Selective Disclosure and Insider Trading
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Federal Register › Vol. 64 › 64 FR 72590
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 240, 243, and 249
[Release Nos. 33-7787, 34-42259, IC-24209, File No. S7-31-99]
RIN 3235-AH82
Selective Disclosure and Insider Trading
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission is proposing new rules
to address three issues: the selective disclosure by issuers of
material nonpublic information; whether insider trading liability
depends on a trader's ``use'' or ``knowing possession'' of material
nonpublic information; and when the breach of a family or other non-
business relationship may give rise to liability under the
misappropriation theory of insider trading. The proposals are designed
to promote the full and fair disclosure of information by issuers, and
to clarify and enhance existing prohibitions against insider trading.
DATES: Public comments are due on or before March 29, 2000.
ADDRESSES: Please send three copies of your comment letter to Jonathan
G. Katz, Secretary, Securities and Exchange Commission, 450 5th Street,
NW, Washington, DC 20549-0609. Comments can also be sent electronically
to the following e-mail address: [email protected]. Your comment
letter should refer to File No. S7-31-99. If e-mail is used, include
this file number on the subject line. Anyone can inspect and copy the
comment letters in the Commission's Public Reference Room at 450 5th
St., NW,
Washington, DC 20549. Electronically submitted comments will be posted
on the Commission's Internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Richard A. Levine, Assistant General
Counsel, Sharon Zamore, Senior Counsel, or Elizabeth Nowicki, Attorney,
Office of the General Counsel, at (202) 942-0890.
t letters in the Commission's Public Reference Room at 450 5th
St., NW,
Washington, DC 20549. Electronically submitted comments will be posted
on the Commission's Internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Richard A. Levine, Assistant General
Counsel, Sharon Zamore, Senior Counsel, or Elizabeth Nowicki, Attorney,
Office of the General Counsel, at (202) 942-0890.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission
(Commission) today is proposing for comment new rules: Regulation
FD,\1\ Rule 181 under the Securities Act,\2\ Rule 10b5-1,\3\ Rule 10b5-
2,\4\ and amendments to Forms 8-K \5\ and 6-K.\6\
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\1\ 17 CFR 243.100 and 243.101.
\2\ 17 CFR 230.181.
\3\ 17 CFR 240.10b5-1.
\4\ 17 CFR 240.10b5-2.
\5\ 17 CFR 249.308.
\6\ 17 CFR 249.306.
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I. Executive Summary
Information is the lifeblood of our securities markets. Congress
enacted the federal securities laws to promote fair and honest
securities markets, and a critical purpose of these laws is to promote
full and fair disclosure of important information by issuers of
securities to the investing public. The Securities Act of 1933
(Securities Act) and the Securities Exchange Act of 1934 (Exchange
Act), as implemented by Commission rules and regulations, provide for
systems of mandatory disclosure of certain material information in
securities offerings and in periodic reports.
The antifraud provisions of the federal securities laws also play a
very important role in furthering full and fair disclosure. Among other
things, the antifraud provisions prohibit insider trading, or the
fraudulent misuse of material nonpublic information
egulations, provide for
systems of mandatory disclosure of certain material information in
securities offerings and in periodic reports.
The antifraud provisions of the federal securities laws also play a
very important role in furthering full and fair disclosure. Among other
things, the antifraud provisions prohibit insider trading, or the
fraudulent misuse of material nonpublic information. Unlike the law
underlying the issuer disclosure requirements, which generally has been
developed through statutes and rules, the law of insider trading has
largely been developed through a series of Commission and judicial
decisions in civil and criminal enforcement cases involving fraud
charges. As a result, a few areas of insider trading law have been
marked by disagreement among the courts.
Today's proposals address several issues related to full and fair
disclosure of information, and insider trading law. The proposed rules
are the following:
Regulation FD (Fair Disclosure), a new issuer disclosure
rule, deals with the problem of issuers making selective disclosure of
material nonpublic information to analysts, institutional investors, or
others, but not to the public at large. Although analysts play an
important role in gathering and analyzing information, and
disseminating their analysis to investors, we do not believe that
allowing issuers to disclose material information selectively to
analysts is in the best interests of investors or the securities
markets generally. Instead, to the maximum extent practicable, we
believe that all investors should have access to an issuer's material
disclosures at the same time. Regulation FD, therefore, would require
that: (1) When an issuer intentionally discloses material information,
it do so through public disclosure, not through selective disclosure;
and (2) whenever an issuer learns that it has made a non-intentional
material selective disclosure, the issuer make prompt public disclosure
of that information
o an issuer's material
disclosures at the same time. Regulation FD, therefore, would require
that: (1) When an issuer intentionally discloses material information,
it do so through public disclosure, not through selective disclosure;
and (2) whenever an issuer learns that it has made a non-intentional
material selective disclosure, the issuer make prompt public disclosure
of that information.
Rule 10b5-1 addresses an important unsettled issue in
insider trading law: whether the Commission must show in its insider
trading cases that the defendant ``used'' the inside information in
trading, or merely that the defendant traded while in ``knowing
possession'' of the information. The Rule would state the general
principle that insider trading liability arises when a person trades
while ``aware'' of material nonpublic information, but also provides
four exceptions to liability. In these four situations, where a trade
resulted from a pre-existing plan, contract, or instruction that was
made in good faith, it will be clear that the trader did not use the
information he or she was aware of.
Rule 10b5-2 addresses another unsettled issue in current
insider trading law: what types of family or other non-business
relationships can give rise to liability under the misappropriation
theory of insider trading. The Rule would set forth three non-exclusive
bases for determining that a duty of trust or confidence was owed by a
person receiving information: (1) When the person agreed to keep
information confidential; (2) when the persons involved in the
communication had a history, pattern, or practice of sharing
confidences that resulted in a reasonable expectation of
confidentiality; and (3) when the person who provided the information
was a spouse, parent, child, or sibling of the person who received the
information, unless it were shown affirmatively, based on the facts and
circumstances of that family relationship, that there was no reasonable
expectation of confidentiality.
practice of sharing
confidences that resulted in a reasonable expectation of
confidentiality; and (3) when the person who provided the information
was a spouse, parent, child, or sibling of the person who received the
information, unless it were shown affirmatively, based on the facts and
circumstances of that family relationship, that there was no reasonable
expectation of confidentiality.
II. Selective Disclosure: Regulation FD
A. Background
Full and fair disclosure of information by issuers of securities to
the investing public is a cornerstone of the federal securities laws.
In enacting the mandatory disclosure system of the Exchange Act,
Congress sought to promote disclosure of ``honest, complete, and
correct information'' \7\ to facilitate the operation of fair and
efficient markets.\8\
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\7\ S. Rep. No. 73-1455, at 68 (1934).
\8\ ``The idea of a free and open public market is built upon
the theory that competing judgments of buyers and sellers as to the
fair price of a security brings about aq situation where the market
price reflects as nearly as possible a just price. . . . [T]he
hiding and secreting of important imformation obstructs the
operation of the markets as indices of real value,'' H.R. Rep. No.
73-1383, at 11 (1934). See also S. Rep. No. 73-792, at 10-11, 19-20
(1934).
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a security brings about aq situation where the market
price reflects as nearly as possible a just price. . . . [T]he
hiding and secreting of important imformation obstructs the
operation of the markets as indices of real value,'' H.R. Rep. No.
73-1383, at 11 (1934). See also S. Rep. No. 73-792, at 10-11, 19-20
(1934).
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Despite this well-recognized principle, the federal securities laws
do not generally require an issuer to make public disclosure of all
important corporate developments when they occur. Periodic reports
(e.g., Forms 10-K and 10-Q) call for disclosure of specified
information on a regular basis, and domestic issuers are additionally
required to report some types of events on a Form 8-K soon after they
occur. However, in the absence of a specific duty to disclose, the
federal securities laws do not require an issuer to publicly disclose
all material events as soon as they occur. While we encourage prompt
disclosure of material information as the best disclosure practice,\9\
and self-regulatory organization (SRO) rules often require this,\10\
issuers retain some control over the precise timing of many important
corporate disclosures.
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\9\ See Timely Disclosure of Material Corporate Developments,
Securities Act Release No. 5092 (Oct. 15, 1970) (35 FR 16733).
\10\ See, e.g., NYSE Listed Company Manual, para. 202.05 (Timely
Disclosure of Material News Developments); NASD Rules 4310(c)(16),
4320(e)(14), and IM-4120-1 (Disclosure of Material Information).
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9\ See Timely Disclosure of Material Corporate Developments,
Securities Act Release No. 5092 (Oct. 15, 1970) (35 FR 16733).
\10\ See, e.g., NYSE Listed Company Manual, para. 202.05 (Timely
Disclosure of Material News Developments); NASD Rules 4310(c)(16),
4320(e)(14), and IM-4120-1 (Disclosure of Material Information).
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In practice, issuers also retain control over the audience and
forum for some important disclosures. If a disclosure is made at a time
when no Commission filing is immediately required, the issuer
determines how and to whom to make its initial disclosure. As a result,
issuers sometimes choose to disclose information selectively--i.e., to
a small group of analysts or institutional investors--before making
broad public disclosure by a press release or Commission filing.
Many recent cases of selective disclosure have been reported in the
media.\11\ In some cases, selective
disclosures have been made in conference calls or meetings that are
open only to analysts and/or institutional investors, and exclude other
investors, members of the public, and the media. In other cases,
company officials have made selective disclosures directly to
individual analysts. Commonly, these situations involve advance notice
of the issuer's upcoming quarterly earnings or sales figures--figures
which, when announced, have a predictable and significant impact on the
market price of the issuer's securities.
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es,
company officials have made selective disclosures directly to
individual analysts. Commonly, these situations involve advance notice
of the issuer's upcoming quarterly earnings or sales figures--figures
which, when announced, have a predictable and significant impact on the
market price of the issuer's securities.
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\11\ See, e.g., Susan Pulliam and Gary McWilliams, Compaq Is
Criticized for How It Disclosed PC Troubles, Wall St. J., Mar. 2,
1999, at C1; Susan Pulliam, Abercrombie & Fitch Ignites Controversy
Over Possible Leak of Sluggish Sales Data, Wall St. J., Oct. 14,
1999, at C1; Randall Smith, Conference Calls to Big Investors Often
Leave Little Guys Hung Up, Wall St. J., June 21, 1995, at C1; George
Anders and Robert Berner, Webvan to Delay IPO in Response to SEC
Concerns, Wall St. J., Oct. 7, 1999, at C16 (disclosure to
institutional investors in road-show presentations). In addition, a
recent study of corporate disclosure practices by the National
Investor Relations Institute reported that 26% of responding
companies stated that they engaged in some types of selective
disclosure practices. National Investor Relations Institute, A Study
of Corporate Disclosure Practices, Second measurement, 18 (May 1998)
(NIRI Corporate Disclosure Study).
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actices by the National
Investor Relations Institute reported that 26% of responding
companies stated that they engaged in some types of selective
disclosure practices. National Investor Relations Institute, A Study
of Corporate Disclosure Practices, Second measurement, 18 (May 1998)
(NIRI Corporate Disclosure Study).
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We are troubled by the many recent reports of selective disclosure
and the potential impact of this practice on market integrity. As the
Supreme Court has recently emphasized, promoting investor confidence in
the fairness of our securities markets is an ``animating purpose'' of
the Exchange Act.\12\ Clearly, one critical component of that mission
is protecting investors from the prospect that others in the market
possess ``unerodable informational advantages'' \13\ obtained through
superior access to corporate insiders.
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\12\ United States v. O'Hagan, 521 U.S. 642, 658 (1997).
\13\ Id. (citing Brudney, Insiders, Outsiders, and Informational
Advantages Under the Federal Securities Laws, 93 Harv. L. Rev. 322,
356 (1979)).
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In our view, the current practice of selective disclosure poses a
serious threat to investor confidence in the fairness and integrity of
the securities markets. We have recognized that benefits may flow to
the markets from the legitimate efforts of securities analysts to
``ferret out and analyze information'' \14\ based on their superior
diligence and acumen. But we do not believe that selective disclosure
of material nonpublic information to analysts--or to others, such as
selected investors--is beneficial to the securities markets
curities markets. We have recognized that benefits may flow to
the markets from the legitimate efforts of securities analysts to
``ferret out and analyze information'' \14\ based on their superior
diligence and acumen. But we do not believe that selective disclosure
of material nonpublic information to analysts--or to others, such as
selected investors--is beneficial to the securities markets. As a
recent academic study indicated, selective disclosure has the immediate
effect of enabling those privy to the information to make a quick
profit (or quickly minimize losses) by trading before the information
is disseminated to the public.\15\ Indeed, while issuer selective
disclosure is not a new practice,\16\ the impact of such selective
disclosure appears to be much greater in today's more volatile,
earnings-sensitive markets. Accordingly, we think that a continued
practice of selective disclosure by issuers inevitably will lead to a
loss of public confidence in the fairness of the markets.
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\14\ Raymond L. Dirks, 47 S.E.C. 434, 441(1981). This concern
about protecting the legitimate functions of securities analysts was
a basis for the Supreme Court's decision in Dirks v. SEC, 463 U.S.
646 (1983), which addressed an analyst's liability under Rule 10b-5
insider trading law. See also Daniel R. Fischel, Insider Trading and
Investment Analysts: An Economic Analysis of Dirks v. Securities and
Exchange Commission, 13 Hofstra L. Rev. 127, 142 (1984). But see
Donald C. Langevoort, Investment Analysts and The Law of Insider
Trading, 76 Va. L. Rev. 1023, 1044 (1990) (stating that the argument
favoring special treatment for analyst disclosures is
``substantially overstated''). We discuss the Dirks case in greater
detail at infra pp. 12-13.
\15\ See Richard Frankel, Marilyn Johnson, and Douglas J.
Skinner, An Empirical Examination of Conference Calls as a Voluntary
Disclosure Medium, 37 J. Acct. Res. 133 (Spring 1999)
ing, 76 Va. L. Rev. 1023, 1044 (1990) (stating that the argument
favoring special treatment for analyst disclosures is
``substantially overstated''). We discuss the Dirks case in greater
detail at infra pp. 12-13.
\15\ See Richard Frankel, Marilyn Johnson, and Douglas J.
Skinner, An Empirical Examination of Conference Calls as a Voluntary
Disclosure Medium, 37 J. Acct. Res. 133 (Spring 1999). This study
revealed that, during and immediately following teleconference calls
between analysts and issuers, trading volume in the issuers' stock
increased, average trade size increased, and stock price volatility
increased. This led the researchers to conclude that material
information is released during these selective disclosure periods,
which is immediately filtered to a subset of large investors who are
able to trade on the information before it is fully disseminated to
the market.
\16\ The NIRI Corporate Disclosure Study indicates that a higher
percentage of issuers engaged in possible selective disclosure
practices in 1995 than in 1998. See NIRI Corporate Disclosure Study,
supra note 11 at 18.
