M E M O R A N D U M. Regulation FD Update: The SEC Brings its First Reg FD Enforcement Actions

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1 919 THIRD AVENUE NEW YORK, N.Y (212) FAX (212) WRITER'S DIRECT NUMBER M E M O R A N D U M TO: FROM: Clients and Friends Kramer Levin Naftalis & Frankel LLP DATE: December 2002 RE: Regulation FD Update: The SEC Brings its First Reg FD Enforcement Actions The Securities and Exchange Commission ( SEC ) has brought its first enforcement actions under Regulation FD. On November 25, 2002, the SEC instituted and contemporaneously settled three cease-and-desist proceedings and issued one report of investigation chronicling Regulation FD violations by Raytheon Co., Secure Computing Corp., Siebel Systems, Inc. and Motorola, Inc., respectively. Regulation FD 1 prohibits selective disclosure of material, nonpublic information to market professionals and investors and requires prompt corrective disclosure if material, nonpublic information is inadvertently released. These initial proceedings provide a first look at the SEC s approach to enforcing Regulation FD. In particular, we note: Issuers who are dissatisfied with the market s understanding of their material public communications should use further public disclosures, not selective contacts with analysts, to correct or modify their earlier statements. In two of the reported matters, issuers sought to clarify earlier public announcements through selective contacts with analysts. Issuers should expect that the SEC will use hindsight to determine whether information is material. In the reported matters, the SEC considered as part of its analysis changes in stock price and trading volume following the disclosure at issue. When appearing in certain forums, such as privately-held conferences, management should keep Regulation FD in mind. In Siebel, the disclosure 1 17 C.F.R (2001).

2 was viewed as intentional even though the CEO making the disclosure did not know the forum was not webcast, because other Siebel personnel did. In both Raytheon and Secure Computing, the SEC obtained relief against individual officers of the companies, not merely the issuers themselves, reinforcing that violations of Regulation FD can lead to sanctions against the responsible individuals involved. Consulting with counsel prior to making selective disclosures may, in some instances, insulate an issuer from liability under Regulation FD -- even if the advice from counsel is incorrect. The proceedings are described on the following pages. If you have any questions about this memorandum or about Regulation FD, please do not hesitate to contact Thomas E. Molner or Alan R. Friedman at Kramer Levin Naftalis & Frankel LLP at (212)

3 Recent SEC Proceedings Enforcing Regulation FD 1. In re Raytheon Co., Exchange Act Release No. 46,897 (Nov. 25, 2002) The SEC instituted cease-and-desist proceedings against Raytheon and its CFO for violating Regulation FD by selectively disclosing quarterly and semi-annual earnings guidance -- the prototypical disclosures Regulation FD aimed to prohibit -- to sell-side analysts. During a February 2001 investor conference, Raytheon provided annual, but not quarterly, earnings per share guidance. Soon after, Raytheon discovered that analysts first quarter earnings estimates generally exceeded its internal estimates and tended to reflect less seasonality than Raytheon s 2000 results. To remedy this, Raytheon arranged one-on-one calls with analysts to give them quarterly earnings guidance, including information on Raytheon s expected seasonality. This information was not publicly disclosed. Raytheon also informed particular analysts that their estimates for the first quarter were too high, aggressive, or very aggressive. Following the one-on-one calls, all of the analysts lowered their estimates and at least two analysts directly communicated with their firm s sales force about their revisions. By mid-march, sell side analysts 2001 first quarter EPS consensus estimate had dropped to a penny below Raytheon s internal forecast. Raytheon met the revised first quarter consensus estimate. The SEC reiterated that a primary purpose of Regulation FD is to prohibit the practice of selectively providing guidance to analysts and other designated persons regarding earnings forecasts. That Raytheon s selective disclosure involved earnings guidance weighed in favor of a materiality finding. The SEC enumerated other factors considered in its analysis, including the methodical way Raytheon contacted analysts with additional earnings guidance, as well as the analysts uniform reaction -- namely, lowering their estimates -- to this information. 25, 2002) 2. In re Secure Computing Corp., Exchange Act Release No. 46,895 (Nov. The SEC instituted cease-and-desist proceedings against Secure Computing and its CEO for their disclosure of information about a significant original equipment manufacturing agreement it had entered into to two portfolio managers. Initially, neither party to the OEM publicly announced the arrangement. Then, during a March 6, 2002 conference call with a portfolio manager, Secure Computing s CEO inadvertently disclosed information about the OEM. The CEO learned of his inadvertent selective disclosure soon after the call ended, but Secure Computing did not issue any corrective disclosure on March 6. On March 7, both investors and analysts contacted Secure Computing about rumors of the OEM agreement. Although no public announcement had been made yet, Secure Computing s CEO privately confirmed the OEM to another institutional investor. Only after the market closed on March 7 did Secure Computing issue a press release about the OEM agreement. From March 5 through March 11, Secure Computing s stock price rose 35%. Secure Computing made no other significant announcements in this period. The SEC determined that although the March 6 disclosure was unintentional, Secure Computing failed to make prompt public disclosure regarding the OEM agreement as 3

