Contingent Liabilities Draft Stirs It Up

Comments on FASB's proposals for related disclosures are due this Friday, and a clash is likely.
Marie LeoneAugust 4, 2008

With the deadline looming this Friday for public comment on how companies should account for contingent liabilities, the battle lines are clear. And a battle it should be.

On one side, investors with a social-responsibility mandate think current accounting disclosure rules are too lax. They support the enhanced disclosure being floated in the Financial Accounting Standards Board’s exposure draft , but think more should be done to reveal potential risks associated with environmental or social-justice violations.

On the other side: companies, audit firms, and attorneys, mostly, all believing that existing disclosure rules could use some work — but opposed to FASB mandating that companies disclose and quantify all potential environmental and legal risks, regardless of how remote or how far distant the risks might extend. That kind of broad disclosure policy leads companies to “overstate contingent liabilities,” writes Michael Gibbs, general counsel at the Texas-based Whataburger Restaurants.

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FASB, after digesting the 23 written comments,will be the final arbitrator. However, the current draft proposal being floated for comment includes enhanced disclosure provisions supported by the activists shareholders, and opposed by financial statement preparers and auditors.

To be sure, groups like the Social Investment Forum the Investor Environmental Health Network (IEHN), the Dominican Sisters of Hope, and Trillium Asset Management support FASB’s latest exposure draft to revise FAS 5, Accounting for Contingencies and FAS 141(R), Business Combinations. FASB’s stated goal is to make sure companies are providing adequate information for investors, analysts, and other financial statement users, regarding the “likelihood, timing, and amount of future cash flow associated with loss contingencies.” But they want the standard-setting body to go further.

Currently, FASB’s exposure draft requires disclosure of severe financial threats that a company deems remotely probable if the issue is expected to be resolved within a year. But activist investors say they are long-term investors, and are therefore concerned about threats that may seem remote, until they spin out of control, such as the Enron accounting scandal, the subprime crisis, and asbestos liabilities. “All too often we have seen that these momentous issues were looming for many years and eventually resulted in catastrophic consequences for investors,” writes Trillium’s executive vice president, Cheryl I. Smith, in her comment letter.

What’s more, “The [FASB] proposal may allow corporate lawyers to routinely block disclosure of almost any information that they designate as [potentially damaging to the company], or prejudicial,” said IEHN attorney Sanford Lewis, in a press statement on Monday. He continued: “When investors are unaware of impending financial pain at companies in which they hold stock, they often face expensive surprises.”

But Gretchen Haggerty, CFO of U.S. Steel Corp., sees it differently. She argues in her comment letter that the level of detail about contingencies required in the exposure draft would be “unduly burdensome,” the assessment of potential outcomes will be “subjective and difficult to estimate with any precision,” and the additional disclosures — both quantitative and qualitative — could harm companies by requiring the release of information that could be used against them in pending and future lawsuits.

Indeed, Haggerty and others also worry about running “afoul of the work product protections,” that guard privileged information exchanged between lawyers and their clients, as well as auditors and clients. Furthermore, disclosing an estimated cost — or even a range of costs — associated with potential liabilities “often creates a false sense of certainty to what, in many cases, are very speculative and uncertain matters,” argues Haggerty in her letter.

Haggerty and others admit the disclosure policies could be enhanced, but some say they would like to see it handled outside of FAS 5 and FAS 141. For instance, Big Four auditor Ernst & Young would like to see disclosure requirements for contingent liabilities addressed in conjunction with FASB’s project on fair value measurement and recognition.