Update (2) – More FAS 5 – More Transparency or More Shilling

And the US Chamber of Commerce also pipes in.  As expected, they are on the side of their corporate management constituency.  Although I agree with their position about erosion of attorney client privilege, I do not agree with their position regarding this privilege when it comes to information requested by auditors.

Auditors (internal and external) must have access to all information, including free and open access to Board Minutes and to all management and directors.

Perhaps the change that needs to be made is to strengthen the protections over information auditors need to protect shareholders (that is their role, no?) without having it be needlessly discoverable?

Just a thought.

Dear Francine,

On August 8, the Chamber voiced strong opposition to proposed accounting rule changes that it says would and open the door to lawsuit abuse by trial lawyers and would not provide clear or useful new information to investors.

In a letter to the Financial Accounting Standards Board (FASB), the Chamber outlined its objections to proposed amendments to Statement of Financial Accounting Standard No. 5 (FAS 5), “Accounting for Contingencies,” which would significantly increase the amount of information publicly traded companies are required to disclose regarding pending or threatened litigation. According to the Chamber, these additional requirements would force companies to release immaterial or confidential information—likely resulting in excessive or harassing lawsuits filed by plaintiffs’ trial attorneys.

Under the current standard, companies are required to disclose loss contingencies for “probable losses.” The proposed rule would substantially raise that standard, in some cases requiring companies to disclose all contingencies regardless of how “remote” the losses. The Chamber added that the proposed changes would lead to the erosion of attorney-client and work product privileges by requiring companies to reveal analysis and strategy regarding pending or potential future litigation.

Broc Romanek also chimes in. He points directly at the auditor-lawyer issue.  Interesting times coming.  Are those lawyers who play both sides of the fence like Mike Young, ready?

One of the hot topics at this weekend’s ABA Annual Meeting was the early June proposal by the FASB that would require companies to disclosure more about their litigation risks (here is Dave’s blog outlining the proposal). Here is the ABA’s comment letter that was just submitted; comments are due now.
One member called the proposal a “Summertime Submarine” as many lawyers feel that the accountants are mounting a major attack on the attorney-client privilege and a disturbance on the ABA’s Accord regarding lawyers’ responses to auditor inquiries adopted back in 1975.  Many lawyers also see that the proposal’s change in FAS 5’s disclosure requirements as inevitably increasing auditor demands for information and that auditors also will seek greater justification for what is disclosed.

For the uninitiated, here’s a quick summary of how disclosure of legal contingencies currently works.

Now, I usually like lawyers.  I’ve even complimented the ones that defend the partners and the Big 4 firms.
And I admire the ones that really know their stuff, guys like Jim, Jake, Broc, and Tom.
Ok, I like guys with really big brains and a bad-ass attitude.  I’m busted.

Edith Orenstein has a very extensive summary on the FEI Blog of the latest in potential changes to FAS 5 disclosures. The proposal is causing a significant amount of consternation and wrinkled brows for the corporate lawyers.

But in this case, the corporate lawyers are going all out to defend their corporate clients and their bias shows like a tattered slip under a cheap floozy’s summer wrapper.
Consider one of the most vocal ones.  Mike Young is always good for a good quote about how any and all disclosure is bad for his clients’ (company management, certainly he’s not thinking about shareholders) position vis a vis their defense and negotiation with those that sue them.
He’s a (big) talking head for the audit firms, too.  But he’s also afraid of the auditors.
Which side are you on, Mike?
…It is to the Board’s credit that it seeks to mitigate these concerns through the possibility of aggregation.  While that attempt is commendable, however, it doesn’t really solve the problem. The prominence of large litigation often cannot be disguised by aggregation, and both large and small litigation would presumably be the subject of robust discussion with the outside auditor in disaggregated form, thereby making highly prejudicial information potentially available to adversaries through loss of the attorney-client privilege…

Yeah.  He makes a great case for me to agree with squelching disclosure.
Let’s take a look at a recent case of lack of disclosure: Nokia-Qualcomm.
As I wrote in a blog post back in October, 2007, Nokia and Qualcomm had some significant litigation going on and there was nary a mention of it in their most recent annual reports at the time, per FAS 5 current rules.  PwC was on all sides of this conflict.  Hmmmmmm.
A reader who had been following that case much more closely wrote:
…I speculated [back in October when I wrote the original post] that it may have something to do with the ever-boastful Nokia’s true status with regards to their pending litigation with Qualcomm. At the time I predicted that Nokia would cave and settle within 12 months, for terms that perhaps would be less favorable to Nokia than they might have led their shareholders to expect.
Well, the above played out true to form this past Wednesday, as Nokia raised the white flag on the courthouse steps, just as the trial was to commence. While there have been quite a number of prominent articles the past 48 hours stating that Nokia “got the best of Qualcomm”, I would submit to you that the share price action the past 2 days indicates otherwise.

A “short” Nokia/”long” Qualcomm strategy has worked rather well the past 6 months, and I suspect this will continue to be the case going forward.

As for poor Carl……………………I suspect he and/or his employer saw this day coming all too well.

Without sufficient disclosure, how could either side’s shareholders been able to gauge the impact of pending litigation accurately in order to make proper investment decisions?

Read more here about the corporate defense lawyers who are afraid of the external auditors (or internal auditors) having access to any real strategic business information.

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