The SEC has followed through on its promise to continue to focus enforcement efforts on Regulation FD and selective disclosure with its September 9, 2003 charges against Schering-Plough Corporation and its former CEO, Richard J. Kogan. In the most subtle of its FD enforcement actions, the SEC brought charges arising from both verbal and nonverbal selective disclosure of material, nonpublic information about Schering's earnings. To settle the charges, Schering and Mr. Kogan agreed to pay civil fines of $1,000,000 and $50,000, respectively, and to cease and desist from any future Regulation FD violations. The SEC's action reconfirms its commitment to enforcing Regulation FD and follows its first Regulation FD enforcement actions in November 2002, which are discussed in the December 11, 2002 Perkins Coie Update, accessible at our website.

Regulation FD

Regulation FD (fair disclosure) prohibits a public company from selectively disclosing material, nonpublic information to market professionals, such as broker-dealers and analysts, or to its investors if it is reasonably foreseeable that investors will trade based on the information. Material information must be broadly disclosed by the company to the public by filing a Form 8-K or through other methods, such as a press release, that will provide broad, nonexclusionary distribution of the information to the public. Conference calls and analyst conferences comply with Regulation FD if they are accessible to the public through a Webcast or a dial-in number and if the company gives advance public notice of the call or conference.

Charges Against Schering-Plough and Its Former CEO

Schering-Plough manufactures Claritinâ, an extremely successful allergy drug that was facing the loss of patent protection in 2002. Schering-Plough had warned investors that loss of patent protection might have a significant impact on sales.

Private Meetings and Market Activity

On September 30, 2002, Mr. Kogan and other Schering senior executives were informed of internal forecasts of the Company's earnings for the third quarter and for 2002 and 2003 that were significantly lower than Wall Street analysts' consensus estimates for those periods and lower than Schering's prior earnings guidance for 2002. Later that day and the next day—weeks before Schering's scheduled release of Q3 earnings—Mr. Kogan and the senior vice president of investor relations met at previously scheduled, private meetings with analysts and portfolio managers of four institutional investors, including three of Schering's largest stockholders.

Mr. Kogan did not make a formal presentation at the meetings, which followed a question and answer format. He made more explicit or detailed statements about Schering's plans and estimated earnings than had been made in prior Company statements, including:

    • The Company would take a "hard hit" to earnings in 2003 and 2003 would be a "very, very difficult" and "tough" year, in part, due to the loss of a key patent. Previously the Company had said less definitively that the likely adverse effect of the loss of the patent protection "may be mitigated if the Company is successful in its patent litigation."

    • Analysts had not adequately lowered their estimates for the third quarter of 2002. Schering had publicly warned that year-over-year results for the third quarter of 2002 would be significantly reduced, but this was the first time that it commented on analysts' forecasts.

    • Margins would decrease in 2003 due to increased manufacturing expenses and sales of more products requiring royalty payments by Schering, and no significant cost-cutting measures were anticipated for the year. This contrasted with the Company's previous softer warning about royalty and manufacturing expenses.

    • He did not favor any repurchases by Schering of its shares. This contrasted with previous statements that the Company had not decided whether to repurchase stock.

Immediately following the meetings, two analysts downgraded their ratings of Schering's stock. In the three days following the first meetings, Schering's average daily trading volume quadrupled and its share price fell by over 17%. Sales by two of the institutional investors whose portfolio managers participated in the meetings accounted for over 30% of the trading volume.

At a previously scheduled private meeting with a larger group of analysts and portfolio managers on October 3, 2003, Mr. Kogan reiterated many of the statements he made at the earlier meetings. Later that day, Schering released earnings guidance for 2003 and the third quarter of 2002 and revised guidance for 2002 in response to press inquiries and active trading in its stock.

In its Order, the SEC placed Mr. Kogan's actions squarely within Regulation FD by reemphasizing that "[t]he Commission adopted Regulation FD out of concern that issuers were 'disclosing important nonpublic information, such as advance warnings of earnings results, to securities analysts or selected institutional investors or both, before making full disclosure of the same information to the general public.'"

SEC Concern With Nonverbal "Cues" or Communications

The fascinating lesson from Schering is the SEC's focus on nonverbal cues. The Schering action conveys a concern that indirect and nonverbal communications can contribute to the selective disclosure of material, nonpublic information. The SEC states that Mr. Kogan disclosed "negative and material, nonpublic information regarding Schering's earnings prospects" at each of the private meetings "through a combination of spoken language, tone, emphasis, and demeanor." The SEC's Order includes reports of participants' reactions to Mr. Kogan's presentations. Participants referenced negative tones. One analyst downgraded Schering's stock, in part, based on Mr. Kogan's "downbeat" demeanor at the meeting and the amount of time he devoted to discussing the risk to earnings tied to the loss of patent protection.

The Order quotes from prior SEC releases and enforcement actions, stating that "[i]ssuers may not evade the public disclosure requirements of Regulation FD by using 'code' words or 'winks and nods' to convey material nonpublic information during private conversations."

Practical Lessons From Schering

After the Schering action, management may question the upside in having private meetings with analysts or investors. If analysts change stock ratings or substantial trading occurs after a private meeting, the SEC will likely infer a violation of Regulation FD.

Nonetheless, these private meetings will continue. Here is some advice to minimize the risk of violating Regulation FD at these meetings:

    • Follow the Script. Executives should prepare a presentation, rehearse it and then stay on message at the meeting.

    • Do Not Go Beyond Public Statements. Although no one really talks the way press releases and disclosure documents are written, executives should use the language of the company's public statements to address previously disclosed matters and should not venture into new matters unless they are clearly immaterial or have been publicly disclosed.

    • Do Not Confirm or Provide Guidance on Analysts' Estimates. Providing guidance about analysts' estimates, even if similar to previously disclosed company projections, may violate Regulation FD.

    • How You Say It May Be as Important as What You Say. The SEC has made clear that it will assess whether there has been disclosure of material, nonpublic information in light not only of what is expressly stated, but also of how it is communicated through emphasis, tone and body language. The SEC will judge the impact of non-verbal cues with 20-20 hindsight. Participants' inferences from the meeting or conversation may play a role in this assessment.

Text of the SEC Action and Additional Information

This Update is only a summary of the SEC's Action. You can review the full text of the SEC's enforcement action regarding Schering at http://www.sec.gov/litigation/admin/34-48461.htm. You can find further discussion of Regulation FD and other recent laws and regulations of interest to public companies on our website.