Handling of Litigation Contingency Disclosure Facing Greater SEC Scrutiny
The following is a summary of an interview conducted by the Journal of Accounting with attorney Michael Young who is the chair of Willkie Farr & Gallagher LLP’s Securities Litigation & /enforcement Practice Group (Journal of Accounting para.1).
A treaty crafted three decades ago by the American Institute of Certified Public Accountants (AICPA) and the American Bar Association is being intersected with an increased scrutiny by Securities and Exchange Commission (SEC) of complying with rules of financial statement disclosure on court losses that are potential.
The treaty captures auditor-lawyer dialogue. It provides for lawyers to only give predictions to auditors on the outcome of litigation when the chance of being wrong is slight. However the treaty is not viewed as a part of generally accepted accounting principles (GAAP) and the SEC’s view is that it cannot be an excuse to impede dialogue with the auditor (Journal of Accounting para.3-7).
The issue has become a hot topic because of the increased concern by FASB and SEC. During this financial reporting season, FASB is weighing the options of revising the standard while SEC is looking at the possibility of enhancing the present standard. The problem is that companies might expose themselves by giving self-created evidence if they become very transparent by reporting on litigation. Currently, standards require that the company that is supposed to disclose litigation should offer an estimate loss or a statement with a reason for not making the estimate.
The FASB has come up with an exposure draft that is an improvement to an earlier one; it is still working through more than 380 comment letters. This draft contains a feature requiring companies to disclose any accrued amount connected to litigation contingency. If this is allowed, then the draft would be asking companies to confess by disclosing a forward looking prediction in their financial statements.
The proposals are going to be of interest to all companies that use accounting. This includes the accounting departments in the respective company, outside lawyers since they are usually called by auditors to provide information that touches on litigation eventuality, and so will financial statements auditors pay attention so as to evaluate whether the financial reports are conforming to Generally Accepted Accounting Principles (GAAP). Although the standard will apply to both public and private companies, the public ones will face a bigger problem as they face greater possibility of massive class action-litigation. No company wishes to face the consequences of not complying, and this alone is serving as the main reason for them to work hard to get the compliance right (Journal of Accounting para.11-21).
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