Comments of Boris Feldman
On Proposed Regulation FD
File No. S7-31-99
I am a member of Wilson Sonsini Goodrich & Rosati, P.C., in Palo Alto, California (www.wsgr.com). I counsel public companies on disclosure obligations and defend them, and their directors and officers, in shareholder lawsuits. My bio is available at www.borisfeldman.com. I submit these comments personally, not on behalf of any clients or my firm.
Proposed Regulation FD will radically alter the way that many public companies provide guidance to the market on future financial results. Before addressing particular provisions of FD, it may be useful to review common practices and the reason they have evolved as they have.
Many (but not all) public companies have long felt compelled to provide guidance to analysts. They have done so, in my experience, for two reasons. First, it is difficult to maintain robust research coverage if company officials are unwilling to provide their own expectations to analysts seeking to model the company. This is particularly true for younger public companies, which often have no coverage beyond that provided by the underwriters’ analysts. If these companies go silent on the analysts post-IPO, the analysts are likely to devote less attention to them.
Second, without some guidance from management, the analysts are often likely to create expectations that the company cannot meet. The vast majority of companies that I have represented have provided guidance (if they did so at all) in order to lower Street expectations, not to raise them. Companies that provided little or no guidance often found that, even if they achieved their internal targets for a quarter, analysts had set the bar so high that the results were viewed as a miss. This "miss" often triggered major stock declines, not to mention the inevitable shareholder class actions.
Thus, providing financial guidance has been unavoidable for many public companies, especially in the technology sector. The practices that have evolved for providing guidance, however, have ranged from byzantine to baroque. For decades, guidance has been given in the shadow of the class action lawsuit. Management had to balance the laudable desire of keeping the market informed as to internal targets for upcoming periods against the fear that, if the crystal ball turned out to have been cloudy, the company would be rewarded for its candor with lawsuits alleging that the guidance had been reckless. For some companies, the guidance process was suffused with the desire to leave no fingerprints on the Street estimates, in order to reduce the risk of strike suits.
Congress understood this phenomenon. A principal motivation underlying the Private Securities Litigation Reform Act of 1995 was to encourage public companies to provide guidance in a transparent manner, while shielding them from shareholder lawsuits if the predictions failed to come about. The statutory Safe Harbor for forward-looking information is the linchpin in this statutory scheme. A company that provides guidance accompanied by the requisite cautionary disclosures cannot be sued over them, no matter how wrong they prove to be. 15 U.S.C. § 78u-5(c)(1)(A)(i). Even if the company omits the disclosures, it cannot be sued over guidance unless the plaintiffs can establish compellingly, at the outset of the litigation and without discovery, that the executive had actual knowledge at the time that the guidance was false. 15 U.S.C. § 78u-5(c)(1)(B).
In my experience, the Safe Harbor has already had salutary effects on the guidance process. Many companies that previously provided guidance one-on-one to analysts have moved that process onto their conference calls, with the entire buy-side and sell-side communities participating. While the SEC may view this as selective disclosure to "favored analysts," the reality is that such calls often are The Market; when trading in the company’s stock opens the next morning, the price will reflect the widespread dissemination of information from the call that typically occurs. Others companies have posted on their Web sites audio files or transcripts of the conference calls containing the guidance. A few companies have even moved their guidance into their earnings releases. Thus, the process that Congress started with the Reform Act Safe Harbor appears to be proceeding well.
Nevertheless, the Commission has now determined to short-circuit that evolution of investor-relations practices by mandating full, transparent publication of any guidance. Only time will tell whether this discontinuity will result in greater or lesser disclosure of forward-looking expectations. My purpose here is not to challenge the Commission’s objective, but rather to urge it to provide greater guidance to public companies as to which practices are, and which are not, permitted under FD.
Assume that a public company, E-widgets.com, announces its year-end 1999 results and provides guidance as to its expected top-line revenue growth rate for the full year 2000. Presumably, this would constitute material information under FD, and the company would be required to disseminate it by press release, open conference call, etc. Now, assume that on April 17, E-widgets.com announces results for the March quarter. On the conference call, an analyst asks whether the company is still on-track for its anticipated 2000 revenue growth. May the CFO say no? May she say yes? If she says, "we have not changed our guidance for the year," does that constitute material information?
Now, move forward to the end of May. E-widgets.com has completed two months of its second quarter and is about to enter the final month; historically, the company has little visibility into whether it will miss a quarter until the last two weeks of month three. An analyst calls and asks whether the company thinks it will reach Street expectations for the June quarter. May the CEO answer the question? What if she says "we think we can hit the low end of the published range?" What if she says "we won’t know until we see how many orders that are in the pipeline close at the end of the quarter, but for now we haven’t changed our guidance?"
In my opinion, the Commission owes it to the public company investor-relations community to address these questions in the final Regulation FD release. These are not mere hypotheticals; they are the reality that pervades dealing with analysts today. The Commission should avoid the temptation to take the easy way out by saying "materiality is a complex, fact-specific determination. Figure it out yourself." The Commission must declare whether typical quarterly guidance and checks by sell-side analysts on the progress of the quarter are improper under FD.
I suspect that the answer, whether or not provided in the final regulations, is "yes." For most public companies, there is little information more material than whether or not the company is on track to make the quarter. If the Commission believes that such information must be communicated directly to the market by press release or Form 8K, rather than filtered through the analysts, then it should say so explicitly. Absent such guidance, public companies will be left to guess whether hitherto common communications are deemed by the Commission to be improper.
A model that I have advocated may be of interest to the Commission in this regard. I have proposed that public companies provide their guidance in the body of their quarterly earnings release and then disclaim any duty to update that guidance until the quarter is over. As part of that process, companies would not give periodic updates to analysts when they call during the quarter to assess progress toward those targets. Selective Disclosure, Analyst Guidance, and the Duty to Update: Building a Safer Safe Harbor. If this approach is acceptable to the Commission, I believe that many additional companies would implement it.
I appreciate the Commission’s consideration of my views.