What You Can Say: The State of Play

Presented by

Shannon V. Patterson

Troutman Sanders LLP

NIRI Richmond Chapter

September 16, 2011

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Regulation FD• Reg FD adopted in 2000• Several early enforcement actions

(2002-2005)• Adjusting analysts’ earnings expectations• Selective disclosure of significant new

contract• Disclosure at an investor conference• Guidance through language, tone, emphasis

and demeanor• Reaffirming earnings guidance

• Fairly quiet until August 2009

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Regulation FD• What is Regulation FD?

• Prohibits selective disclosure of material non-public information

• Any intentional disclosure of material non-public information must be preceded or accompanied by a public disclosure by:

• Form 8-K• Press release or• Webcast

• Any non-intentional disclosures must be “promptly” disclosed to the public (within 24 hours)

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Regulation FD• Applies to disclosures BY:

• the issuer • senior officials and directors• officers, employees and agents of the

issuer who regularly communicate with securities professionals and shareholders

• Applies to disclosures TO:• securities professionals • any shareholder where it is reasonably

foreseeable that such shareholder would trade on the basis of the information disclosed

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Regulation FD

• Does not apply when communicating:• to employees• to persons who owe a duty of trust or

confidence (attorneys, investment bankers, accountants)

• to persons who expressly agree to maintain the information in confidence (suppliers, customers)

• in connection with certain registered securities offerings

• Dodd-Frank Act required the SEC to remove a prior exemption for ratings agencies effective October 4, 2010

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Regulation FD

• Disclosure is intentional if a person making the disclosure knows or is reckless in not knowing that the information is both material and non-public

• Information is non-public unless:• it has been disseminated in a manner

calculated to make it available to investors generally, and

• public investors have had a reasonable period of time to react to the information

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Regulation FD

• To be material, there must be a substantial likelihood that a fact would have been viewed by a reasonable investor as having significantly altered the “total mix” of information available• The SEC has said that companies will not be

second-guessed on close materiality judgments• In the case of a selective disclosure attributable to

a mistaken determination of materiality, liability will arise only if no reasonable person under the circumstances would have made the same mistake

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Regulation FD

• No “bright-line” materiality standard, but typical material information includes:• earnings information• mergers, acquisitions, tender offers, joint

ventures or changes in assets• new products or discoveries, or developments

regarding customers or suppliers (e.g., the acquisition or loss of major contract)

• changes in control or in management• developments regarding significant lawsuits

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Regulation FD

• No “bright-line” materiality standard, but typical material information includes (cont.):• change in auditors or notification that a company

may no longer rely on an auditor’s audit report

• events regarding a company’s securities

• defaults on senior securities

• calls of securities for redemption

• repurchase plans

• stock splits or changes in dividends

• changes to the rights of security holders

• public or private sales of additional securities

• bankruptcy or receivership

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Recent Developments

• August 2009: SEC issued guidance• September 2009: SEC v. Black • March 2010: SEC v. Presstek • October 2010: SEC v. Office Depot

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Recent Guidance

• First SEC guidance issued August 2009 (and updated June 2010)

• http://sec.gov/divisions/corpfin/guidance/regfd-interp.htm

• Confirmation of previous forecast• Selective confirmation is permitted, provided

additional material information is not included• Timing of confirmation is important (end of

period confirmation or confirmation following lapse of time or significant event could be viewed as indicating actual performance)

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Recent Guidance• Confirmation of previous forecast (cont.)

• Company stating that it has “not changed” or that it is “still comfortable with” prior guidance is the same as providing a direct confirmation of the prior guidance — even a reference to the prior guidance may imply confirmation of that guidance

• If a company does not wish to confirm the prior guidance, use “no comment”

• A company could make clear when referring to prior guidance that the guidance was provided as an estimate as of the date it was given, and that it is not being updated at the time of the subsequent statement

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Recent Guidance

• Reviewing draft analyst reports• Companies may review or comment on draft analyst

reports, provided no material, non-public information is revealed

• Inconsequential data may not be material, even if a skilled analyst can discern material information from it

• Unauthorized Disclosures• Selective disclosures of material non-public

information by persons not authorized to speak to enumerated persons are not covered by Reg FD

• Directors• Directors authorized to speak on behalf of company

may speak privately with shareholders but caution is needed not to disclose material non-public information

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Recent Guidance• Use of confidentiality agreements

• Material, non-public information may be provided to analysts and investors if they enter into confidentiality agreements

• Disclosure to employees• Companies may provide material, non-public information

to employees, as they are subject to duties of trust and confidence and are bound by insider trading policies

