United States: Federal Court Dismisses SEC´s Regulation FD Complaint Against Siebel Systems

The United States District Court for the Southern District of New York recently dismissed the complaint filed by the Securities and Exchange Commission (SEC) against Siebel Systems, Inc. and two of its officers for alleged violations of Regulation FD. This is the first federal court decision to interpret Regulation FD.

Regulation FD prohibits U.S. public companies from selectively disclosing material nonpublic information to market professionals or to their security holders (where it is reasonably foreseeable that these persons will trade on the basis of such information).

If a company intentionally makes selective disclosure of material nonpublic information, Regulation FD requires that the company make simultaneous disclosure to the general public. If the selective disclosure is unintentional, the company must make public disclosure "promptly," which is defined in Regulation FD to mean as soon as possible (but in no event after the later of 24 hours or the commencement of the next day's trading on the New York Stock Exchange) after a senior officer of the company becomes aware of the unintentional disclosure.

The company must make public disclosure by filing a Form 8-K containing the required information or otherwise disseminating the required information by another method, such as a press release, that is designed to provide broad, non-exclusionary distribution of the information to the public. Posting information on a company's Web site does not, by itself, constitute public disclosure under Regulation FD.

The SEC commenced the action against Siebel in July 2004. The SEC also sued Siebel's Chief Financial Officer and Director of Investor Relations, who the SEC alleged criminally aided and abetted the company's violation. The charges stemmed from what the SEC alleged was "material, nonpublic information" that Siebel disclosed during two separate private meetings with analysts and institutional investors. Specifically, the SEC alleged that Seibel's CFO told the analysts and institutional investors that (1) Siebel had some $5 million deals in its pipeline for the second quarter of 2003; (2) new deals were coming into the sales pipeline; (3) Siebel's sales pipeline was "growing" or "building"; and (4) Siebel's sales or business activity levels were "good" or "better." The SEC alleged these statements were materially different from prior public statements made by Siebel in analyst conference calls and at a conference (communications that satisfied Regulation FD requirements). The SEC also alleged that various analysts purchased Siebel stock following the private meetings and the Siebel stock rose in heavy trading shortly after the one of the meetings.

Disagreeing with the SEC, the court found that the complaint could not support a conclusion that the communications violated Regulation FD and that material information privately provided was unavailable to the public. Analyzing each of the statements at issue, the court held that:

• The statement that Siebel had some $5 million deals in the pipeline for the second quarter was substantially the same as the information previously publicly disclosed by the CFO, who had said, "[O]ur guidance and license revenue for the quarter is 120 to 140 million range. I think that we'll see lots of small deals. We'll see some medium deals. We'll see a number of deals over a million dollars. And I suspect we'll see some greater than five. And now that's what the mix will look like."

• The statements that new business was coming into the pipeline had been addressed by public statements by Siebel's Chairman and then CEO, who had said that "every quarter will be some place between 45 and 55 percent of our business with new customers," which according to the court clearly suggested that the pipeline in the second quarter would contain new deals;

• The statement that the pipeline was "growing" or "building" had been addressed by public statements that "the Company projected that its software license revenues would be in the range of $120 to $140 million, which was more than the Company's reported revenues for the first quarter," and other public disclosures that the total revenues for the second quarter were projected to be between $340 to $360 million, which was greater than the total revenues for the prior quarter, and that the expected increase in the license revenues was based on an analysis of the pipeline, all of which led the court to hold that a reasonable investor would conclude that the sales pipeline was "growing" and "building" and that the private statements therefore did not add to the total mix of information publicly available.

• The statements that Siebel's sales or business activity levels were "good" or "better" were based on publicly available information as Siebel had previously reported that it expected an increase in the company's performance; the court also held that the terms "better" and "good" were "merely generalized descriptive labels" that provided no more information than Siebel had already disclosed publicly.

The SEC was further criticized by the court for "nit-picking" as well as the degree to which it scrutinized the information. The court stated that "[I]t would appear that in examining publicly and privately disclosed information, the SEC has scrutinized, at an extremely heightened level, every particular word used in the statement, including the tense of verbs and the general syntax of each sentence. No support for such an approach can be found in Regulation FD itself, or in the Proposing and Adopting Releases. Such an approach places an unreasonable burden on a company's management and spokespersons to become linguistic experts, or otherwise live in fear of violating Regulation FD should the words they use later be interpreted by the SEC as connoting even the slightest variance from the company's public statements."

The court also found it significant that none of the statements in question fell within the seven categories listed by the SEC, in the release adopting Regulation FD, as highly probable of being considered material. The court then went on to say, "Applying Regulation FD in an overly aggressive manner cannot effectively encourage full and complete public disclosure of facts reasonably deemed relevant to investment decisionmaking. It provides no clear guidance for companies to conform their conduct in compliance with Regulation FD. Instead, the enforcement of Regulation FD by excessively scrutinizing vague general comments has a potential chilling effect which can discourage, rather than, encourage public disclosure of material information."

The court also took notice of the views of Richard Walker, the then Director of SEC Division of Enforcement, in a speech shortly after Regulation FD was adopted in which he stated that the SEC was "not going to second-guess close calls regarding the materiality of a potential disclosure," noting that "an issuer's incorrect determination that information is not material must represent an extreme departure from standards of reasonable care in order for [the SEC] to allege a violation of [Regulation] FD" as well as other comments of the SEC that "enforcement of the regulation will be focused on clear violations."

The complaint also alleged that certain attendees, and other individuals with whom they communicated, purchased Siebel stock following the private meeting statements, causing an increase in trading and a rise in the Siebel stock price. The SEC argued that it is reasonable to infer from this activity that the information was both new and material. However, the court held that "[a]lthough stock price movement is a relevant factor to be considered in making the determination as to materiality, it is not, however, a sufficient factor alone to establish materiality."

Additionally, the court dismissed the SEC's charges that Siebel had violated the provisions of Section 13(a) of the Securities Exchange Act of 1934 and Rule 13a-15 by failing to maintain adequate disclosure controls because the complaint failed to set forth sufficient factual allegations to establish that the Siebel officers had selectively disclosed nonpublic material information.

The SEC is reviewing the decision and has not yet decided whether to appeal. If the decision stands, it may make it harder for the SEC to prove inappropriate disclosures and therefore may dampen its enthusiasm to pursue subsequent cases where they believe Regulation FD was violated, although we expect that the SEC will continue to be very watchful in this area. On the other hand, the decision does not offer much assistance to company executives on the degree and extent to which they may privately elaborate on public comments. Such situations will always be a facts and circumstances test and judged in hindsight. Notwithstanding the court's comments, significant trading volume or price swings shortly following any private statements will add weight to any argument that the comments were material non-public information.

The safest course of action would be not to engage in private conversations. However, as this is not practical, we continue to caution company executives to be careful about what they say privately to analysts and other members of the investment community.

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