OT: New SEC Rules On Selective Disclosure And Insider Trading Increase Risks.
Author/s: John Egan, & David Cifrino
Issue: Sept 25, 2000
Typically, the last act in a private equity investor's job is sitting on the board of a newly minted public company. Given the risks inherent in guiding the disclosure policies of an emerging company with a volatile stock price while simultaneously realizing upon their firm's investment in the company, this role often presents the greatest potential for liability to the investor. Recently, the Securities and Exchange Commission raised the stakes even higher by issuing Regulation FD (for Fair Disclosure) and two new insider trading rules.
Regulation FD
Regulation FD is intended by the SEC to end the practice of selective disclosure by public companies to analysts and large investors in closed conference calls and one-on-one meetings. Under Regulation FD, public companies that intentionally disclose material inside information to a select group of analysts or investors must simultaneously disclose it to the public.
In the case of unintentional disclosures, public companies must disclose the information within 24 hours of the inadvertent disclosure or by the start of the next trading day. Failure to comply with Regulation FD can result in enforcement action by the SEC, the mere threat of which could threaten a company's reputation and its market value.
The adoption of Regulation FD was controversial and the final rule contained several significant concessions in response to numerous comments to the rule as first proposed.
For example, Regulation FD does not cover communications made in connection with most registered public offerings and violation of Regulation FD will not affect an investor's ability to resell under Rule 144 or a company's ability to use a Form S-3 short form registration statement. In addition, the rule does not apply to conversations with suppliers, customers, the news media or rating agencies. In the final rule, the SEC also exempted foreign issuers from its coverage.
Many commentators objected to the rule as unnecessary given that the current practices of most public companies are designed to avoid selective disclosures. Many companies provide advance notice of their quarterly earnings calls with analysts and allow the public to listen in via a Webcast on the Internet or by telephone.
Moreover, Nasdaq and New York Stock Exchange listing requirements have mandated for years that public companies promptly disclose any material information.
Nonetheless the SEC adopted the rule in order to give the SEC enforcement powers, including injunctions and monetary penalties, to go after individuals and companies that engaged in selective disclosure.
Although the rule expressly states that violations cannot in and of themselves be the basis for a securities class action, the specter of an SEC enforcement action has already had a significant chilling effect on the willingness of public companies to talk with analysts privately.
Regulation FD may not have a significant impact on large-caps such as General Electric or Intel, which are covered by dozens of analysts and about which there is ample publicly available information. However, small start-up, emerging companies are often in need of analyst coverage to tell their story to investors, and the new rule will likely have a chilling effect on their ability to do that.
Typically, these companies have a limited investor following, so there's less incentive for analysts to cover them, and they are often in newer, emerging markets about which there is less publicly available information. As a result, analysts often require in-depth one-on-one meetings with management before they pick up coverage of these companies to develop the background information and knowledge they need. The potential for the new rule to disproportionally impact smaller, emerging companies will be a real concern.
