Rethinking Disclosure Liability in the Modern Era

The state of issuer disclosure in 1997 is like the proverbial half-filled glass. On one hand, as Dean Seligman has amply demonstrated in his contribution to this symposium, the glass is half empty in the sense that the legal incentives for established issuers to engage in high quality disclosure at the time that they sell new securities have decreased in recent decades. Due to the more liberal exemptions available under Regulation S, Rule 144A, Regulation D and Regulation A, a much smaller portion of such sales is even subject to the formal disclosure oriented registration process under Section 5 of the Securities Act of 1933 (the Securities Act ). For the portion that is, the resulting amount of disclosure has been reduced in many cases because short form and shelf registration has weakened underwriter due diligence. On the other hand, the glass is half full in the sense that some of these same reforms have improved the quality of disclosure at times when such issuers are not selling new securities. Under the Securities Exchange Act of 1934 (the Exchange Act ), publicly traded issuers are required to file periodic disclosure reports with the SEC-10-K\u27s, 10-Q\u27s and 8-K\u27s whether or not they are selling new securities. Traditionally, before short form and shelf registration, issuers provided much lower quality disclosure in these periodic filings than in their section Securities Act registration statements. Although both sets of documents were supposed to answer essentially the same questions, the periodic filings provided lower quality disclosure because they were subject to a less severe liability regime and were not given a due diligence review by an investment bank. Today, issuers have an incentive to improve the quality of their periodic filings. Improved quality puts an issuer in a better position to utilize short form registration and shelf registration should it decide subsequently to sell new securities. The attraction of each of these reforms is based on the ability it gives an issuer to incorporate by reference disclosures set out in its Exchange Act filings. This would be of no use to an issuer with low quality periodic filings because material incorporated by reference in this fashion is subject to the much stricter Securities Act liability regime.\u27 These new incentives, however, take us only halfway. For a variety of reasons, an issuer preparing a periodic filing that it might in the future want to incorporate by reference is still not going to feel the same pressures to be accurate and complete as it would have felt preparing a traditional Securities Act registration statement prior to short form and shelf registration. One way to make ourselves happy with the current half-filled glass is to look at it with an optimistic attitude. Another, better way is to make the glass all full. To do so, we should establish a system of liability that creates incentives for established public issuers to provide disclosure in their periodic filings that is as high quality as they traditionally provided at the time of a registered public offering prior to short form and shelf registration