Reg FD and the Internet Are Somehow Still a Thing
I sort of thought we were done with Reg FD and THE INTERNET being a thing. But no!
Some Scandalous Background
Once upon a time, we had a scandal involving publicly traded companies and the analysts who covered them. From time to time, the analysts would trade positive ratings of the companies they covered (Buy! Buy!) for investment banking business and extra information from those companies that other analysts and investors did not get. People got mad about it, and some of them said one answer was a rule to prevent this selective disclosure of information to only some people without publishing that information to the market generally. Then-SEC chair Arthur Levitt said investors he spoke to couldn’t believe there wasn’t a rule like that already.
So in 2000 the SEC wrote Regulation Fair Disclosure, or Reg FD, which says essentially that if a company releases material information to one party, it has to announce it to everyone. There’s more, but those are the basics.
A Brief History of the Internet
If a company needs to announce material, nonpublic information to the market, it can always just file a Form 8-K. No one will complain. But . . . the internet now exists. You probably know it can be an efficient form of mass communication. Some executives tried to use it to discuss matters at their companies. The SEC caught on and in 2008 issued SEC Interpretative Release 34-58288, Commission Guidance on the Use of Company Web Sites (effective Aug. 7, 2008). The release noted that posting material company information on websites could count as making that information publicly available if:
the site “is a recognized channel of distribution;” and
its posting “disseminates the information in a manner making it available to the securities marketplace in general.”
WebMediaBrands Inc.
This informational two-step was put to the test in late 2010 when CorpFin staff sent comments to WebMediaBrands Inc. on a number of its filings and asked how the CEO’s Twitter account and his blog on the company’s website complied with Reg FD. The company clapped back in a January 2011 letter. Taking the release’s two requirements for publicity in order, the company argued:
It had disclosed the company’s website on a 10-K and noted that its SEC filings and other information about the company could be found there. Also, “[b]ecause WMB is an internet company, its website is the most obvious and recognized source and channel of distribution of company information.”
The CEO’s blog was clearly displayed and readily accessible on the company’s public website, and his tweets were widely distributed to his 2,000+ followers. This distribution fit with the 2008 release’s focus on “the manner in which information is posted” and “the timely and ready accessibility of such information.”
All this talk of “tweets” and 2,000 followers sounds so quaint now. Still, the letter must have been compelling because the SEC didn’t sue WebMediaBrands or the CEO for violating Reg FD.
Netflix
Netflix CEO Reed Hastings tried his luck at the same sort of thing in 2012. In January of that year, Netflix announced by press release and a letter to shareholders that it had streamed two billion hours of content in Q4 2011. In the Q4 earnings call on January 25th, Hastings was asked why this streaming metric was relevant (since Netflix’s revenues are derived through fixed subscriber fees, not based on the number of hours of programming viewed). Hastings explained what seems obvious now, but maybe wasn’t then: at a time when Netflix was transitioning out of its DVD-by-mail model, two billion hours showed “a measure of an engagement and scale” and “widespread adoption and usage of the service.” Also, while he didn’t expect to report hours of streamed content regularly, Netflix would brag about it when it hit big hourly milestones.
On July 3, 2012, just before 11:00 a.m. Eastern time, Hastings posted the following message on his personal Facebook page:
Congrats to Ted Sarados, and his amazing content licensing team. Netflix monthly viewing exceeded 1 billion hours for the first time ever in June. When House of Cards and Arrested Development debut, we’ll blow these records away. Keep going, Ted, we need even more!
This announcement represented a nearly 50% increase in streaming hours from Netflix’s January 25, 2012 announcement that it had streamed 2 billion hours over the preceding quarter. Maybe needless to say since we’re writing about this now, Hastings did not get input from Netflix’s CFO or its legal or investor relations departments before hitting “send”.
Recognized Channel?
Was Hastings’s Facebook page a recognized channel of distribution? At the time it had over 200,000 subscribers, including equity research analysts, shareholders, reporters, and bloggers. On the other hand:
Neither Hastings nor Netflix had previously used that page to announce company metrics.
Neither had taken steps to make the investing public aware that they would do that.
Instead, Netflix consistently directed the public to the company’s own Facebook page, Twitter feed, blog, and web site for corporate information.
In December 2012, Hastings said out loud that “we [Netflix] don’t currently use Facebook and other social media to get material information to investors; we usually get that information out in our extensive investor letters, press releases and SEC filings.”
Generally Available Distribution?
Did Hastings’s post “disseminate[] the [streaming] information in a manner making it available to the securities marketplace in general”? Well, the streaming milestone reached the securities market “incrementally”. About an hour after the post, Netflix sent it to several reporters, but not to the broader mailing list it normally used for corporate press releases. A technology blog also picked it up about an hour later, and a few news outlets published reports within two hours. After markets closed at 1:00 p.m. for the Fourth of July, and several articles in the mainstream financial press and research analysts finally got around to this positive story.
Later that day, Netflix did issue a press release announcing the date of its Q2 2012 earnings release but didn’t mention Hastings’s Facebook post. Netflix’s stock continued a rise that began when the market opened on July 3, increasing from $70.45 at the time of the post to $81.72 at the close of the next trading day.
