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September 11, 2008
Investors Push Companies For Greater Disclosure on Lawsuits
    by Robert Kropp

A proposed FASB rule change would require that loss contingencies related litigation be disclosed to investors.


In a move cheered by investors and environmentalists but decried by corporations, the Financial Accounting Standards Board (FASB) released a draft proposal seeking to modify current rules governing loss contingencies. Public comment on the proposal closed in August, and if the proposal remains unchanged it will become effective for annual financial statements for fiscal years ending after December 18, 2008.

According to the document, entitled "Disclosure of Certain Loss Contingencies: An Amendment of FASB Statements No. 5 and 141(R), "Investors 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…"

FASB proposed that in cases of litigation or pending litigation, companies be required to disclose "specific quantitative and qualitative information" about loss contingencies from lawsuits. Companies would be required to report "remote" possibilities of loss if the cases were expected to be resolved within a year. Any such disclosures would include claims related to environmental litigation.

The SRI community has expressed strong support for the proposed modification. In a letter to FASB, Cheryl I. Smith, Executive Vice President of Trillium Asset Management, states, "We feel strongly that it is critical to have accurate and complete information about liabilities in financial statements. The changes proposed by the FAS 5 exposure draft Accounting for Contingencies to address this issue represent an important step in providing all investors with improved disclosures."

Yet investors and environmentalists express concern that the proposed changes are not yet strong enough. Sanford Lewis, counsel for Investor Environmental Health Network (IEHN) states, “For Enron, subprime lending and asbestos, the unifying theme is that management treated these severe-impact issues as only ‘remotely likely’ to hurt their companies. Now FASB wants to make some of these ‘remotely likely’ issues discloseable, but only if the issue is expected to be resolved within a year. Yet issues such as these typically take many years, if not decades, to be resolved.

"Investors need to know about them now, not right before the financial catastrophe hits,” he continued.

Not surprisingly, the corporate world has mounted objections. Of the more than 200 responses to FASB's call for input, the vast majority were overwhelmingly negative. In its letter to the FASB, the U.S. Chamber of Commerce asserted, "adopting these proposed changes would add uncertainty, complexity, new liability, and a great deal of cost while compelling companies to provide potentially unreliable, and often immaterial, information about pending litigation. This proposal will also endanger the integrity of the attorney-client and work product privileges.

"Further, the proposed amendments will obstruct FASB’s stated goals of converging U.S. accounting standards with international standards and severely inhibit the competitiveness of the U.S. capital markets."

The Wall Street Journal weighed in with the following in its editorial pages: "The effect will be to force corporate defendants to fight lawsuits with one hand tied behind their backs -- assuming the company can even figure the "fair value" of a lawsuit it has no idea if it will win or lose. Predicting the trajectory of complex, often multiyear litigation is inherently unscientific. As we saw with Merck and Vioxx, a company's stock price can jump or fall depending on jury verdicts whose results are impossible to predict."

In his response to the Wall Street Journal editorial, Robert H. Herz, Chairman of FASB, wrote, "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. 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.

"We believe that information would improve their ability to make informed investment decisions," Herz added.

FASB is expected to converge with International Accounting Standards Board (IASB), within a few years, and corporate voices have seized on convergence as an argument against adopting the rule change. The IASB, these voices argue, does not require disclosures for remote loss contingencies, regardless of potential severity. However, IASB is deliberating changes to its rules that may close the gap between the two organizations.

Furthermore, the proposed FASB rule change allows for exemption from reporting requirements under rare circumstances, while IASB permits exemptions only under "extremely rare" circumstances.

Jonas Kron of Trillium describes the controversy as existing between "corporate counsel, on the one hand, and accountants, auditors, and institutional investors on the other." In a conversation with socialfunds.com, Kron went on to say, "It's long-term investors like Trillium that own these corporations, not management."

Kron pointed out that FAS 5, the rule whose modification is being considered, was written in 1975, when the markets were markedly different. According to investors who commented on the proposed changes, some companies are not even complying with current standards.

In response to corporate arguments that increased transparency would not help investors make informed investment decisions, Jon Walker, Managing Director of Environmental Data Resources Inc., writes, "If a company in which I am investing is a defendant in a $300,000,000 lawsuit, I would like to know."

 

 
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