Thank you for the opportunity to appear before you today.
This subcommittee is considering how to encourage publicly traded corporations to disclose more fully information about their Year 2000 remedial efforts in various filings required by the federal securities laws. No doubt, some degree of disclosure pertaining to Year 2000 issues is required of virtually all publicly traded corporations as all are substantially impacted by this problem. Most corporations are working diligently to prepare for the Year 2000 and would like to be able to share information about their remedial efforts and progress with the Securities and Exchange Commission ("SEC") and the general public.
But, the very real threat that detailed Year 2000 disclosures will trigger, and harm corporations in, future Year 2000-related litigation is a strong disincentive to providing meaningful disclosures. The securities laws and regulations, by design, provide latitude to companies to determine what information is "material" about their Year 2000 problems. Given the charged legal atmosphere surrounding the Year 2000 problem, most corporations are wisely cautious about disclosing too much information about the extent of their problems and progress of their remediation efforts.
As currently written, the securities laws attempt to force public companies to disclose information by threatening enforcement action for inadequate disclosures. The threat of enforcement, however, does nothing to promote disclosure of more than the bare minimum amount of information required. As well, the lifespan of enforcement proceedings surely will exceed the immediate need that exists for Year 2000 information.
To promote full, and more immediate, disclosure of Year 2000 issues in securities filings or other contexts, this subcommittee should consider limits on liability or litigation exposure for those companies who can demonstrate that they met certain defined Year 2000 disclosure requirements. The same incentives also should be tied to the ability of a company to demonstrate that it undertook diligent efforts to address its Year 2000 problems. This approach would both encourage beneficial corporate behavior and reduce Year 2000 litigation by removing some of the incentive to filing suits, particularly class actions.
It has been said that the litigation costs resulting from the Year 2000 problem could exceed the costs expended to resolve the problem. Plaintiffs' firms are actively contemplating the prospect of bringing Year 2000-related class action suits -- at least five have been filed already concerning products that have yet to fail. In the current legal environment, it is easy to understand the reluctance on the part of corporations to openly discuss their Year 2000 problems and efforts.
Year 2000-related disclosures can be divided into two broad categories: 1) disclosures relating to a company's internal problems and remediation efforts; and 2) disclosures concerning a company's products and services. There are strong and legitimate legal concerns that could dissuade a company from disclosing more than absolutely required about both categories, but particularly about a company's internal Year 2000 issues.
One of the primary pieces of information the subcommittee has contemplated requiring companies to disclose, quarterly, is "a description of the progress of the issuer in completing the 5 recognized phases of Year 2000 remediation." Year 2000 Computer Remediation and Shareholder Protection Act of 1997 S. 1518, 105 Cong. § 3 (I 997)("CRASH"). This requirement would be the equivalent of throwing fuel on the fire of plaintiffs' lawsuits. Much of the Year 2000-related litigation will turn on the timeliness and adequacy of the measures employed by the defendant to prevent or prepare for Year 2000 problems. This question certainly will be central to Year 2000-related claims against a company's officers and directors.
The more specific a company is about its reinediation efforts, even if the company is seemingly making progress addressing its Year 2000 problems, the more likely it is that the information will be used against it in a prejudicial manner in a Year 2000-related lawsuit. Overly detailed disclosures of corporations' progress in addressing their Year 2000 problems will provide an easy way for plaintiffs to compare companies and, perhaps unfairly, use such comparisons against defendant corporations in litigation. Detailed quarterly remediation reports might also be used by plaintiffs as a "roadmap" for discovery in a Year 2000-related action. Detailed disclosures could also lead to immediate legal disputes with suppliers, customers and other business partners if they believe, based on the disclosure, that the company will not meet contractual obligations as a result of failing to remedy Year 2000 problems in time.
There are also legal disincentives to disclosing product or service compliance information, although less severe than for internal remediation disclosures. While some information technology ("IT") companies have been more forthcoming lately about the compliance status of their projects, this openness is not without risk. IT producers, as well as other manufacturers and service providers, may create unintended representations and warranties for products if too much is said about the Year 2000 status of such products. At the same time, disclosing that a product is not compliant could easily set up a myriad of contractual disputes with customers who have purchased that product. In addition, companies that provide Year 2000-related product information that later is found to be incorrect could face fraud or negligent misrepresentation claims.
Not surprisingly, some in the legal community are cautioning companies to say as little as possible about Year 2000 problems.
The threat of punishment for inadequate disclosure of material information is the incentive under the current securities laws and regulations for public corporations to disclose information about their Year 2000 problems. But, the threat of enforcement encourages corporations to do no more than to provide as little information as possible without violating the law. Efforts, to date, by the SEC, as well as other federal entities, to elicit more than boilerplate Year 2000 disclosures have been in the form of guidelines or directives. These guidelines are based on the same implicit threat of enforcement actions if disclosures are insufficient. CRASH is no different, as it would simply amend the securities laws to require disclosure of specific Year 2000 information, leaving intact the laws' existing enforcement mechanisms. In short, the current laws are sticks, not carrots.
Further, little has been done to encourage companies to provide substantive Year 2000 information directly to their customers, suppliers and other business partners. The Department of Justice announcement that the sharing of information with competitors about reniediating the Year 2000 problem should not violate the antitrust laws, however, is very much a step in the right direction.
