Indirect Communications Can Be Violations of Regulation FD — the SEC's Case Against Office Depot

On October 21, 2010, the SEC announced that it had settled charges against Office Depot, Inc., its CEO, and its then-CFO for violations of Regulation FD¹ resulting in cease-and-desist orders and fines of $1 million for Office Depot and $50,000 each for the CEO and then-CFO. The charges related to Office Depot intentionally communicating “signals” to analysts in one-on-one calls late in the second quarter of 2007 that implied that Office Depot would not meet the analysts’ quarterly earnings estimates. These calls occurred six days prior to Office Depot’s filing a Form 8-K announcing its earnings would be negatively impacted by a softening economy.

Regulation FD² provides that when a company, or person acting on its behalf, discloses material nonpublic information to certain enumerated persons (in general, securities market professionals and holders of the issuer’s securities who may trade on the basis of the information), it must make public disclosure of that information. For an intentional selective disclosure, the issuer must make public disclosure simultaneously.

Office Depot’s Regulation FD Violations

Late in the second quarter of 2007, the CEO alerted Office Depot’s board of directors that Office Depot would likely not meet the analysts’ consensus earnings-per-share estimates for the second quarter and that senior management was developing a strategy to avoid a complete surprise to the market. The CEO and then-CFO were apparently uncomfortable issuing a press release at that time because the internal estimates of earnings per share were not final. Instead of making a public announcement, the CEO and then-CFO jointly decided to instruct the director of investor relations to call 18 analysts covering Office Depot individually and refer them to recent earnings announcements by two comparable companies whose results were impacted by a slowing economy.

The then-CFO and others drafted the following talking points for the director of investor relations to use on these individual analyst calls:

• Haven’t spoken in a while, just want to touch base.
• At beg. of Qtr we’ve talked about a number of head winds that we were facing this quarter including a softening economy, especially at small end.
• I think the earnings release we have seen from the likes of [Company A], [Company B], and [Company C] have been interesting.
  • On a sequential basis, [Company A] and [Company B] domestic comps were down substantially over prior quarters.
  • [Company C] mentioned economic conditions as a reason for their slowed growth.
• Some have pointed to better conditions in the second half of the year – however who knows?
• Remind you that economic model contemplates stable economic conditions – that is midteens growth.

The director of investor relations contacted the 18 analysts over two business days. By the end of the second day of the calls, 15 of the 18 analysts lowered their estimates. The SEC noted in the complaint that on June 22, 2007, the first day of the calls, Office Depot’s stock price decreased 2.8 percent and trading volume was more than double the average volume for that week. Furthermore, the SEC noted that between June 22, 2007 (the first day of calls) and June 28, 2007 (the last market close before Office Depot filed a Form 8-K publicly disclosing that the economy had negatively impacted its earnings), Office Depot’s stock price dropped 7.7 percent.

The SEC noted that:

• Office Depot did not have a written Regulation FD policy and had never conducted any formal Regulation FD training
• Both the CEO and then-CFO had prior investor relations experience and were directly involved in the actions that caused the violation
• The timing of the calls (at the end of the quarter) implied that the calls were based on actual data
• The reaction of the market was a significant movement in both volume and price

Information to Take Away From the Office Depot Enforcement Action

The Office Depot enforcement action was unique in that Office Depot did not directly tell the analysts that it would not meet its earnings estimates; rather, this message was “signaled” to the analysts in individual calls. This case is a stark reminder to companies that even implied signals to the market can create a Regulation FD violation. Furthermore, this case highlights the risk that companies take when they have one-on-one calls with analysts in general and especially near the end of a reporting period.

¹ See http://www.sec.gov/news/press/2010/2010-202.htm.

Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues.

If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:

Michael B. Kirwan
Jacksonville, Florida
904.633.8913
[email protected]

Danielle R. Whitley
Jacksonville, Florida
904.359.8789
[email protected]

John J. Wolfel, Jr.
Jacksonville, Florida
904.359.8778
[email protected]