Regulation FD

Why Netflix got into hot water

December 17, 2012: 10:51 AM ET

It might seem like the Netflix case is very different from an insider trading case. But selective disclosure and insider trading are birds of a feather.

FORTUNE -- We've certainly witnessed a bonanza of insider investigations and trials involving corporate secrets in 2012: Raj Rajaratnam of Galleon Group, SAC Capital, and Tiger Asia Management as a few examples.

In all these cases, inside information was the seedling for the alleged insider trading.

Executives are often put in positions where they can take advantage of inside information. Corporate execs are under investigation for insider trading at Big Lots (BIG), VeriFone Systems (PAY), Body Central (BODY), Micrel (MCRL), and Cobalt International Energy (CIE), the Wall Street Journal reported. Based on their analysis, at least 4,185 executives made trades since 2004 that could be suspicious.

Selective disclosure of inside information to just a few people can also lead to misbehavior. It may involve whispering in one person's ear: think Rajat Gupta's alleged leaking of Goldman (GS) board secrets. Or it might involve disclosure of company information just to your Facebook (FB) fans, something the SEC is looking into in the case of Netflix (NFLX). It could involve selective disclosure to your fellow Harvard alumni in a social network group. Or it could involve telling me, an outsider, what is happening inside your company because you want to explain why you might not be able to meet me at a certain time or date.

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It might seem like the Netflix case, which is related to potential selective disclosure of material company information, is very different from an insider trading case. But selective disclosure and insider trading are birds of a feather. CEO Reed Hastings' Facebook message was perhaps not for his immediate personal gain, but he may have unwittingly turned his Facebook readers into insiders.

Regulation FD (Fair Disclosure) -- which requires that companies disclose material information to the public rather than just share it with a select group of people -- was adopted in August 2000 to help make the markets fairer. Harvey Goldschmid, the architect of Regulation FD, was general counsel at the SEC when the rule was formed.  Goldschmid, who later became an SEC commissioner, explained to me several years ago how and why Regulation FD was born.

In the late 1990s, it was possible to hold individuals' feet to the fire if they made money on an insider trade, but it was much harder to address other cases of inside information and trading. One common issue involved sharing information with Wall Street analysts. An executive might provide inside information to an analyst or just a group of analysts, letting them in on what the quarter would look like for their company. The Wall-Streeters in the know might then "trade on it in proprietary terms or their clients would trade. It set up all of the reprehensible aspects of insider trading," Goldschmid told me. While the executive might not pocket any money, he might be buying goodwill or ingratiating himself to his followers. More

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