UNITED STATES OF AMERICA
In the Matter of
|ORDER INSTITUTING CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934|
The Securities and Exchange Commission ("Commission") deems it appropriate that public cease-and-desist proceedings be instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Schering-Plough Corporation ("Schering") and Richard J. Kogan ("Kogan"), and such proceedings are hereby instituted.1
In anticipation of the institution of these proceedings, Schering and Kogan have submitted Offers of Settlement, which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except that Schering and Kogan admit the jurisdiction of the Commission over them and over the subject matter of these proceedings, Schering and Kogan consent to the entry of this Order Instituting Cease-And-Desist Proceedings, Making Findings, and Imposing A Cease-And-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934 ("Order").
On the basis of this Order and the Offers of Settlement of Schering and Kogan, the Commission finds that:
During the week of September 30, 2002, Kogan, Schering's then chairman and chief executive officer, along with Schering's senior vice president of investor relations, met privately in Boston, Massachusetts with analysts and portfolio managers of four institutional investors, three of which were among Schering's largest investors. At each of these meetings, through a combination of spoken language, tone, emphasis, and demeanor, Kogan disclosed negative and material, nonpublic information regarding Schering's earnings prospects, including that analysts' earnings estimates for Schering's 2002 third-quarter were too high, and that Schering's earnings in 2003 would significantly decline. Immediately after the meetings, analysts at two of these firms downgraded their ratings on Schering, and portfolio managers at three of the firms heavily sold Schering stock. The price of Schering's stock declined over the next several days by more than 17 percent on approximately four times normal volume. On October 3, in the midst of this sell-off, Kogan also held a previously scheduled private meeting with approximately 25 analysts and portfolio managers at Schering's New Jersey headquarters, during which he said, among other things, that Schering's 2003 earnings would be "terrible." Late that evening, Schering issued a press release providing earnings guidance for 2002 and 2003 that was materially below analysts' consensus estimates and, with regard to the full 2002 fiscal year, materially below the company's own prior earnings guidance.
1. Schering-Plough Corporation is a New Jersey pharmaceutical company headquartered in Kenilworth, New Jersey. Schering's common stock is registered with the Commission pursuant to Exchange Act Section 12(b) and trades on the New York Stock Exchange.
2. Richard J. Kogan, 62, was Schering's chairman of the board from 1998 through November 2002, and its chief executive officer from 1996 until he retired in April 2003.
In 2001, Claritin antihistamine was Schering's biggest selling drug, accounting for more than 28 percent of Schering's sales and a larger percentage of its earnings. Generic drug companies had challenged Schering's patents on Claritin. In March 2002, Schering applied to the Food and Drug Administration to switch all forms of Claritin from prescription to over-the-counter ("OTC"). While those applications were pending, on August 8, 2002, a federal district court ruled that one of Schering's primary Claritin patents was invalid.
On August 13, 2002, Schering filed with the Commission its quarterly report on Form 10-Q for the fiscal quarter ended June 30, 2002, in which it disclosed the adverse ruling in the patent litigation, stated that it was in the process of appealing, and further disclosed that, as a result of the ruling, generic prescription or OTC forms of loratadine (Claritin's active ingredient) could enter the market as early as December 2002. Schering's Form 10-Q also stated, as prior public disclosures had, that the introduction of generic prescription or OTC loratadine or OTC Claritin in the U.S. market "would likely have a rapid, sharp and material adverse effect on the Company's results of operations beginning at the occurrence of such an event and extending for an indeterminate period of time thereafter," and that the "effect on the Company's results of operations may be mitigated if the Company is successful in its patent litigation."2 Finally, Schering disclosed that it expected U.S. wholesalers to deplete their prescription Claritin inventories by year end, with the majority being worked down in the third-quarter, and that it expected this to have an approximately $250 million negative impact on Schering's pretax profits for the remainder of 2002.
2. Schering's Internal Forecasts
On September 25, 2002, Schering's controller provided Kogan and other Schering senior management with Schering's preliminary plan for 2003. That preliminary plan forecasted earnings per share ("EPS") of $1.03 in 2003, which was significantly below Wall Street analysts' consensus estimate of $1.42. As of this time, Schering had not issued 2003 earnings guidance.
