International Law Advisory - SEC Disclosure for Operations in Sensitive Countries

Earlier this year, at the behest of Congress, the Securities and Exchange Commission (“SEC”) established an Office of Global Security Risk.  Its mission is to ensure that companies (domestic or foreign) trading on U.S. exchanges disclose business activities in or involving states designated by the State Department as sponsoring terrorism – currently, Iran, Iraq, Syria, Libya, Cuba, North Korea, and Sudan.  The SEC has opened the Office of Global Security Risk within the SEC’s Division of Corporation Finance and has begun to staff it.  As discussed below, however, questions remain with respect to whether the activities of the Office will change the disclosure obligations of domestic and foreign companies listed on U.S. exchanges.  Moreover, the SEC has signaled that the new Office will actively seek information on corporate activities in terrorist-sponsoring countries and will share that information across government agencies.

The procedural background of the congressional directive to establish the Office of Global Security Risk indicates that SEC may have significant discretion in administering the new Office.  While the mandate came through the appropriations process, it was not contained in the Consolidated Appropriations Act, 2004, Pub. L. 108-199.  Rather, the genesis of the Office is found in the Conference Report accompanying that bill, which incorporated by reference an underlying House Report to a predecessor bill.

The House Report directs the new Office to shoulder five key responsibilities:

1.  Develop a process to allow the SEC to identify companies on U.S. exchanges operating in terrorist-sponsoring states as designated by the State Department;
2.  Ensure that companies traded on U.S. exchanges operating in terrorist states disclose such activities to investors;
3.  Implement enhanced disclosure requirements based on the asymmetric nature of the risk to corporate share value and reputation stemming from business interests in these higher risk countries;
4.  Coordinate with other government agencies to ensure the sharing of relevant information across the federal government; and
5.  Initiate a global dialogue to ensure that foreign corporations whose shares are traded in the U.S. are properly disclosing their activities in State Department-designated terrorist states to American investors.

The House Report also expressed the view that “a company’s association with sponsors of terrorism and human rights abuses, no matter how large or small, can have a material adverse effect on a public company’s operations, financial condition, earnings, and stock prices, all of which can negatively affect the value of an investment.”

The key unresolved issue with respect to the SEC’s new mandate involves whether the SEC will alter its historic approach to disclosure – the “materiality” standard – whereby information must be disclosed if a reasonable investor would consider the information important in making an investment or voting decision.  The House Report calls for “disclosure” whenever a foreign or domestic company operates in a country deemed to sponsor terrorism.  The House Report also refers to “enhanced disclosure requirements for such activities.”

Beyond the question of the disclosure standard, the House Report language contains other ambiguities.  The Report contains no definitions or explanations for such key terms as “operating” in a country, or engaging in “activities” in a country.  Further, the Report does not clarify whether the intended disclosure is supposed to reach as far as companies affiliated with listed companies and, if so, what level of affiliation would trigger disclosure.

At the end of March 2004, SEC Chairman William Donaldson provided congressional testimony stating that the Office of Global Security Risk “will function within the traditional disclosure mission of the Commission.”  This language appears to be an attempt to tone down the strong language of the House Report.  Nevertheless, once staff is in place to analyze activities of companies operating in countries on the State Department list, the issue could take on a life of its own.  It is also important to note that Chairman Donaldson testified that the Office will pursue the following objectives:

1.  Identifying companies whose activities raise concern about global security risks material to investors;
2.  Obtaining appropriate disclosure where merited; and
3.  Sharing information as necessary and appropriate with the other key government agencies responsible for tracking terrorist financing.

If you have any questions regarding how the mandate of the Office of Global Security Risk may apply to the operations and activities of your company or its affiliates, please contact Edward Krauland 202.429.8083 or Julia Court Ryan.