Federal Securities Law Disclosure Obligations Regarding Governmental Investigations

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1 Federal Securities Law Disclosure Obligations Regarding Governmental Investigations Jared S. Richardson Associate General Counsel & Secretary Trinity Industries, Inc. W. Scott Wallace Partner Haynes and Boone, LLP The views expressed in this presentation are those of the speakers and do not necessarily reflect the opinions of their respective companies or firms.

2 Overview There is no statute or rule that specifically imposes a duty to disclose the existence of a governmental investigation to investors. Company should consider the principles that guide an analysis of any disclosure of an investigation. Whether to disclose an investigation is based on an assessment of materiality, which involves an assessment of the probability and magnitude of the outcome. Consider the known facts, alleged misconduct, positions of the company personnel that are implicated and potential impact (financial and otherwise) of any legal proceeding likely to result. Disclosure of an investigation may have an impact on the stock price, business relationships, employees and others. Federal securities laws and regulations provide a duty to disclose specific events that arise during an investigation. 2

3 Regulation S-K Disclosure Matters that May Arise During an Investigation 1. Item 103 Legal Proceedings Item 103 requires a brief description of any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject. The name of the court or agency in which the proceedings are pending must be included, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought must be included. Similar information as to any such proceedings known to be contemplated by governmental authorities must also be included. (emphasis added) 3 3

4 Regulation S-K Disclosure Matters that May Arise During an Investigation (cont.) An investigation in and of itself is not a pending legal proceeding until it reaches a point where an agency or authority makes it known that it is contemplating filing suit or bringing charges. Prior to a recent case, many considered the issuance of a Wells Notice by the SEC Enforcement Staff a matter to rise to the level of a proceeding known to be contemplated by a government agency. A Wells Notice is how the SEC staff advises the Company that it is considering asking SEC commissioners to authorize filing a lawsuit or administrative proceeding. In June 2012, the Judge in Richman vs. Goldman Sachs Group, Inc. (S.D.N.Y.) found no general, affirmative duty to disclose receipt of a Wells Notice even where the company had made prior disclosures regarding the fact that it is under investigation. The Court noted that a duty to disclose the contingency was not triggered until the regulatory investigation matures to the point where litigation is apparent and substantially certain to occur. The Wells Notice indicated that governmental investigations were indeed ongoing, which was consistent with Goldman s prior disclosures. It did not indicate that litigation was substantially certain to occur. 4

5 Regulation S-K Disclosure Matters that May Arise During an Investigation (cont.) 2. Item 303 MD&A and Financial Condition and Results of Operations MD&A addresses disclosure obligations arising from changes in the company s financial position and results of operation. MD&A must address any known trends and uncertainties that the company reasonably expects will have a material and unfavorable impact on the sales, revenue or income from continuing operations. Item 303 also has disclosure requirements related to off-balance sheet arrangements and known events or uncertainties that are reasonably likely to result in termination or material reduction of liquidity capital available to the company. 3. Item 503(c) Changes in Risk Factors Depending on the seriousness of the matter involved, a change or modification of the company s risk factors may be required. 4. Item 401(f) Involvement of Directors or Executive Officers in Legal Proceedings Companies must describe certain events that are material to an evaluation of the ability or the integrity of a director, nominee or executive officer. Included in such events is whether the person is a named subject of a pending criminal proceeding. Generally, such disclosure is made when an indictment is imminent. 5 5

6 Form 8-K Disclosure Matters that May Arise During an Investigation 1. Item 5.02 Resignation or Removal of Director or Executive Officer Disclosure is required when a director or certain officers have resigned from the company, which may occur in connection with wrongful actions. Disclosure is also required when a director has resigned or refuses to stand for re-election because of a disagreement with the company on any matter relating to its operations, policies or practices. A brief description of the circumstances representing the disagreement must be given. 2. Item 4.02 Non-Reliance on Financial Statements Investigations regarding financial reporting may result in discovery of significant financial problems such that reliance on previously issued financial statements is questioned. If a company concludes that previously issued financial statements should no longer be relied upon, the company must provide a brief description of the facts underlying the conclusion to the extent known at the time of the filing. Disclosure is also required if the independent auditor advises that disclosure should be made or action should be taken to prevent future reliance on a previously issued audit report or financial statement. 6 6

7 Form 8-K Disclosure Matters that May Arise During an Investigation (cont.) 3. Item 4.01 Change in Certifying Accountant The resignation or dismissal of the company s independent auditor generally triggers a disclosure obligation. The resignation or dismissal may be brought upon by disagreements related to an accounting or reporting matter. 4. Item 1.01 Material Definitive Agreements SEC and DOJ settlement agreements may be considered material definitive agreements, particularly when the terms of the settlement are financially or otherwise detrimental to the company. Settlement agreements may include undertakings to perform remedial actions or injunctions, for example, and would likely trigger a Form 8-K filing. 5. Item 8.01 Other Events Depending on how an investigation is proceeding and the likelihood of public disclosure through other means, a company may choose to make a voluntary filing rather than waiting for a specific triggering event or waiting until its next periodic report is filed. 7 7

8 Factors Favoring Disclosure Even though governmental investigations are typically private, there could be informational leaks from a number of sources. Multiple parties may be involved, meaning a great many individuals will have knowledge of the investigation. There may be leaks (unintended or otherwise) from persons involved with the investigation. An initial do not destroy documents memo or may go to a sufficiently large group of individuals that keeping the investigation confidential will prove difficult. A company s voluntary disclosure of an investigation will give it the opportunity to provide accurate information with respect to the situation, particularly in instances where rumors may be far worse than reality. Failure to disclose an investigation in the early stages may be second guessed if the situation worsens and the initial disclosure is made significantly later than it could have been. Auditors may request disclosure because they want to account for all contingencies before signing off on company financials. Disclosure promotes transparency, which may boost investor confidence. 8

9 Factors Against Disclosure The seriousness of the investigation and its potential impact on a company may be quite uncertain or unknown in the beginning stages, and many investigations result in no action being taken. Disclosure could result in market and stockholder overreaction. Disclosure could increase the likelihood of the company and its officers and directors being named in private securities litigation. The company s relationship with creditors, suppliers, customers and business partners may be immediately impacted. Disclosure of an investigation in the early stages will require the company to determine what subsequent developments merit an update as the investigation proceeds. Employee morale may be negatively affected. 9 9

10 Company Disclosure of an Investigation If a Company determines to disclose an investigation, what should be said? The determination will be based on all facts and circumstances known at such time. Seek information from all company personnel that can provide insight into the subject matter. General guidelines are as follows: The company has a duty to make complete disclosure. Attempt to minimize the need for future supplemental information. Disclosure should cover the type of inquiry, the subject matter and the status of the investigation. Consider any prior statements made by the company and if such statements will be misleading if not updated. As more changes are made to previous disclosures, additional bad press is possible. Do not make statements predicting the outcome of the investigation. Incorrect predictions may only make matters worse and provide a basis for possible litigation or additional regulatory actions. Do not over-emphasize that the inquiry is informal or voluntary as it may sound defensive and require further disclosures if the investigation worsens. 10