The Jumbled Mess Surrounding If and When to Disclose

Last week I wrote about the definition of materiality in the context of investor relations, and the case decisions wrestling with the concept.  When I boiled it all down, what I came up with is that an investor relations officer will determine something is material when, based on his experience dealing with investors who are interested in his company, he knows that the investors will think the information is important.  It’s not perfect, but it has the elegance of simplicity.  So now it’s time to take the next step on this slippery slope and ask ourselves; “OK, we know this information is material, now when do I have to disclose it?”  

On the face of it, this should be a simple problem.  Logic would dictate that if information is important, it should be disclosed as soon as possible, so that investors are not disadvantaged by the silence of the corporation.  If we had principle-based disclosure with continuous disclosure obligations on the part of the corporate issuers, this would be the case.  There would of course, be exceptions for sensitive issues such as merger negotiations, products under development, quarterly earnings and the like, but the general rule would be clear: Disclose as soon as possible.

Alas, we do not live in a world where the legalities surrounding investor relations are governed by logic.  We live in a world where investor relations is governed first, by statute, next by governmental regulation and third, by the case law arising out of the litigation caused by the first two.  The result is a jumbled mess when it comes to when the obligation to disclose begins and what happens thereafter.

In general, here’s how I understand all of this fits together.  (Note:  Although I am a lawyer, I am not your lawyer, and in writing this I am not expressing a legal opinion.  If this stuff is really important to you, get your own damn lawyer.)  The Securities Exchange Act of 1934 empowers the Securities and Exchange Commission (the “SEC”) to require companies to file periodic reports on their business, generally 10-Ks (annual) and 10-Qs (quarterly). These reports are designed to get companies to disclose all material information surrounding their companies.  Originally, if a material development occurred in between the filing of the periodic reports, a company had no obligation to disclose that development, but if they did choose to disclose it, they could do so on Form 8-K.  More recently, in 2004, the SEC came out with a release (SEC Releases Nos. 33-8400, 33-49424 (March 16, 2004)) that lists certain material events they deem so important they trigger the obligation to disclose on a form 8-K within four business days. These events include such things as entry into a material non-ordinary course agreement, departure of directors and officers, material impairments and many others. The list is lengthy, but not exhaustive.  So, if your company has a material development in between your periodic reporting cycle, and it’s not on the list, you may choose to remain silent on it, provided the company is not actively buying or selling the company’s securities. 

Not only may you choose to remain silent to the detriment of your investors, the regulatory and case law decisions push you in that direction, because once you say something, the anti-fraud provisions of Rule 10b-5 attach and you’ve got to be absolutely correct or you’ll get sued.  This might be difficult to do initially in situations where things are unfolding and you are uncertain of the magnitude.  Next, if you do say something, you will trigger a duty to correct in the event facts change, as they almost certainly will, and may also create a duty to update the information in the future.  Lawyers, who’s job it is to mitigate their client’s risks, will therefore almost always advise their clients to say nothing, and if you do have to say something, say as little as possible.  If fully informed investors lead to the most efficient markets, can this be good for the markets?

Let’s just take a hypothetical case.  Say you had a charismatic chairman who not only was the public face of the corporation, but was also viewed as having saved the company from ruin.  Let’s call him Steve Jobs.  The chairman, who has previously had a bout with cancer, makes a public appearance and looks like death warmed over, triggering speculation about his health.  Clearly, it’s something investors think is important, based on their reactions and questions.  The health of the chairman is not something the SEC has thought to put on its list of things that have to be disclosed within 4 business days.  The company could stay silent on it, triggering massive speculation.  Instead, a company spokesman states that the chairman had picked up a “common bug”.  Presumably the statement is correct, since if they knowingly made a misleading statement they would have violated the antifraud provisions of Rule 10b-5 and at some point they wil get the bejesus sued out of them.  Now however, they are saddled with a duty to correct, should things turn out differently and potentially, a duty to update.  And how long do these duties last?  This reminds me of the tar baby situation from Uncle Remus.  No wonder companies don’t want to say anything if they don’t have to.  (For a more complete, lawyer-like analysis of this situation, see Brock Romanek’s July 25^th post on the Corporate Counsel blog, link listed on the side.)

Which leads me back to what common sense tells me the underlying principle should be:  If it’s important, a company should disclose it as soon as possible, and continue to disclose as events unfold, except in very specific and narrow situations.  At the end of the day, the principle should be biased to favor the flow of information to investors, not to create additional liability and obligations if you do disclose.