April 28, 2000
|Re:||Securities Act Release No. 33-7787
Exchange Act Release No. 34-42259
Investment Company Act Release No. IC-24209
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Attn: Jonathan G. Katz, Secretary
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Securities Regulation of The Association of the Bar of the City of New York in response to the Securities and Exchange Commission's Release Nos. 33-7787, 34-42259, and IC-24209 and request for comments, dated December 20, 1999, regarding selective disclosure. The Committee is composed of lawyers with diverse perspectives on securities issues, including members of law firms, counsel to investment advisers, investment companies and their independent directors, academics and members of the judiciary. A list of our Committee members is attached.
The practice of some issuers of selectively disclosing material nonpublic information to analysts, institutional investors or others, but not to the public at large, raises serious issues regarding fairness to individual investors and the integrity of the United States securities markets as a whole. Preserving the fairness and integrity of the country's securities markets of course should be of paramount concern, and we applaud the Commission's efforts in grappling with perceived inequities in the current system of disclosure. If the likely consequence of Regulation FD were simply more widespread disclosure at moderate additional cost and effort, we would support it. Conceptually, giving more investors accessto additional information is a good thing. We believe, however, that the proposed Regulation raises complex issues and a number of serious concerns.
Although the disclosure system that has evolved in the years since the Supreme Court's decisions in Chiarella v. United States and Dirks v. SEC does not guarantee parity of information to all investors, overall the system works very well in conveying vast amounts of information to investors. Information reaches individual investors through annual, quarterly and interim reports filed with the Commission as well as through press releases. A substantial amount of information also reaches investors through research reports prepared by professional analysts. An increasing amount of information and analysis is becoming available quickly to individual investors through the Internet.
The Commission points to instances where selective disclosure has been used to unfair market advantage. See Proposed Regulation FD Release at note 11. However, the handful of examples cited by the Commission do not demonstrate evidence of widespread abuse sufficient to justify the fundamental changes that would result from the enactment of Regulation FD as proposed. The ability of issuers to speak freely, candidly and in some cases privately with analysts and investors has become an important part of a disclosure system that has produced the most efficient securities market in the world. While we would applaud efforts by the Commission to address the abuse of selective disclosure of material information, we believe that this can and should be accomplished through enforcement of existing rules and regulations or through minor changes to a system that is working well, rather than by implementing the far-reaching changes contemplated by Regulation FD, that are likely, in our view, to do more harm than good.
Regulation FD is unlikely to significantly further the Commission's objective of giving all investors meaningful access to an issuer's material disclosures at the same time. To the extent the Regulation succeeded in broadening disclosure, its benefits would likely be limited to extending whatever informational advantage analysts and large institutional investors may now enjoy to the limited number of investors who follow and act upon corporate disclosures on a real time basis, rather than to the public at large. Moreover, whatever incremental increase in access to information is achieved would, we believe, actually result in a substantial reduction in the total flow of information to all investors.
Regulation FD would have a substantial chilling effect on an issuer's willingness to communicate with market participants in any form other than theopen meeting, open conference call or press release. Currently, many issuers follow the practice of opening their quarterly discussion of business results to all investors and the press. There is no question that technological advancements have made opening conference calls and rapidly distributing information through press releases more practical and efficient. But technology does not - at least for now - provide a feasible mechanism for publicly disclosing all significant information now made available to the market through analysts. For instance, issuers commonly invite analysts to tour new plants and other facilities. During the course of such tours analysts may see and hear things that affect their views of an issuer. Given the breadth of the proposed Regulation, plant tours could raise concerns over potential liability for selective disclosure, but inviting the public on a plant tour is simply not feasible.
While there might be a continued increase in the use of open forums, the threat of enforcement actions and the burdens of compliance would likely severely limit the willingness of issuers to engage in the more informal discussions with analysts that are now common. Technological feasibility is not the only legitimate constraint on broader disclosure. Certain types of important information that reach the market in digested form through an analyst report would, for legitimate business reasons, simply dry up rather than be diverted to a public forum.
