American Society of Corporate Secretaries
April 28, 2000
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W., Stop 6-9
Washington, DC 20549
E-Mail address: email@example.com
Re: Selective Disclosure and Insider Trading Release
Ladies and Gentlemen:
The Securities Law Committee of the American Society of Corporate Secretaries (the "Society") is pleased to provide comments to the Securities and Exchange Commission on the Selective Disclosure and Insider Trading Release referred to above (the "Release"). The Society's membership, now in excess of 4,000 members, represents over 1900 public companies, virtually all of whom are listed on the New York Stock Exchange or the American Stock Exchange, or quoted in NASDAQ. We believe that our members who often serve as the legal advisers to company personnel on disclosure questions, are in a unique position to provide insightful and discerning perspectives on the issues raised in the Release.
I Selective Disclosure and Regulation FD
We understand the Commission's perceived need for a new rule designed to deal with issuers making selective disclosure of material non-public information to analysts, institutional investors and others, but not to the public at large. From conversations with members, however, we are not convinced that selective disclosure presently rises to the level of a serious problem. Given the rate of technological changes and the ability to get information out to the population at large, the general impression is that more universial disclosure is generally improving with issuers. We think that this trend will continue without this proposed rule. Despite the Release's citation in footnote 11 to a 26% response by companies that they engaged in "some type of selective disclosure practices", the perception is that this selective disclosure generally is not of material information, and does not impact the markets in any meaningful way. Moreover, despite the Commission's worries arising out of the Dirk decision, most of our members are conducting their counseling on disclosures generally as though the proposed regulation was currently the law.
Accordingly, if the Commission remains determined to adopt a rule on the subject, we generally do not object to the disclosure type requirements set out in the Release.
The Society's concerns with the new rule are primarily related to the question of "materiality" and the "recklessness" standard in failing to recognize it. First, we are not as confident as the Commission that "the majority of cases [on materiality issues] are reasonably clear."
To Society members, "materiality" is more often in the eye of the beholder. Obviously, facts which might be material to a small company are not to a large; consumer product companies might be somewhat more sensitive to earnings shortfalls than commodity type industrials; the mass of information on a company developed by an analyst might be missing a material piece or two which an information officer might deem immaterial and disclose. The list is endless. Disclosing to one analyst at the end of a quarter what the earnings will be for that quarter or that a particular large acquisition will be made are the most obvious examples of disclosures which it would be difficult for an apologist to call "immaterial". However, suggesting that the analyst do more homework on certain industry trends, or the company's previous public disclosures, thereby causing the analyst to reexamine his or her earnings estimates would not appear to most members to be a material disclosure; similarly, a conversation with an institutional shareholder to "get its pulse" on consolidation in the industry or the value of dispositions versus new acquisitions, thereby suggesting to it that such an event might occur is another example of a material fact possibly being deduced from immaterial facts disclosed in the conversation. These are set forth merely to suggest a very few factual situations which we and our clients examine from time to time and on which we worry that the Commission might have an opinion different from ours.
Accordingly, we believe the Release would be improved in this area if either a series of questions and answers or a background discussion accompanied the final rule and gave several concrete examples of materiality, in the context of the new rule contrasting with examples of close, but less than material selective disclosure, e.g., the two examples cited above. Although we recognize the Commission's general reluctance to publish situational examples for fear of abuse, our members believe the benefits of more light on the Commission's thoughts in this area outweigh any possible disadvantages.
In its Release, the Commission suggested certain practices to guard against non-public disclosures of information which might be deemed "material". It requested comment on the "chilling" effect of these suggestions.
We believe the designation of a limited number of personnel authorized to make disclosure and field inquiries from analysts is a valuable suggestion and one already in force in most seasoned companies. We believe it better enables a company to guard against inadvertent slips of material information by those unfamiliar with legal and market concepts of non-public facts and materiality. The suggestion of recording or having others present at private communications with analysts/institutional investors appears to be winning growing acceptance in the case of quarterly analyst conference calls, which are increasingly open to the public via simulteaneous webcasts. On the other hand, with regard to one-on-one communications, it appears impractical for most companies, given the number of analysts' calls handled on a weekly basis by a typical investor relations department. The number of such communications for several larger member companies can average 100 per week. The communications are usually telephone calls and deal with constantly changing industry announcements, trends gleaned by analysts from various companies' reports, clarification on public information previously provided by a company and tweaking of statistical information, among other things. Recording each conversation would, we believe, have a "chilling" effect; shadowing the investor relations officer with another person in the office on a near permanent basis would be impractical. Having such a person on each call would be as "chilling" as recording the conversations. Similarly, given the rapidity and volume of the question/answer dialogue, confidentiality or non-response until later appears to most of the members, except in extreme circumstances, impractical and potentially "chilling". Finally, the disclosures called for under the new Regulation FD appear more practical and, unless the Commission's understanding of materiality differs markedly from that of most issuers, should not have a "chilling" effect on financial information flow.