On Monday, September 30, 2002, Schering's department heads gave oral presentations to Kogan on the 2003 preliminary plan, and Schering's controller provided Kogan with the latest internal earnings forecast for the remainder of 2002. The controller forecasted third-quarter EPS of $0.27 to $0.28, and full-year 2002 earnings of "slightly above, or slightly below" the company's 2001 earnings of $1.58 per share (before subtracting an extraordinary item). These internal forecasts were below Wall Street analysts' consensus estimates for the third-quarter and full-year 2002, which were $0.35 and $1.64, respectively, as well as Schering's prior 2002 earnings guidance of "mid-single-digit-growth" over 2001 earnings.
3. Schering's Private Meetings With Institutional Investors
On September 30, 2002, the same day Kogan was briefed on Schering's 2003 preliminary plan and the latest internal earnings forecast for the remainder of 2002, Kogan and Schering's senior vice president of investor relations traveled to Boston for previously scheduled meetings with institutional investors. That evening and the following day, Kogan and Schering's investor relations officer met privately in Boston with analysts and portfolio managers at four firms: Wellington Management Company, Massachusetts Financial Services Company ("MFS"), Fidelity Management & Research Company, and Putnam Investments. At the time, Wellington, Fidelity, and Putnam were three of Schering's largest investors. Kogan prepared no formal presentation for these meetings; rather, each meeting followed a question-and-answer format. These meetings are discussed below.
a. Wellington Meeting
On September 30, 2002, Kogan and Schering's investor relations officer had a dinner meeting with Wellington's pharmaceutical analyst and several Wellington portfolio managers. During the meeting, Kogan told them, among other things, that Schering was going to take a "hard hit" to earnings in 2003. This was materially different from the company's earlier public disclosures that its financial results could suffer depending on the outcome of various contingencies, because it conveyed a definitive, as opposed to a contingent, statement not previously disclosed. Kogan also told the Wellington representatives that he did not favor the company repurchasing its own shares, which was materially different than the company's prior public statement that no decision had been made on whether to buy back its shares. Finally, Kogan indicated that Schering's manufacturing costs would increase in 2003 and that no significant cost cuts were planned, which went materially beyond the company's prior public disclosure that its costs had increased during the second quarter of its 2002 fiscal year "primarily due to a shift in sales towards royalty-bearing products and costs associated with manufacturing issues."
At an internal Wellington meeting the next morning, the pharmaceutical analyst who had attended the meeting told Wellington's portfolio managers that she was maintaining her buy recommendation on Schering, but noted that Kogan had emphasized that 2003 would be a "tough" year, that the "language" at the meeting was slightly less positive than it had been a few months ago when Wellington representatives met with Schering's chief financial officer, and that she thought the company wanted earnings expectations to be lower. That same day, several of Wellington's portfolio managers who attended the dinner meeting with Kogan sold Schering stock. At least one of the portfolio managers based his decision, in part, on the "tone" and lowered "confidence level" he inferred from the meeting.
b. MFS Meeting
On the morning of October 1, 2002, Kogan and Schering's investor relations officer met at MFS with that firm's pharmaceutical analyst and several portfolio managers. Going into the meeting, MFS's pharmaceutical analyst had a neutral rating on Schering, and most of MFS's portfolio managers had little or no position in the stock.
At the meeting, Kogan told the MFS representatives, among other things, that 2003 would be a "very, very difficult" year, and that "the street" had not sufficiently lowered earnings estimates for the third quarter of Schering's 2002 fiscal year to reflect the impact from the Claritin inventory work-down. Several months earlier, Schering had publicly warned that it expected its third-quarter earnings to be "significantly lower than the comparable period in 2001," but the company had never publicly commented on Wall Street analysts' earnings estimates for the quarter nor provided any other quantitative guidance suggesting that estimates were too high. At the meeting with MFS, Kogan also said that he did not favor Schering repurchasing its own shares, which, as noted above in connection with the Wellington meeting, was materially different than the company's prior public statement that no decision had been made on whether to buy back its shares. After the meeting, MFS's pharmaceutical analyst, who inferred a negative tone from the meeting, maintained his neutral rating on the stock, and issued a research note in which he described the "takeaways" from the meeting, as "incrementally negative."
