Speaking on behalf of the Association of Corporate Counsel (ACC) at a FASB roundtable last week on proposed changes to disclosure of contingencies under FAS 5, Accounting for Contingencies, Alex Dimitrief, vice president, legal and litigation policy at General Electric, said, “The main thing I’d ask is whether a disclosure is really a place for a registrant to try a lawsuit.” In connection with the roundtable, the ACC issued a statement protesting the proposed changes to FAS 5, noting that 135 chief legal officers had co-signed that statement. (See ACC media alert, and ACC March 6, 2009 statement on FAS 5, which lists the signatories).
FASB convened the March 6 roundtable to obtain additional feedback on its 2008 Exposure Draft (ED), Disclosure of Certain Loss Contingencies, which received 240 comment letters, a substantial portion of which were critical of the proposal, particularly as relates to disclosure of litigation contingencies Concerns voiced on the 2008 ED (see e.g. ABA’s Aug. 5, 2008 letter ABA’s Sept. 15, 2008 letter, ACC’s Aug. 8, 2008 letter, and FEI comment letters), related to, among other things, usefulness of the disclosures, the potential for such disclosures to be misleading (due to the inherent uncertainties of the litigation process), concern about potentially weakening the position of defendants in litigation, and concerns about potentially weakening attorney-client and work product privilege.
FEI Members Among Panelists
FEI members participating in FASB’s roundtable included Gary Kabureck, vice president and chief accounting officer of Xerox Corporation and a member of FEI’s Committee on Corporate Reporting, and Nicole Johnson, senior tax manager and formerly Technical Accounting Director at Koch Industries. The full list of participants can be found in FASB’s board handout.
During the morning session of the panel, FASB Technical Director Russell Golden said to Kabureck, “[M]y interpretation of [FEI’s] letter was, we don’t need to move forward in this project, it is an application issue, not a standard-setting issue.”
Kabureck responded, “The FEI letter is exactly as you stated, FAS 5 is a principles-based document, it has withstood 34 years or so of experience, in general we think it works.” He added, “We are talking about disclosure here – in many ways the goals of the Exposure Draft (ED) are unattainable, in part because of the U.S. (legal) system, more information could be prejudicial.” He noted the ED provided an exemption for prejudicial information, “but at the same time, the ED says ultimate use [of the prejudicial exemption] is expected to be very rare; we do not believe that is the case, (maybe) not all the time, but more frequently than that implies.”
“Lawsuits arrive for lots of reasons,: added Kabureck, “social agendas, political agendas, many times the claims are exaggerated, to put a big number in the system; it is not particularly helpful, unless you are a trained lawyer or trained legal analyst, what do you do with that number, you might make a decision to sell or not invest, where in fact the [claim] may be frivolous.”
During the afternoon session, Golden said, “We think small businesses and private companies are a very critical part of our constituent group.” He asked Johnson, “What kind of questions do you get from your users?”
Johnson replied, “The questions come through credit agreements, through creditors and rating agencies,” adding “the current FAS 5 disclosure requirements are satisfactory to the creditors as well as the ratings agencies,” adding that while credit agreements occasionally will ask for information and updates on litigation, they did not ask for the type of information FASB was proposing.
FASB board member Larry Smith said to Johnson, “You responded in the context of what we exposed as disclosure requirements. I think everybody around the table this morning and this afternoon acknowledged we might not be able to get what we exposed, and there’s been, let’s call it the Mike Young principle” - described below - “that we’ll disclose contentions, but not predictive information. Would there be a problem with asking private companies to disclose that type of information?”
“When you’re talking about [disclosing] contentions, I’d want to further understand that,” said Johnson. She added, “we do provide quite a bit of disclosure today on matters that are material, and do meet the criteria under FAS 5, all other matters are probably not as useful to users of financial statements.”
The ‘Michael Young Principle’
The ‘Michael Young Principle’ referenced by FASB Board Member Larry Smith, noted above, referred to a suggestion made by attorney Michael Young, a partner with Willkie Farr & Gallagher and a former member of FASB’s Financial Accounting Standards Advisory Committee (FASAC). Young suggested disclosure of ‘facts’ and ‘contentions,’ but not ‘predictions.’
