Sarbanes Oxley and Legal risk 1283



  • Sarbanes Oxley and Legal Risk

    The Act imposes a number of new disclosure requirements designed to enhance visibility…

    *Disclosure of financial information prepared in accordance with (or reconciled to) generally accepted accounting principles… that reflect all material correcting adjustments that have been identified by a registered public accounting firm in accordance with GAAP and applicable securities laws.
    *Disclosure of all material off-balance sheet transactions, arrangements, contingent obligations and other relationships with unconsolidated entities.

    *Disclosure of codes of ethics for senior financial officers and, if a code of ethics has not been adopted, the reasons why the issuer has not done so.
    *Real-Time Disclosure ( 409). Under the Act, issuers will be required to disclose to the public, in plain English and on a rapid and current basis, such additional information concerning material changes in the issuer’s financial condition or results of operations as the SEC determines, by rule, is necessary or useful for the protection of investors and in the public interest.

    And… (Sec. Act of 1934) disclosure of the legal risks…

    Example: CISCO LEGAL PROCEEDINGS

    'Beginning on April 20, 2001, a number of purported shareholder class action lawsuits have been filed in the United States District Court for the Northern District of California against the Company and certain of its officers and directors.

    The lawsuits are essentially identical, and purport to bring suit on behalf of those who purchased the Company’s publicly traded securities between August 10, 1999 and April 16, 2001. Plaintiffs allege that defendants made false and misleading statements, purport to assert claims for violations of the federal securities laws, and seek unspecified compensatory damages and other relief. The Company believes the claims are without merit and intends to defend the actions vigorously.

    In addition, beginning on April 23, 2001, a number of purported shareholder derivative lawsuits have been filed in the Superior Court of California, County of Santa Clara, against the Company (as a nominal defendant), its directors and certain officers. At least one purported derivative suit has also been filed in the United States District Court for the Northern District of California, and another has been filed in the Superior Court of California, County of San Mateo.

    The complaints in the various derivative actions include claims for breach of fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment and violations of the California Corporations Code, seek compensatory and other
    damages, disgorgement and other relief, and are based on essentially the same allegations as the class actions.

    WE FACE CERTAIN LITIGATION RISKS

    We are a party to lawsuits in the normal course of our business.

    Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, results of operations or financial condition.’

    WHY CISCO and all public companies explain things like that to the public?
    Because they speak about profits… but they don’t really know… they are not sure… because of the legal risks. Perhaps, they will have to pay MUCH money after a court decision… It is also a cash flow issue…

    Even if you sell pizza, there are very important legal risks… and you have to disclose these risks to the public:

    'We do not have long-term contracts with many of our suppliers, and as a result they could seek to significantly increase prices or fail to deliver.

    We typically do not have written contracts or long-term arrangements with our suppliers.

    Although in the past we have not experienced significant problems with our suppliers, our suppliers may implement significant price increases or may not meet our requirements in a timely fashion, if at all. The occurrence of any of the foregoing could have a material adverse effect on our results of operations.

    We face risks of litigation from customers, franchisees, employees and others in the ordinary course of business, which diverts our financial and management resources. Any adverse litigation or publicity may negatively impact our financial condition and results of operations.
    Claims of illness or injury relating to food quality or food handling are common in the food service industry. In addition, class action lawsuits have been filed, and may continue to be filed, against various quick service restaurants alleging, among other things, that quick service restaurants have failed to disclose the health risks associated with high-fat foods and that quick service restaurant marketing practices have encouraged obesity.

    In addition to decreasing our sales and profitability and diverting our management resources, adverse publicity or a substantial judgment against us could negatively impact our financial condition, results of operations and brand reputation, hindering our ability to attract and retain franchisees and grow our business.

    Further, we may be subject to employee, franchisee and other claims in the future based on, among other things, discrimination, harassment, wrongful termination and wage, rest break and meal break issues, including those relating to overtime compensation.

