SECURITIES LAW DISCLOSURES & SOCIAL MEDIA

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In December 2012, there was quite a stir when the Enforcement Division of the Securities and Exchange Commission (“SEC”) announced that it intended to recommend an enforcement proceeding against Netflix, Inc. and Reed Hastings, Netflix’s CEO due to postings by Mr. Hastings on his Facebook page. The SEC’s case focused on whether Mr. Hastings’ postings constituted sufficient disclosure under the federal securities laws.

This article describes the background of the Netflix case, the legal issues at play, the ultimate result, and a few thoughts on the issued raised.

BACKGROUND

In June 2012, Netflix posted on its corporate blog that Netflix members were getting close to streaming 1 billion hours of its streaming movie and TV service in a month, a first for the company.

On July 3, 2012, Mr. Hastings posted on his personal Facebook page the following message: “Netflix monthly viewing exceeded 1 billion hours for the first time ever in June.” Mr. Hastings had over 200,000 followers on his Web page.

The company’s stock moved up over 6% that day and continued rising over the course of the next few days. By July 9, the overall rise in the stock price was over 22% from the pre-Facebook post stock price.

On December 5, 2012, Netflix filed a report with the SEC stating that the SEC’s Division of Enforcement had sent a “Wells notice” to Netflix and to Mr. Hastings alleging that Mr. Hastings’ Facebook post violated Regulation FD and Section 13(a) of the Securities Exchange Act of 1934, which requires public companies to make certain disclosures with the SEC.

In this same Form 8-K filing, Mr. Hastings also included as an exhibit a Facebook posting that he intended to post the next day rebutting the SEC’s allegations.

DISCLOSURE REQUIREMENTS OF PUBLIC COMPANIES

Netflix’s common stock is listed on the NASDAQ Stock Market, which is a national securities exchange. As a result, Section 13(a) of the Securities Exchange Act requires the company to disclose certain material events.

In 2000, the SEC promulgated Regulation FD, which governs disclosure by issuers. Regulation FD is designed to prevent selective disclosure by issuers and their management of important corporate events, such as earnings updates. The SEC passed Regulation FD due to widespread dissatisfaction with the fact that Wall Street analysts and large investors had access to company executives on conference calls and therefore could trade on that information before other investors received that same information.

Regulation FD is designed to prevent this selective disclosure by requiring issuers to disclose material nonpublic information that is revealed intentionally to everyone at the same time, or if the information is accidentally disclosed, to make a public disclosure promptly thereafter.

METHODS OF DISCLOSURE

Regulation FD officially sanctions the use of a current report (Form 8-K) to make disclosures of material nonpublic information to investors, but this method is non-exclusive; as a result, issuers and management are free to use other methods of ensuing that their disclosures are widely disseminated in accordance with Regulation FD. However, issuers usually file a Form 8-K announcing material events or issue a press release that is disseminated via a national newswire service in order to ensure compliance with Regulation FD.

In 2008, the SEC issued a release providing guidance on the use of corporate Web sites to make disclosures. The SEC noted that using Web sites for such purposes is acceptable, provided that shareholders know that the issuer posts material information there on a regular basis.

Because the 2008 release was issued before social media Web site grew in popularity, many (including, apparently, Mr. Hastings) were uncertain on the application of this guidance to social media, such as Facebook.

OUTCOME OF THE NETFLIX CASE

In determining not to pursue enforcement action against Netflix and Hastings, the SEC issued what is called a Section 21(a) Report of Investigation outlining the SEC’s views on the use of social media to make Regulation FD disclosures. Under Section 21(a) of the Securities Exchange Act, the SEC can issue official reports regarding its positions on certain securities law issues.

In the Netflix Section 21(a) report, the SEC stated that an issuer must (1) disseminate material information non-selectively and broadly, (2) use a recognized channel of distribution for such disclosures, and (3) inform the investing public when it uses or intends to use a non-traditional method of disclosure.

The SEC found that Mr. Hastings’ use of his personal Facebook page did not constitute a recognized channel of distribution since Netflix never advised shareholders (through a Form 8-K, press release, or other notice) that the company could provide updates there. However, the SEC decided not to bring an enforcement action against Netflix or Mr. Hastings due to the perceived uncertainty regarding Regulation FD.

There has not been any further SEC rulemaking or enforcement action regarding the use of social media in making required securities law disclosures since the Netflix investigation and subsequent Section 21(a) report. As a result, we do not have any definitive guidance from the SEC as to what other social media outlets will meet the Regulation FD criteria, although Web sites similar to Facebook should be adequate, i.e. Google+, LinkedIn, etc.

SUGGESTIONS FOR USING SOCIAL MEDIA FOR REQUIRED DISCLOSURES

From the Netflix case, we can divine the following:

  1. Company communications should be made on company Web sites and resources, not personal sites.
  1. If the company intends on making disclosures through social media, it should first inform the investing public of the site it plans to use for these disclosures.
  1. Whatever medium is used for disclosures should have broad distribution.

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