A quick but not-so-simple case study in business ethics follows.
You are the treasurer of Carnation Co., and one day, the company's stock price shoots upward on the New York Stock Exchange. The Dow Jones newswire calls to ask what's going on.
You truthfully reply, "There is no news from the company and no corporate developments that would account for the stock action."
What you don't know is that Carnation's chairman and president have met in secret with a senior official of Nestle, S. A., the Swiss food conglomerate, to discuss a possible merger. Secretive to the core, the Swiss company has warned Carnation it will break off discussions if Carnation makes any public disclosure of the talks.
The true story of the Carnation-Nestle deal and the public denials by Carnation has become a benchmark case for the Securities and Exchange Commission, as it wrestles with the issue of how much inside information corporations should provide to the investing public about sensitive merger negotiations and how quickly that information should flow.
When Carnation Treasurer Michael Malone issued his first denial on Aug. 7, 1984, Carnation's stock opened at just over $62 a share.
On Sept. 4, Nestle announced its intention to buy Carnation for $83 a share.
For the canny investors who deduced or discovered the pending Nestle offer and bought or held onto Carnation stock, the run-up in price of almost $20 a share was a lucractive windfall. One analyst at the time said the professional traders and arbitrageurs "knew what was going on." But for those who shared Malone's ignorance and sold early, the announcement of the deal was a bitter shock.
The SEC found that Carnation's denials were "materially misleading." At the very least, a company spokesman should not be allowed to issue patently false statements in the company's name, SEC commissioners said. But the case illustrates the dilemma such episodes create for companies and securities regulators.
Suppose the SEC had a tougher disclosure requirement that would have forced Carnation to announce the Nestle overture, or publicly correct Malone's inadvertent misstatement.
In response, Nestle might well have terminated the deal. Had it done so, Carnation's stock would not have hit the $83 mark and Carnation shareholders would have lost as much as $700 million, the difference between the company's stock price on Aug. 7 and the Nestle offering price on Sept. 4.
If the point of SEC disclosure requirements is to protect shareholders, full disclosure in this circumstance would have had the opposite effect. The SEC wouldn't have received many "thank you" cards from the shareholders.
Earlier this month, a panel of experts met with SEC commissioners at a day-long panel discussion to seek a clearer understanding of the issue.
On one side was Daniel R. Fischel, a professor at the University of Chicago law school, who argued that early-disclosure requirements could hurt the economy by discouraging valuable mergers. A reasonable amount of secrecy is necessary to protect the value of secret information to the company and its shareholders, whether that information concerns a possible merger, or the discovery of a new, secret manufacturing process, or an oil field, he said.
Others argued that the overall credibility of the market is more important than the rights of a particular shareholder. That credibility is threatened by the kind of misinformation that emerged in the Carnation case, said Gary Lynch, the SEC's director of enforcement.
A loose disclosure policy could prompt abuses in other areas, he said, encouraging companies to duck their responsibilities for public disclosure of a financial downturn or other bad news on the same grounds of protecting their shareholders. "I'm not fond of the suggestion," Lynch said.
"We don't care if we cause information to lose value . . . We're representing the integrity of the marketplace," said Royce Griffin, president of the North American Securities Administrators Association.
If the SEC does act in this area, it could be in a limited way, to give a company a little more leeway in dealing with the disclosure dilemma.
Under current SEC policy, companies are permitted to issue a consistent "no comment" when their stock begins to trade dramatically. But the SEC won't allow a company to deny a rumor, as Carnation did, then switch to a "no comment" stance if the rumor becomes true. If a company denies a rumor, and events make it true, the company is required to say so, under current policy.
As a consequence, more and more companies are sticking to a blanket "no comment" to every query about their stock activity, even when a stock price is being whipsawed by false rumors.
The SEC may permit companies to change from denial to "no comment," thus encouraging a company to be truthful while protecting its interests and those of its shareholders. "We shouldn't be in the position of placing a legal impediment, or a disincentive to companies that want to tell the truth," said SEC Commissioner Joseph A. Grundfest. Beyond that, he sees no easy absolute answers. "Not all problems can be solved easily."