    We have been subject to these types of claims in the past, and we are currently subject to a purported class action claim of this type in California relating to rest break and meal break compensation, and if one or more of these claims were to be successful or if there is a significant increase in the number of these claims, our business, financial condition and operating results could be harmed. ’

    In simple terms… we speak about profits… but nobody knows what will happen… because of the legal risks.

    The Sarbanes Oxley Act immediately increased criminal penalties, including both fines and imprisonment, and provided new methods of enforcement against persons who are found to be in violation of securities laws.
    Legal risks:
    The whistleblower protection for employees who assist in investigations of securities fraud claims against their companies ( 806)
    An issuer may not discharge or discriminate against an employee who assists in an investigation, or participates in a proceeding against the issuer, regarding any conduct that the employee reasonably believes constitutes a violation of securities laws or constitutes fraud against the issuer’s shareholders.
    Retaliation Against Informants ( 1107)
    It is unlawful to knowingly and intentionally retaliate against any person, including interfering with the person’s lawful employment, for providing a law enforcement officer with any truthful information relating to the commission or possible commission of a federal offense. A violation of this provision may lead to fines and imprisonment for up to 10 years.
    The destruction, alteration or falsification of documents ( 802)
    The destruction of corporate audit records ( 802)
    The White-Collar Crimes ( 903, 904)
    The ‘mistakes’ or ‘omissions’ in the certification by corporate officers ( 906)
    It is a criminal offense for the chief executive or chief financial officer of an issuer to file certifications of periodic reports, as required by Section 906 of the Act, knowing that the periodic report accompanying the statement does not comport with all of the requirements of the securities laws, as attested to in the certificate.
    A ‘knowing’ violation of this provision carries a maximum punishment of a fine of up to USD1,000,000 and imprisonment for up to 10 years. A ‘willful’ violation of this provision carries a maximum punishment of a fine of up to USD5,000,000 and imprisonment for up to 20 years.

    (From my new web site legal-risk.com)



  • Do you think that ANY large company should go to such extent in preparing this section of its MD-and-A? What if a company has an ‘umbrella insurance’ for various lawsuits AND does not have any material lawsuits outstanding at year end? Would you still recommend it to make the same general statement? (’<i>Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, results of operations or financial condition.</i>’)



