The SFAS 5 Amendments - New And Lethal Weapons For Plaintiff's Counsel

Wednesday, October 1, 2008 - 01:00

The Editor interviews Michael D. Fricklas, Executive Vice President, General Counsel and Secretary, Viacom.

Editor: Bill Ide, chair of the ABA Task Force on Attorney-Client Privilege (Task Force) mentioned that you had been a strong supporter of the Task Force from day one, dating back to the Thompson Memorandum, and had been very helpful in rallying the corporate community and in giving substantive input in connection with the Task Force Comments on the Financial Accounting Standards Board (FASB) exposure draft titled "Disclosure of Certain Loss Contingencies: An Amendment of FASB Statements 5 and 141(R)" (Exposure Draft or Amendment). Why did you feel that the corporate counsel perspective would be helpful to the Task Force?

Fricklas: Corporate counsel have a lot of expertise in how litigation gets managed. If you manage a broad range of cases for a company, as I do, you get a feel for how difficult it is to predict their outcomes and the wide variety of factors that can influence that outcome. When I heard about the proposed amendment, I and other corporate counsel and financial executives became concerned that noise would be introduced into the system that would simultaneously confuse investors and damage our corporations' litigation efforts by radically tilting the playing field against them. Given the nature of our legal system, the accountants were hypothesizing a level of predictability and measurability that just isn't there - and by requiring corporations to make an attempt to make these disclosures, they would be actually damaging the corporations.

The Exposure Draft statement assumes you have good information about the nature of the case at the outset and that you can run it through a model and evaluate that information, when in fact, as every corporate counsel managing litigation knows, litigation is a fact-finding process that takes many months or years. Only at the end of the process are the facts determined by a judge or jury - only then is an evaluation made. The FASB assumes you have a snapshot when in fact the lens cover is still on the camera - it's hard to derive a lot of useful information from that.

Take the example of our Google-YouTube litigation. Millions of documents are going to be produced over many months, and, at the early stages of the case, would we know all the information in Viacom's documents? Of course not. Google's counsel is in the same position with respect to its documents. And, neither of our lawyers would have had an opportunity to review the other party's documents or depose witnesses. Yet, if the facts that I may someday know are not part of my quarterly analysis, it could lead somebody to say "Hey, wait a minute. Somebody in the organization knew 'X' or wrote 'Y' - why wasn't that part of the evaluation about the success of your case?" The fact is that the facts aren't known, the context for the facts is not known, and both parties feel strongly about their respective positions and ability to prevail. To try to put a dollar value on the facts as we know them at a point in time, and then on a quarterly basis, when the whole point of the litigation process is to gather facts and present them to a fact finder is dangerous. Even if the facts were known, often plaintiffs are not required to put forward a serious analysis of damage theories until late in a case, leaving defendants in the position of guessing what they might be.

Editor: You spoke about the Amendment radically tilting the litigation playing field for U.S. companies. Looking at the range of civil justice reform issues facing corporate counsel today, where in the scale of importance would you place the issues raised by the Amendment?

Fricklas: At or near the top. From a civil justice reform point of view, it will, in its present form, hand plaintiffs' counsel a powerful weapon. Plaintiffs' counsel will be speculating about how best to use it. Should they claim huge damages in their complaints, which will have to be disclosed, or should they omit an ad damnum and try for an admission by forcing the defendant to estimate damages? How does the defendant value the case? Most plaintiffs, at least the kind that civil justice reform advocates are concerned about, are not going to have the same disclosure burdens that are going to be imposed on their adversaries, and so this could give them a meaningful tactical advantage. It is certainly not fair to know your opponents' perspective on the case without having to disclose your own.

Editor: Would investors benefit from the disclosures required by the Amendment?

Fricklas: Companies have learned, sometimes through bitter experience, that it is best to follow a "no surprise policy" with their shareholders. Wall Street doesn't like surprises very much, so companies realize that it is in their interest to make sure that Wall Street's judgments about contingent liabilities are as realistic as possible. When Viacom and CBS were together, I managed the docket of asbestos cases. Every time there would be a verdict in a particular case, the analysts and media tended to apply the results of that verdict to the entire docket without regard to the differences in the facts, the applicable law and the jurisdiction. As a result, we spent a lot of time educating analysts and the media in a fairly sophisticated manner about the ups and downs of asbestos litigation and what's really going on in the docket.