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Even apart from the issue of fundamental fairness to all investors,
selective disclosure poses other real threats to the health and
integrity of our securities markets. Corporate managers should be
encouraged to make broad public disclosure of important information
promptly. If, however, they are permitted to treat material information
as a commodity that can be parceled out selectively, they may delay
general public disclosure so that they can selectively disclose the
information to curry favor or bolster credibility with particular
analysts or institutional investors.\17\
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\17\ See SEC v. Phillip J. Stevens, Litigation Release No. 12813
(Mar. 19, 1991).
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c disclosure so that they can selectively disclose the
information to curry favor or bolster credibility with particular
analysts or institutional investors.\17\
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\17\ See SEC v. Phillip J. Stevens, Litigation Release No. 12813
(Mar. 19, 1991).
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Moreover, if selective disclosure were to go unchecked,
opportunities for analyst conflicts of interests would flourish. We are
greatly concerned by reports indicating a trend toward less independent
research and analysis as a basis for analysts' advice, and a
correspondingly greater dependence by analysts on access to corporate
insiders to provide guidance and ``comfort'' for their earnings
forecasts.\18\ In this environment, analysts are likely to feel
pressured to report favorably about particular issuers to avoid being
``cut * * * off from access to the flow of non-public information
through future analyst conference phone calls'' or other means of
selective disclosure.\19\ This raises troubling questions about the
degree to which analysts may be pressured to shade their analysis in
order to maintain their access to corporate management. We believe that
these pressures would be reduced if issuers were clearly prohibited
from selectively disclosing material information to favored analysts.
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This raises troubling questions about the
degree to which analysts may be pressured to shade their analysis in
order to maintain their access to corporate management. We believe that
these pressures would be reduced if issuers were clearly prohibited
from selectively disclosing material information to favored analysts.
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\18\ Fred Barbash, Companies, Analysts A Little Too Cozy, Wash.
Post, Oct. 31, 1999, at H1 (``Companies coddle analysts to obtain
the most favorable coverage, which is critical to their stock price.
Analysts covet their access to companies, because special knowledge
is the only thing they have to offer clients.''); Andrew Hill, Let
the buyer beware, Fin. Times, Oct. 27, 1999, at 14 (``The death of
the `sell' note is perhaps the clearest signal that big securities
houses are suppressing or toning down negative analysis of companies
that are clients or potential clients. In a snapshot of 27,700
individual analyst reports, taken at the beginning of this month,
First Call/Thomson Financial, the research company, found nearly 70
per cent recommended that investors buy the stock, and just under 1
per cent advised they should sell.''); Gretchen Morgenson, The
Earnings Waltz: Is the Music Stopping?, N.Y. Times, Oct. 24, 1999,
at 3 (``As quarterly earnings numbers became paramount, analysts
grew more dependent upon company management for `guidance' to the
correct earnings forecast. The more help they received, the less
work they did.''); Robert McGough, One Analyst Anticipated IBM News,
Wall St. J., Oct. 22, 1999, at C1 (``Too often analysts rely on
executives at the companies they cover to let them know what's going
on in the business.''); Jonathan Weil, In Stock Ratings, Many
Analysts Say `Sell' Is a Four-Letter Word, Wall St
idance' to the
correct earnings forecast. The more help they received, the less
work they did.''); Robert McGough, One Analyst Anticipated IBM News,
Wall St. J., Oct. 22, 1999, at C1 (``Too often analysts rely on
executives at the companies they cover to let them know what's going
on in the business.''); Jonathan Weil, In Stock Ratings, Many
Analysts Say `Sell' Is a Four-Letter Word, Wall St. J., May 6, 1998,
at T2 (attributing analysts' ``speak no evil'' motto to fact that
``most analysts don't want to risk offending corporate executives,
who have been known to retaliate by restricting access to
information or selecting competitors' corporate-finance departments
to do lucrative investment-banking deals. So analysts issue watered-
down critiques, and shareholders have to read between the lines for
suggestions on when to get out of a stock.''); Jeffrey M. Landerman,
Who Can You Trust? Wall Street's Spin Game, Stock Analysts Often
Have a Hidden Agenda, Bus. Wk., Oct. 5, 1998, at 148 (referencing a
recent survey of Wall Street research, sales, and trading practices
in which nearly one-third of the 272 responding large U.S. companies
said that in response to an analyst's sell recommendation they would
`` `reduce communications and reduce access' . . . . The great fear
of the analyst when he or she goes calling on a company is to find
the door shut.'').
\19\ John C. Coffee, Jr., Is Selective Disclosure Now Lawful?,
N.Y.L.J., July 31, 1997, at 5. Professor Coffee also argues that
selective disclosure may impair market efficiency in one other
respect. If market efficiency is measured by the width of bid/asked
spreads, market makers will widen spreads to protect themselves if
they fear that others possess and will exploit asymmetric
informational advantages. See also Amitabh Dugar, Siva Nathan,
Analysts' Research Reports: Caveat Emptor, 5 J. Investing 13 (1996)
(``Analysts depend on corporate management for accurate and timely
information about the companies they follow
d by the width of bid/asked
spreads, market makers will widen spreads to protect themselves if
they fear that others possess and will exploit asymmetric
informational advantages. See also Amitabh Dugar, Siva Nathan,
Analysts' Research Reports: Caveat Emptor, 5 J. Investing 13 (1996)
(``Analysts depend on corporate management for accurate and timely
information about the companies they follow. It is no secret that
companies wield restriction of access as a weapon against analysts
who issue a negative research report on their stock. Retribution
ranges from refusing the analyst's calls for information, to barring
the analysts from mailings, conference calls, and meetings, and even
threats of legal action and physical harm.'' (citations and footnote
omitted)).
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These concerns about selective disclosure are widely shared, as
reflected both in stock exchange listing standards and in ``best
practices'' guidelines of investor relations and analyst groups. The
New York Stock Exchange Listed Company Manual and the NASD Rules both
require listed issuers to disclose promptly ``to the public''
information about material developments.\20\ The National Investor
Relations Institute (NIRI) guidance in this area also states that an
issuer ``should not disclose in selective situations--such as
conference calls and analyst meetings--information that it is unwilling
to make available for general public use.'' \21\ Similarly, the
Association of Investment Management and Research Standards of Practice
Handbook states that if an analyst selectively receives disclosure of
information that he deems material, ``the member must encourage the
public dissemination of that information and abstain from making
investment decisions on the basis of that information unless and until
it is broadly disseminated to the marketplace.'' \22\
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k states that if an analyst selectively receives disclosure of
information that he deems material, ``the member must encourage the
public dissemination of that information and abstain from making
investment decisions on the basis of that information unless and until
it is broadly disseminated to the marketplace.'' \22\
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\20\ See supra note 10.
\21\ National Investor Relations Institute, Standards of
Practice for Investor Relations, 30 (Apr. 1998).
\22\ Association for Investment Management and Research,
Standards of Practice Handbook, 232 (8th ed. 1999).
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Finally, revolutions in communications and information technologies
have made it much easier for issuers today to disseminate important
information broadly and swiftly. A generation ago, issuers may have
relied on conferences attended by a handful of interested parties, or
news releases that led to delayed, indirect retransmission of
information to the public. Lacking effective means to communicate
directly to large numbers of investors, issuers may have relied on
analysts to serve as information intermediaries. In the last few years,
however, new, effective methods for mass communications have become
widely available. Today, issuers can--and many do--use a variety of
these new methods to communicate with the market, including: live
transmissions of annual meetings and news conferences on the Internet
or closed circuit television; listen-only telephone transmission of
meetings and analyst conferences; and company websites.\23\ With the
availability of these new technologies, issuers can much more easily
reach a wide investor audience with their disclosures, and do not need
to rely on analysts as heavily as in the past to serve as information
intermediaries.\24\
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hone transmission of
meetings and analyst conferences; and company websites.\23\ With the
availability of these new technologies, issuers can much more easily
reach a wide investor audience with their disclosures, and do not need
to rely on analysts as heavily as in the past to serve as information
intermediaries.\24\
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\23\ See, e.g., National Investor Relations Institute, Executive
Alert, Investor Relations Officers Report Dramatic Change in Ways
Companies Communicate With Key Audiences (June 18, 1999); Lynn
Cowan, Internet Broadcast of Conference Calls Creates Buzz and Niche
for Businesses, Wall St. J., May, 24, 1999, at B9D.
\24\ We also have greater flexibility and improved technology
for widespread dissemination of information. The Commission's EDGAR
system permits investors to access issuer information almost as soon
as it is filed with us.
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Nevertheless, issuers are continuing to engage in selective
disclosures of material nonpublic information, perhaps due in part to
the uncertainty in current law about when selective disclosures are
prohibited. For at least the past 30 years, the issue of potential
liability for selective disclosure has been addressed under the
principles of fraud law, particularly the law of insider trading. Under
early insider trading case law, which appeared to require that traders
have equal access to corporate information,\25\ selective disclosure of
material information to securities analysts could lead to
liability.\26\
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re has been addressed under the
principles of fraud law, particularly the law of insider trading. Under
early insider trading case law, which appeared to require that traders
have equal access to corporate information,\25\ selective disclosure of
material information to securities analysts could lead to
liability.\26\
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\25\ SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir.
1968) (en banc), cert. denied, 394 U.S. 976 (1969.
\26\ See SEC v. Bausch & Lomb, Inc., 565 F.2d 8 (2d Cir. 1977).
At the same time, however, issuers were encouraged to divulge
tidbits of non-material information to analysts to help them piece
together more informed opinions. Id. The courts reasoned that
although giving analysts direct, nonpublic, material information was
prohibited, the law should permit ``[a] skilled analyst with
knowledge of [a] company and the industry [to] piece seemingly
inconsequential data together with public information into a mosaic
which reveals material non-public information.'' Elkind v. Liggett &
Myers, Inc., 635 F.2d 156, 165 (2d Cir. 1980). This theory is known
as the `'mosaic theory.'' The resulting tension between prohibited
material disclosures and acceptable non-material disclosures led one
judge to compare the corporate official's encounter with an analyst
to a `'fencing match conducted on a tightrope.'' Bausch & Lomb, 565
F.2d at 9.
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(2d Cir. 1980). This theory is known
as the `'mosaic theory.'' The resulting tension between prohibited
material disclosures and acceptable non-material disclosures led one
judge to compare the corporate official's encounter with an analyst
to a `'fencing match conducted on a tightrope.'' Bausch & Lomb, 565
F.2d at 9.
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This changed with the Supreme Court's decisions in Chiarella v.
United States \27\ and Dirks v. SEC.\28\ In Chiarella, the Court
rejected the ``parity of information'' approach, which considered
trading to be fraudulent whenever the trader possessed material
information not generally available. The Court instead held that there
must be a breach of a fiduciary or other relationship of trust and
confidence before the law imposes a duty to disclose information or
refrain from trading.
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\27\ 445 U.S. 222 (1980).
\28\ 463 U.S. 646 (1983).
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In Dirks, the Supreme Court addressed the disclosure, or
``tipping,'' of material nonpublic information by an insider to an
analyst.\29\ The Court rejected the idea that a person is prohibited
from trading whenever he knowingly receives material nonpublic
information from an insider. Instead, it stated that a recipient of
inside information is prohibited from trading only when the information
has been made available to him ``improperly''--that is, in breach of
the insider's fiduciary duty to shareholders. To determine whether a
breach of duty occurred, ``courts [must] focus on objective criteria,
i.e., whether the insider receives a direct or indirect personal
benefit from the disclosure, such as a pecuniary gain or a reputational
benefit that will translate into future earnings.'' \30\
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s fiduciary duty to shareholders. To determine whether a
breach of duty occurred, ``courts [must] focus on objective criteria,
i.e., whether the insider receives a direct or indirect personal
benefit from the disclosure, such as a pecuniary gain or a reputational
benefit that will translate into future earnings.'' \30\
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\29\ In Dirks, a securities analyst had been informed about a
major fraud at Equity Funding of America by a former officer of the
company. Although Dirks made an effort to make the fraud public, he
also told his clients, enabling them to sell their Equity Funding
securities and avoid losses when the fraud became publicly known.
The Commission charged that Dirks was a ``tippee'' of the insider,
and in turn tipped his clients.
\30\ 463 U.S. at 663. On the facts of the case, the Court found
that Dirks' source did not breach a duty in disclosing information
to Dirks because he did not receive a personal benefit from the
disclosure and was clearly motivated by a desire to expose the
fraud. Because a tippee's duty is ``derivative'' from the duty of
the tipper, and the insider source did not breach a duty, the Court
held that Dirks did not violate Section 10(b) of the Exchange Act or
Rule 10b-5.
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After Dirks, there have been very few insider trading cases based
on disclosure to, or trading by, securities analysts. In some
situations, an insider's selective disclosure can be viewed as
improper, because the disclosure was motivated by a desire for some
type of personal benefit.\31\ In other cases, however, the evidence to
support the ``personal benefit'' argument under Dirks is less clear
ter Dirks, there have been very few insider trading cases based
on disclosure to, or trading by, securities analysts. In some
situations, an insider's selective disclosure can be viewed as
improper, because the disclosure was motivated by a desire for some
type of personal benefit.\31\ In other cases, however, the evidence to
support the ``personal benefit'' argument under Dirks is less clear. As
a result, many have viewed Dirks as affording considerable protection
to insiders who make selective disclosures to analysts, and to the
analysts (and their clients) who receive selectively disclosed
information.\32\
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\31\ SEC v. Phillip J. Stevens, supra note 17 (allegation of
personal benefit based on corporate official's desire to protect and
enhance his reputation).
\32\ See, e.g., Paul P. Brountas Jr., Note: Rule 10b-5 and
Voluntary Corporate Disclosures to Securities Analysts, 92 Colum. L.
Rev. 1517, 1529 (1992).
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Although the antifraud provisions of the securities laws do not
require that all traders possess equal information when they trade, we
believe that our disclosure rules should promote fair
treatment of large and small investors by, among other things, giving
all investors timely access to the material information an issuer
chooses to disclose. Therefore, we are today proposing new rules, which
use a different legal approach, to address selective disclosure.
The approach we propose does not treat selective disclosure as a
type of fraudulent conduct or revisit the insider trading issues
addressed in Dirks. Rather, we propose to use our authority to require
full and fair disclosure from issuers, primarily under Section 13(a) of
the Exchange Act, as a basis for proposed Regulation FD
use a different legal approach, to address selective disclosure.
The approach we propose does not treat selective disclosure as a
type of fraudulent conduct or revisit the insider trading issues
addressed in Dirks. Rather, we propose to use our authority to require
full and fair disclosure from issuers, primarily under Section 13(a) of
the Exchange Act, as a basis for proposed Regulation FD. This
Regulation is designed as an issuer disclosure rule, similar to
existing Commission rules under Exchange Act Sections 13(a) and
15(d).\33\ We believe this approach would further the full and fair
public disclosure of material information, and thereby promote fair
dealing in the securities of covered issuers.
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\33\ 15 U.S.C. 78m(a) and 78o(d).
