In an article in CFO Magazine David Katz discusses a working paper by David Tabak of NERA Economic Consulting. Tabak's work demonstrates that when a company defending a securities fraud class action discloses the action sooner rather than later, damages received by the plaintiffs will be less. This makes sense, as the company's stock price should adjust to reflect the newly disclosed information. If a company does not disclose in a timely fashion, investors will overpay for the shares.
SEC Regulation S-K, Item 103, governs disclosure of litigated matters. The instructions to the item give companies the clearance to leave out of 10-Qs and 10-Ks matters that involve claims for damages not in excess of 10% of the registrant's current assets on a consolidated basis. There are certain types of claims that must, however, be disclosed. These include "material proceedings to which any director, officer," affiliate, or 5% holder of registrant securities is adverse to the company. The company must also disclose claims that are material to the business or financial condition of the registrant and proceedings involving claims by the government for monetary sanctions of $100,000 or more.
If you're reviewed many Item 103 disclosures in the past few years, you've seen companies using this section of their periodic filings as cheap D&O insurance. By making early disclosure of lawsuits -- even if they might not meet the test for required disclosure -- the company limits available damages in securities fraud class actions. After all, once the disclosure is made, the company's stock price should reflect the total mix of information about the company.