The incidence of shareholder litigation has exploded in recent years so that a high growth company or one operating in a volatile industry can expect to be hit with securities fraud class action at some point in its life. Recent changes in the law offer some relief: the Private Securities Litigation Reform Act of 1995 aims to protect companies when they provide ‘forward-looking’ information. It puts a premium on including appropriate risk disclosures when providing guidance to the Street.
But over the years, shareholder lawsuits have focused more and more on the IR function in companies and they will continue to do so. On the grounds that forewarned is forearmed, it’s worth talking through certain issues with management and your outside securities counsel now, before you get sued.
On most of these, there are no ‘right’ answers – just trade-offs involving exposure in a securities suit, credibility with the Street, and degrees of forward-looking guidance. They are merely suggestions and are presented as a checklist so that you can sit down with management and counsel and work through the items one by one.
1. The IR Policy
Has the company reviewed its IR needs lately? Many companies implement IR practices piecemeal, without any overall plan or analysis of objectives and risks. And they tend to perpetuate existing practices even when circumstances change.
Take the example of a newly public company followed by just a few analysts, without much of a track record. It may feel compelled to provide greater guidance to the Street than a company which has been public for many years, has known risks and is covered by many analysts. Similarly, a company that normally provides guidance may enter a period in which its results are more uncertain; it may decide to reduce guidance until it returns to a more stable cycle.
At least once a year (at annual report time, for example), your company should convene a meeting of the IRO, senior management and securities counsel to decide explicitly what the company’s guidance practices will be for the coming year. Ad hoc reassessment will also be appropriate when a company is entering a period that will be riskier, because of product or market issues.
2. Clear and In Writing
You should set out the agreed IR policy in writing. This will improve the chances of doing what management has agreed that you should do. In the event of a deposition years later, you may not recall the specifics of particular events, but you will remember that you made it a point never to deviate from the policy. And in the event of an isolated deviation, the company may be protected by the fact that its conduct was not encouraged or permitted by corporate policy.
There is no good reason not to have a written policy but few companies bother to prepare one. Taking time to do so could pay off.
3. Consistent Practice
Once the IR policy is in place, companies need to ask themselves, at regular intervals, whether their practices are consistent with it.
If there is to be consistency, the policy will have to reflect the reality of how your management deals with investors. In the event of a shareholder suit, plaintiffs will exploit any differences between policy and practice, so make sure everyone involved in the IR process is familiar with (and periodically reminded of) the policy.
4. Talking to the Street
Companies must establish who may talk to the Street. The more narrowly you restrict the group that can communicate with analysts and investors, the less likely it is that your IR practices will get you into trouble. So define the group that has IR authority to address particular topics and include this in your written policy.
Many companies limit contact with analysts to the IRO, CEO and CFO. To the extent that someone other than the IRO can meet with analysts, many companies require that the IRO be present – to prevent deviations from the policy; to play the ‘bad cop’ in refusing to discuss certain topics; and to stay current on senior management’s thinking on particular issues.
5. The Same Songsheet
In a shareholder suit, inconsistent statements by different executives are a plaintiff’s best friend. Make sure that analysts cannot catch you out by calling around to different execs until they find one who will talk about something that the rest of you have agreed not to discuss.
As IRO, you can help ensure that everyone sings the same tune by preparing – or at least reviewing – scripts, Q&As, and so on. And you can then discourage ad-libbing from the agreed content.
6. Keeping Up-to-Date
It is imperative for the IRO (or other spokesperson) to be kept fully informed, on a real-time basis, of all key corporate developments: forecasts, M&A activity, product developments, market trends.
Ideally, the IRO will attend any senior staff meetings at which these issues are discussed. But life is rarely ideal and the reality is that the IRO is often not far enough up the corporate information ladder to be allowed to go to such meetings. The result is that IR staff may be saying things to analysts that do not reflect the latest thinking of senior management.
At the very least, if your company provides any type of forward-looking guidance to the Street you should regularly review with senior sales and finance executives the continued validity of the guidance given in the past. One of the greatest services the IRO can perform is to ask periodically: do we need to change our guidance?
