FAS - 5: Heightened Corporate Disclosure No Longer Remote

Back in 2008 and 2009 we posted several times about the pendency of changes to FAS – 5 (that’s the “Financial Accounting Standards Board, Statement No. 5” for long), having to do with what companies must disclose publicly about ongoing “loss contingencies.”  “Loss contingencies” include, among other things litigation.  And litigation, of course, includes mass torts in which our clients are sued.

 

The problem with the proposed additional disclosure requirements, of course, was that they would affect the very litigation about which they reported – any similarity between FAS – 5 and the Heisenberg Uncertainty Principle being, we guess, “remote” (but knowing accountants, that statement may have to be qualified).

 

What effect could a bunch of boring accounting stuff have?

 

The same effect that we have to think about every time we post something on this blog – that the other side has eyes, too, and they’ll read what we write. The Cal Biz Lit blog (link on our blog roll) recently satirized  the problems with FAS – 5 by suggesting (tongue firmly in cheek, of course) the following possible client letter:

 

Dear counsel:

 

Please prepare a letter about the large cases you are defending for our company, honestly and completely explaining:

 

What are our risks in cases where we re being sued?  Do you think we are going to win or lose?  If we lose, how bad is it likely to be?

 

When do you think you will settle the case?

 

Include an evaluation of any cases where you are sure we will win and not owe anything, but if you’re wrong and the wheels fall off, the verdict will have a “severe impact” on our company.  And then write about any cases where you're sure we’re going to win, but defending the case is going to be really expensive and disruptive – we want your evaluation of those cases, too.

 

And when you’re done writing all this down, we’re going to put it up on the internet where the other side can read all of your thoughts about these cases.

 

After you’ve shown all your cards, good luck defending the cases.  Don’t let us get into trouble. And have a nice day.

As the spoof letter indicates, this proposal is objectionable in that it would take all sorts of otherwise confidential, and even privileged (although the new draft tries to reduce that) evaluation of ongoing litigation – Will we win?  How do we win?  How much might we pay if we lose?  How much will it cost to litigate? – and requires its public disclosure.

 

Mass tort plaintiffs, needless to say, aren’t subject to any such disclosure requirement. So the proposed disclosures would be a one-way street. We wouldn’t even get to see theirs after showing them ours.

 

We have our own ulterior interest, of course – as counsel, we don’t want to be subject to discovery over the any waivers of attorney/client privilege.

 

So what’s up now?  After a year of digesting the numerous complaints it received about its original proposal (the one we blogged about earlier), the Financial Accounting Standards Board (“FASB”) published an amended proposal last month.  You can read the whole thing here.  Comments on the revised proposal are due by August 20, 2010, that is, next week (sorry about being a bit late off the blocks, but its not like this stuff hasn’t been publicized elsewhere).

 

The FASB would like its FAS - 5 amendments to be final in time for 2010 annual reports.

 

Now – sort of like what happened with the ALI’s Aggregate Litigation Project – some of the worst excesses (of the original 2008 FASB proposal have been trimmed back.  The amount of non-public, privileged material has been reduced (although arguably not eliminated) and disclosure is no longer based on a plaintiff’s ad damnum, to name two.  However, there’s still plenty in there to give us and our mass tort clients heartburn.

 

We’re not going to compete with accounting law specialists, but here’s what we see as product liability lawyers:

 

First, and from our perspective, foremost, the July 2010 amended proposal still demands increasingly detailed (over time, as litigation evolves) disclosures of what it calls the “nature, potential magnitude, and potential timing” of a contingency.

 

Put in lay terms, “nature” means the FASB wants us and our clients to tell the public (including, obviously, the other side) what we think the litigation (we’ll stick to mass torts) is primarily about. That necessarily means telegraphing our evaluation of which claims and defenses have the most merit, and by negative implication, which ones don’t.

 

The FASB’s “potential magnitude” requirement would require estimates of both the potential value of claims should they be tried, or (more commonly in mass torts) what we see as the potential settlement value of the litigation.  The proposal would also require “high end” and “low end” ranges.  That means we’re giving the other side targets to shoot at (and to tell courts/mediators about in settlement conferences), so the at best estimates could well take on the characteristics of a self-fulfilling prophecy.  But it could be worse than that, as these estimates could well be used by the other side as a floor for what they’re willing to take in settlement.  How many self-respecting plaintiff’s counsel would take less than the defendant’s publicly stated “low end” estimate?

 

Crying wolf?  We don’t think so – given what we already see plaintiffs doing with (if you don’t know, we unfortunately can’t tell you in public) publicly disclosed litigation expense figures in mass tort cases.

 

The “timing” requirement, in addition to involving more routine things as trial schedules, could also give the other side hints about settlement strategies.

 

Second, “aggregation” by “class” or “type” is allowed in the FASB proposal, but with a mass tort, that’s not likely to help very much with the problem – since mass torts themselves are, by definition, already aggregated.  Nor do we think it’s likely that “mass torts” could be aggregated into a single category by companies unfortunate enough simultaneously to be defending more than one, because the “taxonomy” (see below) seems to contemplate product-specific disclosures.

