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FASB litigation accounting V

Letters poured into the Financial Accounting Standards Board with last Friday's deadline for comments on "Disclosure of Certain Loss Contingencies--an amendment of FASB Statements No. 5 and 141(R)." Corporations don't like the proposal because -- among other things -- it would require highly speculative reporting about the possible results of litigation, casting unnecessary doubt about a company while giving trial lawyers another edge in their suits. Bar and counsel associations contend the new rules would violate attorney-client privilege.

As of this writing, there are 165 entries on FASB's site, with well over 90 percent critical of the proposal, we'd say. The few in favor we find are "socially conscious" investors of one sort or another, including Trillium Asset Management Corporation, a group of charitable foundations, and the Social Investment Forum. From the latter's letter:

While we are pleased with this important step and supportive of the progress it represents, there are a few points of concern that we would like to take this opportunity to raise briefly. In particular, SIF is concerned with how the draft treats severe long-term risks. At FAS 5 Exposure Draft paragraph 6, the draft only requires disclosure of severe financial threats that a company deems remotely probable if the issue is expected to be resolved within a year. Many of SIF's members are long-term investors and are acutely aware that there is a long and troubled history of companies underestimating the likelihood of severe financial threats - Enron, the subprime lending crisis, and asbestos liabilities are three recent examples. All too often we have seen that these momentous issues were looming for many years and eventually resulted in catastrophic consequences for investors. For these reasons, we believe FAS 5 should require companies to disclose all known severe threats whether or not they are expected to be resolved within a year. Recognizing the need to ensure that disclosures are made in a cost effective manner, SIF would like to suggest that "remotely probable" risks that are not expected to be resolved within one year be described in a narrative form, but would not need to be quantified other than to specify that they may be severe.

The bolded sentence is rephrased and bolded in the other letters cited. Short version: Guestimate.

The Association of Corporate Counsel submitted a letter stating the basic objection to this sort of speculation:

Even if the disclosure of litigation-related loss contingencies were a serious systemic problem, it is extremely doubtful that compelling companies and their lawyers to quantify litigation risks would yield more accurate financial statements. As every trial lawyer knows, litigation anywhere in the world -- but especially in American courts and before American juries -- inherently is unpredictable. The reaction of a single juror or the impact of a single ruling can have a dramatic and unanticipated impact. Indeed, it is highly doubtful that any company or lawyer who ever lost a billion-dollar case expected that result -- they were presumably surprised by the extent of the negative outcome. Had they expected to lose or to lose so badly, they surely would have settled. In this instance, requiring the losing lawyer or company to have produced a more precise description of the outcome would not have provided more accurate disclosure to investors. In short, the case has not been made for change.

BTW, the 800 lbs. gorilla of Cal-Pers submitted a letter, calling for expanded reporting of these contingent liabilities. More nuanced than the "socially aware" investors, but same basic arguments.

For Walter Olson's previous posts, see here, here, here, and here.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.