The Investor Relations Checklist

The investor relations issues facing a public company are a complicated mixture of legal obligations, practical necessities, and the ever-present danger of shareholder litigation. Below is a list of questions covering some of the most important areas of concern to an investor relations officer & indeed, to company management as a whole. It is important to stress that every company's situation is different and that a company should tailor its investor relations policies to its unique situation.

Context: It's a Dangerous World

• Incidence of shareholder litigation has exploded in recent years
  
• A company that is high growth or in volatile industry can realistically expect to be hit with securities fraud class action at some point in its life
  
• More and more, these lawsuits have focussed on the Investor Relations ("I/R") function in the company
  
• In order to sue because the company missed Street expectations for a quarter, plaintiffs must be able to establish a duty to disclose"
  
  • Typically, the duty to disclose a bad quarter can be based on either:
    
    • Explicit projections issued to the public (e.g., We expect EPS to increase by 35% quarter-to-quarter"); or
      
    • Guidance to securities analysts (e.g., We are comfortable with your earnings estimates for next quarter")
      
  • Given that few companies publish earnings projections, plaintiffs always allege that the company was under a duty to disclose the down quarter because it had guided Wall Street analysts
    
  • If plaintiffs cannot establish that guidance, they will usually lose, wholly apart from other issues as to good faith of the forecasts, materiality, market awareness, etc.
    
• As a result, one of the most important focusses of any shareholder class action will be the I/R function
  
  • How did you guide the Street?
    
  • What did you know when you gave the guidance?
    
  • How did analysts interpret what you told them?
    
• Recent legislation, The Private Securities Litigation Reform Act of 1995, is designed to protect companies when they provide "forward looking" information
  
  • That legislation puts a premium on including appropriate risk disclosures when providing guidance to the Street
    
• What follows are issues that you should talk through with management and your outside securities counsel now, before you get sued
  
  • On most of these issues, there are no right" answers & only tradeoffs involving exposure in a securities suit, credibility with the Street, and degrees of forward-looking guidance
    
  • Suggestions are just that & they do not imply that there is anything illegal, immoral, improper, or imprudent about doing something in a different way from that noted here
    
  • This is presented as a checklist so that you can sit down with management and counsel and work through the items

Existence — and Documentation — of an I/R Policy

1. Have we reviewed our I/R needs lately?

• Many companies implement I/R practices piecemeal, without any overall plan or analysis of objectives and risks
  
• Companies tend to perpetuate their practices even as circumstances change
  
  • For example, a newly public company that is followed by just a few analysts, and that has little track record, may feel compelled to provide greater guidance to the Street than a company that has been public for several years, that has known risks, and that is covered by many analysts
    
  • Similarly, a company that normally provides guidance may enter a transitional period in which its results are much more uncertain; it may decide to reduce or eliminate its guidance until it returns to a more stable cycle
    
• At least once a year (e.g., around the time of the annual report), your company should convene a meeting among the I/R Director, senior management, and securities counsel to decide explicitly what the company's guidance practices will be for the coming year
  
  • Reassessment is also appropriate when entering a riskier period for the company, because of product or market issues

2. Are our I/R policies set forth clearly and in writing?

• There is great value in having a written I/R policy
  
  • It increases the odds that you will do what your management has agreed that you should do
    
  • In the event of a deposition years later, you may not recall the specifics of particular events, but may remember that you made it a point never to deviate from the I/R policy
    
  • In the event of an isolated deviation, the company may be protected by the fact that the conduct in question was not encouraged or permitted by corporate policy
    
• Although there is no good reason not to have a written I/R policy, few companies bother to prepare one
  
  • Take a minute now to add this to your action item list

3. Are our practices consistent with the policy?

• Your I/R policy must reflect the reality of how your management deals with investors
  
• In the event of a shareholder suit, plaintiffs will exploit any differences between the policy and your company's actual I/R practices
  
• Make sure that everyone involved in the I/R process is familiar with (and periodically reminded of) your company's policies

Chain of Command and Information Flow

4. Who can talk to the Street?

• The more narrowly restricted the group that can communicate with analysts and investors, the less likely it is that your I/R practices will get you into trouble
  
• Define the group that has I/R authority (including limited authority to address particular topics) and include those restrictions in your written I/R policy
  
• Many companies limit contact with analysts to the I/R Director, the CEO, and the CFO
  
• To the extent that someone other than the I/R Director can meet with analysts, many companies require the I/R Director to be present during such meetings: to prevent deviations from the policy; to play the bad cop" in refusing to discuss certain topics; and to stay current on senior management's thinking on particular issues

5. Is everyone singing from the same hymnal?

• In a shareholder suit, inconsistent statements by different executives are a plaintiff's best friend
  
• Make sure that an analyst cannot ferret information out of your company by calling around to different execs until he finds one who will talk about something that the rest of you have agreed not to discuss
  
