The FASB plants a litigation bomb

PoL discusses the big problems brewing from proposed FASB Statement 5 on accounting from loss contingencies.

As PoL says, linking The Recorder, this would force disclosures of details and predictions concerning lawsuits that are non-remote, as compared with “probable” under the prior standard. But it’s worse than that, since the rule would require disclosure even of remote contingencies that could have a "severe impact on the entity’s financial position, cash flows, or results of operations." "Severe impact" is helpfully defined as one that has "a significant financially disruptive effect on the normal functioning of an entity," and "less than catastrophic." Here the rule goes even beyond international accounting standards.

PoL details the problems this causes for firms. But they basically boil down to one big problem: “companies will have a new reason to fold and pay a high settlement in order to get an even higher contingent liability off the books.” In other words, the standard significantly increases the strike value of litigation. As if that were not already enough of a problem.

Of course this gives firms a new reason to go private or elsewhere.

Aside from mumbling about improving disclosure, the FASB gives no hint that it took these costs of increased disclosure into account.

Comments

[Jeff Lipshaw]

Larry, as a former GC, I have to say I'm not surprised (a) this proposal has produced more protest than any other FASB yet, and (b) the only statement in favor comes from a plaintiffs' lawyer.

The real problem is not just the additional disclosure of remote (versus reasonably possible versus probable); it's the requirement that in each case you actually quantify the estimated cost and probability of loss. I was listening to this week's Car Talk, where Tom and Ray were trying to coax the name of the auto mechanic on whom the caller had a crush. They said, "don't worry, it's just us, nobody else is listening." Yeah, right.

The rule leaves the general counsel and the company on the horns of this dilemma: either you are irresponsible by engaging in willful ignorance so as not to disclose, or you deliberately dissemble.

The existing ABA response to FAS 5 has a nice statement about the nature of a lawyer's guesstimate of probability of outcome - namely, that the beta around the estimate is so great as to make it meaningless. I don't know how many times I had it out with internal and external accountants who thought you could quantify this to a meaningful percentage.

[save_the_rustbelt]

Speaking for auditors, this is a bad idea.

It is already tough enough to get the truth out of some clients, trying to run them through a confessional does little for disclosure and probably gives the clients more incentive to hide problems.