Monday, August 24, 2009

FASB Stakes A Claim On Disclosure Of Litigation Contingencies

At its board meeting last week, the Financial Accounting Standards Board began redeliberations of its 2008 proposal on Disclosure of Certain Loss Contingencies. (See FASB Project Summary, and FASB staff's Comment Letter Summary on last year's Exposure Draft. FEI's Committee on Corporate Reporting, Committee on Government Business, and Committee on Private Companies - Standards were among those who commented on the Exposure Draft; see FEI comment letter.)

As detailed further below, FASB will continue to meet on this issue before issuing a final standard, which is currently slated to be issued 4Q09. The upcoming final standard could potentially be effective this year-end; as noted in FASB's board handout (pdf pg 11, para. 5), FASB announced last year the final standard would be effective "no sooner than fiscal years ending after Dec. 15, 2009." However, FASB has not yet made a final decision on effective date, and will address that question at a future board meeting.

The discussion at the August 19 meeting focused on litigation contingencies; other types of loss contingencies will be discussed at a future meeting. Following are highlights from the August 19 meeting, as excerpted from FASB's Summary of Board Decisions, unless otherwise noted.

Disclosure objective: The board agreed on the following disclosure object for loss contingencies: An entity shall disclose qualitative and quantitative information about the loss contingency to enable a financial statement user to understand the nature of the contingency and its potential timing and magnitude.

Disclosure principles: The board agreed on three broad principles for loss contingencies:
  1. Disclosures about litigation contingencies should focus on the contentions of the parties, rather than predictions about the future outcome.
  2. Disclosures about a contingency should be more robust as the likelihood and magnitude of loss increase and as the contingency progresses toward resolution.
  3. Disclosures should provide a summary of information that is publicly available about a case and indicate where users can obtain more information.

Quantitative disclosure requirements: The board directed the staff to develop an approach that would focus on disclosure of nonprivileged quantitative information that would be relevant to making an estimate of the potential loss, for consideration by the Board at a future meeting.

Reasonably possible equals more than remote:The board decided to maintain the existing requirement to disclose asserted claims and assessments whose likelihood of loss is at least reasonably possible and to clarify that at least reasonably possible and more than remote have the same meaning.

Disclosure of certain remote contingencies: The board agreed that certain remote loss contingencies should be disclosed, and the board directed the staff to develop possible approaches for discussion at a future meeting.

Unasserted claims: The board agreed to maintain existing threshold requirements for unasserted claims and assessments and agreed to enhance the existing interpretive guidance about the threshold.

Recoveries, indemnifications, and settlement negotiations. The board agreed that:

  • entities should not consider the possibility of recoveries from insurance or indemnification arrangements when assessing whether a contingency should be disclosed.
  • to require disclosure about possible recoveries from insurance and other sources if and to the extent that the information has been provided to the plaintiff in discovery.
  • not to require entities to disclose information about settlement negotiations.

Effective date: "The Board discussed the effective date of any final guidance on this project and decided not to rule out the possibility that it could be effective for fiscal years ending after December 15, 2009."

NOTE: Denise Lugo of BNA reported in the August 20 article, FASB Open to Changing Effective Date On Loss Contingency Accounting Disclosures, that: "FASB Chairman Robert Herz said it is remote that the guidance will be effective for the end of this calendar year, but the board decided to leave the issue open until it is further ahead on the bulk of its discussions."

Other Topics Discussed: Other topics discussed at FASB's Aug. 19 board meeting - separate from the loss contingencies project - included the scope of the financial instruments project, issues relating to FASB's revenue recognition project, and some technical corrections. See FASB's Summary of Board Decisions.

My two cents
The remainder of this post expresses some personal observations relating to the loss contingencies project; I remind you of the disclaimer on the right side of this blog.

Was there a consensus on the 'Michael Young [Disclosure] Principles'? As shown above, FASB's "Disclosure Principles" for litigation contingencies center on disclosing information that is already publicly available elsewhere, including "contentions" such as the amount of claims filed against an entity.

The principles of disclosure, centering on 'contentions' vs. 'predictions,' were described by FASB staff and board members at FASB's March 6 roundtable as the 'Michael Young principles' - i.e. principles outlined at the roundtable by Willkie Farr attorney (and former Financial Accounting Standards Advisory Council member) Michael Young.

As noted in the August 19 FASB board handout: "The [FASB] staff believes that there was broad consensus at the March 6, 2009 roundtables on the key principles" of disclosure.

Indeed, in this blog's summary of the March 6 roundtable, Disclosure is Not a Place to Try a Lawsuit, ACC Tells FASB, I noted that: "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, I also noted: "[N]o formal (or informal) votes were taken during the morning or afternoon sessions of the two part roundtable."

Personally, (and I have said this before about organizations other than FASB) I get a little nervous when a board or staff member of a standard-setting or regulatory organization or advisory group thereto announces "I hear a consensus," when in my view (based on listening to the webcast of the meeting), there was a dispersion of stated views on the particular issue, and there was no formal call for the question. This is particularly true when an announcement is made, e.g., during an afternoon panel of a day-long roundtable (as it was during the March 6 roundtable), expressing a view as to a consensus reached during the a.m. panel, when some members of the a.m. panel were not participants on the p.m. panel during which their perceived consensus was presented.

As I recall, some panelists at the March 6 roundtable were concerned that the disclosure of 'contentions' could in itself be misleading (particularly depending how granularly one interprets the related principle among the disclosure principles described further above, which would require disclosure of a "summary of information that is publicly available about a case and indicate where users can obtain more information.")

Additionally, it will be interesting to see how the FASB staff's proposal shapes up - to be discussed at a future board meeting - as to potentially requiring disclosure of "nonprivileged quantitative information that would be relevant to making an estimate of the potential loss."

