Does a company have to notify its investors when it faces legal proceedings?

By Investopedia Staff AAA
A:

Not necessarily. The SEC guidelines do not require businesses to publicize legal proceedings if these proceedings are a part of ordinary business and are not expected to cost more than 10% of the firm's assets; otherwise, any legal proceedings need to be reported. These guidelines are stated in Regulation S-K.

A problem arises, however, in the interpretation of the regulation: "ordinary business" is a very broad term that can encompass many situations. Because it is left to the discretion of the company to decide whether the legal proceedings are part of ordinary business, there is always a possibility that you will not find out about legal proceedings that you may consider important.

Three main elements go into the decision to disclose: If the answer is "yes" the company usually has to disclose
1. Is the case material information? Will it make a difference, or would investors want to know?
2. Is the combined lawsuit worth more than 10% of the company?
3. Is it outside of "ordinary" work?

There are many other factors which call for disclosure such as when the interests of the company and a director differ in a law suit, or when there are environmental laws involved. Legal proceedings must also be disclosed for director nominees and executive officers, if that information is material to the elevation of the nominee. This is to better understand the character and competence, but civil settlements do not need to be disclosed.

For related reading, see Knowing Your Rights As A Shareholder.

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