Because of the amorphous nature of the term "materiality", many Society members worry that "reckless in not knowing" is susceptible of being interpreted with twenty-twenty hindsight as something more akin to "negligent in not knowing." Perhaps, the worries are unfounded; still, some members would like to see a "safe harbor" to give our practitioners a greater degree of certainty in advising clients in the disclosure area. It is suggested that the existence of an issuer disclosure program which (1) limits company personnel who can talk to the investment community; and (2) sets out certain rules regarding information discussed on a selective basis, together with the good faith adherence by a "senior official" to the program prior to putting out or failing to put out a disclosure should be proof that he or she was not "reckless in not knowing" of a material selective disclosure. Other members would prefer a definition of "reckless" which would include absence of good faith as an element.
The Society does have suggestions on the distinction between "intentional" and "non-intentional" disclosures. The examples given in the Release of non-intentional disclosure are helpful, but do not focus on what we believe will be the typical case, i.e., the treatment of a disclosure of non-public information which the issuer mistakenly (but not in reckless disregard of the truth) believes to be non-material.
We believe the Rule would be improved, and generate less adverse reaction if, in its background discussion or in a series of questions and answers, examples of situations and a more precise description of the handling of each were discussed, e.g., a vice-president-marketing of a technology company says to a customer group that the company is working on a new process. Word circulates quickly and within a few days the company stock moves up sharply. At this time, the investment relations officer looks into the price run-up and determines that there was a disclosure of non-public information which may be the reason for the run-up. This would appear to be a "non-intentional" material selective disclosure. At this point, the damage is done, but there would apear to be no violation of the rule. Still, it appears that some disclosure would now be required. The investment relations officer would have 24 hours (or the time the Rule ultimately sets) to file or publish the disclosure. Failure to do so would cause the disclosure to be "intentional."
Obviously, legal commentators will generate scores of such examples after the Rule's ultimate promulgation; however, the Society believes useful examples of the working of the proposed Rule will facilitate a greater understanding and acceptance among the corporate legal practitioners.
A very serious concern expressed by many of our members was whether S-3 filing status was lost as a result of a late filing under the proposed new rule. Generally, there is no time requirement involved with filings on Form 8-K; yet, Regulation FD imposes a simultaneous/24 hour limit. We question whether failure to abide by the new Rule's time requirements would foreclose use of S-3 registration.
We suggest that the Commission better classify the relationship of FD filings and the rule governing an issuer's use of Form S-3; ideally, the Commission, should exclude late filings of non-intentional disclosures from such a draconian penalty.
Directly related to the foregoing suggestions, we would prefer that disclosures under Regulation FD be permitted to be made under Item 5 of Form 8-K. This would afford the issuer the alternative of satisfying Regulation FD without admitting that the disclosure was "material" thereby getting more information upon which there was a question of materiality made public. Also, this provides the least deviation from present practice with regard to selective disclosure questions.
Another area of concern to our members is the broad reach of the Rule's terms "a person acting on behalf of an issuer" and "to any person outside the issuer." As evidenced by the background discussions of the Rule, the aim of the Commission was centered on selective disclosures to analysts and institutional investors, but the scope of the Rule's coverage would net in communications by any employee or employee of any agent to any third party. We would like the regulation narrowed to discussions by persons who regularly communicate with the investing public to non-issuer personnel who regularly make or might reasonably be expected to make investment decisions involving the issuer's securities. Again, the background discussion of the Release seems to center on this type of communication and audience, but the Rule is much broader.
A similar rethinking of the term "senior official of the issuer" is suggested. Since it is this person who is the lynchpin in the process of knowing of a disclosure, of its materiality and of its non-public nature, it is suggested that there are several executive officers in many companies who would not be in a position to know whether a disclosure was material or not, and perhaps even whether it was public or not. This could include executives in charge of businesses, human resources or technology, who speak at trade shows or other public forums, but not usually to the investment community. These persons should not be within the ambit of the proposed Rule. Accordingly, we would suggest that a senior official be defined to include only officers or assistant officers responsible for or regularly involved in investor or public relations or communications with the investment community.
