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Inside Straight: FAS 5 Fracas

Ed. note: This is the latest installment of Inside Straight, Above the Law’s column for in-house counsel, written by Mark Herrmann.

First, a shameless plug; then, back to business.

The plug: I’ll be giving my “book talk” about The Curmudgeon’s Guide to Practicing Law in several locations in the next couple of weeks, including in a conference room at Skadden and in auditoriums at the law schools of Northwestern and Indiana University. If you have a group that might be interested in the talk, please contact me. We’ll sneak you into one of the upcoming talks, and you can decide whether my spiel would actually fit your occasion.

Now, the business. And it’s real business this time around — a business issue that has caught the attention of an awful lot of in-house counsel. The issue has to do with the Financial Accounting Standards Board’s deliberations over whether to alter corporate disclosures about loss contingencies. (Sorry, guys. No pictures of naked Canadian judges after the jump here. You’ve gone from the sublime to the ridiculous, or vice versa.)

Here’s the backstory: Investors legitimately want to know whether companies are about to lose a ton of money in litigation. So investors want companies to make fulsome disclosures about their “loss contingencies,” which picks up a lot of territory, including pending or threatened litigation.

Companies, on the other hand, are reluctant to disclose publicly that they anticipate losing a lawsuit. If companies were to make that type of disclosure, their litigation opponent would be energized and the settlement value of the case would skyrocket….

Historically, FASB Statement No. 5 (or “FAS 5”) governed disclosure of loss contingencies. FAS 5 required corporations to disclose a loss contingency if a loss was “reasonably possible.” For reasonably possible losses, the disclosure requirement turned on whether the loss was “probable” and the amount of the loss could be “reasonably estimated.” If a loss was both probable and estimable, the company was required to take an accrual of the loss and disclose the nature and amount of the accrual. If the loss was not both probable and estimable, no accrual was required, although certain disclosures were still necessary. (Please note that the preceding three sentences are general descriptions of the accounting rules, and they are not precisely accurate. The same is true of everything that follows in this column. I don’t want this silly blog post to be used against my client-employer in a brief some day. You want accounting advice? Hire an accountant. You want loosey-goosey descriptions of accounting rules that I crank out in my spare time for consumption by the general public? Keep reading — but don’t use it against me later. In fact, I hereby disclaim this entire post; it’s all a crock of lies!)

Three years ago, FASB proposed to strengthen FAS 5. The proposed revision would have required companies to describe the factors likely to affect the ultimate outcome of a loss contingency, assess the most likely outcome of the contingency, and disclose the status and anticipated timing of its resolution (among other things). Corporate America took to the streets with pitchforks! (Well, okay; no pitchforks. But fountain pens! And not exactly to the streets. But to their offices!) People wrote 236 comment letters to the FASB, overwhelmingly objecting to the proposed draft. Among many other objections, people noted that disclosing a company’s perception of pending litigation would disclose privileged information and hurt the company in pending cases.

FASB went back to the drawing board. Two years later, it tried again. By 2010, FAS 5 had been renamed Accounting Standards Codification 450-20. In Summer 2010, FASB issued a revised draft of a proposed standard for disclosure. The new draft addressed many of the objections to the earlier one, but it still would have required more disclosure than the existing rules. Among other things, the new draft took a categorical approach to disclosing accruals of material amounts, seeming to require that “[a]n entity shall disclose,” “[f]or all contingencies that are at least reasonably possible . . . the amount accrued, if any.” (Corporate officers read that to mean: “You must tell the plaintiffs how much you anticipate losing in their lawsuits.”) The new draft would also have required disclosure of “asserted but remote” loss contingencies, if the contingency could have a severe impact on the company. (Thus: “If the harebrained lawsuit seeks enough in damages, you must disclose it in your securities filings.”) The new draft was to become effective on December 15, 2010.

Corporate America again took to arms! (Well, okay, not arms — but hands! Hands hovering over keyboards.) FASB received over 300 letters commenting on the new draft, objecting that the required disclosures would still invade the attorney-client privilege, increase the risk of conflicts with auditors, and cause innumerable other problems.

In November 2010, FASB changed course and suspended its deliberations on the new standard. FASB instead directed its staff to work with the staffs of the SEC and the Public Company Accounting Oversight Board to understand what those organizations are doing to address investors’ concerns about current disclosures. The SEC staff mailed letters to corporate CFOs covering some areas where the SEC thought disclosures might be enhanced. Later this year, FASB will consider whether corporate disclosures made in 2010 were better than disclosures made in past years and will decide how to proceed.

The tension between investors, who legitimately want more information about pending or threatened litigation, and corporations, which legitimately prefer not to disclose their litigation concerns (and strategies) to their adversaries, is palpable. FASB, the SEC, and the PCAOB are sure to return to these subjects shortly to try to devise a compromise that accommodates all parties’ concerns. And that means three things:

First, the rules governing disclosure of loss contingencies will change in the coming months or years.

Second, corporations will be forced to adapt to the new rules.

And, third, opportunities will exist for lawyers and accountants able to give intelligent advice on these evolving standards.

Earlier: Prior installments of Inside Straight

Mark Herrmann is the Vice President and Chief Counsel – Litigation at Aon, the world’s leading provider of risk management services, insurance and reinsurance brokerage, and human capital and management consulting. He is the author of The Curmudgeon’s Guide to Practicing Law.

You can reach him by email at

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