April 26, 2000
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington D.C. 20549-0609
RE: File Number S7-31-99: Selective Disclosure and Insider Trading
Dear Mr. Katz:
The Association of Publicly Traded Companies ("the Association" or "APTC") is made up of public companies from every industry and every part of the country. While our membership is primarily small cap and mid cap companies, the Association represents the spectrum of new, growing companies, as well as larger, more established issuers.
The Association's members face particular challenges in the dissemination of information to investors and to the markets. Therefore, we are pleased to provide the comments of the Association in the hope that the Commission will be able to improve its proposed regulation on selective disclosure.
Like the Commission, the Association is interested in promoting the broadest and most timely dissemination of information to shareholders and investors. As the Commission has noted, significant progress has been made in the simultaneous availability of important information to all investors. We credit the work of Chairman Levitt and Commissioner Unger in raising the veil on abusive practices that can result from selective disclosure. We are very concerned with reports of violations of the insider trading laws by analysts, investors and public company officials who provide non-public information for unlawful or unethical purposes.
Indeed, the Association shares many of the Commission's concerns. We support the availability of information about companies and the markets for their securities, and we support efforts to provide better, more timely information to all investors. Therefore, we are pleased to offer our support of the Commissions overall effort and our recommendation as to a way to cure the proposed regulation's principal defect.
The effect on small and mid cap companies
A divide exists among public companies based on market capitalization and trade volume. Larger companies on one side of the divide have an abundance of analyst coverage and spend a great deal of time in contact with analysts. Many of these companies have developed strict policies for dealing with analysts. Others would welcome some uniform restrictions on analyst communications.
On the other hand, smaller, and newer companies that have limited following among analysts struggle to establish contact with analysts and generate interest among them. Therefore, the prohibitions the new rule would create regarding "non-intentional" disclosures and one-on-one conversations with analysts will disproportionately burden smaller public companies. How will an analyst with only marginally interested react to an answer like, "Let me get back to you on that after I talk to my lawyer?" This is a practical problem that the Commission's proposed rule fails to recognize.
The crux - materiality
The legal definition of materiality is vague and fact specific. It is said that the SEC values the concept of materiality because of its breadth and imprecision. It is certainly clear that the Proposing Release does not offer any guidance as to how the SEC will define "material" for the purpose of this new rule. We note that the Release asks for comment on whether there should be better guidance on the definition of "nonpublic," but does not ask the same question with regard to "material."
There is no disputing the difficulty of determining materiality of any given piece of information in the course of a wide-ranging discussion. As the Release notes, under the new rule, companies will become more dependent on legal counsel in the investor relations arena. The Release also says that a greater sensitivity to "materiality issues," in all its shades and hues, will promote fair disclosure.
However, a more likely outcome is that companies that analysts cannot ignore will simply provide less information or provide information only in a very structured format. On the other hand, companies that cannot afford to ignore an analyst will face the no-win choice of exposure to SEC enforcement based on the murky materiality standard or exposure to a securities class action suit.
When a company has only a few analysts and the company's performance fails to meet just one analyst's expectations, the market can drive the stock price down dramatically providing the first predicate of a securities class action suit. The ability to have a frank private conversation with the analyst whose earnings projection is unrealistically high, is the current preferred method for attempting to avoid the market surprise that drives stock prices down. The executive who must have this conversation while walking the ever-moving line of "materiality" will certainly wonder why the Commission cannot write a rule with greater clarity. Moreover, the worthy goal of this hypothetical conversation - protecting the investments of the company's shareholders - will certainly suffer from this lack of clarity.
The solution: be specific
There is a solution to this problem, which could cure the principal defect of the proposed rule. The flow of information to the markets might well continue unabated, despite the new risk of enforcement action, if the rule is clear and the risk is well defined. A bright line around the information the SEC views as critical to the investment public will serve the purpose of the rule far better than the purposefully vague materiality standard.
Since only the SEC will enforce this rule (a very good idea), the Commission should be willing to state the types of information that are worth an enforcement action. We must assume that the Commission has determined what kinds of important information are currently being disclosed selectively to the disadvantage of ordinary investors. A description of this information and similarly important types of information in the rule would serve clear notice on issuers and potential illegal traders alike, and would justify vigorous enforcement of the new rule by the Commission.
The Commission has already taken this step with respect to the filing of 8-K reports. Rules specify events that require an 8-K. Regulation FD ought to similarly specify the types of information that it requires to be made public. Indeed, we strongly recommend that the Commission re-propose Regulation FD based on the duty to publicly disclose specific information rather than the amorphous materiality standard.
Admittedly this approach to curbing selective disclosure, limits the Commission's enforcement options. However, greater clarity as to the types of information that the rule is intended to make instantaneously public will have a number of benefits. First, investors will know what type of information they can expect to receive, and those who comment on the re-proposed rule would have an opportunity to comment on specifically included or excluded information. Second, issuers would have the same opportunity and, in addition, would need to spend far less time and resources on grasping the subtleties of materiality and its many fact-intensive interpretations. Third, communications between issuers and analysts would be bound by clear standards and, perhaps, less a continuation of the current games of thrust and parry. Analyst could spend time analyzing information that they obtained rather than "ferreting" for non-public information. Finally, the Commission could enforce the new rule efficiently since violations would be relatively straightforward. Moreover, the list of important information need not be rigid since the rulemaking process allows for its continual revision.
APTC sincerely believes that this approach will accomplish the Commission's goal of encouraging the fair public release of whatever types of information the investing public most needs. It will permit issuers to carry on their investor communications work on behalf of shareholders without the continual monitoring of counsel.
Consequences of the new rules as proposed by the Commission
Absent certainty, the new rules will likely result in less useful information being available to the market as a whole. Either companies will communicate less with the market through analysts, or they will continually flood the market with information that may or may not be material in order to avoid the risk that they have violated the law. Certainly neither result will benefit the investing public.
It is certain that the new rule will change the way many companies communicate with the markets. As a result, the degree of coverage by analysts may be diminished. One certain result is that the financial press will gain greater access to conference calls and will become an increasingly important outlet for news about issuing companies.
Companies that attract wide coverage may well find it increasingly difficult to tell a coherent story about the company. It is possible that a cacophony of stories from a variety of news outlets will instead control the company story. Given the 1st Amendment protection that the financial press enjoys, companies will expend greater resources on press relations as opposed to investor relations. The communications between the financial press and issuers may be the next "dysfunctional relationship" that the SEC will have to attempt to regulate, but with much greater difficulty.
Finally, the wider availability of information may level the playing field but inhibit the overall level of information and perhaps negatively impact the efficiency of the market for a given stock. In the face of these risks, the Commission should attempt to narrow the consequences of its pro-parity policy choice. For these reasons we recommend the more modest approach set out above.
The Association supports the Commission's effort to curb selective disclosure and recommends that it pursues this goal. However, for the reasons stated here, we recommend that the Commission abandon the materiality standard for Regulation FD and, instead specify a list of the types of information that should be publicly disclosed and re-propose the rule on that basis.
For the Board,
|Robert S. Merritt/s/
| Brian T. Borders /s/