Securities Act Release No. 6791

Exchange Act Release No. 25951

Investment Company Act No. 16509

August 1, 1988

RELEASE NO. 32 Disclosure Obligations of Companies Affected by the Government; Defense Contract Procurement Inquiry and Related Issues

ACTION: Interpretation.

SUMMARY: Companies are reminded to consider their disclosure obligations in connection with issues arising from the government's defense contract procurement inquiry.

FOR FURTHER INFORMATION CONTACT: Robert A. Bayless, Deputy Chief Accountant, Division of Corporation Finance, (202) 272-2553, or Daniel W. Rumsey, Attorney, (202) 272-3755, Division of Corporation Finance, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission ("Commission") today called attention to its requirements under the Securities Act of 1933¹  ("Securities Act"), the Securities Exchange Act of 1934²  ("Exchange Act"), and the Investment Company Act of 1940 ("Investment Company Act")³  regarding disclosure obligations of registrants in connection with the ongoing government investigation into illegal or unethical activity in the procurement of defense contracts. The Commission recognizes that the exact subjects and scope of the government's inquiry are still unknown. In view of the potential adverse effects upon registrants that may result from the investigation as well as any governmental action that may result, however, companies engaged in the defense business should review on an ongoing basis the need for appropriate disclosure, particularly in connection with their forthcoming reports or registration statements to be filed with the Commission.⁴

These considerations equally apply to companies that are subject to the inquiry and to companies that, although not targeted in the investigation, otherwise may be materially affected by the investigation as a result of additional expenditures incurred or policies and practices altered in connection with defense contract procurement. For example, disclosure of a change in practice may be required where a company, through its consultants, agents or otherwise, has been engaged in questionable conduct and thereafter alters its policies for obtaining defense contracts, or if general industry procedures change as a result of issues highlighted by the inquiry.

In addition, any investment company that has adopted a fundamental policy to concentrate⁵  its investments in an industry dependent upon government defense contracts should consider disclosing in its prospectus the potentially adverse impact the government's investigation may have upon the investment company's investment in the companies within such industry.

The rules regarding filings with the Commission impose obligations on registrants to disclose specified material information in registration statements filed under the Securities Act, initial registration statements filed under the Exchange Act,⁶  and annual⁷  and quarterly⁸  reports filed under the Exchange Act. Depending upon the provisions of the particular Form, such requirements relate to various aspects of the registrant's business, legal proceedings, management, and financial condition, among other matters.

The requirement regarding a description of the registrant's business⁹  includes disclosure pertaining to any material portion of a company's business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.¹⁰  A company's or its subsidiary's dependence on government contracts also would be required to be disclosed where the loss of such contracts would have a material adverse effect upon the company.¹¹  Likewise, companies, at a minimum, must disclose certain loss contingencies in their required financial statements.¹²

Disclosure also is required of material pending legal proceedings involving a company or its subsidiaries.¹³  Legal proceedings known to be contemplated by government agencies similarly should be disclosed where management reasonably believes that such government action will have a material effect upon the company and its business.¹⁴  In this regard, disclosure of known contemplated government proceedings may be required where the result may be the cancellation of a governmental contract, suspension of payments under a contract, termination of further business with the government, or alteration of the registrant's procedures for obtaining government contracts.

Legal proceedings involving directors, nominees, executive officers, promoters, and control persons should likewise be disclosed where material to the ability or integrity of such person.¹⁵  In this regard, disclosure generally is required, for example, where such person was convicted in a criminal proceeding; a named subject of a pending criminal proceeding; subject to an order, judgment or decree enjoining or limiting such person from engaging in specified activities; or found to have violated any federal or state securities law.

The potential effects of the government's inquiry must be discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") in a company's annual and quarterly reports as well as transactional filings if, in light of the associated probabilities and magnitudes, the effects may be material.¹⁶  Such a discussion should be included where the registrant reasonably expects that the government's inquiry will have a material adverse effect on a company's financial condition, liquidity, capital resources, net sales, revenues or income from continuing operations, or such inquiry otherwise would cause a material change in the relationship between costs and revenues. Disclosure also should be provided where, in light of the uncertainty regarding the government's inquiry, reported financial information would not necessarily be indicative of the company's future operating results or financial condition.

The Commission's rules also require disclosure of any additional material information, beyond information specifically required to be disclosed, that is necessary to make the required statements not misleading, as to the business, financial results and condition, and the management of the company.¹⁷  In this regard, consideration should be given to disclosing the effects of the government's inquiry where management reasonably believes that existing disclosure may be materially deficient because of the investigation's potential impact upon company expenditures, earnings, or competitive position within the industry.¹⁸  Moreover, if a company has a policy or approach towards defense contract procurement that is likely to be affected as a result of the inquiry, it may be necessary to disclose such effects, including the resulting costs, in the description of the company's business, MD&A, or financial statements as appropriate.

Attention also is directed to the antifraud provisions under both the Securities Act and the Exchange Act, which apply not only to statements and omissions made in filings with the Commission but also to those made outside Commission filings.¹⁹  Accordingly, statements made concerning companies and their management should include sufficient disclosure so as not to be materially misleading.

List of Subjects in Parts 231, 241, and 271.

Reporting and Record Keeping Requirements, Securities.

Parts 231, 241, and 271 of Title 17, Chapter II of the Code of Federal Regulations are amended by adding this Release No. 33-6791, 34-25951, IC-16509, and FR-32 (August 1, 1988) to the lists of interpretive releases.

By the Commission.

¹ 15 U.S.C. §77(a), et seq.

² 15 U.S.C. §78(a), et seq.

³ 15 U.S.C. §80a-1, et seq.

⁴ While this Release highlights these disclosure concerns in the context of registration statements and reports filed with the Commission, registrants should be mindful of the fact that similar issues may arise in connection with other filings, particularly transactional filings such as proxy and information statements, tender offer and issuer tender offer documents, and going private filings.

⁵ See, e.g., Section 8(b)(1), 15 U.S.C. 80a-8(b)(1), of the Investment Company Act and Item 4(a)(ii) of Form N-1A.

⁶ Form 10.

⁷ Form 10-K.

⁸ Form 10-Q.

⁹ Regulation S-K, Item 101, "Description of Business," .

¹⁰ Regulation S-K, Item 101(c)(ix).

¹¹ Regulation S-K, Item 101(c)(vii).

¹² Regulation S-X, Article 5-02. See also Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (March 1975).

¹³ Regulation S-K, Item 103, "Legal Proceedings."

¹⁴ Id.

¹⁵ Regulation S-K, Item 401(f) and (g), "Directors, Executive Officers, Promoters and Control Persons."

¹⁶ Regulation S-K, Item 303.

¹⁷ See Securities Act Rule 408; Exchange Act Rule 12b-20. See also Rule 14a-9.

¹⁸ See also Regulation S-K, Item 101(c)(x), which requires disclosure of the competitive conditions within a company's industry.

¹⁹ See Securities Act Section 17(a), 15 U.S.C. §77q(a), and Exchange Act Section 10(b), 15 U.S.C. §78j(b), and Rule 10b-5 thereunder.