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B. Description of Proposed Regulation FD
Rule 101 of Regulation FD sets forth the basic rule regarding
``selective disclosure.'' Under this Rule, whenever:
(1) an issuer, or any person acting on its behalf,
(2) discloses material nonpublic information
(3) to any other person outside the issuer,
(4) the issuer must
(a) simultaneously (for intentional disclosures), or
(b) ``promptly'' (for non-intentional disclosures)
(5) make public disclosure of that same information.
Several definitional and other provisions in the Regulation
establish the scope and effect of the general rule. As a whole, the
Regulation would require that whenever an issuer makes an intentional
disclosure of material nonpublic information, it must do so in a manner
that provides general public disclosure, rather than through a
selective disclosure. In the case of an unintentional selective
disclosure, the issuer must make full public disclosure promptly after
it learns of the selective disclosure. Regulation FD does not mandate
that issuers make public disclosure of all material developments when
they occur
public information, it must do so in a manner
that provides general public disclosure, rather than through a
selective disclosure. In the case of an unintentional selective
disclosure, the issuer must make full public disclosure promptly after
it learns of the selective disclosure. Regulation FD does not mandate
that issuers make public disclosure of all material developments when
they occur. What it does require, however, is that when an issuer
chooses to disclose material nonpublic information, it must do so
broadly to the investing public, not selectively to a favored few.
The key provisions of the Regulation are discussed in greater
detail below.
1. Disclosures by ``An Issuer or Person Acting on its Behalf''
Regulation FD applies to all issuers with securities registered
pursuant to Section 12 of the Exchange Act, and those issuers required
to file reports under Section 15(d) of the Exchange Act, including
closed-end investment companies but not including other investment
companies.\34\ It would apply not only to a selective disclosure
formally made in the name of the issuer, but also to a selective
disclosure made by a ``person acting on behalf of an issuer.'' This
term is defined by Rule 101(c) as any officer, director, employee, or
agent of the issuer who discloses material nonpublic information while
acting within the scope of his or her authority.
---------------------------------------------------------------------------
\34\ See Proposed Rule 101(b).
---------------------------------------------------------------------------
f of an issuer.'' This
term is defined by Rule 101(c) as any officer, director, employee, or
agent of the issuer who discloses material nonpublic information while
acting within the scope of his or her authority.
---------------------------------------------------------------------------
\34\ See Proposed Rule 101(b).
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The definition of ``person acting on behalf of an issuer''
distinguishes between cases where a properly authorized employee or
agent of the issuer makes a selective disclosure, and cases where an
employee or agent discloses material nonpublic information for his or
her own benefit--i.e., provides a ``tip'' that would violate Rule 10b-5
if securities trading ensued. This distinction means that the issuer
would not automatically be liable under Regulation FD (or be
responsible for making simultaneous or prompt public disclosure)
whenever one of its employees or agents improperly trades or tips.\35\
The Rule also would not apply if an official disclosed information to
another person who owed him or her a duty of trust or confidence--such
as a medical professional. By focusing on employees and agents acting
within the scope of their authority, the Rule would make an issuer
responsible only for the disclosures of company officials, employees,
or agents who are properly authorized or designated to speak to the
media, the analyst community, and/or investors.
---------------------------------------------------------------------------
\35\ The proper response in this type of case is to hold the
employee or agent responsible for illegal insider trading, not to
force the issuer to make a public disclosure due to the misconduct
of one of its employees or agents.
---------------------------------------------------------------------------
/or investors.
---------------------------------------------------------------------------
\35\ The proper response in this type of case is to hold the
employee or agent responsible for illegal insider trading, not to
force the issuer to make a public disclosure due to the misconduct
of one of its employees or agents.
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We request comment on this approach. Is the definition of ``person
acting on behalf of an issuer'' appropriate? Should it be narrower--for
example, limited to executive officers and directors, and persons
acting on their behalf? Or should it be broader, to prevent evasion--
for example, covering any person authorized to act on behalf of the
issuer?
2. Disclosure of Material Nonpublic Information
Regulation FD addresses the selective disclosure of ``material
nonpublic information.'' The Regulation does not define the term
``material,'' but instead relies on the same definition as is generally
applicable under the federal securities laws: information is material
if ``there is a substantial likelihood that a reasonable shareholder
would consider it important'' in making an investment decision, or if
it would have ``significantly altered the `total mix' of information
made available.'' \36\
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\36\ TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449
information is material
if ``there is a substantial likelihood that a reasonable shareholder
would consider it important'' in making an investment decision, or if
it would have ``significantly altered the `total mix' of information
made available.'' \36\
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\36\ TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449
(1976); see Basic v. Levinson, 485 U.S. 224, 231 (1988); see also
Securities Act Rule 405, 17 CFR 230.405; Exchange Act Rule 12b-2, 17
CFR 240.12b-2; Staff Accounting Bulletin No. 99 (Aug. 12, 1999) (64
FR 45150) (discussing materiality for purposes of financial
statements).
---------------------------------------------------------------------------
We recognize that materiality judgments can be difficult. Corporate
officials may therefore become more cautious in communicating with
analysts or selected investors, or may feel compelled to consult with
counsel more frequently about their ability to respond to questions
from analysts and investors. We understand that these communications
take many forms, including unrehearsed question-and-answer sessions,
and responses to unsolicited inquiries. We are mindful of the potential
burdens of requiring instant materiality judgments to be made by those
put in the position of responding immediately to questions.
We believe that these concerns are significant but can be mitigated
in several ways, many of which involve practices already in place at
many issuers.\37\ First, issuers can designate a limited number of
persons who are authorized to make disclosures or field inquiries from
analysts, investors, or the media. Second, issuers can make sure that
some record is kept of the substance of private communications with
analysts or selected investors--for example, by having more than one
person present during these contacts or by recording conversations
\ First, issuers can designate a limited number of
persons who are authorized to make disclosures or field inquiries from
analysts, investors, or the media. Second, issuers can make sure that
some record is kept of the substance of private communications with
analysts or selected investors--for example, by having more than one
person present during these contacts or by recording conversations.
Third, issuer personnel can decline to answer questions that raise
issues of materiality until they have had an opportunity to consult
with others. Fourth, issuer personnel can secure the agreement of
analysts not to make use of certain information for a limited time
until they have had the opportunity to review their notes of the
conversation and engage in whatever consultation they deem necessary to
reach a conclusion as to
materiality; \38\ then, if the issuer determines that public disclosure
of the information is necessary, it can do so. Finally, and most
importantly, as described in greater detail below, the Regulation
recognizes that issuers may sometimes unintentionally make a selective
disclosure of material nonpublic information, and it treats such
unintentional disclosures differently from cases in which the issuer
makes a planned selective disclosure.
---------------------------------------------------------------------------
\37\ See NIRI Corporate Disclosure Study, supra note 11.
\38\ If a person receives material nonpublic information subject
to such a confidentiality agreement, the use or disclosure of the
information for securities trading purposes will lead to insider
trading liability under Rule 10b-5.
---------------------------------------------------------------------------
-----------------------------
\37\ See NIRI Corporate Disclosure Study, supra note 11.
\38\ If a person receives material nonpublic information subject
to such a confidentiality agreement, the use or disclosure of the
information for securities trading purposes will lead to insider
trading liability under Rule 10b-5.
---------------------------------------------------------------------------
We also believe that a heightened awareness of materiality issues
may well have overall benefits to the disclosure process. Senior
corporate officials who are responsible for dealing with analysts,
investor relations, and disclosure issues already should be sensitive
to materiality questions. When particularly difficult issues arise,
responsible officials should seek the advice of counsel. Though it is
likely that this Regulation will require corporate officials to
consider more thoughtfully precisely what to disclose, it is unlikely,
given the robust, active capital market, that the flow of information
to the market will be significantly chilled.
Although materiality issues do not lend themselves to a bright-line
test, we believe that the majority of cases are reasonably clear. At
one end of the spectrum, we believe issuers should avoid giving
guidance or express warnings to analysts or selected investors about
important upcoming earnings or sales figures; such earnings or sales
figures will frequently have a significant impact on the issuer's stock
price. At the other end of the spectrum, more generalized background
information is less likely to be material. We request comment on
whether use of the procedures discussed above or similar procedures can
significantly reduce the risk of ``chilling'' the flow of corporate
information to the marketplace
earnings or sales
figures will frequently have a significant impact on the issuer's stock
price. At the other end of the spectrum, more generalized background
information is less likely to be material. We request comment on
whether use of the procedures discussed above or similar procedures can
significantly reduce the risk of ``chilling'' the flow of corporate
information to the marketplace.
The Regulation also does not specifically define the term
``nonpublic.'' It is well established that information is nonpublic if
it has not been disseminated in a manner making it available to
investors generally.\39\ In order to make information public, ``it must
be disseminated in a manner calculated to reach the securities market
place in general through recognized channels of distribution, and
public investors must be afforded a reasonable waiting period to react
to the information.'' \40\ The Regulation does specify means by which
``public disclosure'' is to be made.\41\ We request comment on whether
to rely on existing standards for the term ``nonpublic.'' Should we
provide further guidance, or is the specific definition of ``public
disclosure'' provided in Rule 101(e) sufficient?
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\39\ See, e.g., Texas Gulf Sulphur, 401 F.2d at 854; In re
Investors Management Co., 44 S.E.C. 633, 643 (1971).
\40\ Faberge, Inc., 45 S.E.C. 249, 255 (1973). Thus, for
purposes of insider trading law, insiders must wait a ``reasonable''
time before trading. What constitutes a reasonable time prior to
trading depends on the circumstances of the dissemination. Id.,
citing Texas Gulf Sulphur, 401 F.2d at 854.
\41\ See, infra Section II.B.5.
---------------------------------------------------------------------------
e, Inc., 45 S.E.C. 249, 255 (1973). Thus, for
purposes of insider trading law, insiders must wait a ``reasonable''
time before trading. What constitutes a reasonable time prior to
trading depends on the circumstances of the dissemination. Id.,
citing Texas Gulf Sulphur, 401 F.2d at 854.
\41\ See, infra Section II.B.5.
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3. Selective Disclosure ``To Any Other Person Outside the Issuer''
Rule 100(a) covers selective disclosures made to ``any person or
persons outside the issuer.'' Therefore, the Rule would not apply to
communications of confidential information by officials and employees
of issuers to each other. Only selective disclosures to outsiders, such
as analysts or selected investors, are covered by the Regulation.
To make clear the scope of the Regulation, paragraph (b) of Rule
100 expressly states that the Rule does not apply to disclosures of
material information to persons who are bound by duties of trust or
confidence not to disclose or use the information for trading.
Paragraph (b) expressly refers to several types of persons whose misuse
of the information would subject them to insider trading liability
under Rule 10b-5: (1) ``temporary'' insiders of an issuer--e.g.,
outside consultants, such as its attorneys, investment bankers, or
accountants; \42\ and (2) any other person who has expressly agreed to
maintain the information in confidence, and whose misuse of the
information for trading would thus be covered either under the
``temporary insider'' or ``misappropriation'' theory.\43\
---------------------------------------------------------------------------
tside consultants, such as its attorneys, investment bankers, or
accountants; \42\ and (2) any other person who has expressly agreed to
maintain the information in confidence, and whose misuse of the
information for trading would thus be covered either under the
``temporary insider'' or ``misappropriation'' theory.\43\
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\42\ ``Classical'' insiders--an issuer's officers, directors, or
employees--are of course also subject to duties of trust and
confidence and to Rule 10b-5 insider trading liability if they trade
or tip.
\43\ United States v. O'Hagan, 521 U.S. 642 (1997); Dirks, 463
U.S. at 655 n.14.
---------------------------------------------------------------------------
This approach recognizes that issuers and their officials may
properly share material nonpublic information with outsiders when those
outsiders agree to keep the information confidential. This would permit
issuers to discuss confidential strategies or plans with outsiders, as
necessary for business purposes, without need to make public disclosure
under this Rule. For example, issuers could share material nonpublic
information with other parties to a business combination transaction or
with a purchaser in a private placement without having to make public
disclosure if the party receiving the information agrees to hold the
information in confidence. Similarly, if it served an issuer's
corporate interests to make disclosure of material information to
selected analysts--for example, to give the analysts sufficient time to
analyze complex information before its public release, or to solicit
analysts' views on a business strategy under consideration--it could do
so, provided that the recipients of the information expressly agreed
not to use the information and to keep it confidential prior to public
disclosure. Such a confidentiality agreement would also include an
agreement not to trade on the nonpublic information
yze complex information before its public release, or to solicit
analysts' views on a business strategy under consideration--it could do
so, provided that the recipients of the information expressly agreed
not to use the information and to keep it confidential prior to public
disclosure. Such a confidentiality agreement would also include an
agreement not to trade on the nonpublic information.
We request comment on whether the proposed Regulation covers the
appropriate categories of persons. Should other types of persons be
enumerated in Rule 100(b) as proper recipients of material nonpublic
information? By permitting disclosures to outsiders who agree to
confidentiality requirements, does the Regulation adequately permit
issuers to engage in legitimate business communications with customers
or suppliers, potential co-venturers, and others? Would purchasers in
private offering who receive material nonpublic information be willing
to sign confidentiality agreements? How would this affect the resale
market for private offerings and the flow of information in these
transactions? Would the proposals reduce liquidity in the 144A market?
How should the Regulation account for practices in this market? Should
we require that confidentiality agreements take any specific form--
i.e., be written--or include certain required provisions?
4. Timing of Public Disclosure Required by Regulation FD
An important provision of Regulation FD is that the timing of
required public disclosure differs depending on whether the issuer has
made an ``intentional'' or a ``non-intentional'' selective disclosure.
When an issuer makes an ``intentional'' disclosure of material
nonpublic information, Rule 100(a)(1) requires the issuer to publicly
disclose the same information simultaneously. In effect, this
requirement for simultaneous disclosure means that issuers cannot
engage in an intentional selective disclosure consistent with the terms
of Regulation FD
a ``non-intentional'' selective disclosure.
When an issuer makes an ``intentional'' disclosure of material
nonpublic information, Rule 100(a)(1) requires the issuer to publicly
disclose the same information simultaneously. In effect, this
requirement for simultaneous disclosure means that issuers cannot
engage in an intentional selective disclosure consistent with the terms
of Regulation FD.
Under the definition provided in Rule 101(a), a selective
disclosure is
``intentional'' when the individual making the disclosure either knew
prior to making the disclosure, or was reckless in not knowing, that he
or she would be communicating information that was material and
nonpublic. This definition would cover, for example, situations where
an issuer official determined to hold a conference call or meeting that
excluded the public, or selectively contacted a particular analyst or
investor, to disclose material nonpublic information. The individual
making the disclosure must know (or be reckless in not knowing) that
the information he or she is going to disclose is both material and
nonpublic. Thus, for example, a communication would not be
``intentional'' under this Rule if it was disclosed inadvertently
through an honest slip of the tongue, or because the individual
mistakenly (but not in reckless disregard of the truth) believed that
the information had already been made public.
Under Rule 100(a)(2), when this type of ``non-intentional''
disclosure of material nonpublic information occurs, the issuer is
required to make public disclosure promptly. In this situation, because
the disclosure was unplanned, the Rule does not require simultaneous
public disclosure
nly (but not in reckless disregard of the truth) believed that
the information had already been made public.
