A recent SEC enforcement action against Flowserve Corporation under Regulation FD is instructive about precautions public companies should take in updating or confirming earnings guidance in a non-public forum, particularly in the second half of a fiscal quarter.  On March 24, 2005, the SEC settled enforcement proceedings against the Chairman, President and Chief Executive Officer of Flowserve and the Director of Investor Relations of Flowserve for violations of Regulation FD and Section 13(a) of the Securities Exchange Act of 1934.  This is the first settled action against a director of investor relations.[fn1}

Regulation FD prohibits public companies from selectively disclosing material non-public information to certain persons, such as securities analysts, broker-dealers, investment advisers and institutional investors, before disclosing the same information to the public.

Flowserve, a calendar year-end company, publicly issued guidance early in 2002 and, in July of that year, lowered its EPS guidance.  It again lowered its guidance in September and reaffirmed the guidance in its Form 10-Q filed October 22, 2002.  At private meetings with analysts on November 19, 2002, Flowserve allegedly reconfirmed the guidance again.  The SEC took the position that even a simple reaffirmation of earnings guidance "well into a fiscal quarter" (in this case, the reaffirmation allegedly happened  approximately 55% of the way through the fiscal quarter) can be material information, and its selective dissemination, such as to a small group of analysts, will violate Regulation FD.

Flowserve apparently took the position that no such reaffirmation happened, which was seen by the SEC as inconsistent with the company's press release confirming the guidance on November 21, 2002, only two days after the alleged selective dissemination (but beyond the 24-hour window required under Regulation FD for corrective press releases).  Flowserve’s stock price rose 6% in those two days, suggesting to the SEC that the guidance confirmation was material.  Of particular interest is the fact that Flowserve had properly (under Regulation FD) reaffirmed guidance on October 22, 2002, so that the November 19, 2002 reaffirmation at issue in this action, while admittedly 55% of the way through the fiscal quarter (past the SEC’s line of "mid-quarter" or "well into a fiscal quarter") was only 28 days (or only an additional 31% of the way through the fiscal quarter) after the latest guidance had been given on October 22. 

Without admitting or denying the SEC’s allegations, Flowserve and the Chief Executive Officer consented to the entry of a final judgment by a federal court that would require them to pay civil penalties of $350,000 and $50,000, respectively (the Director of Investor Relations was not required to pay a monetary penalty).

The SEC seems to be sending a clear message that it is very suspicious of Regulation FD violations in reaffirmed guidance.  Days - not months - seem to be the relevant time period during which guidance remains "fresh."  This sensitivity appears to be heightened during the second half of a fiscal quarter. Statements by members of the SEC staff have expressly warned of Regulation FD violations in cases where companies reaffirmed guidance after "mid-quarter."

What to Do

Companies should reevaluate their policies regarding reaffirmation of guidance, particularly during the last half of the quarter.  Companies may choose not to reaffirm earlier guidance at all in non-public settings and, if asked, state that the company’s policy is not to comment on earnings guidance in non-public meetings.  Alternatively, a company may decide to issue a press release reaffirming the guidance in advance of a non-public meeting.  In addition, companies should increase their focus on the education of their Investor Relations Officers, and ensure that the Investor Relations Officer:

• participates in meetings with analysts and investors,
• is instructed and empowered to prevent a company officer from making potentially problematic statements reaffirming guidance; and,
• in the event an inadvertent disclosure does occur, has the authority and resources to act quickly by filing a correcting press release or Form 8-K within the 24-hour grace period under Regulation FD for unintentional violations.  Companies should be cautious when relying on this grace period for "unintentional" violations, however, since it requires that the person didn't know that the information he or she communicated was either material or nonpublic.

For the SEC’s press release announcing this enforcement action, please follow this link:  www.sec.gov/news/press/2005-41.htm.

Footnotes:

1:The Siebel Systems Regulation FD case is still pending in New York District Court with Siebel Systems and its officers challenging the constitutionality of Regulation FD under the First Amendment to the U.S. Constitution.