2 Sarbanes-Oxley materiality nightmares and a court tr 1950

  • We have discussed this week about materiality and the 5% rule. BA has just landed and I am alone… and I remembered…
    My Sarbanes-Oxley materiality nightmares

    1. Sarbanes Oxley Section 401
      The Commission shall disclose all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons, that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses.’’.
      Plus a SEC final rule sec.gov/rules/final/33-8182.htm#IIIC
      'require a registrant to disclose the material facts and circumstances that provide investors with a clear understanding of a registrant’s off-balance sheet arrangements and their material effects.
      Which is the definition of ‘material’ here?
      Do not search… no consensus about that.
    2. Sarbanes Oxley Section 307
      Minimum standards of professional conduct for attorneys…
      (1) requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent
      We have so many final rules and interpretations… but …
      Which is the definition of ‘material’?

    Lessons Learned:

    1. Materiality is always disputed in the courts.
    2. The right to remain silent is not a license to mislead

    A court trial
    A. Some Columbia shareholders sold their shares in the open market before the merger of Columbia and Sony
    B. After that, they sued Sony: Sony defrauded them by denying the existence of merger discussions with Columbia
    C. Sony denied that any merger negotiations with Columbia had occurred (public statements in Forbes, The New York Times, and Reuters)
    D. The district court found that the statements made by Sony were potentially misleading.
    The court rejected Sony’s argument that the merger discussions were immaterial (again, the problem is materiality) because the possibility of an agreement had not reached a more likely than not status.
    Question: Did Sony owe any fiduciary duties to the shareholders of Columbia?

    Answer: No. There is no duty to disclose to the shareholders of a target company anything.
    So where was the problem?
    If Sony remained silent regarding merger discussions, there was no problem. But Sony made public statements and misled investors. It was ‘material’ information in order to make informed decisions, to buy or to sell shares.
    Sometimes we have the right to remain silent, and this is not is not a license to mislead.

  • Good points George.
    I think this goes to the root of the problem that many face with SOx. For want of a better expression there has often been a ‘checklist’ approach to financial reporting in the US. This is evidenced by partiuclarly voluminous and directive accounting standards and the practices in the auditng profession. The behaviour that goes along with this is very much about ensuring ‘if I follow the checklist I can’t be sued’.
    Sox is far more about applying professional judgement to provide the right answer and this makes a lot of people uncomfortable. However, one has to realise that in a complex world there may not always be a ‘right answer’ you just have to try and apply the right pricniples and come up with a sensible answer.
    In the long run I believe that this approach is far more powerful.

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