The Financial Accounting Standards Board’s (FASB) recent decision to extend to Dec. 31, 2009, the proposed effective date of a new expanded standard for reporting loss contingencies may be a mixed blessing for general counsel and the defense bar.
The decision allows counsel to put the issue off until year’s end instead of being obligated to comply with the original December 2008 implementation date. The board hasn’t removed the most offensive parts of the proposed standard, but it did promise to “redeliberate” it, meaning that something akin to Chinese water torture has replaced the agony that likely would have accompanied certainty.
Undoubtedly, the response to the proposed revision of FASB Statements No. 5 and 141(R), circulated for comment in June 2008, has been nothing less than vitriolic, drawing more than 235 comments of intense criticism from a host of companies, trade associations and lawyers.
Association of Corporate Counsel GC Susan Hackett has publicly gauged her membership’s response as unprecedented in her two decades with the organization. The American Bar Association, the Intellectual Property Owners Association (IPO), Apple GC Daniel Cooperman and Sun Microsystems GC Michael Dillon are among those who have lined up in opposition.
“I believe the decision to redeliberate the proposal is a direct reaction to the uproar from the corporate and legal communities,” says Tom White, a partner at Wilmer Cutler Pickering Hale and Dorr.
At the heart of the uproar is the key component of the proposal: lowering the threshold for reporting the potential loss from a lawsuit from the current “probable” to anything short of “remote.” The proposal also would require detailed quantitative and qualitative information about the potential impact of loss contingencies, particularly litigation claims, on the company’s financial positions.
According to David Furbush, a partner at Pillsbury, moving from probable to remote will mean going from a system where detailed reporting of litigation claims is hardly ever required to one where it will be hard to avoid.
“Probability has been defined as being much greater than 50 percent, more like 80 percent,” he says. “In law, few things have a chance of success greater than 80 percent, so reporting is rarely required. Similarly, an adverse outcome is rarely remote, which means that reporting will frequently be required.”
Currently, because many loss contingencies are reasonably possible rather than probable, companies usually deal with significant litigation by describing it and stating that an estimate of loss cannot be made. That’s a far cry from the detailed liturgy FASB’s original proposal mandated, a liturgy that critics say will not only fail to work as intended, but will prejudice companies in a variety of ways.
The argument against the proposal begins with the assertion that estimating contingent losses is difficult at best. Critics point out that litigation is unpredictable; that plaintiffs frequently do not state the amounts they are seeking and when they do the amounts claimed can be unreasonable; and that the reporting party may not have the information required to make a reasonable estimate of the potential loss.
Apart from the difficulty of quantifying loss contingencies, critics add that frequent and early disclosure creates undue risks for companies. Most significantly, they say that early disclosure would blur the balance between attorney-client privilege and work product immunity, and increase the likelihood that disclosure will amount to a waiver of privilege.
“The drum that the defense side has been beating is that the inevitable march to full disclosure simply can’t make it impossible for companies to deal with counsel by bringing privileged documents into the public domain,” says Richard Walton, of counsel at Buchalter Nemer.
Critics also say that forcing defendants to respond to plaintiffs’ unreasonable demands in a disclosure would put unfair pressure on defendants to settle; that the required analysis includes description of factors impacting the litigation such as the strengths and weaknesses of available defenses, thereby providing plaintiffs’ counsel with important information about defendants’ litigation strategies; that the losses estimated in the disclosures would become floor figures for settlement; and that if the disclosures differ significantly from the actual losses, shareholder lawsuits will result.
“In addition, disclosing parties are likely to err on the side of overestimating potential liability in order to minimize shareholder lawsuits,” writes IPO president Steve Miller in his comments on the proposal. “Therefore, the proposed amendments will fail to achieve the goal of providing reliable financial information, and lawsuits will have an unnecessary and depressive effect on the valuations of companies making such disclosures.”
Fortunately, it appears that FASB is prepared to listen and learn.
When it issued the extension in September 2008, FASB announced it would develop an alternative model for loss disclosure aimed at addressing the concerns regarding privilege and prejudicial impact. Field testing of the original and the alternative proposals had been scheduled for November and December 2008. The field testing involves asking volunteer companies to prepare sample disclosures based on both models.
“The idea is to get companies to demonstrate how they would have made the disclosure under either model,” Furbush says. “It’s an interesting and atypical way of doing things, but it gives both sides something concrete to discuss.”
FASB is expected to conduct a roundtable discussion on the proposal by March, and then recast the proposal by the end of April.
But while these developments have been welcomed favorably by those objecting to the original proposal, it’s not quite clear what the ultimate outcome will be.
“FASB has certainly not backed off entirely from consideration of expanded contingency disclosure,” White says. “Still, they do seem to have decided to pull back somewhat.”
It’s not unreasonable, then, to assume that the final rule will be less expansive and therefore potentially less intrusive on privilege and on forcing companies into prejudicial disclosures. On the other hand, it may be that predicting what FASB will do is as daunting an endeavor as quantifying the vagaries of litigation loss contingencies.