Magazine article Management Review

Risky Business

Magazine article Management Review

Risky Business

Article excerpt

To disclose or not to disclose. That is the question being examined by everyone in Washington--from Congress to the SEC, from the federal courts to FASB.

Four years ago, the management of Xoma Corp. in Berkeley, Calif., thought they had a blockbuster of a new drug. Given the experimental name E-5, it was to be a treatment for the often deadly blood disease sepsis. They were so proud of it, that even before the drug was approved by the FDA, Xoma began telling the world about the drug's fabulous prospects--for those who were dying of this disease and, above all, those who were thinking of investing in the company on the basis of its new miracle drug.

There was only one problem. The FDA hadn't approved the drug--and, it turned out, did not. Not many people benefited from its supposed attributes. Over 3 years, a lot of people bought the company's stock, riding it all the way up from 12-3/4 to 32. Until June 4, 1992, when the FDA refused to approve the drug. Suddenly, in a single day, the price plummeted 24 percent. A number of investors sued.

It had, of course, been a risky investment--too risky, a three-judge panel in the 9th U.S. Circuit Court of Appeals finally seemed to be saying three-and-a-half years later when, in January, it reinstated a class-action suit by shareholders against senior management. Xoma executives, the plaintiffs contended, knew just how unlikely it was that the FDA would approve E-5. Investors had made a risky investment in a risky company with a risky product made all the more risky by the company's failure to disclose some material facts. But just how risky is too risky?

That's what folks in Washington-- from Congress to the SEC, from the federal courts to the Financial Accounting Standards Board--are struggling, as never before, to define.

Our Lips Are Sealed

For 50 years, standards of corporate risk--and its disclosure--have been quite specifically defined by Congress and the SEC. Since 1933, when Franklin D. Roosevelt's New Deal set up the SEC and defined just how much companies would be required to disclose about their operations to their present or prospective shareholders, corporate disclosure has been specifically and very carefully spelled out. Basically, management needed to disclose every corporate event of a material nature that had gone before and could talk about nothing that might take place in the future.

"A national corporate disclosure program has been in place since 1933, and that whole area has been remarkably successful," says Steve Wallman, an SEC commissioner for the past two years. "It has fueled capital formation, fueled liquidity and deep markets."

These laws and the regulations that enforced them also provided a growing series of anomalies over the past half-century. The problem, as far as many corporations were concerned, was less what could be disclosed than what could not. The problem, as far as individuals were concerned, was less what could not be disclosed than how little had to be revealed.

What companies could not talk about were their future plans and prospects. "When I began teaching corporate-security law in 1970, a company could not say anything about the future" says Professor Harvey J. Goldschmid, still a professor of securities law at Columbia Law School. "The past has hard facts. The future is all too speculative; the future is inherently misleading"

Meanwhile, Back in Court

The result was that companies and investors found themselves continually in the courts or the halls of Congress seeking judicial or legislative redress. In the courts, investors were constantly seeking to recover damages when they bought stock on the basis of some corporate braggadocio of spectacular earnings forecasts that turned out to be more a wish than a promise, or a revolutionary new product or process that later turned out to be little more than vaporware.

Finally, Congress acted. The new securities law--vetoed by President Clinton, then overridden by the Republican Congress to become law just before last December's Christmas recess--loosens the reins substantially on corporate hopes and aspirations. …

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