  • Do you think that ANY large company should go to such extent in preparing this section of its MD-and-A? What if a company has an ‘umbrella insurance’ for various lawsuits AND does not have any material lawsuits outstanding at year end? Would you still recommend it to make the same general statement? (’<i>Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, results of operations or financial condition.</i>’) %0AYES, I absolutely believe it.%0AIf you have an umbrella insurance, it is good, but you must not feel that sure. There are several limitations%0A1. There are several terms that are very important to read and understand. %0A2. There are very high premiums and substantial coverage restrictions.%0A3. Discuss with your lawyers. There is always a lack of understanding of the true purpose of umbrella/excess liability coverage%0A4. There are inadequate insurance limits%0A5. The adverse trends in litigation (jury decisions, new exposures) make ‘umbrella insurance’ no longer adequate%0A6. What about professional or pollution liability coverage?%0A Now, some legal risks: %0ACompanies are beginning to consider the impact that employment related lawsuits are having on their financial stability. %0A %0AThe number, size and prominence of these allegations being brought are unprecedented. %0AThe negative publicity is long and lasting.%0A %0AAllegations of sexual harassment…%0A… age and racial discrimination…%0A… wrongful termination…%0A… hostile work environment…%0A… whistleblower protection/Sarbanes-Oxley…%0A… medical leave act violations…%0A… disabilities act violations… %0A… mishandled interpersonal conflict… %0A… inappropriate workplace behavior…%0A %0AEmployees (not always the most important asset) can become a significant liability. Because one of the managers did something wrong, yes, WRONG, but the company, the shareholders and the other innocent employees are paying the price…%0A %0A150,000+%0ANumber of wrongful employment practices complaints currently filed at US state agencies and the Equal Employment Opportunity Commission (EEOC).%0A %0AUSD650,000%0AThe average damage award employers must pay in employment related lawsuits.%0A %0A2,000%%0AThe increase in discrimination suits since 1974.%0A %0A33%%0AThe percent of all employment practices awards involving punitive damages.%0A %0A461,530%0AThe number of people who charged their employers with some type of discrimination from 1991 to 1997 according to the U.S. Equal Employment Opportunity Commission (EEOC).%0A %0A80%%0AThe percent of all defendant-employers who feel that they are victims of unfair or frivolous allegations, as indicated by the California Chamber of Commerce.%0A %0A450%0AThe estimated number of employment lawsuits filed in the United States every day.%0A %0A43 million%0AThe estimated number of Americans with physical or mental impairments protected by the 1990 Americans with Disabilities Act (ADA).%0A %0A20%%0AThe percent of civil litigation in the United States now involving employment related issues.%0A %0AUSD1 billion%0AThe total amount spent between 1992 and 1997 by Corporate America on sexual harassment settlements and award damages, as estimated by Treasury and Risk Management.%0A %0A33%%0AThe percent of women in the U. S. who claim to have suffered on-the-job sexual harassment in one form or another.%0ASexual harassment costs the typical Fortune 500 company USD6.7 million dollars a year.%0ALegal fees for defending a sexual harassment average USD250,000%0AYour last question:%0A’Would you still recommend it to make the same general statement? Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, results of operations or financial condition.’%0AYES. If you do not explain to your investors all the risks, tour public statements are false and misleading. If your shareholders lose money, they will blame your company for hiding information… IT IS A VERY SERIOUS PROBLEM.%0AIn April 2003, in Small v. Fritz Companies, Inc., the California Supreme Court ruled that a shareholder who neither bought nor sold stock, but who merely held on to shares he already owned, could sue a company if its public statements turned out to be false or misleading. %0A You must be ready for a new wave of lawsuits by investors claiming they relied on a company’s faulty disclosure… %0AThe best thing about a securities fraud class action is that the majority of shareholders don’t need to do much to participate, and they can possibly recoup some of their investment losses. %0ACLASS ACTION: The worst nightmare…%0AA lawsuit against a corporation is granted class action status by a judge, …%0A… all shareholders receive a letter alerting them of the litigation…%0A… attorneys advertise the terms of the award in major newspapers, and encourage shareholders to contact them…%0A… law firms issue press releases announcing the filing of a securities fraud class action…%0A… lawyers in class action cases keep about one-third of any negotiated settlement or jury award… %0A… so they do not want money from the shareholders…%0A… if you are a shareholder, you lose nothing and you have much money to expect…%0A… the negative publicity is a disaster for the company and for the stock price…%0AEnd of the nightmare.%0ABelieve me, I am an expert witness. 😉



  • And… (Sec. Act of 1934) disclosure of the legal risks…

    George, could you please direct me to the specific section of the 1934 Act where it speaks about disclosure of legal risks ? Thank you.



  • George might be able to find specific language in the 1934 Act.
    For SOX and reporting of legal risks, I performed a query and found the following:
    Document Retention Policies
    Section 802 of Sarbanes-Oxley adopts stringent rules (with associated criminal penalties) for persons and parties who engage in the destruction, alteration, or falsification of corporate records during the pendency of any federal investigation. Moreover, these rules appear applicable to all types of corporations (non-profit and for-profit alike), not just to publicly traded companies.
    The breadth and scope of Section 802’s provisions, and the severity of its related penalties strongly suggest that existing document retention policies and procedures be reviewed and, where necessary, revised for consistency with the statutory requirements. Many entities currently maintain document retention programs that are focused on insurance defense and corporate compliance-related positions. Such well-intentioned programs may, however, be incomplete in view of prohibitions established by Section 802 of Sarbanes-Oxley.

