Given recent headlines, public companies would be remiss if they did not give some thought to disclosure in their periodic Form 10-K and 10-Q filings of information related to internal investigative findings that a director, executive officer or key employee engaged in sexual misconduct. The most direct affirmative legal duty to disclose sexual misconduct allegations under the federal securities law falls under Item 103 of Regulation S-K. Item 103 mandates disclosure of “any material legal proceedings” currently pending against a company being adjudicated before a court or agency, or known to be contemplated by governmental authorities, as well as the potential impact to the company of any such legal proceedings. Item 103, however, stops short of specifically requiring disclosure of internal sexual misconduct investigations (as it would for any other workplace claim prior to a lawsuit) because adverse findings against such key individuals neither rise to the level of pending legal proceedings for purposes of Item 103, nor are they deemed to constitute the initial stage of pending legal proceedings.
Recent events, however, have shown that substantiated allegations against senior executive officers have triggered their terminations or resignations even absent the commencement of legal proceedings, suggesting that material events are occurring prior to formal legal proceedings being initiated. In these cases, Rule 10b-5 provides a second legal duty to disclose. Under this rule, public companies may not omit material information – including a finding as a result of a company’s internal investigation that a senior executive engaged in sexual misconduct – if doing so makes the company’s other statements misleading. Many public companies routinely disclose in their SEC filings in general terms that they rely on their senior management to succeed. A company’s failure to disclose existing internal sexual misconduct allegations or the results of an internal investigation may be deemed misleading.
Of course, there is substantial risk inherent even in disclosure of a finding that a key senior officer engaged in sexual misconduct. Federal securities law should not impose an obligation on a company to speculate on the outcome of internal allegations alone or what the likelihood of liability may be, especially with the risk of re-evaluation in hindsight. Additionally, disclosure of a matter such as sexual misconduct requires more generalized disclosure so as not to name the victims involved which may lead to greater investor confusion.
Nonetheless, consideration should be given to the necessity of such disclosure. Whether technically disclosable or not, public companies need to make sexual misconduct allegations part of their disclosure conversation.
PartnerArmed with more than three decades of capital market experience, Spencer represents smaller publicly traded companies, and often underwriters and investment funds, in public and private securities offerings. He focuses ...