Risk Management

The Jury’s Out

A reversal of a big jury award to shareholders lends support to critics of proposed revisions to FAS 5.
Alix StuartOctober 1, 2008

Last January, Apollo Group, owner of the University of Phoenix, learned a hard lesson about the risk of going to trial when a jury ordered it to pay shareholders up to $278 million in a securities class-action case. But the company enjoyed a reversal of fortune in August, when the judge who oversaw the case overturned the jury verdict and released Apollo from any payments to shareholders.

Such reversals are rare, but Judge James Teilborg of the U.S. District Court of Arizona agreed with Apollo that the jury had misperceived how quickly professional investors react to news. The key issue: Teilborg deemed a 2003 stock drop following an analyst’s report unrelated to news reports a week earlier that revealed Apollo’s regulatory problems. “The judge said that even if all evidence was true, it doesn’t lead to damages,” says the company’s attorney, Wayne Smith, of Gibson, Dunn & Crutcher LLP.

The outcome is unlikely to encourage more companies to go to trial or fewer plaintiffs’ attorneys to file suits, say experts. But earlier this year, Smith noted that the case provided a perfect example of why controversial changes that the Financial Accounting Standards Board is considering to FAS 5, the accounting rule that covers such litigation, could prove both difficult to follow and “disastrous” in their effect. In a June draft, FASB asked companies to disclose “specific quantitative and qualitative information” about losses associated with contingent liabilities like lawsuits. Hundreds of comment letters replied that such disclosure could give plaintiffs’ lawyers unprecedented insight into a company’s legal strategy, and produce a raft of meaningless numbers.

Apollo, for example, “could have estimated its loss at zero, because we were confident, or at some arbitrary number, because you never know what a jury will do,” says Smith. The company recorded a charge of $168.4 million after the verdict, the midpoint of a range of estimated losses. Apollo now believes that “a loss is no longer probable” and will likely reverse the reserve, says CFO Joseph D’Amico. Since plaintiffs’ lawyers plan to appeal, Apollo’s actual costs may not be clear until 2010.

Companies may be momentarily safe, at least on the accounting front. The Financial Accounting Standards Board recently pushed back the deadline for when companies would have been required to provide new disclosures about their contingent liabilities under the proposal. Earlier, companies with a calendar fiscal year-end had been expected to comply with the rule in mid-December. But at a September board meeting, FASB pushed off that date by another year after hearing that many companies could not implement a new policy for disclosing potential lawsuit liabilities in time.

Also, the board is sifting through the feedback from lawyers, auditors, and financial statement preparers who worry the newly shared information could reveal confidential data, offering aide to the plaintiffs’ bar. And a final decision isn’t expected until next year.

Percentage of securities class-action settlements topping $100m