    SOX and ‘Up The Ladder’ Reporting
    Section 307 of Sarbanes-Oxley required the SEC to issue rules setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission, including requiring an attorney to report material breaches of securities law or breaches of fiduciary duties by the company or any agent thereof to the chief legal counsel and, if necessary, up the ladder.
    This requirement led the American Bar Association to appoint a Task Force to review and report on the role of lawyers in the checks and balances system of corporate activity. The report, ultimately adopted by the ABA’s House of Delegates, contained two highly controversial recommendations for changes to the Model Rules of Professional Conduct, as well as placing the ABA’s stamp of approval on recommendations for improving corporate governance.
    The level of effort and compliance obligation is increasing as it relates to corporate responsibility and to the obligations of the Office of the General Counsel in protecting an organization’s interests. General Counsel can provide enormous assistance to their organizations if they assist in implementing best practices for corporate governance that implement the provisions of Sarbanes-Oxley and demonstrate a sensitivity to the changing expectation of regulators, the media, and constituency groups.
    Note that consideration of e-mail communications and related legal risks are covered in the document retention requirements.
    Regards,
    Milan



  • Section 802, like the rest of the act, only applies to those entities under the jurisdiction of the SEC. This would exclude any non-public companies (unless they have public debt).



  • Thank you all for your responses.
    I am just trying to find out whether SOX/1934 Act specifically requires disclosure of ‘potential legal risks’ or such disclosure is simply considered ‘best practice’ under the requirement to disclose all potential risks.
    Again, if SOX/1934 Act specifically refers to disclosure of legal risks , please refer me to that specific section.
    Thank you again for your assistance.



  • Thank you all for your responses.
    I am just trying to find out whether SOX/1934 Act specifically requires disclosure of ‘potential legal risks’ or such disclosure is simply considered ‘best practice’ under the requirement to disclose all potential risks.
    Again, if SOX/1934 Act specifically refers to disclosure of legal risks , please refer me to that specific section.
    Thank you again for your assistance.
    Are you looking for guidance in disclosing contigent legal liabilities (pending or open legal litigation that may lead to an unfavorable settlement) or general business risks (potential litigation based on the business environment that you operate in)?



  • Are you looking for guidance in disclosing contigent legal liabilities (pending or open legal litigation that may lead to an unfavorable settlement) or general business risks (potential litigation based on the business environment that you operate in)?
    The latter is what I’m interested in. However, the confusion starts from the very beginning, where the thread’s author stated that disclosing legal risks (specifically) is a new requirement under SOX, and then went on to give examples of some companies disclosing ‘potential legal proceedings in the normal course of business’ as a general business risk.
    Therefore, let me put my question this way: If I am a SEC registrant, who has no pending/open litigation at year end, am I required by SOX to say something about ‘potential legal proceedings in the normal course of business’ in my MD-and-A and/or AIF?
    Hope that clarifies my question. Sorry for the confusion and thank you for your patience.



  • Or again, based on the author’s initial example:

    WE FACE CERTAIN LITIGATION RISKS

    We are a party to lawsuits in the normal course of our business.

    Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, results of operations or financial condition.’

    WHY CISCO and all public companies explain things like that to the public?
    Because they speak about profits… but they don’t really know… they are not sure… because of the legal risks. Perhaps, they will have to pay MUCH money after a court decision… It is also a cash flow issue…

    The question is: Was the public company in this example specifically required by SOX to add such comment even if it had no outstanding litigation at year end or the author means that such comment is desirable under the principles of disclosure of general business risks?
    Sorry, this makes quite a difference… I would appreciate if we can clarify this to see what is REQUIRED and what is RECOMMENDED.



  • NO. SOX does not require this language. It is however, recommended.
    Every public company will have differing disclaimers in it’s safe-Harbor language.
    Here is a link to an overview of safe-harbor language that is generally used in any type of news releases or MD-and-A by public companies -
    The 1934 Securities Act does not specifically identify the language that is to be used in these situations. The SOX Act of 2002 did not add anything to this. George’s mention of increased legal risk more relates to the various legal penalties that a company could be hit with under the SOX Act.
    A disclosure duty exists where a known trend, demand, commitment, event or uncertainty is both presently known to management and is reasonably likely to have a material effect on your financial condition or results of operation. This is from Rule 175© under the securities exchange act of 1933 and rule 3b-6 of the Exchange Act of 1934.



