Improving Contingency Disclosure? Just Keep Doing The Shuffle

Super Bowl Shuffle

Given all the discussion around disclosure of legal contingencies under FAS 5, I thought I would take a look at two more cases that were recently settled. These are two cases where, I believe, current FAS 5 disclosure rules fall far short of meeting the needs of investors.  In fact, they downright hide, obfuscate, and thumb their noses at the need for investors to know what’s going to happen to their investment.

A range?  A full description of the suits and an estimate of how serious they are or how close they are to resolution?  Anything…  Give me, the investor in these two beleaguered companies, GM and Xerox, something, please.
The shareholders in these companies, those that remain, have been beaten to the pulp and then they get hit again with what the management feels is a good settlement.  But, in reality, it’s a lot of money, whether covered by insurance or not.

And full disclosure as to the potential liabilities of the Big 4 firms, Deloitte and KPMG in these two cases?  Well, there is none.  If someone knows how much is possible for each case they have, how much if anything each firm is putting aside (and where they’re getting the dough,) how close they really are to “catastrophe,” they’re not telling.  Instead they’re supporting liability caps.
The most recent disclosure of aggregate numbers to the Treasury was dismissive and superficial.  If you are an investor in a company these firms have screwed up while auditing, you won’t know the implications of that involvement until the settlement is reached.  If you are a shareholder suing company management and auditors for screwing up, the disclosure rules are protecting them, not you as a shareholder. And you often have to live with those same auditors continuing to produce the financial statements you depend on because your vote doesn’t count. The firms almost always capitulate (except poor schmuck BDO) by settling and they admit, by default, that they are not willing to defend themselves.
I’m sorry, but it’s a disgrace.
General Motors and Deloitte & Touche have agreed to settle a class-action securities lawsuit against them alleging the automaker filed misleading financial reports between 2002 and 2006. The lead plaintiffs in the suit were a pair of funds managed by Germany’s DekaBank. Under the terms of the settlement, which requires court approval, Deloitte will pay $26 million in cash, while GM will pay $277 million.

The plaintiffs alleged that GM improperly accelerated income — primarily credits and rebates from suppliers for volume purchases — that should have been reported over longer periods, and also claimed the carmaker recorded extraordinary items of income as ordinary income. Deloitte was GM’s auditor during the period covered by the suit.

Deloitte is still GM’s auditor. How can a firm continue as auditor when its own clients, the shareholders, are suing them for approving misleading financial reports.  That would seem to me to be the epitome in independence violations.
SEC (PCAOB), why do you continue to allow this?
Seems everyone is mixed up as to who the Big 4’s clients are.  And it’s happening elsewhere, most recently in the high profile AIG case.

In GM’s most recent annual report, issued April 25, 2008, they reported on Contingencies, including litigation, with no mention of even the specific lawsuit pending, let alone any estimates of the huge potential liability either in judgement or settlement. Maybe because, at least for GM, much of settlement is covered by insurance.

Various legal actions, governmental investigations, claims and proceedings are pending against us, including a number of shareholder class actions, bond- holder class actions, shareholder derivative suits and class actions under the U.S. Employee Retirement Income Security Act of 1974, as amended (ERISA), and other matters arising out of alleged product defects, including asbestos-related claims; employment-related matters; governmental regulations relating to safety, emissions, and fuel economy; product warranties; financial services; dealer, supplier and other contractual relationships and environmental matters. With regard to the litigation matters discussed in the previous paragraph, we have established reserves for matters in which we believe that losses are probable and can be reasonably estimated. Some of the matters may involve compensatory, punitive, or other treble damage claims, or demands for recall campaigns, incurred but not reported asbestos-related claims, environmental remediation programs, or sanctions, that if granted, could require us to pay damages or make other expenditures in amounts that could not be reasonably estimated at December 31, 2007. We believe that we have appropriately accrued for such matters under SFAS No. 5 or, for matters not requiring accrual, that such matters will not have a material adverse effect on our results of operations or fi nancial position based on information currently available to us. Litigation is inherently unpredictable, however, and unfavorable resolutions could occur. Accordingly,
it is possible that an adverse outcome from such proceedings could exceed the amounts accrued in an amount that could be material to us with respect to our results of operations in any particular reporting period.

Material.  Indeed.
Deloitte’s Deborah Harrington sings the usual Big 4 settlement shuffle song:

“Deloitte & Touche LLP is pleased that it has been able to resolve the securities class action brought by investors in General Motors Corporation,” the audit firm said in an E-mailed response to inquiries by “Although it has strong defenses to these claims, Deloitte concluded that it was in the best interests of the firm and its clients to settle this matter now rather than face the burden, expense and uncertainty of continued litigation.”

As of the date of the last Xerox Annual Report, April 7, 2008, which represents status of the company as of year end Decemebr 31, 2007, the class action lawsuit,
Carlson v. Xerox Corporation, et al., which included KPMG as a defendant, was still pending.

A consolidated securities law action (consisting of 21 cases) is pending in the United States District Court for the District of Connecticut against the Company, KPMG and Paul A. Allaire, G. Richard Thoman, Anne M. Mulcahy, Barry D. Romeril, Gregory Tayler and Philip Fishbach.The parties are engaged in discovery. The individual defendants and we deny any wrongdoing and are vigorously defending the action. In the course of litigation, we periodically engage in discussions with plaintiffs’ counsel for possible resolution of the matter.
Should developments cause a change in our determination as to an unfavorable outcome, or result in a final adverse judgment or be settled for significant amounts, there could be a material adverse effect on our results of operations, cash flows and financial position in the period in which such change in determination,judgment or settlement occurs. Based on the present stage of the litigation, it is not possible to estimate the amount of loss or range of possible loss that might result from this matter.

The press release:
Xerox Corp. announced on March 31 that it had received “preliminary court approval to settle the investor lawsuit that has been in court for eight years for $670 million. Xerox will pay the settlement into a fund in five installments this year and co-defendant KPMG LLP, Xerox’s former auditor, will pay an additional $80 million. The case, filed in 2000 in U.S. District Court in New Haven, Connecticut, claimed that Xerox misled investors about its financial health.”

3 replies
  1. Anonymous
    Anonymous says:

    A bit off topic but slightly related.

    GM, Ford and Chrysler are essential components to the American economy. Despite the fact that management hasn’t made a correct decision in the last two decades we must have our “American made” cars. Congress must bail these companies out. Sheesh.

    Please wake up folks. There is a new distribution of wealth occurring. The American “dream” of a big house and two cars for EVERY American, including those who can’t afford them, are making indentured servants of us all. Bailout Freddie, bailout the car companies, bailout the banks because they are all so integral to maintaining our overextended lifestyle.

    There is no incentive to run a company well. Management makes out like a bandit while they run the company into the ground, but all is well as the government will bail them out. So management gets paid, Wall Street gets paid, and J6P gets the bill. Enjoy your trip down the road to serfdom.


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