request comment on the proposal's approach for making public disclosure. We acknowledge that filings on EDGAR may only be made during specified hours, and only on business days of the Commission. In the case of filings permitted to be made in paper (as in the case of foreign private issuers), there are similar constraints because of our filing desk hours. Therefore, when an issuer is required to make public disclosure within 24 hours, the timing of a weekend or holiday may mean that EDGAR filing is not an available method of public disclosure. Issuers would therefore have to use one of the other methods. We solicit comment on whether this approach is workable, or whether we should alter the timing requirements of the Rule so that filing is always an available method. How else can we promote issuer flexibility and investor access?

We are also considering whether to require a delayed filing of a Form 8-K (within two business days) when an issuer chooses one of the other methods of making public disclosure. This would ensure that the information is part of the Commission's public files. Should we adopt this alternative approach? If so, is two business days the appropriate time period, or should it be shorter (e.g., one business day) or longer (e.g., five business days)?

Are the current technologies that we discuss available to all issuers? Are they prohibitively costly? Would they provide all investors with sufficient access? Are there other methods of public disclosure that might be as effective as a press release or an open press conference? Should these methods be specified in the Rule? Would an open press conference alone provide adequate dissemination of information in all circumstances (e.g., for smaller companies with less media or analyst coverage)? Should we require that information be posted on an issuer's website, if it has one, in addition to the other methods of publicizing the information?

6. Issuers Covered by the Regulation

Regulation FD would apply to all issuers with securities registered under Section 12 of the Exchange Act, and all issuers required to file reports under Section 15(d) of the Exchange Act, including closed-end investment companies but not including other investment companies. Are there any categories of issuers that should not be included? Should we have different and/or modified rules for small business issuers? If so, what modifications are warranted?

We are proposing to apply Regulation FD to foreign private issuers that are subject to the reporting requirements of the Exchange Act, although these foreign issuers would be permitted to make filings under the Regulation on Form 6-K rather than Form 8-K.⁵² The vast majority of these issuers have subjected themselves to such reporting requirements by their election to access U.S. markets. Most of the issuers have a class of securities listed on the New York or American Stock Exchanges, or are admitted to trading on the Nasdaq Stock Market. The listing standards of these markets make no distinction between domestic and foreign issuers in requiring timely disclosure of material information.⁵³

The content and timing of submissions on Form 6-K currently are based on a foreign private issuer's disclosure obligations and practices in its home jurisdiction and in any other jurisdiction where its securities are listed. We recognize that this Rule proposes for the first time to add a substantive disclosure requirement to Form 6-K, thereby changing the fundamental character of the form. We understand that some foreign issuers may view Regulation FD as requiring a change in what they consider to be normal communications with major shareholders, analysts, the press, labor unions, and other constituencies. In many cases, the disclosure requirements of Regulation FD also will impose a translation requirement on the information disclosed to the public and/or filed on Form 6-K. On the other hand, the benefits of the proposal to shareholders in all markets, not just the U.S. capital markets, may warrant the additional steps required of foreign issuers.

Regulation FD permits issuers to use other means for publicly disseminating non-intentional selective disclosures as alternatives to Forms 8-K or 6-K. Under current Form 6-K requirements, however, foreign private issuers are required to submit a Form 6-K containing any material information that is disseminated publicly, promptly after the dissemination. As proposed, foreign private issuers would not have to file a Form 6-K if they use one of the alternative means of disclosure permitted by Regulation FD.

We note that Forms 6-K are not currently required to be filed on EDGAR, which may impede investor access to information. Does this limitation make the requirement to file on Form 6-K less useful? If so, how should we address this issue?

We request comment on the proposed coverage of Regulation FD. Would it be appropriate to exempt all foreign private issuers from compliance with Regulation FD? If so, what would be the basis for this exemption and how would we address the impact on U.S. investors of having different requirements for selective disclosures by U.S. issuers and foreign private issuers? Would it be more appropriate to limit the application of Regulation FD to only certain foreign private issuers, such as those issuers with equity securities listed on a registered national securities exchange or the Nasdaq Stock Market National Market System, or foreign private issuers whose number of U.S. shareholders or volume of trading in our capital markets exceeds certain levels? If so, what levels should trigger the application of Regulation FD? Are there other ways the proposal could be modified to reduce the burden on foreign private issuers? Should foreign and domestic issuers be treated similarly with respect to the application of Section 18 to Regulation FD disclosure?

We are proposing to apply Regulation FD to closed-end investment companies, but not other types of investment companies. Investment companies that are continually offering their securities to the public already are required to update their prospectuses to disclose material changes subsequent to the effective date of the registration statement or any post-effective amendment, and are not permitted to sell, redeem, or repurchase their securities except at a price based on their securities' net asset value. While we believe that Regulation FD would offer little additional protection to investors in these types of investment companies and therefore they should be excluded from its coverage, these considerations do not apply in the case of closed-end investment companies. We are thus proposing to include closed-end investment companies within the requirements of Regulation FD.

At present, no form used by registered closed-end investment companies is equivalent to Form 8-K. In order to provide closed-end investment companies with the same disclosure options under Regulation FD available to operating companies, we propose to permit registered closed-end investment companies to file on Form 8-K for the sole purpose of making the public disclosure required by Regulation FD. The Commission does not intend by this rule proposal to otherwise require registered investment companies to file on Form 8-K.⁵⁴

We request comment on whether any investment companies should be covered by Regulation FD, and if so, which types of investment companies should be covered. Commenters should address whether there are specific types of information relating to investment companies that could be the subject of problematic selective disclosure (e.g., the impending departure of a portfolio manager who is primarily responsible for day-to-day management of the fund, or information relating to the fund's portfolio investments). We also request comment on whether it is appropriate for closed-end investment companies to file on Form 8-K for purposes of making disclosure under Regulation FD, and whether there should be a separate Item 11 for closed-end investment companies making disclosure on Form 8-K, so that members of the public can easily distinguish filings by closed-end investment companies from those of operating companies. Commenters that oppose the use of Form 8-K by closed-end investment companies should discuss other methods for obtaining equivalent disclosure from those companies.

7. Liability Issues and Securities Act Implications

Regulation FD is an issuer disclosure rule that is designed to create duties only under Sections 13(a) and 15(d) of the Exchange Act and Section 30 of the Investment Company Act. It is not an antifraud rule, and unlike other Section 13(a) and 15(d) reporting requirements, it is not intended to create duties under Section 10(b) of the Exchange Act or any other provision of the federal securities laws. As a result, no private liability will arise from an issuer's failure to file or make public disclosure.⁵⁵

If an issuer fails to comply with Regulation FD, however, it will be subject to an SEC enforcement action.⁵⁶ We could bring an administrative action seeking a cease and desist order, or a civil action seeking an injunction and/or civil money penalties.⁵⁷ In appropriate cases, we could also bring an enforcement action against the individual(s) at the issuer responsible for the violation, either as "a cause of" the violation in a cease and desist proceeding,⁵⁸ or as an aider and abetter of the violation in an injunctive action.⁵⁹

In addition, Regulation FD does not affect or undermine any existing bases of liability under Rule 10b-5. Thus, for example, liability for "tipping" under Rule 10b-5 may still exist if a selective disclosure is made in circumstances that meet the Dirks "personal benefit" test.⁶⁰ In addition, an issuer's failure to make a public disclosure still may give rise to liability under a "duty to correct" or "duty to update" theory in certain circumstances.⁶¹ And in other cases, an issuer's contacts with analysts may lead to liability under the "entanglement" or "adoption" theories.⁶²

Moreover, if an issuer's filing or public disclosure made under Regulation FD contained false or misleading information, or omitted material information, the issuer could incur liability for those misstatements or omissions. Rule 10b-5 would apply to any materially false or misleading statements made to the public, and if an issuer had filed a Form 8-K containing false or misleading information, Section 18 of the Exchange Act⁶³ would apply as well. If a Form 8-K filed under Regulation FD was required to be incorporated into an issuer's registration statement, it would be subject to liability under Section 11 of the Securities Act.⁶⁴ If the public disclosure is not filed on a Form 8-K, it may nevertheless be subject to Section 11 liability if the information is otherwise required to be included in a registration statement subject to Section 11.