• One way to facilitate consistency is for the I/R Director to prepare (or at minimum review) scripts, Q&A's, etc. for investor presentations — and then discourage ad libbing

6. Is our information up-to-date?

• It is imperative that the I/R Director (or other spokesperson) be kept fully informed, on a realtime basis, with respect to all key corporate developments: forecasts, M&A activity, product developments, market trends
  
• Ideally, the I/R Director should be permitted to attend senior staff meetings at which key issues are discussed
  
• The reality, unfortunately, is that the I/R Director is often farther down the information ladder and may be saying things to analysts that do not reflect the latest thinking of senior management
  
• At minimum, if your company provides any type of forward-looking guidance to the Street, you should regularly review with senior sales and finance executives the continued viability of the guidance that you have given
  
• One of the greatest services that the I/R Director can perform for a company is to ask periodically: do we need to change our guidance?

Review of Analyst Reports

7. Should we review draft analyst reports?

• In virtually every securities case, plaintiffs will allege (without any idea whether or not it is true) that the company reviewed draft analyst reports and commented on the analyst's revenue and earnings models, thereby giving rise to a duty to update if the company's internal projections later drop
  
• Companies' policies on reviewing draft reports tend to vary with their age and size
  
  • A newly public company with little coverage may feel that it has no choice
    
  • Larger, more established corporations often decline

• In general, a company can reduce its securities exposure by declining to review analyst reports

   

8. On what issues should we comment?

• If your company decides that it will review reports, then it should ensure that the topics on which it will comment are consistent with its guidance policies: e.g., if a company will not comment on analysts' estimates in a meeting or phone call, it should not inadvertently deviate from that policy by commenting on EPS estimates in a draft report
  
• Many companies have a practice of correcting objective factual errors in a draft report (e.g., past results, product features), but of declining to comment on forward-looking information
  
  • If that is your company's practice, be sure to include it in your written I/R policy
    
• Do not, even in jest, respond to draft reports with comments that can later appear intended to push the analyst to a more favorable assessment
  
  • By definition, these will become an issue only when you have failed to meet the Street's expectations

Distribution of Analyst Reports

9. Should we send out copies of analyst reports?

• Plaintiffs routinely allege that a company adopted an analyst's projections by distributing copies of his reports to investors
  
• The easiest way to avoid this issue is by declining to distribute analyst reports — they are readily available to investors from a variety of sources
  
• If your company insists on providing copies, consider including a disclaimer to the effect that you are providing the report as a courtesy to the investor and that the company does not necessarily agree with anything contained in the report, which is the independent conclusion of the analyst who wrote it
  
  • Consider whether you are distributing analyst reports fairly or are culling out those you don't like

The Investment Bank's Ethical Wall

10. What should we expect of our bankers?

• Plaintiffs have recently attempted to argue that companies assume the duty to update by providing projections to their investment bankers, who may leak them to the firm's analysts
  
• When providing sensitive information to your investment bankers or underwriters, confirm with them that they observe an ethical wall between their corporate finance and research departments

The Earnings Release Conference Call

11. Should we hold a post-earnings release conference call?

• Most public companies issue earnings releases after the market has closed and then follow up, that afternoon, with a conference call with analysts to discuss the results in more detail than a press release permits
  
• Such calls are usually more efficient than individual calls with many market professionals; they also minimize the risk of selective disclosure to a particular analyst

12. How should we structure the conference call?

• If the information contained in the press release (whether an earnings release or some other significant announcement) is particularly surprising, you may need to schedule the call after the close of extended trading on NASDAQ, not just after the regular market close
  
• The script for the call, along with Q&A's, should be vetted by the entire management team for accuracy, as well as for consistency with the company's I/R policy
  
• Companies differ on whether or not such calls should be tape-recorded; think this issue through with your counsel when you prepare your I/R policy
  
• Don't say anything on such a call that you would not be happy to see in the newspaper the next morning

Forms of Guidance

13. What are the consequences of guiding the Street?

• The topic of analyst guidance on forward-looking information is so vast that it cannot adequately be addressed by generalities; nuances in the message can have significant legal consequences in a shareholder suit
  
• In very general terms (and subject to numerous qualifications), if your company provides specific guidance to the Street as to expected future results, that practice may trigger a variety of legal requirements
  
  • The guidance that you give should have a reasonable, good-faith basis, and should not be significantly undermined by material, adverse, undisclosed information then known to you
    
  • To benefit from the "safe harbor" for forward-looking information created by the recent Reform Act, you should include in your statements a discussion of important factors that could cause actual results to differ materially from your projections
    
    • In the case of forward-looking information that you provide orally (as opposed to in written documents), you can satisfy the "safe harbor": by stating clearly that the information is forward-looking; by stating that actual results could differ materially from the projections; and by referring to a widely available disclosure document (such as a quarterly report on Form 10-Q) that discusses the important factors that could cause actual results to differ from your projections
      
  • If your internal expectations later change materially, and your earlier guidance is still alive in the market, then you need to consider whether you have a duty to update the earlier guidance
    
