Originally Published MX March 2001
A new SEC regulation limits selective disclosure of information by public companies.
Ethna M. S. Piazza and Michael A. Henry
Late last year, the Securities & Exchange Commission (SEC) leveled the playing
field for all investors when it instituted its Regulation FD (Fair Disclosure),
new rules designed to limit the practice of selective disclosure of "material"
information by public companies. Simply put, Regulation FD says that when a public
company discloses material nonpublic information to certain investment professionals
(e.g., analysts, brokers, or institutional investors) or shareholders when it
is reasonably foreseeable that they or people to whom they may pass the data may
trade on that information before it becomes public, the information must be provided
simultaneously to the public as well. The rule does not define or limit the types
of information companies may share with securities markets professionals or shareholders.
"Public disclosure" may be made by filing a Form 8-K or by disseminating the information using a method (or combination of methods) that is "reasonably designed to provide broad, nonexclusionary distribution of the information to the public." Examples of such methods include issuing news releases through a widely circulated news or wire service and making announcements via conference calls or news conferences that the public may attend or listen to in person, on the phone, or on the Internet. The SEC has stated that while disclosure on a company's own Web site may play an important role in disclosure, disclosure of information in this manner alone may not be considered sufficient.
When a company violates the new rule, the SEC may bring an enforcement action seeking injunctive relief, civil monetary penalties, or a cease-and-desist order. Regulation FD expressly states that it does not create a private right of action. That is, individual investors cannot sue a company for failing to publicly disclose material data when the company has selectively disclosed such information to financial professionals and certain shareholders; only the SEC may bring suit under Regulation FD. However, selective disclosure could result in liability in private or SEC actions if it results in tipping, insider trading, or a violation of other securities laws.
Now is the time for publicly held medical technology companies to review their policies and practices regarding discussions with outside parties to ensure that they comply with the new Regulation FD.
What Is "Material" Nonpublic Information?
First, it's important to clarify the types of information that the SEC might consider "material"—that is, influencing an investor's trading decision and thus setting off a full public disclosure of said information if it is selectively shared with securities markets professionals or certain shareholders. While the SEC did not define "material nonpublic information," the courts have recognized that information is material when "there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision, and a reasonable investor would view it as having a significant effect upon the "total mix" of other available data.
In addition, the SEC has identified the following factors as possibly affecting investment decisions (noting that none are per se "material").
- Earnings information.
- Mergers, acquisitions, tender offers, joint ventures, or changes in assets.
- New products or discoveries, or developments regarding customers or suppliers.
- Changes in control or in management.
- Change in auditors or auditor notification that the issuer may no longer rely on an auditor's report.
- Events regarding the issuer's securities (such as defaults on senior securities, calls of securities for redemption, repurchase plans, stock splits, changes in dividends, changes in rights of security holders, or public or private sales of additional securities).
- Bankruptcies or receiverships.
Who Gets the Information?
Regulation FD strives to give all potential investors in companies the same information at the same time. The requirements of Regulation FD apply when a company selectively discloses nonpublic information that may influence an investment decision to any of the following: brokers or dealers; investment advisors, institutional investment managers, or anyone with whom the foregoing are associated; investment companies or people affiliated with investment companies; or shareholders of the company when it is reasonably foreseeable that they will trade on the basis of the nonpublic information.
Under Regulation FD, if a company discloses material nonpublic information to any of these parties, the company also must disclose that information publicly.
There are several instances in which communications with investment professionals will have the potential to trigger a broad public disclosure duty. Many companies hold conference calls with their analysts to discuss the company's financial statements. Some companies review and comment upon an analyst's draft report about the company. In both of these instances, the company is at risk that it may share with the analysts material information about the company before the public becomes aware of the data. Such disclosures must be accompanied by simultaneous public disclosure of that information. Thus, company policies and procedures addressing communications between company officials and investment professionals should be reviewed and updated to protect against such disclosures without broad simultaneous public announcements and to provide a method for making a simultaneous public disclosure in accordance with Regulation FD in the event that a disclosure is to be made to one of the mentioned investment professionals or shareholders.
Companies also need to consider all business relationships, negotiations, and discussions with parties who are also shareholders of the company. Examples of sensitive communications include the following.
- Communications with a shareholder who has given a loan to the company (often the company is required under the loan to provide financial and other information to the lender or shareholder even before it becomes public).
- Communications with an FDA consultant who also holds stock in the company.
- Due diligence communications in connection with a potential merger, or product development or distribution arrangement, where the other party is also a shareholder of the company.
As noted previously, if a disclosure of nonpublic material information is made to a limited number of existing shareholders in a manner that would give those shareholders an opportunity to trade on the basis of the information before it becomes public, a broad public disclosure of the information must also be made.