Under Rule 100(a)(2), when this type of ``non-intentional''
disclosure of material nonpublic information occurs, the issuer is
required to make public disclosure promptly. In this situation, because
the disclosure was unplanned, the Rule does not require simultaneous
public disclosure. Instead, the Rule requires ``prompt'' public
disclosure, with ``promptly'' defined to mean ``as soon as reasonably
practicable'' (but no later than 24 hours) after a senior official of
the issuer knows (or is reckless in not knowing) of the non-intentional
disclosure.\44\ ``Senior official'' is defined as any executive officer
of the issuer, any director of the issuer, any investor relations
officer or public relations officer, or any employee possessing
equivalent functions.\45\
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\44\ Proposed rule 101(d)(1). Although requirements for
``prompt'' disclosure exist elsewhere in the securities laws--e.g.,
the requirement that amendments to Schedules 13D be filed
``promptly''--Proposed Rule 101(d)(1) defines ``prompt'' disclosure
for purposes of Regulation FD. This definition is not meant to apply
in any other contexts.
\45\ See Proposed Rule 1010(d)(2). For closed-end investment
companies that are subject to Regulation FD, the term ``senior
official'' would also cover directors, officers, and employees of
the fund's investment adviser.
---------------------------------------------------------------------------
osure
for purposes of Regulation FD. This definition is not meant to apply
in any other contexts.
\45\ See Proposed Rule 1010(d)(2). For closed-end investment
companies that are subject to Regulation FD, the term ``senior
official'' would also cover directors, officers, and employees of
the fund's investment adviser.
---------------------------------------------------------------------------
By creating a separate requirement for ``prompt'' public disclosure
in the case of a non-intentional selective disclosure, the Rule
recognizes that corporate officers may sometimes make mistakes without
the intent to selectively disclose material nonpublic information. When
mistakes are made, absent intent or recklessness, we do not believe
that the issuer should be held in violation of Regulation FD for not
having made simultaneous public disclosure.\46\
---------------------------------------------------------------------------
\46\ Of course, a pattern of ``mistaken'' selective disclosures
would make less credible the claim that any particular disclosure
was not intentional.
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If, however, an inadvertent selective disclosure of material
information occurs, the issuer must take prompt ``corrective'' action
when it knows (or is reckless in not knowing) that the disclosure of
material information has occurred. The requirement to take corrective
action arises when a senior official of the issuer (as defined above)
becomes aware of the selective disclosure.\47\ When that occurs, the
issuer is required to act ``as soon as reasonably practicable'' to make
full public disclosure of the information that has been selectively
disclosed.\48\
---------------------------------------------------------------------------
rement to take corrective
action arises when a senior official of the issuer (as defined above)
becomes aware of the selective disclosure.\47\ When that occurs, the
issuer is required to act ``as soon as reasonably practicable'' to make
full public disclosure of the information that has been selectively
disclosed.\48\
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\47\ For example, a senior official may become aware of his
mistake when he sees a significant change in the market price and/or
trading volume of his company's securities. Alternatively, a senior
official might learn that a lower-level employee mistakenly
disclosed material information, because an analyst or investor who
received the information called the officer to confirm the
information.
\48\ Proposed Rule 101(d)(1) states that the required public
disclosure must be made no later than 24 hours after the issuer or a
senior official of the issuer knows (or is reckless in not knowing)
of the selective disclosure. The 24-hour period takes into account
the issuer's potential difficulty in making the disclosure any
sooner because of the need to marshal all the information necessary,
and reach the appropriate personnel. In other cased, however, the
issuer may well be able to make public disclosure before the maximum
allowable 24-hour disclosure period. In such cases, the requirement
to disclose ``as soon as reasonably practicable'' means that the
issuer should act sooner than 24 hours later.
---------------------------------------------------------------------------
sary,
and reach the appropriate personnel. In other cased, however, the
issuer may well be able to make public disclosure before the maximum
allowable 24-hour disclosure period. In such cases, the requirement
to disclose ``as soon as reasonably practicable'' means that the
issuer should act sooner than 24 hours later.
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We request comment on the distinction between ``intentional'' and
``non-intentional'' disclosures for purposes of the timing of public
disclosure. Does the proposed definition of ``intentional'' disclosure
draw the appropriate distinction? Does the definition of ``promptly''
provide an appropriate time period for the required public disclosure?
Should the time period be shorter (e.g., same trading day); or longer
(e.g., next business/trading day or 48 hours later)? Is the definition
of senior official appropriate, or should it be narrower (e.g.,
executive officers only) or broader (e.g., all employees)?
5. Definition of ``Public Disclosure''
Rule 101(e) defines the type of ``public disclosure'' that will
satisfy the requirements of the Regulation. This definition provides
issuers with considerable flexibility in determining how to make the
required public disclosure.
In general, the Rule states that issuers can comply with the
``public disclosure'' requirement by filing a Form 8-K with the
Commission containing the information (or, in the case of foreign
private issuers, by filing a Form 6-K).\49\ We are proposing to add a
new Item 10 to Form 8-K for disclosures made under Regulation FD.
Should we permit issuers to make Regulation FD disclosures on existing
Item 5 of Form 8-K as an alternative to proposed new Item 10? Item 5 is
not confined to material disclosures; accordingly, if a registrant used
Item 5 it would not acknowledge that the information disclosed was
necessarily material. Is this a preferable approach?
---------------------------------------------------------------------------
it issuers to make Regulation FD disclosures on existing
Item 5 of Form 8-K as an alternative to proposed new Item 10? Item 5 is
not confined to material disclosures; accordingly, if a registrant used
Item 5 it would not acknowledge that the information disclosed was
necessarily material. Is this a preferable approach?
---------------------------------------------------------------------------
\49\ Proposed Rule 101(e)(1).
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As alternatives to making a Commission filing, the Rule permits an
issuer to choose other methods of public disclosure. Under Rule
101(e)(2), an issuer will be exempt from the filing requirement if it
uses one of the following alternative methods of public disclosure:
First, an issuer could make public disclosure by
disseminating a press release containing the information through a
widely circulated news or wire service. Under current practice and SRO
rules, corporate issuers typically provide press releases to services
such as Dow Jones, Bloomberg, Business Wire, PR Newswire, or Reuters.
Any of these services would continue to be a satisfactory means of
making public disclosure.
Second, an issuer could make public disclosure by
disseminating information through any other method of disclosure that
is reasonably designed to provide broad public access, and does not
exclude access to members of the public--such as announcement at a
press conference to which the public is granted access (for example, by
personal attendance or by telephonic or electronic transmission). In
order to afford broad public access, an issuer must provide notice of
the disclosure in a form that is reasonably available to investors.
As noted above, current technology provides various means that
issuers can use to transmit announcements and press conferences to the
public
the public is granted access (for example, by
personal attendance or by telephonic or electronic transmission). In
order to afford broad public access, an issuer must provide notice of
the disclosure in a form that is reasonably available to investors.
As noted above, current technology provides various means that
issuers can use to transmit announcements and press conferences to the
public. The Rule would not require use of any particular technological
means, but would give issuers their choice of any method that did not
limit public access to announcements and conferences.
An additional method for issuer dissemination of material
information is posting the information on the issuer's website.\50\ We
encourage issuers who maintain websites to post information
on their websites whenever they make public disclosure through one of
the means described above. However, the proposed Rule would not
consider a website posting by itself to be a sufficient means of public
disclosure.\51\ Will this limitation make issuers less willing to post
information on their websites?
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\50\ See NIRI Corporate Disclosure Study, supra note 11, at 9,
21 (finding that 82% of responding issuers used their websites to
post disclosures of quarterly finanical results).
\51\ Despite the rapid expansion of Internet access, a
significant number of households do not have access. Moreover,
simply putting information on a website does not alert investors
that it is available.
---------------------------------------------------------------------------
1 (finding that 82% of responding issuers used their websites to
post disclosures of quarterly finanical results).
\51\ Despite the rapid expansion of Internet access, a
significant number of households do not have access. Moreover,
simply putting information on a website does not alert investors
that it is available.
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We request comment on the proposal's approach for making public
disclosure. We acknowledge that filings on EDGAR may only be made
during specified hours, and only on business days of the Commission. In
the case of filings permitted to be made in paper (as in the case of
foreign private issuers), there are similar constraints because of our
filing desk hours. Therefore, when an issuer is required to make public
disclosure within 24 hours, the timing of a weekend or holiday may mean
that EDGAR filing is not an available method of public disclosure.
Issuers would therefore have to use one of the other methods. We
solicit comment on whether this approach is workable, or whether we
should alter the timing requirements of the Rule so that filing is
always an available method. How else can we promote issuer flexibility
and investor access?
We are also considering whether to require a delayed filing of a
Form 8-K (within two business days) when an issuer chooses one of the
other methods of making public disclosure. This would ensure that the
information is part of the Commission's public files
g requirements of the Rule so that filing is
always an available method. How else can we promote issuer flexibility
and investor access?
We are also considering whether to require a delayed filing of a
Form 8-K (within two business days) when an issuer chooses one of the
other methods of making public disclosure. This would ensure that the
information is part of the Commission's public files. Should we adopt
this alternative approach? If so, is two business days the appropriate
time period, or should it be shorter (e.g., one business day) or longer
(e.g., five business days)?
Are the current technologies that we discuss available to all
issuers? Are they prohibitively costly? Would they provide all
investors with sufficient access? Are there other methods of public
disclosure that might be as effective as a press release or an open
press conference? Should these methods be specified in the Rule? Would
an open press conference alone provide adequate dissemination of
information in all circumstances (e.g., for smaller companies with less
media or analyst coverage)? Should we require that information be
posted on an issuer's website, if it has one, in addition to the other
methods of publicizing the information?
6. Issuers Covered by the Regulation
Regulation FD would apply to all issuers with securities registered
under Section 12 of the Exchange Act, and all issuers required to file
reports under Section 15(d) of the Exchange Act, including closed-end
investment companies but not including other investment companies
te, if it has one, in addition to the other
methods of publicizing the information?
6. Issuers Covered by the Regulation
Regulation FD would apply to all issuers with securities registered
under Section 12 of the Exchange Act, and all issuers required to file
reports under Section 15(d) of the Exchange Act, including closed-end
investment companies but not including other investment companies. Are
there any categories of issuers that should not be included? Should we
have different and/or modified rules for small business issuers? If so,
what modifications are warranted?
We are proposing to apply Regulation FD to foreign private issuers
that are subject to the reporting requirements of the Exchange Act,
although these foreign issuers would be permitted to make filings under
the Regulation on Form 6-K rather than Form 8-K.\52\ The vast majority
of these issuers have subjected themselves to such reporting
requirements by their election to access U.S. markets. Most of the
issuers have a class of securities listed on the New York or American
Stock Exchanges, or are admitted to trading on the Nasdaq Stock Market.
The listing standards of these markets make no distinction between
domestic and foreign issuers in requiring timely disclosure of material
information.\53\
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\52\ As is the case currently, Form 6-K used to mkae Regulation
FD disclosure would not be deemed to be ``filed'' for purposes of
Section 18 of the Exchange Act or subject to liability under that
section.
\53\ See supra note 10.
---------------------------------------------------------------------------
ormation.\53\
---------------------------------------------------------------------------
\52\ As is the case currently, Form 6-K used to mkae Regulation
FD disclosure would not be deemed to be ``filed'' for purposes of
Section 18 of the Exchange Act or subject to liability under that
section.
\53\ See supra note 10.
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The content and timing of submissions on Form 6-K currently are
based on a foreign private issuer's disclosure obligations and
practices in its home jurisdiction and in any other jurisdiction where
its securities are listed. We recognize that this Rule proposes for the
first time to add a substantive disclosure requirement to Form 6-K,
thereby changing the fundamental character of the form. We understand
that some foreign issuers may view Regulation FD as requiring a change
in what they consider to be normal communications with major
shareholders, analysts, the press, labor unions, and other
constituencies. In many cases, the disclosure requirements of
Regulation FD also will impose a translation requirement on the
information disclosed to the public and/or filed on Form 6-K. On the
other hand, the benefits of the proposal to shareholders in all
markets, not just the U.S. capital markets, may warrant the additional
steps required of foreign issuers.
Regulation FD permits issuers to use other means for publicly
disseminating non-intentional selective disclosures as alternatives to
Forms 8-K or 6-K. Under current Form 6-K requirements, however, foreign
private issuers are required to submit a Form 6-K containing any
material information that is disseminated publicly, promptly after the
dissemination. As proposed, foreign private issuers would not have to
file a Form 6-K if they use one of the alternative means of disclosure
permitted by Regulation FD.
We note that Forms 6-K are not currently required to be filed on
EDGAR, which may impede investor access to information
o submit a Form 6-K containing any
material information that is disseminated publicly, promptly after the
dissemination. As proposed, foreign private issuers would not have to
file a Form 6-K if they use one of the alternative means of disclosure
permitted by Regulation FD.
We note that Forms 6-K are not currently required to be filed on
EDGAR, which may impede investor access to information. Does this
limitation make the requirement to file on Form 6-K less useful? If so,
how should we address this issue?
We request comment on the proposed coverage of Regulation FD. Would
it be appropriate to exempt all foreign private issuers from compliance
with Regulation FD? If so, what would be the basis for this exemption
and how would we address the impact on U.S. investors of having
different requirements for selective disclosures by U.S. issuers and
foreign private issuers? Would it be more appropriate to limit the
application of Regulation FD to only certain foreign private issuers,
such as those issuers with equity securities listed on a registered
national securities exchange or the Nasdaq Stock Market National Market
System, or foreign private issuers whose number of U.S. shareholders or
volume of trading in our capital markets exceeds certain levels? If so,
what levels should trigger the application of Regulation FD? Are there
other ways the proposal could be modified to reduce the burden on
foreign private issuers? Should foreign and domestic issuers be treated
similarly with respect to the application of Section 18 to Regulation
FD disclosure?
We are proposing to apply Regulation FD to closed-end investment
companies, but not other types of investment companies
trigger the application of Regulation FD? Are there
other ways the proposal could be modified to reduce the burden on
foreign private issuers? Should foreign and domestic issuers be treated
similarly with respect to the application of Section 18 to Regulation
FD disclosure?
We are proposing to apply Regulation FD to closed-end investment
companies, but not other types of investment companies. Investment
companies that are continually offering their securities to the public
already are required to update their prospectuses to disclose material
changes subsequent to the effective date of the registration statement
or any post-effective amendment, and are not permitted to sell, redeem,
or repurchase their securities except at a price based on their
securities' net asset value. While we believe that Regulation FD would
offer little additional protection to investors in these types of
investment companies and therefore they should be excluded from its
coverage, these considerations do not apply in the case of closed-end
investment companies.
We are thus proposing to include closed-end investment companies within
the requirements of Regulation FD.
