April 20, 2000
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Selective Disclosure - Proposed Regulation FD
Securities Act Release No. 7787, File No. S7-31-99
Ladies and Gentlemen:
Charles Schwab & Co., Inc. ("Schwab") appreciates the opportunity to comment on proposed Regulation FD. Schwab is the fourth largest financial services provider in the US in terms of customer assets, with over $800 billion in customer assets. Schwab is the world's largest online broker-dealer in terms of transactions and customer assets, and overall has 6.9 million customer accounts, most of which are held by retail investors. Schwab is keenly interested the Commission's efforts to end selective disclosure.
In our view, selective disclosure is a substantial threat to the integrity of the US financial markets, and the Commission is right to oppose this practice. One of the major deterrents preventing Americans from participating in the securities markets is their perception that they are not on a level informational playing field with market insiders. Every time that a security's price moves substantially, and only afterwards does the information responsible for that move become public, investors lose confidence in the fundamental fairness of our markets. When such a price move is caused by insider trading, the Commission quite appropriately brings enforcement proceedings. We believe the Commission's insider trading enforcement program, while it can never entirely eliminate insider trading, has done much to increase public confidence that market insiders who systematically engage in this practice will be held accountable.
By contrast, the Commission currently lacks an effective enforcement tool to deter intentional selective disclosure. Yet the harm to investor confidence from a major price move caused by selective disclosure is just as great as the harm from a major price move caused by insider trading. Indeed, because selective disclosure is currently permitted, it may undermine investors' willingness to participate in the securities markets even more than insider trading. There has been a long series of news articles about issuers which exclude analysts because of the analysts' insufficiently positive opinions, or which leak material news to favored analysts or investors before the public. These reports lead the public to believe that the markets are unfair, and have discouraged many Americans from entering the markets and saving as they should for retirement, education or other goals.
At the same time, Schwab understands the legitimate concern that imposing liability in this area could have the potential to "chill" beneficial disclosure. We do not minimize the difficulty issuers face in balancing public disclosure obligations with responsiveness to individual inquiries. For this reason, we applaud the Commission's decision not to impose private civil liability under the rule: the threat of private civil litigation in this area, without the expert judgment and checks and balances embodied in the Commission's investigative and enforcement processes, would in fact chill disclosure. We suggest a clarification described in more detail below that would protect innocent but mistaken judgments about what information is material. With this clarification, Schwab can support the Commission's proposal, although we understand how other commenters in good faith might come to a different conclusion.
We believe that the basic principle reflected in the Commission's proposal is a "best practice" that the majority of responsible public companies already follow. Most public companies announce news they know to be material by means of a generally disseminated public press release. Most public companies engage in frequent discussions with securities analysts and the press to explain public news, put that news in context, and answer questions, but take pains not to disclose material information for the first time in such one-on-one discussions. Certainly this is Schwab's policy.1 In short, we believe the Commission's proposal will not represent a change for most public companies.
Much of the adverse industry reaction to the Commission's proposal is driven by concern over the informational role played by analysts at broker-dealers. We respect the role played by analysts. In the past, when retail investors and issuers could not communicate directly, analysts played a critical role in disseminating information to the market. We respectfully suggest that in the Internet age, this function has changed. Today, retail investors can obtain real-time information about issuers - over services such as CNBC and CNNfn, or through personalized websites or automated emails which deliver news about issuers they select. Many issuers that conduct investor-relations conference calls (by telephone or over the Internet) now grant access to retail investors as well as analysts. In short, we believe the Commission should not assume that all retail investors need analysts to filter and interpret their news for them. Rather, its goal should be to allow, to the maximum extent possible, simultaneous equal access to all material news for all investors. Investors can then choose whether to receive that information directly, or wait for filtering and interpretation by analysts or other intermediaries.
We do not see any necessary conflict between equal and simultaneous access for all investors and the ability of analysts to carry out their roles. Indeed, we believe legitimate analysts do not want or need to receive selective disclosure of material nonpublic information to perform their jobs. Legitimate analysts compete on the basis of their superior analysis of publicly available information.
Clarifying the Issuer's Responsibility for Innocent Mistakes In Judgment
We concur with the distinction made in the proposing release between "intentional" and "inadvertent" disclosures of material nonpublic information. However, the Commission should clarify that a good faith but mistaken judgment that information is immaterial constitutes an "inadvertent" disclosure. In the past, the Commission and its staff have sometimes taken the position that materiality is an "objective" standard, and that it is irrelevant whether a defendant held a good-faith but (in hindsight) mistaken subjective view that information was immaterial.2 If the Commission were to apply this view to Regulation FD, then we would have to agree those critics who argue that the rule would in fact deter useful communications.
