The consequences of the Enron debacle and other eminent corporate collapses have been farther-reaching than even the most pessimistic among us could have predicted, at least initially. The scandals have led, directly or indirectly, to legislation and proposed legislation in the fields of auditing, corporate governance, options accounting and pension fund management, among others. They have also contributed to a dramatic rise in insurance premiums, particularly in the arena of indemnity insurance for professionals and for company directors and officers.
The skyrocketing cost of insurance also comes at a time when the regulatory compliance burden in the UK has increased significantly under the new Financial Services & Markets Act regime. We now have a new market abuse regime and a widened exposure for misleading the market. The net is also being cast wider in terms of who’s covered.
When it comes to handling price-sensitive information and ensuring that the market is not misled, companies, their investor relations team and external advisors need to be on their guard. Insurers too are concerned about companies having effective risk management procedures.
There are two basic rules that companies should follow. First, they need to avoid the selective disclosure of price-sensitive information. Second, they must always be wary of misleading the market, and this includes through omission as well as via misleading statements.
The exposure for failing to meet the standards required includes damages claims from investors who might have lost out. However, in addition, there is also the risk of hefty fines (there is no limitation on the FSA regarding the amount of any fine) and public censure of companies and employees as well as their advisors.
A familiar scenario: A subsidiary of a listed company has been notified of the loss of a key contract representing 10 percent of its income. If known to the market, there is likely to be a hit to the share price, at least in the short term. Management does not want the information to come out at this juncture because they think they can rescue the situation.
The non-executives on the board, on the other hand, are concerned because there is no certainty that the position can be rescued and, in the meantime, investors will trade unaware of the problem. Notwithstanding that in certain circumstances a company is able to seek a dispensation enabling it to delay making an announcement, the non-executives feel that the share price will be affected no matter when the information gets to the market, and counsel the executive to bite the bullet and release the information now to avoid criticism later.
The non-executives should be in a position to force the hand of the executive, although this is often countered by the argument that non-executives could be overly cautious. What does an IRO do in a situation where, say, the CEO is insisting on putting out an announcement that the IRO knows to be misleading? In the new environment, external advisors are probably likely to side with the non-executives rather than expose themselves to charges of having allowed the market to be misled. Internal procedures should recognize this possibility.
The same applies to putting out an announcement in a situation where the press officer knows that the announcement does not tell the whole story and, in fact, paints a rosier picture than the reality, thus running the risk of misleading the market. The press officer knows they may be personally exposed if they allow the announcement to go out in the proposed form.
Finally, what should a company do if it has shared price-sensitive information with outsiders and made them insiders? Making them insiders does not deal with the fact that as soon as an announcement goes out, they may go ahead and trade immediately, effectively ‘front-running’ the market.
To cut down the risk of becoming the victim in scenarios like these, companies, their boards, investor relations officers, press officers and advisors need to agree on effective risk management procedures to deal with the handling and dissemination of price-sensitive information. Careful planning and thinking ahead are essential. Based on the UK Listing Authority (UKLA) guidelines, following is a useful overview of the issues organizations should consider to avoid falling foul of the regulations:
What is PSI?
– The first step is to build awareness of what constitutes price-sensitive information. It is important that all those who may be involved in handling price-sensitive information are trained to understand the requirements of the market, the sensitivities and the penalties for failure to meet the obligations placed on them.
– Companies should draw up sensitivity lists to help them ascertain, in a given situation, whether information runs the risk of constituting price-sensitive information.
Putting in place the right procedures
– Companies need to clearly define internal roles and responsibilities for all financial disclosures, identifying specifically those personnel who are empowered to talk to analysts and journalists.
– They need to acknowledge that situations may arise where the executive and non-executive directors and advisors may be at odds and try to work a system that overcomes this. Much of this turns on the sagacity of the non-executives and the degree of trust they build with the executives.
– There should be a system enabling employees to bypass the chief executive and still save their bacon. This is where the non-executive directors and/or financial advisors ought to be able to bring their authority to bear.
– In terms of the procedure for making public announcements, both companies and their advisors should ensure that someone is made responsible for verifying and signing off on the announcement. Those charged with disseminating the information should ensure that announcements are signed off by nominated persons as being accurate, complete in context and not misleading. They should perhaps go one step further and obtain assurance that someone has verified the information and, where relevant, ask for sight of the verification documentation.
– Have a procedure in place to deal with draft analysts’ reports sent to companies for comment.
– Discuss the procedures with the insurers to ensure they’re happy with them and seek guidance from them on any additional measures they would recommend.
Policing the communications channels
– Communicate the policy internally so that people know not to talk out of turn, and pass on queries to the relevant individual/department. This should be part of the terms and conditions of employment, with a breach being grounds for disciplinary action.
– Companies should also consider communicating the list of authorized spokespeople externally so that journalists, analysts and others know who to contact. Investor relations web pages are a useful mode of communication in this respect.
– Anticipate the effect that an announcement is likely to have. Study the wording of the announcement to ensure that it is as complete as possible, accurate and not likely to mislead the market.
– Have a system to deal with inadvertent disclosure of price-sensitive information – a rapid response system including a swift announcement to ensure damage limitation.
– Think about the announcements calendar and consider whether you should be giving more regular updates on trading rather than the normal half-yearly or quarterly announcements. Ahead of shareholders’ meetings, analyst meetings or press briefings where relevant questions may be raised, anticipate the sort of questions that may be asked and prepare responses to avoid inadvertent release of price-sensitive information to a selected group.
And finally
– Companies should secure undertakings that those who are made insiders will not deal for a specified time after an announcement. This should ensure they do not have an unfair advantage over the market.
– Make sure that adequate insurance is in place to cover likely liabilities (recognizing that US-style litigation risks are becoming more commonplace in the UK).
The last word
It is more important than ever before for companies to ensure they are beyond reproach when it comes to dealing with price-sensitive information. It can look like a minefield, but getting the right advice and putting in place watertight procedures from the outset can dramatically cut down the chances of making a mistake.
Clare Grayston is a partner and head of the corporate department at specialist corporate law firm Lewis Silkin
