The SEC recently settled an enforcement action against Flowserve Corporation, its CEO and Director of Investor Relations for reaffirming the company’s previous earnings guidance in a private meeting with analysts, near the end of a reporting period. Companies should ensure that their Regulation FD policies are enforced and that their investor relations professional cautions analysts in a private setting about topics that are off-limits. Companies should be wary about changing or confirming any earnings guidance in a non-public forum, especially near the end of a reporting period. Background In August 2000, the SEC adopted Regulation FD (“Fair Disclosure”), which prohibits a company from selectively disclosing material non-public information to shareholders or to market professionals before disclosing the information to the public generally. If the disclosing person knows (or is reckless in not knowing) that the information is both material and non-public, this “intentional” disclosure cannot be cured by subsequent public disclosure. However “unintentional” selective disclosure may be cured by disclosing the material non-public information, such as on a Form 8-K or a press release or other method that will provide broad public dissemination promptly after a senior official of the issuer becomes aware of the disclosure. “Promptly” means as soon as reasonably practicable and within 24 hours or the start of trading the next day, whichever is later. Flowserve Action Flowserve reduced its full-year earnings projections by more than 30% in a series of publicly announced statements from February to September 2002. The Company reaffirmed its September guidance in its Form 10-Q filed on October 22, 2002. On November 19, 2002, Flowserve’s CEO and Director of Investor Relations (“IR”) held private meetings with analysts, and in response to a question during one of the meetings, the CEO reaffirmed the Company’s September earnings guidance. The CEO’s response was contrary to the company’s disclosure policy that earnings guidance was effective as of the date given and would not be updated until the company publicly announced updated guidance. The Director of IR was present but remained silent during this exchange with the analysts. The next day, November 20, one of the analysts released a report that highlighted Flowserve’s reaffirmation of its earnings guidance. Following that, on November 21, the Company’s stock price closed approximately 6% higher than the day before, and the trading volume in the Company’s stock increased by 75%. Flowserve furnished a Form 8-K after the market closed on November 21, acknowledging that the company had reaffirmed its earnings estimates earlier in the week. The SEC concluded that the CEO’s reaffirmation was material information, and considered the market reaction to the selective reaffirmation (and the market’s later indifference to Flowserve’s Form 8-K) to be compelling evidence of materiality. The SEC found that Flowserve violated Regulation FD and also charged the Company’s CEO and Director of IR with causing Flowserve’s violations. Under the settlement agreement, Flowserve and its CEO agreed to pay civil penalties of $350,000 and $50,000, respectively and, along with Flowserve’s Director of IR, were the subject of a cease-and-desist order. Important Lessons for Public Companies
- Have a Regulation FD policy that addresses earnings guidance. When discussing earnings expectations in a private setting, companies may want to consider a “no comment” policy or a response that the earnings guidance was effective at the date given and would not be updated until the company publicly announces updated guidance.
- Set the ground rules for all one-on-one meetings. The company’s representative should caution the analysts prior to the meeting about the topics that are off limits.
- Enforce your Regulation FD policy. Any senior officer who may speak publicly for the company should be familiar with the company’s Regulation FD policy generally and consideration should be given to periodic “continuing education.” If an officer is asked a question that could elicit a material, non-public answer, the IR professional may need to interrupt and advise the officer not to respond to the question. Promptly, if a selective disclosure does occur, the IR professional should immediately reiterate the company’s Regulation FD policy, correct the statement and disclose the material non-public information in a press release and/or a Form 8-K the same day. The SEC took action against Flowserve’s IR director because of his silence following the CEO’s reaffirmation.
- Be wary about reaffirming earnings guidance. The SEC in a telephone interpretation, accessible at http://www.sec.gov/interps/telephone/phonesupplement4.htm, has advised that there might be instances early in a quarter and shortly after the issuance of public guidance where a private reaffirmation would not run afoul of Regulation FD. In Flowserve, however, the confirmation was almost one month after the prior public guidance, and just 42 days before the end of the fiscal year. The safer course is for a company never to change or confirm guidance in any non-public forum.
- Be prepared to disclose. If it is determined that material non-public information was disclosed, the company should issue a press release and file a Form 8-K as soon as possible, ideally before the market can trade on the information. In Flowserve, the SEC noted that the Form 8-K filing was more than 53 hours after the meeting with the analysts, and 26 hours after the analyst’s report was circulated.
- Co-operate with the SEC. In Flowserve, the SEC specifically cited the lack of cooperation by the Company and its executives. Specifically, and inconsistent with statements made in the Company’s Form 8-K, the CEO and Director of IR both denied that a reaffirmation occurred at the private meeting with analysts.
For further information or questions on Regulation FD or your Regulation FD policy, please contact a member of our Corporate Practice Group.