Lurking in the Shadows: The Hidden Issues of the Securities and Exchange Commission's Regulation FD
Steinberg, Marc I., Myers, Jason B., Journal of Corporation Law
I. THE SEC's VIEW OF SELECTIVE DISCLOSURE: THE PROBLEM AND THE SOLUTION
In the not-so-distant past, issuers of publicly held securities often would selectively disclose material nonpublic information to analysts and other securities market insiders in advance of any broad public announcement. Perceiving that such practices impeded a fair marketplace to all investors, the Securities and Exchange Commission (Commission or SEC) promulgated Regulation FD (Regulation), standing for "Fair Disclosure," which now proscribes these practices.1 Today, issuers of publicly held securities can no longer selectively disclose material nonpublic information to analysts, broker-dealers, other market professionals, or favored shareholders without a corresponding announcement to the general public.
A. Identifying the Problem
The practice of selective disclosure, as well as its effects, is illustrated in an October 1999 Washington Post article regarding Hewlett-Packard (H-P).2 The episode in question started October 1, 1999, when H-P's CEO held a conference call with analysts at which the executive disclosed, among other bits of information, that an earthquake in Taiwan may disrupt the production of a component that the company used in producing personal computers. This conference call was open to the media and H-P posted the transcript of the call on its Internet Web site. A few weeks later, analysts called H-P to obtain more information from the company before it went into a regular, self-imposed silence period prior to issuing its quarterly report. H-P officials told analysts who called the company that it was in fact experiencing a disruption. As a result, several analysts downgraded their earnings estimates for H-P, leading to a large sell-off of stock. By the time H-P issued a press release two days later and a formal announcement the day after that, the company's stock price fell twelve percent. Those investors affiliated with the analysts to whom H-P conveyed the information were able to sell off stock before the price fell, thus protecting the value of their investment. Others, however, stood by watching their investment decline without any public statement from H-P.3
This incident, highlighting the practice and effects of selective disclosure, is not the most egregious example; indeed, H-P can point to a number of practices in its defense. First, the company had publicly disclosed the potential disruption of its flow of PC components in its October 1 conference call. In addition, H-P did not consider the distinction between may have problems and in fact having problems to be significant.4 But for those investors outside the informational loop, the effect of the selected disclosure was the same: the "`chosen few' analysts ... guard[ed] the information carefully to maximize the advantage of their pre-knowledge" while the general public "frustrating[ly] [sat] by in ignorance."5
According to former SEC Chair Arthur Levitt, selective disclosure practices benefit market professionals at the expense of small investors and "simply ... defy the principles of integrity and fairness."6 Before Regulation FD, however, even though selective disclosure of material nonpublic information may have been perceived as unfair, it normally was not illegal. The practice of selectively disclosing such information generally does not fall within the antifraud provisions of Section 10(b) of the 1934 Securities Exchange Act and its regulatory counterpart, Rule 10b-5.7 Thus, no liability normally attaches to issuers, their executives, or market professionals for trading by the professsionals' clients in the subject companies' securities based on material nonpublic information.
How did the securities laws develop in such a way that permitted selective disclosure? For many years, selective disclosure had been seen as generally falling under early insider trading case law, thus leading to liability exposure for issuers and their insiders who selectively tipped material nonpublic information as well as their tippees who themselves tipped or traded on the information. …