For public companies. rules governing what and how a company communicates to the public have grown substantially. An already complex disclosure minefield has become only more difficult. Only time will tell whether these new rules will achieve their intended purpose of increasing the integrity, timeliness and transparency of financial reporting. However, with ever increasing new rules, it is all the more important to stay focused on the some of the basic tenets of financial disclosure.
Creating And Maintaining "Trust." There are few things more important in creating long-term value for a public company than trust and reliability. Analysts and institutions work to minimize the guesswork in their analysis of a company. Both a company's business reputation and its stock price generally go down in direct relation to any significant uncertainty concerning that company, and uncertainty arises when market professionals do not have access to reliable real time information.
Every company will have negative news from time to time, and company management typically fears the market's possible overreaction to that negative news. But no matter how bad the news may be, the long-term financial interests of a company will be best served by timely communication of events. The axiom that bad news does not get better with time tends to find its proof in the public markets, and the long-term value created by clear, timely and full disclosure of events will generally outweigh any reason for delaying the communication of negative news.
Advisability of One-on-Ones With Analysts and Institutions. Many securities lawyers would prefer that their public company clients not engage in private discussions with analysts or other members of the investment community, in light of the significant risks under Regulation FD. However, from a business perspective, choosing not to communicate with the investment community other than in public forums is unrealistic and could significantly hurt the company and its shareholders. Analysts rely on being able to speak with management on a regular basis. Their views on a company are based in part on their judgment as to the strength of management. It is impractical to think that public companies can or should abandon their one-on-one discussions. If they were to do so, the investment community could well decide not to cover the company, to the detriment not only of that company's shareholders but also of the investing public that uses information and analysis published by analysts. However, it is all the more important to prepare fully for these private discussions, as well as to increase the sensitivity of company management to the need to avoid all selective disclosure of important company information or providing different versions of the same message.
Prepare Earnings Releases with Subsequent Oral Message Points in Mind. When preparing earnings and other financial press releases, company management needs to plan for:
- what analysts and other members of the investment community can be expected to ask in their follow up calls.
- what particular message points the company may want to convey to the investment community in any subsequent private discussions.
Those future message points should be prepared at the same time as the press release and public conference call script, and the "public" and "private" messages always need to be the same. And company executives need to be just as careful concerning "subtleties" in their private discussions, such as using phrases like "significantly better" or "significantly worse" in the one-on-ones where the same color or emphasis or degree of impact was not provided with their public comments.
Have an Enforcer as a Regular Part of Your Calls. For calls with analysts and institutions, company management should always have someone else sitting with the main company contact, participating in the calls as the designated "enforcer." Keep in mind that the analysts and institutions generally have somebody doing the same thing at the other end. And be aware that analysts are keeping careful notes of these discussions, and it is likely that immediately following the call or other private discussions they will send out email notes to others within their organization and elsewhere concerning the information that the company has just provided.
Be Wary in Informal Settings. If company management is invited to a lunch or dinner meeting with members of the investment community, remember that while the sponsor and other guests may indeed personally enjoy the presence of the company representatives, their sole purpose is to illicit information. And information has a way of seeping out more easily in an informal setting without a set structure.
Know What Information Each Particular Market Professional Finds Important. Always know in advance of a call, discussion or meeting with an analyst or institution what that person or firm considers to be important in valuing the company and prepare the message that management wishes to convey in advance of the communication. And companies should not hesitate to ask questions back, such as what the analyst or institution likes or dislikes about the company.
Establish a Track Record for Honesty - It Will Be a Valuable Asset. Members of the investment community will either believe what you say or not. based on your track record for honesty and frankness. When things are not as rosy as you had hoped. having had a history of telling information forthrightly and early on will only help stabilize the situation.
Courts and the SEC Can be Expansive as to What Constitutes "Material" Information. "Material" information means information that a reasonable investor would consider important in making an investment decision concerning the company (that is. whether to buy, sell, or hold the company's securities). The SEC has for many years cautioned public companies that materiality is to be judged not only "quantitatively" but also "qualitatively," and SAB 99 as well as the SEC's recent enforcement action against KPMG bring this quantitative/qualitative analysis into sharp focus. The old 5% rule of thumb is long gone.
If you think that the price of your stock will move as a result of the public disclosure of particular information, in almost all cases that information will be found to be material. But on the flip side, a number of courts have said that the fact that your stock price does not change based on the particular disclosure does not necessarily take the information out of the material category. And, if analysts or institutions typically ask about it or comment on it in their reports or notes, this tends to support a conclusion that this type of information is considered to be material. If you are struggling over whether to disclose something, there is a good chance it is material.
Courts can be expansive in determining culpability of individual company executives. In securities class actions, plaintiffs are required to plead specific facts showing a strong inference of intent. That means that they need to prove that company executives intended to deceive. Actual knowledge satisfies this test. But legal recklessness may also satisfy this test in many jurisdictions. This is the hole through which plaintiffs often try to overcome motions to dismiss securities class action lawsuits. They plead that the individual executive must have known these facts and that it was an extreme departure from accepted standards for such executives not to have told the true state of facts.
In preparing press releases, 10-Ks, 10-Qs, 8-Ks, conference call scripts, Qs and As, etc., make sure the information reflects all that senior management knows and that it is the best, most accurate statement of affairs. And always critically assess the completeness of the statements being made in the press release, SEC filing or conference call script and ask whether or not they tell the "entire story."
Company Executives Often Complain That Their Statements Are Unfairly Judged in the Harsh Light of "Hindsight." Senior management can take steps to avoid being blinded by hindsight. The key is to adequately address those issues that management, from the inside, does understand and are concerned about at the time the statements are made. Companies cannot worry about hindsight, as there is nothing they can do about it. They can worry about omitting facts. risks or other circumstances that serve to convey, in the totality, the most accurate and complete picture about what the company is communicating.
Be Careful of "Positive Spin." Most public company executives do not try to mislead the investing public. Executives do worry, however, about painting an unnecessarily dark or negative picture of their company. This is not because they want to deceive or defraud people. This is because they believe in their company and, as the leaders of the company, they want to project a positive, optimistic face to their board, to their employees, to their competitors and to the public.
While these are understandable reasons, none of these reasons is recognized under the federal securities laws. By trying to put a "positive spin" on situations, management may not lay out the facts or issues or risks as they actually exist or as the company insiders really see them.
When company management publicly speaks, they must be truthful and accurate. Most importantly, they must be complete. They cannot fail to include facts or concerns that paint the full picture. For example, talking about great revenue prospects, without at the same time mentioning anticipated increased operating expenses or possible restructuring charges, may paint an unduly positive (and potentially misleading) picture, through omission.
The whole approach of the federal securities laws is that when a company chooses to speak, the investor should be able to make the same general judgments as inside management concerning the company's results, financial condition or prospects, including the particular significant risks involved. Every company has obstacles and the investment community is used to this. By approaching financial reporting in a full and complete manner, not only may the company earn the long-term trust of its investors, it also is more likely to avoid lawsuits and enforcement actions.
Published January 1, 2005.
