Siebel II Dismissed

The August 31 ruling by Judge Daniels of the Southern District of New York in SEC v. Siebel Systems et al. is a powerful rejection of the SEC’s enforcement approach in that case, the second proceeding brought against Siebel under Regulation FD. The allegations asserted that Siebel’s CFO improperly shared material nonpublic information about the company’s business activity in private investor meetings. The SEC also asserted that Siebel violated the requirement to maintain adequate disclosure controls, as well as aiding and abetting violations against the CFO and the company’s chief IR officer at the time of the alleged violations. Finding that the CFO in fact had not disclosed material nonpublic information, the Court dismissed the complaint against all parties in its entirety for failure to state a claim, leaving unresolved Siebel’s challenges to the Regulation’s constitutionality and the SEC’s authority to adopt it. The SEC has not decided whether to appeal.

Siebel provides considerable comfort to companies balancing the imperatives of Regulation FD with the utility of informal investor communications, such as “Q&A” at one-on-one meetings and industry conferences and the fast-growing phenomenon of corporate “blogging” by senior executives. The Court quoted at length from the SEC’s own past statements about Regulation FD, including that its final scope was narrowed to avoid chilling communications and that enforcement would be “focused on clear violations.” Despite the ruling’s favorable implications, we believe companies will not significantly change communication practices, given the SEC’s broad enforcement power and the risk that complex materiality judgments will be second-guessed in hindsight.

We summarize below the key points of the decision, which is also attached.

1. Company statements must be reviewed in context. In a noteworthy procedural twist that provides important protection for companies, the Court rejected the SEC’s assertion that the standard for review compelled it not only to accept the SEC’s allegations as true, but also to limit its review to the portions of Siebel’s public statements cited in the complaint. The Court stated that constraints on judicial notice of documents outside the complaint derive from the absence of notice to the plaintiff, a rationale that did not exist in Siebel: “Since the SEC relied on the non-disclosure in the public statements, as an integral component in the framing of its complaint, the full content of the statements, as oppose[d] to the limited portions the SEC selectively decided to include in the complaint, is properly considered by the Court.”

2. The SEC’s heightened scrutiny is without support and imposes an unreasonable burden. The Court wholly rejected the SEC’s exegesis of the CFO’s statements, noting that the agency “scrutinized, at an extremely heightened level, every particular word used in the statement, including the tense of verbs and the general syntax of each sentence.” Finding no support for this approach, the Court stated that it “places an unreasonable burden on a company’s management and spokespersons to become linguistic experts, or otherwise live in fear of violating Regulation FD should the words they use later be interpreted by the SEC as connoting even the slightest variance from the company’s public statements. Regulation FD does not require that corporate officials only utter verbatim statements that were previously publicly made.” Providing its own detailed comparison of the company’s public and private statements, the Court concluded that they were “equivalent in substance” and that a more demanding standard could impede a broad flow of information to the public.

3. Stock movement is relevant but not sufficient to establish that information was material or nonpublic. Virtually all of the Regulation FD enforcement actions have involved movements in trading prices or volume for the company’s stock, and the Court noted that ”[a] major factor in determining whether information is material is the importance attached to it by those who were exposed to [it] . . ..” The Court concluded, however, that the investors’ reaction to the CFO’s statements – which included buying activity that drove up the stock price – was alone insufficient to conclude that the statements were material or nonpublic. “Significantly,” according to the Court, the CFO’s statements did not “fall squarely” within the types of information identified in the adopting release for Regulation FD as more likely to be material. These include information about earnings, M&A activity or new products; developments about customers and suppliers; changes in company control or management; changes in auditors or auditor notifications about non-reliance on audit reports; and debt defaults. The Court again recalled favorable guidance in the SEC’s adopting release: “The focus of Regulation FD is on whether the issuer discloses material nonpublic information, not on whether an analyst, through some combination of persistence, knowledge and insight, regards as material information whose significance is not apparent to the reasonable investor.”

4. A claim of deficient disclosure controls may not be possible absent an underlying disclosure violation. The Court dismissed the SEC’s count asserting deficient disclosure controls on the basis that there were no factual allegations providing independent support for this claim absent the alleged violation of Regulation FD. The Court’s action is noteworthy in light of the SEC’s allegations about Siebel’s lack of formal Regulation FD policies and training and the fact that no notes were retained by Siebel about the substance of the private meetings, all of which are commonly recommended practices to facilitate compliance with the Regulation. It would be imprudent for companies to conclude, however, that these practices are not important components of a compliance program. The Court’s dismissal suggests instead that a violation of the disclosure controls requirement may not be asserted independently of an underlying violation of the SEC’s disclosure rules.

Please feel free to call any of your regular contacts at the firm or any of our partners and counsel listed under Capital Markets or Corporate Governance in the Our Practice section of our web site if you have any questions.

CLEARY GOTTLIEB STEEN & HAMILTON LLP