Exclusive: Bank of America kept AIG legal threat under wraps

By Lauren Tara LaCapra

NEW YORK (Reuters) - Top Bank of America Corp lawyers knew as early as January that American International Group Inc was prepared to sue the bank for more than $10 billion, seven months before the lawsuit was filed, according to sources familiar with the matter.

Bank of America shares fell more than 20 percent on August 8, the day the lawsuit was filed, adding to worries about the stability of the largest U.S. bank. It wasn't until Warren Buffett stepped up with a $5 billion investment that those fears were eased, though hardly eliminated.

The bank made no mention of the lawsuit threat in a quarterly regulatory filing with the U.S. Securities and Exchange Commission just four days earlier. Nor did management discuss it on conference calls about quarterly results and other pending legal claims.

The SEC's rules for litigation disclosure are murky, and some lawyers said Bank of America may have been justified in not revealing AIG's lawsuit before it was filed. The bank's litigation disclosures are in line with those of many rivals.

But other lawyers said banks have an obligation to disclose legal threats that could have major consequences.

"Publicly owned companies are supposed to disclose material threatened litigation under generally accepted accounting principles," said Richard Rowe, a former director of the SEC's Division of Corporation Finance, who was commenting generally and not specifically about Bank of America.

Rowe, now a partner in the Washington, D.C., office of law firm Proskauer Rose, said bank executives must make a "judgment call" as to what is material, but "the general rule is, if it's threatened litigation and it's material, and you can put a number on it, you should disclose it."

AIG's lawsuit shows why investors are so fearful: they have no idea how much litigation lurks behind closed doors.

"Management surely has a credibility problem with investors," said Jonathan Finger, whose Finger Interests Number One Ltd in Houston owns Bank of America shares. "They continue to under-address or under-disclose on the mortgage issue."

Finger in 2009 sued the bank over its disclosures related to the takeover of Merrill Lynch & Co.

Bank of America and AIG declined to comment for this article.

DISCLOSING MORE

SEC staff have this year advised banks including Bank of America, JPMorgan Chase & Co, Citigroup Inc, Wells Fargo & Co, Goldman Sachs Group Inc, and Morgan Stanley to disclose more information about lawsuits that have been filed, as well as legal proceedings that they know the government is considering.

Banks have responded by providing additional information, including legal loss estimates in some cases.

But the agency has given banks more leeway in disclosing the expected cost of early-stage litigation, or threats of litigation whose outcome is more difficult to predict, according to securities lawyers and current and former regulatory officials.

There are two standards for disclosing legal liabilities. One under banks' legal proceedings relies on whether losses are "reasonably probable" and "reasonably estimable." Another, under management's discussion and analysis, is based on whether losses are "reasonably possible." Disclosure relies heavily on management's assessment of the merits of a case.

Companies might need to disclose large potential lawsuits, even if they believe a loss is improbable, as well as less consequential cases if a loss appears certain, said Meredith Cross, director of the agency's Division of Corporation Finance, in an interview with Reuters about the SEC's disclosure requirements.

"The goal has been to have better disclosures, which should result in fewer surprises," said Cross, who was speaking generally and not commenting on any specific institution.

Legal experts say it is difficult for top bank executives to decide exactly what they have to disclose in relation to pending and potential legal matters. That is particularly true in the current environment, they said, in which confidence in large banks is so easily shaken by legal threats that may or may not have merit.

"This is a classic problem in the disclosure regime with litigation," said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "You're required to disclose anything material. The question is, 'is it material?' You have to gauge the size and the probability of success, which is very hard to evaluate."