Finally, our members question the Commission's reluctance to include the posting on an issuer's website as an additional method of dissemination of material information. Members' comments suggest this as a surer means of getting the news out to those interested in the issuer than dissemination of a press release through a widely circulated news or wire service or an 8-K filing. If the Commission's worry is that there is insufficient notice to the investing public, acceptable website dissemination could be limited to those issuers who alert the investing public to periodic disclosures on their websites by communicating the future use of this practice in their annual reports and other public filings.
II Rule 10b5-1: Trading "On the Basis of" Material Non-public Information
The proposed Rule 10b5-1 would define any trade made by a person who "was aware of" non-public material information as having been made "on the basis of" that information; the rule then defines four affirmative defenses to liability for such trading.
Many of our members would urge the Commission to reexamine its proposal to adopt a standard equating awareness with use of non-public information. We think the Adler decision of the Eleventh Circuit is a much farier standard, with possession providing a strong inference of "use" of material non-public information.
The reasons for this less rigid approach are our experience with our own Corporate officers' selling or buying of issues securities and the elusiveness of what constitutes "material" information. More often than not, many of our companies' officers sell stock to meet extraordinary needs, e.g., buying a house or other large capital item, paying a tax bill or a tuition payment. Purchases are more rarely made, primarily because issue stock, either through bonus grants or options constitutes such a large part of any officer's investment portfolio. Often these are made merely because of a drop in the stock price which causes the officer to think it's a good buy at such a low price. Such sales and purchases are generally made in a window period, which may vary from a few days following earnings announcements to two-and-a-half months after such announcements, depending on the company. During the "window period," if material non-public information is available within part of the officer group, often the securities counsel plays traffic cop on who can sell/buy and who cannot, depending on his or her assessment of who has knowledge of the non-public information or whether a decision to buy/sell was previously postponed because of the preceding "blackout" period. Sometimes, counsel makes a subjective determination as to whether the sale/purchase could be seen as based on the non-public information; sometimes, he or she weighs the materiality of the non-public information which, subsequently, the investing world judges differently. These examples are given in an effort to give a small insight into the myriad factors attending the buying or selling securities by company officers in which awareness of non-public information might not enter into the decision. We submit that possession of such information should carry presumption, but that the individual be allowed to rebut the presumption by showing an earlier pattern, a previous order, or similar evidence of non-intent to use the non-public information.
If the Commission decided not to adopt the Adler standard, we would urge you to rethink the Rule's exclusion of limit orders from the list of exceptions. Similarly, we would urge inclusion of the type of limit order used in the cashless exercise of options as an exception.
Limit orders are extensively used by corporate executives to sell/buy their securities. So long as a set price is given at a time when the executive was not aware of non-public material information, we see no reason to exclude this common mechanism form the list of exceptions merely because there is no date certain and the executive is able to change his mind.
Similarly, in the cashless exercise of options, a common way that this is done is for an executive to give a limit order, that is a price at which the option would be exercised and immediately sold. Many of our members' companies allow such exercises even during "blackout" periods, depending on whether the order is put in before the beginning of the period. As with regular limit orders discussed above, we believe this practice should be included in the list of exceptions if Rule 1065-1 is adopted as presently proposed.
III Rule 10b5-2: Duties of Trust or Confidence in Misappropriate Insider Trading Cases
The proposed Rule 10B5-2 sets forth a non-exclusive definition of family or personal relationships which create a duty of trust or confidence for purposes of the "misappropriation" theory of insider trading under Rule 10b-5.
The Society also supports the Commission's proposed new rule. We would not limit the enumerated relationships to family members residing in the same household since the history pattern or practice of sharing confidences normally is not isolated to a household but, given the current state of communications, is readily maintained by telephone or e-mail.
The Society appreciates this opportunity to comment on the Release and participate in the Commission's efforts to enhance the public disclosure process. If you have any questions on our views please let us know. We would be pleased to discuss our views further with the Commission.
Margaret M. Foran
Chairman, Securities Law Committee
James W. Guedry
Chairman, Selective Disclosure
cc: David Martin, Director, Division of Corporation Finance,
Securities and Exchange Commission
Maure Osheroff, Associate Director, Division of Corporation
Finance, Securities and Exchange Commission
D. Craig Nordlund, Chairman, American Society of Corporate
David Smith, President, American Society of Corporate