Federal securities law requires publicly held companies to release financial reports. If there is the possibility that a lawsuit will affect profit margins, the corporation should include this information in the report. It risks fines, penalties, sanctions, and the suspension of trading. There could also be criminal charges alleging that the company knowingly or willfully made materially false or misleading statements, which is a felony. There is also the risk of a class action on behalf of the stockholders.
Rules for disclosing the suit
The SEC requires that the disclosure must include the following information:
- Name all the parties involved in the lawsuit.
- Provide a fact-based description of disagreement.
- List the date when the lawsuit was filed.
- List the amount that the plaintiff seeks in damages.
What companies do not need to disclose
While many believe that full disclosure is the safest approach rather than risking additional penalties or legal action, there are some valid reasons for not announcing the litigation:
- The claim is a routine or common occurrence for the company.
- The damages in the suit are less than 10% of the business’s assets.
Setting up a reserve
Certain generally accepted accounting principles (GAAP) apply to public and privately held businesses. One principle is that the defendant needs to set up a reserve account to pay for the damages or losses incurred, especially when there is a high likelihood that the company will need to pay damages and penalties. This account must have enough in it to reasonably address the lawsuit. If this is not the case, the company will need to explain why.
The SEC requires that the company disclose any proceedings involving a government agency. It also requires the company to tell when a director, officer or shareholder with at least 5% ownership filed the lawsuit. Failure to do it can mean an SEC investigation and enforcement action with a court injunction that forces the company to divulge the litigation. However, an investigation can also clear the company of wrongdoing, which means no fines and penalties.
Legal guidance makes a difference
Executives and board owners weighing their options often turn to business law attorneys with experience handling disputes, litigation and compliance. These legal professionals offer insight on the best legal options and whether the company needs to publicly announce that it faces a lawsuit.