• Intentional selective disclosure• Follow-up release of information does not cure a Reg FD

violation

• Immediate disclosure• Once the issuer has made disclosure through an EDGAR

filing, the issuer may immediately publicly disclose the information

• Press presence not enough• The presence of press at a non-public meeting does not

render the meeting “public” for Reg FD purposes

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Corporate Websites

• 2008 interpretive guidance on the use of a company website to disclose material non-public information to investors

• The guidance focused on • whether website disclosure is a satisfactory

method for public disclosure and • when information posted on a company website

is considered “public” so that subsequent disclosure of the information will not violate Reg FD

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Corporate Websites

• For information to be “public”:• must be disseminated by means of a recognized

channel of distribution • such posting disseminates the information in a

manner that makes it available to the securities marketplace in general and

• investors must be afforded a reasonable waiting period to react to the information

• Use of company’s website to satisfy Reg FD, if • the website is a “recognized channel of distribution”

and • the information is “posted and accessible”

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Corporate Websites

• How to make your website a “recognized channel of distribution” – a place an investor would go to for material information:• Remind investors in your press releases and periodic

reports that you post important information about the company on your website

• Post important information on your website - more than posting your Exchange Act filings

• Present investor information in an easily identifiable manner (e.g., have an “Investor Information” tab on the home page)

• Organize information so investors know when new content has been added to a section

• Use push technologies such as RSS feeds

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Corporate Websites – Best Practices

• What is “a reasonable waiting period to react” to the website information?• No clear guidance; suggests a “seasoning”

concept so investors have enough time to digest the information after its release before it is considered “public”

• Length of waiting period should be at least as conservative as the company’s current policy on public dissemination of information in press releases

• Due to uncertainty, companies likely will continue to prefer Form 8-Ks and press releases

• Companies should consider a phase-in period for using corporate websites to disseminate material information

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Recent Enforcement Actions

• Selective emails on changes in earnings guidance• In SEC v. Black (Sept. 24, 2009), the SEC brought an

action against the former CFO of American Commercial Lines, Inc.• The CFO sent an email on a weekend to certain analysts

(“additional color”) stating that the company’s earnings were actually closer to half of what the company previously had disclosed in its guidance

• The CFO failed to have the company’s outside counsel review his email correspondence prior to sending it to analysts after he was advised to do so by the CEO

• The SEC brought the action against the CFO individually and did not bring an enforcement action against the company

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Recent Enforcement Actions

SEC decided not to bring an enforcement action against the company in Black:• Company “cultivated an environment of

compliance”• CFO acted independently and outside of the

company’s control systems, which had been implemented to prevent such violations

• Company promptly made public disclosure of the information on a Form 8-K

• Company promptly reported the CFO’s conduct to the SEC and cooperated with the SEC

• Company took remedial measures, including the adoption of additional controls, to prevent recurrences

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Recent Enforcement Actions

One-on-one telephone call with investment adviser

• In SEC v. Presstek (Mar. 9, 2010), the SEC brought an action against Presstek, Inc. and its former CEO

• Investment adviser called 2 days before end of 3Q to ask about results and CEO signaled results were disappointing

• CEO tried to be vague (“summer not as vibrant,” overall performance was a “mixed picture”) but investment adviser got the message and immediately sold its funds’ entire investment in the company

• Stock price dropped significantly but company did not disclose negative information to anyone else until it issued a press release with revised forecast the next day

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Recent Enforcement Actions

• Company paid $400,000 civil penalty• SEC took note of remedial actions:

• The company revised its corporate communications policy and corporate governance principles

• The company replaced its management team

• The company appointed new independent board members

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Recent Enforcement Actions

Implied earnings disclosures• In SEC v. Office Depot (Oct. 21, 2010), the SEC

settled charges with Office Depot and its CEO and former CFO related to one-on-one telephone calls to analysts that Office Depot would not meet analysts’ quarterly earnings estimates

• No direct statements that the company would not meet expectations

• CFO prepared “talking points” for investor relations officials to signal the message by referring to recent public statements of comparable companies about the impact of the slowing economy on their earnings and by reminding the analysts of Office Depot's prior cautionary public statements

• Analysts promptly lowered their estimates for the period in response to the calls

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Recent Enforcement Actions

• Some analysts expressed concern that this information was not being publicly disclosed in a company press release

• Stock price began dropping significantly on increased volume

• The company filed a Form 8-K with revised information 6 days after commencing the calls

• The company paid $1 million and each executive paid $50,000 in civil penalties

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Recent Enforcement ActionsMistakes made by Office Depot, its CEO and its former CFO:º Communicating privately with analysts concerning

earnings– high degree of risk under Reg FD when an officer engages

in a private discussion with an analyst seeking guidance about earnings estimates

– true whether the information about earnings is communicated expressly or through indirect “guidance,” the meaning of which is apparent though implied

º Statements were made at the end of a quarter– may convey information about how the issuer actually

performed – inference a reasonable investor may draw from such a

confirmation may differ significantly from the inference he or she may have drawn from the original forecast early in the quarter

º Active involvement of the CEO and CFO, each of whom had prior investor relations experience

º Calls influenced many analysts to revise and lower their 2Q 2007 forecasts.

