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Fear and Loathing on the IR Trail: Class Actions, Enforcement Proceedings and Restatements. Jerome F. Birn, Jr. March 18, 2005. Topics. Shareholder Class Actions SEC & U.S. Attorney Proceedings Reg. FD MD&A Safe Harbor SOX 404 and Erosion of Materiality. Shareholder Class Actions.

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fear and loathing on the ir trail class actions enforcement proceedings and restatements

Fear and Loathing on the IR Trail:Class Actions, Enforcement Proceedings and Restatements

Jerome F. Birn, Jr.

March 18, 2005

topics
Topics
  • Shareholder Class Actions
  • SEC & U.S. Attorney Proceedings
  • Reg. FD
  • MD&A
  • Safe Harbor
  • SOX 404 and Erosion of Materiality
shareholder class actions
Shareholder Class Actions
  • Filing trends
  • Institutional plaintiffs
  • Evolving case law
  • Personalized exposure
sec u s attorney proceedings
SEC & U.S. Attorney Proceedings
  • New attitude
    • A crime is a crime
    • Aiding & abetting
  • Explosion of chain-of-command: whistleblowers
  • Up and down the org chart
  • Enforcement as retrospective regulation
  • What they expect
    • Independent internal investigation
    • Discovery costs and burdens
    • Privilege waivers
reg fd recent enforcement actions
Reg. FD:Recent Enforcement Actions
  • Schering-Plough (Sept. 2003)
    • Conduct
      • Individual meetings with several fund managers/buy-side analysts
      • Non-webcast meeting with sell-side analysts
    • Improper disclosures
      • Negative tone on Q3-02 and FY 2003 – but no specific numbers
      • Prior disclosures said trends “could” happen; comments said “would”
    • “Providing guidance to a select few through a combination of spoken language, tone, emphasis, and demeanor, is precisely the kind of unfair advantage that the SEC wants to prevent.”
    • $1 million fine against Company; $50,000 fine against CEO
reg fd recent enforcement actions1
Reg. FD:Recent Enforcement Actions
  • Allegations in Siebel Systems (June 2004)
    • Conduct: after CFO held one-on-one meeting with institutional investor and invitation-only dinner with investment banker, stock rose 8% the next day
    • Improper alleged actions
      • Positive comments about business activity level and deal pipeline in contrast to prior negative comments
      • IR Director named because he “failed to prevent selective disclosure” and “failed to cause Siebel to make public disclosure the next day”
    • First enforcement action for failure to maintain adequate disclosure controls and procedures
reg fd lessons
Reg. FD Lessons
  • Current quarter guidance especially sensitive
  • FD applies to good news or bad news
  • SEC focusing on nudge and a wink
  • High risk
    • One-on-one meetings
    • Analyst changes projections after private meeting or call
  • Best Practices
    • Email
    • Don’t reaffirm guidance unless you really mean it
    • No follow-up calls to make sure they “get it”
    • Consider a press release or web-cast updates
    • Always check with counsel
meaningful md a
Meaningful MD&A
  • Caterpillar (known trends and uncertainties)
    • Brazilian subsidiary accounts for 23% of profits but not separately disclosed in MD&A
    • Notwithstanding risk disclosures in 10-K and 10-Q, Caterpillar did not go far enough to disclose uncertainties and potential adverse effects on earnings.
    • Company lacked "adequate procedures . . . designed to ensure compliance with the MD&A requirements."
meaningful md a1
Meaningful MD&A
  • The key: meaningful disclosure controls
    • Appropriate controls can atone for a mistake
    • Accounting controls vs. disclosure controls
    • Create viable internal channel for whistleblowers and procedures for responding
    • Review of MD&A
      • Compare disclosures to internal presentations on trends and risks
      • Elicit views of counsel/disagreements
    • Non-GAAP financial measures (Reg. G and Item 10 of Reg. S-K)
      • Accompany and reconcile
      • Consistency and transparency
  • Need protocol to close quarter and issue results, including MD&A
  • Same protocol for guidance updates
effective use of safe harbor
Effective Use of Safe Harbor
  • Significance and structure of Safe Harbor
  • Written vs. oral
  • Baxter case
    • No basis to conclude the important risks were disclosed
    • The risks remained the same; the problems allegedly didn’t
  • Companies often fail to
    • Identify the forward-looking information
    • Accompany it with risk factors
    • Make the cautionary disclosures meaningful
sox 404 and the erosion of materiality
SOX 404 and the Erosion of Materiality
  • Quick overview of Section 404
    • Management design and test controls
    • Auditors must attest to efficacy of controls
  • What is a “material weakness”?
    • “More than remote” chance that a defective control will create a material error
  • You must disclose and describe a material weakness
  • End of the era of non-material errors?
    • SAB 99 and the old “5% rule”
    • A 1% error could be immaterial to financial statements but a “material weakness” requiring disclosure
  • Beginning of the era of “presumptive restatement”?
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