New York State Bar Association
One Elk Street
Albany, NY 12207
Business Law Section
Committee on Securities Regulation
April 28, 2000
Securities and Exchange Commission
450 Fifth Street N.W.
Mail Stop 6-9
Washington, D.C. 20549
E-mail address: firstname.lastname@example.org
Attention: Jonathan G. Katz, Secretary
Re: Securities Act Release No. 33-7787
Exchange Act Release No. 34-42259
Ladies and Gentlemen:
The Committee on Securities Regulation of the Business Law Section of the New York State Bar Association appreciates the opportunity to comment on Releases Nos. 33-7787 and 34-42259, dated December 20, 1999 (the "Release"), as the Release relates to proposed Regulation FD.
The Committee on Securities Regulation (the "Committee") is composed of members of the New York Bar, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice, in corporation law departments and in government agencies. A draft of this letter was circulated for comment among members of the Committee and the views expressed in this letter are generally consistent with those of the majority of the members who reviewed the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association, or its Business Law Section.
We agree with the Staff's initial statement that "information is the lifeblood of our securities markets." We also agree that the anti-fraud provisions of the federal securities laws play an important role in furthering full and fair disclosure. However, Regulation FD is not being proposed for adoption under the anti-fraud provisions of the federal securities laws and represents a major change in the way the Commission regulates public disclosure. We have concerns as to the Commission's authority to adopt regulations of this type, and we question the wisdom of the dramatic change in policy and law suggested by this proposal. The scope of the proposed regulation is very broad, the application of many of its terms will be unclear to issuers and their executives, and the potential liability is significant. We are most concerned that issuers and their counsel will have practical difficulties in monitoring compliance with the proposed regulation. As a result, we are fearful that Regulation FD will chill rather than expand the amount and quality of information made available to investors by reporting companies.
Moreover, even if the Commission adopts Regulation FD we believe that a number of changes are required in order for issuers to be in a better position to comply with the new requirements.
In light of the limited empirical evidence of selective disclosure, we urge the Commission to delay the adoption of Regulation FD until the impact of the proposal upon public companies can be evaluated. We believe the trend in the area of public disclosure of information has been consistent with the goals of the Release. Over time, actual practice may convince the Commission that a regulation of this type is unnecessary and impractical. The technological advances being made in the dissemination of information to the investing public, in addition to analysts and institutional investors, may also make the Regulation unnecessary. Any concern about the objectivity of sell-side analysts is being met by the media's ranking of analysts' performance. The number of Web-based advisory services also is growing. A study of two such Web sites last summer showed that, on average, they have provided more accurate earnings estimates of 101 high-tech companies than Wall Street analysts have. (Mark Hulbert, Compromised Analysts? The SEC Is Shocked, W.S.J. December 29, 1999 at A14).
II. Commission Authority
We have serious reservations about the Commission's authority to adopt Regulation FD under the federal securities laws. Neither the Securities Act of 1933 nor the Securities Exchange Act of 1934 contemplates equal access to all material information that is made available to persons outside the issuer. Moreover, nothing in the current law requires all investors to have access to the same information at the same time. In both Chiarella v. United States and Dirks v. SEC, the Supreme Court denied the Commission authority to impose an absolute equal information rule in light of the absence of explicit congressional intent. Congressional action may be necessary for a proposal like Regulation FD. Even if the Commission has the legal authority to adopt Regulation FD, the discussion below should lead the Commission to conclude that the adoption of the Regulation, as proposed, would be unwise. In its effort to provide equal access to information, the Commission may be reducing the amount of material information available to investors thereby impairing the functioning of the securities markets.
The scope of Regulation FD is too broad. The Regulation would apply to the disclosure of "material" non-public information to "any other person outside the issuer". If the primary objective of the Regulation is to regulate the flow of information to investors, we do not believe it is desirable for the Commission to attempt to regulate routine business communications between issuers and third parties. The proposal does not distinguish between communications to investors or analysts and those to vendors, suppliers or consultants on subjects that would cover every aspect of a corporation's business. The proposed Regulation would require executives who share corporate strategies and plans with customers, suppliers and other outsiders to get those individuals to sign confidentiality agreements if the company wants to avoid publicly disclosing the information (Lisa Fried, Lawyers Worried About SEC's Proposed Regulation on Disclosure, N.Y.L.J. March 16, 2000). The potential liability of public companies for communications that would generally not be considered as being directed to the investing public appears unnecessary to achieve the Commission's objective of enhancing the quantity and quality of information available to investors.
The scope of the proposed Regulation also is impacted by its reference to "an issuer or any person acting on its behalf". This language could literally cover any person in the issuer's organization, notwithstanding the requirement that the disclosing person act "within the scope of his or her authority". Further, the reference to a "senior official" in relation to a non-intentional disclosure would include an outside director who generally would not be considered responsible for discussing financial matters with investors. The inclusion of an outside director impacts not only the person disclosing the information but also the person whose knowledge of a disclosure requires prompt public disclosure by the company. We believe it is unreasonable to impose obligations upon an issuer based on the need for a determination by an outside director as to whether the information is material, has not been publicly disclosed or was intentionally or unintentionally disclosed by another "person on behalf of an issuer".
One of the cornerstones of the anti-fraud rules under the federal securities laws is the concept of materiality. For documents prepared for filing with the Commission under the supervision of counsel, the concept of materiality is an accepted standard. The materiality standard may not be easily applied to everyday communications by employees to outsiders, or securities analysts, when the definition refers to what a reasonable shareholder would consider important in making an investment decision or if the information could significantly alter the total mix of information made available. This standard places the company official in the undesirable position of determining whether the statements in question are material, without the ability to consult with counsel.
