Admitting The SEC Form 10-K Annual Report As A Business Record

In civil enforcement action, admitting SEC Form 10-K Annual Report restating financial statements was a business record “as a report made at or near the time of the accounting review by those with knowledge of” the company books which was a “financial statement audit,” in S.E.C. v. Jasper, 678 F.3d 1116 (9th Cir. May 15, 2012) (No. 10-17064)

The Ninth Circuit recently considered the admissibility of a financial statement audit required in an annual report by the Securities and Exchange Commission (SEC) as a business record under FRE 803(6). In citing support by some district courts for this holding, the Ninth Circuit appears to be one of the first appellate courts to address this issue.

The case involved a civil enforcement action involving backdated stock options against the former chief financial officer of publicly traded company. Before trial, the defendant moved to exclude the SEC Form 10-K annual report, which included audited financial statements prepared as required under law. See 15 U.S.C. § 78m (Periodical and Other Reports). The challenged report had restated the company’s financial statements and was issued after the defendant had resigned from the company. The trial court admitted the report as a business record since it was “a report made at or near the time of the accounting review by those with knowledge of [the company] Maxim’s books,” and “[t]he circumstances of its creation do not indicate that it lacks trustworthiness.” Jasper, 678 F.3d at 1122 (footnote omitted). The jury returned a verdict in favor of the SEC. On appeal, the defendant contested the admission of the SEC annual report as inadmissible hearsay.

The Ninth Circuit affirmed the admission of the report and the jury’s verdict. The circuit concluded that the business record requirements had been satisfied as it was “prepared by people with personal knowledge, at or near the time of the events, who were just doing their ordinary jobs.” The report “was a review of what the books of Maxim showed for the period of the stock options backdating, a comparison of the exercise price to the market price when the options were actually granted, and the consequent losses/expenses to Maxim.” Jasper, 678 F.3d at 1123.

In support, the circuit noted that other district courts had admitted financial reports as business records, including In re Homestore.com, Inc., No. 01-11115, 2011 WL 291176, at *5 (C.D. Cal. Jan. 25, 2011) (concluding "the Restatement was made at or near the time of the accounting investigation by those with knowledge of the company's books, the circumstances of its creation do not indicate a lack of trustworthiness, and the Restatement was created and kept in the regular business practice of the company, as the company had a duty to file restated financial statements with the SEC"); In re WorldCom, Inc. Sec. Litig., No. 02-3288, 2005 WL 375313, at *6 (S.D.N.Y. Feb. 17, 2005) (concluding "the Restatement was created and kept in the course of the regular business practice of the company, and the company had a duty not only to issue restated financials but to file restated financial statements with the SEC"). The circuit distinguished cases involving a “special audit” which may not satisfy the business record requirements from a “financial statement audit” such as the report introduced at trial which satisfied generally accepted accounting principles.

The circuit dismissed the defense claim that the report was inadmissible since it was prepared with a view toward litigation:

This argument has no limiting principle: the filing of an accurate 10-K was and continues to be a legal requirement for Maxim. In today’s litigation-heavy climate, the filing of any 10-K can always subject companies to legal exposure. That is why lawyers pore over 10-Ks every year at substantial expense to shareholders. Were this court to accept Jasper’s contention, virtually every document a public company releases to the public would be inadmissable as a business record merely because companies are worried about litigation risks. That is not the law under the Federal Rules of Evidence.
Jasper, 678 F.3d at 1124.

The circuit also dismissed the defense claim that the report contained inadmissible expert testimony under FRE 702 based on “the accounting judgments involved.” Without deciding that the report contained expert opinion, the circuit concluded:

it was not an abuse of discretion for the district court to admit it without affirmatively stating that the requirements of Rule 702 were satisfied because Rule 803(6) expressly provides for the exclusion of a business record if the source of information indicates a lack of trustworthiness.
Jasper, 678 F.3d at 1124. The defendant did not object to the failure to provide pretrial notice of any expert opinions under Fed. R. Civ. P. 26(a)(2) and did not show any prejudice.

Finally, the circuit found unpersuasive the defendant’s argument that the report was unfairly prejudicial under FRE 403 as the annual report was “probative of the falsity of the previously filed documents and the magnitude of the corrections.” Jasper, 678 F.3d at 1124.

Given the importance of SEC annual reports, the Jasper case provides useful guidance on their admissibility as a business record at trial.

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Federal Rules of Evidence
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