At that time, I remember attending seminars given by law firms about the asbestos cases. These sessions were largely attended by financial analysts and members of the media who were trying to understand the implications of the cases. There was also some evidence that plaintiffs' lawyers also would communicate with Wall Street in an effort to pressure companies into unfavorable settlements.

Because the analysts and the media get their information in these and other ways, they come to understand the uncertainties that are inherent in our litigation system and in specific cases and take account of that when communicating with investors. As a result, the investor has a better understanding of the effect of litigation than the FASB realizes.

The Amendment is unnecessary. The existing channels I mentioned, current SFAS 5, SEC MD&A disclosure requirements and the public availability of court records have prevented the investor from being taken by surprise by litigation outcomes. Cornerstone conducted several market event studies that were designed to determine whether the public announcement of the final resolution of litigation has a statistically significant effect on defendants' stock prices. The evidence uncovered by the studies suggests that, even at the level of individual litigation contingencies, the market was adequately informed about such contingencies prior to the public announcement of their settlement.

Editor: The Amendment provides for exemptions where disclosure would have a prejudicial effect on a company. One permits disclosures to be aggregated. Another provides for exemption in "rare cases." Do these help?

Fricklas: Another mistaken assumption in the Exposure Draft is that a company has a ton of litigation so you can avoid disclosing facts about a specific case by aggregation. Sometimes that's true, but not always. For example, RIM's patent litigation or the constellation of Vioxx cases would have overwhelmed everything else for the affected companies and their estimated exposures would have been evident even in aggregated figures. Therefore, aggregation would not necessarily avoid providing the other side with information that would weaken a company's position in an important case. And, the cost of constantly making reestimates of amounts beyond those already required could be significant, including that of instituting new disclosure controls in order to capture on a quarterly basis large amounts of information - all in the interest of making disclosures that the market doesn't need and which will be misleading since they are snapshots taken at particular point in time with highly imperfect information.

The proposed exemption for "rare cases" will not mitigate prejudice, because a need for exemption will not be "rare."

Editor: Do the disclosures required by the amendment jeopardize the attorney-client privilege and work-product protections (Privilege)?

Fricklas: A number of courts have reached the enlightened view that sharing Privileged information with your auditing firm shouldn't be viewed as a waiver for a variety of reasons - it's a confidential relationship, it's not an adversarial relationship, and, as a policy matter, disclosure serves a useful policy goal in enhancing the reliability of financial information. It is a positive thing from a policy standpoint. Companies should to be encouraged to be open with their auditors. Unfortunately, there are other cases that hold sharing Privileged information with auditors waives as to third parties.

Companies wishing to bolster the nonwaiver argument are looking at ways to beef up their Privilege protection - for example by including appropriate language regarding confidentiality in engagement letters or in their reliance on professional standards, for example. In addition, companies are looking at ways of relying on nonPrivileged information to support accounting positions, so that auditors have access to nonPrivileged information that is sufficient for them to fulfill their auditing responsibilities

While there is some variation in the cases, courts are concerned about unfairness that can result from selective waiver of the Privilege and therefore often find waivers that go beyond the specific information that is deliberately made nonconfidential. Therefore, even limited waivers in compliance with the proposed revision of SFAS 5 may result in courts allowing inquiry into areas that might otherwise have been considered Privileged.

Editor: Does the fact the SEC is moving forward with its program to bring about the convergence of U.S. and international accounting standards, present problems that make the resolution of issues affecting the Exposure Draft more difficult?

Fricklas: Yes. The SEC and FASB are working toward bringing about a convergence of U.S. GAAP and international accounting standards and have proposed a roadmap that would result in convergence by 2014. Harmonization is going to involve a lot of work. Overall you'd say that it is a good thing to be able to compare financials of companies across borders and eliminate competitive advantages that one company might have by reason of the applicable accounting standards. Part of the problem is that international accounting standards are informed by the EU civil law perspective. In defining loss contingencies, most of the rest of the world is not used to the potentially large judgments that are found in the U.S. They are not used to the concept of Privilege since discovery and the integrity of the adversarial system are not fundamental to civil litigation in most countries. As a result, harmonization of current SFAS 5, as it applies to U.S. companies, with the vastly different legal system addressed by IAS, is not a simple matter.