Monthly Archives: April 2013

#InsidersBeware: Social Media and Regulation FD

Many CEOs have now obtained celebrity-like status.  And like their Hollywood counterparts, they have made themselves more digitally connectable through social media.  Last July, Reed Hastings (CEO of Netflix) announced to 200,000+ of his dearest “friends” that his company had streamed 1 billion hours of its online library during the single month of June.  His forum was not a quarterly earnings call or an official press release, but instead his Facebook wall.  Here’s the actual post (no, I’m not Facebook friends with Reed…my friend request was blocked due to an excessive number of pending friend requests in Reed’s queue):


The SEC’s Division of Enforcement, concerned that Hastings may have violated Regulation FD, began a formal investigation that led to a report issued on April 2, 2013 (the “Report”).

Reg FD Refresher

In a nutshell, Regulation FD says that when a company shares material, non-public information to securities professionals (think investment advisers) or shareholders where such information would be a basis for making an investment decision, then the company must contemporaneously share that same information to the public at large.  As the SEC stated in its report, “Regulation FD was adopted out of concern that issuers were selectively disclosing important nonpublic information, such as advance warning of earnings results, to securities analysts or selected institutional investors before making full disclosure of the same information to the general public.”  The Commission went on to say,

In our previous statements on Regulation FD, we have recognized that the regulation does not require use of a particular method, or establish a “one size fits all” standard for disclosure. We did, however, caution issuers that a deviation from their usual practices for making public disclosure may affect our judgment as to whether the method they have chosen in a particular case was reasonable.


The SEC’s 2008 Guidance

In 2008, the SEC issued a report entitled Commission Guidance on the Use of Company Web Sites (the “Guidance”).  In the 2008 Guidance, the SEC addressed the growing use by public companies of the internet as a means for disseminating (either intentionally or inadvertently) material, non-public information.  At the time, the Commission was primarily concerned with companies’ websites, although the Guidance certainly acknowledged that internet technology and media may change in the future, so cautioned against a rigid interpretation of the Guidance.

As explained in the 2008 Guidance,

Whether a company’s web site is a recognized channel of distribution will depend on the steps that the company has taken to alert the market to its web site and its disclosure practices, as well as the use by investors and the market of the company’s web site.

And then restated slightly in the Netflix Report,

The central focus of this [recognized channel] inquiry is whether the company has made investors, the market, and the media aware of the channels of distribution it expects to use, so these parties know where to look for disclosures of material information about the company or what they need to do to be in a position to receive this information.


Social Media as a Channel

In issuing the Report, the SEC took the opportunity to expound on Regulation FD in an effort to clarify its application to disclosures made through social media channels.  Using the facts of the Netflix CEO’s Facebook posting as its backdrop (although they stressed every cases will be determined on its own facts), the SEC made two key points:

  1. A company’s communications through social media require careful Regulation FD analysis; and,
  2. The 2008 Guidance applies by extension to disclosures made via social media.

So, if a company finds itself in a position like Netflix, the key question seems to be whether the social media channel, in a given case, provides an avenue for the information to be disseminated in a manner reasonably designed to provide “broad, non-exclusionary distribution of the information to the public.”  And, more specifically, whether the particular forum is a “recognized channel” of distribution for communicating with the company’s investors.  The SEC does not provide a bright-line rule, but instead points to factors that may support a finding that a given social media channel is a “recognized channel,” for example,

Disclosures on corporate web sites identifying the specific social media channels a company intends to use for the dissemination of material non-public information would give investors and the markets the opportunity to take the steps necessary to be in a position to receive important disclosures —e.g., subscribing, joining, registering, or reviewing that particular channel.


So, did Hastings’ Facebook Post Violate Regulation FD?

Interestingly, the Report makes clear that Hastings’ post would generally run afoul of Regulation FD, when evaluated in light of the established channels that Netflix made use of prior to the post.  The Commission states,

Although every case must be evaluated on its own facts, disclosure of material, nonpublic information on the personal social media site of an individual corporate officer, without advance notice to investors that the site may be used for this purpose, is unlikely to qualify as a method “reasonably designed to provide broad, non-exclusionary distribution of the information to the public” within the meaning of Regulation FD. (emphasis added)

Moreover, the Report highlights a series of facts that would seem to cut against Netflix’s position:

  • The information Hastings disclosed was “material”

During Netflix’s 2011 year-end and fourth quarter earnings conference call on January 25, 2012, 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 that streaming was “a measure of an engagement and scale in terms of the adoption of our service and use of our service. . . . . It [two billion hours streaming in a quarter] is a great milestone for us to have hit. And like I said, shows widespread adoption and usage of the service.”


