Disasters and Disclosures

Donald Langevoort is Thomas Aquinas Reynolds Professor of Law at the Georgetown University Law Center. This post is based on his recent paper.

Corporate disasters happen with unnerving frequency. These can be visibly dramatic events like the BP Deepwater Horizon oil rig catastrophe, with loss of life, environmental damage, and great consequential economic loss. Many are (or are also) legal compliance disasters: a massive fine or penalty imposed on the company after government authorities determine that the corporation surreptitiously had violated the law. Others may be on a smaller scale yet still painful, as with a defective product on which the company had pinned its hopes or the departure of a key leader under questionable circumstances. In a working paper entitled Disasters and Disclosures, I explore the legal risks associated with corporate disclosures before, during and after these kinds of events, focusing mainly on Rule 10b-5 fraud-on-the-market litigation.

Disaster cases are mostly (though not all) about distortions via the alleged concealment of risk factors prior to the crisis. In an ideal world, serious warning signs would presumptively be subject to a duty to disclose, with scienter and materiality the only hard questions—there is no social value to justify deliberate concealment once those thresholds are met. Yet for a host of doctrinal, pragmatic and political reasons, there is no clear-cut duty. The SEC has imposed a set of requirements that sometimes forces risk disclosure, but does so neither consistently nor adequately, and with uneven enforcement. (A portion of my paper visits the issue on which, in the Leidos case, the Supreme Court was prepared to weigh in on about private enforcement of line item omissions, before the case was mooted by settlement.)

Courts in fraud-on-the-market cases have instead made duty mainly a matter of active rather than passive concealment and thus, literally, wordplay: there is no antifraud-based duty to disclose risks unless and until the issuer has said enough to put the particular kind of risk “in play.” But when that is, and why, flummoxes them. A particularly striking example can be found in the litigation following what is said to be Brazil’s worst environmental disaster, the collapse of the Fundao dam in November 2015. The dam (holding back toxic sludge from mining operations) was owned by a joint venture co-owned by two global companies with mines nearby, Vale and BHP Billiton. Both companies had securities traded in the U.S., and hence 10b-5 lawsuits were filed separately against each in the Southern District of New York for making statements touting their commitment to the safety of their projects while not revealing facts allegedly known to both indicating that Fundao was at risk. The public statements each made with respect to the respective companies’ commitment to safety and the environment were comparably soft and filled with marble-mouthed generalities. (For instance, Vale: “[w]e are striving to build a company of solid values,” including “respect [for] the environment and genuine care for the safety and well-being of fellow colleagues and respect for the communities in which our company operates,” and “we seek nothing less than zero harm”; BHP Billiton: “[t]he health and safety of our people must come first and so across BHP Billiton we’ve interacted with the whole workforce to reaffirm our commitment to their safety and well-being, and to insist any work that is unsafe must be stopped.”) Yet the reactions of the two district judges, ruling just a few months apart, were palpably inconsistent on whether these kinds of statements could mislead the reasonable investor. No said the judge in the Vale case, because the touting was ordinary puffery with no solid communicative content; yes the judge said as to BHP because, while the touting statements might indeed be general, they were nonetheless made in a way that stressed the importance of mine safety “over and over and over,” suggesting that the company knew that reasonable investors cared about these risks, thus drawing the inference that it was trying to deceive them.

So who was right, and why? This incoherence could be rationalized by a more thoughtful assessment of how and why words matter to investors and better appreciation of the variable role that managerial credibility plays in the process of disclosure and interpretation, which are the two main contributions of my paper. Research in financial economics is paying more attention to these complex interactions—essentially, the micro-structure of corporate communications—which are far more complicated than suggested by the simplifying assumptions about near-perfect market efficiency that once dominated. Courts seem to be a step behind, and lawyers seem to have found the doctrinal soft spots. But even if there is more thoughtfulness to the endeavor, it is fair to ask why wordplay should make so much of a difference as to duty in the first place, or whether instead our impoverished conception of duty deserves a more thorough makeover.

While much of my paper is devoted to the wordplay problem, a broad-based study of disaster-related disclosure reveals more. Indeed, managerial credibility reappears as a unifying theme that connects to other issues that commonly arise in disaster litigation, including loss causation and the problem of “collateral damage” for reputational damage, corporate scienter, and the adequacy of risk management and internal controls. There are many pay-offs from this kind of inquiry, both academic and practical. By looking closely at alleged falsity over the course of a disaster timeline, we get a good glimpse of how disclosure works in real time, as corporate executives and the company’s lawyers craft strategic responses to the line-item disclosure obligations that the SEC imposes and negotiate the murky world of voluntary disclosure—whether and what to say in response to marketplace pressures (from the analysts, institutional investors, the media and other vocal stakeholders) to reveal more than the SEC forces about the risks the company faces.

In terms of fraud-on-the-market liability exposure, disasters are an ideal (if disturbing) setting for thinking through the background norms of corporate discourse—the implicit rules of interpretation for how marketplace actors interpret what issuers say and don’t say, whether in formal SEC disclosures, conference calls, press conferences and even executive tweets. They also offer a distinctive reference point for thinking about contemporary controversies associated with bringing matters of social responsibility (e.g., law abidingness) and sustainability (environmental compliance, cybersecurity, product safety, etc.) into the realm of securities law. Especially as more and more attention is paid to the environmental, regulatory and social risks corporations face, with fears of so many potential disasters in their future, this subject will surely grow in both interest and importance.

The complete paper is available here.

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