c. Fidelity Meeting
Following the meeting with MFS, Kogan and Schering's investor relations officer traveled to Fidelity and met with that firm's pharmaceutical analyst and numerous portfolio managers. Kogan told them that 2003 would be a "tough" or "difficult" year with regard to Schering's earnings due to the loss of the Claritin patent and to spending on new product launches, which went materially beyond Schering's prior public disclosures. Kogan also indicated that Schering would not be significantly cutting costs in 2003 and that gross margins would be negatively impacted by the sale of more products on which Schering paid royalties and by increased manufacturing expenses, which, as noted above in connection with the Wellington meeting, went materially beyond the company's prior public disclosures that its costs had increased during the second quarter of its 2002 fiscal year "primarily due to a shift in sales towards royalty-bearing products and costs associated with manufacturing issues."
On the morning of October 2, before the market opened, the Fidelity pharmaceutical analyst announced in a voicemail to Fidelity portfolio managers that he was downgrading Schering from a "buy" to a "sell." The analyst said in that voicemail, among other things:
I am going to downgrade Schering Plough to a sell after our in-house meeting with the CEO. This had been one of my best near term ideas based on the Zetia launch in November and my belief that there was no risk from 2003 guidance until the January conference call, but the meeting today made me think that 2003 guidance will be worse than expected and could come on the Q3 earnings call in October. My previous 2003 estimate was $1.38 and I am cutting this to $1.17 based on a lower gross margin assumption, no Clarinex-D revenue, and higher [operating expenses] due to the Zetia and OTC Claritin launch costs. Stock was very weak today after our in-house meeting, underperforming the group by 10%, but there is further downside with a 2003 guidance range of $1.00 to $1.20 [versus] the current consensus estimate of $1.42. (emphasis added).
This analyst's downgrade resulted, in part, from Kogan's "downbeat" demeanor at the previous day's meeting and from the amount of time Kogan spent during the meeting discussing the risk to Schering's earnings from the loss of the Claritin patent. In the days following the meeting with Kogan, Fidelity portfolio managers heavily sold Schering stock.
d. Putnam Meeting
After the meeting with Fidelity, Kogan and Schering's investor relations officer went to Putnam and met with that firm's pharmaceutical analyst and numerous portfolio managers. Going into this meeting, Putnam's analyst had an "outperform" rating on Schering, although he had announced internally that he would likely downgrade his rating on the stock.
During the meeting, Kogan told the Putnam representatives that when Claritin went off patent and got moved to the OTC market, revenues from Claritin would shrink meaningfully, and that sales of Clarinex and OTC Claritin would not recoup the loss of revenue from Claritin prescription sales, a statement that Schering had not previously made in its public filings. These statements were materially different from the company's earlier public disclosures that its financial results could suffer depending on the outcome of various contingencies. Additionally, Kogan indicated that Wall Street consensus earnings estimates for the third quarter of Schering's 2002 fiscal year had not come down far enough to reflect the impact from the Claritin inventory work-down. Prior to this meeting, as noted above in connection with the MFS meeting, Schering had publicly warned that it expected third-quarter earnings to be "significantly lower than the comparable period in 2001," but the company had never publicly commented on Wall Street analysts' earnings estimates for the quarter nor provided any other quantitative guidance suggesting that estimates were too high.
On the morning of October 2, before the market opened, Putnam's pharmaceutical analyst sent a voicemail to Putnam's portfolio managers announcing that he was downgrading Schering to an "underperform" and lowering his earnings estimates for the company. In his voicemail, the analyst said, among other things:
I will leave only one or two points on our broadly attended meeting with the CEO. I would describe him as being more difficult to get information from than the norm. While he was not explicit, the very interesting meeting left us with the impression that numbers for consensus certainly had been too high for the quarter and for 2003. We also learned that they were not convinced that all investors were aware of the revenue hole that Claritin's move to OTC next year will cause, which is partly why I believe numbers are still coming down. (emphasis added).