7. Reviewing Draft Reports
Companies are often unsure whether they should review draft analyst reports or not. In virtually every shareholder lawsuit, plaintiffs will allege – without having any idea if it is true – that the company reviewed draft analyst reports and commented on the revenue and earnings models in them, thereby giving rise to a duty to disclose any subsequent drop in internal projections.
In practice, companies’ policies on reviewing draft reports tend to vary with their age and size. A newly public company with little coverage may feel that it has no choice but to do this, whereas a larger, more established one may have the confidence to decline. In general, a company can reduce its securities exposure by declining to review analyst reports.
8. To Comment or Not
If your company decides it will review reports, it should ensure that the topics on which it will comment are consistent with its guidance policies.
So, for example, if your company will not comment on analysts’ estimates in a meeting or phone call, it should not inadvertently deviate from that by commenting on EPS estimates in a draft report.
Many companies have a practice of correcting objective factual errors in a draft report – say, an inaccurate historical figure or a wrong description of product features – but of declining to comment on forward-looking information. If that is your practice, be sure to include it in your written IR policy. Never, even in jest, respond to draft reports with comments that can later appear intended to push the analyst to a more favourable assessment. By definition, these will become an issue only when you have failed to meet the Street’s expectations.
9. Sending Out Analyst Reports
Companies should be cautious about sending out copies of analyst reports. Plaintiffs routinely allege that a company adopted analysts’ projections by distributing copies of their reports to investors. The easiest way to avoid that issue is by not distributing them: after all, they are readily available to investors from other sources.
If your company insists on providing copies, consider including a disclaimer to the effect that you are doing so as a courtesy to the investor and that the company does not necessarily agree with the content of the report, which is the independent conclusion of the analyst who wrote it. And ask yourself whether you are really passing on such reports disinterestedly, without selecting the good ones or culling the bad.
10. Expectations from Bankers
Plaintiffs have recently attempted to argue that companies assume the duty to update by providing projections to their investment bankers, who may leak them to the firm’s analysts. When providing sensitive information to your investment bankers or underwriters, confirm with them that they observe an ethical wall between their corporate finance and research departments.
11. Conference Calls
Most companies issue earnings releases after the market has closed and then follow up, that afternoon, with a conference call with analysts to discuss the results in more detail. Such calls are clearly more efficient than individual calls to numerous market professionals. They also minimise the risk of selective disclosure to a particular analyst.
But it’s important to structure the call appropriately. If the information contained in the press release – whether it’s an earning release or some other significant announcement – is particularly surprising, you may need to schedule the call after the close of extended trading on Nasdaq, not just after the regular market close.
And the script for the call, along with Q&As, should be vetted by the entire management team for accuracy as well as for consistency with the company’s IR policy. Companies differ on whether such calls should be tape-recorded: think this through with your counsel when you prepare your IR policy. And don’t say anything on such a call that you would not be happy to see in the newspaper the next morning.
12. The Safe Harbor
The topic of analyst guidance on forward-looking information is so vast that it cannot adequately be addressed by generalities; nuances in the message can have significant legal consequences in a shareholder suit.
In general terms, and this is subject to numerous qualifications, if your company provides specific guidance about expected future results, that may trigger a variety of legal requirements. Any guidance you give should have a reasonable, good faith basis and should not be significantly undermined by material, adverse, undisclosed information then known to you.
To benefit from the ‘safe harbor’ for forward-looking information created by the recent Reform Act, you should include in your statements a discussion of important factors that could cause actual results to differ materially from your projections.
With forward-looking information you provide orally, you can satisfy the safe harbor by stating clearly that the information is forward-looking; by stating that actual results could differ materially from the projections; and by referring to a widely available disclosure document (say, a quarterly report on Form 10-Q) that discusses the important factors that could cause actual results to differ from your projections.
If your internal expectations do later change materially and your earlier guidance is still in the market, then you need to consider whether you have a duty to provide an update. This is subject to many caveats and is an area in which both the case law and statutes are evolving dramatically.
13. How Much Guidance?
This is the central question in any IR policy. In general, the law does not require you to disclose internal projections of future results, but it does permit such disclosure. As indicated, the legal ramifications of different levels of guidance vary substantially.
