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Financial Reporting and the Law

A recent district court decision suggests that disclosure about an uncertainty under Item 303 of Regulation S-K may not be required when a company concludes that assertion of a claim relating to the uncertainty is not considered to be probable. In In re SAIC, Inc. Securities Litigation, the U.S. District Court for the Southern District of New York dismissed the complaint upon reconsideration of its earlier denial of a motion to dismiss because the court admitted that its prior analysis of the accounting literature was flawed. Topic 450-20-50-6 of the FASB Accounting Standards Codification requires disclosure about an unasserted claim only if assertion of the claim is probable and there is a reasonable possibility that the outcome will be unfavorable. Given the absence of evidence in SAIC that the assertion of a claim was probable, the court held that the allegations did not support a finding that the financial statements did not comply with GAAP. The court then held that, similarly, the allegations would not support a finding that disclosure about the uncertainty was required in the Management’s Discussion and Analysis (MD&A) by Item 303. Item 303 mandates, in the first instance, that the uncertainty be actually known.

The plaintiffs had alleged that SAIC’s financial statements did not comply with GAAP because SAIC did not recognize, on a timely basis, material charges relating to its having fraudulently billed New York City for services under a service contract, the CityTime project, performed by both SAIC and another company. In addition, the plaintiffs had alleged that SAIC’s financial statements and MD&A did not appropriately disclose loss contingencies related to the CityTime project. The court concluded that the complaint did not present allegations that met the probability requirement at the time SAIC filed the annual report on Form 10-K containing the financial statements and the MD&A that did not reflect the uncertainty relating to the CityTime project.

In its opinion, the court addressed the allegations that the government had commenced and was prosecuting criminal cases against non-SAIC employees involved in the CityTime project, and that SAIC had commenced an internal investigation of the project and put the person in charge of the CityTime project on administrative leave. The court explained that these allegations did not undermine SAIC’s professional judgment that disclosure was not required by GAAP and did not establish that “management (1) had knowledge that the company could be implicated in the CityTime project fraud or (2) could have predicted a material impact on the company.”