A few weeks ago, New York’s Gov. Andrew Cuomo may have said it best in a press conference addressing the global uncertainty caused by COVID-19. In answering questions about how and when to reopen New York’s economy, the governor stated simply: “None of this has been done before. Anyone who says to you, ‘oh, I know what we should do. I know.’ Yeah, you don’t know because nobody knows and that’s the one thing that we have learned over and over again.”
Every day there is an explosion of headlines filled with troubling news and uncertainty as political leaders and health officials try to determine when and how it will be safe to reopen and restart the world economy. In the meantime, issuers, and their senior operational and financial officers, are still required to make critical disclosures to the investing public about known trends, events, and uncertainties concerning their businesses.
But with a global shutdown of the world’s economy caused by COVID-19 — which has decimated production, shipping, and sales — how can CEOs and CFOs predict or be expected to fairly and accurately describe the impact of these never-before-seen events without later criticism from the Securities and Exchange Commission and suits from the plaintiffs’ bar? While the temptation to embrace boilerplate disclosure is strong, there are several steps senior officers can take to help ensure that the required disclosures are meaningful and made without running afoul of federal securities laws, so they do not unwittingly incur personal liability.
Item 303 of Regulation S-K requires a registrant to disclose in the Management’s Discussion and Analysis of Financial Condition and Results of Operations sections of periodic filings “any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” Additionally, “If the registrant knows of events that will cause a material change in the relationship between costs and revenues . . . the change in the relationship shall be disclosed.”
Issuers today are facing uncertainties at every turn, including those that could make or break their businesses. Once the dust finally settles from the COVID-19 crisis, the last thing issuers will want is to face an inquiry and possible enforcement action by the SEC for statements and disclosures made during this volatile time. CFOs are exposed to an increased risk of liability, as they are required to sign off on the financial statements and related disclosures and are charged as a matter of law with heightened financial knowledge and expertise, making them an easy target.
While the COVID-19 crisis is unparalleled, turning to other crises in recent memory provides a cautionary tale. Bank of America, for example, was charged by the SEC in 2014 for failing to inform investors during the financial crisis about known uncertainties to future income from its exposure to repurchase claims on mortgage loans. By not disclosing known uncertainties about the future costs of mortgage repurchase claims when filing its financial reports for the second and third quarters of 2009, Bank of America failed to adhere to the requirements of Regulation S-K. A former SEC regional director commented that “Bank of America failed to make accurate and complete disclosure to investors and its illegal conduct kept investors in the dark.” Bank of America paid a $20 million civil penalty to settle the SEC’s charges, part of a larger global settlement.
Importantly, liability for inaccurate or insufficient disclosures has also resulted in senior financial officers being charged. For example, the SEC charged Walgreens and its former CEO and former CFO with misleading investors about increased risk that the company would miss a key financial goal announced in connection with a merger agreement. After completing the first step of a two-step merger, Walgreens’ internal forecasts indicated that the risk of missing its 2016 projection regarding combined adjusted operating income had increased significantly, but Walgreens and the former CEO and CFO repeatedly publicly reaffirmed the projection without adequately disclosing the increased risk. Walgreens agreed to pay a $34.5 million penalty, and the former CEO and CFO agreed to each pay a $160,000 penalty to settle the SEC’s action.
A statement by SEC Chairman Jay Clayton and Director of the Division of Corporation Finance William Hinman, highlighted the importance of disclosure for investors, the market and the fight against COVID-19. While noting that historical information may be relatively less significant than under normal circumstances, the statement explained that “[c]ompany disclosures should reflect this state of affairs and outlook and, in particular, respond to investor interest in: (1) where the company stands today, operationally and financially, (2) how the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and its customers, is progressing, and (3) how its operations and financial condition may change as all our efforts to fight COVID-19 progress.” Significantly, Clayton and Hinman encouraged companies that provide forward-looking disclosures to avail themselves of the safe harbors for such statements, and also noted that they “would not expect good faith attempts to provide appropriately framed forward-looking information to be second-guessed by the SEC.”
While this positive reinforcement from the SEC might be reassuring today, it is not binding on future SEC commissioners and will be of no help in defending a class action unless the issuer and the signing officers can document the good faith supporting the disclosures.
The best defense therefore must begin with following practices and documenting disclosure compliance before filings are made. Good faith is defined as “[a] state of mind consisting in (1) honesty in belief or purpose, (2) faithfulness to one’s duty or obligation, (3) observance of reasonable commercial standards of fair dealing in a given trade or business, or (4) absence of intent to defraud or to seek unconscionable advantage.” With that definition in mind, issuers and senior officers should consider the following before making disclosures about any known trends, events, and uncertainties that may have a material unfavorable impact on the state of the business:
- Seek advice of counsel, both in-house and external. Not only will advice of counsel help develop well-informed disclosures now, it will also provide a strong indicator of good faith should the SEC look to investigate later. External counsel may also have a pulse on what other market participants are thinking and doing. Corporate executives should consider creating a kind of dossier for counsel — and possibly external auditors — to review before making public disclosures.
- Exercise heightened diligence in information gathering. Under routine circumstances, most companies have systematic methods of communication between certain corporate levels, departments, and individuals. During the weeks and months ahead, issuers cannot simply fall back on the norm. Corporate executives must be sure that relevant information is gathered from all departments and levels of the organization to ensure accurate and detailed disclosures.
- Do not overlook existing policies and procedures. While it is hard to imagine corporate policies and internal controls that could have accounted for the magnitude of the current crisis, existing policies and controls are still in place to keep companies operating effectively and appropriately while they try to manage these events. Following internal procedures, and modifying or updating them as necessary, is another strong indicator of good faith. Companies should think critically about whether there are sufficient policies and controls in place, particularly as most people are working remotely and the flow of information and materials is altered.
- Be disciplined in messaging. Disclosures must have internal support behind them. Ideally, as discussed above, this support would be vetted by in-house and external counsel, and by external auditors as appropriate. Forward-looking statements should be identified as such and accompanied by meaningful cautionary language that does not rely on traditional boilerplate. While disclosing uncertainties and potential risks to the future of a business has consequences, so too does knowing those risks and failing to disclose them. The SEC may not second-guess good faith attempts to provide appropriately framed forward-looking information, but it has also warned “any bad actor who would seek to use this challenging time to take advantage of our investors or our markets [that] . . . the women and the men of the SEC are watching.”
Issuers and their senior executives will be faced with both unique and common challenges as the COVID-19 crisis continues to unfold. There is unfortunately no one-size-fits-all approach to demonstrating good faith in disclosing uncertainties regarding the crisis but implementing the above practices will go a long way. While Gov. Cuomo is right that “none of this has been done before,” by implementing these steps in preparing, framing, and ultimately sharing information on trends, events. and uncertainties, issuers and their executives can prove that it can be done without exposing senior officers to liability.
The views expressed in this article are those of the authors and not necessarily those of BakerHostetler or its clients.
John J. Carney is a partner with BakerHostetler in the firm’s New York office and serves as co-leader of the firm’s national white-collar defense and corporate investigations group. Bari R. Nadworny is an associate at BakerHostetler.
 17 C.F.R. § 229.303(a)(3)(ii).
 Black’s Law Dictionary (11th ed. 2019).