Interpreting the fair disclosure rule

Telecom firms are poring over the Securities and Exchange Commission's new ruling that governs communications with securities analysts and large, institutional shareholders. How wide-ranging the effect of the new regulations will be still is unknown, but common practices such as one-on-one meetings with sell-side analysts, reviewing draft analyst reports and even speaking at broker conferences could become no-no's.

Regulation Fair Disclosure (FD), passed by the SEC in a 3-to-1 vote on Aug. 10, essentially requires a company's senior management and investor relations professionals to reveal "material" information to the public virtually at the same time they disclose it to investors and Wall Street analysts.

As defined by the regulation, "material" information is anything that holders of the company's securities would be likely to trade on. The rule, which was revised at the last minute, does not cover communications with the media or day-to-day information exchanged with business partners, and companies have a 24-hour grace period to disseminate news that is released inadvertently.

The ruling was drawn up to put an end to "selective disclosure," whereby companies give Wall Street insiders and large shareholders crucial business information prior to making it public. Regulation FD brings all investors - regardless of size - into the information loop, said SEC Chairman Arthur Levitt, and stops the "quid pro quo" that can impair the objectivity of securities analysts.

"Some in corporate management treat material information as a commodity - a way to gain and maintain favor with particular analysts," Levitt said. "What's more, as analysts become more and more dependent on the `inside word,' the pressure to report favorably on a company has grown even greater as analysts seek to protect and guarantee future access to selectively disclosed information. These practices defy the principles of integrity and fairness."

Many telecom companies said they are already in compliance with the measure. Carriers with large shareholder bases are accustomed to following broad disclosure, said Dave Frail, director of financial communications for Verizon, a company with 2.7 million stockholders. Many already use webcasts to hold earnings calls and discuss acquisition news concurrently with analysts and the public.

But telecom lawyers are scrutinizing the fine print to determine if changes are warranted. For example, ADC Telecommunications chief financial officer Robert Switz said his company may need to make its guidance on future revenue and earnings more widely available. "Overall for us there will be some small, incremental changes," Switz said.

For the most part, however, companies such as ADC are taking a wait-and-see attitude. Many will look to the National Investor Relations Institute for guidance.

Investor relations executives that regularly discuss earnings estimates with sell-side analysts to keep expectations in line with estimates may have to stop unless they put that guidance in an earnings call or press release, said Louis M. Thompson Jr., president and CEO of the NIRI. In addition, executives may have to stop speaking at investor conferences unless the events are broadcast over the Web.

"Analysts are shell-shocked over this," Thompson said. "The SEC has emasculated the sell side."

According to the NIRI, another concern for companies involves whether merely posting a news release on a company Web site constitutes full and fair disclosure. An executive alert issued by the NIRI said that doing so without using some form of "push" technology to notify interested parties falls short of compliance.

"[The] NIRI would recommend that companies use a combination of a news release or an 8-K filing and, if desired, the Web-posted news release, using push technology, until we have clearer guidance from the SEC on using the Internet Web posting alone," Thompson wrote in an NIRI executive alert.

An NIRI survey of 462 investor relations professionals found that, in light of the new fair disclosure rule, 42% probably would limit communications practices to some degree; 34.9% said they would cut back or eliminate holding one-on-one meetings with analysts and institutional investors; and 22.5% said they would cut back or eliminate the question-and-answer portion of conference calls.

Although corporations are concerned about liability issues, "it's a lot of handwringing over nothing until somebody gets sued," said Brendan Fitzpatrick, vice president of JM Lafferty & Associates. "In the short run, companies are going to listen to their attorneys and wait for somebody else to stick their neck out and see how things are interpreted."

Meanwhile, securities industry associations are criticizing the ruling. The Securities Industry Association, an organization of investment banks, broker dealers and mutual fund companies, said Regulation FD would restrict the flow of useful information to investors and hamper analysts' ability to "ferret out information on behalf of investors," according to an SIA press release.

The Association for Investment Management and Research agreed.

"Corporations will almost certainly curtail the information flow to the market to avoid having to decide `on the spot' whether certain information will be deemed to be material after the fact by the SEC," said a statement by Michael S. Caccese, senior vice president and general counsel of AIMR. "To avoid any possible SEC enforcement actions, corporations will reduce their communications to `sound bites' and `boilerplate' disclosures."

Although at this point that seems unlikely, how the SEC interprets the rule will be key to whether the information flow between companies and investors will run dry.

"If this ruling is interpreted very broadly and opens the door for lawsuits, that will have a very detrimental effect on the quality of information that comes from companies - and that will hurt all shareholders," Fitzpatrick said. "It also could be a lot less fun to be an analyst."