What Is Selective Disclosure?
The desire of investors to obtain additional information regarding issuers and conduit borrowers of municipal securities must be weighed against what can be provided to them without violating the U.S. Securities and Exchange Commission’s (SEC) rules. While there is no direct guidance on the application of selective disclosure rules to municipal securities, guidance may be drawn from SEC enforcement actions in this area and how the law is applied to other types of securities.
Selective disclosure may occur when only certain investors are provided material non-public information. Information is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision and view it as having significantly altered the information currently available. SEC Rule 10b-5 prohibits organizations, including municipalities, from making false statements and omitting material information and applies both during and after the issuance of securities. It is imperative for issuers and conduit borrowers of municipal securities to understand what disclosures could result in selective disclosure or violate the anti-fraud rules.
What Is Considered a Violation of Anti-fraud Rules?
A violation of the anti-fraud rules occurs when an organization provides inaccurate information about financial conditions to investors with the hope of obtaining favorable results. An organization also violates anti-fraud rules when it fails to provide adequate information to investors and leaves them to rely on potentially inaccurate public statements. The following are examples of violations of anti-fraud rules:
- An organization received updated financial statements after publishing previous financial statements in connection with a bond issue. Because the updated financial statements showed a substantive negative cash flow, the organization decided not to update the financial statements. Intentionally using outdated financial information to avoid showing detrimental financial changes violates the anti-fraud rules. An organization must always make it clear when information has not been updated and may become stale and therefore inaccurate, false, or misleading.
- An organization had not issued securities before and did not know or understand the relevant rules. Due to lack of knowledge, the organization made fraudulent disclosures and provided inaccurate information to investors. An organization cannot rely on lack of internal procedures or experience in debt offerings to excuse fraudulent disclosures made to investors. An organization must inquire into the relevant rules around selective disclosure and anti-fraud rules before engaging in a debt offering.
Selective disclosure may occur unintentionally and may go unnoticed. The following are examples of selective disclosure:
- An issuer recently settled a lawsuit, but the details of settlement have not been made public. The issuer is aware that the amount it owes will be substantially less than originally expected. The issuer holds a conference call with its current bondholders to provide information related to the lawsuit, but this information was not provided to potential future investors or the market more broadly. To comply with the selective disclosure rules, the issuer should have made the information available to all potential investors not just the current bondholders.
- During an initial issuance, a municipal advisor hosts a general informational meeting for an invited list of potential purchasers on behalf of an issuer. During the Q&A session, an employee of the issuer mentions that a large infrastructure project is significantly behind schedule. This information has not been disclosed to the marketplace broadly. Because the information has now been shared with specific potential purchasers, the issuer must immediately (no later than 24 hours) make the information available to the entire marketplace.
Other examples of when selective disclosure and violations of the SEC’s anti-fraud rules may occur include: (1) posting on websites and social media, (2) conducting roadshows, (3) conference calls or meetings with groups of investors and bondholders or one-on-one conference calls or meetings, (4) certain public statements, and (5) discussions with investor analysts.
Websites and Social Media
- Before posting on a website, analyze whether the post will be deemed public. For a post to be deemed public, (1) the website must be a recognized distribution channel for information about the organization as well as its business, financial condition, and operations; (2) the post must result in dissemination of information in a manner making it available to the securities market in general; and (3) a reasonable waiting period must have occurred for investors and the securities marketplace to react to the information. The SEC has stated that if clearly dated, website disclosures are considered made when posted.
- The SEC has determined that information posted to a website constitutes information reasonably expected to reach investors and is subject to anti-fraud rules. To prevent violations, statements made by employees on social media should be monitored to ensure that they are not false or misleading. Consider monitoring links to third-party sites/content. The use of the links could be perceived as the organization’s endorsement of the information, and the organization could be held liable for any false or misleading statements by the third party.
- Information posted to the Electronic Municipal Market Access (EMMA) website or other investor relations websites, as well as financial and other potentially material information posted elsewhere to the issuer’s or conduit borrower’s website or social media, should be subject to procedural safeguards to ensure compliance with anti-fraud rules.