As noted above, Regulation FD applies only to issuers that have securities registered under Section 12 of the Exchange Act or that are required to file reports under Section 15(d) of that Act. Accordingly, the Regulation would not apply during an issuer's initial public offering (IPO) of its securities prior to effectiveness of the registration statement.⁶⁵

The proposed Regulation would, however, apply to disclosures made by reporting issuers while they have pending registration statements for securities offerings. For example, the Regulation would apply to statements made in a "roadshow" for a reporting issuer's offering. In that situation, if an issuer made oral selective disclosure of material information, Regulation FD would require the issuer also to make public disclosure of the same information. This would be a departure from current distinctions in the Securities Act between oral and written communications around the time of an offering.⁶⁶

The required public disclosure could also be considered an "offer" of the securities for purposes of Section 5 of that Act,⁶⁷ and when made by writing or broadcast could be considered a "prospectus" for purposes of Section 2(a)(10) of the Act.⁶⁸ This creates the possibility that an issuer may violate Sections 5(c) or 5(b)(1) of the Securities Act by making the public disclosures required by Regulation FD.

To permit an issuer that has already filed a registration statement to make the required public disclosure without violating Section 5(b)(1) of the Securities Act, we are proposing new Rule 181 under the Securities Act. Under this Rule, any public disclosure required by Rule 100(a) of Regulation FD would not be required to satisfy the requirements of Section 10 of the Securities Act⁶⁹ for a prospectus, as long as the disclosure was made in compliance with Regulation FD. We request comment on whether this Rule should apply only to non-intentional disclosures. Should we place other conditions on the use of this Rule – for example, requiring the material information to be included in the registration statement at the time it is declared effective?

A more difficult situation arises when a reporting company is planning an offering, but has not yet filed a registration statement. A company may find itself in the position of being required by Regulation FD to disclose to the public information which could constitute an "offer" of its securities prior to the filing of a registration statement, contrary to Section 5(c). While companies are not supposed to make offers to anyone prior to filing a registration statement, an inadvertent disclosure of material nonpublic information to one person could result in an obligation to disclose information to the public, thus resulting in offers being made to many persons. If the company complies with the Regulation FD requirement in that situation, its disclosure would violate Section 5(c), and subject it to liability under Section 12(a)(1) if it proceeds with its offering. The public disclosure also could constitute a general solicitation and therefore preclude the company from undertaking a private exempt offering.

If the Commission were to adopt an exemption from Section 5(c) for Regulation FD-required disclosure, however, companies could abuse that exemption to make public communications that hype an offering before filing a registration statement with the Commission. In that event, the balanced full disclosure, against which to test the hyping information, would not be available. The protections of Section 5 could thus be eroded. While we have published proposals that, if adopted, would allow offers to be made prior to the filing of a registration statement in some offerings, those proposals did not extend to offerings by unseasoned companies to less sophisticated investors.⁷⁰ We proposed to retain the pre-filing prohibition on offers in those cases because of the continued need for this aspect of investor protection.

We request comment on whether we should also adopt an exemption from liability under Section 5(c) of the Securities Act for communications made before the filing of a registration statement. If we do so, should the exemption apply only to non-intentional disclosures? Do the same reasons for providing a Section 5(b)(1) exemption also apply to Section 5(c), either for all issuers, or for offerings made by very large issuers or to more sophisticated investors? Or could a Section 5(c) exemption provide issuers with such freedom to make public disclosures prior to filing a registration statement that issuers could engage in the hyping of an offering that Section 5(c) is designed to prevent?

With respect to the interplay between Regulation FD and the Securities Act, we request comment on the proposed approach described above. Should the Regulation also apply to issuers engaged in IPOs? Alternatively, given the liability questions under the Securities Act for these disclosures and the pending proposals in the Securities Act Reform release, should the Regulation not cover communications made as part of securities offerings under the Securities Act?

In our recent release on business combinations,⁷¹ we adopted non-exclusive exemptions under the Securities Act, proxy rules, and tender offer rules that permit communications with respect to business combinations⁷² for an unrestricted length of time without a cooling-off period between the end of communications and the filing of definitive disclosure documents. Those communication exemptions apply regardless of materiality, so long as the conditions to the exemption are satisfied. All written communications must be filed on the date of first use. Those communications must contain a prominent legend advising investors to read the registration, proxy, or tender offer statement, as applicable, when it becomes available. Under those rules, oral statements are not required to be reduced to writing and filed.

Proposed Regulation FD would impose requirements on material communications, written and oral, that are in addition to the filing and legend requirements of the new business combination rules. Any material information disclosed to the public, whether oral or written, would be required to be publicly disseminated by filing, press conference, news release, or otherwise.⁷³ Issuers may use confidentiality agreements to protect communications in the context of business combinations or other transactions which the issuers expressly mean to reserve from public disclosure. Early discussions among parties negotiating a transaction that are subject to confidentiality agreements among the parties and are kept confidential generally would not be subject to disclosure requirements of Regulation FD or the communications exemptions. Similarly, discussions between a party to a transaction and a security holder regarding a possible "lock-up" or other agreement generally would not be subject to these requirements so long as a confidentiality agreement is in effect.

Under current practice, parties negotiating a transaction do not always enter a confidentiality agreement, so Regulation FD may effect a change to current practice. Does this provide a practicable solution for parties seeking to negotiate transactions or to discuss "lock-ups"?

III. Insider Trading Issues

The prohibitions against insider trading in our securities laws play an essential role in maintaining the fairness, health, and integrity of our markets. We have long recognized that the fundamental unfairness of insider trading harms not only individual investors, but also the very foundations of our markets, by undermining investor confidence in the integrity of the markets. Congress, by enacting two separate laws providing enhanced penalties for insider trading,⁷⁴ has expressed its strong support for our insider trading enforcement program. And the Supreme Court in United States v. O'Hagan has recently endorsed a key component of insider trading law, the "misappropriation" theory, as consistent with "an animating purpose" of the federal securities laws: "to insure honest securities markets and thereby promote investor confidence."⁷⁵

Neither we nor Congress have expressly defined insider trading in a statute or rule. Instead, insider trading law has developed on a case-by-case basis under the antifraud provisions of the federal securities laws, primarily Section 10(b) of the Exchange Act and Rule 10b-5. As a result, from time to time there have been issues on which various courts have disagreed. With the Supreme Court's O'Hagan decision, the fundamental issues in insider trading law are now settled. Today's proposals address two issues on which disagreement remains.

A. Rule 10b5-1: Trading "On the Basis of" Material Nonpublic Information

1. Background

One unsettled issue in insider trading has been what, if any, causal connection must be shown between the trader's possession of inside information and his or her trading. In enforcement cases, we have argued that a trader may be liable for trading while in "knowing possession" of the information. The contrary view is that a trader will not be liable unless it is shown that he or she "used" the information for trading.