    • This is subject to numerous caveats and is an area in which the caselaw — and statute — are evolving dramatically

14. How much guidance do we want to give?

• This is the central question in any I/R policy, written or not. In general, the law does not require you to disclose internal projections of future results, but permits such disclosure. As indicated above, the legal ramifications of different levels of guidance vary substantially
  
• In every instance, your guidance policy will be determined, not just by legal concerns, but also by market needs
  
  • Some companies may feel that they have no choice but to inform the market of their expectations as to future results
  • Other companies may decide that they will let the market make its own best guess as to the future, with no input from the company
  • Whatever your company's decision, you should recognize the full legal and market consequences when you draw the line, and then incorporate that decision in your I/R policy

• A particularly important issue is whether your company will give guidance on a quarterly basis, or only with respect to annual results
  
• One of the most unfortunate consequences of the proliferation of shareholder class actions is that many companies have dramatically reduced the information that they provide to investors, in order to minimize their exposure in the event that the forecast does not come true
  
  • The Reform Act "safe harbor" is designed to encourage companies to provide more candid forward-looking guidance, so long as they accompany it with meaningful discussion of the risks that could cause the projections not to come about

15. What method of guidance should we use?

• Again, this will require a lengthy discussion among your executive team. The methods that companies use to guide the Street include the following:
  
  • Including the guidance in the MD&A section of Forms 10-Q and 10-K
    
  • Providing broad parameters in the post-earnings release conference call
    
  • Advising analysts that their estimates are in the ballpark" or are reasonable targets to shoot at
    
  • Questioning the assumptions used by the analyst in developing the earnings model
    
• None of these methods is right or wrong; each has potential legal consequences that you must evaluate when you adopt your guidance policy
  
• The one thing that you can be sure of is that, when your company misses a quarter, whatever guidance you provided will be subject to microscopic scrutiny with the benefit of hindsight; any internal documents that are inconsistent with the guidance will be brandished in court by plaintiffs as smoking guns," ignoring the reality of forecasting in a diverse business entity

16. How should we formulate the guidance?

• Whatever method of guidance you choose, you need to make sure that you can later document that it had a good faith, reasonable basis at the time, and that you continued to assess whether an update was required
  
• Many companies guide the Street to results that are somewhat lower than what they actually expect, in order to give themselves a margin of error
  
• The process of formulating guidance is dynamic, not static. It often begins as soon as the results for the prior quarter begin to shape up. An especially important stage is the preparations for the conference call announcing the prior quarter's results. That should be viewed as integral, not just to the guidance to the Street, but also to the drafting of the MD&A section in the Form 10-Q

17. What about "buy-side" analysts?

• The term "buy-side analyst" is a misnomer. Sell-side analysts, i.e., those who publish reports for the market, provide a function recognized by the courts (although not necessarily by the SEC) in disseminating information in an efficient market. Buy-side analysts" are really traders at large funds or institutions. They rarely disclose information to the market. Information provided to them is subject to serious selective-disclosure (and even tipping) concerns

The Quiet Period

18. Should we adopt a quiet period?

• Most companies stop providing any guidance to the Street near the end of the quarter. The rationale is that information at that point is ultra-sensitive and subject to misinterpretation based on subtle nuances. The later in the quarter a company revises its internal projections, the more likely it is to disclose that revision by press release, not by market guidance

19. How should we implement a quiet period?

• If you decide to adopt a quiet period, the duration can vary. Many companies shut down guidance beginning at the start of the third-month of the quarter, and ending upon issuance of the earnings release. Other companies wait until two weeks before the end of the quarter to start the quiet period
  
• Whatever your quiet period, you should consider stopping all communications with analysts during that period, not just those involving the quarterly results. Analysts are wily creatures: if you talk to them about anything during the quiet period, they may draw inferences (often unintended) about the quarter from comments on other topics or even from the tone of your answers
  
• If you observe a quiet period, then don't tell analysts what your guidance was prior to the quiet period, lest that be misconstrued as suggesting that the prior guidance is still viable

   

• Remember, despite your best efforts, a large enough stock drop can trigger a shareholder suit against even the most honest, well-managed company
  
• You cannot live your professional life preoccupied with plaintiffs' securities lawyers. What you can do is make sure that the policies and practices that you follow are ones that you are proud to defend and that reflect fundamental integrity and good-faith
  
• Even if your company is sued, the tide appears to have turned (at least for now). These suits can be won, and increasingly they are being won. Your efforts in the I/R process will be key to the outcome
  
• Although the recently enacted Securities Litigation Reform Act will not get rid of all meritless shareholder suits, it will over time make companies more secure that, if they have conducted their I/R guidance in a responsible manner (and included appropriate cautionary disclosures), the exposure from a disgruntled shareholder will be reduced substantially

   

Boris Feldman is a partner in the litigation department of Wilson, Sonsini, Goodrich & Rosati.