An Inter-Agency Analysis of Terrorism Risk Assessment Disclosure

John W. Bagby Information Sciences & Technology The Pennsylvania State University

Policy Risk Analysis

  Primary Research & Instruction Focus on Risk Analysis of Litigation, Legislation, Regulation, ADR, Goodwill, Market Impact  Once a Securities now a Security Lawyer Last Spring recognized the merger extends beyond, disclosure fraud, insider trading & SOX internal control assessment to:  Pervasive Interest in Financial System Risk   Financial Economics current primary focus is risk mgt Ins Indus relies heavily on Financial Economics

Research Objectives

     Explore Implications of post-9.11 Inter-Agency Relations Demonstrate Disclosure Regime Externalities Analyze IT diffusion in eGovernment  Interactive Disclosure Initiatives   SST Web tool XBRL Data Tag Evaluate Effectiveness of Disclosure Methods Focus Public Dialog on the Conduct of Foreign Policy  Game Theoretic Critique of Public Pressure Methods   Presidential Election Rhetoric, Exec. Appointments Alternative Channels of Public Preference Communications Outside Executive Branch

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Problem Statement(s)

Public Cos. Sustain Many Unexplored Risks   Risk Analysis is a Field Expanding Beyond Insurance Underwriting & Derivative Securities  Aggressive Risk ID, Analysis & Management Needed Terrorism Risk Assessment is Complex, Imprecise, too long province of only DoD, Foreign Policy Think Tanks Huge Investor Appetite for Terror-Risk Disclosure  Disclosure Methods Differences Matter Significant Institutional & Competitive Obstacles Impede Effective Inter-Agency Coordination   DoS, DHS, DoD, DoJ, Intell Community (IC), SEC Should SST Designation Trigger SEC Disclosures?

Designating State Sponsors of Terror (SST)

  Designated by Secretary of State  Consultation DoS’s Office of the Coordinator for Counterterrorism Annother Interagency Consultation:  Participants: DoS, National Security Council (NSC), Department of Defense (DoD), Treasury, Department of Homeland Security (DHS)  Includes inputs from U.S. Intelligence Community (IC)

Who are the SSTs?

    SSTs: Cuba, Iran, Sudan & Syria  Most recently dropped: North Korea  Formerly dropped: Iraq, Libya, Yemen Axis of Evil: W’s 1.02 State of the Union Address  UN Ambassador John R. Bolton (recess appointee only) included “rogue states:” Libya, Syria, Cuba WMD  E.g., nuclear, gas, pathogens, weapon sales   But…No clear reference to planes as weapons Instrument of Terror, Blackmail Opaque Fusion of Intelligence, History & Administration Strategy

SST Sanctions Restrict What?

   Restricted Exports from U.S   Arms Dual-use technologies plausibly useful for non-terrorism purposes but adaptable to provide military capacity supporting terrorism Prohibited Economic Assistance:    Blocks loans to SSTs from World Bank & other fitonancial institutions Denial of duty-free treatment of imports U.S. from SST Prohibits DoD contracts over $100K w/ SST controlled Cos.  Sovereign immunity waiver, U.S. civil actions by terror victims & families Various Economic Sanctions   No tax credits Export license requirements & financial transactions restrictions on U.S. Cos attempting SST relations

Risks of SST Relations

U.S. Public Cos Risks from SST Relations  Discipline/Punishment aforementioned     “Operations, Financial Condition, Earnings, Stk Price:”   Focuses on investment/return risk of SHs EX: Asset Impairment, Employee Injury, Productivity Compromise, Supply Disruption, Customer Reliability, Payments Delay/Failure Goodwill, Reputation, Stock Price, Liquidity Support/Fund Terrorism, MoneyLaundering  Human Rights Violator Undermine U.S.’s Reputation, Foreign Policy, Economy

Alternative Designations of Terrorism Risk

      Specially Designated Terrorists (SDT)  Treasury’s Office of Foreign Assets Control (OFAC) Foreign Terrorist Organizations (FTO) Specially Designated Global Terrorists (SDGT) Specially Designated Nationals and Blocked Persons (SDN) Terrorist Exclusion List (TEL) Many Others are Maintained by Int’l Orgs  UN 1267 List (since 1999)

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Disclosure Purposes Encompass Terrorism Risks under SecReg

Cardinal Principle:  Asymmetries Cause Adverse Selection “provide full & fair disclosure of the character of securities, to prevent frauds in the sale thereof, & for other purposes.” ’33 Act “keystone of the entire structure of federal securities legislation” ’63 Special Rpt “appropriate publicity tends to deter questionable practices and to elevate standards of business cond9 uct” ’69 Wheat Rpt Many Commentators, incl. Louis, Loss & Brandeis

SEC Regulation SK

      Regulation SK (narrative, discretionary, qualitative) vs. Regulation SX (quantitative, financial, acctg stds)  No Specific SST or Terror Risk Std.

