Tuesday Jul 22, 2008

Accounting and the Tour

I love it when July rolls around. It means the Tour de France is underway. Despite the issues with this event in the past few years, I can't think of a more compelling display of physical endurance, strategy and teamwork. Much to my family's annoyance, for most of the month I am glued to the TV. But, today I thought I'd pull myself away from the race for the Maillot Jaune to write about a subject that many find equally exciting - Financial Accounting Standards No. 5.

Ok. Perhaps, it's only accountants who find FAS 5 to be exciting. However, all in-house counsel should be aware of the potential impact of the changes to FAS 5 proposed by the Financial Accounting Standards Board. In general, these changes would lower the threshold for disclosure of certain litigation loss contingencies, as well as require companies to disclose substantially more information about the underlying litigation.

Under the proposed changes, companies would need to provide disclosures for loss contingencies that are more than "remote". This is a change from the current higher threshold of "probable loss". Where disclosure is required, the proposed amendments are significantly broader requiring companies to provide "a description of the contingency, how it arose, its legal or contractual basis, its current status, and the anticipated timing of its resolution; a description of the factors that are likely to affect the ultimate outcome of the contingency along with their potential effect on the outcome; the entity's qualitative assessment of the most likely outcome of the contingency; and significant assumptions made by the entity in estimating the amounts disclosed...".

While increased transparency clearly benefits shareholders, the changes proposed by FASB create some significant issues. Among them are the potential that the disclosures may:

- enable opposing counsel to determine important elements of a company's litigation strategy,

- possibly be admissible as evidence as an admission against interest,

- create the potential for waiver of attorney-client privilege and work product immunity, and

- lead to securities litigation if a disclosure later proves to be inaccurate and an investor relied on it.

Underlying this last point is the real difficulty with the proposed changes - that litigation (like The Tour de France) is inherently unpredictable. Despite having almost unlimited information about the riders, their training regimens, racing strategies, and the strength and weaknesses of their respective teams, you might think you would be able to guess who will be wearing the yellow jersey on the final ride into Paris. However, races are frequently determined by events that are uncontrollable and unforeseen - things like inclement weather, road conditions, mechanical problems, accidents and even dogs. Litigation is much the same. Often the outcome of a case depends on your choice of counsel, discovery resources, venue, identifying expert witnesses, success of key motions and the members of your jury. This uncertainty is the reason that most cases in the US are settled.

You can read the proposed amendments here . Comments to FASB are due by August 8th.

And, in case you're interested, I'm still picking Cadel, but then again, you never know what will happen.

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