Companies should establish procedures to determine which parties to business discussions are shareholders, since any discussions with those parties will then be subject to Regulation FD. Then, medtech companies should attempt to exempt their business communications from Regulation FD by requiring that each existing shareholder of the company sign a confidentiality agreement before the company enters into discussions or business relationships with the shareholder. That agreement should expressly provide that the shareholders will not trade on the basis of nonpublic material information provided to them by the company.
Who Gives the Information?
Regulation FD also considers who is providing the information to securities markets professionals and shareholders. The regulation is triggered if the material nonpublic information is disclosed by the following people acting on behalf of the company: a director, an executive officer, an investor relations officer, a public relations officer, or other employees or agents who regularly communicate with shareholders or analysts.
Disclosures of material nonpublic information by other employees are not considered disclosures by "persons acting on behalf of the issuer" unless the employee is acting upon instructions from a senior official. Also, if one of the enumerated people discloses material nonpublic information while breaching a duty of trust or confidence that he or she owes to the company, that disclosure will not be considered to be made on behalf of the issuer.
Companies should review their policies and procedures to consider adding provisions to address disclosure of material information about the company by its directors, officers, and other personnel. In addition, companies may wish to require all such employees covered by Regulation FD to sign confidentiality and nondisclosure agreements.
When Must Information Be Made Public?
Regulation FD requires public dissemination of nonpublic material information when the nonpublic information is disclosed to the investment professionals and shareholders mentioned previously. "Intentional" disclosures are treated differently from "nonintentional" disclosures.
"Intentional" disclosures must be accompanied by simultaneous public disclosure. A disclosure is considered intentional if the person making the disclosure knows, or is reckless in not knowing, that the information being communicated is both material and nonpublic. For example, if before a conference call with analysts an executive prepares a discussion outline that identifies an item of material nonpublic information—or if a company decides that it will discuss material developments in proceedings before FDA in a conference call with an analyst before those developments have been made public—it must simultaneously announce the information to the general public, perhaps in an open conference call or Webcast.
"Nonintentional" disclosures are any other disclosures of nonpublic information that are not within the definition of "intentional" disclosures. When a company discovers that a nonintentional disclosure has occurred, the public disclosure of the information must be made as soon as reasonably practicable but no more than 24 hours after an officer, director, investor relations officer, public relations officer, or similar employee learns of the disclosure and knows, or is reckless in not knowing, that the information disclosed was both material and nonpublic.
While many commentators have thought that unplanned disclosures would be considered nonintentional, the SEC has stated that a disclosure of information that an officer knows is material and nonpublic, even if the officer did not intend or plan to make the disclosure, will be considered intentional. Thus, even if an outline for an analyst call specifically states that there will be no discussion of pending negotiations for a potential merger between the issuer and a major competitor, if the company officer inadvertently discloses the information on the call, the SEC may take the position that the disclosure was intentional. Therefore, companies must undertake greater preparation and counseling of officers and other employees who communicate with investment professionals and other parties that are also shareholders of the company.
Exemptions
Of course, like many rules, this one has its exceptions. For Regulation FD, disclosures made to people who owe a duty of trust or confidence to the issuer (such as an attorney, investment banker, or accountant) are exempt from the rule. Also, material information disclosed to customers, distributors, joint development partners, and other strategic partners who expressly agree to maintain the information in confidence are exempt. Companies may also disclose material nonpublic information to credit-rating services when the disclosure is made to develop a credit rating.
Communications made in connection with a registered offering under the Securities Act of 1933 are also excluded because other provisions of the Securities Act control disclosure of information in that context. The SEC did not want to create a conflict between any existing law regarding registered offerings and the new Regulation FD.
The SEC also has indicated that a company may disclose confidential information to its employees in the ordinary course of communicating with employees, even if they are also shareholders.
In seeking to limit selective disclosure, the SEC is working to ensure that all investors will have equal footing in today's active marketplace. By reviewing their corporate policies and procedures in light of these new rules, medtech companies can ensure that they are standing on solid ground as well.
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Fast Facts On October 23, 2000, the Securities & Exchange Commission's Regulation FD (Fair Disclosure) went into effect, limiting the practice of selective disclosure by public companies. To ensure that they're abiding by the new guidelines, publicly held medtech companies should do the following.
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Ethna M. S. Piazza, Esq., is special counsel (San Diego) and Michael A. Henry, Esq., is an attorney with Sheppard, Mullin, Richter & Hampton LLP (Los Angeles). Piazza handles business formation, mergers and acquisitions, securities, and intellectual property issues for life sciences and other technology companies. Henry focuses on mergers and acquisitions, securities, business formation, and finance issues.
Copyright ©2001 MX