  • Sorry for the delay I was traveling.
    Bogyman, let’s go to your very interesting questions.
    Sarbanes Oxley is not only the Act. It is also every final rule after the act. The interpretations of the act are very important, and we have to monitor the final rules and the web sites (PCAOB, SEC) every month.
    The same is true also with the Securities Exchange Act of 1934.

    1. You must read the following very important document. SEC explains what to include in the form 10-K
      http://www.sec.gov/about/forms/form10-k.pdf
      ‘This Form shall be used for annual reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) (the Act ) for which no other form is prescribed. This Form also shall be used for transition reports filed pursuant to Section 13 or 15(d) of the Act.’
      FORM 10-K
      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 GENERAL INSTRUCTIONS
      Item 3. Legal Proceedings.
      (a) Furnish the information required by Item 103 of Regulation S-K ( 229.103 of this chapter).
      (b) As to any proceeding that was terminated during the fourth quarter of the fiscal year covered by this report, furnish information similar to that required by Item 103 of Regulation S-K ( 229.103 of this chapter), including the date of termination and a description of the disposition thereof with respect to the registrant and its subsidiaries.
      If you read the text, you see that they speak about the Regulation S-K ( 229.103). This is something very important.
    2. Regulation S-K
      http://www.sec.gov/divisions/corpfin/forms/regsk.htm#leg
      Application of Regulation S-K. This part Reg. 229.103. Item 103.
      Describe briefly 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. Include the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought. Include similar information as to any such proceedings known to be contemplated by governmental authorities.
      Instructions to Item 103.
    3. If the business ordinarily results in actions for negligence or other claims, no such action or claim need be described unless it departs from the normal kind of such actions.
    4. No information need be given with respect to any proceeding that involves primarily a claim for damages if the amount involved, exclusive of interest and costs, does not exceed 10 percent of the current assets of the registrant and its subsidiaries on a consolidated basis. However, if any proceeding presents in large degree the same legal and factual issues as other proceedings pending or known to be contemplated, the amount involved in such other proceedings shall be included in computing such percentage.
    5. Notwithstanding Instructions 1 and 2, any material bankruptcy, receivership, or similar proceeding with respect to the registrant or any of its significant subsidiaries shall be described.
    6. Any material proceedings to which any director, officer or affiliate of the registrant, any owner of record or beneficially of more than five percent of any class of voting securities of the registrant, or any associate of any such director, officer, affiliate of the registrant, or security holder is a party adverse to the registrant or any of its subsidiaries or has a material interest adverse to the registrant or any of its subsidiaries also shall be described.
    7. Notwithstanding the foregoing, an administrative or judicial proceeding (including, for purposes of A and B of this Instruction, proceedings which present in large degree the same issues) arising under any Federal, State or local provisions that have been enacted or adopted regulating the discharge of materials into the environment or primarily for the purpose of protecting the environment shall not be deemed ‘ordinary routine litigation incidental to the business’ and shall be described if:

    A. Such proceeding is material to the business or financial condition of the registrant;
    B. Such proceeding involves primarily a claim for damages, or involves potential monetary sanctions, capital expenditures, deferred charges or charges to income and the amount involved, exclusive of interest and costs, exceeds 10 percent of the current assets of the registrant and its subsidiaries on a consolidated basis; or
    C. A governmental authority is a party to such proceeding and such proceeding involves potential monetary sanctions, unless the registrant reasonably believes that such proceeding will result in no monetary sanctions, or in monetary sanctions, exclusive of interest and costs, of less than USD100,000; provided, however, that such proceedings which are similar in nature may be grouped and described generically.
    3. Yes, there are new requirements under Sarbanes Oxley. SARBANES OXLEY IS NOT ONLY THE ACT, BUT THE INTERPRETATIONS, IN THE NEW LEGAL AND POLITICAL CONTEXT.
    Well, the interpretations are different now. The disclosure requirements are now more important. There is no room to ‘forget’ to include legal proceedings after Sarbanes Oxley and all the certifications.
    After Sarbanes Oxley, Regulation S-K, Item 103Legal Proceedings is more important. And the interpretations from the court are VERY bad for companies… here is the NEW legal risk
    Example:
    In April 2003, in Small v. Fritz Companies, Inc., the California Supreme Court ruled that a shareholder who neither bought nor sold stock, but who merely held on to shares he already owned, could sue a company if its public statements turned out to be false or misleading.
    That is why companies must be very careful
    There are several new rules. Another example: Companies must evaluate and, if material, disclose liabilities from actual or threatened legal proceedings, and financial impacts that may result from emerging trends in environmental regulations.