Young explained, “What I had in mind was contention, meaning, circumstances, and what the party may argue based on those circumstances; [e.g.]: we entered a contract, that ‘s a fact, we would assert we didn’t breach it, that’s a contention, how it comes out, the prediction, is up to the court.”
John Genovese, an attorney with MetLife, similarly offered, “To try to reach a little bit of consensus here …and I know its not easy to have a rule that fits every case or every circumstance - but to the extent that we can put in a description of a case so that a reader can get a little bit better idea of what’s pending against the company.” He detailed what he thought that description could include, but cautioned, “What I get concerned about is having to provide some of the information Russ [Golden] mentioned earlier, in terms of a quantitative assessment of a lawsuit, especially earlier on, when it’s difficult to quantify, or even later on, when we’re engaged in settlement negotiations with the plaintiff’s counsel.”
A number of FASB board and staff members, including FASB Fellow David Elsbree and FASB Board Member Larry Smith, said they heard a ‘consensus’ around the Michael Young Principle of disclosing facts and contentions, but not predictions. However, no formal (or informal) votes were taken during the morning or afternoon sessions of the two part roundtable.
A Question of Fact
Golden observed, “One of the things that was clear, there seemed to be an observation that it is substantially more difficult to disclose and estimate information that needs to be predicted, vs. facts that are there, although with respect to facts, there was some concern that actual disclosure of claims could be misleading.”
Former SEC General Counsel Giovanni Prezioso, now a partner with Cleary, Gottlieb Steen & Hamilton, and representing the American Bar Association during the afternoon panel, cautioned, “I want to make sure we’re all on the same page, when we talk about factual information, I want to echo something Linda [Griggs, an attorney with Morgan, Lewis & Bockius] said earlier … there’s a series of things that are factual in the sense they are public in a record of litigation - that you can say, so and so filed a complaint that avers the following, and there was this motion filed on this date, and that’s a certain kind of public fact.”
He continued, “there’s a different kind of ‘factual’ that goes to, what happened in the situation, and that kind of fact - as Linda noted - even when you get to the Supreme Court, you’ve got dissent disagreeing with the majority; and its not really a fact, this ultimately is a dispute, there’s something about the way people view the status of the litigation, that are very different kinds of public facts, than these other ones.”
Alex Dimitrief, who we noted at the top of this post said, “The main thing I’d ask is whether a disclosure is really a place for a registrant to try a lawsuit,” observed, “It really puts a burden when you ask for a’ fair, factual description of circumstances,’ or whatever your qualitative standard is; it later lends itself to being assessed or measured by others, including your opponents in litigation, who look at the description, and they will claim that you left out certain things from the description, or that if you believed in a certain defense, why wasn’t it listed in the disclosure that you made when you listed defenses 1, 2 and 3 but you didn’t talk about defense number 4, you must not have believed in it very much or it would have been included. And so, all of a sudden, all of the standards from a litigation get imported over to the disclosure statement, and there’s just a burden entailed, in terms of trying to come up with something that fairly captures both the claim, and the defenses to the claim, that I think is an unintended consequence of a well-intentioned desire for more disclosure.”
He continued, “Lawyers struggle all the time; judges impose ten page limits on briefs and lawyers can’t meet them; and so the idea that we can satisfactorily somehow come up with a way to deal in a paragraph with something we can’t do in a ten or twenty page limit, is something I would suspect unrealistic, if not unduly burdensome.”
Stan Keller, a partner with law firm Edwards, Angell, Palmer & Dodge, representing the American Bar Association during the morning panel, noted that overall, “The problem is balancing competing interests – no one can question the value of disclosure, but at some point you have to measure disclosure against the cost of disclosure and see how close you can get to what’s necessary without causing harm you want to seek to avoid.”
John Huber, a partner with Latham & Watkins, and former Director of the Division of Corporation Finance at the SEC, added, “I’ll never forget a U.S. Steel proxy statement that had twelve printed pages of nothing but these claims, which goes to the idea of inundating investors with meaningless information somebody might think important; the idea of ‘too much’ goes to the idea of [what is] material – goes to … the question of relevance and reliability – being able to tell the investor what’s important … the difference between what you know and what you might think.