SK: Item 101 SK: Item 103 Legal Proceedings SK, Item 303 Management Discussion & Analysis (MD&A) SK, Item 503(c) – Risk Factors Office of Global Security Risk (OGSR)

Regulation SK: Item 101

   General Descriptions in Narrative Form Organized Variously including Geographic  Domicile, Customers, Foreign Operations   Revenue & Risk, Regions or Nations To the Extent Vulnerable to Terror Risks Organized by Business Segment  Business Component, profit center, subdivision, geographic division  Segment Managed (ops, finances, forecasts, plans)

SK: Item 103 Legal Proceedings

   Co vulnerable to SST Enforcement DoJ, DoS, Treasury, SEC “Material,” Pending/Contemplated, not routine    Filing date, Forum, Parties, Allegations, Relief Also included if key official is named party EX: Environmental separately specified  Not yet SST or other terror risk indicator

SK, Item 303 Management Discussion & Analysis (MD&A)

    Broad discussion foci Narrative catch-all Mgt’s own unique intimacy informs interpretation from perspective of insiders & experts Financial Performance Indicators   Liquidity, Capital Resources, Results of Ops SST EX: Contracts impacted by SST relations

SK, Item 503(c) – Risk Factors

   IPO Tradition: Mechanical List of Horribles  2005 Expansion to Periodic Reports No SST-Specific Trigger “Contextomy” Boot-Strap  ½ Truths Require Clarification    Materiality focus on Total Mix Risk Disclosures incomplete w/o Terror-Risks User Demand Rising for SST Disclosures  Like Environmental & Risk Factors Disclosures

SEC’s Corp Fin-OGSR

Office of Global Security Risk (OGSR)  ’04 Appropriations Legislative Findings  Significant global security risks impact Cos  ID Cos w/ SST Relations   Monitors SST Disclosure  Jawboning w/ OGSR Comment Letters: 200 in ’06-’07  Formerly Inaccessible or FOIA Accessible  Now EDGAR Organized OGSR Inter-Agency Consultation & Int’l Dialogue Pressuring Foreign Issuers

The 2007 SST Web tool

    Debut: 6.25.07, Suspend: 7.20.07-26 days Immediately Popular: 15K hits by 7.16.07

Navigation Path:  Sec.gov; Investor Info, SST, 5 nations, All Cos Firestorm of Criticism:   SEC Com. Atkins (R); Cong.Spencer Bachus (R-Ala); SIMFA SEC letter from Barney Frank (D-Mass)

SST Concept Release

   Defends SEC’s SST Disclosure History Solicits Specific Comments  SST Disclosure Propriety  SST Web tool improvements  Issuer Data Tagging in XBRL 28 Comments, see Appendix

Data Sources

     OGSR Comment Letters SST Concept Release Comments FOIA Request EDGAR search KWIC Manual Review  E.g., Disclosures, Co’s Web, News Sources, Blogs

XBRL Tagging Challenges

   Incentives for Robust Tagging Regime    False negatives: tag fails to ID material info False Positives: tags immaterial info Subjective vs. Objective Taggers Incentives for Tag Monitoring  Tag Monitor Incompetence, Moral Hazard Impact Measures: xbrl Tagging Disclosure      Tag Usability & Communication Effectiveness Fin.Econ. Event Studies Tag Triggers Corp. Governance Tag Induces Public Policy Intervention Tag Impacts Markets: Suppliers, Customers, “Partners”

OGSR Enforce ment Files Deliberate Disclosure InAccessible Accessible Thru FOIA EDGAR Accessible SST Web tool XBRL Tagged Involuntary Involuntary Semi Voluntary Semi Voluntary Voluntary

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Future Work

Ventilating SST Commentators Incoherence  ECMH mantra “SST info already well known” vs. “SST Discl will adversely surprise markets & damage issuer” Evaluating Disclosure Methods   ECMH debate redux Effectiveness hierarchy   Secret, FOIA, EDGAR, Web tool, XBRL Could base on Insider Trading dissemination method safe harbors:  E.g., press release, web posting, broadtape SST Disclosure Externality #1  Securities Markets coerce divestment  Alt. encourage humanitarianism SST Disclosure Externality #2  Executive Branch’s Claim to Exclusive Conduct of Foreign Policy  Risks vs. Benefits of Fishbowl Negotiations