– By the end of the second day of the calls, 15 of the 18 analysts lowered their estimates.

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Recommendations

• Be proactive in preventing Reg FD violations• Cultivate an environment of compliance• Implement written Reg FD policies and conduct

formal training• Be on the lookout for information that seems material• Consult legal department or outside counsel prior to

making disclosure

• Adopt specific policies that:• limit the group of persons authorized to speak• limit private communications with analysts• encourage adherence to a script in private

conferences• require monitoring of marketplace information • require consultation with counsel• encourage obtaining confidentiality agreements

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Recommendations

• Be wary of private discussions• “high degree of risk”• mere timing of conversation can convey

information or create an unintended implication• Don’t attempt an end-run around the rule• Act quickly if a violation does occur:

• make public disclosure of the information• consider self-reporting to SEC• cooperate with SEC• review controls and make adjustments to

anticipate and prevent a recurrence• Periodically review compliance and

controls to ensure they are comprehensive and up to date

Regulation G

• Reg G adopted in 2003• Implemented Section 401(b) of

Sarbanes-Oxley Act• Addressed concerns about improper

use of non-GAAP financial measures dating back to 1970s

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Regulation G

• What is Regulation G?• Applies whenever a reporting company,

or a person acting on its behalf, publicly discloses material information that includes a non-GAAP financial measure

• Does not apply to registered investment companies or disclosure covered by SEC’s rules for proposed business combinations

• Limited exception for certain disclosures by foreign private issuers not listed on a U.S. exchange

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Regulation G

• Prohibits reporting companies from disseminating false or misleading non-GAAP financial measures or presenting non-GAAP financial measures in a manner that would mislead investors or obscure the company’s GAAP results

• Requires that public disclosure of non-GAAP financial measures be accompanied by:• a presentation of the most directly

comparable GAAP financial measure and • a reconciliation of the non-GAAP financial

measure to the most directly comparable GAAP financial measure

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Regulation G

If the non-GAAP financial measure is released orally, telephonically, by webcast, by broadcast or by similar means:• Required information may be provided

on corporate website• Must be posted when the non-GAAP

financial measure is made public• Company must provide the location of

its website during presentation

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Regulation G Plus – Earnings Releases

In addition to the requirements of Reg G, Item 2.02 of Form 8-K requires a company furnishing an earnings release to the SEC to comply with Item 10(e)(1)(i) of Regulation S-K:• present, with equal or greater prominence, the

most directly comparable financial measure or measures calculated and presented in accordance with GAAP

• state why management believes the non-GAAP financial measure provides useful information for investors and

• to the extent material, state the additional purposes for which management uses the non-GAAP financial measure (if any).

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Regulation G Plus Plus – “Filed” Documents

In addition to the requirements of Reg G, if a non-GAAP financial measure is included in an SEC filing (e.g., Form 10-K or Form 10-Q), company must also comply with all of Item 10(e) of Regulation S-K:• present, with equal or greater prominence, the

most directly comparable financial measure or measures calculated and presented in accordance with GAAP

• state why management believes the non-GAAP financial measure provides useful information for investors and

• to the extent material, state the additional purposes for which management uses the non-GAAP financial measure (if any), and…

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Regulation G Plus Plus – “Filed” Documents

Item 10(e) prohibits:• non-GAAP financial measures of liquidity that

exclude items requiring cash settlement (other than EBIT and EBITDA, which are allowed)

• adjustment of non-GAAP financial measures of performance to eliminate or smooth items characterized as “non-recurring, unusual or infrequent” when a similar charge or gain makes it reasonably likely to recur within 2 years

• presentation of non-GAAP financial measures on face of financial statements or accompanying notes and

• the use of titles or descriptions for non-GAAP financial measures that are the same as, or confusingly similar to, GAAP financial measures.

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Spotting Non-GAAP Financial Measures

Regulation G and Item 10(e) define a “non-GAAP financial measure” as a numerical measure of financial performance, financial position or cash flows that excludes amounts that are otherwise included in the most directly comparable measure calculated and presented in the financial statements under GAAP (or includes amounts that GAAP would exclude)

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Spotting Non-GAAP Financial Measures

• Non-GAAP financial measures are different from what is presented in the financial statements, such as: • Operating income that excludes an expense or

revenue item identified as non-recurring• EBITDA• Ratios or percentages based on measures

where one or both components are not calculated in accordance with GAAP

• Look for words that often signal non-GAAP financial measures (“excluding”, “other than”, “adjusted”, etc.)