Even if counsel were present, it would be difficult for the company official to comply with the requirements of Regulation FD. On a "real time" basis, there would not be sufficient time for the company official and counsel to discuss the issue and consider all relevant factors. A company official, in a meeting with analysts or institutional investors, realistically could not consult with counsel before making a statement that might be considered material non-public information. Further, any attempt to consult with counsel could be misunderstood by the audience as suggesting that the issue is one of materiality when the reason for the consultation could be unrelated to legal issues. The materiality issue could also lead to the end of analyst "one-on-ones" with company management. Counsel would have to review all materials for such meetings for materiality. (Shaun Butler, Managing Director and Head of Investor Relations. Lehman Brothers Holdings, Inc., 1934 Act Disclosure: A Practitioner's Viewpoint, Practicing Law Institute's Preparation of Annual Disclosure Documents 2000, January 28, 2000). It will be difficult to determine whether the Commission would consider a comment that an executive makes to an analyst explaining information already disclosed in a press release is simply an expansion of the original statement or new, material information subject to public disclosure (Lisa Fried, Lawyers Worried About SEC's Proposed Regulation on Disclosure, N.Y.L.J. March 16, 2000).
If materiality judgments are difficult for lawyers, it seems unreasonable for the Commission to impose that standard on everyday communications by company officers and employees. This would be a heavy burden, especially when the Commission has not provided guidance (if it could) to assist issuers anxious to comply with the Regulation. This difficulty is highlighted by the subjective nature of any analysis of materiality. The Staff, in Staff Accounting Bulletin No. 99, has emphasized the fact that qualitative, in addition to quantitative, considerations must be included in the analysis. The materiality analysis may also have to take into account the volatility of an issuer's stock in response to certain types of disclosures. This uncertainty could, in our view, make issuers reluctant to share information with analysts. This would impair the analysts' ability to perform a function that the Commission acknowledges, in its Release, to be valuable.
If the Commission decides to adopt Regulation FD at this time, we believe it should attempt to identify the types of material information covered by the Regulation. The Commission could, for example, identify specific types of forward-looking information, such as projections of revenues or earnings, and other significant factors that could impact the value of an issuer's business, such as changes in customers or suppliers, applications for patents or FDA approvals.
The same deficiencies that apply to materiality also apply to the ill defined concept of "intent". When an issuer makes an intentional disclosure of material nonpublic information, proposed Rule 100 (a)(1) would require that the issuer simultaneously make that disclosure to the public. Issuers will be required to determine whether a disclosure was "intentional" and subject to simultaneous public disclosure or was "non-intentional" and requires "prompt" public disclosure under proposed Rule 100(a)(2). The company will have as difficult a time determining whether a disclosure was "intentional" as it will in determining whether it was material. The requirement of "scienter" has been the standard of liability under rule 10b-5. By eliminating the scienter requirements the Commission is creating uncertainty and a questionable basis for issuer liability. We believe that if the Commission adopts Regulation FD, the regulation should only cover intentional disclosures, recognizing that this standard would be less than the standard under Rule 10b-5.
VI. Liability and Related Adverse Consequences
The Release states that Regulation FD is not intended to create a private right of action under the Exchange Act. The Release, however, also makes it clear that Regulation FD could result in enforcement action and liability under Section 5 of the Securities Act, when disclosures are made at the time of a public offering. A company could also be liable under the Securities Act if it incorporates into a registration statement a Form 8-K that was filed to comply with Regulation FD. Proposed Rule 181 only addresses a small piece of the problem by focusing on disclosures made after a Securities Act filing. It does not address pre-filing disclosures or the impact of the regulation on the concepts of "offer", "prospectus", "gun jumping", "general solicitation" or "directed selling effort", all of which can result in liability risk under the Securities Act.
An issuer's failure to comply with Regulation FD could also cause the loss of eligibility to use Forms S-2, S-3 and S-8 for up to twelve months. This could have a dramatic effect on the ability of issuers to raise capital, make acquisitions or maintain employee benefit plans. In addition, owners of "restricted" or "control" securities may not be able to use Rule 144 if the issuer is not timely in its Regulation FD reporting requirements. We believe that these results are unwarranted. If new rules are adopted, provision should be made so that the eligibility to use Forms S-2, S-3 and S-8, and the ability to satisfy Rule 144, are not affected by non-compliance with Regulation FD.
VII. Non-Public Information
The Release fails to define "non-public" as it relates to the disclosure of information. As a technical matter, we believe that the Regulation should make clear that the disclosure of information in documents filed with the SEC, in press releases or in any other manner that would have been adequate under the Regulation after the fact, should eliminate the need to make subsequent disclosure under Regulation FD, at least where the time interval is reasonable.
We have not attempted to comment on all aspects of Regulation FD. We have attempted to highlight what we believe are the most serious deficiencies, in an effort to convince the Commission that the proposed Regulation would be counterproductive. The Commission's authority to adopt a regulation of this type is unclear. We also question the wisdom of such action, particularly at this time. It would be unfortunate, if in an effort to increase the flow of information into the marketplace, the Commission's actions had the opposite effect, causing a decrease in liquidity and an increase in the volatility of stock prices.
COMMITTEE ON SECURITIES REGULATION
Guy P. Lander
Chairman of the Committee
cc: Hon. Arthur Levitt
Hon. Paul R. Carey
Hon. Isaac C. Hunt, Jr.
Hon. Norman S. Johnson
Hon. Laura Simone Unger
Director, Division of Corporation Finance