Putnam portfolio managers heavily sold Schering stock in the days following the meeting with Kogan. The day after the meeting, one portfolio manager who had attended the meeting told a Putnam trader who was selling Schering stock for Putnam's portfolio managers:
I'll tell you, since I was in the meeting yesterday, I'll be quite clear on the fact that they clearly, they're going to miss third-quarter. They're going to miss numbers next year. And so, if that's the same message they're giving other people, that's why people are out there selling. It's certainly why we are selling.
* * *
I'm at a Cowen health care conference, so it's a big buzz down here because, I'll tell you, . . . no one had any idea why the stock was down yesterday. So there's a lot of speculation going on, because . . . there was no news story, et cetera. So everyone down here is thinking maybe there's a problem with one of their products or something else. So, the larger community, anyone who didn't meet with them over the last couple days, doesn't have a clue as to what's going on. (emphasis added).
4. Market Reaction
From October 1 through October 3, 2002, Schering's stock price fell by more than 17 percent, from $21.32 to $17.64 per share, with volume each day averaging more than four times the stock's typical daily volume (i.e., over 20 million shares per day compared to an average of less than 5 million). Schering knew of this volume increase and price decline. This market reaction was substantially the result of heavy sales of Schering stock by the institutions whose analysts and portfolio managers had met with Kogan and Schering's investor relations officer that week in Boston. In particular, Fidelity and Putnam each sold more than 10 million Schering shares during that three-day period, accounting for more than 30 percent of the overall market volume for the period.
5. Schering's October 3rd Meeting and Press Release
On Thursday, October 3, Schering held a previously scheduled meeting with analysts and portfolio managers at its offices in Kenilworth, New Jersey. The meeting was neither webcast nor otherwise accessible to the general public or the media. In a question-and-answer session over lunch, Kogan told those present that "next year will be tough, real tough," and that Schering's earnings would be "terrible." He also said that Schering's gross margins would suffer because of royalty expenses and manufacturing spending, and that Schering had decided not to "skimp" on its 2003 product launches. These statements went materially beyond the company's prior public disclosures. Later that day, Schering received press inquiries about whether Kogan had used the word "terrible" in describing 2003 earnings.
In response to the press inquiries and the heavy trading in Schering stock that week, at approximately 10:45 p.m. on October 3, Schering issued a press release in which it, among other things, provided earnings guidance for 2002 and 2003. Specifically, the press release projected EPS for the third fiscal quarter of 2002 in the range of $0.28 to $0.29, EPS for the full 2002 fiscal year as "approximately flat" as compared to 2001 earnings of $1.58 per share (before subtracting an extraordinary item), and EPS for the full 2003 fiscal year in the range of $1.00 to $1.15. Each element of this earnings guidance was materially below Wall Street analysts' consensus estimates and, with regard to the full 2002 fiscal year, for which the company had previously provided its own guidance, materially lower than that previous guidance.3
D. LEGAL ANALYSIS
Regulation FD, which was intended to level the playing field for all investors, prohibits public companies from selectively disclosing material, nonpublic information to certain persons outside the company, including institutional investors, securities analysts, and other securities professionals. See generally Final Rule: Selective Disclosure and Insider Trading, Exchange Act Rel. No. 43154, 65 Fed. Reg. 51,716 (Aug. 15, 2000) (hereinafter the "Adopting Release"). Thus, whenever a public company discloses material, nonpublic information to any such person, Regulation FD requires that the company also disclose the information to the public. 17 C.F.R. § 243.100(a). Where a selective disclosure is "intentional," the company must make public disclosure simultaneously with the selective disclosure. 17 C.F.R. § 243.100(a)(1). For purposes of Regulation FD, intentional means "when the person making the disclosure either knows, or is reckless in not knowing, that the information he or she is communicating is both material and nonpublic." 17 C.F.R. § 243.101(a). Where the selective disclosure is "non-intentional," the public disclosure must be made "promptly," which Regulation FD defines to mean "as soon as reasonably practicable (but in no event after the later of 24 hours or the commencement of the next day's trading on the New York Stock Exchange)." 17 C.F.R. §§ 243.100(a)(2) and 243.101(d). Failure to make the required public disclosure constitutes a violation of both Exchange Act Section 13(a), 15 U.S.C. § 78m(a), and Regulation FD. See Adopting Release, 65 Fed. Reg. at 51726.
