Ready or not litigation settlements continue to surprise investors
Seems to me disclosure has gotten much worse not better and auditors are complicit in helping companies to strategically disclose.
FASB Statement No. 5, Accounting for Contingencies is the GAAP standard that requires companies to disclose the nature of an accrual made for an estimated loss from a loss contingency such as a legal settlement or a financial guarantee.
Questions about accrual and disclosure of loss contingencies are questions I get frequently. The inquiries often reflect confusion between when an accrual for a loss contingency is required and when a disclosure of a loss contingency is required.
Loss contingencies are
• Recognized/Accrued on Balance Sheet if (1) probable and (2) estimable, and
• Disclosed if (1) probable and not estimable, or (2) reasonably possible and estimable.
Gain contingencies are accrued/recognized only when realized.
If no accrual is made, or if an exposure to loss exists in excess of the amount accrued, the company is required to disclose the contingency when it is other than remote (that is, reasonably possible) that a loss or an additional loss may have been incurred. The disclosure should include the nature of the contingency and an estimate of the possible loss or range of loss or state that such an estimate cannot be made.
It's important to note that PCAOB Auditing Standard (AS) 3101, Departures from Unqualified Opinions and Other Reporting Circumstances, formerly covered by AU Section 431, Adequacy of Disclosure in Financial Statements, requires an auditor to express a qualified or an adverse opinion if disclosures required by GAAP are omitted from the financial statements.
.24 Inadequate disclosure.
Information essential for a fair presentation in conformity with generally accepted accounting principles should be set forth in the financial statements (which include the related notes). When such information is set forth elsewhere in a report to shareholders, or in a prospectus, proxy statement, or other similar report, it should be referred to in the financial statements. If the financial statements, including accompanying notes, fail to disclose information that is required by generally accepted accounting principles, the auditor should express a qualified or adverse opinion because of the departure from those principles and should provide the information in the report, if practicable, unless its omission from the auditor's report is recognized as appropriate by a specific PCAOB standard.
.29 If the auditor concludes that a matter involving a risk or an uncertainty is not adequately disclosed in the financial statements in conformity with generally accepted accounting principles, the auditor should express a qualified or an adverse opinion.
I've written about auditors and loss contingencies a lot, going back many years. I was prompted to write again for two reasons.
The first reason was that I saw that UBS AG and several of its U.S.-based affiliates recently agreed to pay $1.435 billion in penalties to settle a civil action filed in November 2018 alleging misconduct related to UBS’ underwriting and issuance of residential mortgage-backed securities (RMBS) issued in 2006 and 2007.
The Department of Justice press release, which went out August 14 but it's not stated what time, says that this settlement "resolves the last case brought by a Justice Department working group dedicated to investigating conduct of banks and other entities for their roles in creating and issuing RMBS leading up to the 2008 financial crisis."
Whew! A settlement related to RMBS issued 16-17 years ago, brought five years ago for the kind of fraud that led to the financial crisis 15 years ago.
"...the Justice Department has collected more than $36 billion in civil penalties from entities for their alleged conduct in connection with mortgages securitized in failed RMBS leading up to the 2008 financial crisis. These resolutions include settlements with the following banks, mortgage originators, and rating agencies: Ally Financial; Aurora Loan Services; Bank of America; Barclays; Citigroup; Credit Suisse; Deutsche Bank; General Electric; Goldman Sachs; HSBC; JPMorgan; Moody’s; Morgan Stanley; Nomura; Royal Bank of Scotland; S&P; Société Générale; and Wells Fargo."
When the case was filed, UBS said:
“The DOJ’s claims are not supported by the facts or the law,” the Zurich-based bank said Wednesday, before the complaint was filed. “UBS will contest any such complaint vigorously in the interest of its shareholders. UBS is confident in its legal position and has been fully prepared for some time to defend itself in court.” The bank also denies any wrongdoing in the French tax case.
Be careful about protesting too much, especially if you say the case is “without merit” when you know otherwise!
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