Sometimes you have to step back from revisions to realize that your initial work was pretty good and your editing spawns more problems than solutions. On October 27, 2010, the Financial Accounting Standards Board stepped back and decided to reassess and postpone the effective date for its proposed Accounting Standards Update, Contingencies (Topic 450); Disclosure of Certain Loss Contingencies (ASC 450-20).
The Board’s intent in drafting the proposed amendments was good-hearted. It sought to modify accounting standards related to disclosure of pending and threatened litigation to provide transparent, comprehensive, and useful information to investors who read and rely on financial statements. But, the final product is impracticable and flawed.
For example, the Board proposed mandatory disclosure of publically available quantitative information concerning a lawsuit, such as the amount of damages claimed by a plaintiff or the amount of damages indicated by the testimony of an expert witness. This ignores the reality that some plaintiff attorneys are notorious for overstating their client’s damages in an attempt to capture headlines and attract more clients. Many states by rule now prohibit plaintiffs from including a specific dollar amount demand in their complaint for this very reason.
Likewise, presuming that damages are certain simply based on expert say so can be very misleading. We defended an environmental contamination case where our client entered into an agreed order with U.S. EPA and the state to remove and remediate impacted soils to a certain threshold, which U.S. EPA and the state determined was protective of human health and the environment. Plaintiffs’ expert witness barely acknowledged this remedy. Instead, he prepared an expert report claiming that the soil should be remediated to the condition it was in essentially at the time of the Garden of Eden to the tune of $225 million. The expert ultimately reduced his damage estimate to $78 million following his deposition. Of course, plaintiffs didn’t want the court to order them to spend the money to perform their hypothetical clean up; they just wanted money damages. A federal district court eventually threw out the expert’s testimony, entered summary judgment against plaintiffs’ $78 million clean up claim, and later characterized the claim as a “swing for the fences.” Clearly, to issue disclosures to investors based on the expert’s report would have been more misleading and caused more problems for the company than would have been helpful to investors.
Another example of the flawed nature of the proposed amendments is that they would require a disclosure if the company’s insurer denied, contested, or reserved its rights to disclaim coverage. Almost 15 years ago, the Indiana Supreme Court held that the absolute pollution exclusion in commercial general liability policies, which insurers typically rely on to disclaim coverage of environmental claims, is void because it is ambiguous. Yet, for almost 15 years, issuers with absolute pollution exclusions in their policies have denied coverage or issued reservation of rights letters. Requiring a disclosure based on an insurer’s assertion of a meaningless exclusion would be misleading.
The proposed amendments are also not clear in liability assessments. As PricewaterhouseCoopers LLP noted in its comments to the Board, the proposed amendments could be interpreted to require companies that are jointly and severally liable to disclose an aggregate liability amount when determining whether the contingency meets the disclosure threshold. Instead, a company that is one of multiple potentially responsible parties (PRPs) in an environmental case should only assess and disclose its allocable share of liability (including those of non-participating PRPs) in determining whether the contingency meets the disclosure threshold.
Finally, the proposed amendments would require the disclosure of the company’s assessment of a plaintiffs’ claim and company’s legal defense strategy. Many fear such disclosures would set a floor in settlement negotiations with plaintiffs and disclosure of legal strategy could result in courts finding that companies waived their attorney-client and work product privileges by making such disclosures.
As the American Bar Association commented, “we do not believe it has been established that under the existing disclosure standards users of financial statements are failing to receive the information about pending or potential litigation that they need in order to assess a company’s financial condition.” The disclosure obligations should simply require disclosure of material and non-prejudicial information about loss contingencies.