The Commission adopted Regulation FD out of concern that issuers were "disclosing important nonpublic information, such as advance warnings of earnings results, to securities analysts or selected institutional investors or both, before making full disclosure of the same information to the general public." See Adopting Release, 65 Fed. Reg. at 51726. The Commission explained in adopting Regulation FD:
If the issuer official communicates selectively to the analyst nonpublic information that the company's anticipated earnings will be higher than, lower than, or even the same as what analysts have been forecasting, the issuer likely will have violated Regulation FD. This is true whether the information about earnings is communicated expressly or through indirect "guidance," the meaning of which is apparent though implied.
Adopting Release, 65 Fed. Reg. at 51726. See also Report of Investigation in the Matter of Motorola, Inc., Exchange Act Release No. 46898 (Nov. 25, 2002) ("Issuers may not evade the public disclosure requirements of Regulation FD by using `code' words or `winks and nods' to convey material nonpublic information during private conversations").
As described above, Schering violated Regulation FD and Exchange Act Section 13(a), and Kogan caused such violations, by providing guidance that included material, nonpublic information about Schering's earnings prospects during private meetings with institutional investors and analysts, and by failing to make a public disclosure of the information as required by Regulation FD. Although Kogan's purpose may not have been to suggest that institutional investors sell Schering stock, his conduct failed to meet the requirements of Regulation FD. Kogan's statements, demeanor and general expressions of concern for Schering's prospects during private meetings amounted to selective disclosure and prompted a significant sell-off in Schering stock. These communications to selective groups of industry professionals are precisely the kind of selective disclosures that Regulation FD was designed to prevent. Although Schering and Kogan were free to convey the serious concerns they had over Schering's earnings prospects to industry professionals, Schering had a legal obligation to disseminate that information to the rest of the marketplace in accordance with Regulation FD. Schering failed to do that. As a result, the investing public was placed at a disadvantage relative to those institutional investors privy to the disclosures.
Based on the foregoing, the Commission finds that Schering violated, and Kogan was a cause of Schering's violations of, Exchange Act Section 13(a) and Regulation FD.
Kogan has undertaken to pay $50,000 as a civil penalty. Kogan will make this payment within ten (10) business days after entry of this Order by certified check, bank cashier's check, or United States postal money order payable to the Securities and Exchange Commission. The payment will be delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Mail Stop 0-3, Alexandria, Virginia 22312, and will be accompanied by a letter identifying the name and number of this administrative proceeding. A copy of this transmittal letter and check or money order will be delivered or mailed to Brian O. Quinn at the Securities and Exchange Commission's Division of Enforcement, 450 Fifth Street, N.W., Washington, DC 20549-0806.
In determining whether to accept Kogan's Offer of Settlement, the Commission has considered this undertaking.
ACCORDINGLY, IT IS HEREBY ORDERED, pursuant to Exchange Act Section 21C, that:
By the Commission (Commissioner Atkins dissenting as to the imposition of a penalty against Schering in the related civil action).
Jonathan G. Katz
|1||In addition, the Commission has contemporaneously filed a complaint in the United States District Court for the District of Columbia charging Schering with violating Exchange Act Section 13(a) and Regulation FD and seeking a civil penalty. Without admitting or denying the Commission's allegations, Schering has consented to the entry of a final judgment by the Court that would require Schering to pay a $1,000,000 civil penalty. See SEC v. Schering-Plough Corporation, Case No. 1:03CV01880 (D.D.C.) (CKK), Lit. Rel. No. 18330 (September 9, 2003).|
|2|| Additionally, the Form 10-Q disclosed:
|3||Schering subsequently reported actual EPS of $0.29 for the third quarter and $1.34 for the full 2002 fiscal year, while lowering its EPS guidance for the full 2003 fiscal year to a range of $0.75 to $0.85.|
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