When facing a material dispute, a company must not only defend the underlying claims but also navigate accounting and Securities and Exchange Commission guidance concerning the accrual for and disclosure of the litigation contingency.
The recent settlement in SEC v. Mylan N.V. shines a spotlight on how difficult it is for a company to navigate these issues, particularly while vigorously contesting liability. In October 2016, Mylan reached a $465 million settlement with the Department of Justice after vigorously contesting the DOJ’s liability case concerning the classification of its EpiPen product as a generic drug.
Nearly three years later, on Sept. 27, the SEC announced that Mylan agreed to pay another $30 million to settle charges that the company failed to follow accounting and disclosure requirements during its dispute with the DOJ.
A company must consider these critical questions:
- When must it first disclose the dispute?
- When is a loss contingency “reasonably possible,” triggering disclosure obligations, and what obligation does the company have to disclose the amount of its liability, or a range of estimates?
- When has a loss contingency become “probable” and “reasonably estimable,” triggering the need to record a liability on the balance sheet?
- What impact does the exchange of information or settlement discussions between the company and its adversary have on these obligations?
- How should a company balance the need to comply with accounting and disclosure requirements with the need to zealously defending the dispute on behalf of shareholders?
Facts From SEC Complaint
The SEC’s complaint against Mylan set forth the following alleged facts:
Pre-2013: Mylan classified EpiPen as a generic drug in reliance on a 1997 letter from the Centers for Medicare & Medicaid Services (CMS).
Late 2014: CMS informed Mylan’s executives and counsel on a conference call that Mylan had misclassified the drug and should not rely on the 1997 letter; Mylan received a subpoena from the DOJ concerning the EpiPen’s classification.
2015: Mylan made a presentation to the DOJ detailing why it believed the DOJ lacked any basis to assert claims based on the EpiPen’s classification; the DOJ and Mylan agreed to a tolling agreement to allow the DOJ to continue to consider whether it would assert such claims without concern over the statute of limitations.
Q3 2015: Mylan provided an analysis to the DOJ indicating that the financial impact for a single quarter in 2015 of classifying the EpiPen as generic was $12 million to $42 million.
The SEC alleged that, at this time, Mylan knew or should have known that the likelihood of a material loss was “reasonably possible” and that Mylan should have disclosed the investigation, as well as a range of estimated losses. The SEC noted that these figures were limited to only one quarter and that treble damages were available under the False Claims Act.
Q2 2016: Mylan and the DOJ continued to meet concerning the claims and agreed to another tolling agreement; Mylan provided information that the economic impact of the classification issues for 2015 was in the $114 to $260 million range (without taking into account treble damages available under the False Claims Act).
The SEC alleged that, at this time, Mylan knew or should have known that the likelihood of a material loss was “probable” and “reasonably estimable” and that the dispute should have been disclosed and a loss should have been recorded.
July 2016: The DOJ indicated it was prepared to sue; Mylan offered to settle with the DOJ for $50 million.
August 2016: Mylan agreed to settle with the DOJ for $465 million.
October 2016: For the first time, Mylan disclosed the DOJ’s investigation and its loss in connection with the dispute.
The SEC noted that EpiPen was Mylan’s most important product by profits and sales. This fact, as well as the size of the DOJ settlement, must have played a role in the SEC’s decision to take action.
What made the circumstances particularly difficult for Mylan, however, was that the company vigorously defended itself against the DOJ’s claim on liability grounds, including by relying on a letter from CMS itself agreeing with the classification that Mylan had adopted.
Companies should take note of the allegations in this matter when facing a potentially material dispute or investigation.
A few practical considerations:
- When considering accounting and disclosure obligations in connection with litigation contingencies, companies should consult multiple sources in both accounting and also SEC literature giving rise to these obligations.
- The accounting and SEC standards allow for litigation contingency disclosures to change over time.
- Those standards allow a company to disclose a dispute, even while vigorously contesting liability.
- Nothing in the standards suggest that if a company believes that it is without liability that it nevertheless must disclose that a loss is probable or reasonably estimable.
- Some companies disclose a dispute, as well as the proposed or alleged damages in the dispute, even while explaining to investors that the company is disputing liability.
- In other instances, a company may instead choose to explain why it cannot reasonably estimate a reasonable possible or probable loss or range of loss.
- The accounting standards do suggest that if a company makes a settlement offer that the company should accrue for the loss in an amount that is at least the amount of that offer.
A company facing a potentially material dispute should review its relevant disclosures with these principles in mind. While the Mylan case demonstrates the SEC is willing to take enforcement action related to such disclosures, the SEC’s Division of Corporate Finance has also been actively reviewing and commenting on companies’ litigation-related disclosures in recent years.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Jessica Pulliam chairs the Baker Botts Trial Department in Dallas. She defends public companies and their officers and directors, private enterprises and professional firms in high stakes lawsuits and has handled matters involving class actions, corporate crisis, business torts, securities fraud, fiduciary litigation, accounting and disclosure issues, SEC and PCAOB investigations, whistleblowerclaims, and post-deal disputes.