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Going Dark

When a few large public companies decided in 2002 and 2003 that they would no longer provide quarterly earnings guidance, many analysts dismissed it as a fringe phenomenon among a few companies that consistently had trouble hitting their numbers. But while this phenomenon didn't create a sea change in disclosure practices, it grew into a relatively small but important trend.

"There has been a movement away from quarterly earnings guidance for several years now," says Mark Perlow, a partner with Kirkpatrick & Lockhart Nicholson Graham in San Francisco, and formerly an SEC senior counsel. "Many companies, particularly larger and more seasoned issuers, have concluded that quarterly earnings guidance was making their stock more volatile rather than less."

Ironically, governance reforms exacerbated the issue by tightening disclosure standards and prohibiting accounting structures that companies used to smooth out earnings fluctuations from quarter to quarter.

"Even the best companies will have good and bad quarters, and SOX demanded they report those for what they are," Perlow says.

Additionally, the SEC's Regulation Fair Disclosure (Reg FD), which took effect in late 2000, further restricted the way companies talk to investors. The combined effect of the governance reforms was to put even greater emphasis on short-term earnings figures.

"The rules have now been changed to favor a culture of immediate financial gratification without regard to long-term costs," said Tom Donohue, CEO of the U.S. Chamber of Commerce, speaking at a gathering of Wall Street analysts in late November 2005.

Donohue called for issuers to simply stop providing quarterly earnings guidance. "There is no better illustration of the short-term thinking game than quarterly earnings," he said.

In this context, many companies are rethinking their earnings-guidance practices. In-house counsel will discover that while being more tight-lipped about future numbers makes sense from a legal point of view, the business considerations are somewhat more complicated.

The Earnings Trap

Companies are understandably tempted to move away from providing frequent earnings guidance. Even successful companies have suffered serious consequences when they've disappointed Wall Street. And skittish investors combined with the frenzied competition among securities analysts and business media have magnified the focus on quarterly earnings guidance. The result has been stock-price volatility.

"For some companies, providing quarterly guidance was causing the problem it was meant to fix," Perlow says. Earnings guidance generally is intended to give investors advance notice of a company's performance. But it hasn't worked out that way for all companies, and the pressure to beat the street might have driven some executives to play accounting shell games a?? 1/2 la Enron and WorldCom.

Seeing these ills, some prominent executives and investors have called for more companies to follow the examples of Coca-Cola, AT&T, Gillette and other high-profile companies that have pulled back from offering such guidance.

"What we are complaining about is not just the emphasis on quarterly results, but continual management attention on predicting results and then managing toward those numbers," says David Chavern, director of the U.S. Chamber of Commerce's corporate governance initiative.

Ceasing to offer quarterly earnings guidance, however, isn't a popular step with analysts and investors who want more information from issuers, not less.

"Guidance is good for investors and markets in general," says Stephen Quinlivan, a shareholder with Leonard, Street and Deinard in Minneapolis. "Well thought-out guidance helps keep a company's stock price on an even keel."

This issue is arguably less critical for large companies, which can count on thorough analyst coverage whether they forecast numbers or not. And more large public companies thus are joining the trend.

In this environment, how much the movement might grow depends on factors that are difficult to predict--not the least of which is the future direction of federal securities regulation. A key motivating factor is the growing sense of being muzzled by SEC enforcement of securities laws--particularly Reg FD.

The Siebel Chill

The SEC's enforcement of Reg FD has public companies and executives on edge about the liabilities they face when discussing earnings and prospects.

"Regulation Fair Disclosure is a big part of it," Chavern says. "It has pushed the conversation among companies and analysts away from the business and toward the numbers."

The poster child for this concern is the SEC v. Siebel Systems Inc., Kenneth A. Goldman and Mark D. Hanson--in which the SEC brought charges against Siebel Systems and two of its executives for discussing what the Southern District of New York court called "subjective general impressions" about information that was already publicly available.

The decision in favor of Siebel was widely heralded as a victory for corporations concerned about Reg FD enforcement. While the SEC elected not to appeal the case, to what degree the court's ruling has chastened the SEC's enforcement division remains uncertain.

In its defense, Siebel argued that Reg FD violated the First Amendment because it was too vague and effectively abridged free speech among companies and their executives. The district court did not, however, address constitutionality issues in its ruling, and as a result Reg FD remains in force despite Siebel's victory.

Indeed, Judge George B. Daniels included a cautionary footnote in the court's decision: "Although Reg FD pertains solely to the disclosure of information, ?? 1/2 tacit communications such as a wink, nod or a thumbs-up or -down gesture, may give rise to a violation."

This potential is more than hypothetical. In 2003, the SEC charged Schering-Plough Corp. with violating Reg FD through the CEO's non-verbal "demeanor and general expressions" (SEC v. Schering-Plough). The Siebel decision might hearten companies about their chances of prevailing in a court battle with the SEC. But how the SEC's enforcement regime is evolving will remain unclear until the commission brings new Reg FD enforcement actions.

"I wouldn't read the Siebel decision to mean now there's more play in the joints, and we can back off Reg FD compliance," Quinlivan says. "Instead it means the SEC should interpret Reg FD in a commonsense way, and shouldn't build in gotchas for issuers."

Seeking Safe Harbor

Irrespective of how the SEC's enforcement policies might change, Regulation Fair Disclosure remains a strong incentive for companies to review their earnings-guidance strategies.

"The Siebel case isn't a high-water mark," Perlow says. "There are some new currents in the water, but it is not receding. Reg FD is still in effect, and the SEC has shown a strong ability to enforce it."

Thus companies cannot afford to let their guards down, and many will reconsider their earnings-guidance practices. As they do so, they must consider the legal risks in the context of market and business factors. Many public companies--perhaps most of them--likely will maintain the status quo until the risk-reward balance shifts more decisively in favor of going dark.

"When done right, earnings guidance is a good thing," Quinlivan says. "Managing toward short-term expectations is a bad thing, but the two may not be mutually exclusive."


Michael T. Burr

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