Expanded disclosure distress

There is the view that many, if not most, public companies disclose in their financial statements fewer loss contingencies than exist and lower loss contingency costs than are realistic, including for environmental loss contingencies. Investors holding this view contend this under-representation of loss contingencies leaves them unable to evaluate company liabilities sufficiently. FASB, acknowledging this view, has proposed a new standard on disclosure of loss contingencies for companies to implement beginning in 2009.

The new, proposed standard is FASB’s Disclosure of Certain Loss Contingencies, released on June 5, 2008, as an exposure draft, File Reference No. 1600-100. It amends the loss contingency disclosure requirements of FAS 5 and 141R. FASB has scheduled it to be effective for annual financial statements issued for fiscal years ending after December 15, 2008, and for interim and annual periods in subsequent years. This would be beginning in calendar year 2009 for most companies. Under the proposed standard, companies must expand disclosure about their loss contingencies beyond what has been sufficient under FAS 5.

Detractors contend that developing the expanded information will add to the compliance burden that companies already face. They also contend that companies will be vulnerable to subjective and risky judgments they must make about their loss contingencies in order to meet the proposed standard’s information requirements, vulnerable because such judgments can prove wrong.

In fact, for prior compliance with FAS 5, companies already have made their loss contingency determinations. Under the proposed standard, they simply must disclose the basis on which they reached those conclusions. The proposed standard essentially moves information investors need about loss contingencies from company files into investor’s hands.

So, it is not necessarily true that companies will have additional information to develop. Nor is it necessarily the case they will become more vulnerable to the consequences of their judgments as a result of having to provide more information about those judgments.

Distress among companies about compliance with FASB’s proposed standard, as currently written, may derive, at least in part, from prior misapplication of FAS 5 disclosure requirements, wherein companies may have avoided identification of loss contingencies that already should have been indicated in financial statements. This would be consistent with the view that loss contingencies historically have been under-represented in number and estimated cost.

It could well mean that the proposed standard, if it proceeds to finalization, has the messy job—beyond its specific scope—of bringing companies into correct application of FAS 5 recognition and measurement requirements in addition to new implementation of this standard's disclosure requirements.

[For more information, see Raymond Rose's "Expanded Disclosure Distress and Two Classes of Loss Contingencies," Environmental Claims Journal, Corporate Environmental Disclosure Column, Vol. 20, Issue 4, Oct-Dec 2008.]