Until recent years, there has been little case law discussing this issue. Although the Supreme Court has variously described an insider's violations as involving trading "on"⁷⁶ or "on the basis of"⁷⁷ material nonpublic information, it has not addressed the use/possession issue. Three recent court of appeals cases address the issue, but have reached different results.

The three court of appeals cases recognize the practical difficulty of divorcing a trader's knowing possession, or awareness, of inside information from its "use" in a trade. In United States v. Teicher,⁷⁸ the Second Circuit suggested that "knowing possession" is sufficient to trigger insider trading liability, for precisely this reason.⁷⁹ In SEC v. Adler, the Eleventh Circuit held that "use" was the ultimate issue, but that proof of "possession" provides a "strong inference" of "use" that suffices to make out a prima facie case.⁸⁰ In United States v. Smith, the Ninth Circuit required that "use" be proven in a criminal case.⁸¹

The Adler court suggested that we could adopt a new rule or amend existing Rule 10b-5 to adopt a presumption approach or to provide for liability for trading while in "knowing possession" of material nonpublic information.⁸² In view of the differing opinions expressed in the three cases discussed above, we agree that it would be useful to define the scope of Rule 10b-5, as it applies to the use/possession issue.

In our view, the goals of insider trading prohibitions – protecting investors and the integrity of securities markets – are best accomplished by a standard closer to the "knowing possession" standard. Whenever a person purchases or sells a security while aware of material nonpublic information that has been improperly obtained, that person has the type of unfair informational advantage over other participants in the market that insider trading law is designed to prevent.⁸³ As a practical matter, in most situations it is highly doubtful that a person who knows inside information relevant to the value of a security can completely disregard that knowledge when making the decision to purchase or sell that security. In the words of the Second Circuit, "material information can not lay idle in the human brain."⁸⁴ Indeed, even if the trader could put forth purported reasons for trading other than awareness of the inside information, other traders in the market place would clearly perceive him or her to possess an unfair advantage.

On the other hand, we recognize that an absolute standard based on knowing possession, or awareness, could be overbroad in some respects. Sometimes a person may reach a decision to make a particular trade without any awareness of material nonpublic information, but then come into possession of such information before the trade actually takes place. A rigid "knowing possession" standard would lead to liability in that case. We believe, however, that for many cases of this type, a reasonable standard would not make such trading automatically illegal.

The Adler case attempted to balance these considerations by means of a "use" test with a strong inference of use from "possession." We propose a somewhat different approach today: a general rule based on "awareness" of the material nonpublic information, with several carefully enumerated exceptions. We believe our proposed Rule would lead to the same outcome as Adler in almost all insider trading cases, but will provide greater clarity and certainty than a presumption or "strong inference" approach. Our proposed approach will better enable insiders and issuers to conduct themselves in accordance with the law.

2. Proposed Rule 10b5-1

Proposed Rule 10b5-1 is designed to address only the use/possession issue in insider trading cases under Rule 10b-5. As the Preliminary Note states, the Rule does not modify or address any other aspect of insider trading law, which has been established by case law under Rule 10b-5.

Paragraph (a) sets forth the general prohibition of insider trading contained in existing case law. Under existing law, it is illegal to trade a security "on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information."⁸⁵ This language incorporates all theories of insider trading liability under the case law – classical insider trading, temporary insider theory, tippee liability, and trading by someone who misappropriated the inside information.⁸⁶

Paragraph (b) defines trading "on the basis of" material nonpublic information. A trade is on the basis of material nonpublic information if the trader "was aware of" the information when he or she made the purchase or sale. Thus, the general rule is that "awareness" of the inside informationinevitably leads to use of the information, and provides a sufficient basis for liability.

Paragraph (c) provides specific affirmative defenses against liability. A purchase or sale is not "on the basis of" information when a person can establish that one of four exclusive situations is true. These four defenses cover situations in which a person can show that the information he or she possessed was not a factor in the trading decision.

First, an affirmative defense is available if, before becoming aware of material nonpublic information, a person had entered into "a binding contract" to trade "in the amount" and "at the price" and on the date at which he or she ultimately traded.⁸⁷ This defense permits persons to carry out pre-existing contracts to purchase or sell a specified number (or dollar amount) of shares of a particular security at a specified price (or at the market price), as long as the person was not aware of material nonpublic information when he or she entered into the contract.⁸⁸

Second, an affirmative defense is similarly available if, before becoming aware of material nonpublic information, a person "had provided instructions to another person to execute" a trade for the instructing person's account, "in the amount, at the price, and on the date" at which that trade was ultimately executed.⁸⁹ This defense would apply, for example, to an insider who instructs his or her broker to execute a plan to sell stock in accordance with Rule 144 at the expiration of a required holding period. If the insider provides the instructions without awareness of any material nonpublic information, the Rule would permit him or her to complete the previously instructed sales plan even if he or she later became aware of inside information.

Third, the Rule provides an affirmative defense if, before becoming aware of material nonpublic information, a person "[h]ad adopted, and had previously adhered to, a written plan specifying purchases or sales of the security in the amounts, and at the prices, and on the dates at which the person purchased or sold the security."⁹⁰ This provision is designed to apply in the case of an insider who wishes to establish a regular, pre-established program of buying or selling his or her company's securities. If the plan is established before the insider is aware of material nonpublic information, and provides for specified trades at specified times, the insider will be permitted to engage in those trades even if he or she later becomes aware of material nonpublic information. As discussed below, plans of this type must be entered into in good faith, and not as part of a plan or scheme to evade insider trading prohibitions.⁹¹

Fourth, the Rule provides an affirmative defense for purchases or sales that result from a written plan for trading securities that is designed to track or correspond to a market index, market segment, or group of securities.⁹² This defense would permit trading by an index fund, for example, where the fund's trading strategy was pre-established by the fund or its manager, even if the manager later became aware of material nonpublic information regarding one of the securities in the index. The defense would be available if the plan was sufficiently circumscribed to prevent trading decisions from being affected by the manager's later awareness of material nonpublic information.

The Rule provides one important limitation on the availability of all of the affirmative defenses. Paragraph (c)(1)(ii) states that a defense would be available only if a contract, plan, or instruction to trade relied on for a defense was entered into in good faith, and not as part of a plan or scheme to evade the prohibitions of this Rule. If a person changes a previous contract, plan, or instruction in any respect after becoming aware of material nonpublic information, he or she will lose any defense against liability. Thus, for example, if an insider enters into a contract or plan to sell 1, 000 shares of his or her company's stock without being aware of material nonpublic information, then learns negative material nonpublic information and doubles his or her planned sale to 2, 000 shares, he or she will lose the defense for the entire sale of 2, 000 shares. Similarly, if the insider accelerates the timing of a planned sale in order to complete it before the release of negative corporate news that he or she has recently learned, he or she will have no defense for the transaction.

Paragraph (c)(1)(ii) also specifies that a person will lose any defense for a trade if he or she enters into or alters a "corresponding or hedging transaction or position" with respect to the planned securities trade. This requirement is designed to prevent persons from devising schemes to exploit inside information by setting up pre-existing hedged trading programs, and then canceling execution of the unfavorable side of the hedge, while permitting execution of the favorable transaction. By altering the corresponding position, the insider would lose any defense for the transaction that he or she permitted to be executed.⁹³

The Rule provides an additional, separate affirmative defense designed solely for entities that trade.⁹⁴ This defense is derived from the defense against liability currently provided in Exchange Act Rule 14e-3(b)⁹⁵ regarding insider trading in a tender offer situation. To meet this defense, an entity must demonstrate two things: first, that the individual(s) making the decision on behalf of the entity was not aware of the inside information; and second, that the entity had implemented reasonable policies and procedures (e.g., informational barriers, restricted lists) to prevent insider trading.

