United States: In First Regulation FD Decision, Court Rejects SEC’s Overly Aggressive Enforcement

In the first court decision to interpret Regulation FD, the U.S. District Court for the Southern District of New York, on September 1, 2005, dismissed the SEC’s complaint against Siebel Systems, Inc. and two of the company’s senior executives. The SEC had alleged violations of Regulation FD and failure to maintain adequate disclosure controls and procedures for the proper reporting of material information. The SEC promulgated Regulation FD (Fair Disclosure) in 2000 to require equal disclosure of material, nonpublic information to all groups of investors.

While the decision provides important guidance to companies attempting to comply with Regulation FD as outlined below, it has a broader significance for corporations faced with increased SEC scrutiny on a wide range of issues. The court admonished the SEC for its overly aggressive enforcement efforts in the case. The court was particularly concerned that:

[a]pplying Regulation FD in an overly aggressive manner 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.

As corporations and their officers face increasing demands by various staff members of the SEC despite lack of previous guidance, the court’s comments may assist in persuading the SEC staff to return to a more reasoned approach and give corporations ammunition with which to fight unreasonable demands.

On April 4, 23, and 28, 2003, Siebel’s then CEO made public statements about the company’s performance in the first quarter of that year and its anticipated performance in the second quarter of that year. The SEC, using excerpts from those statements, alleged that the total mix of this publicly provided information conveyed a pessimistic view of the company’s current and anticipated performance based on deals that had slipped into future periods, poor economic conditions, and a lack of any indication that poor economic conditions were improving.

On April 30, 2003, Siebel’s CFO disclosed information about the company’s business activity and sales pipeline at two private institutional investor meetings. The allegedly material, nonpublic information disclosed by the CFO consisted of statements that: (i) the company’s activity levels were "good" or "better"; (ii) new deals were coming into the pipeline; (iii) the pipeline was "growing" or "building"; and (iv) there were some deals valued at $5 million in the company’s pipeline. After the meetings, investors who attended purchased additional company stock, causing a surge in trading and a significant price increase. The company did not file a Form 8-K disclosing the CFO’s statements.

The SEC asserted that the April 30, 2003, statements altered the total mix of information and provided material, non-public information to a select group of investors. By failing to publicly disclose the information, the company, its CFO and the other senior executive allegedly violated Regulation FD.

The failure to make the disclosure supported a separate claim that the company’s disclosure controls and procedures were deficient. The SEC alleged that those controls and procedures were deficient because: (i) neither the executive responsible for compliance nor his staff had received any formal training in Regulation FD compliance; (ii) the executive had not issued a formal company policy about Regulation FD compliance; and (iii) the executive had not implemented additional safeguards to ensure that violations would not occur.

The court dismissed the SEC’s complaint in its entirety in an opinion which raises serious questions about the SEC’s decision to commence the action.

As an initial matter, the court rejected the SEC’s contention that the court could consider only the selective excerpts of the company’s public statements in reviewing the complaint. Instead, the court examined the complete text of the public statements made by the company in April 2003. The court concluded, based on that review, that the substance of the April 30 statements was fully disclosed in the company’s prior public statements. Consequently, the court ruled that there was no Regulation FD violation. Absent a violation, the disclosure controls and procedures claim failed as well.

What permeates the court’s decision is its practical and realistic approach in considering the issues.

The court rejected the SEC’s scrutiny "at an extremely heightened level" of "every particular word" used in the CFO’s statements "including the tense of verbs and general syntax of each sentence." The court found that Regulation FD did not support such an approach which imposes an "unreasonable burden on company’s management and spokespersons to become linguistic experts" for fear of running afoul of the rule if a private statement varies even slightly from a public statement. Regulation FD does not require corporate officials to repeat verbatim previously made public statements. No greater disclosure is required where a private statement is the "equivalent in substance" to material information already publicly disclosed by the company.

The court also noted that generalized descriptive language such as "good" or "better" used to describe a company’s activity levels does not implicate Regulation FD where that language is based on or supported by publicly disclosed quantitative information. Corporate officials are entitled to provide positive or negative views or optimistic or pessimistic subjective general impressions "based upon or drawn from the material information available to the public."

The court also held that the decision of the institutional investors to substantially increase their investments after hearing the CFO’s views was not by itself a basis to infer that Regulation FD was violated.

Noting that none of the types of statements made by Siebel’s CFO were identified in the Regulation FD adopting release as likely to be considered material, the court suggested that the SEC’s "overly aggressive" approach was unfair and could have the effect of chilling rather than encouraging disclosure as Regulation FD was designed to do.

Although the court’s decision is subject to appeal and Regulation FD remains alive and well, the decision should help provide some much-needed guidance to companies facing less than clear issues. In addition, the decision may serve as a wake-up call to regulators that they should provide clear guidance to those whom they regulate.

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