Risk & Compliance

Six Days in June: Behind Office Depot’s Reg FD Violation

A strategy of talking down analyst expectations earned the company, CEO, and former CFO stiff SEC penalties.
Roy HarrisOctober 29, 2010

When Office Depot’s CEO and CFO determined in May 2007 that per-share earnings probably would fall short of analysts’ 48 cent consensus, they devised an unorthodox strategy.

Just after CEO Stephen Odland notified the board of the lower projections on May 31, according to a recent Securities and Exchange Commission settlement agreement, he and then-CFO Patricia McKay held back on issuing a press release, citing incomplete corporate estimates. Instead, on June 20 the Office Depot CEO proposed to the CFO that analysts should be approached one by one to get them to lower their estimates. Two investor-relations executives were assigned the task, using talking points drafted by McKay.

What happened during the next six days — before any 8-K filing or press release issuance — is detailed in an SEC complaint charging Office Depot with violating Regulation FD, the fair-disclosure rule that prohibits companies from selectively disclosing material nonpublic information. On October 21, the agency announced that the company, Odland, and McKay agreed to settle the charges against them without admitting or denying the SEC’s findings and allegations. Office Depot will pay a $1 million penalty, and Odland and McKay will pay $50,000 each. (McKay left the company in February 2008, and Office Depot announced on Monday that Odland is resigning, effective November 1.)

The settlement has been positioned by the SEC as placing a new emphasis on companies not to use indirect analyst communications in lieu of a direct public 8-K filing and a press release.

The SEC’s complaint describes an elaborate and remarkably successful (at least on one level) attempt to improperly manipulate lower analyst estimates. The CFO-designed talking points helped the IR executives in “selectively conveying to analysts and institutional investors” that they should cut their estimates. That indirect approach, however, apparently began to fall apart when certain analysts inquired about why a press release had not been issued. (The SEC also observes that Office Depot had a policy of not offering specific quarterly earnings guidance, but did not have written Reg FD policies or procedures, and had never conducted formal Reg FD training.)

According to Reg FD, “you need to start with that broad communication” — an 8-K filing and a press release — “and then deal with individuals,” says Jeffrey D. Morgan, president and CEO of the National Investor Relations Institute (NIRI). “This was just the opposite, with the broad communication coming at the end.”

The six-day analyst onslaught by Office Depot began with IR getting the talking points, along with instructions on how to get analysts down from 48 cents and toward the 44 cents the company’s preliminary internal estimates foresaw. On Friday, June 22, and the next Monday, the two IR officials called 18 analysts following these points:

• The reason for the call is “just about touching base,” referencing earlier discussions that had noted “head winds that we were facing,” including a softening economy.

• Three specific competitors, which were named, had reported results that “have been interesting” — showing two of them down, and a third mentioning “economic conditions as a reason for their slowed growth.”

• “Some have pointed to better conditions in the second half of the year — however who knows?”

• A final reminder was offered that Office Depot’s model “contemplates stable economic conditions — that is midteens growth.”

“Word of these calls spread among analysts, some of whom believed that Office Depot was ‘talking down’ analysts’ earnings estimates,” the complaint adds. On June 23, McKay e-mailed CEO Odland that two analysts had lowered their estimates, leading him to urge that the calls continue. Through the second day of calls, 15 of the 18 analysts had lowered their estimates, bringing consensus down to 45 cents. However, two analysts expressed concern about the lack of a press release, according to the complaint.

Still, on June 25, McKay instructed the director of IR to call Office Depot’s top 20 institutional investors “and relay the same talking points to them,” the complaint adds.

Office Depot’s stock price fell 2.8% on the first day of the calls, to close at $33.49 on active trading, as part of a 7.7% price fall-off over the six days.

Not until June 28 did Office Depot file an 8-K “disclosing, among other things, that its earnings would be ‘negatively impacted due to continued soft economic conditions,’” the SEC complaint says. In announcing the settlement, SEC enforcement director Robert Khuzami said the selectively shared information illegally “gave an unfair advantage to favored investors at the expense of other investors.”

Although NIRI’s Morgan is “not sure if there are any new wrinkles” in the Office Depot case — the prohibition of such one-on-one communications with analysts “is exactly what Reg FD was originally intended to cover,” he says — he suggests that the case could lead more companies to adopt disclosure policies and establish disclosure committees.