Under the current system, issuers are often willing to discuss detailed technical information with knowledgeable analysts (many of whom have extensive industry experience or advanced academic training) in order to allow them to write better informed research reports. Some of the information provided to analysts is information that if published more broadly in raw form could be used competitively against the issuer. For instance, issuers involved in high technology industries are often willing to discuss aspects of their proprietary intellectual property with analysts, not to leak confidential material information, but rather to enable the analysts to understand the science behind the issuer's business and thereby better assess its business prospects and competitive position. This is information that the vast majority of individual investors would be unable to use. Issuers have come to expect analysts to write high quality reports without disclosing the underlying technical information they are provided. Under the current system, the average investor benefits from the information conveyed to the broader market by the research analyst's report. That same information would likely become unavailable in a regime governed by Regulation FD.
Under Regulation FD, private discussions with analysts, a valuable means of keeping an open dialogue with the market, would become impractical from a compliance standpoint. An issuer would need to evaluate each and everydiscussion both before it took place, to assure that the issuer's representative would be adequately prepared to avoid what could be argued was an intentional material nonpublic disclosure, and after it took place, to evaluate whether any non-intentional material nonpublic disclosure was made and, if so, issue a prompt public disclosure. Compliance problems would be particularly burdensome in light of what we believe is an overly broad definition of "person acting on behalf of an issuer." By encompassing any officer, director, employee or agent "who discloses material nonpublic information while acting within the scope of his or her authority" the Regulation would create an unwieldy compliance problem for large issuers.
The Commission suggests a number of mechanisms to mitigate Regulation FD's chilling effect on disclosure. We do not believe that these mechanisms would be effective.
As an initial matter, the Commission's suggestions do not address the substantive reduction in disclosure that would likely result from the prohibition of confining the release of detailed technical information to analysts. As tools to mitigate the procedural impediments to disclosure in compliance with the proposed Regulation, the suggestions have significant practical limitations.
For instance, recording private communications with analysts and investors will do nothing to alleviate the issuer's need to evaluate each informal communication for potential materiality. In fact, such recordings would likely further chill communications because of the fear that they could later be used against the issuer in an enforcement proceeding. Declining to answer questions prior to an internal review and consultation concerning materiality, while perhaps helpful in assuring compliance with the Regulation, would act as a serious impediment to the free flow of information.
Limiting the number of persons authorized to field inquiries from analysts, investors and the media might be of some utility if the Regulation were limited to disclosures to these groups, but as written, the Regulation would also govern discussions between an issuer and its suppliers, vendors, strategic partners and customers on potentially material topics such as sales and marketing strategies, product development and production and other commercial areas. Limiting the number of people authorized to speak on behalf of the issuer in this much broader context would be impossible. Likewise, the use of confidentiality agreements, another suggestion made by the Commission, is not customary (or practical) in this context.
The Commission suggests that the most important tool to mitigate the Regulation's chilling effect is the less stringent disclosure standard proposed for non-intentional material disclosures. Unfortunately, the protection afforded by the standard for non-intentional disclosures will be substantially undercut by the inclusion of recklessness as a sufficient basis to bring the issuer under the stringent rules for intentional disclosures. To issuers familiar with the unpredictability of litigation over what type and amount of evidence is sufficient to demonstrate recklessness, the "non-intentional" standard will provide little comfort.
In addition to what we believe would be the generally negative effect on the overall flow of information to the market, proposed Regulation FD could also seriously impede the free flow of information in situations that do not implicate the Commission's concerns over the misuse of selective disclosure.
As recognized in the Commission's release, Regulation FD would present many potential liability questions under the Securities Act in connection with communications made as part of registered offerings. These pitfalls would be particularly problematic in the context of investor "roadshow" presentations conducted in connection with a securities offering. Roadshows typically involve presentations to groups of institutional investors in addition to one on one question and answer sessions. These presentations and discussions often elaborate on the information included in the preliminary prospectus. Roadshows are a vital part of the marketing process. We believe that existing (and proposed) laws and regulations specifically governing communications in registered public offerings provide ample protection for individual investors. For this reason, Regulation FD should, at a minimum, exempt communications made as part of securities offerings under the Securities Act.
