In December 1999, the Securities and Exchange Commission proposed a new rule called Reg FD (Fair Disclosure). Its recent adoption may be a thorn in the sides of some investor-relations professionals and Wall Street analysts, but small individual investors think it is a wrong made right. Either way, it promises to change the way many publicly held energy companies communicate with all their stakeholders. Reg FD grew out of the SEC's concern that selective disclosure of material, nonpublic information by publicly traded companies to securities analysts and institutional investors created a significant disadvantage to the general investing public. Despite the new world of easy Internet access to more detailed investment information by the lay investor, the SEC wanted to ensure a level playing field. The proposal touched a nerve. The SEC received nearly 6,000 comment letters, largely from individual investors, urging that the commission adopt some form of Reg FD. Not surprisingly, institutional investors generally opposed the rule. Nevertheless, the SEC adopted it and it became effective October 23. What does it all mean? At the National Investor Relations Institute's annual conference in October, and at local chapters everywhere, IR pros have been debating the ramifications. Does issuing a press release on the news wires and Internet suffice? Can executives still hold dinners, golf outings, rig trips or other informal meetings with big investors or analysts without fear of disclosing something material that the general public doesn't yet know? Should every such event be simultaneously accompanied by a press release to all? First, what is meant by selective disclosure? In the context of Reg FD, it arises when an issuer discloses material, nonpublic information to a securities analyst or other securities professional, or to a large stockholder, without simultaneously disclosing that information to the public. Federal securities laws do not require public disclosure of all material corporate developments as they occur. The timing of many important disclosures is subject to the business judgment of a company's officers and directors. With Reg FD, the SEC is reducing the ability of securities issuers to limit the audience to whom some disclosures are made. Many commentators have argued that stock analysts play an important role in the marketplace by collecting and analyzing sometimes arcane information and using it to help the market more accurately reflect a company's value. Nevertheless, the SEC has long frowned on the practice of selective disclosure, although its arguments sometimes seemed more grounded in purely ethical, rather than legal, reasons. Prior to Reg FD, SEC officials often cited two concerns about selective disclosure: first, it created an uneven playing field by providing some information to one group of investors but not to all investors, and second, it undermined investor confidence in the fairness of the marketplace. Other experts pointed out that an analyst may feel pressured to report favorably on a particular company, to maintain a line of communication with that company for selectively disclosed information. On the other side of the coin, companies may delay public disclosures so that information can be selectively disclosed to a particular analyst or investor. For enforcement purposes, the SEC tried to characterize selective disclosure as a violation of insider-trading laws under Rule 10b-5 (the primary antifraud rule under the federal securities laws), but that characterization did not always fit. That, in turn, resulted in a significant amount of uncertainty as to when certain disclosure practices were prohibited. The state of insider-trading law began to develop with the Supreme Court's decision in Chiarella v. United States in 1980. That case rejected the notion that deemed trading to be fraudulent whenever the trader possessed material nonpublic information. It instead held that there must be a breach of fiduciary duty or some other relationship of trust before the law will impose a duty to either publicly disclose such information or refrain from trading. Three years later, in Dirks v. SEC, a case involving insider trading based on selective disclosure to an analyst, the Supreme Court set forth a three-part test to show liability under Rule 10b-5 for insider trading: 1. A corporate insider must have breached a fiduciary duty to the company's stockholders by tipping an outsider; 2. The corporate insider received a personal benefit from providing the tip; and 3. The recipient of the tip knew or should have known that the insider was breaching a fiduciary duty. Many observers interpreted "personal benefit" to mean strictly financial gain, although there has been little further judicial interpretation of the term. In a later enforcement proceeding, SEC v. Stevens, the SEC argued that the personal benefit standard under Dirks need not be satisfied by financial benefit, but may be satisfied by the tipper receiving a "reputational" benefit. Although that case ultimately settled prior to a definitive court ruling on that issue, it gave an indication of the SEC's aggressiveness in combating selective disclosure by pushing the envelope of insider-trading liability. As we shall see, under Reg FD the SEC need not show any personal benefit to the tipper or, for that matter, to the tippee. Rather, liability is based on the mere fact of selective disclosure being made. What is "material"? We should point out one thing that Reg FD does not do: give a great deal of guidance on how to determine what is "material." Many commentators urged the SEC to establish some definite standards, lists or limitations as to what would be material, because of the difficulty that issuers have in making rapid judgments as to materiality. The SEC elected not to do so. Instead, it adopted existing definitions of that term as established in the case law. A thorough discussion of the concept is beyond the scope of this article. However, one