Regulation Fair Disclosure and New Insider Trading Rules
August 10, 2000
Today the Commission will consider adopting new rules to address the problem of selective disclosure and clarify existing insider trading law. The new rules relate to three issues:
- Selective disclosure by issuers of material nonpublic information;
- When insider trading liability arises in connection with a trader's "use" or "knowing possession" of material nonpublic information; and
- When the breach of a duty of trust or confidence in a family or other non-business relationship gives rise to liability under the misappropriation theory of insider trading.
On December 20, 1999, the Commission proposed new Regulation FD – for "fair disclosure" – to combat selective disclosure. Selective disclosure occurs when issuers release material nonpublic information about a company to selected persons, such as securities analysts or institutional investors, before disclosing the information to the general public. This practice undermines the integrity of the securities markets and reduces investor confidence in the fairness of those markets. Selective disclosure also may create conflicts of interests for securities analysts, who may have an incentive to avoid making negative statements about an issuer for fear of losing their access to selectively disclosed information.
Regulation FD would require that when an issuer intentionally discloses material information, it do so publicly and not selectively. The company may make the required disclosure by filing the information with the Commission, or by another method intended to reach the public on a broad, nonexclusionary basis, such as a press release. When selective disclosure of material information is made unintentionally, the company must publicly disclose the information promptly thereafter.
Comments on the Proposal and Revisions to Narrow Regulation FD
The Proposing Release prompted an outpouring of public comment – nearly 6,000 comment letters. The vast majority of the comments were from individual investors who urged – almost uniformly – that the Commission adopt Regulation FD. These investors expressed frustration with the practice of selective disclosure, believing that it places them at a severe disadvantage in the market.
The Commission also received numerous comments from securities industry professionals, issuers, lawyers, media representatives, and professional and trade associations. Some expressed concerns about the approach of the proposal and suggested alternative methods for addressing selective disclosure.
Regulation FD has been revised in light of the issues raised by the commenters. The principal changes are summarized below:
Narrowed Scope of the Regulation
- The regulation will apply only to an issuer's communications with market professionals, and holders of the issuer's securities under circumstances in which it is reasonably foreseeable that the security holders will trade on the basis of the information. The regulation will not apply to issuer communications with the press, rating agencies, and ordinary-course business communications with customers and suppliers.
- The regulation will apply only to communications by the issuer's senior management, its investor relations professionals, and others who regularly communicate with market professionals and security holders.
Rule of Disclosure That Does Not Create Private Liability
- The regulation text makes clear that it is a disclosure rule. It does not create liability for fraud. Where the regulation is violated, the SEC could bring an administrative proceeding seeking a cease and desist order, or a civil action seeking an injunction and/or civil penalties.
- The regulation has been revised to eliminate the prospect of private liability for companies solely as a result of a selective disclosure violation.
Requirement of Intentional or Reckless Conduct
- The regulation requires public disclosure only where the person making the selective disclosure knows or is reckless in not knowing that the information disclosed was both material and nonpublic.
No Application to Most Registered Offerings or Foreign Issuers
- The regulation now expressly excludes communications made in connection with most registered securities offerings.
- The regulation does not apply to foreign issuers.
No Effect on Eligibility for Short-Form Registration or Resales Under Rule 144
- A violation of Regulation FD will not disqualify a company from use of short-form registration, or affect investors' ability to resell under Rule 144.
With these changes, Regulation FD establishes a clear rule against selective disclosure and encourages broad public disclosure. At the same time, it does not impede legitimate business communications or expose issuers to liability for selective disclosure arising from arguable but mistaken judgments about the materiality of information.
New Insider Trading Rules
The prohibitions against insider trading play an essential rule in maintaining the fairness, health, and integrity of our markets. Insider trading law has developed on a case-by-case basis under existing provisions of the federal securities laws. From time to time there have been issues on which various courts have disagreed. The Commission will consider adopting new Rules 10b5-1 and 10b5-2 to resolve two such issues. In all other respects, the law of insider trading remains unchanged.
Courts have split on whether insider trading liability requires trading while in "knowing possession" of material nonpublic information, or proof that the trader "used" the information in trading. New Rule 10b5-1 provides that, for purposes of insider trading, a person trades on the basis of material nonpublic information if a trader is "aware" of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability, which have been modified in response to comments. These exceptions permit persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.
Clarifying Duties of Trust or Confidence in Misappropriation Cases
The misappropriation theory of insider trading, upheld by the Supreme Court in the O'Hagan case, provides that a person commits insider trading by misappropriating and trading on inside information in breach of a duty of trust or confidence. The theory's application is most clear in cases involving misappropriation of confidential information in breach of an established business relationship, such as lawyer-client or employer-employee.
The Commission is considering adoption of new Rule 10b5-2 to clarify how the theory applies to certain non-business relationships. Under the new rule, a person receiving confidential information under the following circumstances would owe a duty of trust or confidence, and thus could be liable under the misappropriation theory when:
- The person agreed to keep information confidential;
- The persons involved in the communication had a history, pattern, or practice of sharing confidences that resulted in a reasonable expectation of confidentiality; or
- 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.
The new rules will take effect 60 days after publication in the Federal Register.