3. Request for Comments

We request comments on all aspects of proposed Rule 10b5-1. Is the approach we propose – a general standard of "awareness" of the information, with specific affirmative defenses – the appropriate one? Are the proposed affirmative defenses appropriate? Should we provide additional defenses to liability, and if so, what should they be? Are the provisions defining the "amount" and "price" of pre-planned trades specific enough to permit plans to be made? Should we require written plans or instructions in all cases? Should we require that contracts, instructions, or trading plans be approved by counsel?

We also request comment on whether the defense for institutional traders is appropriate and adequate. Has this provision worked effectively for entities subject to Rule 14e-3? Is there any reason the same type of provision would not be adequate for this Rule?

B. Rule 10b5-2: Duties of Trust or Confidence in Misappropriation Insider Trading Cases

1. Background

In United States v. O'Hagan, the Supreme Court upheld the misappropriation theory of insider trading.⁹⁶ Under that theory, a person commits fraud in violation of Section 10(b) of the Exchange Act and Rule 10b-5 by misappropriating material nonpublic information for securities trading purposes, in breach of a duty of loyalty and confidence.

Certain types of businessrelationships by themselves provide the duty of trust or confidence necessary in a misappropriation theory case. In O'Hagan, for example, the attorney-client relationship established the duty of confidence. In other cases, the agency relationship inherent in an employer-employee relationship provides the duty.⁹⁷ It is not as settled, however, under what circumstances certain non-business relationships, such as family and personal relationships, may provide the duty of trust or confidence required under the misappropriation theory.

Two courts have considered this issue in criminal cases: United States v. Chestman⁹⁸ and United States v. Reed.⁹⁹ Although Chestman and Reed took into account common law notions of fiduciary and confidential relationships, they both took a relatively narrow view of when a duty of confidence exists in the context of criminal liability for insider trading.

In Reed, the court did not find a father-son relationship sufficient in itself to provide the required duty of confidence. But it stated that if family members have a prior history of sharing confidences, such that one family member has a reasonable expectation that the other will keep those confidences, there may be a sufficient relationship of trust and confidence. The final determination is left to the fact finder.¹⁰⁰

In Chestman, a narrow majority of the Second Circuit en banc, while not overruling Reed, took a more restrictive view.¹⁰¹ The Chestman majority held that marriage alone does not suffice to create a fiduciary relationship.¹⁰² It stated that in the absence of an "express agreement of confidentiality, " or a "pre-existing fiduciary-like relationship between the parties" to a family relationship, there is not a sufficient basis for establishing the necessary duty to support a fraud conviction under the misappropriation theory.¹⁰³

Chestman makes clear that its narrow approach, in contrast to the "elastic" definition of confidential relations employed by courts of equity in the civil context, was influenced by the criminal context of the case before it.¹⁰⁴ In our view, however, the Chestman majority's approach does not fully recognize the degree to which parties to close family and personal relationships have reasonable and legitimate expectations of confidentiality in their communications.¹⁰⁵ For this reason, we believe the Chestman majority view does not sufficientlyprotect investors and the securities markets from the misappropriation and resulting misuse of inside information.

We have investigated and prosecuted a large number of insider trading cases that involved trading by friends or family members of insiders. In many of these cases, the evidence supports the claim that the insider intended to give the information to the friend or family member for trading.¹⁰⁶ The evidence in such cases supports liability under a classical tipper-tippee theory.¹⁰⁷

In other circumstances, however, the evidence does not support the view that the disclosing insider intended or expected that the recipient of the inside information would trade. Instead, the evidence indicates that the insider confided the material nonpublic information to the friend or relation with the reasonable expectation that the recipient of the information would maintain the confidence. In those situations, a classical tipper-tippee theory of liability would probably not be available under the Dirks analysis. The misappropriation theory of liability would fit the facts better, because the trader breached a duty of confidentiality to the disclosing insider when he or she traded on the basis of the inside information. However, misappropriation liability is very difficult to establish in these situations under the restrictive analysis of Chestman, because Chestman appears to require either an express agreement of confidentiality, or a pre-existing fiduciary-like relationship that included the prior sharing of business confidences. Stated differently, under Chestman, it is not sufficient that the disclosing insider had a reasonable expectation of confidentiality based on his or her prior relationship with the trader.

Chestman thus leads to the following anomalous result. A family member who receives a "tip" (within the meaning of Dirks) and then trades violates Rule 10b-5. A family member who trades in breach of an express promise of confidentialityalso violates Rule 10b-5. A family member who trades in breach of a reasonable and legitimate expectation of confidentiality, however, does not necessarily violate Rule 10b-5.

We think that this anomalous result harms investor confidence in the integrity and fairness of the nation's securities markets. The family member's trading has the same impact on the market and investor confidence in the third example as it does in the first two examples. In all three examples the trader's informational advantage "stems from contrivance, not luck, " and the informational disadvantage to other investors "cannot be overcome with research or skill."¹⁰⁸ We believe that permitting the trader in the third example to trade legally is inconsistent with investors' expectations about what types of informational advantages can be properly exploited. Moreover, this result provides all trading family members – including those in the classical tipper-tippee example – with a roadmap for concocting a story that could provide a lawful explanation for the trading. Finally, the need to distinguish between the three types of cases may require an unduly intrusive examination of the details of particular family relationships.

Accordingly, we believe that there is good reason for the broader approach we propose today for determining when family or personal relationships create "duties of trust or confidence" under the misappropriation theory. Our proposed approach is not designed to interfere with particular family or personal relationships; rather, our goal is to protect investors and the fairness and integrity of the nation's securities markets against improper trading on the basis of inside information.

2. Proposed Rule 10b5-2

Proposed Rule 10b5-2 sets forth a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the "misappropriation" theory of insider trading under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. As stated in the Preliminary Note to the Rule, the law of insider trading is otherwise defined by judicial opinions interpreting Rule 10b-5, and this Rule is not intended to address or modify the scope of insider trading law in any other respect.

Paragraph (a) states that the Rule applies to any cases based on the misappropriation theory of insider trading, whether involving trading or tipping. Paragraph (b) enumerates a non-exclusive list of circumstances under which a "duty of trust or confidence" shall exist.¹⁰⁹

a. Agreement Between the Parties

First, whenever a person agrees to maintain information in confidence, a duty of trust or confidence exists.¹¹⁰ This reflects the common-sense notion, acknowledged in Reed and Chestman, that reasonable expectations of confidentiality, and corresponding duties, can be created by an agreement between two parties. Although sometimes, most commonly in a business context, the parties will sign an express, written confidentiality agreement, the Rule does not require either a written or an express confidentiality agreement. This approach recognizes the fact that in everyday personal interactions, individuals frequently rely on reasonable, implicit understandings of confidentiality. In some situations, it may not be realistic or socially acceptable to insist that a close friend or relative execute a signed confidentiality agreement, or expressly consent to an oral agreement.

b. Relationships With A History, Pattern, Or Practice Of Sharing Confidences

Second, the Ruleprovides that a duty of trust or confidence exists when two people have a "history, pattern, or practice of sharing confidences, such that the person communicating the material nonpublic information has a reasonable expectation that the other person would maintain its confidentiality."¹¹¹ This part of the Rule does not use a bright line test that enumerates specific relationships, but instead sets forth a "facts and circumstances" analysis derived from Reed. This standard recognizes that in some circumstances a past pattern of conduct between two parties will lead to a legitimate, reasonable expectation of confidentiality on the part of the confiding person. This analysis does not requirethat the history, pattern, or practice of sharing confidences include the sharing of business confidences for there to be a duty of trust or confidence for purposes of misappropriation liability. However, evidence about the type of confidences shared in the past might be relevant to determining the reasonableness of the expectation of confidentiality.