At present, no form used by registered closed-end investment
companies is equivalent to Form 8-K. In order to provide closed-end
investment companies with the same disclosure options under Regulation
FD available to operating companies, we propose to permit registered
closed-end investment companies to file on Form 8-K for the sole
purpose of making the public disclosure required by Regulation FD. The
Commission does not intend by this rule proposal to otherwise require
registered investment companies to file on Form 8-K.\54\
---------------------------------------------------------------------------
e to operating companies, we propose to permit registered
closed-end investment companies to file on Form 8-K for the sole
purpose of making the public disclosure required by Regulation FD. The
Commission does not intend by this rule proposal to otherwise require
registered investment companies to file on Form 8-K.\54\
---------------------------------------------------------------------------
\54\ Business development companies (``BDCs''), a category of
closed-end investment companies not required to register under the
Investment Company Act, are already required to file reports on Form
8-K. Under this proposal, BDCs would continue to be subject to Form
8-K filing obligations, including those imposed by Regulation FD.
---------------------------------------------------------------------------
We request comment on whether any investment companies should be
covered by Regulation FD, and if so, which types of investment
companies should be covered. Commenters should address whether there
are specific types of information relating to investment companies that
could be the subject of problematic selective disclosure (e.g., the
impending departure of a portfolio manager who is primarily responsible
for day-to-day management of the fund, or information relating to the
fund's portfolio investments). We also request comment on whether it is
appropriate for closed-end investment companies to file on Form 8-K for
purposes of making disclosure under Regulation FD, and whether there
should be a separate Item 11 for closed-end investment companies making
disclosure on Form 8-K, so that members of the public can easily
distinguish filings by closed-end investment companies from those of
operating companies. Commenters that oppose the use of Form 8-K by
closed-end investment companies should discuss other methods for
obtaining equivalent disclosure from those companies.
7
should be a separate Item 11 for closed-end investment companies making
disclosure on Form 8-K, so that members of the public can easily
distinguish filings by closed-end investment companies from those of
operating companies. Commenters that oppose the use of Form 8-K by
closed-end investment companies should discuss other methods for
obtaining equivalent disclosure from those companies.
7. Liability Issues and Securities Act Implications
Regulation FD is an issuer disclosure rule that is designed to
create duties only under Sections 13(a) and 15(d) of the Exchange Act
and Section 30 of the Investment Company Act. It is not an antifraud
rule, and unlike other Section 13(a) and 15(d) reporting requirements,
it is not intended to create duties under Section 10(b) of the Exchange
Act or any other provision of the federal securities laws. As a result,
no private liability will arise from an issuer's failure to file or
make public disclosure.\55\
---------------------------------------------------------------------------
\55\ Courts have held that there is no implied private right of
action under Section 13(a) of the Exchange Act. Lamb v. Phillip
Morris, Inc., 915 F.2d 1024 (6th Cir. 1990), cert. denied, 498 U.S.
1086 (1991); J.S. Service Center Corp. v. General Electric Technical
Services Co., 937 F. Supp. 216 (S.D.N.Y. 1996).
---------------------------------------------------------------------------
-----
\55\ Courts have held that there is no implied private right of
action under Section 13(a) of the Exchange Act. Lamb v. Phillip
Morris, Inc., 915 F.2d 1024 (6th Cir. 1990), cert. denied, 498 U.S.
1086 (1991); J.S. Service Center Corp. v. General Electric Technical
Services Co., 937 F. Supp. 216 (S.D.N.Y. 1996).
---------------------------------------------------------------------------
If an issuer fails to comply with Regulation FD, however, it will
be subject to an SEC enforcement action.\56\ We could bring an
administrative action seeking a cease and desist order, or a civil
action seeking an injunction and/or civil money penalties.\57\ In
appropriate cases, we could also bring an enforcement action against
the individual(s) at the issuer responsible for the violation, either
as ``a cause of'' the violation in a cease and desist proceeding,\58\
or as an aider and abetter of the violation in an injunctive
action.\59\
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\56\ In addition, eligibility to file on a number of ``short-
form'' Securities Act registration statements requires, in part,
that the registrant be timely in filing its Exchange Act reports.
The obligation to be timely in these filings includes the filing of
a required Form 8-K. As such, any required Form 8-K filing under
proposed Item 10 would have to be made in a timely manner for the
registrant to be eligible to file such a short-form registration
statement. If, under today's proposals, the registrant would not be
required to file under Item 10 of Form 8-K because it uses an
alternative means of public dissemination, the failure to file an
Item 10 Form 8-K would not affect that registrant's form
eligibility.
\57\ Regulation FD does not expressly require insurers to adopt
policies and procedures to avoid violations, but we expect that most
issuers will consider implementing appropriate disclosure policies
to guard against selective disclosure
because it uses an
alternative means of public dissemination, the failure to file an
Item 10 Form 8-K would not affect that registrant's form
eligibility.
\57\ Regulation FD does not expressly require insurers to adopt
policies and procedures to avoid violations, but we expect that most
issuers will consider implementing appropriate disclosure policies
to guard against selective disclosure. We are aware that many, if
not most, issuers already have policies and procedures regarding
disclosure practices, the dissemination of material information, and
the question of which issuer personnel are authorized to speak to
analysts, the media, or investors. The existence of this type of
policy, and the issuer's general adherence to it, may often be
relevant to determining the issuer's intent with regard to a
selective disclosure.
\58\ Section 21C of the Exchange Act, 15 U.S.C. 78u-3.
\59\ Section 20(e) of the Exchange Act, 15 U.S.C. 78t(e).
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In addition, Regulation FD does not affect or undermine any
existing bases of liability under Rule 10b-5. Thus, for example,
liability for ``tipping'' under Rule 10b-5 may still exist if a
selective disclosure is made in circumstances that meet the Dirks
``personal benefit'' test.\60\ In addition, an issuer's failure to make
a public disclosure still may give rise to liability under a ``duty to
correct'' or ``duty to update'' theory in certain circumstances.\61\
And in other cases, an issuer's contacts with analysts may lead to
liability under the ``entanglement'' or ``adoption'' theories.\62\
---------------------------------------------------------------------------
.\60\ In addition, an issuer's failure to make
a public disclosure still may give rise to liability under a ``duty to
correct'' or ``duty to update'' theory in certain circumstances.\61\
And in other cases, an issuer's contacts with analysts may lead to
liability under the ``entanglement'' or ``adoption'' theories.\62\
---------------------------------------------------------------------------
\60\ See SEC v. Phillip J. Stevens, supra note 17.
\61\ See generally Backman v. Polaroid Corp., 910 F.2d 10 (1st
Cir. 1990); In re Phillips Petroleum Sec. Litig. 881 F.2d 1236 (3rd
Cir. 1989).
\62\ See, e.g., Elkind v. Ligget & Myers, Inc., 635 F.2d 156 (2d
Cir. 1980); In the Matter of Presstek, Inc. Exchange Act Release No.
39472 (Dec. 22, 1997).
---------------------------------------------------------------------------
Moreover, if an issuer's filing or public disclosure made under
Regulation FD contained false or misleading information, or omitted
material information, the issuer could incur liability for those
misstatements or omissions. Rule 10b-5 would apply to any materially
false or misleading statements made to the public, and if an issuer had
filed a Form 8-K containing false or misleading information, Section 18
of the Exchange Act \63\ would apply as well. If a Form 8-K filed under
Regulation FD was required to be incorporated into an issuer's
registration statement, it would be subject to liability under Section
11 of the Securities Act.\64\ If the public disclosure is not filed on
a Form 8-K, it may nevertheless be subject to Section 11 liability if
the information is otherwise required to be included in a registration
statement subject to Section 11.
---------------------------------------------------------------------------
\63\ 15 U.S.C. 78r.
\64\ 15 U.S.C. 77k. This proposal is not intended to change
existing liability for forms incorporated by reference.
---------------------------------------------------------------------------
if
the information is otherwise required to be included in a registration
statement subject to Section 11.
---------------------------------------------------------------------------
\63\ 15 U.S.C. 78r.
\64\ 15 U.S.C. 77k. This proposal is not intended to change
existing liability for forms incorporated by reference.
---------------------------------------------------------------------------
As noted above, Regulation FD applies only to issuers that have
securities registered under Section 12 of the Exchange Act or that are
required to file reports under Section 15(d) of that Act. Accordingly,
the Regulation would not apply during an issuer's initial public
offering (IPO) of its securities prior to effectiveness of the
registration statement.\65\
---------------------------------------------------------------------------
\65\ After the registration statement for the IPO becomes
effective, however, and the issuer becomes subject to Section 15(d)
of the Exchange Act, it would be subject to Regulation FD.
---------------------------------------------------------------------------
The proposed Regulation would, however, apply to disclosures made
by reporting issuers while they have pending registration statements
for securities offerings. For example, the Regulation would apply to
statements made in a ``roadshow'' for a reporting issuer's offering. In
that situation, if an issuer made oral selective disclosure of material
information, Regulation FD would require the issuer also to make public
disclosure of the same information. This would be a departure from
current distinctions in the Securities Act between oral and written
communications around the time of an offering.\66\
---------------------------------------------------------------------------
\66\ Our staff is currently engaged in a more comprehensive
review of the regulatory issues raised by ``roadshows.''
---------------------------------------------------------------------------
re from
current distinctions in the Securities Act between oral and written
communications around the time of an offering.\66\
---------------------------------------------------------------------------
\66\ Our staff is currently engaged in a more comprehensive
review of the regulatory issues raised by ``roadshows.''
---------------------------------------------------------------------------
The required public disclosure could also be considered an
``offer'' of the securities for purposes of Section 5 of
that Act,\67\ and when made by writing or broadcast could be considered
a ``prospectus'' for purposes of section 2(a)(10) of the Act.\68\ This
creates the possibility that an issuer may violate sections 5(c) or
5(b)(1) of the Securities Act by making the public disclosures required
by Regulation FD.
---------------------------------------------------------------------------
\67\ 15 U.S.C. 77e.
\68\ 15 U.S.C. 77b(a)(10).
---------------------------------------------------------------------------
To permit an issuer that has already filed a registration statement
to make the required public disclosure without violating section
5(b)(1) of the Securities Act, we are proposing new Rule 181 under the
Securities Act. Under this Rule, any public disclosure required by Rule
100(a) of Regulation FD would not be required to satisfy the
requirements of section 10 of the Securities Act \69\ for a prospectus,
as long as the disclosure was made in compliance with Regulation FD. We
request comment on whether this Rule should apply only to non-
intentional disclosures. Should we place other conditions on the use of
this Rule--for example, requiring the material information to be
included in the registration statement at the time it is declared
effective?
---------------------------------------------------------------------------
\69\ 15 U.S.C. 77j.
---------------------------------------------------------------------------
y to non-
intentional disclosures. Should we place other conditions on the use of
this Rule--for example, requiring the material information to be
included in the registration statement at the time it is declared
effective?
---------------------------------------------------------------------------
\69\ 15 U.S.C. 77j.
---------------------------------------------------------------------------
A more difficult situation arises when a reporting company is
planning an offering, but has not yet filed a registration statement. A
company may find itself in the position of being required by Regulation
FD to disclose to the public information which could constitute an
``offer'' of its securities prior to the filing of a registration
statement, contrary to section 5(c). While companies are not supposed
to make offers to anyone prior to filing a registration statement, an
inadvertent disclosure of material nonpublic information to one person
could result in an obligation to disclose information to the public,
thus resulting in offers being made to many persons. If the company
complies with the Regulation FD requirement in that situation, its
disclosure would violate section 5(c), and subject it to liability
under section 12(a)(1) if it proceeds with its offering. The public
disclosure also could constitute a general solicitation and therefore
preclude the company from undertaking a private exempt offering.
If the Commission were to adopt an exemption from section 5(c) for
Regulation FD-required disclosure, however, companies could abuse that
exemption to make public communications that hype an offering before
filing a registration statement with the Commission. In that event, the
balanced full disclosure, against which to test the hyping information,
would not be available. The protections of section 5 could thus be
eroded
t an exemption from section 5(c) for
Regulation FD-required disclosure, however, companies could abuse that
exemption to make public communications that hype an offering before
filing a registration statement with the Commission. In that event, the
balanced full disclosure, against which to test the hyping information,
would not be available. The protections of section 5 could thus be
eroded. While we have published proposals that, if adopted, would allow
offers to be made prior to the filing of a registration statement in
some offerings, those proposals did not extend to offerings by
unseasoned companies to less sophisticated investors.\70\ We proposed
to retain the pre-filing prohibition on offers in those cases because
of the continued need for this aspect of investor protection.
---------------------------------------------------------------------------
\70\ The Regulation of Securities Offerings, Securities Act
Release No. 7606A (Nov. 13, 1998) (63 FR 67174). As discussed below,
we also have adopted rules that allow offers in the business
combination context to be made before filing a registration
statement.
---------------------------------------------------------------------------
We request comment on whether we should also adopt an exemption
from liability under section 5(c) of the Securities Act for
communications made before the filing of a registration statement. If
we do so, should the exemption apply only to non-intentional
disclosures? Do the same reasons for providing a section 5(b)(1)
exemption also apply to section 5(c), either for all issuers, or for
offerings made by very large issuers or to more sophisticated
investors? Or could a section 5(c) exemption provide issuers with such
freedom to make public disclosures prior to filing a registration
statement that issuers could engage in the hyping of an offering that
Section 5(c) is designed to prevent?
With respect to the interplay between Regulation FD and the
Securities Act, we request comment on the proposed appr
e issuers or to more sophisticated
investors? Or could a section 5(c) exemption provide issuers with such
freedom to make public disclosures prior to filing a registration
statement that issuers could engage in the hyping of an offering that
Section 5(c) is designed to prevent?
With respect to the interplay between Regulation FD and the
Securities Act, we request comment on the proposed approach described
above. Should the Regulation also apply to issuers engaged in IPOs?
Alternatively, given the liability questions under the Securities Act
for these disclosures and the pending proposals in the Securities Act
Reform release, should the Regulation not cover communications made as
part of securities offerings under the Securities Act?
In our recent release on business combinations,\71\ we adopted non-
exclusive exemptions under the Securities Act, proxy rules, and tender
offer rules that permit communications with respect to business
combinations \72\ for an unrestricted length of time without a cooling-
off period between the end of communications and the filing of
definitive disclosure documents. Those communication exemptions apply
regardless of materiality, so long as the conditions to the exemption
are satisfied. All written communications must be filed on the date of
first use. Those communications must contain a prominent legend
advising investors to read the registration, proxy, or tender offer
statement, as applicable, when it becomes available. Under those rules,
oral statements are not required to be reduced to writing and filed.
---------------------------------------------------------------------------
\71\ Regulation of Takeovers and Security Holder Communications,
Securities Act Release No. 7760 (Oct. 22, 1999) (64 FR 61408)
(effective date Jan. 24, 2000).
\72\ The proxy rule amendments are not limited to communications
concerning business combinations.
---------------------------------------------------------------------------
------------------------------------------------------------
\71\ Regulation of Takeovers and Security Holder Communications,
Securities Act Release No. 7760 (Oct. 22, 1999) (64 FR 61408)
(effective date Jan. 24, 2000).
\72\ The proxy rule amendments are not limited to communications
concerning business combinations.
