OverviewIn the proposed Release, the Commission states that Regulation FD requires an issuer to disclose material nonpublic information "broadly to the investing public, not selectively to a favored few." Although we applaud the Commission's goal of promoting broad disclosure of material information, we are concerned that the practical effect of Regulation FD will be exactly the opposite: it will discourage many issuers from disclosing much of the information that now enters the marketplace. We say this based on our experience not only as a public company, but also as an underwriter of other public companies and a leading provider of research throughout the world.1
Our fundamental concern with Regulation FD is its overwhelming reliance on "materiality," a concept that can only be defined in general terms as something that a reasonable investor would want to know. The fact is that few lawyers will even opine on materiality issues that come up in informal communications between issuers and analysts because different lawyers, judges, juries, and regulators will apply the standard differently in similar circumstances. While some information is obviously material (e.g., M&A announcements and significant earnings shortfalls), much of the information that is communicated to the public through informal means is neither obviously material nor obviously immaterial (e.g., changes in inventory, loss of a customer, etc.). The amorphous nature of materiality judgments was a major part of the reason that the Supreme Court in Dirks rejected the Commission's proposed standard for insider trading liability, and insisted that to avoid deterring valuable communications between issuers and analysts, the SEC must find not only materiality but also that the insider had disclosed the information for an improper purpose.2
Furthermore, there will be many situations in which an issuer discloses information that it believes is not material, yet helps analysts complete their analyses of the issuer's business. The resulting report may affect the price of the stock and, therefore, the underlying information may be judged material in hindsight. The susceptibility to hindsight judgments in such cases will deter issuers from taking the risk of communicating meaningful information in informal settings. We believe that the Commission's suggestion that issuers obtain confidentiality agreements from analysts not to use or disclose the information until the issuer can determine whether the information is material in light of Regulation FD is unworkable and, in any event, presents a conflict with analysts' obligation to their clients.
Rather than run the risk of hindsight judgments, based on amorphous standards, applied to situations in which immediate determinations of materiality must be made, we believe many issuers will limit disclosures to quarterly earning releases and sterilized analyst conference calls. The result will be far less information reaching the marketplace and more volatility. Thus, we do not believe that the Commission should run the risk of fundamentally altering the incentives that have made the U.S. capital markets the most informed and efficient in the world.
Persons Acting on Behalf of Issuer
Rule 101 (c) of Regulation FD defines "person acting on behalf of an issuer" or any officer, director, employee, or agent of the issuer who discloses material nonpublic information while acting within the scope of his or her authority. We believe this definition is overly broad and persons to whom the Regulation should apply must be limited to those designated persons authorized to speak on behalf of the company - for example, executive officers and other designated spokespersons. As written, Regulation FD could cover numerous instances of employees who, while acting within the scope of their duties, disclose information that could be material to "outsiders" which would then trigger a Regulation FD disclosure by the issuer. Besides being unduly burdensome for the issuer, it is impractical and does not address the concerns regarding conscious abuse about which the Commission has stated it is most concerned.
Rule 100 (b) exempts from Regulation FD disclosures made to a person who owes a duty of trust or confidence to the issuer, e.g., an outside consultant such as an attorney, investment banker or accountant, or to a person who has expressly agreed to maintain such information in confidence. We recommend expanding this protection to include disclosures to self-regulatory organizations and government agencies.
Encouragement of Best PracticesWe believe that the Commission should give greater thought to identifying best practices with regard to the dissemination of material information and should encourage issuers and analysts voluntarily to follow these practices. For example, Merrill Lynch requires its analysts uniformly to disseminate their comments to both retail and institutional investors simultaneously. Analysts are not permitted to convey information, or their opinion of that information, to any Merrill Lynch trader, institutional investor or any specific person until the analyst has made such information available to all of Merrill Lynch's clients. Analysts' oral comments and analysis about a particular event are broadcast through the Firm's "squawk box" and are made available to Merrill Lynch's traders and institutional and retail sales force and posted on Merrill Lynch's websites for Merrill Lynch clients. These oral comments are quickly followed by a written research report that is available to all of the above constituents. Further, any change of an analyst's research opinion results in a 24-hour restriction of trading in that stock for Merrill Lynch employees. Personal trading by analysts is also subject to pre-approval and several other limitations. We believe that all of these practices are the types of practices that the Commission should encourage across the industry.
Similarly, we note that analysts conference calls are increasingly being opened to the media and individual investors. According to the National Investor Relations Institute (NIRI), 82% of the issuers who conduct analysts conference calls allow individual investors real-time access and 74% allow the media access to their calls. Further, information conveyed during analysts conference calls are typically conveyed immediately by electronic news wire services and participants' websites, with the information being further distributed shortly thereafter by other financial news websites. Here too, many of the concerns addressed by the Commission can be addressed simply by encouraging issuers to adopt such practices.
ConclusionWe believe that the few isolated examples of issuers knowingly providing material nonpublic information to one analyst or investor before making it public should not be condoned and should be addressed through remedies presently available to the Commission, not through a new regulation. We recommend that the Commission allow technology to continue to make information more broadly available to more investors and that it work with NIRI to ensure that issuers continue the trend of providing more information, not less.
By continuing an open dialogue the Commission can best achieve our common goal of encouraging the flow of more information to investors and providing for a more efficient marketplace. We would like to be part of this ongoing dialogue and to assist the Commission in any way.
If you would like to further discuss our response, please do not hesitate to contact the undersigned.
Very truly yours,/s/Carlos M. Morales cc: The Honorable Arthur Levitt, Chairman The Honorable Norman S. Johnson, Commissioner