18 February 2011
In the wake of the financial crisis, banks and other financial institutions are facing increased litigation exposure. Federal regulators are pushing for additional, more detailed disclosure of that exposure in annual and quarterly filings. In particular, the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) are focusing on disclosure of estimates of potential losses and reserve amounts.
In July 2010, the FASB proposed more stringent rules for the disclosure of litigation-related contingencies. This proposal was met with opposition from some groups, including the Association for Corporate Counsel (ACC), which expressed concern that expanded disclosure could actually lead to higher settlement costs, potential waivers of the attorney-client privilege and higher litigation costs. As the ACC explained, “[o]nce a company has disclosed the specific amount accrued for a litigation contingency, no plaintiff would rationally settle for a lower amount.”
The FASB, however, insists that the additional disclosure is necessary to protect investors. Acting Chair Leslie Seidman recently explained that the FASB has received investor complaints about the paucity of information in most disclosures and that the current level of disclosure is viewed as “too little too late.”
The FASB’s proposed rule change has not yet been adopted. However, regulators are increasing efforts to force compliance under the existing disclosure rules. For example, the SEC has indicated that it is going to be taking a closer look at litigation-related disclosures than it has in the past. In October 2010, the SEC sent letters to the chief financial officers of certain (undisclosed) companies detailing what disclosure the SEC expects to see in quarterly and annual filings, including with regard to certain litigation exposure.1 According to the SEC’s website, the purpose of the letters was to remind companies of their disclosure obligations “in light of continued concerns about potential risks and costs associated with mortgage and foreclosure-related activities or exposures.”
The SEC has also increasingly used comment letters as a means of obtaining additional disclosure of litigation costs from financial firms. Comment letters are used by the SEC to inquire about a company’s disclosures and typically seek clarifications and enhancements to disclosures that issuers provided in their public filings.
The issuance of comment letters by the SEC also appears to be on the rise. A recent study commissioned by Reuters found that the SEC sent comment letters inquiring about litigation costs to 165 companies in 2009, compared with 140 in 2008. The number of comment letters issued in 2010 likewise appears to be up.2
In any event, these recent efforts indicate that at a time when banks and other financial institutions are facing increased litigation-related exposure, regulators are taking a more aggressive attitude toward adequate and timely disclosure of that exposure. These increasing disclosure demands will force companies to balance the heightened disclosure requirements with the potential risk to their litigation defense and settlement efforts.
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