---------------------------------------------------------------------------
Proposed Regulation FD would impose requirements on material
communications, written and oral, that are in addition to the filing
and legend requirements of the new business combination rules. Any
material information disclosed to the public, whether oral or written,
would be required to be publicly disseminated by filing, press
conference, news release, or otherwise.\73\ Issuers may use
confidentiality agreements to protect communications in the context of
business combinations or other transactions which the issuers expressly
mean to reserve from public disclosure. Early discussions among parties
negotiating a transaction that are subject to confidentiality
agreements among the parties and are kept confidential generally would
not be subject to disclosure requirements of Regulation FD or the
communications exemptions. Similarly, discussions between a party to a
transaction and a security holder regarding a possible ``lock-up'' or
other agreement generally would not be subject to these requirements so
long as a confidentiality agreement is in effect.
---------------------------------------------------------------------------
\73\ Written information must be disseminated by filing in order
to satisfy the communication exemptions. A news release or other
means of dissemination would not meet the requirements of the
business combination rules.
---------------------------------------------------------------------------
agreement is in effect.
---------------------------------------------------------------------------
\73\ Written information must be disseminated by filing in order
to satisfy the communication exemptions. A news release or other
means of dissemination would not meet the requirements of the
business combination rules.
---------------------------------------------------------------------------
Under current practice, parties negotiating a transaction do not
always enter a confidentiality agreement, so Regulation FD may effect a
change to current practice. Does this provide a practicable solution
for parties seeking to negotiate transactions or to discuss ``lock-
ups''?
III. Insider Trading Issues
The prohibitions against insider trading in our securities laws
play an essential role in maintaining the fairness, health, and
integrity of our markets. We have long recognized that the fundamental
unfairness of insider trading harms not only individual investors, but
also the very foundations of our markets, by undermining investor
confidence in the integrity of the markets. Congress, by enacting two
separate laws providing enhanced
penalties for insider trading,\74\ has expressed its strong support for
our insider trading enforcement program. And the Supreme Court in
United States v. O'Hagan has recently endorsed a key component of
insider trading law, the ``misappropriation'' theory, as consistent
with ``an animating purpose'' of the federal securities laws: ``to
insure honest securities markets and thereby promote investor
confidence.'' \75\
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\74\ Insider Trading Sanctions Act of 1984, Pub. L. No. 98-376,
98 Stat. 1264; Insider Trading and Securities Fraud Enforcement Act
of 1988, Pub. L. No. 100-704, 102 Stat. 4677.
\75\ O'Hagan, 521 U.S. at 658.
---------------------------------------------------------------------------
omote investor
confidence.'' \75\
---------------------------------------------------------------------------
\74\ Insider Trading Sanctions Act of 1984, Pub. L. No. 98-376,
98 Stat. 1264; Insider Trading and Securities Fraud Enforcement Act
of 1988, Pub. L. No. 100-704, 102 Stat. 4677.
\75\ O'Hagan, 521 U.S. at 658.
---------------------------------------------------------------------------
Neither we nor Congress have expressly defined insider trading in a
statute or rule. Instead, insider trading law has developed on a case-
by-case basis under the antifraud provisions of the federal securities
laws, primarily Section 10(b) of the Exchange Act and Rule 10b-5. As a
result, from time to time there have been issues on which various
courts have disagreed. With the Supreme Court's O'Hagan decision, the
fundamental issues in insider trading law are now settled. Today's
proposals address two issues on which disagreement remains.
A. Rule 10b5-1: Trading ``On the Basis of'' Material Nonpublic
Information
1. Background
One unsettled issue in insider trading has been what, if any,
causal connection must be shown between the trader's possession of
inside information and his or her trading. In enforcement cases, we
have argued that a trader may be liable for trading while in ``knowing
possession'' of the information. The contrary view is that a trader
will not be liable unless it is shown that he or she ``used'' the
information for trading.
Until recent years, there has been little case law discussing this
issue. Although the Supreme Court has variously described an insider's
violations as involving trading ``on'' \76\ or ``on the basis of'' \77\
material nonpublic information, it has not addressed the use/possession
issue. Three recent court of appeals cases address the issue, but have
reached different results.
---------------------------------------------------------------------------
g this
issue. Although the Supreme Court has variously described an insider's
violations as involving trading ``on'' \76\ or ``on the basis of'' \77\
material nonpublic information, it has not addressed the use/possession
issue. Three recent court of appeals cases address the issue, but have
reached different results.
---------------------------------------------------------------------------
\76\ See Dirks, 463 U.S. at 654.
\77\ See O'Hagan, 521 U.S. at 651-52.
---------------------------------------------------------------------------
The three court of appeals cases recognize the practical difficulty
of divorcing a trader's knowing possession, or awareness, of inside
information from its ``use'' in a trade. In United States v.
Teicher,\78\ the Second Circuit suggested that ``knowing possession''
is sufficient to trigger insider trading liability, for precisely this
reason.\79\ In SEC v. Adler, the Eleventh Circuit held that ``use'' was
the ultimate issue, but that proof of ``possession'' provides a
``strong inference'' of ``use'' that suffices to make out a prima facie
case.\80\ In United States v. Smith, the Ninth Circuit required that
``use'' be proven in a criminal case.\81\
---------------------------------------------------------------------------
\78\ 987 F.2d 112 (2d Cir), cert. denied, 510 U.S. 976 (1993).
\79\ Teicher was a criminal case premised on the
misappropriation theory of insider trading. The court reasoned, in
dicta, that the simplicity of a ``knowing possession'' standard
recognizes the informational advantage that a trader with inside
information has over other traders. ``Unlike a loaded weapon which
may stand ready but unused, material information can not lay idle in
the human brain.'' Id. at 120.
\80\ 137 F.3d 1325 (11th Cir. 1998). Adler was a civil action
under ``classical'' insider trading theory
that the simplicity of a ``knowing possession'' standard
recognizes the informational advantage that a trader with inside
information has over other traders. ``Unlike a loaded weapon which
may stand ready but unused, material information can not lay idle in
the human brain.'' Id. at 120.
\80\ 137 F.3d 1325 (11th Cir. 1998). Adler was a civil action
under ``classical'' insider trading theory. The court stated that
trading while ``in possession of'' the material nonpublic
information gives rise to a ``strong inference'' that the defendant
``used'' the information in trading, thereby allowing the Commission
to establish a prima facie case based on possession of the
information. The court reasoned that this inference addresses the
Commission's proof difficulties by allowing the Commission to make
out a prima facie case without establishing direct proof of a causal
connection between possession of the information and its use. Id. at
1337-38. The defendant, however, has the opportunity to rebut this
inference by introducing evidence to establish that the information
was not used in making the trade. It is left to the fact finder to
weigh the evidence to determine whether the information was used.
Id. at 1337.
\81\ 155 F.3d 1051 (9th Cir. 1998), cert. denied, 119 S. Ct. 804
(1999). Smith was a criminal case under ``classical'' insider
trading theory. The court expressed no view on whether the Adler
presumption could be permitted in a civil enforcement case. Id. at
1069 & n.27.
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whether the information was used.
Id. at 1337.
\81\ 155 F.3d 1051 (9th Cir. 1998), cert. denied, 119 S. Ct. 804
(1999). Smith was a criminal case under ``classical'' insider
trading theory. The court expressed no view on whether the Adler
presumption could be permitted in a civil enforcement case. Id. at
1069 & n.27.
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The Adler court suggested that we could adopt a new rule or amend
existing Rule 10b-5 to adopt a presumption approach or to provide for
liability for trading while in ``knowing possession'' of material
nonpublic information.\82\ In view of the differing opinions expressed
in the three cases discussed above, we agree that it would be useful to
define the scope of Rule 10b-5, as it applies to the use/possession
issue.
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\82\ ``We note that if experience shows that this approach
unduly frustrates the SEC's enforcement efforts, the SEC could
promulgate a rule adopting the knowing possession standard, as the
SEC has done in the context of tender offers * * * or a rule
adopting a presumption approach in which proof that an insider
traded while in possession of material nonpublic information would
shift the burden of persuasion on the use issue to the insider.''
Adler, 137 F.3d at 1337 n.33 (citation omitted).
---------------------------------------------------------------------------
ndard, as the
SEC has done in the context of tender offers * * * or a rule
adopting a presumption approach in which proof that an insider
traded while in possession of material nonpublic information would
shift the burden of persuasion on the use issue to the insider.''
Adler, 137 F.3d at 1337 n.33 (citation omitted).
---------------------------------------------------------------------------
In our view, the goals of insider trading prohibitions--protecting
investors and the integrity of securities markets--are best
accomplished by a standard closer to the ``knowing possession''
standard. Whenever a person purchases or sells a security while aware
of material nonpublic information that has been improperly obtained,
that person has the type of unfair informational advantage over other
participants in the market that insider trading law is designed to
prevent.\83\ As a practical matter, in most situations it is highly
doubtful that a person who knows inside information relevant to the
value of a security can completely disregard that knowledge when making
the decision to purchase or sell that security. In the words of the
Second Circuit, ``material information can not lay idle in the human
brain.'' \84\ Indeed, even if the trader could put forth purported
reasons for trading other than awareness of the inside information,
other traders in the market place would clearly perceive him or her to
possess an unfair advantage.
---------------------------------------------------------------------------
he words of the
Second Circuit, ``material information can not lay idle in the human
brain.'' \84\ Indeed, even if the trader could put forth purported
reasons for trading other than awareness of the inside information,
other traders in the market place would clearly perceive him or her to
possess an unfair advantage.
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\83\ Under the classical theory, there is an additional argument
why trading in ``possession'' of inside information is fraudulent. A
``classical'' insider has a fiduciary duty to the corporation's
shareholders. The insider violates this duty, and thereby commits
fraud, if he or she trades in the company's securities while in
possession of inside information without disclosing the information
to the other party. The insider violates this duty regardless of
whether he or she ``uses'' the insider information. See Brief of the
Securities and Exchange Commission at 22-24, SEC v. Soroosh (9th
Cir. 1998) (No. 98-35006); Brief of the Securities and Exchange
Commission at 18, SEC v. Adler (11th Cir. 1997) (No. 96-6084).
\84\ Teicher, 987 F.2d at 120.
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On the other hand, we recognize that an absolute standard based on
knowing possession, or awareness, could be overbroad in some respects.
Sometimes a person may reach a decision to make a particular trade
without any awareness of material nonpublic information, but then come
into possession of such information before the trade actually takes
place. A rigid ``knowing possession'' standard would lead to liability
in that case. We believe, however, that for many cases of this type, a
reasonable standard would not make such trading automatically illegal
reach a decision to make a particular trade
without any awareness of material nonpublic information, but then come
into possession of such information before the trade actually takes
place. A rigid ``knowing possession'' standard would lead to liability
in that case. We believe, however, that for many cases of this type, a
reasonable standard would not make such trading automatically illegal.
The Adler case attempted to balance these considerations by means
of a ``use'' test with a strong inference of use from ``possession.''
We propose a somewhat different approach today: A general rule based on
``awareness'' of the material nonpublic information, with several
carefully enumerated exceptions. We believe our proposed Rule would
lead to the same outcome as Adler in almost all insider trading cases,
but will provide greater clarity and certainty than a presumption or
``strong inference'' approach. Our proposed approach will better enable
insiders and issuers to conduct themselves in accordance with the law.
2. Proposed Rule 10b5-1
Proposed Rule 10b5-1 is designed to address only the use/possession
issue in insider trading cases under Rule 10b-5.
As the Preliminary Note states, the Rule does not modify or address any
other aspect of insider trading law, which has been established by case
law under Rule 10b-5.
Paragraph (a) sets forth the general prohibition of insider trading
contained in existing case law
Rule 10b5-1
Proposed Rule 10b5-1 is designed to address only the use/possession
issue in insider trading cases under Rule 10b-5.
As the Preliminary Note states, the Rule does not modify or address any
other aspect of insider trading law, which has been established by case
law under Rule 10b-5.
Paragraph (a) sets forth the general prohibition of insider trading
contained in existing case law. Under existing law, it is illegal to
trade a security ``on the basis of material nonpublic information about
that security or issuer, in breach of a duty of trust or confidence
that is owed directly, indirectly, or derivatively, to the issuer of
that security or the shareholders of that issuer, or to any other
person who is the source of the material nonpublic information.'' \85\
This language incorporates all theories of insider trading liability
under the case law--classical insider trading, temporary insider
theory, tippee liability, and trading by someone who misappropriated
the inside information.\86\
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\85\ Proposed Rule 10b5-1(a).
\86\ See United States v. O'Hagan, 521 U.S. 642 (1997); Dirks v.
SEC, 463 U.S. 646 (1983); Chiarella v. United States, 445 U.S. 222
(1980). In O'Hagan, the Supreme Court recognized that under the
misappropriation theory of insider trading liability, the fraud is
consummated when the defendant, without proper disclosure to the
source, ``uses the information to purchase or sell securities.''
Proposed Rule 10b5-1 is consistent with this view in that it
provides for no liability when a trader can meet one of the stated
defenses in paragraph (c) demonstrating lack of use.
---------------------------------------------------------------------------
fraud is
consummated when the defendant, without proper disclosure to the
source, ``uses the information to purchase or sell securities.''
Proposed Rule 10b5-1 is consistent with this view in that it
provides for no liability when a trader can meet one of the stated
defenses in paragraph (c) demonstrating lack of use.
---------------------------------------------------------------------------
Paragraph (b) defines trading ``on the basis of'' material
nonpublic information. A trade is on the basis of material nonpublic
information if the trader ``was aware of'' the information when he or
she made the purchase or sale. Thus, the general rule is that
``awareness'' of the inside information inevitably leads to use of the
information, and provides a sufficient basis for liability.
Paragraph (c) provides specific affirmative defenses against
liability. A purchase or sale is not ``on the basis of'' information
when a person can establish that one of four exclusive situations is
true. These four defenses cover situations in which a person can show
that the information he or she possessed was not a factor in the
trading decision.
First, an affirmative defense is available if, before becoming
aware of material nonpublic information, a person had entered into ``a
binding contract'' to trade ``in the amount'' and ``at the price'' and
on the date at which he or she ultimately traded.\87\ This defense
permits persons to carry out pre-existing contracts to purchase or sell
a specified number (or dollar amount) of shares of a particular
security at a specified price (or at the market price), as long as the
person was not aware of material nonpublic information when he or she
entered into the contract.\88\
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his defense
permits persons to carry out pre-existing contracts to purchase or sell
a specified number (or dollar amount) of shares of a particular
security at a specified price (or at the market price), as long as the
person was not aware of material nonpublic information when he or she
entered into the contract.\88\
---------------------------------------------------------------------------
\87\ Proposed para. (c)(1)(i)(A).
