FASB Considers 'Michael Young Principle' Of Disclosing Facts, Not Predictions, For FAS 5 Contingencies

March 10, 2009
FEI Summary

At a public roundtable on March 6, 2009 the Financial Accounting Standards Board appeared to move away from certain changes proposed last year to amend disclosure of contingencies under FAS 5, Accounting for Contingencies, moving instead toward what FASB Board Member Larry Smith described as the “Michael Young principle” of disclosing facts and contentions, rather than predictions.

However, as noted by FASB Technical Director Russell Golden, some had voiced concern about disclosure of certain facts. For example, some panelists said disclosure of the amount of claims, which in their view can be grossly exaggerated by plaintiffs given the nature of the litigation and settlement process, could be misleading.

A majority of the 240 comment letters FASB received on last year’s proposal to amend the disclosures in FAS 5 objected to the proposal, particularly with respect to the proposed expansion of disclosures for litigation contingencies. (See FEI comment letters filed Aug. 8, 2008).

FEI Members Participate in Panel

Two FEI members participated in FASB’s March 6 roundtable: Gary Kabureck, vice president and chief accounting officer of Xerox Corp. and a member of FEI’s Committee on Corporate Reporting, and Nicole Johnson, senior tax manager and formerly director of Accounting Policy for Koch Industries Inc.

ACC, 135 Chief Legal Officers Object to Proposed Changes to FAS 5 Disclosures
On the day of the roundtable (March 6), the Association of Corporate Counsel announced it had issued a statement protesting the proposed changes to FAS 5, and that 135 chief legal officers had co-signed that statement. (See ACC media alert and ACC March 6, 2009 statement on FAS 5, which lists the signatories).

Relevance, Reliability and Privilege

Some panelists at the March 6 FASB roundtable noted that factual information about legal cases would have limited predictive value and, therefore, limited usefulness to investors. However, others noted that the ability of preparers and attorneys to predict the potential outcome of cases, and for auditors to audit that information, is limited by the inherent uncertainty of the litigation process, as well as the “treaty” reached in 1975 between the American Bar Association and the American Institute of Certified Public Accountants aimed at preserving attorney-client privilege while enabling attorneys to make representations to auditors to assist the auditors in corroborating certain information.

Prejudicial Exemption Debated

To minimize potential negative consequences of such disclosure on the disclosing company, FASB offered a prejudicial exemption in last year’s proposal (Exposure Draft). However, the ED said the need to use the prejudicial exemption would be “rare,” although some comment letters and roundtable panelists disagreed with that contention.

Additionally, some FASB staff and board members indicated at the roundtable that they may consider whether or not a prejudicial exemption is even necessary to include, if they were to adopt instead the “Michael Young principle” of requiring disclosure of facts and contentions rather than predictions.

Next Steps
FASB Technical Director Russell Golden said at the close of the roundtable that panelists could submit further comments if they wish, which would be treated as supplemental comment letters. He said staff would consider the feedback received to develop a project plan to present to the board to move forward with redeliberation of the proposed changes to contingency disclosures.

Read More In Detailed Summary
More details on FASB’s March 6 roundtable can be found in FEI’s Detailed Summary of the FAS 5 Roundtable. The summary (10 pages) can only be downloaded by FEI members. Not an FEI member? Now is a great time to join; if you become a member by April 6, you can attend FEI’s Summit conference for free! For further information about FEI membership or this summary, contact Edith Orenstein eorenstein@financialexecutives.org 973.765.1046. The detailed summary covers the following areas discussed at the roundtable:

• Background
• FEI members among panelists
• Investor Views (page 3)
• Litigation as a Black-Swan Event; Attempts to Fill the Gap (page 4)
• FASB Senses Consensus Around ‘Michael Young Principle:’ Facts, Contentions, Not Predictions (page 5)
• Pushback From Some: “Disclosure Is Not a Place to Try a Lawsuit”  (pages 5-7)
• The Need for Holistic Approach to Disclosures: SEC and FASB (page 7)
• Discussion of Probability Thresholds, and Attorney-Client Privilege (page 8)
• Will Prejudicial Exemption Be Removed? (pages 8-9)
• Pros and Cons of Tabular Reconciliation (pages 9-10)
• Next Steps (page 10)

Prepared March 10, 2009 by Edith Orenstein, director, Accounting Policy Analysis, Financial Executives International (FEI). This summary does not represent FEI opinion unless specifically noted above.