The Financial Accounting Standards Board once again finds itself on the horns of a dilemma.At issue are proposed amendments to Financial Accounting Standard 5, on disclosure of loss contingencies. If adopted as presented in an exposure draft issued earlier this year, the amended standard would require companies to disclose the extent of their exposure to loss in lawsuits and environmental matters, including not only the amount of litigation claims, but also of predicted court costs and possible punitive damages.
While this information might be of great interest to investors and other users of financial reports, it would also be of great interest to plaintiff attorneys, who could introduce the information in court as evidence of a company's implied acceptance of guilt.
"What's going on here is a conflict of cultures," explained attorney Michael Young, a partner with the law firm of Willkie Farr & Gallagher and an expert in securities law. "On the one hand, you have the culture of transparency in financial reporting. On the other, you have our adversarial system of justice, which balances transparency against the opportunity for everyone to have his day in court. As a practical matter, that means the users of financial information are, understandably, asking for a clearer window into privileged communication. The preparers of financial reports and their lawyers are understandably resistant to that."
The Wall Street Journal rallied to the defense of corporations in an August editorial that called the board's proposal a "lawyer's bonanza" and an impediment to companies' right to a fair trial.
"While FASB says [the proposed standard] would offer more transparency to the investing public, the real gift is to the trial lawyers, who will be able to use the information to extort settlements and influence jury verdicts," the editorial stated.
The editorial went on to say that, "For a company in high-stakes litigation, [disclosing what litigation could end up costing] means showing its hand to plaintiffs' attorneys, allowing them to gauge management's upper estimate of what the case is worth."
The newspaper also claimed that the standard could result in even more litigation if a corporation failed to accurately predict the financial outcome of a court case.
The op-ed prompted FASB Chairman Robert Herz to fire off a letter that was published 10 days after the close of the exposure draft's comment period. Herz vehemently objected to various points, though he did not respond to the Journal's claim that FASB members are "partisans of the idea that accounting can provide black-and-white answers."
"The board attempted to ensure the proposal would not require a company to '[show] its hand to plaintiffs' attorneys,'" Herz said. "For example, the proposal allows companies to aggregate claim amounts, so that the plaintiff's attorneys would not be able to identify specific cases. We have also proposed an exemption for certain disclosure situations that would be clearly prejudicial to the company."
WHY PROPOSE IT?
According to FASB practice fellow David Elsbree, the board was considering amendments to FAS 5 because constituents had expressed concerns that they were often surprised at sudden losses from litigation that hadn't been disclosed previously, that corporations too often declined to disclose potential losses because an estimate could not be made, and that disclosures tended to be boilerplate and not convey the information that investors needed.
The board received a total of 234 comment letters on the exposure draft. Disclosures about litigation risks raised the most concern, with corporations tending to object to the potential effects of such disclosures. Investors called the disclosures relevant and important.
A comment letter from the Social Investment Forum - a national group that promotes socially and environmentally responsible investing - praised the proposal, saying that it "agrees with the finding that the current statement on disclosure of loss contingencies fails to 'provide adequate information to assist users of financial statements in assessing the likelihood, timing and amount of future cash flows associated with loss contingencies.'"
The SIF went on to say that the proposed disclosures of loss contingencies did not go far enough by requiring only disclosures about contingencies expected in the next year, and that long-term investors needed to see farther into the future.
The American Bar Association recommended that the board not adopt the amendments because they "will have a number of harmful unintended consequences, including further erosion of the protections of attorney-client privilege and the work-product doctrine during the audit process."
Elsbree said that the board had tried to address that issue by allowing a "prejudicial exemption" that would let corporations avoid disclosing information that might influence the outcome of litigation.
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