When a company learns that it must disclose bad news—such as a restatement of earnings, a common trigger of shareholder suits—outside directors can mitigate the fallout with a prompt and informed response. Doug Hagerman is the Chicago-based chairman of the securities litigation practice group at Foley & Lardner, a national law firm that routinely defends corporations in securities litigation. He suggests that upon learning about such a problem, directors immediately call an emergency board meeting to make sure the company reacts appropriately, as described in this checklist. “They should also insist that they be kept in the loop throughout the crisis,” he says. While following Hagerman’s rules may not prevent a shareholder lawsuit, it will certainly assist the company in fighting one.
Tell the truth and do not sugarcoat the news. Do not deny wrongdoing unless you are 100% certain you are right.
Develop a communication strategy. Limit designated spokespersons, script statements, and consider hiring a crisis PR specialist.
Consider whether to quantify the problem when you disclose it, and how seriously to characterize the problem. Quantify it only if you can do so with a high degree of certainty.
Decide whether to disclose expected future results and the impact of the problem on those results. And make sure you include appropriate language to qualify your predictions for safe-harbor treatment under the Private Securities Litigation Reform Act of 1995, which exempts companies from liability for forward-looking statements if they are accompanied by meaningful cautionary language.
Hire qualified, specialized defense counsel, which may not be your regular law firm.
Start an internal investigation to determine the facts and the need for changes in controls and personnel. Conduct the investigation under the control of counsel to obtain the protection of attorney-client privilege.
Consider calling the Securities and Exchange Commission to voluntarily disclose the problem and to cooperate with SEC staff. The SEC and prosecutors say that prompt and full cooperation may in some circumstances cause them to decline to bring charges against a company.
Bar insider trading while you prepare to disclose the crisis.
Notify your insurers of the crisis.
Preserve existing evidence, but be careful about the evidence that will be generated during this time. As people rush to consider the problem, they may create an ill-considered written record that could haunt the company in future litigation.
Consider disclosure obligations under the rules of the National Association of Securities Dealers or the exchange where your stock is traded. Those rules may be broader than federal securities laws.
Communicate with your auditors and lenders, but carefully. Bring them into the loop without causing undue alarm, without waiving attorney-client privileges, and without making an adversary out of someone whose cooperation you will need.
Don’t allow management to overrule counsel on how and when to disclose information.
Beware of contentions that certain problems are immaterial. Corporate constituents, including management, often argue for withholding disclosure on the basis of rationalizations that the information is not material—and they are often wrong. The consequences of an erroneous judgment call on materiality can be severe, both in shareholder litigation and in dealings with the SEC.
