Understanding the impact of the many new statutes and regulations affecting corporate governance and public reporting is only a part – albeit an important part – of protecting a company's value in the current shift toward management transparency. Creating a culture of corporate responsibility throughout the organization and developing processes that enable the company to deal with and respond to the complex, fluid, and time sensitive market and regulatory forces, are equally important.
The stakes are higher than they ever have been. Companies need to understand the playing field as well as the rules of the game if issues arise – because in today's environment, even relatively small issues can spin out of control and lead the company into a devastating downward spiral. While a failure to comply with reporting requirements was always a serious matter, current changes to the enforcement environment require a new commitment to vigilant compliance. Circumstances also require contemplation of a comprehensive management response plan should your company become the focus of enforcement activity. Here are some of the principle considerations for a comprehensive response plan.
Multi Pronged Enforcement Activity: Federal and State Scrutiny
While historically, securities enforcement has been led by the SEC, the states have been asserting themselves in a significant way. Recent investigations have been spearheaded by state attorneys general, sometimes working in conjunction with federal regulators, sometimes seeming to be in competition with them. When an investigation hits, companies need to understand that parallel enforcement proceedings may be underway. Your response team needs to be prepared to manage these related but different activities.
Pay Attention to the Political Winds
Given the high profile that the media has given recent corporate "scandals," politics is a significant consideration in your response plan. Elected officials increasingly have been drawn to investigations of alleged corporate wrong-doing. Any management response plan needs to anticipate that regulatory scrutiny has the potential to become politicized and part of a public debate on corporate activity.
Media Scrutiny: Good Will Gone Bad
The reputation of a company – among investors, customers, employees, the market, and others – is a vital asset. Harsh and negative media coverage can quickly destroy what has been built over many years. Your management response plan must address the specific activity you will undertake to provide the media with your response to the scrutiny. Also, it is important to remember that Regulation FD prescribes how companies may communicate about financial issues. Recent enforcement actions by the SEC demonstrate that regulators will scrutinize closely what you are telling the investing public in times of distress. Be wary of advice that has you simply saying "no comment."
Action is Often Better than Reaction
Companies need to be proactive and take the initiative to the extent possible, addressing everything from a possible re-statement of earnings, potential stock deterioration, analyst downgrades, securities class actions, criminal prosecutions or bankruptcy filings in a way that sends the message that they are being forthright and forthcoming.
How a company in question presents itself to the market initially is critical. Companies that have been hit the hardest know that every second counts and those that have fared the best did so by understanding all of their options and potential outcomes up front.
Assemble Your Management Response Team Now
Once a government enforcement notification is received, the first decision a company has to make is selecting its team of highly experienced professionals who can work exceptionally well together, which is no easy feat given the number of parties involved. At the very least, a company will retain an interdisciplinary team of securities lawyers, litigation counsel, SEC/regulatory counsel, a forensic accounting firm, counsel for significant employees, representation for the audit committee, criminal defense, and someone who will pay attention to public relations and political/community relations.
Avoiding a company death spiral means managing the parallel issues. There are several significant areas a company should understand and prepare for the moment a government enforcement notification is received:
Restatement of Earnings: In some cases, the first step may be a restatement of earnings. It is one of the most complicated steps yet it is critical. The new calculations need to be done quickly and accurately. The restatement, in turn, will likely start a number of other dominoes falling.
Stock Deterioration: The market will react badly to an earnings restatement. It is critical to communicate information that reassures investors and analysts that management and the board understands the problem, is committed to dealing with it in an honest and direct way, and can be counted on to provide accurate information promptly and frequently going forward.
Securities Class Actions: Significant declines in value may lead to shareholder lawsuits, whether or not there was actually any wrongdoing. Management and the board have to work with their counsel to develop a strategy for dealing with them, and with the potential public attacks that will come from plaintiffs' attorneys.
Analyst Downgrades: Giving analysts the right information is imperative and getting them to see the bigger picture is not always easy. They need to understand the process and receive as much information as possible as frequently as possible.
Criminal prosecution of individuals or the company: Things spiral quickly in these situations and criminal prosecutions can sometimes follow quickly. Prosecutors may target mid-level executives as a way of gaining leverage over senior executives or the company as a whole. Quickly developing a strategy for avoiding such a scenario and a strategy for defending against it if it happens is crucial.
Bankruptcy Advice: When the downward spiral becomes unstoppable, it may ultimately require a bankruptcy filing. While it is not the ideal outcome, laying out a preventative strategy early can help to minimize losses, while at the same time help the company remain viable until new business strategies can be implemented. And there are often situations where bankruptcy filings and the threat of such filings can be used in ways that give companies additional leverage.
Seek Counsel
While their have been seismic changes in corporate governance, many have negotiated through these multi-faceted problems before. Seek counsel early to gain control, management and influence over as many of the applicable issues as possible.
Mr. O'Connell leads Nixon Peabody's Financial Services and Securities Litigation and Corporate Governance Teams, which handle all manner of corporate governance litigation. He is resident in the Boston, Massachusetts office.
Mr. Langan leads Nixon Peabody's Business Group and Corporate Governance Team. He is resident in the New York City office.