Hancock Rothert & Bunshoft LLP
As the Millennium draws nearer, more and more financial institutions are recognizing that in addition to a technical problem, a staffing problem, a resources problem and a funding problem, the Year 2000 problem poses a host of legal challenges. Financial institutions are beginning to recognize that a discrete Year 2000 legal strategy is necessary to manage both incoming potential liabilities, to manage Year 2000 contractual relationships, and to explore avenues of recovery for the Year 2000 problem. Recent SEC guidance on disclosure brings into focus some challenges for financial institutions.
SEC Announces New Disclosure Guidance
Disclosure by Publicly Traded Companies
Over the course of the last year, the SEC's view of disclosure of Year 2000 related costs and problem has matured considerably. From an initial position that the Year 2000 problem posed no special issues and should be measured by traditional FASB 5 standards, the SEC has recently announced that it considers disclosure to be an important issue.
This past November, in hearings before the Senate Banking committee, several Year 2000 specialists testified that the issue of disclosure was important and being honored in the breach. The need for uniform disclosure prompted Senator Bennett (R Utah) to introduce Senate Bill 1518. The Computer Remediation and Shareholder Protection Act of 1997 (the CRASH Protection Act) would require disclosure of: (1) the amount a company in spending on Year 2000 remediation; (2) what phase the company's Year 2000 plan has achieved; (3) whether the company anticipates litigation arising out of its Year 2000 problem; and (4) whether the company has insurance to protect it against liability arising out of the Year 2000 problem.
In part in response to S. 1518, and uncertainty expressed by members of the accounting and legal professions, the SEC released revised Staff Legal Bulletin No 5 (CF/IM) on January 12, 1998, augmenting its October bulletin. (A staff legal bulletin is not a rule, regulation, or official statement of the SEC; rather it is the SEC division's staff's view of disclosure requirements.)
In its bulletin the SEC staff states that "companies should include disclosure in their "Management's Discussion and Analysis of Financial Condition and Results of Operations" if:
- the cost of addressing the Year 2000 issue is a material event or uncertainty that would cause reported financial information not to be necessarily indicative of future operating results or financial condition, or
- the costs or the consequences of incomplete or untimely resolution of their Year 2000 issue represent a known material event or uncertainty that is reasonably expected to affect their future financial results or cause their reported financial information not to be necessarily indicative of future operating results or future financial condition.
In amplifying this requirement, the SEC staff indicates that if a company has not made an assessment of its year 2000 issue or has not determined whether it has a material Year 2000 issue, disclosure of this "known uncertainty" is required. In determining whether the Year 2000 problem will have a material impact on financial results, the determination should be made "without regard to countervailing circumstances (such as Year 2000 remediation programs or contingency plans). As part of the disclosure, SEC staff would expect, at a minimum, that the following topics would be addressed:
- the company's general plans to address the Year 2000 issues relating to its business, its operations (including operating systems) and, if material, its relationships with customers, suppliers, and other constituents; and its timetable for carrying out those plans; and
- the total dollar amount that the company estimates will be spent to remediate its Year 2000 issues, if such amount is expected to be material to the company's business, operations or financial condition, and any material impact these expenditures are expected to have on the company's results of operations, liquidity and capital resources.
Several points of the SEC staff guidance bear emphasis. First, a publicly traded company must undertake an assessment of the consequences of "incomplete or untimely" resolution of its Year 2000 problem. Second, in determining its obligation to disclose the company must undertake the somewhat metaphysical exercise of ignoring its ongoing remediation plan and assess what impact a Year 2000 problem would have had "without regard to related countervailing circumstances." Based on this standard, it seems as if the SEC if forcing publicly traded companies to make a disclosure.
For most companies, and certainly for most financial institutions, it is likely that if they ignored the Year 2000 problem completely, a disruption of operations would occur. For many institutions, the Year 2000 problem implicates nearly all aspects of the operation -- from customer accounts, to amortization calculations, to investment tracking, to customer relations, to interest calculations, to statement generation. If the institution assumes that these and other basic functions would be impacted by the Year 2000 bug, it will be required to disclose under the SEC's guidance.
The disclosure guidance also suggests that disclosure include a discussion of how the institution is managing its relationships with customers, suppliers and "other constituents." Outreach to vendors and customers is often an area where many Year 2000 programs are lacking. An integrated plan will now need to include a vendor outreach component as well as an analysis of impact on the institution's customer base. For financial institutions, this aspect of an integrated Year 2000 problem should be underway as it has become an aspect of the Federal Reserve's auditing protocol for financial institutions.
Disclosure by Investment Companies and Investment Advisers
The SEC has also indicated that disclosure may be required under the Investment Advisers Act of 1940 and the Investment Company Act of 1940. Significant for open-end investment companies -- mutual funds -- these requirements tend to very roughly parallel the requirements for publicly traded companies. If operational or financial obstacles are presented by the Year 2000 problem, investment advisers and investment companies may be required to make appropriate disclosure. Disclosure will be required if failure to disclose would be "materially misleading" to shareholders.
Investment companies may need to disclose the effect that the Year 2000 problem would have on their adviser's ability to provide the services described in registration statements. Investment advisers may need to disclose their Year 2000 problem if failure to address the Year 2000 problem could materially affect the advisory services provided to their clients. As with publicly traded companies, investment advisers will be required to disclose if the adviser is unable or uncertain about its ability to address the Year 2000 problem.
Need for a Comprehensive Legal Audit
Considered from a step back from the actual intricacies of the SEC legal bulletin guidance, the SEC seems to be attempting to force companies to determine where their Year 2000 exposure lies, to assure that companies are addressing their problem and to reach out to trading partners to assure that relationships are managed in light of the Year 2000 problem.
We have continued to recommend to clients that they undertake a comprehensive legal audit to help manage the risk that is associated with the Year 2000 problem. The audit is designed to accomplish several things:
1. It is designed to help avoid liability by discovering those areas of legal vulnerability that a financial institution might suffer.
2. It is designed to assure that opportunities for cost recovery are identified and, where appropriate, pursued. For many institutions, a recovery of even 10% to 20% of its Year 2000 costs can represent a significant amount of money.
3. It is designed to assist a company in developing a disclosure that will pass SEC muster. This entails a rigorous and detailed analysis of the company's Year 2000 program.
4. It is designed to begin to manage potential litigation by assuring that appropriate privileges attach to key documents bearing on the legal aspects of the Year 2000 problem.
5. It is designed to protect the board and the company's assets. With continued discussion in director's and officer's liability insurance circles of a blanket Year 2000 exclusion for Year 2000 related liabilities, the risk exposure of the board and the corporation is heightened and requires special diligent management.
As the Millennium approaches, more and more financial institutions will need to undertake rigorous management of the legal risk. The SEC's most recent guidance prods publicly traded companies closer to that realization. Proactive management of legal exposure remains an essential ingredient for every Year 2000 plan.
This article is also published in the March issue of the Bank Securities Journal.
Hancock Rothert & Bunshoft has formed a Year 2000 Team to assist companies with related legal problems. If you would like more information on Hancock's Year 2000 Team, or on the firm in general, please contact: Vito C. Peraino on Tel: 213-623-7777 or E-mail: Click Contact Link or visit the Hancock Rothert & Bunshoft website at Click Contact Link
Visit the Year 2000 website at Click Contact Link
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
