DIRECTOR SUMMARY
Year 2000 Update - Vito C. Peraino, Partner, Hancock Rothert & Bunshoft LLP
Los Angeles, California
The new millennium's biggest problem remains in critical condition.
In October 1996, we reported in an article entitled "Corporate Director's Liability and the Year 2000 Problem," that the Year 2000 problem was real, serious, and getting worse. We outlined several areas that should concern directors and advocated that companies implement a proactive plan for managing the liability risks associated with the Year 2000 problem. We are unhappy to report that the problem remains very serious and that many companies are likely to face substantial liabilities as their prospects for timely resolution of the problems dim.
To provide perspective to board members, we provide an update regarding the maturation of the Year 2000 problem, outlining the threat that an alarming percentage of companies are likely to suffer serious Year 2000 failures. Next, we address new developments regarding SEC guidance in reporting as well as proposed legislation that would mandate specific, far-reaching disclosures. Finally, we explore the Year 2000 problem in the context of the business judgment rule, suggesting actions a board might consider taking when addressing this serious and unfortunately worsening problem.
The Problem Continues
As has been widely reported, the Year 2000 problem derives from a common computer software limitation. All calculations and data manipulations that require a date-which is to say a very significant proportion of financial calculations-will be corrupted if the problem is not corrected.
Unfortunately, the problem is not limited to computer software. Some computer hardware and a myriad of other products contain microchips that contain date sensitive logic. Ranging from personal computers to data security systems, communications systems, and medical devices,
PROFESSIONAL GROUPS UNITE TO FACE NEMESIS: 2000
Eleven major professional organizations have joined to encourage executive attention to the Year 2000 problem, calling for "immediate action" from corporate managements. Here is a list of the organizations now cooperating to provide Year 2000 solutions (with names and e-mail addresses of contacts):
American Institute of Certified Public Accountants Alan W. Anderson ( Click Contact Link ) Australian Society of Certified Practicing Accountants Andrew W. Kent ( Click Contact Link ) Association of Information Technology Professionals Ernest E. Nolan ( Click Contact Link ) Canadian Institute of Chartered Accountants Michael H. Rayner ( Click Contact Link ) Information Systems Audit and Control Association Patrick Stachtschenko ( Click Contact Link ) Information Technology Association of America Heidi Hooper ( Click Contact Link ) Institute of Chartered Accountants in Australia Stephen Harrison ( Click Contact Link ) Institute of Internal Auditors William G. Bishop, III ( Click Contact Link ) International Federation of Accountants John Gruner (no e-mail given) Society for Information Management Leon Kappelman ( Click Contact Link ) University of Waterloo Centre for Information Systems Assurance Dr. J. E. Boritz ( Click Contact Link )(tm)
The so-called "embedded chip" problem may be as serious as the software problems associated with the Year 2000 issue.
The so-called "embedded chip" problem may be as serious as the software problems associated with the Year 2000 issue. However, unlike the software aspect of the problem, the embedded chip aspect is far less understood and potentially far more pervasive. In 1995 alone, over 3.3 billion microcomputers were shipped. One estimate suggests that 11 percent of embedded hardware may have date faults. While not all embedded chips contained date logic, even a modest percentage failure could have a far-reaching impact on product functioning, with attendant legal and operational implications.
The problem appears to be worsening not only due to a lack of awareness and commitment by business and an insufficient commitment of resources, but also due to a severe shortage of qualified technicians to address the problem. The Gartner Group, one of the nation's leading computer consultants, estimates that the world is short at least 300,000 programmers to address this problem. This acute shortage has manifested itself in the U.S. by severe upward wage pressure and predatory employment raids by organizations in need of qualified personnel.
The banking community, which has been under the watchful scrutiny of federal regulators, fares better than some sectors but still reports significant problems. A recent survey of the Office of Comptroller of the Currency reports that while 85 percent of large U.S. banks (controlling roughly 85 percent of the nation's banking assets) have a Year 2000 program in place, the programs exhibit serious deficiencies, including lack of a dedicated budget, insufficient prioritization of systems for correction, and insufficiently aggressive timetables. Among community banks, the OCC reported that 15 percent were unaware of the Year 2000 problem and another 20 percent, though aware, were not addressing it.
As suspected, the worldwide implications of the Year 2000 problem appear grim. Reporting on the state of international awareness and preparedness of the problem, Harris Miller, president of the
Information Technology Association of America, testified recently before Congress that, in his role as president of the international version of the ITAA, he polled members and found the results "alarming."
