Corporate Secretary Week: New liability disclosure rules put companies at risk and damage shareholder value

What to do about FASB's controversial changes

Dear readers,

The flood of expanded disclosure requirements for US corporations just keeps getting worse. Congress is responsible for most of the changes, which the SEC is now in the process of interpreting, but now the good folks at FASB have added their own requirements.

In a controversial move, the accounting board has changed the rules regarding the disclosure of contingent liabilities. Many of you have been keeping a close eye on the changes, and I know a number of law firms have sent out advisories to clients on how to manage the new requirements. The problem is FASB has taken a page out of Congress’ book and included a significant degree of ambiguity in the language. The board has also made a mistake that leaves companies in a most unfortunate position. Worst of all, the new rules damage the people they are designed to protect, but you still have to comply.

The biggest issue with the new rules is that they may actually be counterproductive. FASB believes the new rules will help to protect shareholders by shining light on potential future liabilities, but too much sun exposure may lead to severe sunburn. Companies fear that disclosing these contingencies will increase litigation and ultimately damage shareholder value.

But there is an upside because with ambiguity comes flexibility. Depending on your interpretation of the rules, companies will have a choice as to what and how much they disclose. It is going to be a very important decision.

Let’s take a look at the rules themselves. ASC 450, which effectively replaces the old FAS 5, covers accrual and disclosure requirements for loss contingencies, such as pending or threatened litigation, injury or damages caused by products sold, risk of loss of property by hazards, and, along with ASC 410, environmental remediation obligations

It is important to note that large parts of the rule remain the same. Accrual standards don’t change, but some of the disclosure thresholds do. For example, companies must disclose asserted but remote loss contingencies in some circumstances, namely, if those losses are likely to have a ‘severe impact’ on the financials or operations of the company.

You must also include a tabular reconciliation for each annual and interim period that outlines the amount accrued in each period, including any increases or decreases of prior accruals and decreases for settlements. In some cases aggregation will be permitted.

As you can see, this will take a lot of work. More important, releasing this type of information puts the company at risk. For example, if you accrue $100 million for a particular suit – the actual value may be much less or much more – you effectively set a floor for plaintiffs. They will use this disclosure against you saying ‘well you think this claim is worth at least $100 million, and you say so in your own filings.’ There is no way they will settle for anything less than that amount.

Easy. Just undervalue the suit. Well you can’t do that either because then other investors may file suit after the fact claiming that you did not give a true and accurate representation in your filings.

Aggregating may not help much either. Most lawyers read the rules as only allowing certain types of contingencies to be aggregated together, and you still need to give detailed descriptions of the basis for aggregation. It won’t take much for a plaintiff lawyer to turn this against you.

So what about saying all of it is immaterial? That is a risky strategy, too. Outcomes can be very hard to predict and not disclosing will lead to more trouble later.

What many shareholders don't understand is that this could hurt them in the end. It is true that ASC 450 is likely to increase litigation activity and potentially increase payouts to claimants. This takes money out of the corporate coffers, thus ultimately damaging shareholder value. It is unlikely that the proceeds of the claim will offset the decline in value, and, besides, only certain claimants will benefit.

So what can you do about it? You could make sure you don't get sued, but outside of that, if you haven’t already done so, I would get my litigation specialist on the phone and start figuring out a strategy for disclosure that falls within the rules. Understand how you are going to justify any non-disclosure to regulators, and, at the same time, grab your IRO and make sure they are prepared to explain the increased liabilities that are going to appear on filings to the marketplace. The last thing you need is a shareholder seeing big numbers, misunderstanding them and running scared. A little preplanning may help alleviate the problem. You might also try calling FASB to have them repeal the rule but good luck with that.

Don't sit around waiting. The rules take effect as of December 15 this year, so you don’t have a lot of time.