Can shareholders of Bank of America, Citigroup, or JPMorgan learn anything about their potential exposure to the burgeoning LIBOR-fixing scandal from the banks’ most recent public disclosures? In the weeks since UK and US regulators fined Barclays $455 million for attempting to rig LIBOR, investors in the world’s big banks have worried where the next shoe will drop.

The London interbank offering rate, known as LIBOR, is an index of interest rates submitted daily by 16 banks (including three US-based banks—Bank of America, Citigroup and JPMorgan). The interest rates represent each bank’s cost of borrowing from other banks. In addition to being a key benchmark for mortgages and other loans, LIBOR is used to price interest-rate derivative contracts having aggregate notional values of several hundred trillion dollars.

London-based Barclays was found to have submitted false rates in order to aid certain of its and others’ derivative trading positions and in order to assuage doubts in the marketplace concerning the bank’s financial health.

Thus far, the regulators have not implicated any banks other than Barclays. However, they did find that Barclays’ bad actors communicated with some of the 16 banks that make up the LIBOR-setting panel. And Barclays officials alerted regulators as far back as 2007 that other banks were also submitting low rates. So the regulatory and litigation risks are unlikely to be confined to Barclays, and a recent report by Morgan Stanley estimates that fines could weigh 7 to 12 percent on this year’s earnings for each of the LIBOR panelists.

In their most recent annual reports, both JPMorgan and Citigroup disclosed requests for information from various US and international regulators regarding the setting of LIBOR. The banks also detail the status of ongoing class actions filed against them by various parties—including Charles Schwab and the City of Baltimore—claiming harm from LIBOR manipulation.

However, Bank of America (BofA) has made no mention of any such investigation, despite being named in the same civil lawsuits referenced by Citigroup and JPMorgan.

So can BofA shareholders assume the bank is not a target of regulators? It would be unwise to do so. Due to the vagaries of accounting standards and SEC rules regarding the disclosure of legal and regulatory risks—as well as BofA’s track record for such disclosures—few conclusions can be drawn as to the danger posed to BofA by the scandal.

Under Financial Accounting Standard No. 5, a company must create a loss reserve if a litigation or regulatory loss is probable and the amount of the expected loss is material and can be reasonably estimated. For those matters where a possible, but not probable, loss can be estimated, a range of possible losses above this reserve should be disclosed in the notes to the financial statements. (In its most recent 10-Q filing, BofA sets the maximum for this range at $4.2 billion.) The guidance for the accounting standard suggests a legal matter should be disclosed when there is a reasonable possibility that it will cause a material loss.

Public companies must also disclose significant legal proceedings under SEC Regulation S-K Item 103, which requires disclosure of material legal proceedings in Item 5 of Forms 10-K and 10-Q, unless the claims represent less than 10 percent of the company’s current assets. (Companies are generally more forthcoming than this rule requires; for example, BofA had almost $1.0 trillion in current assets on its balance sheet at the end of the first quarter, but the legal matters it disclosed posed risks of far less than $100 billion.)

Thus, investors might conclude from BofA’s lack of disclosure regarding LIBOR that the scandal poses a less serious risk to it than to Citigroup and JPMorgan, who felt it necessary to warn their shareholders. However, another possibility is that BofA has taken a more parsimonious stance toward disclosing pending legal matters, as the aforementioned rules allow it to do. And BofA shareholders know better than to take the bank’s disclosures of legal risk at face value.

In 2011, BofA did not disclose in SEC filings any risk that insurer AIG would sue it to recoup losses on mortgages which BofA (or Countrywide or Merrill Lynch) had originated. When AIG filed suit in August 2011, and claimed $10 billion in damages, BofA’s stock price dropped 20% within one trading session, as the potential loss had not previously been considered by investors.

Episodes such as this have contributed to market suspicions of the bank’s disclosures. BofA has a price-to-book ratio of 0.38, which trails both Citigroup (0.43) and JPMorgan (0.73). The ratio compares a company’s market value to its reported total assets, less intangible assets and liabilities. These figures suggest that investors think each of these banks may be overvaluing their assets (such as mortgages) or underestimating their coming legal and regulatory challenges. Yet, according to the market, no big bank is more off-the-mark than BofA.

Given this evident lack of trust among investors, BofA’s management might have incentive to improve its disclosure in all areas of potential risk. However, to date, they—like most other LIBOR panelists—have said nothing to reassure shareholders that a Barclays-sized fine won’t be coming their way.

At BofA, the board’s audit committee oversees the nature and status of significant legal and regulatory matters that may have a material impact on the Company’s financial statements. In other words, the audit committee is ultimately responsible for BofA’s disclosures regarding the LIBOR investigation. Interestingly, this committee is chaired by former Merrill Lynch director Charles Rossotti. Glass Lewis has recommended voting against Mr. Rossotti at BofA in each of the past four years based in part on his questionable service as a member of Merrill Lynch’s audit and finance committees from 2005 until 2009, when Merrill Lynch was acquired by BofA during the height of the financial crisis.

If BofA’s audit committee is functioning anything like Merrill Lynch’s audit committee in the years leading up to its acquisition, investors have real reason to worry. Merrill Lynch’s audit committee failed to ensure that that company’s risk controls were robust enough to prevent or mitigate its exposure to subprime mortgages—ultimately leading to massive write-downs and the destruction of shareholder value. Now, BofA’s shareholders face a similar sense of questionable oversight and inadequate disclosure regarding an unrelated yet potentially material issue.

As events continue to unfold, shareholders would be wise to examine any changes made to disclosures of loss reserves at big banks, especially at BofA.

By Jack Ferdon and Alex Miller
Image via iStockphoto