On July 20, the FASB issued a new exposure draft of their proposed ASU concerning disclosures of litigation-related loss contingencies.  For anyone who may not have been following this issue over the past 2 years or so, the FASB first issued an exposure draft on June 5, 2008 which proposed enhanced disclosure regarding contingent losses stemming from litigation. 

The proposal generated a lot of discussion and quite a few comment letters (242 letters were summarized by the FASB staff in their comment letter summary).  201 (83%) of those letters did not support the FASB’s proposal.  Preparers and their auditors expressed concern that the new disclosure rules would compel firms to disclose information that would harm their cases by providing private information to plaintiffs suing them. 

After many months of additional research, contacts and pilot studies with cooperative firms, public roundtables held March 9, 2009, and redeliberations by the Board, this new exposure draft, while accomplishing many of the initial objectives of the project, appears to have addressed the concerns that were raised.

My colleagues (Rosemond Desir, Colorado State University; and Kirsten Fanning, soon to be at Villanova University) and I conducted an empirical study aimed at testing the assertions upon which the FASB’s project were based.  In particular, we tried to determine the rate at which firms in the population of public companies were seemingly withholding relevant information about lawsuits until after the suits were settled and losses were recognized.  In our view, such a phenomenon should essentially never occur if the spirit of SFAS No. 5 were followed, so we expected that rate to be very close to zero.  However, we found in our sample of 52 lawsuits that in 4 cases, it appears that an arguably material loss that was apparently probable at the financial statement date was not disclosed and no loss was accrued until the following financial report, when the lawsuit was settled or adjudicated.  This is a rate of 8%.

Overall, we believe our study supports the FASB’s assertion that there is insufficient disclosure under the current regime.  The paper is forthcoming in Accounting Horizons.  Contact Ray Pfeiffer if you would like a copy of the paper in the mean time.

It should be interesting to gauge the response of the legal/preparer and audit communities to this revised proposal.  Have the revisions to the proposal provided the necessary protections as seen by preparers?  It should be equally interesting to see the response of the investor community, whose claims of insufficient disclosure motivated this project.  Have the revisions to the initial proposal gone too far?

Comments are due very quickly (letters are due by August 20).  Stay tuned!