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Materiality

Materiality. Management Integrity. Management Integrity. SIX FEET. inc. Six Feet Inc. (Bonus Hypothetical). PROXY STATEMENT - $10m annual salary - $50m in options ANNUAL REPORT - growth slowing, costs growing, profitability dropping. Management Integrity. SIX FEET. inc.

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Materiality

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  1. Materiality

  2. Management Integrity

  3. Management Integrity SIX FEET inc. • Six Feet Inc. (Bonus Hypothetical) PROXY STATEMENT- $10m annual salary- $50m in options ANNUAL REPORT- growth slowing, costs growing, profitability dropping

  4. Management Integrity SIX FEET inc. • Six Feet Inc. (Bonus Hypothetical) • What can a shareholder do? • file derivative suit against David • gather votes to oust David as director • pressure Board through publicity • sell shares (and encourage others to jump ship, too)

  5. Management Integrity CLASS B 2/3 Directors FRANCHARD f/k/a GLICKMAN CLASS A PublicShareholders • In the Matter of Franchard Corporation

  6. Management Integrity FRANCHARD f/k/a GLICKMAN • In the Matter of Franchard Corporation MATERIALITY- withdrawal of funds- pledges of shares Quality of management is of “cardinal importance” to investors, especially if there is a controlling person.

  7. Management Integrity FRANCHARD f/k/a GLICKMAN • In the Matter of Franchard Corporation MATERIALITY- directors’ lack of care - Glickman’s dominance was obvious - Board did not completely abdicate its responsibilities - State law regulates standards of director behavior

  8. Management Integrity • In the Matter of Franchard Corporation 1. How can Glickman’s withdrawals, which accounted for less than 1.5% of the gross book value of the Registrant, be material? - higher fraction of equity or cash flow - unsavory behavior, regardless of magnitude, is important to investors

  9. Management Integrity • In the Matter of Franchard Corporation 2. What basis does the SEC have for concluding that the Registrant should have disclosed an “encumbrance” on acontrolling stockholder’s shares?

  10. Management Integrity • In the Matter of Franchard Corporation RULE 408 requires mandatory disclosures to be supplemented with “further material information, if any, as may be necessary to make the required statements in light of the circumstances under which they were made not misleading.”

  11. Management Integrity • In the Matter of Franchard Corporation • 3. What if Glickman had a heart condition that increased his probability of death? • “We … cannot agree with registrant’s contention that disclosure of Glickman’s borrowings and pledges of registrant’s stock would have been ‘unwarranted revelation’ of Glickman’s personal affairs.”

  12. Management Integrity • In the Matter of Franchard Corporation • 4. Did the SEC let the Franchard directors off too lightly? • - requiring such disclosures would “stretch disclosure beyond the limitations contemplated by the statutory scheme and necessitated by considerations of administrative practicality”

  13. Management Integrity • SEC v. Fehn C T I Technical MATERIAL? - Form 10-Q was misleading because Wheeler had been CEO for a while - Form S-18 was misleading because Wheeler was the promoter WHEELER promoter incorporator CEO

  14. Management Integrity • SEC v. Fehn C T I Technical MATERIAL? - Form 10-Q requires disclosure of contingent liabilities - Basic materiality standard - probability? - magnitude? PAST SECURITIESVIOLATIONS state blue sky federal low high

  15. Management Integrity • SEC v. Fehn C T I Technical FIFTH AMENDMENT? Disclosure requirements do not target inherently suspicious criminal activity. Disclosure requirements do not mandate revelation of inherently illegal activity. PAST SECURITIESVIOLATIONS state blue sky federal

  16. Management Integrity • SEC v. Fehn 1. Is it realistic to expect company officersto disclose facts that could lead totheir indictment? - no - disclosure requirement is substantive prohibition of underlying criminal acts

  17. Management Integrity • SEC v. Fehn 2. Can we apply the reasoning of Fehn to other forms of illegal activities(e.g., importing illegal drugs)? - large contingent liabilities - large magnitude for the companies, even if probability is low

  18. Management Integrity SIX FEET inc. • Six Feet Inc. (Hypothetical 7) CLAIRE - David and Nate’s little sister - executive assistant (rarely there) - $50,000 annual salary - employee health plan - drug problem

  19. Materiality • Summary • Objective standard – would information assume actual significance in decision of shareholder • Forward-looking information = probability x magnitude • “Truth on the market” – information must be assessed in light of “total mix” including: • Other disclosures • Other publicly available information • Quantitative measures relevant, but not conclusive • Market reaction (or lack thereof) important evidence

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