 

Third, the disclosure requirements – as the Cal Biz Lit spoof letter indicates – “would require disclosure of certain remote loss contingencies,” if they could cause the company “potential severe impact.”  That means more work, and more judgment calls.  Given the amount of information that the other side might use, these requirements might in and of themselves, make these items less “remote.”

 

For example, given the trends in the law that we’ve discussed many times elsewhere, including in cheat sheets, it’s highly unlikely, perhaps even “remote” in the accounting sense, that any given product liability class action will be certified.  But lightning does strike (even if appellate review does tend to fix things), and class actions often are bet the company situations.  Thus, it could be that any product liability class action, no matter how far-fetched, is subject to disclosure.

 

Fourth, disclosure is imposed regardless of insurance or other possible recoveries from third parties, so that’s likely to increase how many things have to be disclosed in the first place – although probably not as much for mass torts as for one-off cases, given their size.

 

Fifth, while disclosure is mostly limited to “non-privileged” information, that includes “discovery.”  What about protective orders?  Anyone who’s ever had a press-corps intervenor in litigation (happens frequently in mass torts with protective orders), knows that discovery not used in court isn’t public information and can be protected, even from the press.  But the required disclosures look like they could call for information protected by court orders – to say nothing of the inevitable expense of combing through (a second time) masses of information produced in discovery.

 

Sixth, in one sense, this new proposal is even worse than the original one.  There used to be an express exemption from disclosure for “prejudicial” information.  That’s no longer present.

 

And we’re not even going to discuss the potential securities law implications of these disclosures, except to note that they exist.  That’s grist for the mill of other legal blogs.

 

Finally, if you want to get a practical sense of just how extensive and prejudicial these disclosures could be in our neck of the woods, take a look at the chart towards the end of the FASB document called “Amendments to the XBRL Taxonomy” (Taxonomy? Sounds positively Linnean. There are no fewer than 41 explicitly “product liability” disclosure categories.

 

You may want to do that twice, wearing different hats.  First, consider these categories as if you were planning to write (or, if in house, supervise the writing of) the descriptions.  Then, put your plaintiff hat (you plaintiff-side guys, try not to drool on your computer) on and consider how much the other side could learn from them.

 

Here’s what FASB says should be disclosed about product liability litigation – all 41 categories.  This bullet-point list (all text is verbatim from the FASB document, not our editorializing) pretty much defines the potential scope of the preview that the other side would get if the current proposal to modify FAS-5 takes effect without further changes:

• Product Liability Contingencies:  Disclosures of exposure to material amount of loss arising from allegations of damages pertaining to and arising from one or more of the entity’s products. This element may be used for a listing and details of all of an entity’s disclosures about such loss contingencies.
• Product Liability Contingency:  Information and financial data about the reasonably possible loss, the remote loss (certain contingencies), or the recognized loss from product liability contingencies related to an individual product.
• Product Liability Contingency, Description:  Describes the damages allegedly caused by appropriate use of the product, such as death from a drug and injury from a toy, which the damaged party reasonably believed was attributable to dangers for which no warning or inadequate warning was provided, such as defects in labeling, construction, and inappropriate (impurities in) processing.
• Product Liability Contingency, Geographic Areas:  Identifies the geographic areas in which the damages were alleged to have occurred.
• Product Liability Contingency, Management Assessment Process:  Describes management’s process to evaluate allegations of damages pertaining to a product and to estimate the impact on the financial statements and ongoing operations.
• Product Liability Contingency, Accrual, Assumptions:  Describes the important assumptions underlying the estimate of the product liability loss, and may describe any changes in the assumptions made since the last reporting period.
• Product Liability Contingency, Circumstances Impacting Precision of Estimate:  Circumstances affecting the reliability and precision of damages estimates for a specified product.
• Product Liability Contingency, Loss Inestimable Explanation:  Reason(s) why an estimate of the probable or reasonably possible loss or range of loss for product liability damages cannot be made.
• Product Liability Accrual, Material Components:  Describes the material components of a loss accrual for damages arising from third-party use of the entity’s product(s) or process(es).
• Product Liability Accrual, Component Amount:  Recorded amount of the accrual for a material component of a product liability contingency.
• Product Liability Accrual, Period Expense, Caption:  Identifies the income statement line item in which the amount of loss reported during the period pertaining to product liability is reflected.
• Product Liability Accrual, Period Expense:  The amount of loss reported during the period pertaining to product liability.
• Loss Contingency Accrual, Product Liability, Undiscounted, Due within One Year:  The portion of the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) that is expected to be paid within one year of the balance sheet date.
• Loss Contingency Accrual, Product Liability, Undiscounted, Due in Second Year:  The portion of the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) that is expected to be paid in the second year after the balance sheet date.
• Loss Contingency Accrual, Product Liability, Undiscounted, Due in Third Year:  The portion of the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) that is expected to be paid in the third year after the balance sheet date.
• Loss Contingency Accrual, Product Liability, Undiscounted, Due in Fourth Year:  The portion of the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) that is expected to be paid in the fourth year after the balance sheet date.
• Loss Contingency Accrual, Product Liability, Undiscounted, Due in Fifth Year:  The portion of the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) that is expected to be paid in the fifth year after the balance sheet date.
• Loss Contingency Accrual, Product Liability, Undiscounted, Due after Fifth Year:  The portion of the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) that is expected to be paid after the fifth year after the balance sheet date.
• Loss Contingency Accrual, Product Liability, Gross:  The estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) as of the balance sheet date. Loss Contingency
• Accrual, Product Liability, Discount:  The amount of imputed interest necessary to reduce (reconcile) the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) to the present value recognized on the balance sheet (if the accrual qualifies for discounting).
• Loss Contingency Accrual, Product Liability, Net:  Present value of the estimated aggregate accrual for damages arising from third-party use of the entity’s product(s) or process(es) as of the balance sheet date (if the accrual qualifies for discounting).
• Loss Contingency Accrual, Product Liability, Net, Explanation of Material Change in Accrual:  Describes the nature or cause of a material change in the expected aggregate amount since the prior balance sheet date, other than a change resulting from pay-down of the obligation.
• Product Liability Contingency, Accrual, Discount Rate:  Rate applied to the undiscounted amount of estimated damages for product liability to arrive at the present value recorded as of the balance sheet date.
• Product Liability Contingency, Accrual, Discount Amount:  The amount of imputed interest necessary to reduce (reconcile) the estimated aggregate undiscounted amount of the accrual for damages arising from third-party use of the entity’s product(s) or process(es) to the present value recognized on the balance sheet (if the accrual qualifies for discounting).
• Product Liability Contingency, Accrual, Present Value:  Present value of the accrual for product liability contingencies as of the balance sheet date (if the accrual qualifies for discounting).
• Product Liability Contingency, Accrual, Caption:  Identifies the balance sheet line item in which the accrual for the product liability loss contingency is reflected.
• Product Liability Contingency, Indication Accrual May Change:  Disclosure that it is reasonably possible that a change in an estimate of the obligation will occur in the near term when information available prior to issuance of the financial statements indicates that it is at least reasonably possible that the product liability accrual estimate will change due to one or more future confirming events.
• Product Liability Contingency, Loss Exposure Not Accrued, Description:  Nature of the reasonably possible allegations of damages and estimate of the loss exposure for product liability for which no accrual has been recorded.
• Product Liability Contingency, Loss Exposure Not Accrued, Best Estimate:  Best estimate of the loss exposure for a reasonably possible liability for product liability damages for which no accrual has been recorded.
• Product Liability Contingency, Loss Exposure Not Accrued, Low Estimate:  Low-end of the range estimate for a reasonably possible liability for product liability damages for which no accrual has been recorded.
• Product Liability Contingency, Loss Exposure Not Accrued, High Estimate:  High-end of the range estimate for a reasonably possible liability for product liability damages for which no accrual has been recorded.
• Standard Label Definition Codification Reference Product Liability Contingency, Loss Exposure Not Accrued, Third Party Recovery Commentary:  Describes the extent to which disclosed but not recognized contingent losses from product liability damages are expected to be recoverable through insurance, indemnification arrangements, or other sources, and any material limitations of that recovery.
• Product Liability Contingency, Loss Exposure in Excess of Accrual, Description:  Nature of the reasonably possible loss contingency and estimate of the reasonably possible loss exposure in excess of the amount accrued for damages pertaining to a specified product.
• Product Liability Contingency, Loss Exposure in Excess of Accrual, Best Estimate:  Best estimate of the reasonably possible loss exposure in excess of the amount accrued for damages pertaining to a specified product.
• Product Liability Contingency, Loss Exposure in Excess of Accrual, Low Estimate:  Low-end of the range estimate of the reasonably possible loss exposure in excess of the amount accrued for damages pertaining to a specified product.
• Product Liability Contingency, Loss Exposure in Excess of Accrual, High Estimate:  High-end of the range estimate of the reasonably possible loss exposure in excess of the amount accrued for damages pertaining to a specified product.
• Product Liability Contingency, Unasserted Claims:  Extent to which unasserted claims are reflected in an accrual or may affect the magnitude of the site contingency.
• Product Liability Contingency, Uncertainties from Joint and Several Liability:  Uncertainties with respect to joint and several liability that may affect the magnitude of the contingency.
• Standard Label Definition Codification Reference Product Liability Contingency, Uncertainties from Insurance:  Uncertainties with respect to the legal sufficiency of insurance claims or the solvency of carriers for product liability damages.
• Product Liability Contingency, Time Frame of Disbursements:  Estimated time frame of disbursements over which the accrued or presently unrecognized amounts may be paid out for damages pertaining to a specified product.
• Product Liability Contingency, Recovery from Third Party Product Liability Contingency Recovery From Third Party Of Environmental Remediation Cost:  Amount of the estimated recovery from third parties recorded in the period pertaining to product liability damages from specified products.

If your clients (or your company, for you in-house folks) haven’t commented on this proposal, it’s something to consider. In the pharma business, it’s all about “an ounce of prevention being worth a pound of cure.”