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SEC wrestles with Internet age in Netflix case

A sign is shown at the headquarters of Netflix in Los Gatos, California September 20, 2011. REUTERS/Robert Galbraith
A sign is shown at the headquarters of Netflix in Los Gatos, California September 20, 2011. REUTERS/Robert Galbraith

By Aruna Viswanatha and Sarah N. Lynch

WASHINGTON (Reuters) - A regulatory probe of Netflix Inc over disclosures made on its chief executive's Facebook page could prove an important test of whether a rule designed to prevent leaks to analysts can translate to the social media age.

The movie and TV streaming service revealed on Thursday that it may face action from the Securities and Exchange Commission if the agency determines the comments from CEO Reed Hastings violate a rule that requires information to be disclosed to investors at the same time.

Hastings' Facebook page had more than 200,000 subscribers, including reporters and analysts, when he told them on July 3 that the company had hit 1 billion hours viewed in June.

By comparison, cable financial news network CNBC had 175,000 viewers and Fox Business News had 59,000 viewers on December 6, according to the website TV by the Numbers, citing Nielsen data.

But the case may not hinge on whether Hastings' Facebook page qualifies as a public dissemination.

Instead, it may come down to two other issues.

One, whether the information was material to investors.

And two, if it was material, whether investors knew that Hastings' Facebook page was a venue to release important company news.

As evidence of materiality, the SEC could point to statements Hastings made earlier in the year highlighting milestones, including hours streamed, as metrics investors should watch.

But the company contends the July 3 comments were not material. It says that the company posted a blog entry a few weeks earlier that said the company was approaching that milestone.

Also, Netflix General Counsel David Hyman testified before a U.S. House of Representatives committee on June 27, and said at the beginning of his testimony that Netflix "delivers close to a billion hours of streaming movies and TV shows to its consumers every month."

Such prior disclosure could hurt any SEC case. "Whether what he said is materially different from what the company has already disseminated, that may be a real challenge for the commission to maintain that position in court," said former SEC lawyer Eugene Goldman who is now with McDermott Will & Emery.

But movements of the company's stock price could bolster an SEC case if the agency can prove the stock jumped on the news. Netflix attributed the jump in its stock price to a positive analyst report released the night prior to Hastings' Facebook post.

The stock closed at $67.85 on July 2, and opened one percent higher the next day at $68.49, on a positive report from Citigroup.

The stock closed at $72.04 on July 3, a six percent jump that would be unusual from an analyst report alone.

'LIVING IN THE REAL WORLD'

The second issue of whether Hastings' Facebook page was a known source of material company news goes to the heart of whether the SEC's rules - and its interpretation of them - are outdated.

SEC adopted the rule at issue, Regulation Fair Disclosure, or Reg FD, in 2000 over concerns that companies were meeting with small groups of analysts or institutional investors and disclosing material information to them.

The concern was that "shortly after these types of meetings, trading would take place on the basis of such information," Goldman said. "This seems a lot different from that."

The new potential action raises questions about whether the rule was designed to address disclosures like the one made by Hastings.

"There's a huge divide between CEOs living in the real world and the financial industry, which lives behind regulatory walls. Reg FD is built for the old way of communicating from behind these walls," said Howard Lindzon, a hedge fund manager and founder and CEO of StockTwits, a social network for traders and investors to share real-time ideas and information about stocks.

Reg FD does not delve into the use of social media for disclosing information to investors. But the SEC issued guidance on the subject in August 2008.

That guidance states that companies can use websites to disclose information as long as they are a "recognized channel of distribution."

To determine that threshold, the SEC lists factors companies should weigh, including whether their site is "posted and accessible" and also whether "the company has made investors and the markets aware that it will post important information" on the website.

Netflix may have hurt itself on this point, if the SEC is able to prove that the information was material.

Hastings acknowledged in a blog posting on Thursday that the company does not "use Facebook and other social media to get material information to investors."

The SEC is likely to home in on that comment as it continues its case against the company.

But Elon Musk, the CEO of Tesla Motors who has posted company-related developments on his Twitter feed, said it is hard to believe that the SEC could consider a CEO's Facebook post to be a narrow release. He noted that reporters regularly follow companies' and executives' social media posts.

"To consider a press release to be a more public venue than a Facebook or Twitter account where someone is followed by hundreds of thousands of people, including the press themselves, is simply untrue," Musk said in an email.

(Reporting By Aruna Viswanatha and Sarah N. Lynch in Washington; Additional reporting by Alistair Barr, Ronald Grover and Nichola Groom; Editing by Karey Wutkowski and Tim Dobbyn)

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