Valenti Hanley PLLC

The dangers of disclosing a financial investigation to investors

If your company is under investigation by the Securities and Exchange Commission (SEC) for financial fraud, should you notify your investors? Some companies believe that transparency is important, so they disclose these investigations.

Another common reason for disclosure is that companies believe that they're legally required to do so. Companies are required to disclose a "necessarily material event." However, they have some discretion in whether to consider an SEC investigation is one of these events.

A recently published study found that such disclosures by publicly held companies can negatively impact their returns -- even if they're ultimately not found guilty of any wrongdoing. The study was led by two professors from Boston College and Harvard Business School. They looked at over 600 investigations of 587 publicly held companies. Only a quarter of those investigations ultimately led to enforcement actions.

Researchers found that the companies that disclosed the investigations had "significantly lower" returns over the following year than the ones that didn't disclose as their stock prices fell. Returns for the disclosing companies were 6.74% lower than the nondisclosing ones two months after the disclosure. That increased to a 12.67% difference a year after disclosure.

Furthermore, the chief executive officers (CEOs) of these disclosing companies were more likely to be removed from their positions. The study found that they were almost 14% more likely to be out within two years than those who led the companies that didn't disclose their investigations. Researchers hypothesized that this could be because the companies' boards were seeking to place the blame on someone besides themselves. CEOs are certainly high-profile targets.

The study recommended that the SEC should "either mandate disclosure for all firms or set clear rulings that no legal liability or sanction will follow from non-disclosure." It noted, "By providing firms the discretion to disclose, those that choose the path of transparency appear to be punished with lower stock prices and lower job security for their most senior leaders."

If your company is under investigation by the SEC or any law enforcement or regulatory agency, it's essential to get your attorneys involved immediately. They can advise you on the legally required steps to take, including any necessary disclosures to investors and/or others.

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Valenti Hanley PLLC
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