Federal securities law dictates that publicly owned companies must issue financial reports. If litigation potentially affects the financial bottom line, the company should include that information in the report. Failure to do so can lead to fines, sanctions, suspension of trading shares, criminal charges, and a class action on behalf of shareholders. The shareholders may allege that the company made materially false or misleading statements.
The SEC rules
The disclosure of a lawsuit must include the following:
- Naming all parties in the lawsuit
- Providing a factual description of the dispute
- Giving the date that the lawsuit was filed
- Providing the amount of damages the plaintiff seeks
What the company need not disclose
Many find full disclosure a better option than risking additional lawsuits or penalties. However, there are some standard reasons a company may not disclose the litigation:
- The claim or damages is less than 10% of the company’s assets
- The claim is a routine event that is part of doing business
There are a generally accepted set of accounting principles (GAAP) and standards that apply to public and privately held companies. One such rule is that the defendant must set up an account or reserve to pay for losses due to litigation, particularly if there is a high probability that the company will pay damages or penalties. It must be a reasonable amount, or the business must explain why it did not set up the account.
The SEC requires disclosure of any proceedings by a government agency or an action where an officer, director or shareholder with more than 5% ownership filed a lawsuit against the company. Failure to disclose can lead to an SEC investigation, and enforcement action can lead to a court injunction forcing the company to disclose the lawsuit. Conversely, the investigation may lead to clearing the company of a violation, which means no penalties or fines.
Each case is different
Executives weighing the company’s legal options typically call upon attorneys who handle business litigation or compliance. They can provide insight on the best course of action and whether the company is legally obligated to disclose the lawsuit.