The Wal-Mart scandal could give rise to potential liability under the Foreign Corrupt Practices Act. It also could give rise to liability under state corporate law and Sarbanes-Oxley. At least for some of those potential sources of liability, a predicate question will be whether the failure to disclose uncharged criminal conduct rendered Wal-Mart's disclosures to its shareholders materially misleading.
Item 103 of Regulation S-K provides that the company must disclose in, inter alia, its annual report to shareholders "any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject."
Importantly for present purposes, the disclosure must include "similar information as to any such proceedings known to be contemplated by governmental authorities."
The SEC has taken the position that this aspect of Item 103 requires disclosure of a prospective or anticipated proceeding if a company is informed by a responsible governmental authority that such an action is “likely.” While there is little guidance, either in the Commission's regulations or elsewhere, as to what constitutes a “proceeding” for purposes of Item 103, the plain meaning of the term “proceeding” as stated in Item 103 suggests that it refers to administrative or adjudicatory proceedings rather than law enforcement investigations. [1278 PLI/Corp 455]
The case law also suggests that failure to disclose uncharged criminal conduct generally will not give rise to liability. See United States v. Crop Growers Corp., 954 F. Supp. 335 (D.D.C. 1997) (holding that Item 103 does not require disclosure of uncharged illegal conduct); In re Browning-Ferris Shareholders Derivative Litig., 830 F. Supp. 361 (S.D. Tex. 1993) (holding that a company need not disclose under Item 103 the fact that a nominee director had received a criminal “target” letter), aff'd mem., 20 F.3d 465 (5th Cir. 1994).
Having said that, however, "failure to disclose uncharged criminal conduct may expose a public company to civil liability if: (1) nondisclosure makes other disclosures materially false and misleading, and (2) nondisclosure is material and directly related to company's financial condition. See, e.g., SEC v. Fehn, 97 F.3d 1276 (9th Cir. 1996), cert denied, 522 U.S. 813 (1997); In re Craftmatic Sec. Litig. v. Kraftsow, 890 F.2d 628 (3d Cir. 1989); Ballan v. Wilfred American Ed. Corp., 720 F. Supp. 241 (E.D.N.Y. 1989); see also Joseph F. Savage Jr., & Allan Urgenti, Secrets and Lies: Is There An Obligation By Public Companies to Disclose Uncharged Criminal Conduct?, White-Collar Crime Rptr. (Jan. 2000)." [1850 PLI/Corp 289, 312]
Suppose, for example, that Wal-Mart's annual report to shareholders bragged extensively about the profits being earned in Mexico. Would failure to disclose the alleged corruption make those disclosures misleading? That's the big question Wal-Mart will be facing in coming years.