FASB to Resume Deliberations on Liability Disclosure

• FASB needs more investor commentators.
• FASB seeks companies to model good financial statement disclosure.
  

You may recall that last summer, when Wall Street was only just beginning its current meltdown, the Financial Accounting Standards Board solicited comments on a new proposal to expand its liability disclosure standards. The proposal would require companies to report more about known and potential liabilities in their financial statements.

FASB received dozens of letters from investors and advisors urging the Board to go forward with disclosure improvements. But it also received letters from hundreds of companies and their lawyers opposing the proposal -- asserting that disclosure of future liabilities is too speculative and that it would would undermine attorney client privilege.

Originally slated for implementation in December 2008, FASB postponed the effective date until at least December 2009. The Board asked FASB staff to conduct “field experiments” to demonstrate models of possible disclosure:

"The staff will develop an alternative model for disclosure requirements that will attempt to address concerns raised by certain constituents about the proposed requirements in the Exposure Draft. The staff will then conduct field testing of both the model in the Exposure Draft and the alternative model. Field testing is expected to take place in November and December 2008…

After field testing is completed, the FASB will hold public roundtable discussions. Those discussions are expected to take place in the first quarter of 2009."

According to FASB staffer David Elsbree, only three companies came forward to volunteer to field test options for disclosure. The companies agreed to actually prepare financial statements consistent with the original proposal, as well as an alternative model based more on factual disclosure and less on speculative judgment calls about potential liability. The theory is that the alternative model might avoid most of the problems that corporate lawyers asserted would breach attorney-client privilege or work product. The alternative model could involve disclosure of factual information sufficient to allow third parties to begin to develop informed estimates of potential liability exposures, without requiring the companies to advance speculative estimations of liability themselves. Apparently there are only a few limited examples of this approach in the model suggested to the field testing companies.

The staff at the FASB is still awaiting results from the three volunteer companies, who are conducting the field trial on a confidential basis.

On March 6, FASB plans to hold a roundtable to discuss the results of the field tests, and seek constructive dialogue among stakeholders as to how to refine the prior proposal into something more workable for all concerned.

As I noted in my prior blog post I believe there is room for refining the prior proposal to better meet investors’ information needs while protecting privileged information.

Action Steps for Interested Investors:

• The participants in the pending FASB roundtable have not yet been selected . There are far more representatives of corporate law firms and corporate filers who have volunteered to be in the roundtable than users of financial statements. ( Full disclosure: I am on the short list of potential roundtable participants from the investors’ perspective.) Interested investors can contact FASB within the next few days and request to be added to the list of possible March 6 roundtable participants. (Or contact me to discuss this further.)

• FASB needs to find additional companies who could model ( either on a public or confidential basis) what a good model of disclosure would look like. Do any candidates come to mind among the companies in your portfolio?

Largest TARP Banks Oppose Board Accountability for Effects on US Economy

In his inaugural address President Barack Obama stated that:

"And those of us who manage the public's dollars will be held to account, to spend wisely, reform bad habits, and do our business in the light of day, because only then can we restore the vital trust between a people and their government.

***

[t]his crisis has reminded us that without a watchful eye, the market can spin out of control. "

The new era of accountability and responsibility heralded by the inauguration of our new leader flags outstanding questions about the ongoing bank bailouts. An enormous amount of taxpayer money is currently being managed by private companies. The two companies that received the most money from the Troubled Assets Relief Program (TARP) are Bank of America and Citigroup. Together they have received nearly $100 billion in taxpayer assistance. With so few strings attached by the outgoing Bush administration, the responsibility for holding those who are managing these public funds accountable seems to have fallen by default upon the board of directors of those companies or their shareholders.

One effort to bring some accountability has been initiated by shareholder John Harrington of Harrington Investments. He has filed shareholder resolutions at both companies that would amend the corporate bylaws to establish a board level committee on US economic security. The role of such a committee would be to identify whether the company’s policies adequately support US economic interests, especially in light of the receipt of these billions of dollars in taxpayer funds.