“More Likely Than Not”; Privilege Waiver
Asked by FASB’s Golden what he thought about an alternative probability threshold such as ‘more likely than not,’ Prezioso replied,” If I am asked to assess whether something is more likely than not, I believe there are some serious professional limitations that would face me in making that kind of assessment if I had limited facts and limited ability to predict the future; because, as lawyers, we are subject not just to privilege concerns, but maters of professional competence and responsibility.” He likened this to, “If you asked your doctor, ‘do you think I am going to live another year,’ and the doctor hasn’t examined you, the doctor would be irresponsible to say, ‘you look healthy to me.’”
Prezioso added, “Based on my experience with the auditing process, I’m trying to envision a company saying ‘this case is more likely than not,’ ‘that case is not more likely than not,’ then being audited and being able to say, take my word for it, without someone saying, well, I want to talk to your lawyers, I want to get behind how you reached that assessment, its at that point, where I think a more likely than not standard, is inexorably, going to push people towards trying to get waiver, in situations [which] will pose a great deal of harm to the system and companies.”
Attorney Linda Griggs added, “Under our Treaty reached between the American Bar Association (ABA) and the AICPA back in 1975, we are told that it is very unlikely that lawyers can reach a judgment that an adverse outcome is probable - because of the vagaries of litigation; it’s not impossible, but not likely at all - so if you change that threshold to more likely than not, my guess - and Michael [Young] and Giovanni [Prezioso] should weigh in- is that the ABA would be unable to support a change in the treaty to go to a more likely than not scenario, because we are not able to make those predictions, the vagaries of litigation are such , that that is not something we can do ,so if you were to change the threshold, and auditors were to push us to reach those kinds of judgments, we would have to say, we can’t do it, its not a matter of getting a waiver.”
Prezioso said, “To the extent there are views I’ve heard within the ABA, their concerns are, that people have pushed too far under the current Treaty, for waiver of privilege, and that there are too many pressures in that direction, there is a sentiment that there needs to be a strengthening of the attorney-client privilege, and that generally, a series of developments, mostly growing out the government investigation world, have eroded the privilege in recent years, and that it is important to reassert the importance [of privilege].”
NOTE: The references to erosion of privilege in connection with government investigations relates to the U.S. Department of Justice’s treatment of waiver of privilege as a factor of ‘cooperation’ under DOJ’s ‘Thompson Memorandum’ which has since been revised, and analogous treatment in the SEC’s ‘Seaboard’ memorandum regarding credit for cooperation.
Will Prejudicial Exemption Be Removed?
As FASB appeared to be focusing in on the ‘Michael Young principle’ FASB Board member Tom Linsmeier asked, “If disclosure is about only factual matters, is anything prejudicial that’s on the table?
Young responded, “I think that takes care of the prejudicial issue, I think it takes care of your audit issue, I think it takes care of the [ABA-AICPA] Treaty issue - if one even exists - if you adopt the [principle], we’re not going the prediction route, I think a lot of problems fall out.”
FASB Board member Leslie Seidman asked, “[I]f we described as prejudicial, information that would potentially adversely effect the outcome of the litigation, [does] that require an attorney to opine on [that]?” A panelist then queried, “Are you taking that (prejudicial) exemption out? Just doing factual [disclosures], and saying nothing in factual [disclosures] is prejudicial?” Seidman replied, “I’m not saying that, it’s all hypothetical.”
Golden added, “I think what Michael (Young) said is, if we just do factual, there’s probably no need to have a prejudicial exemption, but we don’t know if we’ll just do factual.”
FASB Technical Director Russell Golden thanked the panelists at the close of the roundtable, and noted they could submit further comments if they wish, which would be treated as supplemental comment letters. He said staff would consider the feedback received to develop a project plan to present to the board, to move forward with redeliberation of the proposed changes to contingency disclosures.
More details on FASB’s March 6 roundtable can be found in FEI’s Detailed Summary of the FAS 5 Roundtable. The detailed summary (10 pages) can only be downloaded by FEI members. Not an FEI member? Now is a great time to join FEI, to help you navigate the challenges senior financial executives face in the current economy, by offering opportunities for networking, education and advocacy. And, if you become a member by April 6, you can attend FEI’s Summit conference for free! For further information about FEI membership or this summary, contact Edith Orenstein email@example.com 973-765-1046.
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