FASB Disclosure Proposal: NY Bar Says Bad News

By August 20, 2008Briefly Legal

The Financial Standards and Accounting Board has continued to post comments submitted to its proposal, “Disclosure of Certain Loss Contingencies–an amendment of FASB Statements No. 5 and 141(R),” after the August 8 comment deadline. That’s not unusual among regulatory agencies; the comments are still relevant and worth noting, even if they aren’t included in an official record. And the proposal is a significant one that could produce a wave of misleading financial reports and class-action securities lawsuits.

The Business Law Section, Committee on Securities Registration, New York State Bar Association, submitted a letter dated August 15 that nicely captures major problems with the proposals. We appreciate the argument that the proposal would, in fact, reduce transparency.

In our view, the substantial changes proposed to be made regarding financial statement disclosures of certain loss contingencies pursuant to the Exposure Draft would risk significantly misleading users of financial statements. In addition, the disclosures that would be required pursuant to the proposed amendments, and the audit procedures associated with those disclosures, could jeopardize the attorney-client privilege and be deemed to constitute admissions against interest. Further, the disclosure of highly sensitive, proprietary, competitive information could result in substantial harm to companies and their shareholders, and also could impose significant cost burdens on companies.

Were there a showing of compelling need for these changes, we could balance such need against the economic and competitive harm that could arise as a result of these changes, including the possible compromise of the attorney-client privilege. The Exposure Draft does not, however, make any showing of a compelling need for the proposed disclosures. That certain financial statement users may have indicated they would prefer a “highly uncertain estimate supplemented with a qualitative description [rather] than no quantification” provides scant comfort to a company and its representatives, auditors and attorneys, who would be required to prepare, certify, audit and opine on the highly uncertain estimates. The enhanced visibility of such highly uncertain estimates, and the potential for investors and others to rely on such information, increase substantially the risk that plaintiffs will claim that these required disclosures themselves provide a basis for claims against the companies and their representatives if contingencies ultimately turn out to differ from the estimates, as most surely they will do in many cases.

Other commenters, notably the Washington Legal Foundation, have questioned the impetus for FASB’s proposal as well. Given the very small number of supporters for the proposal, we’d say it’s a valid area of inquiry.

The Wall Street Journal’s editorial page demolished arguments for the proposal last week in an August 7 editorial, “FASB’s Lawyer Bonanza.” FASB’s chairman, Robert Herz, responded with a letter to the editor on August 18, “FASB Seeks to Inform Investors, Not to Whack Companies.” Herz asserts:

It is because of the strong and extensive input we’ve received from investors who want greater transparency relating to a wide range of contingencies — including litigation — that we are proposing these expanded disclosures. The new disclosures are aimed at providing information earlier to existing and potential investors in order to give them a greater understanding of the risks companies are facing. We believe that information would improve their ability to make informed investment decisions.

 Well, that belief was mistaken.

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