FASB Rethinking Proposed Amendments to Statement of Financial Accounting Standards No. 5 – Disclosure of Loss Contingencies

September 26, 2008

On September 24, 2008, the Financial Accounting Standards Board approved a staff recommendation to reconsider the Exposure Draft issued June 5, 2008 titled, Disclosure of Certain Loss Contingencies. The Exposure Draft proposed major changes to the reporting and disclosure requirements for loss contingencies, including litigation, under Statement of Financial Accounting Standards No. 5 and has generated substantial controversy as well as comments from users and preparers of financial statements and professionals involved in the financial reporting process. As part of the staff’s September 24 recommendation, the effective date of any final standard was pushed back so that any changes will not be effective sooner than for fiscal years ending after December 15, 2009.

In making this reconsideration proposal, the FASB staff noted that they had received over 235 comment letters on the Exposure Draft and that while users of financial statements were generally supportive of the proposal, financial statement preparers and the legal profession were generally opposed to it.  The staff particularly noted two comments by preparers and attorneys:  (1) that the Exposure Draft proposal could require financial statement preparers that are defendants in lawsuits to disclose prejudicial information and waive the attorney-client privilege and (2) that preparers may not have time to implement additional controls and procedures to collect and review the additional information needed to prepare the expanded disclosures for their 2008 annual financial statements if the effective date of the proposals is for fiscal years ending after December 15, 2008.

The staff stated that it views these as serious concerns that require careful consideration. Therefore the staff recommended and FASB agreed that it will seek volunteers to field test two alternative proposals using sample disclosures based on past events such as a lawsuit or other  contingent liability that has been resolved. One alternative will involve preparing sample disclosures that would have been required if the Exposure Draft had been in effect when the original disclosures were made. The other alternative will involve sample disclosures under an alterative proposal that the FASB staff will develop. The staff alternative proposal will be field tested before it is formally proposed by FASB and released for public comment. While the staff has not finally decided on the form of the alternative proposal, we understand that two possible approaches are under consideration:

• Under one approach, issuers would be required to describe the factual circumstances surrounding the loss contingency and its progress toward resolution. In the case of pending litigation, such disclosures could include items such as a description of the allegations of the complaint, the defenses raised, the procedural posture of the matter and other significant facts but they would not require a quantitative assessment of maximum possible or likely loss exposure, at least before the loss was probable.
• Under the other possible approach, while quantitative disclosures would not be required (at least until a loss had become probable), in addition to factual disclosures, qualitative or narrative disclosures concerning the factors that might be expected to influence the future course and outcome of the matter would be required. Such an approach would be closer to that in the Exposure Draft but without the requirement for current quantification. In the case of pending litigation, required disclosure of matters such as possible motions and their likely outcome, settlement possibilities and other factors that could affect the future course of a matter would likely raise many of the same attorney/client privilege waiver concerns that were expressed by many respondents in comments to the Exposure Draft.

Many commentators on the Exposure Draft also suggested that FAS 5 in its present form works reasonably well and does not require amendment. To the extent problems are perceived to exist, these commentators suggested that additional guidance by FASB or the SEC could eliminate or significantly reduce them. As part of the reconsideration process, we understand that FASB will survey actual past disclosures under FAS 5 to compare them with the sample disclosures resulting from the field tests.

The FASB staff has suggested that field testing will take place during November and December 2008 and a roundtable discussion (originally proposed for September 2008) will be held in the first quarter of 2009. Formal FASB reconsideration of the Exposure Draft is expected to take place in late March or April 2009. While this seems to be an ambitious time table given that volunteers must now be recruited to participate in the field test and that the alternative proposal does not appear to have been finalized, it does appear to reflect a sense of some urgency on FASB’s part to move this project forward.

© 2008 Gibson, Dunn & Crutcher LLP

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