The Inadequate Disclosure of Business Conducted in Countries Designated as State Sponsors of Terrorism

Abstract:     
U.S. investors unknowingly may invest in companies with business operations in countries the U.S. Department of State designates as State Sponsors of Terrorism (SSTs), currently Cuba, Iran, Sudan and Syria. In most circumstances, U.S. companies are prohibited from doing business in SSTs. However, such U.S. sanctions generally do not apply directly either to foreign companies or to foreign subsidiaries of U.S. companies. If a company is organized under the laws of a foreign jurisdiction that does not sanction an SST, then that company may conduct business in the SST. That company, or its parent, may also raise capital in U.S. markets.

A well functioning disclosure regime could both reduce opportunities for regulatory arbitrage and strengthen U.S. efforts to isolate SSTs through economic sanctions. Although the Securities and Exchange Commission (SEC) lacks authority to prevent foreign companies from doing business in SSTs, the SEC may require such companies to disclose their business if they offer securities in U.S. public markets.

Whether business activities must be disclosed often depends on whether the information is “material”. Courts have approached the question of whether a particular business activity is “material” by asking whether there is a substantial likelihood that a reasonable investor would find the information significant. Business in or with an SST would likely be significant to a reasonable investor, i.e. it would be material and therefore should be disclosed by the company. As an empirical matter, however, disclosure of operations in or with SSTs has been limited.

Review of company filings indicates that many companies are not disclosing their operations in or with SSTs. Even when companies disclose the existence of such operations, substantive information about the nature and extent of operations is often withheld. In correspondence between non-disclosing companies and the SEC, companies often argue that their operations are not material because they represent a small percentage of overall revenue. This approach to materiality is both reductive and inconsistent with Supreme Court articulations of the standard. As a result of the narrow interpretation of materiality used by many reporting companies, their disclosure may be inadequate and their conduct may not be disciplined by public scrutiny. U.S. investors unwittingly may support activities that are contrary to U.S. security policy, and that would be illegal for the investor, as a U.S. person, to undertake directly.

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