United States: It's Been Eons Since The SEC Last Did This—Brought A Reg FD Enforcement Action, That Is

Reg FD prohibits selective disclosure of material, nonpublic information by public companies (or by its senior officials or specified other employees) to securities market professionals and shareholders reasonably likely to trade on the information. If a public company does make a disclosure of that kind, the company is required under Reg FD to disclose the information to the public. Information is considered "material" if there is "a substantial likelihood that a reasonable investor would consider the information important in making an investment decision or if the information would significantly alter the total mix of available information." And that's where the thorny part comes in. The test for materiality is a subjective one, based on the facts and circumstances. But judgments about materiality of disclosures are often complicated and muddy and frequently made in real time.

To be sure, as stated in SEC v. Bausch & Lomb, Inc., the "SEC, of course, does not maintain that the securities laws prohibit all disclosures of internal corporate information. The Commission itself has recognized that corporate management may reveal to securities analysts or other inquirers non-public information that merely fills 'interstices in analysis.'" Similarly, the Second Circuit has recognized that the "corporate officer dealing with financial analysts inevitably finds himself in a precarious position, which we have analogized to 'a fencing match conducted on a tightrope.' ....A skilled analyst with knowledge of the company and the industry may piece seemingly inconsequential data together with public information into a mosaic which reveals material non-public information. ( Elkind v. Liggett & Myers, Inc.)

As the SEC noted in the Reg FD adopting release, a company "is not prohibited from disclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer, that piece helps the analyst complete a 'mosaic' of information that, taken together, is material." At the same time, a company "cannot render material information immaterial simply by breaking it into ostensibly non-material pieces." Similarly, the SEC has said that, "since materiality is an objective test keyed to the reasonable investor, Regulation FD will not be implicated where an issuer discloses immaterial information whose significance is discerned by the analyst. Analysts can provide a valuable service in sifting through and extracting information that would not be significant to the ordinary investor to reach material conclusions." Arguably, for example, if a company tells an analyst that an FDA meeting went on for an hour, without more, that information may not be significant to an ordinary investor, but an analyst might have the insight to believe (rightly or wrongly) that an hour-long meeting with the FDA portends positive news.

So when is information disclosed just filling in the interstices or providing fragments for a mosaic, and when is it material information disclosure of which could violate Reg FD? It's a line that's not always easy to discern. What's more, whatever line-drawing takes place, it will always be evaluated by regulators with the benefit of hindsight.

The SEC has infrequently taken action to enforce Reg FD violations, but, in August, the SEC initiated and settled an action against TherapeuticsMD, finding that the company had crossed the line and violated Reg FD on two occasions. The company had been developing a potential new hormone drug therapy for four years, and had just submitted an NDA for FDA approval. The company was expecting to begin discussions with the FDA about marketing and labeling of the potential new drug, but instead, in April, received a letter from the FDA regarding undisclosed deficiencies in the NDA, followed by a Complete Response Letter in May from the FDA that the NDA was deficient because the company had not submitted adequate long-term safety data. Both of those letters were promptly disclosed in press releases and 8-Ks, and both led to substantial stock price declines amid heavy trading. The company also publicly announced a meeting with the FDA that was arranged for mid-June, explaining that "it had two likely paths forward depending on how the June 14th meeting went: either the FDA would allow them to resubmit a revised NDA (putting TX-004HR back on the path to approval), or the Company would pursue formal dispute resolution against the FDA."

June. At the FDA meeting, the company discussed supportive medical studies, including "preliminary data from a soon-to-be published, long-term NIH study with favorable indicators....The meeting lasted an hour and ended without the FDA providing a clear path forward for approval." Expecting inquiries from analysts, company executives held a planning session. Afterwards, consistent with the plan, an executive emailed six analysts, describing the FDA meeting as "'very positive and productive,' and that they would be 'waiting on meeting minutes to decide on the path forward.'" There were also follow-up calls and emails, including one email to an analyst indicating that the company was "pleasantly surprised at how accommodating they [FDA officials] were."