In every instance, your guidance policy will be determined by market needs as well as legal concerns. Some companies feel they have no choice but to inform the market of their expectations as to future results; others decide to let the market make its own best guess, without input from the company. Whatever your decision, you should recognise the full legal and market consequences when you draw the line, and incorporate that decision into your IR policy.
A particularly important issue is whether your company will give guidance on a quarterly basis, or only with respect to annual results. One of the most unfortunate consequences of the proliferation of shareholder class actions has been the dramatic reduction in the information companies provide to investors, in order to minimise their exposure if the forecast does not come true.
The Reform Act ‘safe harbor’ aims to reverse this trend and encourage companies to give more candid forward-looking guidance, provided they accompany it with meaningful discussion of the risks that could stop the projections being achieved.
14. Method of Guidance
This again will require a lengthy discussion among your executive team. The methods companies use to guide the Street include the following:
- Providing broad parameters in the post-earnings release conference call
- Including the guidance in the MD&A sections of Forms 10-Q and 10-K
- Advising analysts that their estimates are ‘in the ballpark’ or are reasonable targets
- Questioning the assumptions used by the analyst in developing the earnings model.
None of these methods is right or wrong; each has potential legal consequences that you must evaluate when you adopt your guidance policy. The one thing that you can be sure of is that when your company misses a quarter, any guidance you provided will be subject to microscopic scrutiny with the benefit of hindsight. And any internal documents that are inconsistent with the guidance will be brandished in court by plaintiffs as ‘smoking guns’ – however much that may ignore the difficulty of forecasting in a diverse business entity.
15. Formulating Guidance
Whatever method of guidance you choose, you should be sure that you can later document that it had a good faith, reasonable basis at the time it was given; and that you continued to assess whether an update was required. Many companies take the precaution of guiding the Street to results that are rather lower than they expect, to give themselves a margin of error.
Whatever the approach, the process of formulating guidance is dynamic, not static; and it often begins as soon as the results for the prior quarter begin to shape up. An especially important stage is the preparation for the conference call announcing the prior quarter’s results: That should be viewed as integral both to the guidance to the Street and to the drafting of the MD&A section in the Form 10-Q.
16. What About the Buy-side?
The term buy-side analyst is a misnomer. Sell-side analysts – who publish reports for the market – are recognised by the courts (although not necessarily by the SEC) for disseminating information in an efficient market. But buy-side analysts at large funds or institutions rarely disclose information to the market. And information provided to them is subject to serious selective disclosure – and even tipping – concerns.
17. The Quiet Period
Most companies stop giving guidance to the Street near the end of the quarter. The rationale is that information at that point contains nuances. The later in the quarter a company revises its internal projections, the more likely it is to disclose that revision by press release, not by market guidance.
If you decide to adopt a quiet period, the duration can vary. Many companies shut down guidance from the start of the third-month of the quarter until the issuance of the earnings release. Others wait until two weeks before the end of the quarter to start the quiet period.
Whatever the chosen time, you should consider stopping all communications with analysts during that period, not just those involving the quarterly results. Analysts are wily creatures: if you talk to them about anything during the quiet period, they may draw unintended inferences about the quarter from comments on other topics or even from the tone of your answers.
If you do observe a quiet period, don’t tell analysts what your guidance was before it, lest that be construed as suggesting that it remains viable.
Remember that despite your best efforts, a large enough stock drop can trigger a lawsuit against even the most honest, well-managed company. Of course, you cannot live your professional life preoccupied with plaintiffs’ securities lawyers; but you can ensure that your policies and practices are ones you are proud to defend and reflect fundamental integrity and good faith.
Even if your company is sued, the tide does appear to have turned, at least for now. And these suits can be, and increasingly are being, won. The Private Securities Litigation Reform Act will not remove all meritless suits. But, over time, it will make companies more secure that, if they have conducted their IR guidance in a responsible way and included appropriate cautionary disclosures, the exposure from a disgruntled shareholder will be reduced substantially.
Your efforts in the investor relations process may be key to the outcome of any such lawsuit; and that has got to be a challenge worth rising to.
Boris Feldman is a member of Wilson Sonsini Goodrich & Rosati in Palo Alto, California. He can be reached at [email protected]. This article reflects his views, not necessarily those of his firm.
