How Regulation FD Has Changed Corporate Disclosure –

Both supporters and critics expected that Regulation FD, which became effective in October 2000, would dramatically alter the nature of discussions that once were held with analysts and important investors in private meetings and during closed conference calls. Months of experience with the regulation make clear that the quantity and quality of information disseminated have changed, but in some cases the changes have occurred in unexpected ways.

Reg FD requires a U.S. public company that intentionally discloses material, nonpublic information to a select group to disclose it simultaneously to the public. Laura S. Unger, who in February 2001 was appointed Acting Chairman of the Securities and Exchange Commission, was a vocal opponent of Reg FD prior to its adoption. On April 24, she opened the SEC Roundtable Discussion on Reg FD by remarking that corporate America had experienced a sea change in its disclosure practices as a result of the new regulation. The rationale for Unger’s initial opposition to the regulation provides an interesting framework for measuring the nature and extent of the changes that Reg FD has wrought.

Increased Electronic Communication. One reason that Unger opposed the adoption of Reg FD was her view that it is unnecessary. She cited a growing trend for public companies to open communications to the public through Internet broadcasts. Since the adoption of Reg FD, a dramatic increase has occurred in the amount of information available to investors generally over the Internet. Wire services report that the number of press releases has grown sharply. Consultants that assist public companies with Web casting report that business is up. The extent to which companies now insist upon Web casting their meetings may be discerned by even a casual glance at the many earnings conference calls, video news releases and other multimedia events scheduled on the Web sites of electronic news services. Web sites that focus on investor relations have also sprung up. Whether or not the trend toward electronic communications would have continued absent Reg FD, the regulation is generally considered to have hastened the change.

Quantity of Information. Unger also feared that Reg FD would encourage public companies to decrease the amount of information that they disclose. The quantitative concern is, of course, easy to measure in hindsight. The National Investor Relations Institute (NIRI) recently published the results, as of Feb. 16, 2001, of a survey of corporate disclosure practices by public companies. The survey asked whether, since Reg FD went into effect, the company had been providing more, the same amount, or less information to analysts and investors. Of the 577 companies responding, 48% reported that the same amount of information was provided; 28% reported that more was provided; and 24% stated that less was provided. What does this mean, given that it reflects the perspective of the companies themselves? One may reasonably conclude the regulation has had no quantitative impact on half of the respondents. Its quantitative impact on the other half of the respondents was inconsistent.

Quality of Information. The final reason for Unger’s opposition to Reg FD focused on her concern about the quality of the information that would be produced. Here again, the results of the NIRI survey are instructive. Viewed as a whole, the survey results indicate a meaningful shift in the type of information being disseminated. The survey also supports the notion, voiced by many commentators, that Reg FD has changed the role of the securities analyst. The analyst no longer earns his keep because of a position of privileged access to information. Now analysts must use their training and professional experience to interpret and extrapolate from information that is publicly available.

The qualitative change in information, and in the role of the analyst, are demonstrated in responses to NIRI survey questions related to the review of draft earnings models prepared by analysts. Of the companies responding, 81% reviewed draft earnings models prior to the adoption of Reg FD, and 14% did not. The remaining 5% had no sell-side coverage. After the adoption of Reg FD, 53% still reviewed earnings models; 47% did not. Of those companies that continued after Reg FD became effective to review draft earnings models, 94% indicated that the models were reviewed only in connection with the factual accuracy of historical information that was in the public domain. Inconsistently, half also responded that they reviewed assumptions that the company believed were nonmaterial. These statistics support the hypothesis that analyst earnings models after Reg FD reflect more original insight on the part of the analyst, as well as considerably less input from management.

The change was also somewhat marked, in the review of draft reports prepared by analysts. Survey respondents indicated that, prior to Reg FD, 83% had reviewed draft analyst reports, while 17% had not. After Reg FD, 72% continued to review analyst draft reports, while 27% did not. Consistent with the responses relating to earnings models, 97% indicated that the review only concerned the factual accuracy of historical information in the public domain. Again, half inconsistently responded that their review extended to assumptions that they believed were non-material. While the statistical change is not dramatic, the survey supports the view that public companies are increasingly sensitive to their role in reviewing draft analyst reports.

Abundance of Earnings Information. Anyone who follows the financial news has noticed media coverage of earnings information. The survey results suggest that this change, too, may have been precipitated by Reg FD. Of the companies responding to the NIRI survey, only 37% publicly disclosed earnings information prior to the adoption of Reg FD; 63% did not. After the adoption of Reg FD, 88% publicly disclosed earnings information; 12% did not. Within a six-month period, a change of this magnitude is notable.