Netflix’s stock continued a rise that began when the market opened on July 3, increasing from $70.45 at the time of Hastings’s Facebook post to $81.72 at the close of the following trading day.


  • The information Hastings disclosed was “nonpublic” 

Prior to his post, Netflix did not file with or furnish to the Commission a Current Report on Form 8-K, issue a press release through its standard distribution channels, or otherwise announce the streaming milestone.


  • Hastings’ Facebook page implicates Regulation FD since the material, nonpublic information was shared with at least some shareholders and securities professionals

Facebook members can subscribe to Hastings’s Facebook page, which had over 200,000 subscribers at the time of the post, including equity research analysts associated with registered broker-dealers, shareholders, reporters, and bloggers.


  • Hastings’ Facebook page is probably not a “recognized channel of distribution”, such that disclosure of this material, nonpublic information was not made to the general public

Neither Hastings nor Netflix had previously used Hastings’s Facebook page to announce company metrics. Nor had they taken any steps to make the investing public aware that Hastings’s personal Facebook page might be used as a medium for communicating information about Netflix. Instead, Netflix has consistently directed the public to its own Facebook page, Twitter feed, and blog and to its own web site for information about Netflix. In early December 2012, Hastings stated for the public record 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.”

Yikes, this sounds like Netflix is going to get pummeled by the Commission, right?  Wrong. The SEC surprisingly declined to file an enforcement action against Netflix based on Hasting’s Facebook post.  The Commission stressed their policy position that communication with investors is a good thing, stating in relevant part,

We do not wish to inhibit the content, form, or forum of any such disclosure, and we are mindful of placing additional compliance burdens on issuers. In fact, we encourage companies to seek out new forms of communication to better connect with shareholders.

So, it remains somewhat unclear what facts would trigger an enforcement action on a Regulation FD theory in the social media disclosure context.  But, what is clear, is that the SEC has taken notice of social media communications made by, or on behalf of, publicly traded companies.  Whether, and to what extent, the Commission is prepared to exercise their enforcement authority in this arena remains to be seen.

Takeaways, if any

Ultimately, what should be gleaned from the Commission’s Report is that although there may be corporate marketing or branding benefits that are gained with an accessible CEO, there are also legal constraints that must be considered when this CEO takes to the social network scene to share company-related information.  Companies should immediately self-audit and determine what social media or networks are in use by its officers and directors, and with that information determine whether such outlets should (or could) become a distribution channel of information.  Armed with a listing of “potential” distribution channels (i.e., those not traditionally used for distributing information), the company should then publish (on their website, Form 8-K, and/or press releases) the identity (whether corporate or personal, as with Reed Hasting’s) associated with these social media channels, their web/app location, and the method for registering or subscribing to receive updates.  And, as always, corporate counsel and compliance officers should provide proactive training to their officers and directors on the proper use of social media, thereby maximizing the commercial benefits to the company while mitigating the inherent risks of such conduct.

Capitol Records v. ReDigi: Used Digital Music Not for Re-Sale

If you are (or should I say, were) a ReDigi user, you’re probably wondering why your marketplace is gone. On Saturday, the Federal District Court for the Southern District of New York determined that ReDigi’s entire business model infringes on copyright holders’ exclusive rights to reproduce and distribute their works, in Capitol Records v. ReDigi (No. 12 Civ. 95 (RJS) (March 30, 2013).

So, for those of us who buy our music “brand-new” from Amazon and iTunes, what exactly is this ReDigi? Essentially, ReDigi provides a marketplace where sellers can resell their “used” music to willing buyers. Here’s how ReDigi describes their service:

Not surprisingly, Capitol Records took issue with ReDigi’s practice and so brought suit not more than 4 months after ReDigi went live back in October 2011. Among other things, Capitol claimed violation of its copyrights on the basis of ReDigi’s unauthorized (1) reproduction and (2) distribution of the underlying protected works. ReDigi attempted to defend against these two claims, arguing (1) the digital reselling method that it employed did not involve reproducing (or “duplicating”) the music because only one music file existed before and after the transaction between users, and (2) its distribution of a music file from one user to another user is protected under the first sale defense.

Of course, there are other aspects of this case, such as fair use defense, liability (direct and secondary infringement), and claims of violation of rights to publically display and perform, but for the purposes of this post, I find the issues I’ve identified above as the most interesting; and, I’m anticipating that they are also the most likely to be closely scrutinized on appeal.

Since I spoiled all suspense as to who won this case in the first paragraph, I’ll turn to the Court’s opinion as penned by Judge Richard J. Sullivan for the rationale.

