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Netflix CEO receives so called “Wells Notice” from SEC

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Reed Hastings, CEO of Netflic has received a so called “Wells Notice” (precursur to a civil claim) from the feared U.S. Securities and Exchange Commission. The Wells Notice relates to a July Facebook post that coincided with the stock’s biggest gain in almost six weeks.

SEC staff alleges Netflix and its CEO violated rules governing selective disclosure, according to a company filing yesterday. The July 3 post by Hastings said Netflix viewing “exceeded 1 billion hours” of videos in June. The shares rose 6.2 percent that day.

The SEC action highlights the potential for legal trouble when company executives like Hastings, who has more than 200,000 Facebook fans, communicate with the public via social media and adds a new minefield to securities regluation. The Regulation Fair Disclosure which is aimed at preventing selective reporting, was passed by the SEC in 2000, before the explosion of social-media outlets like Twitter & Facebook. The SEC directive requires public disclosure, such as through a press release on a widely disseminated news or wire service, or by “any other non-exclusionary method” that provides broad public access. In June, Hastings had posted on his company blog that members were viewing “nearly a billion hours per month.” With neither the June blog post nor the July Facebook post did he issue the mandatory press release or an 8-K filing with the SEC.

What constitutes public disclosure?

“This may be a case when the SEC needs to play catch-up,” said Charley Moore, executive chairman and founder of San Francisco-based online legal services firm Rocket Lawyer. “Disclosing information to 200,000-plus Facebook users is basically the same as issuing a press release.”’

“We think the fact of 1 billion hours of viewing in June was not ‘material’ to investors, and we had blogged a few weeks before that we were serving nearly 1 billion hours per month,” Hastings said in the filing. “We remain optimistic this can be cleared up quickly through the SEC’s review process.”

Both Netflix the company and Hastings each received a Wells Notice, which the SEC sends to a company or an individual after its staff has determined that sufficient wrongdoing has occurred to warrant civil claims being filed.

Though the SEC might argue Netflix and Hastings violated a rule by not issuing an 8-K filing with the Facebook post, that doesn’t mean they committed a material infraction, Rocket Lawyer’s Moore said.

Icahn stake building

Netflix shares fell as much as 3.4 percent to $83.25 yesterday in extended trading on release of the news. The shares climbed 3.4 percent to $86.17 in regularrading and have advanced 24 percent this year – the majority in recent weeks on news of Carl Icahn taking a 10% stake via the options market

YTD daily chart

Company executives are increasingly using social media as a tool to communicate with customers and investors. On Dec. 4, Paypal billionaire Elon Musk, chairman and CEO of Tesla said on Twitter his electric-vehicle company was cash-flow positive.“ I am happy to report that Tesla was narrowly cash flow positive last week,” Musk, 41, wrote to his almost 113,000 followers. “Continued improvement expected through year end.” Musk’s message, which was re-posted more than 600 times by Twitter users, provided no additional information.

Testing the boundaries of info dissemination

Silicon Valley has been testing the boundaries of the SEC’s disclosure rules for years. Some technologists have argued that the Internet has made it easier for people to obtain information, thus making other methods of issuing news such as press-release services less valuable.

A champion of this idea was Jonathan Schwartz, former CEO of Sun Microsystems, who challenged the SEC’s limitations on what constitutes public disclosure of material corporate information.

In 2007 Schwartz posted Sun’s earnings releases on the company’s investor relations website 10 minutes before distributing it through the traditional channels. Schwartz called the SEC’s requirements “anachronistic.”

The following year, the SEC relented, allowing companies to disclose information solely on their websites, as long as they met certain criteria. Netflix regularly releases its earnings results on its website.

“We think posting to over 200,000 people is very public, especially since many of my subscribers are reporters and bloggers,” Hastings said yesterday of his Facebook account.

On July 3, the day of Hastings’s mid-morning Facebook post, Netflix shares had their biggest gain since May 23. In yesterday’s filing, he said the stock was already climbing because of a positive research note from a Citigroup analyst, which called Netflix shares “highly reasonable” with a target price of $130. They closed at $72.04 that day.

“It’s interesting to wonder whether disclosure via a post seen by 200,000 people is more selective than a press release and an SEC filing seen by some unknown number,” said Erik Gordon, a professor at the University of Michigan’s law school and business school. This “could be a tough, precedent-setting case.”

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