A recent U.S. District Court decision on a securities class action suit may give companies some ammunition to fight back against demands for increasingly speculative disclosure related to uncertain legal actions.

Gibson Dunn litigation partner Drew Tulumello says he's hopeful the decision will be regarded as one that sets a precedent for how far companies should be expected to go to make judgments about lawsuits or other pending legal actions where the company simply doesn't know how a given situation might turn out. “I hope this decision makes clear that if companies apply their best, good-faith professional judgement based on what they know at that time, the courts will not second guess them,” he says.

The decision comes from U.S. District Court Judge Deborah Batts in a class action suit against SAIC Inc., a defense contractor in Virginia caught up in a kickback scheme involving a “CityTime” payroll system implementation for the city of New York in 2000. Three men on SAIC's payroll were convicted of taking $30 million in bribes to steer the work to certain subcontractors. SAIC entered into a $500 million deferred prosecution agreement to settle the allegations, says Tulumello.

In a class action suit defended by Gibson Dunn, SAIC faced additional allegations that the company should have disclosed the government's claim against the company earlier than it did, says Tulumello. Companies are required under accounting standards to disclose in their financial statements any contingencies, such as pending lawsuits or other legal actions, that could cost the company money. Historically known as Financial Accounting Standard No. 5, or FAS 5, now contained in the Accounting Standards Codification under Topic 450, the standard provides criteria for when companies should begin making such disclosures. Those criteria have been under strain in recent years as investors have complained about being blindsided by surprise settlements with little or no forewarning.

The Financial Accounting Standards Board attempted to revise the standard but met heavy resistance, then turned it over to the Securities and Exchange Commission suggesting increased enforcement of the existing standard. The SEC has made it a point of focus in its routine review and comment process the past few years, compelling companies to reveal more about what's happening in pending legal matters before investors are hit with final decisions.

As the SEC has become more aggressive in demanding earlier disclosures, the plaintiff's bar has followed suit, says Tulumello. The action against SAIC “is very typical of a wave of FAS 5 litigation going around,” he says. The suit claimed shareholders should have learned about the investigation earlier than they did, and as a result the stock price was inflated.

Initially the court sided with the plaintiffs but then agreed to reconsider, says Tulumello. In her reconsideration, Batt conceded the court applied the wrong test to when a disclosure would be required. After re-examining the standard and the timing of disclosures, Batt pointed out the harm that can come from expecting companies to make speculative disclosures. The original decision “would permit the prosecution of a case where evidence is insufficient to support going forward,” she wrote. “It would unfairly compel the company, which has already been beset by the massive fraud related to the CityTime project, to defend a costly suit, and would cause further harm to defendant SAIC and its stakeholders.”

Tulumello says the facts of the SAIC case illustrate the difficulty in applying FAS 5. “It's very hard to predict in the middle of an investigation how that investigation will end up,” he says. “If in hindsight plaintiffs lawyers can say you should have told us earlier, and if that standard is applied too leniently, companies will face a wrath of impossible judgment calls,” he says.