4 required by Regulation FD. Instead, rather than correcting its error, Secure Computing compounded it by making a second selective disclosure on March 7. Notably, Secure Computing did not avoid Regulation FD liability by issuing a public disclosure about the OEM a mere three hours after the second selective disclosure. 2002) 3. In re Siebel Systems, Inc., Exchange Act Release No. 46,896 (Nov. 25, Siebel violated Regulation FD, and was subject both to a cease-and-desist order and a $250,000 civil penalty, because of its CEO s disclosures at an invitation-only technology conference hosted by Goldman Sachs. * Siebel s investor relations staff, but not its CEO, knew that this conference would not be webcast. At the Goldman conference, Siebel s CEO disclosed, among other things, that the company was pretty optimistic about what we re seeing at this time because we re seeing a return to normal behavior in IT buying patterns. The CEO also disclosed nonpublic information about Siebel s expected Q4 linearity. These disclosures contrasted starkly with the CEO s earlier public comments during a conference call in which he characterized the company s industry as tough and as having an exceptionally soft market. During this call, the CEO also predicted that business would remain difficult through the end of the year. Immediately after the CEO s disclosures at the Goldman conference, certain attendees and others contacted by the attendees purchased Siebel stock. That day, Siebel s stock closed 20% higher than the prior day s close on higher than usual trading volume. Among other things, the SEC noted in its proceedings against Siebel that (i) Siebel did not simultaneously disclose its CEO s statements at the Goldman conference to the public; (ii) these disclosures impacted Siebel s stock price and trading volume; and (iii) these disclosures were intentional for Regulation FD purposes even though the CEO himself did not know that the conference was not going to be webcast. 4. In re Motorola, Inc., Exchange Act Release No. 46,898 (Nov. 25, 2002) Despite its finding that Motorola had made improper selective disclosures, the SEC chose only to issue a report about its investigation. Unlike the other cases, prior to making its selective disclosures, Motorola sought in good faith the advice of in-house legal counsel who determined -- albeit erroneously -- that the disclosed information was immaterial. In both a press release and a webcast analyst call, Motorola disclosed that it did not expect to meet its first quarter sales guidance, blaming significant weakness in orders and sales. Specifically, Motorola noted that semiconductor orders were significantly lower. Motorola did not define what it meant by significant or significantly. Most analysts reduced their estimates after these public disclosures. However, Motorola felt that their estimates continued to be overstated. After consulting with counsel, Motorola directly contacted analysts to discuss their models and, during most of these calls, clarified that significant and * Commissioners Glassman and Atkins dissented as to the imposition of a monetary penalty in the Siebel matter. In both the Raytheon and Secure Computing matters, Commissioner Campos dissented as to the lack of a monetary penalty. 4

5 significantly were intended to indicate a change of 25% or more. Motorola s counsel advised that the mere quantification of the qualitative terms Motorola used in its earlier public disclosure was immaterial. The SEC disagreed. In the SEC s view, Motorola s plan to call analysts seriatim demonstrated that [it] considered it quite important to communicate [a] specific quantitative figure, weighing in favor of the SEC s finding of materiality. The SEC also made the following observations: (i) senior officials of issuers should be particularly cautious during private conversations with analysts; (ii) private communications of material, nonpublic information to securities professionals is not a proper way of supplementing or clarifying earlier public announcements; and (iii) when communicating with securities industry professionals, issuers may not use code words to selectively disclose information they are prohibited from expressly selectively disclosing. Although the SEC accepted Motorola s reliance on counsel defense, it stressed that such a defense will not necessarily provide a successful defense in all future cases. For instance, if an officer knows information would be important to the reasonable investor, he or she cannot seek out and rely on counsel s consent as a shield against liability under Regulation FD. Seeking the advice of counsel before making selective disclosures offers some protection to an issuer, but it is not a fail-safe mechanism for avoiding liability under Regulation FD. This memorandum is provided for educational and informational purposes only. It does not constitute and may not be relied upon as legal advice. 5