Right to Reproduce

As to the infringement of Capitol’s exclusive right to reproduce its protected music, the court states, “the plain text of the Copyright Act makes clear that reproduction occurs when a copyrighted work is fixed in a new material object.” The court relies heavily on London-Sire Records, Inc. (D. Mass. 2008) to define the “material object” requirement:

[w]hen a user on a [P2P] network downloads a song from another user, he receives into his computer a digital sequence representing the sound recording. That sequence is magnetically encoded on a segment of his hard disk (or likewise written on other media). With the right hardware and software, the downloader can use the magnetic sequence to reproduce the sound recording. The electronic file (or, perhaps more accurately, the appropriate segment of the hard disk) is therefore a “phonorecord” within the meaning of the statute. 

According to the Court, “this understanding is, of course, confirmed by the laws of physics, [as it] is simply impossible that the same ‘material object’ can be transferred over the Internet […] because the reproduction right is necessarily implicated when a copyrighted work is embodied in a new material object, and because digital music files must be embodied in a new material object following their transfer over the Internet, the Court determines that the embodiment of a digital music file on a new hard disk is a reproduction within the meaning of the Copyright Act.”

Essentially, this issue turns on what exactly is a reproduction under the Copyright Act. ReDigi’s argument, and entire business model for that matter, relied on the notion that a reproduction means duplication, as in where there existed one copy of a song there are now two (or more) copies of that song. The court is unmoved by ReDigi’s argument that its technology ensures that only one copy of the song exists at all times during the lifecyle of a ReDigi transaction. As the court states,

ReDigi stresses that it “migrates” a file from a user’s computer to its Cloud Locker, so that the same file is transferred to the ReDigi server and no copying occurs. However, even if that were the case, the fact that a file has moved from one material object – the user’s computer – to another – the ReDigi server – means that a reproduction has occurred. Similarly, when a ReDigi user downloads a new purchase from the ReDigi website to her computer, yet another reproduction is created. It is beside the point that the original phonorecord no longer exists. It matters only that a new phonorecord has been created.

This determination on the reproduction issue was the death knell for ReDigi. While they asserted a fair use defense, it was feeble and quickly dismissed by the court.

Right to Distribute

As to the distribution issue, ReDigi did not (nor could it) argue that distribution does not occur on its website. Instead it relied on the first sale defense (in addition to the unsuccessful fair use defense mentioned above). The first sale doctrine only applies to a defense against infringement of the right to distribute. The defense allows “the owner of a particular copy or phonorecord lawfully made under this title […] to sell […] that copy or phonorecord” without the permission of the copyright owner. This once common law principle is codified in the Copyright Act at 17 U.S.C. § 109. As the Court acknowledges, “under the first sale defense, once the copyright owner places a copyrighted item (here, a phonorecord) in the stream of commerce by selling it, he has exhausted his exclusive statutory right to control its distribution” citing to Quality King Distribs., Inc. v. L’anza Research Int’l, Inc., 523 U.S. 135, 152 (1998).

The Court discards ReDigi’s first sale defense for two reasons. First, since the Court already concluded that ReDigi violated Capitol’s right to reproduce above, the Court went on to reason that all digital music files sold on its website are not “lawfully made under this title.” Second, the Court reads Section 109 as limiting the first sale defense to “only distribution by the owner of a particular copy or phonorecord of that copy or phonorecord.” Interestingly, the Court applied this reasoning to the facts of this case as follows:

Here, a ReDigi user owns the phonorecord that was created when she purchased and downloaded a song from iTunes to her hard disk. But to sell that song on ReDigi, she must produce a new phonorecord on the ReDigi server. Because it is therefore impossible for the user to sell her “particular” phonorecord on ReDigi, the first sale statute cannot provide a defense. Put another way, the first sale defense is limited to material items, like records, that the copyright owner put into the stream of commerce. Here, ReDigi is not distributing such material items; rather, it is distributing reproductions of the copyrighted code embedded in new material objects, namely, the ReDigi server in Arizona and its users’ hard drives.

The Court’s statutory construction is certainly one logical interpretation of the statute governing the first sale defense. That said, the Court doesn’t cite an authority other than the statue itself in quickly dismissing ReDigi’s best defense to its infringement on the distribution claim.

Needless to say, I’m guessing this will be closely reexamined at what most certainly will be an appeal to the Second Circuit. Stay tuned, as this decision and its appeal will undoubtedly have impacts beyond ReDigi to other online marketplaces that either currently facilitate used digital sales or looking to do so in the future (think used e-books for your Kindle).