The death of Reg FD?

I have been harping for years on Regulation FD, Arthur Levitt’s brainchild, which restricts issuers from giving true information to analysts without going public.  The main problems with the rule are that it discourages issuers from filtering information into the market through analysts that might cause problems, including a liability risk, if released unfiltered; and it dilutes analysts’ incentives to provide filtering by prohibiting exclusive access.  The SEC defended the rule by citing the problem of analyst favoritism – a problem that I believe the market for securities analysis could have addressed at less cost.

My previous posts have pointed out First Amendment problems and discussed evidence on the effect of Reg FD on market efficiency.

Now the first court decision has come down, SEC v. Siebel Systems, Inc., SDNY 8/31/2005, dismissing the complaint.  I previously discussed this case, including the First Amendment issue it raises and my own arguments for unconstitutionality. The W$J reports on the case. 

The Court avoided a Constitutional confrontation by holding, in harsh terms, that the SEC had not proved a violation. The court accused the SEC of scrutinizing “at an extremely heightened level, every particular word used in the statement, including the tense of verbs and the general syntax of each sentence." 

An FD defender might try to take heart from the fact that the court stressed the SEC’s nitpicky approach in this case rather than invalidating the rule.  But two aspects of the opinion suggest that the case poses big problems for the Rule.

First, the court explicitly relied on the point noted above that the rule can hinder dissemination of information. Here’s the quote (slip at 23):

Applying Regulaton FD in an overly aggressive manner cannot effectively encourage full and complete public disclosure of facts reasonably deemed relevant to investment decisionmaking.  It provides no clear guidance for companies to conform their conduct n compliance with Regulation FD.  Instead, the enforcement of Regulation FD by excessively scrutinizing vague general comments has a potential chilling effect which can discourage, rather than encourage, public disclosure of material information.

The second aspect of the opinion that should disturb the SEC is that the court refused to infer materiality from the fact that recipients of the information bought Siebel, causing the stock to rise and trading to surge. In other words, the court said the SEC had to prove materiality by linguistic analysis rather than market reaction. Yet the court condemned just such a linguistic analysis in this case, topped off with a warning about the rule’s potential “chilling effect.”

If this case stands, the Rule is basically dead, at least for dissemination of soft information. Yet this is precisely the sort of information that Reg FD was aimed at.  Issuers still may not be able to disclose hard earnings figures privately, but they probably have a duty to publicly disclose this sort of data apart from FD.  And if a court does dare to find a violation of the rule, the First Amendment argument seems to be gaining  acceptance.

Advice to the SEC and Cox: do not waste resources on enforcing or defending the Rule.  Don’t bother getting into the kind of fight that would be involved in repealing it. Just let it die.

Update: Here’s Gordon Smith’s response.  Gordon points to the court’s narrow holding that a private statement that just repeats a public statement doesn’t violate the Rule.  Of course that’s true. The interest of the case was in how the court dealt with the SEC’s argument that there was a material difference between the public and private statements.

But I agree with Gordon that the court’s language about chilling disclosures resembled the business judgment rule.  If that’s the way the courts are going to interpret the Rule and the SEC is going to enforce it, then I think what’s left is (fortunately) nothing like Levitt’s dream. Compare the considerably more aggressive way the SEC has been construing the rule recently.

Update 2: More on Siebel at the Securities Litigation Blog, which says that at least the case ends "body language" violations of Reg FD.  As I say above, I think it does more than that.