\88\ Proposed para. (c)(1)(iii) defines the terms ``[i]n the
amount(s)'' and ``[a]t the price(s)'' for purposes of all of
paragraph (c)(1)(i)'s affirmative defenses. These definitions are
designed to ensure that a contract, plan, or instruction is
sufficiently defined to foreclose the use of any inside information
of which the person later becomes aware. A trade specified ``in an
amount'' must specify either the number of securities to be traded
or the total monetary proceeds to be realized from or spent on the
securities to be traded. Thus, a person could plan a sale of, for
example, either 1,000 shares or $10,000 worth of stock; however, the
person could not plan a trade within a range--for example, a sale of
between 1,000 and 2,000 shares. The term ``at the price(s)''
includes a purchase or sale at the market price for a particular
date. Therefore, persons would not be required to commit to trading
at a particular price, but could merely contract, plan, or provide
instructions to trade at the market price on the date of the trade.
Under the Rule, a defense would not be available for a contract,
plan, or instruction to trade that used a limit order. By using a
limit order, the person would not firmly be committing to make a
trade, because if the market price at the relevant date exceeded the
limit order price, the trade would not be made. We request comment
on whether this restriction on the use of limit orders is necessary.
---------------------------------------------------------------------------
ction to trade that used a limit order. By using a
limit order, the person would not firmly be committing to make a
trade, because if the market price at the relevant date exceeded the
limit order price, the trade would not be made. We request comment
on whether this restriction on the use of limit orders is necessary.
---------------------------------------------------------------------------
Second, an affirmative defense is similarly available if, before
becoming aware of material nonpublic information, a person ``had
provided instructions to another person to execute'' a trade for the
instructing person's account, ``in the amount, at the price, and on the
date'' at which that trade was ultimately executed.\89\ This defense
would apply, for example, to an insider who instructs his or her broker
to execute a plan to sell stock in accordance with Rule 144 at the
expiration of a required holding period. If the insider provides the
instructions without awareness of any material nonpublic information,
the Rule would permit him or her to complete the previously instructed
sales plan even if he or she later became aware of inside information.
---------------------------------------------------------------------------
\89\ Proposed para. (c)(1)(i)(B).
---------------------------------------------------------------------------
Third, the Rule provides an affirmative defense if, before becoming
aware of material nonpublic information, a person ``[h]ad adopted, and
had previously adhered to, a written plan specifying purchases or sales
of the security in the amounts, and at the prices, and on the dates at
which the person purchased or sold the security.'' \90\ This provision
is designed to apply in the case of an insider who wishes to establish
a regular, pre-established program of buying or selling his or her
company's securities
``[h]ad adopted, and
had previously adhered to, a written plan specifying purchases or sales
of the security in the amounts, and at the prices, and on the dates at
which the person purchased or sold the security.'' \90\ This provision
is designed to apply in the case of an insider who wishes to establish
a regular, pre-established program of buying or selling his or her
company's securities. If the plan is established before the insider is
aware of material nonpublic information, and provides for specified
trades at specified times, the insider will be permitted to engage in
those trades even if he or she later becomes aware of material
nonpublic information. As discussed below, plans of this type must be
entered into in good faith, and not as part of a plan or scheme to
evade insider trading prohibitions.\91\
---------------------------------------------------------------------------
\90\ Proposed para. (c)(1)(i)(C).
\91\ This exception does not cover trading for a person's
account through a ``blind trust.'' We have not included any express
defenses for blind trust trading, because we do not believe this
trading creates difficulties under existing insider trading law.
When a person places securities in a blind trust, by definition he
or she does not make the decisions to purchase or sell securities in
that account. Therefore, those trading decisions (which are made by
the trustee of the blind trust) should not be attributed to the
person for purposes of potential insider trading liability.
---------------------------------------------------------------------------
person places securities in a blind trust, by definition he
or she does not make the decisions to purchase or sell securities in
that account. Therefore, those trading decisions (which are made by
the trustee of the blind trust) should not be attributed to the
person for purposes of potential insider trading liability.
---------------------------------------------------------------------------
Fourth, the Rule provides an affirmative defense for purchases or
sales that result from a written plan for trading securities that is
designed to track or correspond to a market index, market segment, or
group of securities.\92\ This defense would permit trading by an index
fund, for example, where the fund's trading strategy was pre-
established by the fund or its manager, even if the manager later
became aware of material nonpublic information regarding one of the
securities in the index. The defense would be available if the plan was
sufficiently circumscribed to prevent trading decisions from being
affected by the manager's later awareness of material nonpublic
information.
---------------------------------------------------------------------------
\92\ Proposed para. (c)(1)(i)(D).
---------------------------------------------------------------------------
The Rule provides one important limitation on the availability of
all of the affirmative defenses. Paragraph (c)(1)(ii) states that a
defense would be available only if a contract, plan, or instruction to
trade relied on for a defense was entered into in good faith, and not
as part of a plan or scheme to evade the prohibitions of this Rule. If
a person changes a previous contract, plan, or instruction in any
respect after becoming aware of material nonpublic information, he or
she will lose any defense against liability
a
defense would be available only if a contract, plan, or instruction to
trade relied on for a defense was entered into in good faith, and not
as part of a plan or scheme to evade the prohibitions of this Rule. If
a person changes a previous contract, plan, or instruction in any
respect after becoming aware of material nonpublic information, he or
she will lose any defense against liability. Thus, for example, if an
insider enters into a contract or plan to sell 1,000 shares of his or
her company's stock without being aware of material nonpublic
information, then learns negative material nonpublic information and
doubles his or her planned sale to 2,000 shares, he or she will lose
the defense for the entire sale of 2,000 shares. Similarly, if the
insider accelerates the timing of a planned sale in order to complete
it before the release of negative corporate news that he or she has
recently learned, he or she will have no defense for the transaction.
Paragraph (c)(1)(ii) also specifies that a person will lose any
defense for a trade if he or she enters into or alters a
``corresponding or hedging transaction or position'' with respect to
the planned securities trade. This requirement is designed to prevent
persons from devising schemes to exploit inside information by setting
up pre-existing hedged trading programs, and then canceling execution
of the unfavorable side of the hedge, while permitting execution of the
favorable transaction. By altering the corresponding position, the
insider would lose any defense for the transaction that he or she
permitted to be executed.\93\
---------------------------------------------------------------------------
ion by setting
up pre-existing hedged trading programs, and then canceling execution
of the unfavorable side of the hedge, while permitting execution of the
favorable transaction. By altering the corresponding position, the
insider would lose any defense for the transaction that he or she
permitted to be executed.\93\
---------------------------------------------------------------------------
\93\ As a general matter, the Rule requires that any written
plan specifying trading at a particular time must be made in good
faith. Similarly, paragraph (c)(1)(i)(C) requires that a person have
``previously adhered to'' the written plan, as a means of
demonstrating its bona fides.
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The Rule provides an additional, separate affirmative defense
designed solely for entities that trade.\94\ This defense is derived
from the defense against liability currently provided in Exchange Act
Rule 14e-3(b) \95\ regarding insider trading in a tender offer
situation. To meet this defense, an entity must demonstrate two things:
first, that the individual(s) making the decision on behalf of the
entity was not aware of the inside information; and second, that the
entity had implemented reasonable policies and procedures (e.g.,
informational barriers, restricted lists) to prevent insider trading.
---------------------------------------------------------------------------
\94\ Proposed para. (c)(2).
\95\ 17 CFR 240.14e-3(b).
---------------------------------------------------------------------------
aware of the inside information; and second, that the
entity had implemented reasonable policies and procedures (e.g.,
informational barriers, restricted lists) to prevent insider trading.
---------------------------------------------------------------------------
\94\ Proposed para. (c)(2).
\95\ 17 CFR 240.14e-3(b).
---------------------------------------------------------------------------
3. Request for Comments
We request comments on all aspects of proposed Rule 10b5-1. Is the
approach we propose--a general standard of ``awareness'' of the
information, with specific affirmative defenses--the appropriate one?
Are the proposed affirmative defenses appropriate? Should we provide
additional defenses to liability, and if so, what should they be? Are
the provisions defining the ``amount'' and ``price'' of pre-planned
trades specific enough to permit plans to be made? Should we require
written plans or instructions in all cases? Should we require that
contracts, instructions, or trading plans be approved by counsel?
We also request comment on whether the defense for institutional
traders is appropriate and adequate. Has this provision worked
effectively for entities subject to Rule 14e-3? Is there any reason the
same type of provision would not be adequate for this Rule?
B. Rule 10b5-2: Duties of Trust or Confidence in Misappropriation
Insider Trading Cases
1. Background
In United States v. O'Hagan, the Supreme Court upheld the
misappropriation theory of insider trading.\96\ Under that theory, a
person commits fraud in violation of Section 10(b) of the Exchange Act
and Rule 10b-5 by misappropriating material nonpublic information for
securities trading purposes, in breach of a duty of loyalty and
confidence.
---------------------------------------------------------------------------
\96\ 521 U.S. 642 (1997).
---------------------------------------------------------------------------
person commits fraud in violation of Section 10(b) of the Exchange Act
and Rule 10b-5 by misappropriating material nonpublic information for
securities trading purposes, in breach of a duty of loyalty and
confidence.
---------------------------------------------------------------------------
\96\ 521 U.S. 642 (1997).
---------------------------------------------------------------------------
Certain types of business relationships by themselves provide the
duty of trust or confidence necessary in a misappropriation theory
case. In O'Hagan, for example, the attorney-client relationship
established the duty of confidence. In other cases, the agency
relationship inherent in an employer-employee relationship provides the
duty.\97\ It is not as settled, however, under what circumstances
certain non-business relationships, such as family and personal
relationships, may provide the duty of trust or confidence required
under the misappropriation theory.
---------------------------------------------------------------------------
\97\ See e.g., United States v. Carpenter, 791 F.2d 1024, 1028
(2d Cir. 1986), aff'd, 484 U.S. 19 (1987); SEC v. Materia, 745 F.2d
197, 203 (2d Cir. 1984), cert. denied, 471 U.S. 1053 (1985); United
States v. Newman, 664 F.2d 12, 15 (2d Cir. 1981), aff'd after
remand, 722 F.2d 729, cert. denied, 464 U.S. 863 (1983).
---------------------------------------------------------------------------
Two courts have considered this issue in criminal cases: United
States v. Chestman \98\ and United States v. Reed. \99\ Although
Chestman and Reed took into account common law notions of fiduciary and
confidential relationships, they both took a relatively narrow view of
when a duty of confidence exists in the context of criminal liability
for insider trading.
---------------------------------------------------------------------------
\98\ 947 F.2d 551 (2d Cir. 1991), cert. denied, 503 U.S. 1004
. Reed. \99\ Although
Chestman and Reed took into account common law notions of fiduciary and
confidential relationships, they both took a relatively narrow view of
when a duty of confidence exists in the context of criminal liability
for insider trading.
---------------------------------------------------------------------------
\98\ 947 F.2d 551 (2d Cir. 1991), cert. denied, 503 U.S. 1004
(1992).
\99\ 601 F. Supp. 685 (S.D.N.Y.), rev'd on other grounds, 773
F.2d 447 (2d Cir. 1985).
---------------------------------------------------------------------------
In Reed, the court did not find a father-son relationship
sufficient in itself to provide the required duty of confidence. But it
stated that if family members have a prior history of sharing
confidences, such that one family member has a reasonable expectation
that the other will keep those confidences, there may be a sufficient
relationship of trust and confidence. The final determination is left
to the fact finder.\100\
---------------------------------------------------------------------------
\100\ Reed, 601 F. Supp. at 717-18.
---------------------------------------------------------------------------
In Chestman, a narrow majority of the Second Circuit en banc, while
not overruling Reed, took a more restrictive view.\101\ The Chestman
majority held that marriage alone does not suffice to create a
fiduciary relationship.\102\ It stated that in the absence of an
``express agreement of confidentiality,'' or a ``pre-existing
fiduciary-like relationship between the parties'' to a family
relationship, there is not a sufficient basis for establishing the
necessary duty to support a fraud conviction under the misappropriation
theory.\103\
---------------------------------------------------------------------------
p.\102\ It stated that in the absence of an
``express agreement of confidentiality,'' or a ``pre-existing
fiduciary-like relationship between the parties'' to a family
relationship, there is not a sufficient basis for establishing the
necessary duty to support a fraud conviction under the misappropriation
theory.\103\
---------------------------------------------------------------------------
\101\ Although the facts alleged in Reed were that the father
and son had a prior history of sharing business confidences, 601 F.
Supp. at 690 n.6, the Reed court's analysis states, without
limitation to business confidences, that ``[t]he repeated disclosure
of secrets by the parties or by one party to the other'' or a ``pre-
existing confidential relationship'' could be sufficient to
establish a duty of trust and confidence. Id. at 717-18. The
Chestman majority, however, limited Reed's holding in a criminal
context to its facts--that the repeated sharing of business
confidences between family members could be the basis of a finding
of a relationship of trust and confidence, the functional equivalent
of a fiduciary relationship. Chestman, 947 F.2d. at 569.
\102\ Id. at 568.
\103\ Id. at 571
---------------------------------------------------------------------------
Chestman makes clear that its narrow approach, in contrast to the
``elastic'' definition of confidential relations employed by courts of
equity in the civil context, was influenced by the criminal context of
the case before it.\104\ In our view, however, the Chestman majority's
approach does not fully recognize the degree to which parties to close
family and personal relationships have reasonable and legitimate
expectations of confidentiality in their communications.\105\ For this
reason, we believe the Chestman majority view does not sufficiently
protect investors and the securities markets from the misappropriation
and resulting misuse of inside information
ity's
approach does not fully recognize the degree to which parties to close
family and personal relationships have reasonable and legitimate
expectations of confidentiality in their communications.\105\ For this
reason, we believe the Chestman majority view does not sufficiently
protect investors and the securities markets from the misappropriation
and resulting misuse of inside information.
---------------------------------------------------------------------------
\104\ Chestman recognized that although concern about the ``rule
of lenity'' did not permit the use of ``an elastic and expedient
definition of confidential relations'' in criminal cases, such an
approach may be useful in the civil context. Id. at 570 See also
O'Hagan, 521 U.S. at 679 (concurring and dissenting opinion of
Scalia, J.) (noting applicability of ``principle of lenity'' in
criminal insider trading prosecution, and potential distinction
between criminal and civil construction of Rule 10b-5).
\105\ Cf. Chestman, 947 F.2d at 580 (concurring and dissenting
opinion of Winter, J.) (calling majority's view ``unrealistic'' in
that ``it expects family members to behave like strangers to each
other''). Nor does Chestman consider the recognition of a fiduciary
duty between family members as a matter of common law or statutory
enactments.
---------------------------------------------------------------------------
We have investigated and prosecuted a large number of insider
trading cases that involved trading by friends or family members of
insiders. In many of these cases, the evidence supports the claim that
the insider intended to give the information to the friend or family
member for trading.\106\ The evidence in
such cases supports liability under a classical tipper-tippee
theory.\107\
---------------------------------------------------------------------------
ing cases that involved trading by friends or family members of
insiders. In many of these cases, the evidence supports the claim that
the insider intended to give the information to the friend or family
member for trading.\106\ The evidence in
such cases supports liability under a classical tipper-tippee
theory.\107\
---------------------------------------------------------------------------
\106\ See, e.g., SEC v. Michelle Nguyen, et al., Litigation
Release No. 16199 (June 29, 1999); SEC v. Bharat Kotecha, et al.
