SEC`S “Titan Report ” Raises The Stakes For Disclosure Of Government Investigations
by William W. Horton, Haskell Slaughter Young & Rediker, LLC, Birmingham, AL
The healthcare industry is, and likely will continue to be, characterized by the pervasive presence of government investigations. Many of these investigations are commenced, and continue for months and even years, under the seal of the False Claims Act, so that the specifics of the alleged objectionable conduct may remain somewhat murky even to the organization being investigated. This in turn leads to legal conundrums for publicly traded healthcare companies seeking to fulfill their duties of disclosure under the federal securities laws. A recent pronouncement by the Security and Exchange Commision has introduced a new wrinkle into the already complex disclosure analysis that arises for issuers under government investigation.
On March 1, 2005, the SEC issued its “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on Potential Exchange Act Section 10(b) and Section 14(a) Liability”, Exchange Act Release No. 51283, available at www.sec.gov/litigation/investreport/34-51238.htm (the “Titan Report”). The public announcement of a Section 21(a) Report of Investigation is infrequently used by the SEC, and generally indicates the SEC's desire to use the particular investigation to spotlight something it views as an issue of broad concern. In this case, the Titan Report indicates that the SEC issued it “to provide guidance concerning potential liability under Exchange Act Sections 10(b) and 14(a), and Rules 10b-5 and 14a-9 thereunder, for publication of false or misleading material disclosures regarding contractual provisions such as representations.”
According to the SEC, The Titan Corporation, a military intelligence and communications solution provider, violated the Foreign Corrupt Practices Act by, among other things, funneling $2 million toward the re-election of the president of Benin through an agent in Benin. (The FCPA claims were the subject of a settled SEC enforcement action filed on March 1, in connection with which Titan paid nearly $15.5 million in disgorgement and interest. In addition, Titan pled guilty to criminal charges and paid a fine of $13 million.)
In September 2003, Titan entered into an agreement to be acquired by Lockheed Martin Corporation. The merger agreement contained a representation by Titan that, to its knowledge, neither it nor anyone acting on its behalf had taken any action which would cause Titan to be in violation of the FCPA (the “FCPA Representation”).
The proxy statement relating to the proposed merger described Titan’s representations and warranties, including the FCPA Representation. The merger agreement was attached as an appendix to Titan’s proxy statement relating to the merger, which was filed with the SEC and disseminated to Titan’s stockholders. According to the SEC,
The [m]erger [a]greement and the proxy statement were amended at various times after September 15, 2003, primarily due to SEC and Department of Justice investigations of potential Titan violations of the FCPA. Throughout this period, the FCPA Representation itself remained unchanged. In June 2004, Lockheed terminated the Merger Agreement.
The SEC took the position in the Titan Report that the continuing inclusion of the FCPA Representation in the appendix to the proxy statement (and the unchanged description of the representation in the text of the proxy statement) might constitute a materially misleading disclosure to Titan’s stockholders, because “a reasonable investor could conclude that the statements made in the representation describe the actual state of affairs”, and that Titan’s failure to describe additional material facts “contradicting or qualifying the original representation” (such as the facts relating to the SEC and DOJ investigations) could violate Section 14(a) and Rule 14a-9, or, if the requisite scienter were present, Section 10(b) and Rule 10b-5. The SEC apparently focused on the existence of “specific additional material facts . . . known to an issuer [or which an issuer was reckless or negligent in not knowing]” to conclude that additional disclosure could be required in such circumstances.
This is a somewhat startling result, since (a) the proxy statement disclosure apparently did not go to the truth of the representations in the merger agreement, but merely described them and indicated that the continued accuracy of such representations was a condition to closing, (b) subsequent public announcements and filings by Titan and Lockheed described the potential FCPA problems faced by Titan, and (c) the obligation of an issuer to disclose uncharged criminal conduct (and the timing and form of any such disclosure) is the subject of considerable nuance and ambiguity in the case law.
