December 14, 2007

Corp Fin Sends Letters to Issuers Regarding Off-Balance Sheet Entities

In light of the meltdown in mortgage markets and the resulting liquidity issues, the Corp Fin Staff has recently sent letters to those public companies that have identified investments in structured investment vehicles, conduits and collateralized debt obligations. The Staff has now posted an illustrative letter, suggesting possible disclosure for upcoming annual reports. The letter focuses on the Management’s Discussion & Analysis disclosure required under Item 303(a)(4) of Regulation S-K regarding off-balance sheet arrangements, disclosure that may be necessary under Item 303 regarding critical accounting policies for consolidation and variable interest entities, and the MD&A requirement to discuss trends or uncertainties that may be reasonably expected to have a material favorable or unfavorable impact on income from operations, liquidity and capital resources.

The Staff is calling for very detailed disclosure about the assets held by off-balance sheet entities, including ratings, material write-downs or downgrades, maximum limits on losses for first-loss noteholders, and any variable interests held in off-balance sheet entities. Further, the Staff’s comments focus on funding issues – in particular the forms of funding, difficulties faced in financing and obligations under liquidity facilities – as well as efforts on the part of issuers to bail out their off-balance sheet entities. The letter also seeks disclosure of the risks that off-balance sheet entities could be consolidated and the amount of any material loss that the issuer would expect to realize as a result of material off-balance sheet entities.

These risks are all too real for many firms – as noted in an article from this morning’s Wall Street Journal, Citigroup is bailing out seven struggling structured investment vehicles, bringing $49 billion onto its balance sheet and further depleting the bank’s capital. Scary stuff.

One obvious question is: will disclosure in the 10-K or 20-F about these issues be too late? Current disclosure may be necessary as developments unfold, based on the various items of Section 2 of Form 8-K, and, beyond that, issuers facing these problems really need to keep the markets informed so the problems don’t get any worse.

FCPA Enforcement Going Strong in 2007

Yesterday, the SEC announced yet another Foreign Corrupt Practices Act case, in which Robert W. Philip – the former Chairman and CEO of Schnitzer Steel – was charged with approving illegal cash payments and other gifts to officials at steel mills owned by the Chinese government. Phillip agreed to pay $250,000 to settle these latest SEC charges. Schnitzer Steel had previously paid $7.7 million in disgorgement to settle related SEC charges and $7.5 million in penalties to settle related criminal charges brought by the DOJ.

As noted in this recent memo from Dechert LLP, 2007 has been the most active year in the history of FCPA enforcement. Along with the increased number of cases have come enhanced penalties, with two of the largest penalties ever levied in FCPA cases announced earlier this year. The memo notes that at the American Conference Institute’s 18th National Conference on the Foreign Corrupt Practices Act in November, officials from the SEC and the DOJ indicated that FCPA enforcement activity will continue to intensify. Another notable trend is that the government is increasing its emphasis on charging individuals, with more such cases expected before the end of this year. Further, the SEC is increasingly seeking disgorgement in these matters, which can potentially include the entire gross revenue from a contract obtained through corrupt practices.

The Dechert memo also notes that more resources are being directed toward FCPA matters, with the DOJ recently assigning several FBI agents to work exclusively on FCPA cases – while at the same time ramping up training for field agents. According to the DOJ and SEC officials, industry-wide investigations are also likely if corrupt practices are found to be common in certain industries.

The government’s FCPA enforcement efforts also got a boost from a recent Fifth Circuit decision in the case of United States v. Kay, where the court upheld FCPA convictions even though the defendants argued that the statute was so vague that the defendants could not have been reasonably aware of the potential for engaging in illegal conduct when they were acting in accordance with prevailing business practices, and the payments were made for the purpose of retaining business in the particular country.

For more on the latest FCPA developments and to see some sample FCPA policies, check out our “Foreign Corrupt Practices Act” Practice Area.

What’s The Hub?

The SEC’s FCPA enforcement efforts may now be aided by access to the “Hub.” At a recent SEC Enforcement Division roundtable, Chairman Cox announced the launch of the Hub, a new electronic platform that is supposed to facilitate collaboration among the Enforcement Staff. The Hub is supposed to help the Staff manage their caseloads and provide access to other existing systems for tracking inquiries, investigations and testimony. The system was rolled out in all of the regional offices, with SEC headquarters being the last to implement it.

While collaboration can certainly be an issue among the 11 regional offices spread across the country, it can even be a problem within the SEC’s headquarters – upon moving to their new building, Staff members in the Divisions (including Enforcement) were dispersed throughout the building under an ill-conceived “stacking” approach.

– Dave Lynn