Social Media, the SEC and Corporate Disclosure – a Wobbly Three Legged Stool

I’m always surprised by it, but it turns out that some people actually read what I write. In my last post I wrote about the practical implications of the SEC’s recent Netflix social media investigation. In a nutshell, here’s what I said:

“…the release basically establishes a safe harbor for the use of social media which investor relations departments should waste no time in establishing as a prudent risk management tool. The SEC has said that companies should take steps to alert the market about which forms of communications a company intends to use for dissemination of material, non-public information. Therefore, adding language to a company’s web site and press releases to the effect that the company may from time to time use social media sites to disclose important information would seem to be the prudent thing to do.”

Shortly thereafter I received an email from Broc Romanek at TheCorporateCounsel.net (www.thecorporatecounsel.net) explaining his take on the issues at hand. I have a great deal of respect for Broc and will readily admit that he knows more about the ins and outs of how the Securities and Exchange Commission works and thinks about issues than I do. On the other hand, I’ve spent the bulk of my career inside public corporations and have a pretty good feel for that particular viewpoint.  I’ve reproduced (with Broc’s permission) the email exchange below because I think it is a good illustration of the two points of view on this subject.

John – on your blog about the SEC’s guidance, the CYA approach actually is problematic. As borne out on my webcast on this topic last week, I hear that the SEC Staff is not happy with those companies announcing a bevy of SM channels for which they have no real intention of using them as investor communication venues. And investors probably don’t want to be forced to track a bevy of channels for which the company doesn’t intend to provide useful info for them. It’s a loser on both fronts.

thx, broc

Broc:

I recognize that it's problematic, but it is a problem the SEC created. If I was a general counsel, and I had the opportunity to create one more layer of insulation from Reg FD claims, I would grab it. Fear of Reg FD retroactive enforcement is a giant bugaboo for many companies, so doing everything you can to lower the chance that the SEC will open an investigation makes sense.

From an investor's standpoint it is a real headache to follow multiple feeds, but most investor relations departments will take the view that it is not their job to make the analysts' job easier.

I think the CYA approach only works if the social media site is widely followed and qualifies as a recognized channel of distribution, but as more companies use social media, and CEOs become more comfortable with blogging & posting, there has got to be a way to facilitate open communication without constant fear that you will wander into the Reg FD quagmire.

John

John: I believe there is way too much paranoia about Reg FD compliance. Just because a statement may be Reg FD compliant – because a CYA channel was created – it isn’t insulated from a 10b-5 claim that the statement was misleading or omitted something, which will be the more likely result – and much more serious result – when something “material” is posted on a SM channel, particularly Twitter since it is limited to just 140 characters.

Broc

I’m not sure what all the implications of this social media stuff are, but this is probably a good illustration of the law of unintended consequences relating to governmental regulation. The SEC says its OK to use social media to disclose material non-public information if it qualifies as a “recognized channel of distribution” for communicating with their investors, but then is not happy when companies announce they intend to use them. Companies on the other hand, see this as a way to add a layer of protection so they don’t wind up in the SEC’s crosshairs when their CEO either gets carried away when writing a blog or Facebook post or writes something that they genuinely believe is not material as Reed Hastings of Netflix did.

The point of all of this should be to enhance and facilitate the flow of information to investors and allowing social media to serve as a recognized channel of distribution will help accomplish this. 

Practicing Safe Presentations

How many times have you been at a conference and seen a corporate investor presentation that begins something like this:

“Good morning. I’m Joe Terrific, CEO of Godzilla Industries, and I’m here to bring you up to date on all the great things we’re doing. (Pause while he moves rapidly from the title slide, past the safe harbor slide to the beginning slide describing the business.) Here at Godzilla Industries…”

In other words, the safe harbor statement slide is up on the screen fleetingly, but not referred to verbally. The thinking being that they’ve shown the disclaimer about forward-looking statements, all the investors in the room are sophisticated institutional investors and know that when a company makes projections and statements about the future things don’t always turn out the way the company thinks they will. The requirements of the Private Securities Litigation Act of 1995 have been met, right?

