One way to measure the scale of the fallout from the collapse of Enron is to phone major law firms in the US to try to get on-the-record comment about what has happened.
Never usually shy with opinions, many lawyers are reluctant to talk about the scandal. The reason is that almost anyone who is anyone in the US legal world is working on one aspect or another of the Enron case.
A partner in a mid-size Washington DC firm acting for a group of Enron creditors says: “There are a lot of sophisticated financial institutions out there who are not very happy. I don’t want to risk upsetting them more by talking to journalists right now.” Sometimes, she says, you just have to keep quiet: “This is what happens when there is $30 billion at stake. I can see Enron-related issues being litigated 10 years out from now.”
And whichever way you look at it, the one group that is sure to emerge from the whole affair even better off than before is the lawyers. Not only is there a fabulously complicated network of relationships to untangle, not only are there myriad claims and counter-claims to fight but when the specifics of the Enron case are finally settled many years hence, an entirely new framework of corporate disclosure will have emerged.
In the post-Enron world, companies are going to have to disclose more information more regularly and they will have to ensure they are doing it in a way that can be clearly understood. “There is going to have to be an enormous amount of additional reporting to ensure that a clear message about the status of a company gets through to investors,” says the Washington law partner. As a result, she says: “Companies will be much more pernickety about their outside assistance – you are going to see lawyers checking the work other lawyers are doing. We estimate it will all mean about 30% more work for us from public companies.” Although, she adds with a tone of regret, wily in-house counsel will seek to push down hourly rate charges to compensate.
Anyone doubting what she says need only focus attention on the noises coming out of the Securities&Exchange Commission since the Enron story broke. A series of press releases from SEC chairman Harvey Pitt have been backed up by formal statements outlining the SEC’s attitude towards disclosure and proposals to introduce new rules designed to restructure current requirements. Fortune 500 companies have also been informed that they face extra scrutiny. The SEC news digest of December 21 last year stated that the annual reports of all Fortune 500 companies are to be scrutinized by its corporate finance division to see if there is any evidence of insufficient disclosure.
All publicly listed companies in the US are going to have look very carefully at the way they report to the markets. An analysis of what has been said since December last year makes it clear that there are two general areas on which the SEC is going to focus: closer enforcement of current rules regarding disclosure; and the introduction of new rules that will require companies to report changes in their trading circumstances much sooner.
One major concern to the SEC seems to be the discussion of financial status that is found in the “management’s discussion and analysis of financial condition and results of operation” (MD&A) section of company filings. The purpose of the MD&A is to expand on disclosures made in the financial statement to provide investors with a clear understanding of a company’s financial condition and the trends affecting its results, as well as the factors that are likely to affect performance in to the future.
On January 22, the SEC issued an MD&A statement designed to clarify its thinking on the current disclosure obligations that companies are required to meet. In doing so, the SEC emphasized that the point of the MD&A was to “give the investor an opportunity to look at the company through the eyes of the management”. In particular, the statement suggested that there was a need for companies to look closely at disclosure relating to liquidity and capital resources, including off-balance-sheet arrangements, trading activities concerned with non-exchange traded contracts and related party transactions.
According to Sara Hanks, a partner in the capital markets practice of Clifford Chance Rogers&Wells, the way companies prepare their MD&As will have to be rethought as a result of these latest developments.
Too often, she says, the process is left to junior members of the management team, such as those who are responsible for investor relations. This is going to have to change: “The most important people in the company should now be taking part. Key staff such as the CFO have to be asked what it is that keeps them awake at nights and this should be properly reported.”
Hanks adds that the SEC has now made it clear that even if companies comply with all the accounting rules and disclosure requirements, their disclosure will be insufficient if the language used to convey the message means that investors will have difficulty in understanding what is being said. Inevitably, complying with the requirements is going to mean increasing the time and resources allocated to the disclosure process. She says, however: “Periodic disclosure is not something that you should be looking to save money on.”
The MD&A statement was followed in February by a further statement outlining the SEC’s attitude towards the timing issues involved when companies report on events that could have an effect on their trading activities.
The statement, released on February 13, explains that the SEC plans to introduce new rules that would shorten the length of time that companies have to file quarterly and annual reports. The current 90 days allowed from the fiscal year-end to file annual reports and the 60 days from the close of a quarter to file quarterly reports will be cut to 60 and 45 days respectively.
Of even greater significance was the announcement that the SEC will move to a system of what it calls “affirmative current disclosure”. Under this, “unquestionably material” events would have to be communicated to the markets within two business days of their taking place or even, in some cases, on the following day.
The statement provides a non-exhaustive list of 15 areas where such disclosure would be required, including changes in ratings agency decisions, transactions in the company’s securities with executive officers and directors, and defaults and other events that could lead to acceleration of direct or contingent obligations. Hanks says: “I hate to use the phrase but we are talking about a paradigm shift. They are significantly broadening the requirement that developments in the life of a company have to be reported to the market as soon as possible.”
Officers and companies filing false or misleading statements have always had to face the possibility of civil and criminal action but in the past the SEC’s enforcement capabilities have suffered from a lack of resources.
Hanks explains: “They have brought a lot of cases for inadequate reporting and they have probably caught a lot of people before they could do damage to the economy. But you can’t expect them to catch everyone. Not when they only have 2,000 people and the markets are so much bigger than they have ever been before.”
The SEC’s Pitt, however, seems to be playing his post-Enron hand skilfully. He has requested 100 additional staff members and the ability to offer salaries up to 30% higher than are currently available. The chances are that his request will be accepted. It all means companies must get to work right now. “If they get the new people they have asked for, I think they are going to manage to review pretty well everyone,” says Hanks.
