SEC Brings Enforcement Action for Litigation Accruals
The SEC announced a settled enforcement action against Healthcare Services Group, Inc., John C. Shea, CPA, and Derya D. Warner regarding failure to make accruals for outstanding litigation.
According to the SEC’s order:
- Under ASC 450-20-25-2, a loss contingency shall be accrued if (a) it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and (b) the amount of loss can be reasonably estimated. A loss or liability is considered probable if it is likely to occur. ASC 450-20-20.
- By Q1 2014, HCSG had determined to seek an out-of-court settlement of the three pending class-action lawsuits in California state court (collectively, the “Irizarry” cases) after a joint mediation of those cases with plaintiffs. Under the proposed settlement, HCSG agreed to pay between $2.5 million and $3 million to plaintiffs, with the final amount to be determined based on the amount of claims submitted by class members. These and other settlement terms were set forth in a proposed settlement agreement that was submitted to the court for preliminary approval in Q1 2014. Shea, HCGS’ CFO, had participated in the mediation along with lawyers on behalf of HCSG. At all times, Shea was aware of the proposed settlement amount and the submission of the settlement agreement to the court for preliminary approval.
- HCSG, however, did not accrue for the loss contingency related to the settlement of the Irizarry cases even though the loss was both probable and reasonably estimable no later than Q1 2014. Based on the information available at the time, Shea was aware that, like the other California employment class actions that HCSG had settled in 2013, HCSG intended to settle the Irizarry cases instead of continuing to litigate them. Shea also knew that HCSG would likely incur a liability between $2.5 million and $3 million under the out-of-court settlement, depending on the amount of claims submitted by class members. Shea determined that no amount for this loss contingency was probable or reasonably estimable because the Irizarry settlement claims process was not complete, and the settlement had not received final court approval at the time. Shea also did not maintain any documentation of any purported analysis under ASC 450 of a litigation loss contingency.
- HCSG also did not disclose the nature of this loss contingency or an estimate of the amount of loss in its Q1 2014 Form 10-Q. The Form 10-Q stated HCSG was “subject to various claims and legal actions[,]” including “payroll and employee-related matters[.]” It also stated HCSG “provide[s] accruals if the exposures [to claims and legal actions] are probable and estimable,” and “[i]f an adverse outcome of such claims and legal actions is reasonably possible, we assess materiality and provide such financial disclosure, as appropriate.” Notwithstanding these statements, which were repeated in other Forms 10-Q and 10-K from 2014 to 2015, HCSG did not disclose the nature or an estimate of the loss contingency for the settlement of the Irizarry cases under ASC 450.
- No accrual was made in Q2 2014 even though the Court had granted preliminary approval of the settlement.
- HCSG accrued $2.5 million for the settlement of the Irizarry cases in Q3 2014. This amount was based, in part, on the number of claims submitted under the settlement agreement – an amount which the SEC stated was probable and reasonably estimable no later than Q1 2014.
- The SEC made similar allegations with respect to an out-of-court settlement of a collective action brought against it in 2013 captioned, Kelly v. Healthcare Services Group, Inc.
Among other things, HCSG agreed to pay a $6,000,000 civil monetary penalty to the SEC to resolve the matter.
The defendants (respondents) did not admit or deny the facts set forth in the SEC order.
Contact Steve Quinlivan for more information.