We request comments on the approach proposed in paragraph (b)(2). Does the requirement of a prior "history, pattern, or practice" of sharing confidences provide a sufficiently well-defined standard? Should other factors be relevant to the analysis as well?

c. Enumerated Family Relationships

Third, paragraph (b)(3) sets forth a bright line liability rule for certain enumerated close family relationships, but allows for an affirmative defense. Spousal, parent-child,¹¹² and sibling relationships would be sufficient in themselves as a basis for misappropriation theory liability. Ourenforcement experience demonstrates that these are the relationships in which family members most commonly share information with alegitimate expectation of trust or confidentiality.¹¹³ These also are normally the types of close familial relationships in which the parties have a history, pattern, or practiceof sharing confidences that would lead to a reasonable expectation of confidentiality.

Paragraph (b)(3) permits the person receiving or obtaining the information to assert an affirmative defense by demonstrating that under the facts and circumstances of that particular family relationship, no duty of trust or confidence existed. To demonstrate this, the person must establish that the disclosing family member did not have a reasonable expectation of confidentiality because the parties had neither: (a) a history, pattern, or practice of sharing confidences; nor (b) an agreement or understanding to maintain the confidentiality of the information. If the person receiving or obtaining the information can satisfy the requirements of the affirmative defense set forth in paragraph (b)(3), he or she would not be liable under Rule 10b5-2.

Paragraph (b)(3) does not reach non-traditional relationships (e.g., domestic partners) or more extended family relationships. However, paragraphs (b)(1) and (b)(2) could reach these relationships, depending on the factual context of the relationship. We request comment on whether this is an appropriate distinction.

Are the family relationships enumerated in paragraph (b)(3) the proper ones to cover, or is the list too narrow or too broad? Should the list of enumerated relationships be limited to family members residing in the same household? Should it expressly encompass step-parents and step-children? Should it expressly encompass non-traditional relationships, and if so, which ones? Should it include additional family relationships, such as the list of family relationships covered in our Section 16 rules?

3. Request for Comments

We request comment on all aspects of Proposed Rule 10b5-2. For non-enumerated relationships, does paragraph (b)(2) focus on the proper factors for determining whether a reasonable expectation of confidentiality exists? Is the approach of paragraph (b)(3) – a per se rule with an affirmative defense for certain enumerated family relationships – the most suitable one, or should a different standard be employed?

IV. General Request for Comments

We invite you to submit comments on proposed Regulation FD, Rule 10b5-1, and/or Rule 10b5-2. If you have empirical data relevant to proposed Regulation FD, Rule 10b5-1, or Rule 10b5-2, please include it with your comments. Please submit three copies of your comment letter to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609. You may also submit comments electronically to the following e-mail address: rule-comments@sec.gov. Refer to File No. S7-31-99. If you are commenting by e-mail, include this file number on the subject line. We will make comments available for public inspection and copying in the Commission's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. In addition, we will post electronically submitted comment letters on our Internet Website (http://www.sec.gov).

V. Paperwork Reduction Act

Certain provisions of Regulation FD, and the related amendments to Form 8-K and Form 6-K under the Exchange Act, contain "collections of information" requirements within the meaning of the Paperwork Reduction Act of 1995,¹¹⁴ and the Commission has submitted the proposal to the Office of Management and Budget ("OMB") for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number.

Form 8-K (OMB Control No. 3235-0060)¹¹⁵ was adopted pursuant to Sections 13, 15, and 23 of the Exchange Act. Form 8-K prescribes information, such as material events or corporate changes, that a registrant must disclose. Form 6-K (OMB Control No. 3235-0116)¹¹⁶ was adopted pursuant to Sections 13 and 15 of the Exchange Act. Form 6-K prescribes information that foreign private issuers subject to the reporting requirements of the Exchange Act must disclose. The Commission is also proposing to create a new information collection entitled "Reg. FD - Other Disclosure Materials." This information collection will encompass press releases, webcasts, announcements, conference calls, etc. that are conducted pursuant to Regulation FD, which is proposed pursuant to Sections 13, 15, 23, and 36 of the Exchange Act, and that are not filed under cover of Form 8-K or Form 6-K.

The Commission currently estimates that Form 8-K results in a total annual compliance burden of 140, 500 hours. The burden was calculated by multiplying the estimated number of Form 8-K filings annually (approximately 28, 100) by the estimated average number of hours each entity spends completing the form (approximately 5 hours). The Commission based the number of entities that would complete and file each of the forms on the actual number of filers during the 1999 fiscal year. The staff estimated the average number of hours each entity spends completing each of the forms by contacting a number of law firms and other persons regularly involved in completing the forms.

The Commission currently estimates that Form 6-K results in a total annual compliance burden of 91, 848 hours and $515, 000 non-labor burden costs. This was calculated by multiplying the estimated number of Form 6-K filings annually (approximately 11, 481) by the estimated average number of hours each entity spends completing the form (approximately 8 hours) and adding the non-labor burden costs. The Commission based the number of entities that would complete and file each of the forms on the actual number of filers during the 1999 fiscal year. The staff estimated the average number of hours each entity spends completing each of the forms by contacting a number of law firms and other persons regularly involved in completing the forms.

We believe that the proposed Regulation is necessary to provide for fairer and more effective disclosure of issuer information to all investors and thereby bolster investor confidence in the securities markets. Under the proposed Regulation, issuers would be required to simultaneously (or, in some instances, promptly), upon first disclosure of material, nonpublic information, publicly disclose the information broadly. The disclosure could be made by filing a Form 8-K or Form 6-K with the Commission, disseminating a press release to a widely circulated news or wire service, or disseminating the information through any other method of disclosure that is reasonably designed to provide broad public access to the information and does not exclude any members of the public from access.

We estimate that, on average, completing and filing a Form 8-K under proposed Regulation FD would require the same amount of time currently spent by entities completing the Form – approximately 5 hours. We estimate that, on average, completing and filing a Form 6-K under proposed Regulation FD would require the same amount of time spent completing Form 6-K – approximately 8 hours. As noted, however, under the proposed Regulation, companies are exempt from the requirement to file a Form 6-K or Form 8-K if they disseminate a press release to a widely circulated news or wire service or disseminate the information through any other method of disclosure that is reasonably designed to provide broad public access to the information and does not exclude any members of the public from access. We estimate that other methods of disclosure, such as press releases and press conferences, will require no more than the preparation time of Form 8-K – less than 5 burden hours.

We anticipate that, under Regulation FD, companies will make five¹¹⁷ disclosures per year.¹¹⁸ Since there are approximately 14, 000 companies affected by this Regulation, we estimate that there will be 70, 000 additional disclosures per year under Regulation FD. Based on a burden hour estimate of five hours, we anticipate that companies will incur 350, 000 additional burden hours under Regulation FD.¹¹⁹

Compliance with the disclosure requirements is mandatory. There would be no mandatory retention period for the information disclosed, and responses to the disclosure requirements will not be kept confidential.

