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
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.
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.
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…"
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
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,”
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."
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.
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
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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