Litigation Release No. 16151 (May 18, 1999); SEC v. Hahn Truong, et
al., Litigation Release No. 16080 (Mar. 9, 1999); SEC v. Eugene
Dines, et al., Litigation Release No. 13900 (Dec. 10, 1993); SEC v.
Steven L. Glauberman, et al., Litigation Release No. 12574 (Aug. 9,
1990).
\107\ See Dirks, 463 U.S. at 664 (noting that tipping liability
can exist ``when an insider makes a gift of confidential information
to a trading relative or friend'').
---------------------------------------------------------------------------
In other circumstances, however, the evidence does not support the
view that the disclosing insider intended or expected that the
recipient of the inside information would trade. Instead, the evidence
indicates that the insider confided the material nonpublic information
to the friend or relation with the reasonable expectation that the
recipient of the information would maintain the confidence. In those
situations, a classical tipper-tippee theory of liability would
probably not be available under the Dirks analysis. The
misappropriation theory of liability would fit the facts better,
because the trader breached a duty of confidentiality to the disclosing
insider when he or she traded on the basis of the inside information
recipient of the information would maintain the confidence. In those
situations, a classical tipper-tippee theory of liability would
probably not be available under the Dirks analysis. The
misappropriation theory of liability would fit the facts better,
because the trader breached a duty of confidentiality to the disclosing
insider when he or she traded on the basis of the inside information.
However, misappropriation liability is very difficult to establish in
these situations under the restrictive analysis of Chestman, because
Chestman appears to require either an express agreement of
confidentiality, or a pre-existing fiduciary-like relationship that
included the prior sharing of business confidences. Stated differently,
under Chestman, it is not sufficient that the disclosing insider had a
reasonable expectation of confidentiality based on his or her prior
relationship with the trader.
Chestman thus leads to the following anomalous result. A family
member who receives a ``tip'' (within the meaning of Dirks) and then
trades violates Rule 10b-5. A family member who trades in breach of an
express promise of confidentiality also violates Rule 10b-5. A family
member who trades in breach of a reasonable and legitimate expectation
of confidentiality, however, does not necessarily violate Rule 10b-5.
We think that this anomalous result harms investor confidence in
the integrity and fairness of the nation's securities markets. The
family member's trading has the same impact on the market and investor
confidence in the third example as it does in the first two examples.
In all three examples the trader's informational advantage ``stems from
contrivance, not luck,'' and the informational disadvantage to other
investors ``cannot be overcome with research or skill.'' \108\ We
believe that permitting the trader in the third example to trade
legally is inconsistent with investors' expectations about what types
of informational advantages can be properly exploited
In all three examples the trader's informational advantage ``stems from
contrivance, not luck,'' and the informational disadvantage to other
investors ``cannot be overcome with research or skill.'' \108\ We
believe that permitting the trader in the third example to trade
legally is inconsistent with investors' expectations about what types
of informational advantages can be properly exploited. Moreover, this
result provides all trading family members--including those in the
classical tipper-tippee example--with a roadmap for concocting a story
that could provide a lawful explanation for the trading. Finally, the
need to distinguish between the three types of cases may require an
unduly intrusive examination of the details of particular family
relationships.
---------------------------------------------------------------------------
\108\ O'Hagan, 521 U.S. at 658-59.
---------------------------------------------------------------------------
Accordingly, we believe that there is good reason for the broader
approach we propose today for determining when family or personal
relationships create ``duties of trust or confidence'' under the
misappropriation theory. Our proposed approach is not designed to
interfere with particular family or personal relationships; rather, our
goal is to protect investors and the fairness and integrity of the
nation's securities markets against improper trading on the basis of
inside information.
2. Proposed Rule 10b5-2
Proposed Rule 10b5-2 sets forth a non-exclusive definition of
circumstances in which a person has a duty of trust or confidence for
purposes of the ``misappropriation'' theory of insider trading under
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. As stated
in the Preliminary Note to the Rule, the law of insider trading is
otherwise defined by judicial opinions interpreting Rule 10b-5, and
this Rule is not intended to address or modify the scope of insider
trading law in any other respect
or confidence for
purposes of the ``misappropriation'' theory of insider trading under
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. As stated
in the Preliminary Note to the Rule, the law of insider trading is
otherwise defined by judicial opinions interpreting Rule 10b-5, and
this Rule is not intended to address or modify the scope of insider
trading law in any other respect.
Paragraph (a) states that the Rule applies to any cases based on
the misappropriation theory of insider trading, whether involving
trading or tipping. Paragraph (b) enumerates a non-exclusive list of
circumstances under which a ``duty of trust or confidence'' shall
exist.\109\
---------------------------------------------------------------------------
\109\ Proposed para. (b) does not enumerate relationships that
existing case law already recognizes as providing a clear basis for
misappropriation liability: for example, lawyer-client, O'Hagan;
employee-employer, Carpenter; pshchiatrist-patient, United States v.
Willis, 737 F. Supp. 269 (S.D.N.Y. 1990), appeal dismissed, 778 F.
Supp. 205 (S.D.N.Y. 1991). As the O'Hagan case demonstrates, an
individual working at a professional firm may be liable for
misappropriating information about a particular matter even if he or
she is not personally working on that matter.
---------------------------------------------------------------------------
a. Agreement Between the Parties. First, whenever a person agrees
to maintain information in confidence, a duty of trust or confidence
exists.\110\ This reflects the common-sense notion, acknowledged in
Reed and Chestman, that reasonable expectations of confidentiality, and
corresponding duties, can be created by an agreement between two
parties. Although sometimes, most commonly in a business context, the
parties will sign an express, written confidentiality agreement, the
Rule does not require either a written or an express confidentiality
agreement
he common-sense notion, acknowledged in
Reed and Chestman, that reasonable expectations of confidentiality, and
corresponding duties, can be created by an agreement between two
parties. Although sometimes, most commonly in a business context, the
parties will sign an express, written confidentiality agreement, the
Rule does not require either a written or an express confidentiality
agreement. This approach recognizes the fact that in everyday personal
interactions, individuals frequently rely on reasonable, implicit
understandings of confidentiality. In some situations, it may not be
realistic or socially acceptable to insist that a close friend or
relative execute a signed confidentiality agreement, or expressly
consent to an oral agreement.
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\110\ Proposed para. (b)(1).
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b. Relationships With a History, Pattern, or Practice of Sharing
Confidences. Second, the Rule provides that a duty of trust or
confidence exists when two people have a ``history, pattern, or
practice of sharing confidences, such that the person communicating the
material nonpublic information has a reasonable expectation that the
other person would maintain its confidentiality.'' \111\ This part of
the Rule does not use a bright line test that enumerates specific
relationships, but instead sets forth a ``facts and circumstances''
analysis derived from Reed. This standard recognizes that in some
circumstances a past pattern of conduct between two parties will lead
to a legitimate, reasonable expectation of confidentiality on the part
of the confiding person. This analysis does not require that the
history, pattern, or practice of sharing confidences include the
sharing of business confidences for there to be a duty of trust or
confidence for purposes of misappropriation liability
me
circumstances a past pattern of conduct between two parties will lead
to a legitimate, reasonable expectation of confidentiality on the part
of the confiding person. This analysis does not require that the
history, pattern, or practice of sharing confidences include the
sharing of business confidences for there to be a duty of trust or
confidence for purposes of misappropriation liability. However,
evidence about the type of confidences shared in the past might be
relevant to determining the reasonableness of the expectation of
confidentiality.
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\111\ Proposed para. (b)(2).
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We request comments on the approach proposed in paragraph (b)(2).
Does the requirement of a prior ``history, pattern, or practice'' of
sharing confidences provide a sufficiently well-defined standard?
Should other factors be relevant to the analysis as well?
c. Enumerated Family Relationships. Third, paragraph (b)(3) sets
forth a bright line liability rule for certain enumerated close family
relationships,
but allows for an affirmative defense. Spousal, parent-child,\112\ and
sibling relationships would be sufficient in themselves as a basis for
misappropriation theory liability. Our enforcement experience
demonstrates that these are the relationships in which family members
most commonly share information with a legitimate expectation of trust
or confidentiality.\113\ These also are normally the types of close
familial relationships in which the parties have a history, pattern, or
practice of sharing confidences that would lead to a reasonable
expectation of confidentiality.
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mily members
most commonly share information with a legitimate expectation of trust
or confidentiality.\113\ These also are normally the types of close
familial relationships in which the parties have a history, pattern, or
practice of sharing confidences that would lead to a reasonable
expectation of confidentiality.
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\112\ We do not intend to limit this to minor children. Our
enforcement cases in this area typically involve communications
between parents and adult sons or daughters.
\113\ See e.g., SEC v. Judy Hockett, et al. Litigation Release
No. 15377 (May 30, 1997) (spouse); SEC v. Linda Lou Taylor, et al.,
Litigation Release No. 14775 (Jan. 4, 1996) (spouse); SEC v. Robert
J. Young, et al. Litigation Release No. 14661 (Sept. 29, 1995)
(brother); SEC v. Jonathan J. Sheinberg, et al., Litigation Release
No. 13465 (Dec. 10, 1992) (son-father); SEC v. Thomas C. Reed, et
al., Litigation Release No. 9537 (Dec. 23, 1981) (son-father).
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Paragraph (b)(3) permits the person receiving or obtaining the
information to assert an affirmative defense by demonstrating that
under the facts and circumstances of that particular family
relationship, no duty of trust or confidence existed. To demonstrate
this, the person must establish that the disclosing family member did
not have a reasonable expectation of confidentiality because the
parties had neither: (a) a history, pattern, or practice of sharing
confidences; nor (b) an agreement or understanding to maintain the
confidentiality of the information. If the person receiving or
obtaining the information can satisfy the requirements of the
affirmative defense set forth in paragraph (b)(3), he or she would not
be liable under Rule 10b5-2.
Paragraph (b)(3) does not reach non-traditional relationships
(e.g., domestic partners) or more extended family relationships
agreement or understanding to maintain the
confidentiality of the information. If the person receiving or
obtaining the information can satisfy the requirements of the
affirmative defense set forth in paragraph (b)(3), he or she would not
be liable under Rule 10b5-2.
Paragraph (b)(3) does not reach non-traditional relationships
(e.g., domestic partners) or more extended family relationships.
However, paragraphs (b)(1) and (b)(2) could reach these relationships,
depending on the factual context of the relationship. We request
comment on whether this is an appropriate distinction.
Are the family relationships enumerated in paragraph (b)(3) the
proper ones to cover, or is the list too narrow or too broad? Should
the list of enumerated relationships be limited to family members
residing in the same household? Should it expressly encompass step-
parents and step-children? Should it expressly encompass non-
traditional relationships, and if so, which ones? Should it include
additional family relationships, such as the list of family
relationships covered in our Section 16 rules?
3. Request for Comments. We request comment on all aspects of
Proposed Rule 10b5-2. For non-enumerated relationships, does paragraph
(b)(2) focus on the proper factors for determining whether a reasonable
expectation of confidentiality exists? Is the approach of paragraph
(b)(3)--a per se rule with an affirmative defense for certain
enumerated family relationships--the most suitable one, or should a
different standard be employed?
IV. General Request for Comments
le 10b5-2. For non-enumerated relationships, does paragraph
(b)(2) focus on the proper factors for determining whether a reasonable
expectation of confidentiality exists? Is the approach of paragraph
(b)(3)--a per se rule with an affirmative defense for certain
enumerated family relationships--the most suitable one, or should a
different standard be employed?
IV. General Request for Comments
We invite you to submit comments on proposed Regulation FD, Rule
10b5-1, and/or Rule 10b5-2. If you have empirical data relevant to
proposed Regulation FD, Rule 10b5-1, or Rule 10b5-2, please include it
with your comments. Please submit three copies of your comment letter
to Jonathan G. Katz, Secretary, U.S. Securities and Exchange
Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. You may
also submit comments electronically to the following e-mail address:
[email protected]. Refer to File No. S7-31-99. If you are
commenting by e-mail, include this file number on the subject line. We
will make comments available for public inspection and copying in the
Commission's public reference room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. In addition, we will post electronically
submitted comment letters on our Internet Website (http://www.sec.gov).
V. Paperwork Reduction Act
Certain provisions of Regulation FD, and the related amendments to
Form 8-K and Form 6-K under the Exchange Act, contain ``collections of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995,\114\ and the Commission has submitted the
proposal to the Office of Management and Budget (``OMB'') for review in
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number.
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he Commission has submitted the
proposal to the Office of Management and Budget (``OMB'') for review in
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number.
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\114\ 44 U.S.C. 3501 et seq.
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Form 8-K (OMB Control No. 3235-0060) \115\ was adopted pursuant to
Sections 13, 15, and 23 of the Exchange Act. Form 8-K prescribes
information, such as material events or corporate changes, that a
registrant must disclose. Form 6-K (OMB Control No. 3235-0116)\116\ was
adopted pursuant to sections 13 and 15 of the Exchange Act. Form 6-K
prescribes information that foreign private issuers subject to the
reporting requirements of the Exchange Act must disclose. The
Commission is also proposing to create a new information collection
entitled ``Reg. FD--Other Disclosure Materials.'' This information
collection will encompass press releases, webcasts, announcements,
conference calls, etc. that are conducted pursuant to Regulation FD,
which is proposed pursuant to sections 13, 15, 23, and 36 of the
Exchange Act, and that are not filed under cover of Form 8-K or Form 6-
K.
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\115\ 17 CFR 249.308.
\116\ 17 CFR 249.306.
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e calls, etc. that are conducted pursuant to Regulation FD,
which is proposed pursuant to sections 13, 15, 23, and 36 of the
Exchange Act, and that are not filed under cover of Form 8-K or Form 6-
K.
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\115\ 17 CFR 249.308.
\116\ 17 CFR 249.306.
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The Commission currently estimates that Form 8-K results in a total
annual compliance burden of 140,500 hours. The burden was calculated by
multiplying the estimated number of Form 8-K filings annually
(approximately 28,100) by the estimated average number of hours each
entity spends completing the form (approximately 5 hours). The
Commission based the number of entities that would complete and file
each of the forms on the actual number of filers during the 1999 fiscal
year. The staff estimated the average number of hours each entity
spends completing each of the forms by contacting a number of law firms
and other persons regularly involved in completing the forms.
The Commission currently estimates that Form 6-K results in a total
annual compliance burden of 91,848 hours and $515,000 non-labor burden
costs. This was calculated by multiplying the estimated number of Form
6-K filings annually (approximately 11,481) by the estimated average
number of hours each entity spends completing the form (approximately 8
hours) and adding the non-labor burden costs. The Commission based the
number of entities that would complete and file each of the forms on
the actual number of filers during the 1999 fiscal year. The staff
estimated the average number of hours each entity spends completing
each of the forms by contacting a number of law firms and other persons
regularly involved in completing the forms.
We believe that the proposed Regulation is necessary to provide for
fairer and more effective disclosure of issuer information to all
investors and thereby bolster investor confidence in
fiscal year. The staff
estimated the average number of hours each entity spends completing
each of the form
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