On October 21, 2010, the SEC underscored its renewed focus on Regulation FD by announcing enforcement actions against Office Depot, Inc. as well as its CEO and former CFO. This represents the SEC’s third Regulation FD enforcement action since it published Compliance and Disclosure Interpretations (C&DIs) on Regulation FD in August 2009. Prior to publishing the C&DIs, there had been a five-year hiatus in Regulation FD enforcement actions.
Office Depot’s Implied Guidance Disclosures
In late May 2007, Office Depot’s CEO alerted the company’s board of directors and executive committee that the company would not likely meet analysts’ earnings estimates for the second quarter of 2007, and indicated that senior management was developing a strategy to avoid surprising the market. At the time, as a matter of company policy, Office Depot did not offer specific quarterly earnings guidance, nor did it have any written Regulation FD policies or procedures in place.
Shortly prior to the close of the second quarter 2007, Office Depot’s CEO and CFO devised a strategy for communicating with analysts for purposes of encouraging them to revisit their estimates. Based in part on suggestions from the CEO, the CFO and the investor relations department drafted talking points that guided the one-on-one calls that the director of investor relations placed with 18 of the analysts covering the company (and later with the company’s top 20 institutional investors). Although the talking points did not directly state that the company would not meet analysts’ expectations, the message was signaled with references to recent public statements of comparable companies about the impact of the slowing economy on their earnings and reminders of Office Depot’s prior cautionary public statements.1
Word of the calls, which analysts interpreted as Office Depot was “talking down” their earnings estimates, spread quickly. Within two days, 15 of the 18 analysts had lowered their second quarter estimates. Six days after the calls began, and after a 7.7 percent drop in the company’s stock price, Office Depot filed a Form 8-K publicly disclosing that its earnings would be negatively impacted by soft economic conditions.
Lessons from the Office Depot Enforcement Action
The Office Depot enforcement action serves as a reminder that issuers should continue to be vigilant in their Regulation FD compliance. Among the principal lessons presented to issuers by recent enforcement actions are the following:
- Don’t Attempt to Convey Information You Can’t Expressly Say. The Office Depot enforcement action, consistent with earlier enforcement actions such as a September 2003 action against Schering-Plough, demonstrate that implying or suggesting the existence of material non-public information – whether through words, tone, emphasis or demeanor – can result in a Regulation FD violation. Office Depot’s communications with analysts and institutional investors were limited to observations about industry competitors and economic conditions, but the underlying message was clearly communicated.
- Ensure that Regulation FD Compliance Programs are in Place. The SEC’s complaint against Office Depot stressed the lack of any written Regulation FD policies or procedures at the time. By contrast, the potential benefit of a strong compliance program was demonstrated in the SEC’s October 2009 enforcement action against the former CFO of American Commercial Lines, Inc. That action represented the first instance in which the SEC did not include the reporting company as a party to the action, in part because the CFO acted outside the control systems that had been established to prevent improper disclosures. Internal vigilance with respect to Regulation FD compliance serves both to prevent inadvertent disclosures, and to potentially mitigate the impact of Regulation FD violations on the company. In light of the Office Depot action, issuers with existing Regulation FD compliance programs should consider periodic refresher sessions in which executives and investor relations personnel are, among other things, reminded that Regulation FD requirements cannot be evaded by implicitly conveying material non-public information.
- Maintain a Crisis Management Team and Take Prompt Remedial Measures. Issuers should have a response team in place to quickly ascertain whether an intentional or unintentional Regulation FD violation has taken place, and what remedial measures should be taken. Among other things, the crisis management team should consider whether to promptly file a Form 8-K and/or whether it would be appropriate to self-report the violation to the SEC (as American Commercial Lines, Inc. did) to limit the action the SEC may take against the company. In the case of non-intentional disclosures, Regulation FD requires issuers to make a public disclosure of the information promptly after a senior official of the issuer learns of the non-intentional disclosure. Because Regulation FD defines “promptly” to mean “as soon as reasonably practicable (but in no event after the later of 24 hours or the commencement of the next day’s trading on the New York Stock Exchange),” time is of the essence.