- Do not make “forward-looking statements” about the organization, its performance, or prospects without providing cautionary language, risk factors, and disclaimers. For social media posts with character limitations, consider embedding a link to where complete information is provided.
Roadshows
- Providing a roadshow to only a few investors may result in selective disclosure.
- To make the roadshow available to all investors, the roadshow should be recorded and made available to all potential investors.
Investor Conference Calls
- Selective disclosure may occur during one-on-one meetings and other communications with investors. These meetings must be limited to discussing information that is already available to the public.
- The best practice is to post all information that will be shared with the investors publicly, for example on EMMA, prior to the private meeting.
Public Statements
- Selective disclosure and the violation of anti-fraud rules may occur during speeches by public officials.
- Any speeches or other written or oral public statements should be vetted to ensure that they do not affect the total mix of information available to investors.
- Specifically, misleading financial information through budget reports, other financial statements, or oral speeches should not be made to the public.
Discussions with Rating Agencies
When reviewing and commenting on rating agency reports, comments should be limited to correcting historical facts that are a matter of public record or supplying inconsequential data. Further, there should not be any hidden communication that conveys material non-public information to the rating agencies by code or signaling.
What Is Material Non-Public Information?
The U.S. Supreme Court has defined materiality as information that a reasonable investor would want to know before making an investment decision. Generally, if the information is material enough to give to a rating agency, then it is likely material enough to be deemed selective disclosure if not disclosed to all investors. Rule 15c2-12 also outlines material events that require notice to be provided on EMMA within 10 business days of occurrence. Pertinent questions to consider in determining materiality of information include:
- Is there a substantial likelihood that an investor would consider the information important in deciding whether to buy or sell securities?
- Will the information alter the “total mix” of information available about the municipality in the marketplace?
- Is the information likely to have a substantial effect on the market price of the municipality’s securities?
How Can One Avoid Selective Disclosure?
Regarding voluntary disclosures, all material information that is reasonably expected to reach investors (whether posted to EMMA, on a website or made available on social media) should be reviewed to ensure accuracy and that it does not omit a material fact necessary to make the statement, in light of the circumstances under which they are made, not misleading. If material non-public information is shared with a rating agency, then obtain express agreement by the rating agency to maintain confidentiality until such information becomes public.
To avoid potential selective disclosure, implement procedures to address selective disclosure to ensure that all investors have equal access to information. Consider adding procedural safeguards for your organization’s social media as well as website and media procedures to the organization’s disclosure policy. Procedures should outline steps for reviewing, approving and correcting posts and including cautionary language. Before using social media, inform investors which social media channel(s) the organization expects to use so they know where to look for information. Do not release material information through social media or your website before releasing through an SEC-recognized channel. This avoids the problem of having to show that the website is deemed public or that all investors are aware of the social media channels used to communicate.
Take care during sensitive disclosure periods, such as during securities offerings or proxy solicitations. Social media posts can be deemed unlawful solicitations or offers of securities with disastrous consequences. Develop an external communications policy that limits the number of individuals authorized to speak for the organization and makes it clear which employees may do so. Develop a policy which outlines information that can be shared by employees and establish a mechanism to monitor statements made by employees to ensure employees are not disclosing material non-public information to reduce the likelihood of inadvertent disclosures.
What Should Be Done after a Selective Disclosure?
If the selective disclosure is “intentional,” the information needs to be provided publicly simultaneously. An intentional disclosure occurs when the person making the disclosure knows or is reckless in not knowing that the information they are communicating is both material and nonpublic. If the selective disclosure was unintentional, public disclosure must be made “promptly” – no later than 24 hours after disclosure – or if later, by the commencement of the next day’s trading.
Takeaways
In conclusion, issuers and conduit borrowers of municipal securities should remember to:
- Consider the anti-fraud rules when making any public statements.
- Be careful with respect to disclosure of material non-public information to only some investors.
- Provide context with any voluntary disclosures.
- Evaluate post-issuance compliance policies to ensure that procedures with respect to selective disclosure and electronic disclosure are included.
Please reach out to the authors of this article or any attorney with the firm’s Public Finance Team if you have questions.