MISSION INTANGIBLE

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MISSION:INTANGIBLE, the blog of the Intangible Asset Finance Society, offers critical comments on intangible asset, corporate reputation, and finance; supplemented by quantitative reputation metrics. Intangible assets include business processes, patents, trademarks; reputations for ethics and integrity; quality, safety, sustainability, security, and resilience; and comprise 70% of the average company's value. MISSION:INTANGIBLE is a registered trademark of the Intangible Asset Finance Society.

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Reputation Risk Disclosure is Not Exculpation

C. HUYGENS - Sunday, February 16, 2014
Disclosing reputation risk and doing nothing more may be a risk unto itself and a company's executives, suggests a recent district court decision. As reported by the law firm Morgan Lewis, in In re Longwei Petroleum Investment Holding Ltd. Securities Litigation, the U.S. District Court for the Southern District of New York denied a motion by the CFO to dismiss a case under sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (Exchange Act) noting, among other things, that the signing of Form 10-K alone is sufficient evidence of control (even if control is ineffective or blatantly faudulent). Because of other facts in the case the court also found that the plaintiffs' allegations that the two audit committee members failed to take any action in response to "acknowledged reporting failures" established scienter.

There you have it. Disclose the risk and you help establish scienter without any of the immunities associated with evidencing real working controls. This is a bad hand when playing a high stakes game with an aggressive plaintiff's bar. It is also one more round of bad news for the authors of Forms 10-K who, with respect to reputation risk, were as a group charged with doing it all wrong in a study by Consensiv as reported in the Financial Times service, Agenda.

Richard Leblanc, Associate Professor, Law, Governance & Ethics, York University, observed, Just disclosing the risk may help to establish scienter, but control would be what investors want to see: namely what are the internal controls (or lack thereof) over reputation risk? And are these controls effective? Is the design and implementation of these controls regularly tested and independently reported to the board (or a committee)? Investors want to see how the various risks are being mitigated, not just that there exists reputation risk, which is blindingly obvious.

Real working controls would help exculpate Directors and Officers. Real controls, if sufficiently transparent, would signal value to investors and a red flag to the plaintiff's bar. Reputational value insurances, when designed properly with quantitative measures, provide that transparency.

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