Securities Regulation

Disclosure and Accuracy• Mandatory disclosure

– Forms– Board duties

• Regulation FD• “Up the ladder” reporting

(last updated 19 Mar 13)

Disclosure and Accuracy• Mandatory disclosure

– Forms– Board duties

• Regulation FD• “Up the ladder” reporting

Info Price

Market forcesECMH

Intermediaries

RegulationEx ante disclosure

Ex post enforcement

What is a “public company”?

• Section 12(a)– Listed on national exchange– Brokers can’t transact in stock

unless registered

• Section 12(g)– OTC companies: 500 record

Shs + $10 MM assets– Deregistration: [< 300 Shs] OR

[ < 500 Shs + < 10 MM for 3 yrs]

• Section 15(d)– Company files RS under ’33 Act– Subject to periodic reporting

(not proxy or TO rules)

Pink SheetsReverse Merger

• Section 12(a)– Listed on national exchange– Brokers can’t transact in stock

unless registered

• Section 12(g)– OTC companies: 500 record Shs +

$10 MM assets– Deregistration: [< 300 Shs] OR [ <

500 Shs + < 10 MM for 3 years]

• Section 15(d)– Company files RS under ’33 Act– Subject to periodic reporting (not

proxy or TO rules)

What is a “public company”?

Online information(real time) …

• sec.gov– Search EDGAR– Description of SEC forms– Regulation S-K

• Netflix– Annual report / Form 10K– Special report / Form 8K– Ownership report /

Form 3, 4, 5, 13G

“Continuous disclosure”(real time basis) …

Orange Inc. sells consumer batteries. Sales have lagged this year so it engages in some late-year “channel stuffing.”

When its auditor finds out, the auditor threatens to quit – unless the company revises its financials. Instead, the company CEO resigns in disgrace!

What must be disclosed? When? 1.The “channel stuffing” – once discovered2.The auditor’s threats to quit 3.The CEO’s departure4.The company’s restatement

Form 8-K (revised 2004)

1. Registrant’s Business & Operations

• The entry into, a material amendment to, or termination of a “material definitive agreement,” defined as contracts outside the ordinary course of business.

• The filing of bankruptcy or receivership.

2. Financial Information

•The completion of the acquisition or disposition of assets constituting more than 10% of the registrant’s total assets.•The results of operations and financial condition (if they are disclosed by press release before the filing of the 10-Q or 10-K). • The creation or triggering of an off-balance sheet arrangement.• Costs associated with exit or disposal activities, including termination benefits for employees, contract termination costs and other associated costs.• Material impairments to assets such as goodwill.

3. Securities & Trading Markets

• Receipt of a notice of delisting or a transfer of listing.

• The unregistered sale of equity securities.

• Material modifications to the rights of security holders.

4. Matters Related to Accountants & Financial Statements

• Changes in the company’s outside auditor (and the reasons for the change).

• Notice that previously issued financial statements or audit reports should no longer be relied upon.

Form 8-K (revised 2004)

5. Corporate Governance & Management

• A change in control of the registrant.

• The departure or election/appointment of directors and principal officers [disclose if there is disagreement / opportunity for director response – see Hewlett-Packard (SEC 2007)].

• Amendments to the articles of incorporation or bylaws.

• Changes in the company’s fiscal year.

• Temporary suspension of trading under employee benefit plans

• Amendment to the registrant’s code of ethics or the waiver of the requirements of that code.

[[Reserved for later use]

7. Regulation FD • Any disclosure required to comply with Regulation FD

8. Other Events • Anything that the issuer thinks would be of interest to its security holders.

8-K Filing Frequencies (sample of 200 NYSE firms)

3509

396

660927

1548

2174

0

500

1000

1500

2000

2500

3000

3500

4000

2000 2001 2002 2003 2004 2005

Public Company Disclosure – Pop Quiz

1. What is “public company”? A. One whose securities are listed on

NYSEB. One with more than $100MM in

assets

2. What is required of a public company?

A.Disclosure of material information as it becomes known to management

B.Disclosure as required in SEC forms, even when not material

3. Where would you find out whether Reed Hastings sold his Netflix stock?

A. Form 4B. Form 8-KC. Form 10-QD. Form 10-K

4. Where would you find Reed Hastings’s current pay?

A. Form 8-KB. Form 14AC. Form 10-K

5. Where would you find out whether Netflix subscriber numbers fell or rose last year?

A. Form 10-QB. Form 10-KC. Form 14A

6. If Reed Hastings went to a high-tech conference? A.He could not say that Netflix would be doing a

special deal with Apple, if nobody knewB. He could describe this special deal, given that

many stock analysts were at the conference

7. If you noticed that Netflix’s latest 10-Q had a note identifying a big drop in new customers?

A. You should sell your NFLX stock B. Don’t bother, the market already knows C. Don’t sell NFLX: it’s insider trading

8. A friend works at NFLX and tells you about secret negotiations with Apple …

A. Buy NFLX because it’s stock price is likely to riseB. Don’t do anything, because the info is insider

informationC. Turn your friend into the SEC

1-A / 2-B / 3-A / 4-B / 5-B / 6-A / 7-A / 8-B

Hewlett-Packard (SEC 2007)

Thomas Perkins(Chair, Nominating/Governance Committee)

Disclosure and Accuracy• Mandatory disclosure

– Forms– Board duties

• Regulation FD (voluntary disclosures)

• “Up the ladder” reporting

Hypothetical

CEO of SSSystems Inc. is invited to tech conference by Goldman Sachs. In Q&A, CEO is asked about effects of 9/11 on industry. CEO answers that “contracts are now getting signed” and “our Q4 appears quite normal.”

