Defense Firms Told to Disclose Scandal’s Impact

In a pointed reminder to the defense industry, the Securities and Exchange Commission told military contractors Monday that they are obliged to disclose to investors the possible financial fallout from the Pentagon procurement scandal.

Not only targets of the investigation but other companies, too, may be required to make public disclosures--if they have altered their contracting procedures or face a loss of income as a result of the still-unfolding fraud probe.

“The commission recognizes that the exact subjects and scope of the government’s inquiry are still unknown,” the SEC said in an eight-page statement that interpreted existing reporting requirements.

“In view of the potential adverse effects . . . that may result from the investigation as well as any governmental action that may result, however, companies engaged in the defense business should review on an ongoing basis the need for appropriate disclosure,” the commission said.

Unlikely to Be Dramatic

Investment companies that concentrate their holdings in defense and related industries also were urged to disclose the possible adverse effects of the investigation to would-be investors.

Industry analysts said Monday that any disclosures spurred by the SEC reminder were unlikely to be dramatic, given the limited information available to companies about the nature and extent of the federal investigation of possible fraud, bribery and influence peddling.

Though a grand jury has subpoenaed some 275 companies and individuals in the inquiry, no one has been charged and the financial ramifications of the probe so far have been limited.

The Pentagon last month briefly suspended payments on $1.2 billion in Navy contracts named by investigators as possibly tainted by bribes. Only a single subsidiary of one company--Varian Continental Electronics, a subsidiary of Palo Alto-based Varian Associates--is known to be facing debarment proceedings as a result of the investigation.

Late last month, Varian filed a formal disclosure of the government action with the SEC, though it offered no predictions about the financial significance of the inquiry. Analysts said many other defense contractors can be expected to make similarly vague disclosures over the next several weeks, as they formally report activities for the quarter ending June 30.

“You can see an avalanche of lawyer-written statements saying: ‘The possibility exists we might become involved in this investigation and you should understand any of the following things could come under scrutiny . . . ,’ ” said John N. Simon, an aerospace industry analyst at Seidler Amdec Securities, a Los Angeles brokerage.

The SEC statement listed nearly a dozen circumstances related to the procurement scandal that would necessitate disclosure by a publicly held corporation.

Firms, for instance, might be obligated to disclose the possibility that large contracts could be subject to renegotiation or cancellation, the SEC said, or that contemplated legal action by the government could harm them financially. And if the investigation had spurred a firm to change its procurement practices in potentially costly ways, that should be reported too, the SEC said.

Anticipates Problem

SEC officials said Monday they were not aware of any failures on the part of defense contractors to make required disclosures, but nonetheless wanted to underscore the firms’ legal obligation to lay out to investors the potential fallout from the federal investigation.

“We decided we should anticipate a problem rather than wait and see if one develops and then react to it,” said Mauri Osheroff, associate director for regulatory policy of the commission’s corporation finance division.

Investors, anticipating reduced military spending over the next several years, had demonstrated their wariness of defense stocks well before the procurement scandal became public in mid-June, analysts noted.

On average, aerospace stocks have been selling for about 10 times their earnings, while industrial stocks in general have sold for an average of 13 times their earnings, said Lawrence M. Harris, an analyst with Bateman Eichler, Hill Richards in Los Angeles. “These stocks were already depressed.”

Meanwhile, a bill was introduced in the Senate on Monday to require defense industry consultants, whose secretive dealings are a major focus of the procurement investigation, to register with the federal government. Under the proposal by Sen. David Pryor (D-Ark.), defense contractors could not hire unregistered consultants.