Since its adoption in October 2000, the SEC’s Regulation Fair Disclosure has prompted numerous discussions about corporate disclosure. From practical guidance on how to comply with the regulation to philosophical debates on how (or if) it’s working, Reg FD has been given more column inches in the last few months than any other topic in the IR world.
In May, as part of an ongoing cyberseminar series hosted by Investor Relations and Worldcom, three experts – Chuck Hill, director of research and chief financial analyst of First Call; Maria Clark, associate, department of standard setting and advocacy, AIMR (Association for Investment Management and Research); and Boris Feldman, attorney with Wilson Sonsini Goodrich & Rosati – discussed earnings guidance in the age of fair disclosure. Here are some highlights.
Updating earnings
Feldman: Many companies have gone from giving guidance in one-on-ones with analysts to putting it in their earnings release or doing a conference call. The difficulty is not so much with the initial guidance; the confusion is over giving updates to that guidance during the course of the quarter. In particular, the extent to which a company can confirm the guidance it gave at the beginning of the quarter throughout the rest of the quarter.
A few months after it issued the rule, the SEC came out with additional guidance which it called a telephone manual. Inside, the question was asked whether a company may confirm guidance it has already given on a selective basis. The SEC’s answer was Yes, based on certain factors such as how much time has elapsed between the initial guidance and the confirmation and how market conditions have changed in the interim period.
Hill: What analysts are taking issue with is the inability for companies to give guidance further out in the quarter, but I am not sure that’s a valid complaint. The fact that there won’t be as much guidance later on – selective or public – may be a good thing.
Clark: In discussing earnings estimates and the role of an analyst, we should distinguish between the amount of information accessible to analysts covering large-cap companies versus those covering small and mid-cap companies. A lot of our analysts are saying that FD is causing small and mid caps to clamp down on the amount of information they are releasing. The are two reasons for this: companies are unsure of what constitutes material information; and they are hearing conflicting views on what is and is not acceptable.
Feldman: Companies have clamped down on the amount of information they are willing to provide one-on-one and are remaining very open on the conference call. Before FD, conference calls were conducted at a very high level and were really meant for the analyst community. Then with pressure from individual investors to open conference calls, they became less useful and many of the best analysts would withhold their questions so as not to give away their angle to competitors.
Clark: We recently did a survey of approximately 6,500 AIMR members in the US and found some interesting results about analysts’ sentiments. Our survey asked questions regarding written and oral communications [post-FD]. A third of respondents felt the quality of written communications had deteriorated. The statistics on oral communications were a little different: 55 percent of respondents thought oral communications were less clear; 62 percent thought they were less useful; while 64 percent thought they now offered analysts less specificity.
These results support the idea that companies feel very uncomfortable in determining materiality when an analyst asks them specific information regarding the operations of their company.
Giving guidance
Feldman: We urge our clients to use Regulation FD as a shield when analysts ask them about something they don’t want to answer. Before FD it wasn’t that uncommon for major buy-side people to really hound the CEO or the CFO relatively late in the quarter. Now companies can refuse to answer [sensitive questions] because they run the risk of violating FD.
There are two main objectives spearheading changes to the way companies handle investor relations and earnings guidance. One objective is to provide higher quality information to the market and another is to provide greater transparency to all investors. FD relates to the second objective, not the first.
In my view, FD has damaged the first objective to provide higher quality information. So, as the AIMR survey suggests, there is now more information broadly available but the value of that information has declined.
Hill: The fact that the quality of information has diminished is not necessarily a bad thing. In recent years, we have been faced with a marketplace where too many analysts have been taking what the company tells them and using it to determine whether they will miss or beat [their earnings] that quarter. Well, that game is over and we will see more analysts doing the kind of fundamental, independent research they should have been doing.
Clark: During the boom market in the late 1990s, analysts were covering a lot of different companies in order to meet their clients’ demands. Now some of these companies are dropping off, which allows analysts to focus more on the companies they currently follow. Our survey asked analysts what type of analysis they see themselves conducting post-FD and the answer was a move towards more fundamental, quantitative analysis.
Enforcement
Clark: At the SEC roundtable in New York back in April, [the participants] discussed how Reg FD was working, and some areas were identified as needing more guidance. For example, the SEC may need to give more guidance on materiality as well as information on how they are going to enforce Reg FD.
Feldman: From my standpoint, you don’t want to put a lot of money on Reg FD enforcement. The great thing about securities law in America is that it’s highly self-enforcing. If the government articulates a standard, the overwhelming majority of public companies try to comply with it. With Regulation FD, most companies are trying to comply with it because it’s viewed as best practice.
If the SEC goes after a company for an FD violation, it will be for something the commission could have gone after a company for before the rule was implemented. For example, if a CEO calls an analyst buddy of his to give him a heads up that the company is missing the quarter. The enforcement action will be where a company says a little more than it should in a forum that isn’t fully public.
Stealing the thunder
Feldman: FD has really changed the way companies announce to the public that they are not going to meet their numbers.
In the past companies used more gentle curves in adjusting Street expectations. Maybe the Fortune 100 companies did not do it, but many other companies would have an ongoing dialogue with the analyst community up until week eight or ten of the quarter. Now, FD has shut that down.
In my experience with our clients, ongoing interaction with the Street during the quarter is finished. Companies are not updating the market unless they are going to miss [their numbers] and they have to preannounce earnings. That’s not to say particular analysts might not have a relationship with the CEO that enables him or her to get information but, in general, companies have made a real effort not to talk to analysts further in the quarter.
Some companies are issuing mid-quarter updates to communicate how the quarter is going to the broader market. This is great from an FD standpoint but from a shareholder class action standpoint, it’s a catastrophe. If a company gives guidance on the 17th day of the first month when it issues an earnings release and then three months later it misses its quarter, there is a good chance the lawsuit will get thrown out under the Safe Harbor Provisions.
It’s a lot tougher to do that if in the middle of the quarter, or at the end of the second month, the company came out and reaffirmed its guidance, and then three weeks later announced it was going to miss the quarter.