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (i) evaluate whether the proposed collection of information is necessary for the proper performance of the functions of the agency, including whether the information will have practical utility; (ii) evaluate the accuracy of the Commission's estimate of the burden of the proposed collection of information; (iii) determine whether there are ways to enhance the quality, utility, and clarity of the information to be collected; and (iv) evaluate whether there are ways to minimize the burden of the collection of information on those who are to respond, including through the use of automated collection techniques or other forms of information technology.

Persons submitting comments on the collection of information requirements should direct the comments to the Office of Management and Budget, Attention: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Washington, D.C. 20503, and should send a copy to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609, with reference to File No. S7-31-99. Requests for materials submitted to OMB by the Commission with regard to these collections of information should be in writing, refer to File No. S7-31-99, and be submitted to the Securities and Exchange Commission, Records Management, Office of Filings and Information Services. OMB is required to make a decision concerning the collection of information between 30 and 60 days after publication of this release. Consequently, a comment to OMB is assured of having its full effect if OMB receives it within 30 days of publication.

VI. Cost-Benefit Analysis

A. Regulation FD: Selective Disclosure

Proposed Regulation FD would require that when an issuer intentionally discloses material nonpublic information to any person outside the issuer, it must simultaneously make public disclosure, and when it unintentionally discloses material nonpublic information, it must promptly make public disclosure.

Proposed Regulation FD is intended to produce several important benefits to investors and the securities markets as a whole. First, Regulation FD will inhibit current practices of selective disclosure, which damage investor confidence in the fairness and integrity of the markets. One recent study indicates that analysts and institutional investors immediately use information received in conference calls to trade.¹²⁰ Traders on the other side of these transactions, who are excluded from the conference calls, do not have the same information as the more informed analysts and selected investors. Numerous individual investors have complained about this practice. By addressing selective disclosure of material information, the proposed Regulation will foster fairer disclosure of information to all investors, and thereby increase investor confidence in market integrity.

By enhancing investor confidence in the markets, we believe the proposed Regulation will encourage continued widespread investor participation in our markets, which will enhance market efficiency and liquidity, and foster more effective capital raising.

Second, we believe that issuers may also benefit from more open and fair disclosure practices. One study concluded that companies that more liberally disclose information have a larger analyst following, a narrower consensus in earnings estimates, and a low stock price volatility, which likely leads to a lower cost of equity capital.¹²¹ Proposed Regulation FD would encourage these beneficial disclosure practices.

Third, the proposed Regulation likely will also provide benefits to securities analysts and others in the market for information. This Regulation will place all analysts on equal competitive footing with respect to access to material information. As well, this Regulation will allow analysts to express their honest opinions without fear of being denied access to valuable corporate information.¹²² Analysts will continue to be able to use and benefit from superior diligence or acumen, without facing the prospect that other analysts will have a competitive edge based solely on better access to corporate insiders.

We do not currently have sufficient information to quantify these or other benefits. We therefore request your comments, including supporting data, on the benefits of the Regulation.

The proposed Regulation would impose some costs on issuers. First, there will be some additional cost to publicly disclose material nonpublic information on a non-selective basis. This proposal gives issuers three options for making public disclosure. The issuer can: (1) file a Form 8-K¹²³ or Form 6-K;¹²⁴ (2) disseminate a press release containing the material nonpublic information through a widely circulated news or wire service; or (3) disseminate the information through any other method of disclosure that is reasonably designed to provide broad public access to the information and does not exclude any members of the public from access (e.g., teleconference, web-conference).

Because the Regulation does not require issuers to disclose material information (just to make any disclosure on a non-selective basis), we cannot predict with certainty how many issuers will actually make disclosures under this Regulation. For purposes of the Paperwork Reduction Act, however, we estimate that issuers will make five¹²⁵ public disclosures under Regulation FD per year.¹²⁶ Since there are approximately 14, 000 issuers affected by this Regulation, we estimate that the total number of disclosures under Regulation FD per year will be 70, 000.

If an issuer files a Form 8-K, we estimate that the issuer would incur, on average, five burden hours per filing. This estimate is based on current burden hour estimates under the Paperwork Reduction Act for filing a Form 8-K and the staff's experience with such filings. We believe that approximately 75% of the burden hours are expended by the company's internal professional staff, and the remaining 25% by outside counsel. Assuming a cost of $85/hour for in-house professional staff and $125/hour for outside counsel, we believe the total cost is $475 per filing.

If an issuer files a Form 6-K, we estimate that the issuer would incur, on average, eight burden hours per filing and other miscellaneous costs of $45 per filing. This estimate is based on estimates under the Paperwork Reduction Act for filing a Form 6-K and the staff's experience with such filings. We believe that approximately 75% of the burden hours are expended by the issuer's internal professional staff, and the remaining 25% by outside counsel. Assuming a cost of $85/hour for in-house professional staff and $125/hour for outside counsel, we believe the total cost is $805 per filing.

We have no hard data on which to base estimates of the costs of other disclosure options. However, we anticipate that other methods of disclosure, such as press releases, may require less preparation time than a Form 8-K. If the costs of the other methods of disclosure are less than the cost of filing the Form 8-K, we presume issuers will choose the other methods of public disclosure. Issuers may, however, choose to use methods of dissemination with higher out-of-pocket costs, presumably because they believe these methods provide additional benefits to the issuer or investor.

Given that we estimate that there will be 70, 000 disclosures under Regulation FD per year at a cost of approximately $475 per disclosure, ¹²⁷ we estimate that the total paperwork burden of preparing the information for disclosure per year will be approximately $33, 250, 000.

We request your comments, including supporting data, on our estimates of the costs of each disclosure option, the number of times a company will make a disclosure in a year, and which method companies are likely to use.

The proposed Regulation may also lead to some increased costs for issuers resulting from new or enhanced systems and procedures for disclosure practices. We believe that many, if not most, issuers already have internal procedures for communicating with the public; for many issuers, therefore, new procedures to prevent selective disclosures will not be needed. There might be a cost to these issuers, however, for enhancing and strengthening existing procedures to ensure that nonpublic material information is not inadvertently disclosed and for disclosing inadvertently released materials promptly. We do not have data to quantify the cost of enhancing and strengthening existing internal monitoring procedures, and we seek your comments and supporting data on these costs.

We are sensitive to the concern that the proposed Regulation might "chill" corporate disclosures to analysts, investors, and the media. Issuers may speak less often out of fear of a post hoc assessment that disclosed information was material. If the Regulation has such a chilling effect, there would be a cost to overall market efficiency. However, there are numerous practices that issuers may employ to continue to communicate freely with analysts and investors, while becoming more careful in how they disclose information. Moreover, the Regulation only covers the selective disclosure of material nonpublic information; the level of "soft" or non-material information available to the market need not decrease. As well, we believe issuers have strong reasons to continue releasing information, given the market demand for information and a company's desire to promote its products and services. Further, we note that, in light of existing SRO rules and disclosure practice guidance provided by organizations such as NIRI, many issuers are currently conducting their disclosure practices in a manner consistent with the proposed Regulation. In light of these factors, we request your comments on the effect the proposed Regulation will have on information flow. Please support your comments and conclusions with data.

Today's proposal is designed to create duties only under Sections 13(a) and 15(d) of the Exchange Act, and the Regulation does not create new duties under Section 10(b) of the Exchange Act. We nevertheless request comments on liability exposure, including the underlying case law if applicable, and we request your estimates of any costs that may result from increased risk of liability.