  • Hi George,
    Can I run a hypothetical situation by you with this one please ?
    OK, under SOX 409, is it hypothetically necessary for a corporation under SOX to do a full formal risk analysis of the business, because if any of those risks materialise, couldn’t shareholders subsequently sue the company board for negligence over risk assessment ?
    In other words, to prevent a legal risk of board negligence materialising, would SOX companies have to perform a comprehensive business risk assessment ?



  • kymike, lekatis:
    Thanks a lot for your detailed responses. I really appreciate your time.



  • Bogyman,
    Thank you for the opportunity to discuss more about this serious issue.
    MBAStudent,
    Thank you for the hypothetical situation.
    Yes. Companies have to perform a comprehensive business risk assessment. and, disclose the results to the public. Please read carefully:
    FORM 10-K: http://www.sec.gov/about/forms/form10-k.pdf
    PART I
    Item 1. Business.
    Furnish the information required by Item 101 of Regulation S-K ( 229.101 of this chapter) except that the discussion of the
    development of the registrant’s business need only include developments since the beginning of the fiscal year for which this report is filed.
    Item 1A. Risk Factors.
    Set forth, under the caption Risk Factors, where appropriate, the risk factors described in Item 503© of Regulation S-K (229.503© of this chapter) applicable to the registrant.
    Provide any discussion of risk factors in plain English in accordance with
    Rule 421(d) of the Securities Act of 1933 (230.421(d) of this chapter).
    Item 1B. Unresolved Staff Comments.
    If the registrant is an accelerated filer or a large accelerated filer, as defined in Rule 12b-2 of the Exchange Act (240.12b-2 of this chapter), or is a well-known seasoned issuer as defined in Rule 405 of the Securities Act (230.405 of this chapter) and has received written comments from the Commission staff regarding its periodic or current reports under the Act not less than 180 days before the end of its fiscal year to which the annual report relates, and such comments remain unresolved, disclose the substance of any such unresolved comments that the registrant believes are material. Such disclosure may provide other information including the position of the registrant with respect to any such comment.
    Item 2. Properties.
    Furnish the information required by Item 102 of Regulation S-K ( 229.102 of this chapter).
    Item 3. Legal Proceedings.
    (a) Furnish the information required by Item 103 of Regulation S-K ( 229.103 of this chapter).
    (b) As to any proceeding that was terminated during the fourth quarter of the fiscal year covered by this report, furnish information similar to that required by Item 103 of Regulation S-K ( 229.103 of this chapter), including the date of termination and a description of the disposition thereof with respect to the registrant and its subsidiaries.



  • Hi George,
    Thanks for your reply on this.
    Just following on from your point that you mentioned above, if a business has to do a comprehensive risk assessment based on Form 10-K and Regulation S-K, why does this not include enterprise risk management (or in other words cultural risk management) ? In fact, if you look at Ruglation S-K’s description of risk in Reg. 229.503, it could be interpreted as needing ERM…
    It strikes me as bizarre, because surely ERM is very often the biggest risk that companies face - indeed arguably that was the biggest risk Enron ignored ?



  • ERM is more than Sarbanes Oxley. It is not necessary for compliance. All the discussions and the interpretations of SOX by SEC and PCAOB agree that COSO is enough.


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