In an unprecedented move, the Bush Administration has given its director of national intelligence the authority to exempt corporations from making certain disclosures required by federal securities laws.
The revelation, first reported by Business Week in May, surprised several securities lawyers who spoke with Compliance Week, although many say it’s to be expected in the current climate of heightened sensitivity to terrorism. And upon closer scrutiny, while the president’s move is legal, apparently it can’t be widely applied and is likely be of little consequence to many businesses and investors.
A president’s power to exempt disclosures is contained in a previously obscure provision of the Securities Exchange Act that was inserted into the statute when it was amended in the 1970s. The provision, section 13(b)(3), says that “with respect to matters concerning the national security of the United States,” the president or the head of an executive branch agency may exempt companies from certain critical legal obligations, including keeping accurate “books, records, and accounts” and maintaining “a system of internal accounting controls.”
Van Dorn
Walter Van Dorn, a former special counsel for the Securities and Exchange Commission, says he had never heard of the provision that gives a president the power to make such exemptions. “I don’t think it’s ever happened that this provision has been used. But, as a matter of law, it does exist,” says Van Dorn, now a partner at Thacher Profitt & Wood.
Perino
President George W. Bush granted the exclusion power to his director of national intelligence, John Negroponte. The DNI press office did not respond to a request for comment for this story, and the SEC declined comment through a spokesman. In a briefing with White House reporters, however, presidential spokeswoman Dana Perino played down the news. “There was no expansion of authority,” she said, telling reporters that the legal basis for granting exemptions had not changed.
Iavarone
Nicholas Iavarone, a plaintiffs’ lawyer with SimmonsCooper, says selectively exempting companies from reporting requirements “gives an advantage to these companies. It opens them up for potential mischief. Would you want to be an investor in these companies? If they can do these things and not be held accountable, what does that do to the market and the investing public?”
But Keith Wasserstrom, a securities attorney with Wasserstrom Weinreb & Wealcatch, says he’s “not too concerned” about the situation. “There’s always a potential for abuse but here we have a greater compelling interest—a national security interest—so I think it makes sense.”
No ‘Broad License’
The Bush administration revealed it had invoked the national security provision in a May 5 presidential directive subsequently published in the Federal Register. The timing of the memo, issued days before USA Today reported that several phone companies had turned over millions of telephone records to the government, raised some eyebrows. But attorneys tell Compliance Week that any phone records turned over to the government would not have been covered by mandatory reporting requirements anyway.
Because of the secrecy surrounding national security matters, it isn’t actually known whether Negroponte has exercised the authority given to him.
THE MEMO
Below is the text of the memo sent from President Bush to National Intelligence Director John Negroponte, titled, "Assignment of Function Relating to
Granting of Authority for Issuance of
Certain Directives":
By virtue of the authority vested in me by the Constitution and laws of the United States, including section 301 of title 3, United States Code, I hereby assign to you the function of the President under section 13(b)(3)(A) of the Securities Exchange Act of 1934, as amended (15 U.S.C. 78m(b)(3)(A)). In performing such function, you should consult the heads of departments and agencies, as appropriate.
Source
Assignment of Function Relating to
Granting of Authority for Issuance of
Certain Directives (May 12, 2006 Memorandum)
Zuppone
Michael Zuppone, a partner with Paul, Hastings, Janofsky & Walker and former regional branch chief of the SEC in New York, says that some press reports have wrongly suggested that the exemption constitutes “a broad license of a public company to basically cook the books, for want of a better term.” But the law “doesn’t mean that companies don’t have to account for the expenses that are incurred in some form so that they can produce a compliant financial statement,” he notes. “When you look at the statute, it’s clear that there has to be a specific written directive from a department or agency acting under presidential authority.”
Williams
Greg Williams, a partner with law firm Allen Matkins Leck Gamble Mallory & Natsis, says he understands why the issue would be of great interest to people, but also notes that the Securities Exchange Act exempts other kinds of disclosures and lets companies seek to treat some materials as confidential. “This seems like another one of those” exemptions, he says. “In the current environment, it’s not surprising that, on a case-by-case basis, [the DNI] could exempt a company from disclosing things.”
Veiled In Secrecy
Van Dorn notes that companies granted such national security exemptions are probably the only ones outside the government aware of how the program actually works. “A company can’t just willy-nilly walk up to the SEC or president and say they don’t want to disclose something,” he says. “The company has to be acting in cooperation with a federal department or agency. And I assume that this is not being done lightly or casually. Hopefully these are trustworthy people.”
Hoopes
Jim Hoopes, professor of business ethics at Babson College, says it’s “easy to imagine that there could be a national security interest that would lead to the need to keep Americans unaware of some particular corporate activity.”
But one of the many unanswered questions about the security exemptions is how a company would go about concealing its secretive activity from investors and the public.
“...[A]re lines and or numbers omitted or fudged but with compensations elsewhere, so that investors are still getting accurate bottom line on the statements of earnings and cash flow?”
Williams agrees that how information is concealed, and the effect on a company’s bottom line, is what’s relevant. “If you’re not telling shareholders how you’re spending 20 percent of your operating expenses, that could be a problem,” he says. “If it’s 3.7 percent, however, maybe it’s not too much of a problem.”
Wasserstrom
Wasserstrom, of Wasserstrom Weinreb & Wealcatch, gives a hypothetical example that if a company is spending, say, $2 million in Iraq and the government does not want that activity to be publicly known, the company could simply book that $2 million expense and not disclose exactly where the money is going. “Just say you’re spending it for national security reasons,” he says. “From the investor standpoint, you’re still getting the information you need to know.”
Zuppone acknowledges that the timing of reports about the DNI’s exemption power “is not optimum from the perspective of the Bush administration,” but notes that the intelligence committees of both houses of Congress receive reports every year when the provision is invoked. He also says nothing in the law prevents the SEC from obtaining information it needs in other ways.
Friedman
Lawrence Friedman, who teaches constitutional law at New England School of Law and is critical of administration tactics in the war on terror, says the exemption from reporting requirements could constitute “a pretty big loophole for a lot of companies—they may try to lobby to be included in this waiver if it suits their needs. A great many things these days can be connected to national security.”
Iavarone, of SimmonsCooper, says he could understand if an entire industry—such as the aerospace industry—was exempted from reporting requirements. “But doing it on an individual company basis without knowing who it is or what’s going on—I think that’s a problem. I’ve been [practicing securities law] for 30-some years and I’ve never heard anything like this. I’m sort of shocked.”
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