Having received the funds with so few strings attached, the companies apparently do not want to start accounting for the return on American taxpayers' investment now. So the companies have filed massive No Action letter request with the Securities and Exchange Commission, asking the SEC to allow these companies to exclude the bylaw amendments from their 2009 proxy statements. (Company requests: Citigroup letter; Bank of America letter) As counsel to Harrington Investments I filed rebuttals to these letters on Monday of this week. (Proponent replies: Citigroup letter; Bank of America letter)

The companies make some remarkable assertions in their attempt to block these bylaw amendments from appearing on the corporate proxy. For instance, Bank of America, attempting to cast the resolution as “ordinary business” asserts audaciously that “a review of the corporation’s policies to determine their impact in the US Economic Security do not raise any significant policy issues to be contemplated by 14a-8(7).” While shareholders normally have the capacity to raise major policy issues with the Board of Directors through the shareholder resolution process, the company is essentially asserting that it is none of the shareholders’ business or interest whether the company’s expenditures of the TARP funds benefit the US economy. This is a remarkable assertion, given the impact of the company’s decision-making regarding the well-being of the US economy, whether it be the extent of mortgage foreclosures in the US, the impact on wages of US workers and other questions of investment in the US economy.

Both companies also assert in essence that Delaware law prohibits shareholders from amending the bylaws of the corporation to create a committee on a specific topic, because to do so would limiting the discretion of the Board of Directors to decide whether or not that is an appropriate topic for the board to address. This is an amazing and unprecedented suggestion for a limitation on the shareholders’ franchise. Neither company could cite any legal precedents that would bind the courts to find in favor of the companies on this point. As we argued in our letter, this is clearly an unsettled question of Delaware law, and as such, the companies have not met the burden of proof that would be needed for exclusion of the resolutions from the proxy statements.

Bank of America attempts to take the plain language of the resolution and imposes an aura of vagueness as another grounds for excluding the bylaw amendment. This stuff almost looks like it was written with tongue planted firmly in cheek but somehow it winds up in their opposition letter:

• The Proposal does not define "economy of the US." Does economy refer to an economic measure, such a gross domestic product or inflation? Should the Corporation be analyzing the Proposal in terms of macro or micro-economic indicators? Should regional or global economies be factored into the analysis? Do the stock markets or the Corporation's stock price factor into the economic analysis? Should the Corporation's policies impact" the long term health of the economy of Corporation focus on the trade deficit or measures that may balance the federal budget? The proposal leaves numerous unanswered questions for the proposed Board Committee, the Corporation and its stockholders.
• The Proposal's definition of "US Economic Security" also requires the proposed Board Committee to consider the "economic well-being of US citizens, as reflected in indicators such as levels of employment, wages, consumer installment debt and home ownership." While the proposed Board Committee can review these macro-economic items, it is unclear what the actions they are expected to take to shape corporate policy to support these economic indicators.

The question of the “vague and indefinite” exclusion is whether the shareholders would have enough of an idea about what they are voting on to make an informed choice to vote for or against the resolution. The resolution is quite clear that shareholders would know that they would be creating a committee on US economic security to examine policy issues relative to the impact of the company on the US economy; that the chairman of the board would appoint the members; and that the committee would have a fair amount of flexibility in defining the scope of its activities, but would also have some guidance in terms of the set of suggested issues to consider the possible inclusion. We argue that this is ample guidance for shareholders to know whether they want to vote in favor of the bylaw or not.

Here's hoping that the Securities and Exchange Commission staff, under its new leadership, recognizes the importance of this new day in America, and will support the shareholders' role in bringing accountability to US Economic Security for those in the private sector who are now "managing public funds".

- Sanford Lewis

[You can also listen to audio commentary on this topic by Investor John Harrington at Sea Change radio]