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FASB Proposes To Broaden Requirements for Disclosure of Litigation Loss Contingencies

By Anthony R. McClure, Litigation News Associate Editor – October 17, 2008

Corporations and their counsel are expressing concern about a controversial proposed amendment that would require companies to publicly disclose more information about potential loss contingencies from litigation.

The Financial Accounting Standards Board (FASB) proposed the amendments in an effort to provide more transparency in financial statements, but some in the corporate world think the changes would go too far.

In June, 2008, FASB issued an Exposure Draft with proposed amendments to Financial Accounting Standard No. 5 (FAS 5), which would expand the disclosure requirements for certain “loss contingencies,” including potential losses from pending and threatened litigation, claims, and assessments.

According to FASB , “[i]nvestors and other users of financial information have expressed concerns that disclosures about loss contingencies under the existing guidance . . . do not provide adequate information to assist users of financial statements in assessing the likelihood, timing, and amount of future cash flows associated with loss contingencies.” FASB accepted comments to the proposed amendments through August 8, 2008.

Under the current version of FAS 5, loss contingencies fall into three categories: (1) probable, (2) reasonably possible, or (3) remote. The current version requires companies to provide disclosures for loss contingencies that are “probable.” Under the proposed changes, companies would need to provide disclosures for loss contingencies that are more than “remote.”

The amendments would also broaden the information to be disclosed, requiring “a description of the factors that are likely to affect the ultimate outcome,” a “qualitative assessment of the most likely outcome,” and “significant assumptions” in estimating the amounts disclosed.

Corporate officers and attorneys are concerned. “While in a vacuum it’s a laudable goal, in practice it’s almost impossible,” says Stephen A. Radin, New York, Cochair of the Section of Litigation Committee of Corporate Counsel’s Subcommittee on Corporate Governance.

“It will create tremendous problems, not the least of which will be estimates that will turn out to be wrong,” Radin says.

“When it comes to litigation, nine times out of ten, the outcome is not ‘probable,’ and any loss cannot be reasonably calculated,” agrees Amelia Toy Rudolph, Atlanta, Cochair of the Section’s Professional Liability Litigation Committee Accountants’ Liability Subcommittee.

“Lawyers are not trained to estimate potential loss in a particular case with anything approaching statistical or empirical reliability,” Rudolph says.

However, some investor groups have praised the proposed amendments as a step forward in providing more transparent financial statements.

“It is because of the strong and extensive input we’ve received from investors who want greater transparency relating to a wide range of contingencies — including litigation — that we are proposing these expanded disclosures,” Robert H. Herz, Chairman of FASB, wrote in a Wall Street Journal editorial.

“The new disclosures are aimed at providing information earlier to existing and potential investors in order to give them a greater understanding of the risks companies are facing,” Herz remarks.

Those who are opposed to the amendments respond that early information will not necessarily result in better disclosures. “The proposed amendments seem to under-appreciate the unique nature of litigation,” says David R. Woodcock Jr., Austin, Cochair of the Section’s Professional Liability Litigation Committee Accountants’ Liability Subcommittee.

“An attorney’s case assessment frequently changes over the life of a lawsuit. If you look at the life of an average securities case, for example, it could take years before the parties exchange discovery or depose experts,” Woodcock says.

A requirement to disclose information before this discovery occurs will require companies to make “an uneducated guess,” Woodcock notes.

“If a company overestimates its potential exposure at the onset of the litigation, this may cause the company’s stock price to decrease,” he says. “What happens if the company wins the litigation? Would it then face lawsuits from disgruntled stockholders?”

Others raise concerns related to the attorney-client privilege. “If you’ve relied on the advice of counsel to prepare your disclosures, you’re waiving the privilege with respect to that issue,” says Radin. “What if the company is involved in a pending lawsuit that encompasses that very issue?”

Radin also complains that the broader requirements will make settlement more difficult. “You’re creating a floor for settlement,” he says. “If you report that you’ve reserved, say $2 million for litigation, the other side will see that – and will understand that you’re relying on information that the other side doesn’t have yet.”

Editors note: Due to the concerns expressed, FASB recently decided on a “plan for redeliberations” of its proposed changes. FASB’s staff has been instructed to create an “alternative model” for testing. According to FASB, a final statement on this topic would be effective “no sooner than for fiscal years ending after December 15, 2009.”

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