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Want Info on Corporate Liabilities?
Investors Must Weigh in With FASB by August 20, 2010


Endorse our investor sign-on letter by sending an e-mail with your name, title and organization to Sanfordlewis@gmail.com.

Should Companies Disclose More Information To Investors About the Liabilities They Face?

Sanford Lewis, Counsel
Investor Environmental Health Network

When investors are unaware of impending financial pain at  the companies in their portfolios,  they often face expensive surprises.  Financial accounting  rules are supposed to arm investors with information to avoid these shocks, but the failures are many and notorious –  the collapse of Enron and  WorldCom,  subprime lending,  and massive bankruptcies  from asbestos product  liabilities. 

Guidance for disclosure of pending liabilities  in financial statements  is provided by the Financial Accounting Standards Board (FASB).   After a proposal for reform in  2008  met stiff  opposition  from corporate lawyers, the board has issued a new draft  in July  2010, this time with a proposal that would avoid disclosure of legally privileged or prejudicial information.

At issue: corporate financial statement disclosures on liabilities

Financial statements are required to disclose  potential future losses, known to accountants as “loss contingencies.”    The  FASB concluded in 2008 that its current  contingent liability reporting standards  failed to provide investors and analysts with  sufficient information regarding the likelihood, timing, and amount of liabilities. 

This is a  tricky  policy arena to negotiate. On the one hand, investors need good information; on the other hand, investors and companies do not want to  arm plaintiffs  with information to win higher recoveries  as a result of providing better information to investors.  Therefore,  legal and auditing professions have  carefully  tiptoed around one another  on disclosure  related to ongoing litigation.  Through their professional organizations they established a so-called “treaty,”  limiting the degree to which lawyers would disclose liability projections to auditors and companies for purposes of investor disclosure.  

 But in 2008 the FASB issued draft reforms  that would have  upset that delicate arrangement. Most notably, the draft would have required companies to disclose their attorneys’ worst-case liability projections. FASB was flooded with letters from corporate lawyers urging them not to     go forward with the plan.

So FASB went back to the drawing board.  On July 20, it issued a proposal  (Comments due by August 20) that  eliminates the “worst-case projection”  proposal, but does require companies to disclose more nonprivileged information, such as providing links to company pleadings and disclosure of expert witnesses’ liability estimates.    

 More About The Revised FASB Draft

Contrary to the 2008 proposal,  companies would be allowed to continue the controversial practice of disclosing only their estimate of the “known minimum” of liabilities where there is uncertainty as to the  most likely outcome.  Such an estimate  is unreliable for investors -- the final liability in lawsuits  is often dramatically larger  than this figure -- but it protects  corporate  positions in litigation.

Instead, the proposal seeks to require disclosure  only of non-privileged information, and places the responsibility with investors to use that information to develop their own estimates of the potential magnitude of liabilities.  As guidance to companies it includes the  logical principle that more information should be disclosed and made available  as a case proceeds. This makes sense, since more is known later,  but without specific operational guidelines about  precisely what information must be disclosed when  it will be hard for companies to act on this requirement.

The new proposal could provide  better guidance. For instance it could clarify that disclosed information should include the amount of settlements or judgments issued in similar cases at other companies. The need for such benchmarking could be explicitly  specified.

Scientific Literature Disclosure but Not for Longer Term Liability Risks

The July  2010 proposal adds a new requirement that disclosure may be triggered by new science that indicates “potential significant hazards related to the entity’s products or operations.”   However, it may have only limited impact, because it focuses on whether those studies lead to a requirement to accrue liability amounts, rather than  also triggering  aqualitative disclosures relevant to longer term risks.  

Remote but severe liabilities 

Liabilities judged by  a company to be “remote” would only be require disclosure if they have potential for severe impact and are either “asserted” claims  (lawsuits filed) or relate to other  potential claims that the management has concluded  are both likely to be filed and resolved unfavorably to the company. In practice, this means that even  the most severe long-term issues will seldom be disclosed.

This  perpetuates the tendency of companies to underestimate the likelihood of  longer-term, severe financial threats. Enron, the subprime lending crisis, and asbestos liabilities are three examples of longer-term liabilities that were not disclosed until it was too late. Such large issues loom undisclosed for many years, with eventual catastrophic consequences for investors. Yet under the proposed FASB standard, companies are allowed to avoid disclosing such severe long-term threats if they characterize the claims filed in litigation as “frivolous” or if there are as yet no asserted claims.

HOW TO COMMENT  TO FASB

 Endorse our investor sign-on letter  [link] by sending an e-mail  with your name, title and organization to Sanfordlewis@gmail.com.

You can also submit your own comment letter  to FASB by August 20, 2010 by emailing director@fasb.org, File Reference No. 1840-100.  Those without email may send their comments to the Technical Director — File Reference No. 1840-100 Financial Accounting Standards Board, Financial Accounting Foundation, 401 Merritt 7, PO Box 5116, Norwalk, Connecticut 06856-5116.  Contact Sanford Lewis at 413 549-7333 or sanfordlewis@gmail.com if you have questions.

Note that the FASB has received requests to extend the commenting deadline, but will not decide on an extension until August 18, 2010.  We will notify  the investing community if we learn that the deadline is extended.

The Investor Environmental Health Network  (IEHN) is a coalition of investors concerned with risks and opportunities associated with toxic chemicals in corporate products and operations.  IEHN  has previously   participated in revisions of the contingent liability disclosure standard with comments on the 2008 exposure draft,  outreach to investors for additional shareholder engagement, and by participating in the FASB stakeholders’ roundtable on this topic  in March 2009.   Our report, Bridging the Credibility Gap: Eight Corporate Liability Disclosure Loopholes That Regulators Must Close (2009) raised many of the issues relevant to  need for reform of the  FASB contingent liability closure standard, as well as reforms needed in Securities and Exchange Commission disclosure requirements.

 

 

 


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