Tuesday, September 21, 2010

Will corporate fear mongering deter reasonable action at the FASB?

Yesterday, the comment period closed on the Financial Accounting Standards Board’s proposal to improve corporate disclosure of contingent liabilities in financial filings. The proposed standard is intended to allow investors to better comprehend the magnitude of liabilities facing companies they hold in their portfolios or are considering investing in.

The FASB has been bombarded with comments from companies and their lawyers, asserting that the new disclosures the guidance would require might allow plaintiffs to gain information enabling them to sue companies, or to increase their demands in settlements. The Wall Street Journal even weighed in to editorialize against the proposed standard.

The trouble is, from an investor standpoint, the disclosure standard currently in force barely works at all. Investors are blindsided, because existing disclosures in financial statements do not provide timely information regarding impending corporate liabilities. Consider the disclosures in the asbestos products liability cases, for example:

• Johns-Manville. Previously disclosed quarterly report liability estimate, $350 million; sudden new estimate upon filing for bankruptcy, $2 billion.

• Kaiser Aluminum. Previously disclosed liability estimate $160 million; but then liability at bankruptcy amounted to billions of dollars.

• Dow Chemical. Acquired Union Carbide without disclosure of $2.2 billion in asbestos liabilities, only estimated a year or two after the acquisition.

As I wrote in the Investor Environmental Health Network’s comments to the Board, we believe the new proposal, which avoids requiring disclosure of legally privileged information, but instead only requires modest disclosures of largely public and nonprivileged information available to companies, is a reasonable solution to the problem. The Proposal that has drawn so much ire requires, for instance, that companies disclose average settlements on claims so far, whether their contingent liabilities are insured, and provide tabular disclosures that break down the various types of cases. The board also agreed with our prior comment, that when there are issues emerging in peer-reviewed scientific literature that demonstrate hazards of corporate products or activities, this can be a trigger for disclosure.

Objections that investor disclosures may provide information to potential plaintiffs have been raised as long as there have been securities laws and accounting principles. Incidental disclosure of some information that may be relevant and useful to a diverse array of stakeholders, including consumers and their lawyers for instance, is a price that we pay for relying largely on disclosure, rather than government micromanagement, for protection of investor interests.

The original standard for contingent liability disclosure promulgated in 1975 was greeted with similar objections, as were proposals for various elements of the SEC’s securities regulations -- especially disclosure of “risk factors” and publication of the Management Discussion and Analysis. The legal sky did not fall with the establishment of those requirements; nor would the set of disclosures proposed by the exposure draft significantly alter the shape of the current litigation environment.

The current proposal is also consistent with a balanced approach taken by the judiciary regarding the use of potentially prejudicial information in the courts. The courts take the view that often potentially prejudicial information which is “more probative than prejudicial” should be allowed into evidence. In the current proposed standard, the information disclosures required are also “more probative than prejudicial” from the standpoint of investor interest, as contrasted with the relatively minor potential prejudicial impact on litigation.

So, the approach taken by the Board in the latest draft presents an appropriate compromise. It preserves legally privileged information, but requires disclosure of information, the concealment of which could essentially encourages companies to issue intentionally misleading financial statements. The accounting rules should not countenance such a scenario.

It is unfortunate to see the Chamber of Commerce and corporate bar once again whip up a frenzy of fear and concern among companies about this very modest proposal. One can only hope that common sense will prevail at the FASB, the imbalanced corporate opposition to modest reforms, lacking in a problem-solving approach, will be rejected by the board, and their reasonable new standard will be upheld and implemented.

You can read our comments to the FASB here, and an investor sign-on letter urging the FASB to continue to support investor interest on this issue here.


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