The type of earnings information being released does not appear to have changed significantly. The NIRI survey requested companies who disclosed earnings information to describe all of the types of information they disclosed. Of those responding, disclosure of estimates or forecasts of specific factors that drive earnings, but not all of the factors that might be in internal financial forecasts, were reported by 61% prior to Reg FD and by 51% after Reg FD. Estimated earnings per share were reported by 19% before Reg FD and by 12% afterwards. A range of estimated earnings per share was reported by 61% prior to Reg FD and by 46% after. An earnings model was reported by 8% before Reg FD and by 6% after. The relatively uniform statistical decline suggests little qualitative change.

Increased Earnings Guidance. The financial press has also focused recently on earnings guidance. Of the companies that responded to the survey, 79% now provide earnings guidance. Of these, 89% provide the guidance in a quarterly conference call which is open to all interested parties and the media. The investment community has recently begun to complain that these calls last for hours and contain more information than anyone really needs to know. Attorneys who represent companies also hear negative comments about the effort that these calls divert from running the business. Everyone seems to be looking for a better way. Of those companies providing guidance, 67% issued quarterly news releases instead of, or in addition to a conference call. A Form 8-K, the SEC filing on which public companies report material events, was issued by 14% of the responding companies, and 19% communicated the guidance through their SEC annual report on Form 10-K or their quarterly report on Form 10-Q. Of the responding companies, 87% imposed a quiet period prior to normal earnings announcements during which earnings guidance would not be given. This quiet period had a mean duration of 21 days and a median duration of 21 days.

Mid-quarter Updates. Mid-quarter updates have also enamored the financial press. Of the companies responding to the NIRI survey, 69% felt no commitment to update earnings guidance if it changed materially; 28% indicated publicly that they would provide an update. The survey also posed the more difficult question of whether, if earnings guidance was provided early in the quarter, the company would respond to questions by analysts later in the quarter related to whether the guidance was on still on track. In response, 35% said that they did not update, and 6% said that they routinely issue a mid-quarter review of guidance. Another 12% were uncertain, but 56% responded that they would issue a news release before responding to such a question if facts or circumstances caused the guidance to change. Of those companies that routinely issued a mid-quarter review of guidance, 69% reported that they would disseminate the information by a news release, 27% by a fully accessible, non-exclusionary conference call, and 27% by filing a Form 8-K. These statistics suggest that some public companies have learned to use Reg FD as a strategic tool. Increased and multiple disclosure opportunities may allow a company to release sensitive trend information in an orderly manner. Furthermore, the staged release of information may manage market expectations and avoid sudden shifts that cause price volatility.

A major focus of the debate about Reg FD was the influence of one-on-one meetings conducted between public companies and the investment community. Of the companies responding to the NIRI survey, 74% were conducting the same number of one-on-ones as before; 11% were cutting back; 6% were uncertain; 5% were conducting more; and 4% had not been conducting them and did not plan to begin. Among those who were cutting back on one-on-ones, 84% were conducting fewer one-on-ones with sell-side analysts, and 11% were eliminating them; 80% were conducting fewer with buy-side analysts, and 13% were eliminating them. Of the responding companies, 54% said the personal meeting covered topics related to earnings; 43% said that it did not. Based on these statistics, Reg FD clearly has not killed the one-on-one meeting.

Chinese Walls. One area of concern not covered by the survey involves the implication of Reg FD on “Chinese walls.” This term was coined to describe the practice within an investment bank of prohibiting communication between analysts in the research department and the team that guides a public offering. Increasingly, this term is being used to describe the practice, after Reg FD, of obtaining the express agreement of an analyst to maintain the confidentiality of material, nonpublic information. If used too frequently, this practice threatens to diminish the overall effectiveness of Reg FD. Analysts who are “over the wall” with respect to material, nonpublic information may not overtly address the information in their reports and earnings model, but the information necessarily shapes their thinking.

Predictably, Reg FD has impacted both corporate disclosure practices generally and the specific types and amount of information disclosed. Investors increasingly consult the many electronic sources of information that have proliferated since Reg FD became effective. In addition, earnings models and analyst reports probably now contain more insight and interpretation on the part of the analyst than they did prior to the enactment of the regulation. Conversely, these models and reports also reflect less input from company executives, although analysts are “over the wall” from time to time. Personal meetings with the company are still common, even if the remarks at these meetings are more circumspect than before Reg FD changed corporate disclosure.

Kathryn Beller, a partner in the New York office of McDermott, Will & Emery, specializes in securities regulation, private equity and technology enterprises. Ms. Beller gratefully acknowledges the assistance of Tom Tsatsaronis, an associate in the New York Corporate Department.