Also, as adverted to above, we believe that the proposed Regulation's coverage of disclosures to "any person or persons outside the issuer", excluding only those who owe "a duty of trust or confidence to the issuer . . . or who [have] expressly agreed to maintain such information in confidence," is overly broad. An issuer's discussions of material nonpublic information with its suppliers, vendors, strategic partners and customers on potentially material topics such as sales and marketing strategies, product development and production and other commercial areas simply do not threaten to disadvantage individual investors. Another common example is the communications between an issuer and its commercial bank. Such disclosures are a necessary part of a borrower/lender relationship, but the bank would not qualify as a fiduciary of the issuer and despite assurances that it will not trade on the information, may not be willing to sign a confidentialityagreement. Even routine discussions with competitors could technically be covered by the proposed Regulation. For instance, the rule could compel disclosure of the contents of two competing companies' discussions regarding the political situation in a country in which they both have operations. The companies might be eager to share information they each have in order to protect their employees and assets, but would likely not be willing to do so in the form of a conference call or press release. Any enacted regulation should address the over-inclusive definition of outsider and carve out legitimate commercial communications by the issuer.
Finally, we believe that the Regulation's proposed inclusion of foreign issuers raises additional concerns. The compliance problems for U.S. companies will be compounded for foreign companies: language barriers and inconsistent local legal or regulatory requirements could impede timely disclosures and monitoring of communications. (At a minimum, the Regulation should exempt communications with foreign regulators.) The timing and content of Form 6-K filings are currently governed by the laws of the issuer's home jurisdiction. In addition, as recognized by the Commission, many foreign issuers are already subject to stock exchange or NASDAQ rules requiring prompt public disclosure of material developments. The disclosure obligations imposed from these sources provide ample protection for investors. Moreover, the methods by which issuers communicate with investors and analysts have evolved in different ways around the world. The fact that an issuer wishes to offer its securities in the U.S. should not require it to alter its disclosure methods to fit the Regulation FD model. Declining to impose substantive disclosure obligations on foreign issuers, other than the annual report on Form 20-F, has traditionally been the Commission's policy, and the Commission has attracted foreign issuers to U.S. capital markets with its flexible rules. The significant regulatory burdens that could be imposed by Regulation FD would, we believe, have the opposite effect. Therefore, we urge the Commission to exclude foreign issuers from the Regulation if it is adopted.
We share the Commission's concerns over the potential distorting effects of selective disclosure on a fair and efficient market. However, we do not believe that there is sufficient evidence of abuse in the current system to justify the fundamental and far reaching changes being proposed in Regulation FD. Unless substantial revisions are made to address its overbreadth, the negative collateral consequences of the Regulation will likely overwhelm its limited benefits in promoting information parity.
Stephen J. Schulte
Chair, Committee on Securities Regulation
Richard A. Drucker
Chair, Subcommittee on Proposed Regulation FD
cc: The Honorable Arthur Levitt, Chairman
The Honorable Paul R. Carey, Commissioner
The Honorable Isaac C. Hunt, Commissioner
The Honorable Norman S. Johnson, Commissioner
The Honorable Laura S. Unger, Commissioner
Association of the Bar of the City of New York
Committee on Securities Regulation
Stephen J. Schulte, Esq. (Chair)
André Weiss, Esq. (Secretary)
Craig Barrack, Esq.
Mark H. Barth, Esq.
Anthony J. Bosco, Esq.
Jonathan H. Churchill, Esq.*
Peter C. Clapman, Esq.
Sarah E. Cogan, Esq.
Richard A. Drucker, Esq.
Elisabeth Duncan, Esq.
Mitchell S. Fishman, Esq.
Alan R. Friedman, Esq.
David B. Harms, Esq.
Sarah Hewitt, Esq.
Irshad Karim, Esq.*
Clifford E. Kirsch, Esq.
Paul L. Lee, Esq.
Peter J. Loughran, Esq.*
Thomas M. Madden, Esq.
James B. McHugh, Esq.
Abby S. Meiselman, Esq.
Charles M. Nathan, Esq.*
Ernest T. Patrikis, Esq.*
Janine L. Pollack, Esq.
David W. Pollak, Esq.
Neila B. Radin, Esq.*
Walter G. Ricciardi, Esq.
Richard H. Rowe, Esq.*
Faiza J. Saeed, Esq.
Kathryn F. Schneider, Esq.
Roslyn Tom, Esq.
James Q. Walker, Esq.
Lawrence J. Zweifach, Esq.
* Member of Subcommittee on Proposed Regulation FD