often-quoted case says information is material if "there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision. Quoting another case, information is material if there is a substantial likelihood that it "would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." There is also the probability/magnitude test, which says that materiality "depends at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of company activity." When it adopted Reg FD, the SEC provided a list of types of information that should be reviewed carefully to determine whether they are material. These include: 1. Earnings information; 2. Mergers, acquisitions, tender offers, joint ventures or changes in assets; 3. New products or discoveries, or developments regarding customers or suppliers; 4. Changes in control or in management; 5. Change in auditors or auditor notification that the issuer may no longer rely on an auditor's audit report; 6. Events regarding the issuer's securities, such as defaults and splits; and 7. Bankruptcies. In particular, the SEC does say that giving an analyst guidance on earnings information is very likely to be deemed a selective disclosure of material information and, therefore, a violation of Reg FD. What's involved in the new regulation? Fundamentally, Reg FD says that whenever an issuer, or person acting on its behalf (in general, senior management), discloses material nonpublic information to certain enumerated persons (in general, securities-market professionals or stockholders), the issuer must make public disclosure of that information simultaneously (for intentional disclosures), or promptly (for unintentional disclosures). Let's look at each of these pieces in order. Reg FD's application is limited to disclosures made by "issuers," generally any company that has a class of securities registered under Section 12 of the Securities Exchange Act of 1934, or is otherwise required to file reports under the 1934 Act, such as Forms 10-K and 10-Q. A person acting on an issuer's behalf is, generally, defined as any senior official of the issuing company, or any other officer, employee or agent of the issuer who regularly communicates with the security-holders, or the following "enumerated persons": brokers, dealers and persons associated with them; investment advisors, institutional investment managers and persons associated with them; investment companies and persons associated with them; and security-holders of the issuer, if it is reasonably foreseeable that the holder will trade on the basis of the information. Note that Reg FD does not cover communications with customers and suppliers in the ordinary course of business, nor does it cover communications with the media. There are a few exclusions and exceptions to the rule. Issuers are not required to publicly disclose nonpublic material information made: 1. To a person who owes a duty of trust or confidence to the issuer, such as attorneys and accountants; 2. To a person who expressly agrees to maintain the information in confidence; 3. To credit-rating agencies; or 4. In connection with most public securities offerings. Was it intentional or not? The last part of the Reg FD analysis is whether the material disclosure was intentional or nonintentional. Reg FD defines "intentional" as when the person making the disclosure either knows, or is reckless in not knowing, that the information is both material and nonpublic. This definition goes to the heart of what selective disclosure is all about-for instance, holding a conference call for analysts that excludes the public, or contacting an analyst in order to disclose material nonpublic information. The result under Reg FD is that an intentional disclosure by an issuer to one of the enumerated persons must simultaneously be disclosed to the public. Obviously, the other type of disclosure would be unintentional, such as an inadvertent slip of the tongue. A disclosure would also be considered unintentional if a person mistakenly, but not recklessly, believed the information had already been made public, or mistakenly, but not recklessly, believed the information was not material. Suffice it to say that the recklessness standard creates some level of uncertainty, particularly since an issuer's judgments as to materiality will likely be judged in hindsight. When an issuer makes a nonintentional disclosure of material nonpublic information, it is required to make a public disclosure promptly. Reg FD says that means "as soon as reasonably practical" but in no event after the later of 24 hours or the commencement of the next day's opening of the New York Stock Exchange, no matter if the stock is traded on the NYSE. This definition accounts for events that may arise after the market closes on Friday afternoon. How to disclose What is the type of public disclosure that will satisfy the requirements of Reg FD? The rule provides that public disclosure may be made by furnishing or filing a Form 8-K with the SEC or such other method or combination of methods reasonably designed to provide broad, nonexclusionary information to the public. Interestingly, as part of the adoption of Reg FD, the SEC created a new Item 9 on Form 8-K for Reg FD disclosures. The issuer may file disclosures under "Other Events" or one of the other specific items on Form 8-K, or furnish the information under the new Item 9, "Regulation FD Disclosure." The difference? Information "furnished" under Item 9 will not be deemed to be "filed" and therefore will not be subject to liability based on misleading statements made in a 1934 Act filing. In either event, filing or furnishing information on Form 8-K is not deemed to be an admission by the issuer as to the materiality of the disclosure. Two additional notes on the provisions of Reg FD: 1. Violations of Regulation FD will not affect the availability to an issuer of short-form registration statements on Forms S-2, S-3 and S-8 under the 1933 Act, or the issuer's eligibility to use Rule 144 to sell