In-house corporate lawyers and corporate attorneys at firms are worried that a far-reaching accounting-standard proposal to expand companies’ disclosure about lawsuits and other loss contingencies will threaten attorney-client privilege and expose sensitive litigation information to adversaries.
The Financial Accounting Standards Board, which sets the standards for the U.S. accounting profession, released a draft proposal on June 5 that would significantly alter how companies disclose loss contingencies on financial statements, including litigation against the company. The proposal, which is in the comment stage until Aug. 8, would apply to fiscal years that end after Dec. 15.
Lawyers are uneasy about the proposed requirements to report the amount of a claim against a company or the “best estimate of the maximum exposure to loss.”
Attorneys are also apprehensive about the breadth of qualitative data requirements outlined in the proposal, including a description of the contingency; when the company anticipates resolving it; a description of factors likely to affect the outcome; the company’s qualitative assessment of the most likely outcome; and “significant assumptions” the company made to estimate the potential loss and the most likely outcome.
The proposal requires the detailed disclosures for any loss contingency with more than a “remote” likelihood and for unasserted claims that are probable.
A ‘landslide of interest’
The Association of Corporate Counsel has already heard from 30 to 40 companies since the accounting standards board issued the proposal, said Susan Hackett, general counsel of the Washington.-based group.
“For us that’s a huge landslide of interest,” Hackett said.
And the association’s board is in “vehement agreement” about submitting suggestions to the board on how to temper the proposed disclosure requirements, Hackett said.
“Companies are very concerned that this is going to lead to a heck of lot more privilege waiver and a heck of lot more liability in a practical sense,” Hackett said.
“They’re worried that they’re going to have greater liability because these financial statements allow outsiders to see which matters that the company has set aside as being valued at which dollars.”
The accounting standards board did not respond to requests for an interview, but the organization’s press release about the draft proposal said it “will significantly improve the overall quality of disclosures about loss contingencies, providing financial statement users with important information.”
Topping the list of legal concerns about the standards is the potential damage to attorney-client privilege created by the disclosures and independent auditors’ access to documents companies used to make the estimates.
The qualitative disclosures would most likely be based on confidential communication between companies and their counsel, said Clorox Co. Senior Vice President and Corporate Counsel Laura Stein, who also chairs the association’s board of directors.
“The types of qualitative disclosures that would be required under this new standard would likely reveal legal thinking and strategy for dealing with the claims,” Stein said.
Once a company discloses information about a lawsuit — factors that could affect the outcome and assumptions that support the disclosure — there’s an argument to be made that the company has waived its attorney-client privilege, said Thomas White, a corporate partner in Wilmer Cutler Pickering Hale and Dorr’s Washington office.
“It’s a concern that companies be able to receive full legal advice from their lawyers without having to worry about whether there’s going to be a waiver for some reason,” White said.
The more troubling aspect of the disclosure proposal is that independent auditors would look at “every single piece of paper that supports those numbers and the qualitative assessments,” including opinion letters from counsel, said Rich Walton, of counsel to Los Angeles-based Buchalter Nemer.
“Once you’ve disclosed that to the independent auditor, you may have a real problem later in arguing that that is not discoverable,” Walton said.
The proposal is the latest, and probably not the last, chapter in a saga that began with the collapse of Enron Corp. and the subsequent loss in public confidence in accounting and auditing, Walton said.
Public and investor worries about companies hiding information on financial statements has already spawned other rule changes, including the Sarbanes-Oxley Act of 2002 corporate- governance reforms, Walton said.
Walton also cited another accounting standards board mandate, which took effect for most companies last year, requiring companies to quantify the risk that the Internal Revenue Service would challenge certain types of tax positions on corporate tax returns and financial statements [NLJ, 7-2-07].
The U.S. Securities and Exchange Commission also revamped requirements for disclosing executive and director pay starting in December 2006.
“We’ve seen an important and far-reaching paradigm shift on how public company information is presented to end users,” Walton said.
Walton said the shift has created a tension between transparency and the attorney-client privilege, which is also being played out in a pending 1st U.S. Circuit Court of Appeals case about the IRS’ summons for Textron Inc.’s tax accrual workpapers, which the company claims are protected by attorney-client and tax practitioner privilege. U.S. v. Textron Inc., No. 07-2631 [NLJ, April 11].
“There’s a tension to the view that companies must be accountable and transparent and the sacrosanct privilege with a client and their attorney,” Walton said.
Companies are also nervous that detailed disclosures will arm litigation adversaries with ammunition for current or future cases.
Lawyers need to discuss candidly the range of possible litigation outcomes and issues with clients, but the broad disclosure requirements could hinder such frank conversations, said Bruce S. Mendelsohn, a New York partner at Akin Gump Strauss Hauer & Feld.
“Because you don’t want the other side to know what the various discussions are, it could possibly chill the discussions that corporations have with their litigation counsel,” Mendelsohn said.
Stein said disclosures based on predications that don’t come to fruition because litigation is “inherently unpredictable” could also spark litigation.
“There’s a risk you’ll be sued based on the fact that your estimate was wrong and all kinds of people relied on that,” Stein said.
Assigning a dollar amount to lawsuit contingencies “looks like an admission of guilt,” and could ultimately be plaintiffs’ exhibit No. 1, said Hackett.
“In the hands of someone outside the company, it could be twisted to look like this is what we believe we owe, if you set aside contingencies based on what you could possibly have to pay out,” Hackett said.