"It appears most, if not all, government programs in this area are little more than a year old. Some just started in 1997. Some governments, such as France, have yet to start. Some governments have failed to establish any sort of leadership position on this issue. For those which have started, we found it interesting that many of the polled executives expressed significant skepticism about the government's year 2000 efforts.."
The Gartner Group estimates that at least 30 percent of companies worldwide have yet to begin their Year 2000 project. Asia, Latin America, the Middle Eastern Europe, and Russia all appear to be seriously behind the sluggish efforts of U.S. businesses. Continental Europe remains a mixed picture, with the European Monetary Union conversion drawing significant programming talent away from the Year 2000 projects.
SEC Guidance
As the seriousness of the Year 2000 problem worsens, U.S. companies will need to face the prospect of reporting obligations. Internal and external assessment of the problem will require a deliberate analysis of exposure to the company and its directors.
Since our last report, the Securities and Exchange Commission has published several guidance statements on reporting of Year 2000 efforts. In addition, Congress has begun to consider legislation that would mandate disclosure of Year 2000 efforts.
On May 12,1997, the SEC Current Issues and Rulemaking Projects provided the following guidance with respect to reporting of Year 2000 efforts. Addressing the obligations to discuss Year 2000 efforts in Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A), the SEC stated:
"Companies should review on an ongoing basis the need for disclosures concerning expected expenditures and uncertainties associated with Year 2000 consequences, particularly in connection with their forthcoming reports or registration statements...Consideration should be given to whether the costs of addressing the problem or the consequences of untimely resolution of the problem represent a known, material event or uncertainty that would affect future financial results...(Emphasis added)."
Analysis of the consequences of untimely resolution of the Year 2000 problem may result in a determination that the problem is material and that disclosure is appropriate. For many companies, untimely resolution of the problem would necessarily result in a major disruption of operations that would clearly impact financial results. Careful consideration should be given to undertaking such an analysis.
On October 8, 1997, the SEC issued a Staff Legal Bulletin that provides further guidance on the issue of disclosure. (An SEC staff bulletin represents the Division's staff's views, and is not a rule, regulation, or formal statement of the SEC.) In it the SEC acknowledges the seriousness of the Year 2000 problem and provides certain insight into what can be anticipated to be the SEC's approach to Year 2000 disclosure issues. It states that disclosure must be made in the company's MD&A 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 conditions, or the costs or the consequences of untimely resolution of the Year 2000 issue represent a known material event or uncertainty that is reasonably likely 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."
On January 12, the SEC's corporate finance division issued additional guidance, calling on public companies to inform investors of their Year 2000 plans.
"Companies should review, on an ongoing basis, whether they need to disclose anticipated costs, problems, and uncertainties associated with Year 2000 consequences."
Legislation
Congress has also been active on the 2000 front. Senator Robert Bennett (R-UT) has introduced legislation which would mandate disclosure of the Year 2000 problem. In testimony before the House Banking Committee on November 4, 1997, Senator Bennett outlined the requirements of his proposed legislation. The legislation would require:
- disclosure of the corporations specific progress in the five phases of Year 2000 rededication-awareness, assess- IS, meet, renovation, validation, and implementation-by division, department, or other appropriate business unit
- sure of likely litigation costs and liability outlays associated with the defense of lawsuits brought against the corporation or its directors and officers due to Year 2000 rededication problems, including breach of contract, tort, shareholder class action, an/or product liability suits
- a detailed discussion of existing insurance coverage to cover specific Year 2000 computer failures as well as the defense of lawsuits brought in connection with Year 2000 failures, and
- disclosure of contingency plans for computer systems failure, by division, department or other appropriate business units.
While too early in the spring session to assess the likelihood of passage, Senator Bennett's proposal has received warm response in the House from both the Democratic and Republican members of the committee.
Conclusion
Given the persistence of the Year 2000 problem, and the interest of regulators and legislators in disclosure of this problem, directors must take action.
One step in the right direction would be to form a high-level board committee to investigate the extent to which the Year 2000 problem could affect the legal standing and operations of the company. More important, this committee should see to it that the company is doing all it can to prevent the Year 2000 problem from occurring in the first place.
Vito C. Peraino, Esq. of Hancock Rothert & Bunshoft LLP in Los Angeles, California chairs the firm's Year 2000 Working Group and specializes in 4, Year 2000 legal issues. Reach him 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.
