Publicly held corporations must regularly issue financial reports that accurately reflect the business’s health. If litigation is on the horizon and could impact the bottom line, the company should include this information in its report. Failure to do it risks fines, sanctions, penalties, and suspension of trading. If the corporation knowingly or willingly makes misleading or fraudulent statements, it could face felony criminal charges. The stockholders could also file a class action lawsuit.
What companies must disclose
The SEC stipulates that publicly traded companies must provide the following:
- A fact-based description of the dispute
- When the plaintiff filed the lawsuit
- The names of the parties involved
- The amount the plaintiff seeks
What companies need not share
Honesty is often the best policy, and sharing too much rather than not enough is better. Still, there may be good reasons for not disclosing information about someone’s pending legal action. Two examples are:
- The potential lawsuit involves damages of less than 10% of the corporation’s assets.
- The claim is a routine part of doing business for the company.
The SEC is watching
Along with requiring information about pending legal action, the SEC also requires that the company disclose any proceedings by government agencies that involve the director, officer or shareholder with more than 5% ownership. The SEC will issue a “Wells notice” to notify the company that it found reasonable cause for an enforcement action. It will levy a civil penalty and order the company to disclose the lawsuit. If the SEC doesn’t find wrongdoing during the investigation, it will issue a statement saying as much.
Preparing for a lawsuit
There are some generally held accounting principles known as GAAP Standards. One principle is to prepare for litigation by setting up a reserve or war chest to pay for potential damages of a pending lawsuit. If it fails to do so, the corporation must explain why to the SEC.
Companies need to take potential litigation seriously. Along with setting aside money, bringing in a business law attorney who regularly handles court cases is essential. These legal professionals can provide insight and strategy for managing the matter and whether the company needs to acknowledge the pending legal action publicly.