March 28, 2005

SEC Brings 1st Reg FD Case for Reaffirmation of Expectations

In the first case involving a company reaffirming its previous expectations for earnings, the SEC announced Thursday that it had settled Reg FD charges against Flowserve Corporation, its CEO and its Director of Investor Relations. In the face of this complaint, the company and the CEO consented to pay civil penalties of $350k and $50k, respectively, and the Company, CEO and IR Director consented to a cease-and-desist order. This also is the first time an IR officer was part of an SEC action regarding a Reg FD violation.

The Facts and Allegations: In late September ’02, the company lowered it ’02 calendar-year annual earnings forecast – which it then confirmed in its 10-Q filed on October 22. The SEC alleged that at a private meeting of the CEO and IR Director with analysts on November 19, the CEO reaffirmed this earnings guidance in response to a question (during which the IR Director was silent).

On November 20, one of the analysts issued a report distributed to First Call subscribers stating that the company had reaffirmed earnings guidance, and on the following day, the stock went up about 6% on increased trading volume. After the close of that day, November 21, the company filed an 8-K reporting that it had reaffirmed its guidance in a conversation with analysts.

The company had a disclosure policy to respond to questions about “comfort” with guidance as follows: “Although business conditions are subject to change, in accordance with Flowserve’s policy, the current earnings guidance was effective at the date given and is not being updated until the company publicly announces updated guidance.”

The SEC found that the IR Director did not caution analysts prior to the meeting as to what topics were off-limits for their discussion with the CEO – and did not reiterate the company policy at the meeting.

What The Case Means: This case should help resolve the ongoing debate about how much time is acceptable since the company last gave public guidance to make a private reaffirmation. I believe someone from the SEC Staff said a while ago that confirming a month later clearly would be a problem and this case proves that point.

Some law firms had been suggesting one week is the rule of thumb to use, but I am not sure that many companies followed that guidance. Factors to consider include where is the company in its earnings cycles (ie. it’s safer to confirm guidance in the first half of a quarter than in the second) and whether there have been any intervening circumstances since the company’s last public guidance or reaffirmation (ie. would these intervening circumstances likely cause a reasonable investor to question the continued accuracy of the last estimate).

Until we hear more from the SEC Staff, a safe rule of thumb might now be that a week is okay, but longer can be risky (depending on the circumstances, of course) – any confirm creates risk and the longer the time lapse, the greater the risk. This area is ripe for a webcast now and I am “on it.”

PCAOB to Consider Standard Regarding Corrections of Internal Control Material Weaknesses

On Thursday, the PCAOB will hold an open meeting at 10 am to consider proposing a standard that would permit, but not require, auditors to report on a company’s assertion that it had eliminated a previously reported material weakness in its internal control over financial reporting.

Wal-Mart’s Vice Chair Resignation and the Federal Sentencing Guidelines

On Friday, as disclosed in a Form 8-K under Item 5.02, Wal-Mart’s Vice Chair resigned – and 3 employees were fired – following an internal probe of misappropriated funds; somewhere between $100k-$500k of personal reimbursements, payment of third-party invoices and the use of company gift cards falsified by the Vice Chair (who was the 2nd highest executive officer until he retired in January).

Keith Bishop notes that the interesting aspect of this development is that it appears that Wal-Mart has taken to heart the November 2004 amendments to the federal sentencing guidelines. By conducting an investigation and terminating the Vice Chair, it appears that the company is meeting the sentencing guideline requirement that its compliance program is enforced through “appropriate disciplinary measures for engaging in criminal conduct.”