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

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

Jerome F. Birn, Jr.

March 18, 2005


  • Shareholder Class Actions

  • SEC & U.S. Attorney Proceedings

  • Reg. FD

  • MD&A

  • Safe Harbor

  • SOX 404 and Erosion of Materiality

Shareholder Class Actions

  • Filing trends

  • Institutional plaintiffs

  • Evolving case law

  • Personalized exposure

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

  • 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 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

  • 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

  • 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&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

  • 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

  • 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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