Even with all of that, the SEC didn’t sue Netflix or Hastings for violating Reg FD. Instead, it issued a Section 21(a) Report of Investigation, a thing it does rarely but sometimes if the state of the law is sufficiently uncertain that it thinks an enforcement action might be inappropriate.
DraftKings
All of this brings us to last Thursday, when the SEC dug into its toolbox and sued DraftKings for violating Reg FD. DraftKings does online betting and fantasy sports. If you’ve ever watched ESPN or any professional sports on TV, you’ve probably heard of them.
The “facts” that follow haven’t been tested in court and are really just allegations. They might not be true! In announcing its Q1 results on May 5, 2023, DraftKings said that growth in states where it had existing operations was a “critical element” of DraftKings’ business model. The comments were made through normal channels that don’t implicate Reg FD, but indicate the materiality of what came later.
Two Posts
At 5:52 p.m. on July 27, 2023, DraftKings’ public relations firm published a post on the personal X account of CEO Jason Robins that said:
There’s massive potential growth in new markets – but we’re still seeing really strong growth in existing states. Our 2018-2019 state vintage grew over 80% on the revenue basis year-over-year in Q1. With those numbers, we expect robust growth even without new states opening.
That same day, the PR firm published a post on Robins’s personal LinkedIn account that said:
Not only do we see a massive potential for growth in new markets – but we’re still seeing really strong growth in existing states.
Our 2018-2019 state vintage grew over 80% on the revenue basis year-over-year in Q1. When you’re seeing that kind of scale out of your existing markets, you can expect many years of robust growth even without new state launches – and of course new state launches will only contribute further.
What’s leading to this growth? Organic demand is growing and we’re also taking market share, we’re increasing our hold rate without losing demand just by offering more ways for customers to play.
#Entreprenuership #StartUps #Business
Some, but not all, of DraftKings shareholders follow Robins’s X and LinkedIn accounts. The statement in both posts that DraftKings was “still seeing really strong growth in existing states” was, until that point, nonpublic. They hadn’t previously said that out loud about Q2. DraftKings’ staff, but apparently not including the communications team, reviewed and approved the posts before they went out.
Some Policies
DraftKings has policies that say not to do social media like this. Its Reg FD Policy says the company observes a “quiet period” running from the last day of the calendar quarter until just after the filing of the next 10-Q or 10-K when employees are prohibited from discussing financial or operational results. The quiet period at issue here ran from June 30 to August 4, 2023. That policy also warns that publishing on social media could amount to selective disclosure. And its social media policy prohibits sharing even potentially confidential financial information via social media without approval of the communications team.
Panic at the Disco
Shortly thereafter, and at any rate within the next 30 minutes, it seems that panic probably ensued. The comms staff recognized the problem and within a half hour told the PR firm to take the posts down, which they promptly did.
But DraftKings made no further disclosures to the general public until August 3, when the company announced its financial earnings, and used a slide deck to note that its existing-states revenue had grown over 70% from Q2 2022 to Q2 2023. In the earnings call the next morning, the CEO and CFO confirmed the importance of the growth in existing markets.
The Upshot
The result is DraftKings has to pay a $200,000 civil penalty and all of its employees with responsibilities relating to corporate communications have to attend Reg FD training. It’s not a disaster, but the investigation was likely expensive and not very fun.
Some Notes
The SEC’s order doesn’t focus on Robins’s follower count on LinkedIn or X. We’re not sure what those numbers looked like in July 2023, but today they sit at 17,000 and 28,000 respectively. It also doesn’t explicitly say – but it seems like it might have and would have been somewhat helpful if it did – that DraftKings never designated Robins’s social media accounts as recognized channels of distribution where investors and analysts could expect to find material information about the company. We assume DraftKings never pointed to those accounts in that way.
What could DraftKings have done differently?
First, because its PR firm had the keys to Robins’s social media accounts, it could have educated the firm on Reg FD and its implications for public statements there. Curiously, its undertaking on Reg FD training outlined in the order reaches only to its employees and not its contractors. Here, the contractors did the initial damage and left the employees to clean it up.
Second, after the initial posts went up on the afternoon of July 27th, the company could and should have filed an 8-K as soon as possible. The rule says that intentional disclosures of material, nonpublic information to less than the entire market have to be accompanied by a simultaneous public disclosure. 17 C.F.R. § 243.100(a)(1). If the person doesn’t know the information is material and nonpublic, the company has to make a follow-up disclosure “promptly”. 17 C.F.R. § 243.100(a)(2). Here, DraftKings waited seven days before doing anything to cure the mistake. With an 8-K filed in a couple of hours they could have argued with a straight face that the initial disclosure was not intentional and executed by a PR firm that had gotten too far out over its skis.
Third, if it really wanted to use Robins’s social media or the company’s own website to publish financial or operational information – and it’s not clear to us that it actually does – it could have used a 10-K to designate those channels and separately make them easily accessible to investors.
Still, we’re glad to see Reg FD back. It’s been too long.
Bethany McLean, The Real Culprit in the Analyst Scandal, Fortune (Jan. 9, 2006)
Joel Seligman, The Transformation of Wall Street, 653 (2003)
Letter from Donald R. Reynolds to the Division of Corporation Finance (Jan. 7, 2011)
In re DraftKings Inc., Admin. Proc. File No. 3-22205 (Sept. 26, 2024)