To encourage more substantive disclosures in SEC filings, and a more open exchange of Year 2000 information generally, Congress should consider limits on liability or litigation exposure that would reduce legal disincentives to Year 2000 disclosures and create rewards to promote the flow of Year 2000 information. The idea of limiting liability for Year 2000 problems is not new. Some proposals, among other things, would limit to actual damages the recovery that could be obtained from companies in one industry or another as a result of business disruptions or other problems directly caused by a Year 2000 problem. Legislation proposed in California (now apparently tabled), aimed primarily at protecting the high technology industry, would have limited damages resulting from a Year 2000 computer glitch to damages resulting from bodily injury and costs incurred to repair or replace and test the errant computer system.
Simply limiting liability for Year 2000 problems, without more, may diminish legal disincentives companies now face to disclosing information about their Year 2000 problems sufficiently to promote more open Year 2000 disclosures. Such an approach, however, does nothing to actively promote additional disclosure of information relating to a company's internal Year 2000 issues or other beneficial behavior. And, opponents of proposals like the California bill contend that removing the threat of consequential and punitive damages will take pressure off companies to remedy their Year 2000 problems now.
A better approach is to tie limits on liability to a behavior Congress wants to encourage, in this case disclosure of Year 2000 information and implementation of efforts to address a company's Year 2000 problems. Under this proposal, only those companies that can demonstrate that they met certain defined disclosure criteria, whether in SEC filings or elsewhere, and have taken reasonable steps to address their problems will be entitled to limited Year 2000 liability. To be most effective, liability should be limited for all potential causes of action arising out of a Year 2000 problem (with the exception perhaps of cases involving bodily injury), including actions based on federal and state statutes and regulations.
This approach serves a number of important goals. First, it will reduce the collective time and money spent in this country on unnecessary and wasteful litigation. Second, this approach will actively encourage companies to be more forthcoming about their Year 2000 problems and compliance efforts and to take measures to become Year 2000 ready. Third, it would promote disclosure of Year 2000 information not only by public companies in SEC filings, but private companies with their customers and business partners. Fourth, companies who do not adequately disclose Year 2000 information or ignore the problem will not benefit from legislative protection, but still be exposed to full liability. In short, under this approach, Congress could both encourage responsible and useful Year 2000 corporate behavior and reduce the costs to this country of the litigation likely to arise as result of this problem.
Another important benefit to utilizing rewards to encourage disclosure of information and remediation is that they are likely to have a more immediate impact on how companies behave than the threat of punishment. The need to encourage the flow of Year 2000 information and efforts to address the problem is immediate. Many months, and even years, could pass before resolution of enforcement proceedings or private litigation against companies for failure to adequately disclose Year 2000 information or take measures to address the problem. By that time, it will be too late for the results of such proceedings to impact the manner in which companies address the Year 2000 problem.
Of course, this approach is not without complexity or problems. First, to create a meaningful incentive for disclosure, it will be necessary to find the right mix of appropriate and adequate liability limits or other methods to reduce potential litigation. Eliminating the threat of punitive damages may be a start in the right direction, but, standing alone, may not reduce a company's liability exposure sufficiently to encourage full disclosure. Other limits on damages will likely be required to provide adequate disclosure incentives and substantially reduce the avalanche of Year 2000 litigation expected in this country.
Second, the disclosure and remedial effort standards companies would be required to meet to be eligible for limited liability would have to be carefully defined. Under the approach set forth above, legal disputes will center on whether or not companies have met such standards. The standards set must be reasonable and specifically designed to allow companies to disclose efficiently and effectively pertinent Year 2000 information and address their underlying problems without wasting resources or creating more work than companies already face.
Third, not unlike procedures adopted under the Private Securities Litigation Reform Act of 1995, mechanisms would have to be adopted to allow litigation targets to seek summary adjudication, with little or no discovery, of the issue of whether they are entitled to limited liability. One of the most expensive aspects of litigation is discovery. The threat of prolonged and expensive discovery, therefore, often forces companies to pay to settle even unmeritorious litigation. The true benefits of the limited liability approach in terms of a reduction in the costs of litigation will not be realized without procedures to limit discovery until the threshold issue of the target's liability exposure is determined.
Notwithstanding the difficulties involved, the use of limits on liability or damages by Congress to promote certain corporate behavior is not without precedent. In 1984, Congress afforded certain antitrust protections to companies who engaged in joint research and development ventures to encourage suchjoint projects. The antitrust protections were extended to promote joint production ventures in 1993. See National Cooperative Research Act of 1984, 15 U.S.C. §§ 4301-4306 (1994). This Act limited the antitrust exposure of companies who formed protected joint ventures to actual, as opposed to treble, damages, and allowed prevailing antitrust litigants to obtain costs and attorneys' fees.
The time has come to seriously consider a similar approach to the Year 2000 problem.
Congress has a unique opportunity to devise creative solutions to limit adverse
consequences potentially associated with the Year 2000 problem. A new, bold and different
approach may be required to address the concern of this subcommittee that companies are not
adequately disclosing information about their Year 2000 problems and remedial efforts.
Legislation designed to encourage companies to disclose more Year 2000 information and
address their Year 2000 problems while reducing the potential for wasteful and unnecessary
litigation may be the answer.
1 Veronica Zorrilla contributed significantly to this paper.
2 The thoughts expressed herein are those solely of the author, and do not
necessarily reflect the views of McKenna & Cuneo, L.L.P. or any of the firm's clients.
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