Accounting board drops call for beefed-up litigation risk disclosure

July 11, 2012

More than four years after the Financial Accounting Standards Board first proposed a stringent new standard for corporate disclosure of litigation loss contingencies, it voted Monday to drop the effort, citing increased scrutiny of litigation exposure by the Securities and Exchange Commission and the Public Company Accounting Oversight Board. The accounting rulemaker’s decision has to be considered a relief for public corporations, many of which have bitterly opposed the FASB’s litigation disclosure proposals as a gift to plaintiffs’ lawyers.

The controversy over exactly what corporations must say in their financial statements about potential litigation losses actually dates back to the 1970s, when accountants and defense lawyers compromised on a standard mandating the disclosure of a litigation contingency when there’s a “reasonable possibility” of a loss. The FASB – which is responsible for setting generally accepted accounting principles – eventually decided that there was too much wiggle room in the “reasonable possibility” standard. In 2008, the accounting board proposed new rules that called for corporations to disclose virtually all litigation exposure, including the company’s assessment of its maximum exposure. Defense lawyers, according to Eric Roth of Wachtell, Lipton, Rosen & Katz, read the proposal as a dangerous encroachment on privileged communications about litigation prospects. “You can’t adopt a rule that strips companies of attorney-client privilege,” Roth said. “That was seen as an attack on the adversary system.”

Michael Young of Willkie Farr & Gallagher, who has been talking to FASB board members about litigation contingency disclosure for years, said that if the 2008 proposal had been adopted, plaintiffs’ lawyers arguing for damages could simply have shown juries excerpts on maximum exposure from a defendant’s own financial statements. “To the FASB’s credit, it took the board about two minutes to understand the problem,” Young said.

In 2010 the FASB revised the proposal to eliminate the maximum-exposure requirement, but the raised bar for disclosure still prompted an outcry of opposition from corporations. Of the 339 comments the FASB received in response to the 2010 proposal, 289 opposed it. (And of the 46 commenters who supported the proposal, 19 were plaintiffs’ lawyers, according to the FASB.)

Meanwhile, as the accounting board considered responses to the 2010 proposal, the SEC’s corporate finance division began to crack the whip on compliance with the existing disclosure standard for litigation loss contingencies. As Reuters reported in February 2011, the financial crisis apparently prompted the agency to send hundreds of companies letters questioning litigation disclosures. Banks, in particular, were informed in a “Dear CFO” letter in October 2010 that they’d better disclose exposure to mortgage-related litigation; the SEC’s chief accountant warned securities lawyers in 2011 that they needed to “take a fresh look” at disclosure – “Carefully, carefully comply with the standard,” he said.

Willkie Farr partner Young said the SEC has been participating in the FASB’s consideration of litigation disclosure, and has assured the board that it’s serious about enforcing compliance with the old “reasonable possibility” standard. “An issue from the outset was whether the FASB needed a new standard or just better compliance with the old standard,” Young said. “There was always a question about whether it made sense to push forward.”

By a 5-to-2 vote, the FASB board decided Monday it didn’t need to continue to work on the proposed new standard after all. “Based on feedback received from a wide range of constituents on two exposure drafts over a period of four years, the board concluded that existing loss contingency disclosure requirements are adequate,” the FASB said in a statement. “As a result of the increased scrutiny of loss contingency disclosures in recent years, the board concluded that improvements to financial reporting are more likely to be achieved through robust compliance than through additional standard setting.”

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