unregistered securities, and 2. Failure to make a public disclosure under Regulation FD is not deemed to be a violation of Rule 10b-5. The SEC tried to make clear that Reg FD is solely a disclosure rule and not an antifraud rule; it is not designed to create any new duty for Rule 10b-5 purposes. Accordingly, private plaintiffs may not bring an action under Rule 10b-5 based solely on a failure to make a public disclosure that would otherwise be required by Reg FD. This is not to say that other grounds for Rule 10b-5 claims are affected by Reg FD, as there may be other grounds for liability in many circumstances. If Reg FD requires an issuer to make a disclosure, and that disclosure contains false or misleading information, the issuer would not be protected from claims under Rule 10b-5. Where from here? It is too early to predict what the full effect of Reg FD will be, but it is safe to say that most companies will be carefully reviewing their disclosure policies, or in some cases adopting such policies for the first time. Those policies should identify or otherwise limit the persons authorized to communicate with analysts and investors. They should impose procedures for determining whether potential disclosures are material, and how and when disclosures should be disseminated to the public. The answers to questions that are likely to arise in meetings or conference calls with analysts or investors should be carefully scripted to reduce the possibility of selectively disclosing material, nonpublic information. The likely result for most public companies is greater caution and conservatism with respect to communications with analysts and investor, but such contacts need not be avoided completely. Planned disclosures of material information will likely begin by issuing a press release containing the information, along with notice of a scheduled conference call and instructions on how to access the call. Companies should hold the conference call openly, permitting all investors to listen either by telephone or through Internet webcasting. Note that giving all members of the public the opportunity to listen to the call does not require that all listeners be given the opportunity to ask questions. The issuer may allow only certain participants in the call to ask questions, so long as all listeners can hear the question and the issuer's response. For some public companies, the requirements imposed by Reg FD will run counter to years of practice. For others, the regulation is a reflection of sound disclosure policies already in place. For analysts and institutional investors, it may feel like some kind of threat to business as usual. For individual small investors, it opens a window on more information. As with any new and controversial initiative that tries to deal with many competing interests, the last chapter of the rules on corporate disclosure has probably not yet been written. Roger K. Harris is counsel with law firm Fulbright & Jaworksi LLP's Houston office. He received his J.D. from the University of Houston and joined the firm in 1990. He practices corporate and securities law. ONE ANALYST'S TAKE Reg FD was certainly a hot topic at the annual joint meeting of the National Association of Petroleum Investment Analysts (NAPIA) and the Petroleum Investor Relations Association (PIRA) in October. Why? It challenges the practice of tipping off favored analysts, investors and certain media outlets before others. Reg FD gives the SEC new teeth to bite those who selectively disclose material information. Although Reg FD is an issue mostly for companies, not analysts, the rule also could affect the latter, says G. Allen Brooks, immediate past president of NAPIA and executive director of equity research for CIBC World Markets Corp., Houston. "The SEC kind of muddied the waters here, although that wasn't their intent. The cure is almost worse than the illness. This is going to make a lot of companies more gun shy," he says. "An SEC official [who spoke in Houston recently to clients of BusinessWire] said this was meant, and these are his words, 'to chill the information flow.'" "Reg FD is for a noble cause, but is it really going to level the playing field between institutions and individual investors just because information is immediately available to all? If Houston Astros first baseman Jeff Bagwell takes the softball field with one hand tied behind his back, he is still going to be a better player than most amateurs. I defy any individual to think they can consistently and accurately project the earnings of a company the way a professional analyst can." Brooks speculates that Reg FD either will cause companies to clam up as much as possible, or at the other extreme, let loose a flood of information in an effort to avoid surprises. Already some energy companies say they will issue a press release at the end of each month to update investors and analysts on anything that may affect quarterly results. Others say they will institute a midquarter conference call. Still others will refuse to give presentations at investment conferences unless their remarks are simultaneously webcast to all potential investors. If information becomes harder to get, analysts may end up covering fewer companies, and if there is thus transparency, that could lead to smaller trading multiples and more volatility. "The conversations between companies and analysts have to be different-limited to the facts and not to estimates on reserves or production volumes, but...that sets up the greater likelihood of earnings surprises, which means more volatile stocks and possibly, lower valuations," Brooks says. To easily find disclosures under Reg FD, Edgar-Online Inc., the Internet provider of SEC data, has launched Fair Disclosure Express at www.FD-express.com, which offers Form 8-K and Rule 425 filings, an analysis of the new rule, a link to the actual ruling as well as comment letters and other documents submitted to the SEC concerning the rule. -Leslie Haines