Are We There Yet?

Some argue that an absolute duty to immediately disclose all material information to the public would be the best regime for share markets and suggest that technology now makes such disclosure instantaneous, cheap, and feasible. Others, though disagreeing, argue that such full continuous disclosure would be better than the existing climate of uncertainty. Still others comment that the defensive stance corporates must adopt will in practice soon amount to complete continuous disclosure requirement anyway.

Is the New Zealand business community headed toward de facto “no exceptions” continuous disclosure? And, like children in the back seat of car on long and uncomfortable journey, we might well ask: “Are we there yet?”

Many overseas markets have had some form of continuous disclosure regime in place for years. Experience, usage, and market sophistication have not led to practical, efficient, and effective result. In the United States the rules are now multi-layered: “Regulations” contain individual “Rules”, which in turn refer to “Forms” or “Schedules”, which contain “Items”, which cross-reference other schedules. Then come “Interpretive Releases”, regulatory enforcement proceedings, public comment by regulators, and the courts. One US Cardoso Law Review article, from which I draw heavily for this column, asks if this “smorgasbord” isn’t turning into “indigestible mush”, and concludes that full and accurate description of the situation is: “It is mess.” – Are we there yet?

Managers operate in the competitive world of the “deal flow”. Lawyers try to keep up with changing and evolving regulations. The ability to delay disclosure of confidential business plans, strategies, or events soon comes down to clear-as-mud “maybe”. The manoeuvring room tightens with each new rule or case. Lawyers may advise disclosure as precaution to limit client’s legal liability – as well as their own and that of their insurers.

The more difficult decision is when to advise that client has right to keep information confidential. At some point, the decision becomes so tortured that good lawyer might well conclude that clients ought simply to be advised to honour complete continuous disclosure obligation. – Are we there yet?

Managers who manipulate information flow for personal gain, at the expense of the company and the market, have an obvious conflict that should be condemned. If the managers’ reasons are ostensibly grounded in the firm’s business, the result is much less clear.

Traditionally there has been no general legal duty to disclose material facts, plans, strategies, or other information. The “duty to speak” arises in two circumstances.

* First, periodic reporting: publicly traded firms are required to file annual reports, quarterly reports, etc.
* Second, episodic reporting: an issuer has to file public information on the occurrence of specified events – major corporate transactions, shareholder meetings, tender offers, etc.

New Zealand uses continuous disclosure to supplement periodic and episodic reporting of listed companies. Listing requirements are contracts between the firm and the Exchange for the benefit of shareholders, which can bring an action if either the company or the exchange violates the contract. These actions are rare. Exchanges have two unhelpful incentives.

First, “puffery”: announcing tough rules, allowing lax enforcement, and in classic bargain of mutual convenience, splitting the public relations gain. Such situation may itself be misleading to the market. Second, promulgating rules that are rationalised as giving “confidence to investors” but which are really marketing tools geared to enable the Exchange to compete for business in global market that responds to differentiation in listing rules and enforcement. – Are we there yet?

Disclosure rules rapidly, prolifically, and inevitably breed host of derivative duties.

The “half truth” rule: partial disclosure of facts that are literally correct but misleading in the light of facts that are concealed is as culpable as an affirmative misrepresentation.

The “duty to correct”: incorrect statements made innocently or even negligently must be corrected promptly if the issuer later learns of the error.

The “duty to update”: the requirement to supplement statements that were accurate when made but have become inaccurate or misleading by virtue of subsequent events.

Various courts and regulatory bodies enforce these “duties” even while disagreeing fundamentally on their definition and existence. The seemingly simple rules of continuous disclosure exceptions beget complexity and uncertainty. Silence, press releases, ability to game journalists, analysts, and the regulators – all become valuable tactics. – Are we there yet?

Regulators and courts overseas routinely examine when company’s “no comment” (perhaps after series of explicit denials) is change in pattern that is in itself an admission that might trigger further disclosure duties; examine in great detail and, obviously, in hindsight, consistency with financial information, management commentary, and press releases as much as three years back; assess whether share price movement may have arisen from within company or, for that matter, another company – an acquisition target or merger partner perhaps. All may require mandatory statement to regulator. And perhaps the traditional and simple “no comment” won’t be safe harbour! – Are we there yet?

Information has value to company and its owners. Disclosure may cause reputational injury (caused by embarrassment and an often serious resulting loss of share value) or competitive injury (caused by giving valuable information – business plans, strategies, secrets – to competitors). Disclosure has opportunity costs (what could have been done with information that retained proprietary confidentiality) and liability costs (the legal and litigation expenses of ascertaining the right to maintain confidentiality, and of getting it wrong).

Some managers have committed inexcusable breaches for personal gain at the expense of their company. Does that really give the market sufficient justification to eliminate the possibility that some information has legitimate “best tell” date that managers of integrity, and they are the vast majority, can manage to build shareholder value? And isn’t such management part of the essence of, well, management? – Are we there yet?

So, when contemplating the complexities, here are few (leading) questions to bear in mind.

1) Will “things settle down”, or does this model lead to “a mess”?

2) Will legal advice assist in preserving the value of confidential information, or become mainly defensive?

3) To what extent are the Exchange motives coloured by incentives from within their own business models and competitive international pressures? And to what extent is enforcement vigorous or uniform? I for one will be interested in whether current actions aimed at companies falling unexpectedly short on profits and injuring buyers are matched by actions aimed at those unexpectedly exceeding profits and injuring sellers.

4) By adding continuous disclosure to existing periodic and episodic reporting, are we guaranteeing geometric explosion of complexity and ambiguity?

5) Is continuous disclosure and the potential cycle of press release and market updating and correction likely to lead to “may the best spin win”? Or alternatively, he who manages to say the least the longest preserves most value? kind of Geneva Convention continuous disclosure – name, rank, and serial number…

6) Do you actually believe that more detailed regulation decreases risks for any sector of the public? Or that it deters “bad guys” and “bad” behaviour?

7) Do costs of additional regulation keep more small / medium size players out of the market (off the Exchange)?

8) Has the commercial community sufficiently debated the impact of continuous discl

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