Well, maybe not.

A recent ruling by a federal trial court for the Western District of Washington has underlined the need for companies to make sure they verbally reference the safe harbor disclaimer. The case is In re Coinstar Securities Litigation, Case No. C11-133 MJP (W.D. Washington Oct. 6, 2011) and all practitioners of investor relations should take notice of it.

The case involved allegations that on various occasions the management of Coinstar made projections and statements about future expectations that did not come to fruition. As happens in these cases, the lawyers for Coinstar made a motion to dismiss the complaint. This is a motion made early in the proceedings that has the effect of cutting off the litigation before the really big legal bills start to pile up. It is done before pre-trial discovery takes place, which is when a plaintiff can drive a company to distraction by forcing it to produce thousands of pages of documents and produce members of management for time-consuming depositions. Once discovery starts, the chances of the plaintiff wringing a settlement out of the company go way up, as it is often cheaper to settle than to pay hefty lawyers fees for several years running while lawyers pore over boxcar loads of documents in the hope of turning up a smoking gun, with the Russian roulette of a jury trial lurking in the background.

In the Coinstar case, one of the allegations made in the complaint was that forward- looking statements made by company management at an investor conference were false or misleading. In making the allegation, the plaintiffs relied upon a transcript of the presentation, and because the transcript contained no reference to the cautionary language on the company’s presentation slides, the court ruled that for purposes of a motion to dismiss, they could not take notice of something that wasn’t in the record and therefore the lawsuit could proceed on those allegations.

This does not mean that Coinstar lost the lawsuit, but it does mean that the lawsuit can continue and move into the pretrial discovery phase, which is almost as bad as losing. Coinstar did not accompany their safe harbor slide with a simple statement such as, “Statements made in the course of today’s presentation may contain forward-looking information and actual results may differ materially from what we are presenting today. The slide you now see gives you more information on the assumptions and factors we consider in making those forward looking statements and where to go to get more information on our risk factors.” As a result, they have subjected themselves to, at a minimum, additional and unnecessary legal bills, and at worst, the potential of a large settlement or jury award.

So today’s lesson is, just because the safe harbor slide is in every presentation, and everyone has heard it dozens of times before, doesn’t mean that a trial judge will assume investors have heard about it. Practice safe presentations - always refer to the safe harbor statement and slide.

Do You Think You Could Make That More Boring?

Who ever said that an investor presentation has to be boring? (I exclude from this question the lawyers, who as a default position, always feel that boring and incomprehensible is safer than exciting and interesting.)

I was at an investor conference last month and took the opportunity to sit in on several presentations. I think that most of the company presenters must have been listening to their lawyers. After about two presentations I began to tune out because most of what I heard was pretty bland and uninteresting. It was as if the presenters had all gone to the Sgt. Joe Friday school of public speaking. They were determined to give “just the facts” in the most humdrum fashion possible. (For those of you too young to remember, Sgt. Joe Friday was the principal character in the TV drama Dragnet who gave new meaning to the term poker-faced.)

Honestly, how can you expect an investor to get excited about a stock if the company CEO doesn’t show some enthusiasm when talking about the company? Yet that is exactly what I saw at the conference. This was especially true at the beginning of most presentations, when the speaker should be working the hardest to capture the interest of the audience, yet what I often heard was the recitation of bare bones facts about the company without a lot of context to help investors understand the company’s products and position within the industry.

The other major bone I have to pick about what I heard was that most companies thought their job was done when they had explained what their past activities had been. The implication of such a presentation is “Here’s what we’ve done in the past, now you can go ahead and make your own judgment about what we will do in the future without any help from us.” This is like saying that markets are static, conditions are not going to change and we are not working on any new products or markets. This, of course, is nonsense, as American companies and markets are predicated on growth and conditions change all the time. Further, financial theory 101 teaches that investors are buying your stock based upon the value of FUTURE cash flows, so why not give them some guidance about where you are going in the future? Hey, there’s a safe harbor statement about forward-looking statements in every presentation. Why not put it to good use?