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Spotting Non-GAAP Financial Measures

A non-GAAP financial measure does not include:• operating and other statistical measures such as unit

sales, or number of employees, subscribers or advertisers

• ratios or statistical measures calculated using only one or both of:

º financial measures calculated in accordance with GAAP and

º operating measures or other measures that are not non-GAAP financial measures (such as sales per square foot or same store sales, assuming sales calculated in accordance with GAAP) and

• financial measures required to be disclosed by GAAP, the SEC or regulatory requirement

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Example - EBITDA

This press release contains non-GAAP financial measures within the meaning of Regulation G promulgated by the SEC. The Company believes these non-GAAP financial measures provide information that is useful to the users of its financial information regarding the Company’s financial condition and results of operations. Additionally, the Company uses these non-GAAP measures to evaluate its past performance and prospects for future performance. The Company believes this non-GAAP financial information is helpful in understanding the results of operations separate and apart from items that may, or could, have a disproportional positive or negative impact in any particular period.

While the Company believes these non-GAAP financial measures are useful in evaluating Company performance, this information should be considered as supplemental in nature and not as a substitute for or superior to the related financial information prepared in accordance with U.S. GAAP. Further, these non-GAAP financial measures may differ from similar measures presented by other companies…

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Example - EBITDA

…The Company uses EBITDA, or Earnings Before Income Taxes, Depreciation and Amortization, as a measure to evaluate earnings by excluding certain non-cash expenses. The Company believes that excluding these non-cash charges provides investors and other interested parties with an additional meaningful measure to evaluate the Company’s results of operations. The following table reconciles the non-GAAP financial measure “EBITDA” with “Net income (loss)” calculated and presented in accordance with GAAP.

Reconciliation of EBITDA to GAAP

Net loss $(183)

Add (deduct)

Interest expense 308Income tax benefit (247)

Depreciation, depletion and amortization 3,830

EBITDA $3,708

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Recent Guidance

• In January 2010, SEC updated prior guidance relating to the use of non-GAAP financial measures in SEC filings and other public disclosures

• http://sec.gov/divisions/corpfin/guidance/nongaapinterp.htm• Omits language in the prior guidance that discouraged the

use of non-GAAP financial measures • Appears to reflect a general view that companies can

provide non-GAAP financial information in SEC periodic reports as long as an adequate explanation for the adjustments and reconciliation is provided

• Goal is to reduce differences between the financial metrics disclosed in earnings releases and analyst meetings and those included in SEC periodic reports

• Additional update in July 2011 clarified how Reg G applies to non-GAAP measures contained in CD&A disclosure in proxy statements

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Recent Enforcement Action

• In November 2009, the SEC brought and settled its first civil enforcement action under Reg G in connection with an alleged “earnings management” scheme by SafeNet, Inc.

• SEC alleged that SafeNet, its former CEO, CFO and three former accountants misstated GAAP and non-GAAP financial results to increase SafeNet’s earnings in order to exceed quarterly EPS targets

• SafeNet agreed to pay civil penalty of $1 million and consented to judgment permanently enjoining it from violating Reg G and the antifraud provisions of the federal securities laws

• Five individual defendants also agreed to pay civil penalties

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Recommendations

• Actively look for non-GAAP financial measures in earnings releases or other communications

• Consider the reasons for presenting such information

• Discuss with legal department or outside counsel during drafting stage

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Bonus Material – Proxy Access Update

Proxy Access – SEC initiative that would have made it easier for shareholders of public companies to nominate directors for election to the Board

• August 2010: SEC adopts final proxy access rules in divided vote

• September 2010: Business Roundtable and U.S. Chamber of Commerce filed a lawsuit challenging the SEC’s final proxy access rules

• July 2011: Federal court vacated proxy access rules; found SEC acted in “arbitrary and capricious manner” in adopting rules and failed to address economic impact of rules

• September 2011: SEC announces it will not seek rehearing of federal court’s decision

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Bonus Material – Proxy Access Update

Future of Proxy Access:

• SEC may re-propose some version of proxy access rules, though unlikely in short-term

• Rule 14a-8 amendments permit “private ordering”• Companies may receive shareholder proposals

that attempt to amend corporate bylaws to implement proxy access

• Companies may proactively adopt proxy access mechanisms to avoid these shareholder proposals

• Delaware has adopted a state-level proxy access regime; other states may follow

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Questions & Answers

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