While the precedent on the subject is varied and highly fact-dependent, it is fair to say that courts have not traditionally interpreted an issuer’s knowledge of a pending investigation that has not yet ripened into criminal charges as requiring, in and of itself, disclosure about the investigation. See, e.g., United States v. Matthews, 787 F.2d 38 (2d Cir. 1986); United States v. Crop Growers Corp., 954 F. Supp. 335 (D.D.C. 1997). However, where the issuer makes affirmative statements concerning its business or prospects that are materially misleading in the face of a known pending investigation, courts have been more willing to impose liability for failure to disclose the investigation or the facts underlying it. See, e.g., In re Par Pharmaceutical, Inc. Securities Litigation, 733 F. Supp. 668 (S.D.N.Y. 1990); Greenfield v. Professional Care, Inc., 677 F. Supp. 110 (E.D.N.Y. 1987).
There is no particular indication in the Titan report that the SEC considered the case law precedent and, even if it had done so, the report ignores the fact that Titan made, during the pendency of the merger process, various public disclosures about the FCPA investigation (and publicly disclosed amendments to the merger agreement addressing the FCPA issues). Instead, as one law firm has noted,
“The SEC’s criticism appears to be tied to the fact that . . . there was no express warning in the section of the text of the [proxy statement] describing the compliance with laws and other representations or in the annexed reproduction of the merger agreement . . . that the disclosures set forth elsewhere in Titan’s filings and in the proxy [statement] itself could have a significant impact on that representation.”
Wachtell, Lipton, Rosen & Katz, “SEC Issues Section 21(a) Reporting Challenging Merger Proxy Disclosure of ‘Naked’ Merger Agreement Representations” (client information memo dated March 4, 2005).
The Titan Report does clearly focus on the fact that the merger agreement and associated disclosure were actually contained (or incorporated by reference) in a disclosure document, and expressly notes that “[r]epresentations, covenants, or other provisions of an agreement made by an issuer that are not public or disclosed to shareholders are not covered by the scope of [the Titan Report].” However, the SEC goes on to note that an issuer cannot avoid a disclosure obligation “simply because the information published was contained in an agreement or other document not prepared as a disclosure document.”
It remains to be seen how the principles espoused in the Titan Report will be applied in other factual settings. However, issuers and their counsel should be aware of the SEC’s new view that documents not expressly prepared for disclosure purposes can nonetheless be the basis for liability under the federal securities laws where they (a) are disclosed to investors and (b) contain provisions that may be construed to be inconsistent with material facts relating to the issuer that are known to the issuer.
The implications of this principle in the healthcare arena may be significant. Healthcare issuers are not infrequently faced with the dilemma of what their disclosure obligations are when they are aware of a government investigation precipitated by a False Claims Act case which remains under seal (and as to which the issuer is invariably admonished by the government to honor the seal). In the ordinary course, an issuer may, by prudent management of its public statements, frequently avoid premature disclosure of the investigation through taking care not to make announcements or disclosures that would be materially misleading absent disclosure of the investigation.
However, healthcare transaction agreements (and, for that matter, loan agreements, bond indentures, etc.) commonly contain broad “compliance with law” provisions, and SEC rules may require that such agreements be filed as exhibits to periodic reports and/or discussed in narrative disclosures, without much discretion on the part of the issuer. (For example, issuers are required to file material contracts as exhibits to periodic and current reports under the Securities Exchange Act of 1934.) Where agreements containing such representations are disclosed in SEC filings and the issuer subsequently becomes aware of, say, a sealed False Claims Act complaint and an ensuing government investigation, the issuer will need to carefully consider whether the Titan Report principles expose it to potential securities fraud liability if additional disclosure is not made.The interaction of those principles with the FCA seal pose an interesting and difficult dilemma for healthcare issuers. Accordingly, public companies in the healthcare sector will want to watch carefully further developments and analysis relating to the application of the Titan Report principles.