All was not terrible, however. There were several successful and engaging speakers I saw at the conference. Generally, these successful speakers seemed to have two things in common. First, they got a little worked up about what their company was doing and what made their products and services unique. Secondly, they allowed some of their personality to come through. This is important because if you’ve ever read any of the surveys of investors and what they care about, quality of management is always high up the list. Yet if management is nothing more than a bland talking head, how can an investor be expected to make a qualitative judgment about them?

After all, who ever said, “I liked your presentation, but you could have been a bit more boring”?

Lawyers Gone Wild

To a certain degree, we are all governed by our experiences. In the case of Wal-Mart, that experience seems to include getting sued – a lot. While I was unable to get exact, recent numbers, a 2001 USA Today report had Wal-Mart stating that they were sued 4,851 times during the year 2000. Another source on the web reported that Wal-Mart was sued 845 times in federal court alone during 1999. The point here is not the preciseness of the numbers, but rather the magnitude, and the simple fact is that Wal-Mart finds itself on the receiving end of lawsuits with great regularity.

Having to deal with plaintiff’s lawyers on such a regular basis would warp the sensibilities of almost anyone and it appears that a bunker mentality regarding being prepared for lawsuits has crept into Wal-Mart’s investor relations pronouncements. How else can you explain the safe harbor language for forward-looking statements contained in their most recent earnings call?

A transcript of Wal-Mart’s third quarter earnings call shows that their safe harbor statement runs 1,316 words, or about 4 1/2 pages of dense, lawyer drafted prose. By my calculations using the transcript available on Seeking Alpha, this was slightly more than 10% of all the words spoken during the call. Interestingly, this was almost 300 words longer that their second quarter safe harbor statement, which came in at a mere 1,038 words. To get an idea of how things have escalated, their fourth quarter 2005 earnings call used a safe harbor statement containing 455 words. At this rate, pretty soon Wal-Mart’s entire earnings call will consist solely of a safe harbor statement.

I am fortunate enough that I don’t get sued with great regularity, so I may not be as sensitized to this issue as Wal-Mart is, but to me it seems like lawyerly overkill. Here’s an example:

“This call will contain statements that Wal-Mart believes are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, and intended to enjoy the protection of the safe harbor for forward-looking statements provided by that Act. These forward-looking statements generally are identified by the use of the words or phrases anticipate, are anticipating, are expecting, assume, could be, expect, forecasting, goal, guidance, guided, is expected, is planning, may affect, plan, will accelerate, will add, will be, could save, will drive, will ring, will be growing, will come, will continue, will cost, will experience, will generate, will grow, will improve, will not continue, will remodel, will see, will spend, will take, would represent, or a variation of one of those words or phrases in those statements or by the use of words and phrases of similar import. Similarly, descriptions of our objectives, plans, goals, targets, or expectations are forward-looking statements.”

The lawyer seems to have parsed through every verb that was going to be used in the call and labeled anything that could possibly be construed as future tense as forward looking. Of course, then for good measure, they throw in the phrase “or a variation of one of those words or phrases in those statements or by the use of words and phrases of similar import” which is legalese for “I can’t think of anything else, but if you can that’s excluded too”. Similarly, it appears as though a lawyer was determined to parse through every statement that Wal-Mart proposed to make during its earnings call, call out anything that could be deemed even slightly a forward looking statement, and specifically disclaim liability for it if things didn’t turn out as represented. That goes on for almost four pages. This is deadly stuff, and I don’t mean that in a positive way. I can’t image what Wal-Mart’s lawyers would do if the company actually took questions from analysts during the call.

All of this points out one of the central tensions of investor relations; the desire of IR practitioners to point out the road the company intends to pursue in order to earn future profits, versus the desire of lawyers to insulate the company from liability in a dangerous world where securities class action attorneys wait to pounce on any slight misstep. I’m not sure where the proper balance exists between these two desires, but management needs to recognize when lawyers are getting in the way of the message and tell them to cut back on the excess verbiage.

Certainly, if the lawyers are taking up over 10% of the message, things have gone too far.