"Reasonably Possible" and "More Than Remote"
Given the relatively recent history of experience in practice with the terms "reasonably possible" and "more than remote" as applied in standards on internal control reporting of the Public Company Accounting Oversight Board, I was a little bit surprised to see that FASB decided on August 19, as noted in FASB's Summary of Board Decisions, to: "clarify that 'at least reasonably possible' and 'more than remote' have the same meaning."

When the PCAOB issued Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That is Integrated With an Audit of Financial Statements, (AS5) amending and superseding AS2 on the same subject, (the audit of internal control under Sarbanes-0xley Section 404), the issue of AS2's "more than remote" threshold of materiality (amended to "reasonably possible" in AS5) was a significant issue to many constituents in terms of how auditors were viewed as approaching the two thresholds. Some perceived a substantive difference between the two thresholds, while others did not.

As stated in AS5's Adopting Release, on printed pgs A4-6 and A4-7 (pdf pgs 108-109), under Definition of a Material Weakness:

Financial Accounting Standards Board ("FASB") Statement No. 5 describes the likelihood of a future event occurring as "probable," "reasonably possible," or "remote." The definition in [AS2] referred to a "more than remote" likelihood of a misstatement occurring. In accordance with [FAS 5], the likelihood of an event is "more than remote" when it is either "reasonably possible" or "probable."

As the Board noted in the proposing release [for AS5], however, some auditors and issuers have misunderstood the term "more than remote" to mean something significantly less likely than a reasonable possibility. This, in turn, could have caused these issuers and auditors to evaluate the likelihood of a misstatement at a much lower threshold than the Board intended. Because the term "more than remote" could have resulted in auditors and issuers evaluating likelihood at a more stringent level than originally intended, the Board proposed changing the definition to refer to a "reasonable possibility."

... While the Board agrees that, as a definitional matter, "reasonable possibility" and "more than remote" describe the same threshold, it believes that "reasonable possibility" describes that threshold more appropriately and clearly, and will therefore avoid the misunderstanding of the threshold created by the way it was described in Auditing Standard No. 2. As a result, it retained that term [i.e., reasonable possibility] in the final definition in the standard [AS5]."

(See the related discusion about 'reasonable possibility' and 'more than remote' on pgs 16-17 of SEC's Final Rule published in June, 2007, Amendments to Rules Regarding Management's Report on Internal Control Over Financial Reporting.)

The subject of differing interpretations of 'reasonably possible' vs. 'more than remote' was one of the focal points in the paper Fixing 404, published in the Michigan Law Review [Vol. 105: 1643] in 2007, co-written by former SEC commissioner Joseph Grundfest and Wilson Sonsini Goodrich & Rosati then-Partner (and now, Partner & CEO) Steven Bochner. (The paper included a postscript noting PCAOB's move to amend AS2.)

I wonder if any attempt by FASB at this time to 'clarify' that 'more than remote' equates to 'at least reasonably possible' would, in practice, lower the perceived threshold of "reasonably possible," or raise the perceived threshold of 'more than remote;' and if that would be a desired/desirable outcome in the view of the legal community and others; I invite readers to post comments on this point (or any other point of interest).

The next step in the disclosure of loss contingencies project, according to FASB's Current Technical Plan and Project Updates , is for a final Accounting Standards Update to be issued 4Q09. Deliberations on the final standard will continue at FASB board meetings in the late summer and potentially into the fall. As noted further above, FASB is not yet ruling out that the upcoming final standard could still be effective this year-end, although (as noted in the BNA article cited above), the FASB chairman indicated he currently believes it is a 'remote' possibility that the final standard would be effective at year-end. FASB's final decision on effective date of the upcoming standard is still pending as the board proceeds closer to finalizing the standard.

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Anonymous said...

Personally, I believe your concerns about whether someone overstates that a consensus has been reached are more academic than anything else. Ultimately, there needs to be three names in favor of a final document. If someone states a consensus is there when none exists, a document can't be issued. If there's a "consensus" declared but a minority of Board members disagree or otherwise voice concern about the direction, it ultimately doesn't matter because the rules of the game require only a simple majority.

Edith Orenstein said...

Thank you for your comment. I should have been more specific in that I hear this kind of general statement about a group reaching a 'consensus' more often in advisory groups to a regulatory body, or roundtables of outside experts convened by a regulatory body, not the regulatory body itself, since as you say it is generally more obvious how the 5 board members of the FASB, SEC or PCAOB are voting since they are generally called upon individually for their vote, or the Chair calls the question and asks if anyone objects. Also, the names of assesting and dissenting FASB board members are listed in a final standard.

I have, however, heard a general observation like 'I hear a consensus' without a vote when various views were expressedby advisory groups or roundtables, in situations ranging from the March, 2009 loss contingencies roundtable, to one of the early meetings of the FASB-IASB Financial Crisis Advisory Group (the final meeting was not open to the public or webcast, so I cannot comment on how decisions were reached in arriving at the recommendations in FCAG's final report). Similarly, I remember during one of the earliest meetings of the PCAOB Standing Advisory Group (SAG), when the SAG chair indicated that at the end of the day, he did not hear a need for further revisions to the PCAOB's AS2 (although there were some comments noting implementation issues in practice, and about a year later, after a second joint SEC-FASB roundtable, the SEC and PCAOB agreed to issue further guidance for management was issued by the SEC, and PCAOB amended/superceded AS2 by issuing AS5.)

Since standard-setting boards consider the recommendations of their advisory groups and roundtables, I think its important that if there is not really a 'consensus' of XYZ at the advisory group or roundtable, that no 'consensus' be stated (or a summary of the differing major views be stated.)

I hope that clarification helps; thank you again for your comment.

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