By: George M. Wilson, SEC Institute & Gary M. Brown, Partner, Nelson Mullins Riley & Scarborough LLP (Note: Gary Teaches our SEC Reporting and Practice Skills for Lawyers workshop)
In our Workshops, disclosures about legal proceedings are usually a hot topic for both lawyers and accountants. In these discussions we review the differences between the S-K Item 103 disclosures for legal proceedings and the ASC 450 GAAP disclosures for contingencies. The S-K Item 103 disclosures generally are more about the factual situation and include more details than the GAAP disclosures, including details such as the name of the parties, the court or jurisdiction where the action is taking place and the relief sought. The GAAP disclosures are more focused on expected impact.
One challenging aspect of these differences is what to disclose about plaintiff lawsuits. Generally, the GAAP disclosures focus on contingent liabilities, not the kind of contingent asset that would arise from a plaintiff lawsuit. The ASC guidance for gain contingencies is short and to the point:
A contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization. 450-30-50 Disclosure
Adequate disclosure shall be made of a contingency that might result in a gain, but care shall be exercised to avoid misleading implications as to the likelihood of realization.
S-K Item 103 does not have this same focus on contingent liabilities. In fact, it starts with this language:
Item 103 – Legal proceedings.
Describe briefly any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject. Include the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought. Include similar information as to any such proceedings known to be contemplated by governmental authorities.
The language “material pending legal proceedings” does not limit the disclosure to just defendant actions. And, to reinforce this conclusion, the SEC has issued the following Compliance and Disclosure Interpretation:
Section 205. Item 103 — Legal Proceedings
205.01 The bank subsidiary of a one bank holding company initiates a lawsuit to collect a debt that exceeds 10% of the current assets of the bank and its holding company parent. Due to the unusual size of the debt, Item 103 requires disclosure of the lawsuit, even though the collection of debts is a normal incident of the bank’s business. [July 3, 2008]
This C&DI also illustrates the application of the 10% disclosure threshold and an interesting interpretation about normal course of business issues. And, it clearly shows that Legal Proceedings disclosure should include material lawsuits in which the company is a plaintiff as well as a defendant.
As always, your thoughts and comments are welcome!