As the proposing release acknowledges, judgments about materiality are extremely difficult: it is hard to predict ex ante what the market will treat as material, and very easy to second-guess these decisions ex post. If the "intentional" versus "inadvertent" distinction applies only to the fact of disclosure and not to the materiality of the disclosure, then the safe harbor for "inadvertent" disclosures would be effectively meaningless. If the Commission is unwilling to protect innocent but mistaken judgments about materiality, then Schwab would not be able to support the proposed rule. Fortunately, we believe the Commission's intent was not to impose liability for honest but mistaken subjective judgments; rather, its intent was to deter the intentional selective disclosure of news a company knows is material to the market. We urge the Commission to clarify this point.3
Application of the Selective Disclosure Principle to the Commission's Own
Rules and Interpretations: The Case of Internet Roadshows
For the reasons discussed above, Schwab opposes selective disclosure. We urge the Commission to apply the same principle consistently to its own rules and interpretative positions. For example, the Commission staff, in a series of no-action positions, has permitted issuers and underwriters to transmit "Internet roadshows" to institutional investors without deeming those roadshows to be "broadcasts" or "writings" subject to Section 5 of the Securities Act. Last year, Schwab approached the staff to extend the ability to transmit Internet roadshows to retail investors. In a no-action letter dated November 15, 1999, the Commission staff permitted Schwab to transmit Internet roadshows to some retail investors - but only for those investors whose net worth or trading experience exceeded specific thresholds, and only for IPOs, not secondary offerings. (Query how the very same Internet roadshow could be deemed a "writing" when transmitted to a retail investor but not when transmitted to an institutional investor. As is customary in no-action responses, the staff gives no hint of its rationale.)
Internet roadshows frequently contain material information not contained in a company's prospectus, such as projections of future financial performance. Internet roadshows also convey the demeanor, experience and responsiveness of senior management in a way that a prospectus cannot. This information enables potential investors to make better-informed investment decisions. Under current rules, institutional investors have access to such information, but most retail investors do not.
Regardless of its decision on Regulation FD, the Commission should practice what it preaches. Selective disclosure is just as wrong in the context of Internet roadshows as in the context of issuers with securities trading in the secondary market. At one time, members of the staff indicated that the issue of access to Internet roadshows might be addressed in the long-awaited Internet interpretative release. More recently, they have indicated that the issue may be addressed in a separate rulemaking proceeding, the date of which is uncertain. The SEC should promptly clarify (as Commissioner Unger has urged) that Internet roadshows may be transmitted to all investors, regardless of assets or trading experience, for both IPOs and secondary offerings.4
Schwab applauds the Commission for addressing the issue of selective disclosure. We believe this initiative has the potential to increase investor confidence in the basic fairness of our markets. We urge the SEC to clarify that the rule is meant to sanction intentional selective disclosure of information that the company knows to be material - not honest, innocent but mistaken judgments about materiality. Schwab also urges the Commission to eliminate selective disclosure from its own rules and interpretations, such as its current limits on transmitting Internet roadshows to retail investors.
By prohibiting selective disclosure, and by making real-time streaming market data readily available to all investors at the lowest possible cost (as we have urged in our comment on the Commission's market data concept release), the SEC can take two major steps toward creating a level informational playing field for all investors. These problems are of greater significance to ordinary investors than the "problem" of increased competition among market centers (described as "market fragmentation" by market centers who are suffering from new competition), which we submit actually benefits investors every day. The Commission is to be commended for pursuing the objective of making better quality information equally and simultaneously available to all investors.
Very truly yours,
W. Hardy Callcott
Senior Vice President and General Counsel
Charles Schwab & Co., Inc.
|cc:|| Hon. Arthur Levitt
Hon. Norman S. Johnson
Hon. Isaac C. Hunt, Jr.
Hon. Paul R. Carey
Hon. Laura S. Unger
|1||The Charles Schwab Corporation recently received the "Best Communications with the Retail Market" award for large-cap companies from Investor Relations magazine for the quality and timeliness of our public disclosure.|
|2||For example, consider a company spokesperson who intends to mention to analysts that the company is introducing a new blue widget product, but reasonably believes that blue widgets are functionally indistinguishable from the company's existing red widgets, and therefore the disclosure is immaterial. In fact, some analysts applaud the company's new sense of design, recommend the stock to clients and send its stock up a material amount. In retrospect, the effect on the stock price shows that the news was objectively material. However, neither the company nor the spokesperson should be liable (assuming they promptly make public disclosure of the news once they recognize its materiality). The Commission should not punish innocent mistakes about materiality; it should punish intentional selective disclosures of information the issuer knows is material.|
|3||We concur with Commissioner Hunt and the National Investor Relations Institute that the definition of "persons acting on behalf of the issuer" should be conformed to the definition of "senior officials", rather than sweeping in junior employees who have no experience with disclosure, and whom the market does not view as authoritative sources about the company. We agree that disclosure by means of a generally-disseminated press release should constitute adequate public disclosure, and that a Form 8-K filing should not be necessary. A "prompt" public disclosure after an inadvertent material nonpublic disclosure should be defined as within two business days after senior officials become aware of both the disclosure and its materiality.|
|4||On February 9, 2000, the Commission staff further limited Schwab's no-action letter by requiring Schwab to obtain various representations from the lead underwriter in any IPO in which Schwab did not control the IPO process. We sympathize with the staff's apparent policy concern about the possibility of different roadshows for institutional and retail investors. However, it is completely unfair to place the entire compliance burden for this issue on Schwab - which as a mere syndicate or selling group member typically has no control over the IPO process. In effect, the staff's position gives the lead underwriter (typically a competitor of Schwab) the ability to veto Schwab's and the issuer's desire to transmit Internet roadshows to retail investors. Rather, the compliance burden should be placed on the lead underwriter, who after all controls the underwriting process. We urge the Commission to proceed rapidly with a rule that would fairly and effectively apportion the compliance obligations for Internet roadshows.|