The next day, the stock closed significantly higher on heavy volume, and the NYSE called to ask whether there was any material undisclosed information, to which a company official—unaware of the emails but without conducting any inquiry—replied no. Subsequently, one of the analysts issued a research note using some of the executive's language, and also noting the analyst's positive interpretation of the one-hour duration of the meeting: "in a 'wors[t] case scenario,' the FDA simply reads the CRL and then the meeting adjourns." However, the company had still not issued a press release about the FDA meeting.

July. Over a month later, the company received the formal minutes of the meeting from the FDA, and issued a press release. The press release indicated that the company was able to present new data at the meeting that "could address concerns," but that the therapy was still not on a formal timeline for approval. After issuance of press release, the stock price fell substantially in pre-market and early trading.

In a pre-scheduled analysts' conference call a half-hour later, an executive identified the information submitted to the FDA, forwarded the studies and indicated their impact on safety issues, including the Chief Medical Officer's conclusion that the product did not pose a safety risk. Thereafter, various analysts published research notes with specific information about the FDA meeting and the data submitted, including FDA confirmation that there were no safety signals, that the FDA had been unaware of the large unpublished NIH study and other signs identified as positive. The stock price then rebounded appreciably. The company did not publicly disclose information about the new data provided to the FDA or its impact on safety until its earnings call almost a month later. The SEC Order notes that, at the time of the conduct, the company did not have in place any policies or procedures relating to compliance with Reg FD.

As a result of the conduct described above, the SEC found that the company violated Reg FD for both the June and July disclosures: by providing material, nonpublic information "bearing on TX-004HR's approval prospects to its sell-side analysts," and by "failing to simultaneously or promptly publicly disclose that information" as required by Reg FD. The failure to publicly disclose the material information, the SEC said, put the investing public "at a disadvantage relative to the analysts and their subscribers who were privy to the selective disclosures." The SEC imposed monetary sanctions on the company (not individuals) of $200,000 and issued a cease-and-desist order.

In both of these instances, the company had, very reasonably and understandably, provided the public with cautious bottom-line assessments of the status of its NDA. But, as reflected in the Order, all the data, studies and meeting characterizations that the company provided to the analysts appeared to be unflinchingly positive and inconsistent with the company's public posture. As a result, portraying the data privately disclosed to the analysts as "interstitial" or "part of a mosaic" would likely be quite an uphill climb. And, the sharply upward stock market reactions to analysts' notes and reports in both instances screamed "materiality," making the prospect of meeting that challenge more dubious. Would the SEC's hackles still have been raised had the company's bottom-line public assessments been more consistent with the data disclosed privately to the analysts fleshing out that public assessment? That's a debatable question and, to determine materiality, would depend on a more nuanced analysis of the nature of the precise data and other information furnished to the analysts. But it would likely be an easier case to make. In any event, companies would be well advised to consider carefully before releasing privately to analysts any data or studies or conveying information about FDA meetings or correspondence the substance of which has not already been made public.

Another aspect of the Order that companies may want to remark: as noted above, the SEC Order observed that the company had no Reg FD policy in the course of these violations. In the Reg FD adopting release, the SEC said that, while Reg FD "does not expressly require issuers to adopt policies and procedures to avoid violations, ... we expect that most issuers will use appropriate disclosure policies as a safeguard against selective disclosure....The existence of an appropriate policy, and the issuer’s general adherence to it, may often be relevant to determining the issuer’s intent with regard to a selective disclosure." The Order indicates that the company subsequently implemented policies and procedures that "(a) require public disclosure of material, nonpublic information in connection with Regulation FD, (b) provide examples of types of material, nonpublic information that may arise in light of TherapeuticsMD's business model, and (c) establish specific review protocols for all now external communications, including earnings calls, analyst meetings, and press releases." The company now also provides Reg FD training for employees.

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