SEC cracks down on disclosure of lawsuit costs (Westlaw News & Insight)

February 3, 2011

By Carlyn Kolker

NEW YORK, Feb 3 (Reuters Legal) – The U.S. Securities and Exchange Commission is cracking down on corporate disclosure of litigation costs, a Reuters Legal analysis has found. In particular, the agency is targeting banks and other institutions that have reported large settlements of financial crisis-related lawsuits that they had not disclosed in prior regulatory filings.

The inquiries come in the form of “comment letters” that the SEC routinely sends to companies when it has concerns about accounting practices. The number of comment letters related to litigation costs has steadily risen since the financial crisis, according to Audit Analytics, a research firm that examined thousands of SEC comment letters for Reuters Legal. The study showed that the SEC sent such letters to 165 companies in 2009, compared with 140 in the prior year. The number for 2010 is expected to rise again: Already, the agency has made public litigation-related comment letters to 114 companies, according to the study. There is typically a four-month lag time before the agency makes public such correspondence.

Under U.S. accounting guidelines, companies are required to disclose certain pending lawsuits and estimate their costs. These disclosures appear in quarterly filings and annual reports, which many companies are preparing now. When the agency believes a company hasn’t met the guidelines, it may send a comment letter, to which the company may respond. The SEC letters are framed as requests for information, not demands for compliance, but they often have that effect: Companies don’t want to tangle with their primary regulator, and often revise public filings rather than resist.

Companies are often skittish about disclosing lawsuit costs, but the SEC and shareholder activists see this information as crucial to giving the public an accurate financial picture. In its litigation-related comment letters, the SEC typically asks companies to divulge how much they are setting aside in anticipation of fighting or settling a particular lawsuit and that they give a range of estimated costs for a lawsuit — or else explain why they can’t estimate these costs. “If the SEC asks a question and the company says we don’t have the answer to it,’ that should be a red flag to shareholders,” said Nell Minow, co-founder of the Corporate Library, a corporate-governance research group.

The SEC may be reacting to the massive wave of litigation that has hit banks and other financial institutions in the wake of the mortgage meltdown. Already, dozens of investor suits have been filed, and these cases could ultimately cost the defendants more than $50 billion, according to some estimates. Some of the recent comment letters appear to have been prompted by a company’s announcement that it settled a crisis-related lawsuit that it hadn’t accounted for in prior filings.

For example, in a July 1 comment letter to Morgan Stanley, the SEC asked the bank why it had not disclosed a $102 million settlement with the state of Massachusetts over loans for subprime mortgages in prior regulatory filings. Morgan Stanley responded in a letter to the SEC that the settlement had been too uncertain to disclose in previous filings. A Morgan Stanley spokesman declined to comment. The SEC released no further correspondence, indicating that the matter had ended at that point.


The SEC itself has sent a strong public signal that it is ramping up scrutiny of litigation-cost disclosure. In October, the agency issued so-called “Dear CFO” letters to the top finance executives of several major banks. The purpose of the form letter, according to a copy posted on the agency’s website, was to remind CFO’s of disclosure obligation “in light of continued concerns about potential risks and costs associated with mortgage and foreclosure-related activities or exposures.” An SEC spokesman declined to identify which companies received the mailing.

Last week, Wayne Carnall, chief accountant for the SEC’s division of corporation finance, told a room full of corporate lawyers at a New York City Bar Association meeting, to “take a fresh look” at disclosure of litigation costs in preparing their clients’ quarterly and annual filings. “Don’t simply repeat what was done last year,” Carnall said. “Carefully, carefully comply with the standard.”

Some defense lawyers expect the SEC to be more probing than it has been in the past when companies don’t cite specific dollar amounts, or a range of amounts, for estimated litigation costs. “I interpret what (Carnall is) saying as: Companies have to try pretty hard to put in a range of possible loss in their disclosures,” said Thomas White, a partner at Wilmer Cutler Pickering Hale and Dorr. “And they should be prepared to defend themselves when they don’t.”


The issue of how much disclosure to demand from companies has been hotly contested in recent years. In 2008 the Financial Accounting Standards Board, the regulatory authority that sets accounting standards for public companies, sought to implement new rules requiring companies to expand disclosure about litigation risks, by, for instance, providing predictions about the likely outcome of individual lawsuits. The Association of Corporate Counsel, the American Bar Association, and other lawyer groups strongly opposed the proposed rules, saying they could jeopardize litigation strategies by forcing companies to reveal how much they would settle for and also possibly divulge privileged information.

When the FASB tried again last year with a revised set of proposed rules, it again met stiff resistance. Companies insisted the existing accounting regulations, which provide specific guidelines for making disclosures, were sufficient. At a Nov. 10 meeting, the FASB board of directors tabled its proposal and directed its staff to work with the SEC to focus on increased compliance with existing rules.

The SEC and FASB are essentially calling the lawyers’ bluff: If the existing rules are what you want, the agencies seem to be saying, we’re going to get tougher about holding you to them. The implication is that if filings are not produced with more detailed disclosures going forward, regulators may renew their push to rewrite the guidelines. The FASB “has publicly suggested that it will be evaluating compliance with the existing standard in determining whether a new standard is necessary,” said Michael Young, a partner at Willkie Farr & Gallagher.

The Association of Corporate Counsel says it is wary of companies being asked for more information. “It’s easy to say in the abstract that more is better,” said Susan Hackett, the group’s general counsel. “But willy-nilly disclosures for the sake of greater quantity is frankly going to upset the delicate balance between what it is that companies must disclose and what they are able to keep quiet to protect their own shareholders’ interests.”

This article was first published by ThomsonReuters’ Westlaw News and Insight. Visit Westlaw News and Insight online at

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