Are there other costs we have not identified? Please supply data to help us estimate the cost.

B. Proposed Rule 10b5-1: Trading "On the Basis of" Material Nonpublic Information

Proposed Rule 10b5-1 would define when a sale or purchase of a security occurred "on the basis of" material nonpublic information. Under the proposed Rule, a person trades "on the basis of" material nonpublic information if the person making the purchase or sale was aware of the material nonpublic information at the time of the purchase or sale. However, the proposed Rule provides affirmative defenses to liability when a trade resulted from a pre-existing plan, contract, or instruction that was made in good faith.

We anticipate two significant benefits arising from proposed Rule 10b5-1. First, the Rule should increase investor confidence in the integrity and fairness of the market because it clarifies and strengthens existing insider trading law. Second, the proposed Rule will benefit corporate insiders by providing greater clarity and certainty on how they can plan and structure securities transactions. The Rule provides specific guidance on how a person can plan future transactions at a time when he or she is not aware of material nonpublic information without fear of incurring liability. We believe that this guidance will make it easier for corporate insiders to conduct themselves in accordance with the laws against insider trading. We seek your comments and supporting data on these or other benefits that we have not identified.

The Rule does not require any particular documentation or recordkeeping by insiders, although it would, in some cases, require a person to document a particular plan, contract, or instruction for trading if he or she wished to establish an affirmative defense that his or her trading was not "on the basis of" material nonpublic information. We therefore do not attribute any costs to this aspect of the proposed Rule. We seek comments and data on any costs that this Rule would impose.

C. Rule 10b5-2: Duties of Trust or Confidence in Misappropriation Insider Trading Cases

Proposed Rule 10b5-2 would enumerate three non-exclusive bases for determining when a person receiving information was subject to a duty "of trust or confidence" for purposes of the misappropriation theory of insider trading. Two principal benefits are likely to result from this Rule. First, the Rule will provide greater clarity and certainty to the law on the question of when a family relationship will create a duty of trust or confidence. Second, the Rule will address an anomaly in current law under which a family member receiving material nonpublic information may exploit it without violating the prohibition against insider trading. By addressing this potential gap in the law, the Rule would enhance investor confidence in the integrity of the market. We do not attribute any costs to this aspect of the proposed Rule. We seek comments and data on any costs that this Rule would impose.

VII. Consideration of the Burden on Competition, and Promotion of Efficiency, Competition, and Capital Formation

For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996,¹²⁸ the Commission is requesting information regarding the potential impact of the proposals on the economy on an annual basis. Commenters should provide empirical data to support their views.

Section 23(a) of the Exchange Act¹²⁹ requires the Commission, when adopting rules under the Exchange Act, to consider the anti-competitive effects of any rule it adopts. Because we do not believe the rules would affect companies differently, we do not believe that the proposals would have any anti-competitive effects. We request comment on any anti-competitive effects of the proposals.

In addition, Section 3(f) of the Exchange Act¹³⁰ requires the Commission, when engaging in rulemaking that requires it to consider or determine whether an action is necessary or appropriate in the public interest, to consider whether the action will promote efficiency, competition, and capital formation. We believe that the proposals would bolster investor confidence in the securities markets by improving both the actual and perceived equity of the information available to investors from all companies. Accordingly, the proposals should promote capital formation and market efficiency. We anticipate no impact on competition. We request comment on these matters.

VIII. Initial Regulatory Flexibility Analysis

This Initial Regulatory Flexibility Analysis has been prepared in accordance with 5 U.S.C. 603. It relates to proposed new Regulation FD, Rule 10b5-1, and Rule 10b5-2 under the Exchange Act, as amended. The proposed Regulation and Rules address the selective disclosure of material information and clarify two unsettled issues under current insider trading law.

A. Reasons for the Proposed Action

The proposed Rules address three separate issues. Regulation FD addresses the problem of issuers making selective disclosure of material nonpublic information to analysts or particular investors before making disclosure to the investing public. Rules 10b5-1 and 10b5-2 address two unsettled issues in insider trading case law: (1) whether the Commission needs to show that a defendant "used" material nonpublic information in an insider trading case, or merely that the defendant traded while in "knowing possession" of the information; and (2) when a family or other non-business relationship can give rise to liability under the misappropriation theory of insider trading. By addressing these issues, the proposals will enhance investor confidence in the fairness and integrity of the securities markets.

B. Objectives

Proposed Regulation FD would require that when an issuer intentionally discloses material nonpublic information it do so through public disclosure, not selective disclosure. When an issuer has made a non-intentional selective disclosure, Regulation FD would require the issuer to make prompt public disclosure thereafter. The proposed Regulation provides for several alternative methods by which an issuer can make the required public disclosure. We believe that this proposal will provide for fairer and more effective disclosure of important information by issuers to the investing public.

Proposed Rule 10b5-1 would resolve the unsettled case law on whether the Commission must prove that a defendant "used" or traded while in "knowing possession" of material nonpublic information in order to prove insider trading liability. The proposal would provide a general rule that liability arises when a person trades while "aware" of material nonpublic information. It provides four defenses against liability, in cases where a trade resulted from a pre-existing plan, contract, or instruction that was made in good faith. It also provides a defense against liability for trading by entities, including small entities, when the individual making the trade was not aware of the information, and the entity had implemented reasonable procedures to prevent insider trading. We believe this proposed Rule would clarify an important issue in insider trading law, and thereby enhance investor confidence in market integrity.

Proposed Rule 10b5-2 would define when a non-business relationship, such as a family or personal relationship, may provide the duty of trust and confidence required under the misappropriation theory of insider trading. This issue currently is also unsettled in the case law. Moreover, we believe that the main case on the issue, which arose in a criminal prosecution, does not fully recognize the degree to which parties to close family and personal relationships have reasonable and legitimate expectations of confidentiality in their communications, and leads to anomalous results in certain situations. Accordingly, the proposed Rule defines the scope of "duties of trust and confidence" for purposes of the misappropriation theory in a manner that more appropriately serves the purposes of insider trading law. Proposed Rule 10b5-2 will have no direct effect on small entities.

C. Legal Basis

We are proposing Regulation FD, Rule 181, the amendments to Forms 6-K and

8-K, Rule 10b5-1, and Rule 10b5-2 under the authority set forth in Sections 10, 19(a) and 28 of the Securities Act,¹³¹ Sections 3, 9, 10, 13, 15, 23, and 36 of the Exchange Act,¹³² and Section 30 of the Investment Company Act.¹³³

D. Small Entities Subject to the Proposed Regulation and Rules

Proposed Regulation FD would affect issuers and closed-end investment companies that are small entities.¹³⁴ As of July 31, 1999, the Commission estimated that there were approximately 830 issuers, other than investment companies, that may be considered small entities.¹³⁵ As of December 14, 1999, the Commission estimated that there are approximately 62 closed-end investment companies that may be considered small entities subject to Regulation FD.¹³⁶

Proposed Rule 10b5-1 would apply to any small entities that engage in securities trading while aware of inside information and therefore are subject to existing insider trading prohibitions of Rule 10b-5. This could include issuers, broker-dealers,¹³⁷ investment advisers,¹³⁸ and investment companies. As of July 31, 1999, the Commission estimated that there were approximately 830 issuers, other than investment companies, that may be considered small entities. As of December 31, 1998, the Commission estimated that there were approximately 970 broker-dealers that may be considered small entities.¹³⁹ As of December 15, 1999, the Commission estimated that there were approximately 2, 000 investment advisersthat may be considered small entities.¹⁴⁰ As of December 14, 1999, the Commission estimated that there are approximately 227 investment companies that may be considered small entities. The Commission cannot estimate with certainty how many small entities engage in securities trading while aware of inside information.

