More than 135 general counsel and leading executives from Fortune 500 and 100 companies are protesting a controversial proposed amendment to financial accounting statements on corporate disclosures of litigation-related loss contingencies.
The proposed amendments would require companies to make significantly more extensive disclosures in the notes to financial statements regarding loss contingencies -- including loss contingencies relating to pending or threatened litigation -- even in cases in which the company expects to prevail or does not believe there will be a material cost to settle the matter.
Under the current statement, when there is a "reasonable possibility" that a loss has been incurred, companies must disclose the range of potential losses arising from pending or threatened litigation. Reasonable possibility means that the likelihood of the loss occurring is more than "remote" but less than "likely." No further disclosures are required.
In a letter to the Financial Accounting Standards Board, the senior attorneys and the Association of Corporate Counsel argue that the proposed amendments to Financial Accounting Standards Board Statement No. 5 and 141(R) create "grave problems" that outweigh any benefits they purport to offer.
"Underestimating a large loss will be painted as a professional failure laid at the feet of lawyers who were forced to provide concrete estimates about remote and undeveloped matters," states ACC Senior Vice President and general counsel Susan Hackett.
The letter states four reasons why the proposed amendments should be abandoned:
• There is no systemic failure warranting the change. "Investors are not suffering from inadequate disclosure of litigation-related loss contingencies in financial statements. Furthermore, detailed disclosure that implies an ability to predict with accuracy litigation outcomes that are inherently uncertain creates additional risk that investors will feel misled when unexpected outcomes inevitably occur."
• Even if there were a systemic problem, "it is extremely doubtful that compelling companies and their lawyers to attempt to more specifically quantify litigation risks earlier in the process of assessing potential liabilities would yield more accurate financial statements. As every trial lawyer knows, litigation is inherently unpredictable. As a result, requiring the lawyer or company to better quantify what is inherently unpredictable is still -- at best -- guessing."
• The proposed disclosures create a substantial risk of waiver of the attorney-client privilege and work-product immunity. "Confidential legal advice, lawyer thought processes, and legal analysis disclosed in public filings could be used by an adversary in litigation to argue that a waiver has occurred which would entitle the adversary to review the files and strategies of the company's defense counsel."
Additionally, by requiring disclosure of the corporation's "qualitative assessment of the most likely outcome" of a case, the anticipated timing of resolution of the case and the assumptions made by the corporation in providing a loss estimate, while at the same time not mandating disclosure of such information by the opposing party, the amendments tip the scales of justice in favor of the opponent who doesn't have to report.
• If forced to quantify outcomes based on insufficient information, lawyers responsible for corporate disclosures are likely to feel substantial pressure to exaggerate the potential likelihood and magnitude of a bad outcome rather than risk failing to predict a large loss. Bad numbers could also create new potential liability for the company and lawyers whose stakeholders relied on mistaken estimates. To avoid these failures, the natural tendency for those responsible for estimates may be to err on the side of caution, resulting in "safe" (i.e., high) estimates, and thus inflated loss reserves.
Signatories to the letter include general counsel to such companies as General Electric Co., Accenture Ltd., Apple Inc., The Clorox Co., Coca-Cola Enterprises Inc., FMC Technologies, Inc., Royal Bank of Canada, Xerox Corp., E.I. du Pont de Nemours and Co., Harley-Davidson Motor Co., JPMorgan Chase & Co. and others.