This is news! The securities analysts flip open their cell phones and type into their Blackberrys – “Buy SSS”

Has CEO violated Reg FD – • What is purpose of Reg FD?• Were statements material? Non-public?• Does Reg FD apply at conference?• Could CEO talk to Auditor? Lawyer? Credit rating agency?

Regulation FDDisclosure of material, non-public information

• “covered persons”: B-D, IA, IC, person expected to trade

• Intentional disclosures– Must disclose “simultaneously”– Later file Form 8-K

• Unintentional disclosures– Must disclose “promptly” (within 24

hours)– File 8-K

• Applies to senior executives and those who communicate to public

• Exceptions:– normal course of business (after

Dodd-Frank not credit rating agency, unless confidentiality)

– government officials– ’33 Act “road show”– Disclosure by foreign private

issuers (still subject to antifraud rules)

Is Reg FD constitutional?

Siebel Systems• CEO calls favored stock

analyst– Tipper of “inside information”?

– Mechanism for market efficiency?

• CEO talks at industry conference– Disclosure of non-public

information

– Regulation FD

• CFO and IR director have dinner with inst investor– Disclosure of good news

– Company duties?

Thomas Siebel (CEO)

Regulation FD

Coverage – Rule 100 • Issuer disclosures (senior execs and IR)• Material nonpublic information• Specified market professionals [securities

firms, inv advisers, mutual funds, hedge funds, pension funds, stock traders]

• Exceptions for internal, confidential communications, to credit agencies

Effect• Intentional – simultaneous public

disclosure• Unintentional – promptly, within 24 hours• Liability – SEC enforcement (Rule 102)

Regulation FD

Coverage: • Issuer disclosures (senior execs and IR)• Material nonpublic information• Specified market professionals [securities

firms, inv advisers, mutual funds, hedge funds, pension funds, stock traders]

• Exceptions for internal, confidential communications, to credit agencies

Effect – Rule 100• Intentional – simultaneous public

disclosure• Unintentional – promptly, within 24 hours• Liability – SEC enforcement (Rule 102)

Siebel Systems• Call to favored stock analyst

– Tipper of “inside information”?

– Mechanism for market efficiency?

• CEO talks at industry conference– Disclosure of non-public information

– Regulation FD

• CFO and IR director have dinner with inst investor– Disclosure of good news

– Company duties?

What should the company have done?

• Not held conference?

• Not meet with analysts?

• Add disclosure controls?

• Webcast? [click here]

Siebel Systems• Call to favored stock analyst

– Tipper of “inside information”?

– Mechanism for market efficiency?

• Industry conference– Disclosure of non-public information

– Regulation FD

• CFO and IR director have been having dinner with inst investor– Your duties?

– Company duties?

Thomas Siebel (CEO)

Disclosure and Accuracy• Mandatory disclosure

– Forms– Board duties

• Regulation FD• “Up the ladder” reporting

“Up- the-ladder”

Securities attorney (including subordinate attorney)

• Represents issuer• Becomes aware of evidence of a

“material violation” (securities fraud or fiduciary breach)

Must report evidence forthwith• to issuer's chief legal officer (and

perhaps also CEO)• If not resolved

– Audit committee

– Board committee of outside Ds

– Whole board

Rule 205

“Up- the-ladder”

3(b)(1) If an attorney, appearing and practicing before the Commission in the representation of an issuer, becomes aware of evidence of a material violation by the issuer or by any officer, director, employee, or agent of the issuer, the attorney shall report such evidence to the issuer's chief legal officer (or the equivalent thereof) or to both the issuer's chief legal officer and its chief executive officer (or the equivalents thereof) forthwith.

Rule 205

“Up- the-ladder”

3(b)(2) If the chief legal officer (or the equivalent thereof) determines no material violation has occurred, is ongoing, or is about to occur, he or she shall notify the reporting attorney and advise the reporting attorney of the basis for such determination. OR he or she shall take all reasonable steps to cause the issuer to adopt an appropriate response, and shall advise the reporting attorney thereof.

Rule 205

“Up- the-ladder”

3(b)(3) Unless an attorney … reasonably believes that the chief legal officer or the chief executive officer of the issuer (or the equivalent thereof) has provided an appropriate response within a reasonable time, the attorney shall report the evidence of a material violation to:

• The audit committee of the issuer's board of directors;

• Another committee of the issuer's board of directors consisting solely of [outside directors] or

• The issuer's board of directors

Rule 205

“Up- the-ladder”

3(b), (d) A subordinate attorney shall comply with this part notwithstanding that the subordinate attorney acted at the direction of or under the supervision of another person.

A subordinate attorney may take the steps permitted or required by Rule 3(b) or (c) if the subordinate attorney reasonably believes that a supervisory attorney to whom he or she has reported evidence of a material violation under Rule 3(b) has failed to comply with Rule 3.

Rule 205

The end

WR Grace

Board dutiesYou are the chair of the compensation committee of Grace. What are your responsibilities?

• Send out questionnaires?• Rely on lawyers?• Review contracts?• Make sure contract filed?

SEC CommissionerSteven Wallman

Board duties

Wallman: “Officers and directors [need not ensure] the accuracy andcompleteness of company disclosures. … Enough that Company consented to cease and desist order.”

You are the chair of the compensation committee of Grace. What are your responsibilities?

• Send out questionnaires?• Rely on lawyers?• Review contracts?• Make sure contract filed?