E. Reporting, Recordkeeping, And Other Compliance Requirements

1. Regulation FD

When an issuer, large or small, discloses material nonpublic information, proposed Regulation FD would require it to do one of the following: (1) file a Form 8-K or, in the case of a foreign private issuer, a Form 6-K; (2) disseminate a press release containing the information through a widely circulated news or wire service; or (3) disseminate the information through any other method of disclosure that is reasonably designed to provide broad public access to the information and does not exclude any members of the public from access (i.e., a press conference to which the public is granted access such as by a teleconference or other electronic transmission).

The Regulation's "public disclosure" requirement would give small entity issuers flexibility in how to disseminate information (such as telephonic or Internet conference calls). This flexible performance element enables small entity issuers the freedom to select the method of public disclosure that best suits their business operations, and makes it unlikely that this "public disclosure" requirement would have a disproportionate affect on small entity issuers.

2. Rule 10b5-1

Proposed Rule 10b5-1 does not directly impose any recordkeeping or compliance requirements on any small entities. To the extent that an entity engaged in securities trading wished to rely on one of the defenses against liability provided in the Rule, it might be required to take certain steps. For example, to assert the affirmative defense in paragraph (c)(1)(i)(D) for trades that result from a written plan for trading securities designed to track or correspond to a market index, market segment, or group of securities, an entity, large or small, would have to maintain a written record of the trading plan. More generally, any entity, large or small, that sought to rely on the affirmative defense in paragraph (c)(2) for institutional traders would be required to comply with the specific provisions of that defense, including implementing reasonable policies and procedures to prevent insider trading. We believe that most entities to whom this defense would be relevant – i.e., broker-dealers and investment advisers – already have the required procedures in place, because of existing statutory requirements.¹⁴¹

3. Rule 10b5-2

Proposed Rule 10b5-2 affects individuals and not entities. Accordingly, we believe that proposed Rule 10b5-2 would not have a significant economic impact on a substantial number of small entities.

F. Duplicative, Overlapping, or Conflicting Federal Rules

The Commission believes that there are no rules that duplicate, overlap, or conflict with proposed Regulation FD, Rule 10b5-1, or Rule 10b5-2.

G. Significant Alternatives

The Regulatory Flexibility Act directs the Commission to consider significant alternatives that would accomplish the stated objective, while minimizing any significant adverse impact on small entity issuers. In connection with proposed Regulation FD and Rule 10b5-1 we considered the following alternatives: (a) the establishment of differing compliance or reporting requirements or timetables that take into account the resources available to small entities; (b) the clarification, consolidation, or simplification of compliance and reporting requirements under the Rule for small entities; (c) the use of performance rather than design standards; and (d) an exemption from coverage of the Regulation or Rule, or any part thereof, for small entities.

With respect to proposed Regulation FD, we believe that different compliance or reporting requirements or timetables for small entities would interfere with achieving the primary goal of protecting investors. For the same reason, we believe that exempting small entities from coverage of proposed Regulation FD, in whole or part, is not appropriate. In addition, we have concluded preliminarily that it is not feasible to further clarify, consolidate, or simplify the proposed Regulation for small entities. We have used performance elements in proposed Regulation FD in two ways. Regulation FD does not require that an issuer satisfy its obligations in accordance with any specific design, but rather allows each issuer, including small entities, flexibility to select the method of compliance that is most efficient and appropriate for its business operations. First, each issuer can select what method(s) to use to avoid selective disclosure (e.g., by designating which authorized official(s) will speak with analysts). Second, each issuer can choose what method(s) to use for "public disclosure" (e.g., filing a Form 8-K, issuing a press release, holding a conference call transmitted telephonically or over the Internet, etc.). We do not believe different performance standards for small entities would be consistent with the purpose of the proposed Regulation.

With respect to proposed Rule 10b5-1, we believe that different compliance requirements for small entities would interfere with achieving the primary goal of protecting investors. For the same reason, we believe that exempting small entities from coverage of proposed Rule 10b5-1, in whole or part, is not appropriate. In addition, we have concluded that it is not feasible to further clarify, consolidate, or simplify the proposed Rule for small entities. First, the aspects of proposed Rule 10b5-1 that indirectly involve compliance requirements are affirmative defenses that are not required to comply with the proposed Rule. Second, we have used performance elements for the affirmative defenses based on an index trading plan or an institutional investor implementing proper informational barriers set forth in paragraphs (c)(1)(i)(D) and (c)(2) of proposed Rule 10b5-1. If an entity decides to assert either of these affirmative defenses, proposed Rule 10b5-1 does not require that it satisfy its obligations under either of the affirmative defenses in accordance with any specific design, but rather allows it flexibility to select which measure(s) it wants to put in place to satisfy the elements of each affirmative defense. We do not believe different performance standards for small entities would be consistent with the purpose of the proposed Rule.

H. Solicitation of Comments

We encourage the submission of comments with respect to any aspect of this Initial Regulatory Flexibility Analysis. In particular, we request comments regarding: (i) the number of small entity issuers that may be affected by the proposed Regulation and Rules; (ii) the existence or nature of the potential impact of the proposed Regulation and/or Rules on small entity issuers discussed in the analysis; and (iii) how to quantify the impact of the proposed Regulation and Rules. Commentators are asked to describe the nature of any impact and provide empirical data supporting the extent of the impact. Such comments will be considered in the preparation of the Final Regulatory Flexibility Analysis, if the proposed Regulation and/or Rules are adopted, and will be placed in the same public file as comments on the proposed Regulation and Rules themselves.

IX. Statutory Bases

We are proposing Regulation FD, Rule 181, the amendments to Forms 6-K and

8-K, Rule 10b5-1 and Rule 10b5-2 under the authority set forth in Sections 10, 19(a), and 28 of the Securities Act, Sections 3, 9, 10, 13, 15, 23, and 36 of the Exchange Act, and Section 30 of the Investment Company Act.

List of subjects

17 CFR Part 230

Securities, Reporting and recordkeeping requirements, Investment companies.

17 CFR Part 240

Fraud, Reporting and recordkeeping requirements, Securities.

17 CFR Parts 243 and 249

Securities, Reporting and recordkeeping requirements.

Text of Proposed Rules and Rule Amendments

For the reasons set out in the preamble, Title 17, Chapter II of the Code of Federal Regulations is proposed to be amended as follows:

PART 230 – GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

1. The authority citation for Part 230 continues to read in part as follows:

Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 77sss, 78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-24, 80a-28, 80a-29, 80a-30, and 80a-37, unless otherwise noted.

* * * * *

2. Section 230.181 is added to read as follows:

§ 230.181 Public disclosures required under Regulation FD.

Notwithstanding Section 5(b)(1) of the Act (15 U.S.C. 77e(b)(1)), any public disclosure that constitutes a prospectus need not satisfy the requirements of Section 10 (15 U.S.C. 77j) of the Act if the prospectus is used only as required under Rule 100(a) of Regulation FD (17 CFR 243.100(a)) and the registrant otherwise complies with the requirements of Regulation FD.

PART 240 – GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934

3. The authority citation for Part 240 continues to read, in part, as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d), 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, and 80b-11, unless otherwise noted.

* * * * *

4. Section 240.10b5-1 is a