The proper handling of material information is one of the most common issues we are consulted about. Deciding whether the information is in fact material is of course the hard part. But once that decision is made, we find that clients often are just as uncertain about the consequences.
However, when new material information develops, a whole host of issues arises, often requiring immediate action by the company. Thanks to today’s disclosure control and compliance program requirements, most companies have (or should have!) procedures in place designed to provide advance notice of potentially material developments. Proper disclosure controls provide extra time to think through what needs to be done BEFORE the materiality threshold is crossed.
But sometimes material events occur suddenly, and there may be little time to parse through the issues. Having good controls therefore also means being ready to respond to unexpected developments. We thought a short checklist might help.
What to Worry About
When material developments occur, here’s what you should be thinking about:
- Insider trading
- Issuer market activity
- Duty to update
- Exchange rules
- Regulation FD
- Stop Talking or Be Careful
- Form 8-K
Below are short summaries of the issues to get you started.
Most insider trading policies call for the imposition of an ad hoc black-out period upon development of material inside information that is not being disclosed. This is best practice, because the company may have exposure as a control person for the insider trading of its personnel. It is also embarrassing to the company to be embroiled in an insider trading investigation. Therefore, as soon as it is clear that there is material, inside information, imposing a black-out period should be one of the first things you do.
Issuer market activity
A company that is actively in the market – perhaps by conducting an offering or a repurchase program – may need to suspend its activity (or promptly disclose the material information). Suspension may not always be necessary if, for example, the market activity is covered by a previously entered into, valid 10b5-1 plan. ( Of course, it is too late to create a 10b5-1 plan once you possess material non-public information.) Regardless, once a material development occurs, this analysis needs to be done quickly in order to avoid giving investors a rescission right or creating other types of exposure.
Duty to update
Sometimes a company may have assumed a duty to update the market about material developments. This may or may not have been intentional on the part of the issuer. We recommend that companies take care whenever they make public disclosure to avoid inadvertently creating a duty to update. Even so, sometimes it happens. The only way to be certain that no duty to update has been created is to review the company’s historical disclosures, including not only SEC filings but other public statements such as press releases, investor materials, and website disclosures as well. Staying on top of duty-to-update issues over time will obviously make it easier to get comfortable more swiftly that the company did not previously undertake such a duty and is therefore free to remain silent regarding unexpected material developments. To the extent a duty to update does exist, however, perhaps because company guidance is consider to be “live” in the market, an issuer faces potential liability if it doesn’t update or withdraw the guidance, and as a result, the issuer may not be able to comfortably wait until its next earnings call or 10-Q filing to take action.
The major exchanges all generally require prompt disclosure of material events, sometimes also requiring notice to the exchange itself. However, there is usually an exception for certain types of situations where sound business reasons dictate a need to keep the information confidential. This exception is completely dependent on the company’s ability to keep the information under wraps, and the company has to take steps to prevent leaks.
Unless the company publicly discloses the information, Regulation FD prohibits selective disclosure of the information to certain persons, primarily company security holders (if it can reasonably be expected that they may trade based on the information), analysts, and broker-dealers, unless the company gets an appropriate confidentiality agreement first. This means there are three basic ways to stay on the right side of Regulation FD: publicly disclose, don’t tell the covered class of persons, or collect confidentiality agreements. If the company routinely responds to ad oc inquiries from analysts and investors, or an investor conference is coming soon, dealing with this issue is urgent.
Stop Talking or Be Careful
One of the dangers of failing to disclose material information is that Company personnel will inadvertently say something that could be construed as misleading due to the omission of the new material information. This may be especially likely to happen if the company continues to field calls from analysts or institutional shareholders. We realize that sometimes it’s not practicable to halt all corporate communications. But until the material information is released, all corporate communications will be fraught with danger.
Not every material development triggers a Form 8-K reporting requirement. But today’s Form 8-K includes numerous disclosure items, and the deadline for nearly all of them is only four short business days. Thus, one of the first things you should do is make sure that none of the Form 8-K disclosure items has been triggered. With all of the other urgent issues to be addressed, having four business days may seem like a long time. Keep in mind, however, a certain amount of time is required to draft the 8-K, and some 8-K disclosures are surprisingly lengthy.
When a material development hits unexpectedly, you’re going to have a lot to think about. We hope this checklist helps you hit the ground running.