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Public Companies—Public firms are sweating out the SEC’s latest disclosure ruling

A hint here, some direction there. It’s a game company officials and analysts play when they talk about future earnings. Analysts call it “guidance,” and it’s what they use to formulate projections on companies they follow.

The Securities and Exchange Commission contends the guidance executives offer up favor only a few analysts and can create a semblance of insider trading. That’s why SEC officials have established a new rule, Regulation FD, as in “fair disclosure.” It’s scheduled to take effect Oct. 23 , right in the middle of earnings season.

Officials from Southern California public companies said they’re still figuring out what the rule means for them. But one thing is certain, said those familiar with the new rule: Executives and other officials stand to be a lot less forthcoming as they get accustomed to the regulation.

“A lot of executives don’t understand it,” said Tania Jernigan, president of the Orange County chapter of the National Investor Relations Institute and head of investor relations for IMPAC Mortgage Holdings Inc., a Newport Beach-based real estate investment trust.

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The new regulation is a hot topic. Recently, 125 people attended a forum hosted locally by the National Investor Relations Institute to discuss the new rule, Jernigan said.

Restricts Conversations

The rule restricts the private conversations that executives, board directors and authorized spokespeople can have with individual analysts, stockholders or institutional investors. Any company information given to one analyst, stockholder or institutional investor must also be released to a news service or filed with the SEC.

Executives are expected to become even tighter lipped at cocktail parties, media interviews, breakout sessions at broker-sponsored investment conferences or during on-site visits by analysts and stockholders.

Lawyers are worried that executives might violate the new rule merely by telling an analyst, “We’re on track.” The practice of “walking the Street down” to reset analyst expectations will have to be done through a press release or an open conference call.

At Irvine-based software maker StarBase Corp., chief financial officer Doug Norman said he already has advised analysts to consult with their lawyers about the rule. He said he plans to work with them on what can be said under the new regulation.

“If an analyst has something terribly wrong in their model and their forecast is off, the investors don’t blame the analysts. They blame the company,” Norman said. “I do see that as problematic.” Sanctions for violations of the rule are civil, meaning higher-ranking officials could face fines.

‘Shock To Analysts’

IMPAC Mortgage’s Jernigan predicted the rule will be good in the long run. But in the short run, executives will be nervous about what they say. One unintended consequence could be that analysts might be wrong more often, possibly leading to greater stock price volatility. “It will be a shock to analysts,” she said.

A 1995 survey showed a third of the National Investor Relations Institute’s members provided guidance that their companies couldn’t live up to later. In the old days, they could inform the analysts about changes in expectation individually or through a conference call without issuing a news release, which can send a stock spiraling. “Only 47 percent said they would first issue a news release in this situation,” said Louis M. Thompson Jr., president and chief executive of the institute, during his speech before the local chapter. “We knew we had a problem.”

David Erickson, vice president of investor relations for Irvine heart-valve maker Edwards Lifesciences Corp., said he doesn’t believe companies and analysts abuse the current system. But inadvertent mistakes happen, he said.

“When you’re in the heat of the moment and there’s a rapid exchange of information, an executive lets slip a piece of information,” he said. “I don’t think there’s been widespread intent to mask or hide information. But the system that’s been created has put individual investors at a disadvantage.”

The new rule could hamper relations with the media, where many individual investors turn for information. While the media is exempted from the rule , as are rating agencies and customers , the National Investors Relations Institute is recommending that any information provided to a reporter also be made available to the general public. The institute’s Thompson goes a step further, advising companies to not attract media attention.

“In ‘proving’ its case for Reg. FD, the SEC relied almost exclusively on media stories allegedly reporting instances of selective disclosure,” he said. “And, in the future, media stories will most likely be the primary source for test cases.”

IMPAC Mortgage’s Jernigan agreed that the new rule could have a chilling effect.

“There will be a fear factor among executives,” she said. “They’ll be getting guidance from their attorneys who want to be cautious. There will be a lot of confusion. But once it gets worked out, in the long run, it should be OK.”

Edwards’ Erickson said he believes the rule will cause analysts to rely less on executives for information and more on their own interpretations.

“There is this dance that has been played historically as to how big is big in the analysts’ effort to pull this information out of the company instead of getting information on their own,” he said. “This rule will cause analysts to do more analysis.”

Brennan is a reporter for the Orange County Business Journal.

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