SFAS 5 Tilts The Playing Field Against Defendants - LCJ And The Defense Bar Speak Out

Wednesday, October 1, 2008 - 01:00
Richard B. Phillips, Jr.

Editor: Tell us about LCJ and the other organizations whose views were represented in the LCJ Comments.

Phillips : LCJ is a national coalition of defense trial lawyer organizations and corporations which seeks to restore and maintain balance in the civil justice system for the benefit of the public. LCJ's corporate members include some of America's largest corporations and the LCJ Network includes numerous law firms.

DRI alone has about 22,500 members. It has close relationships with three other national defense organizations. Representatives of those other national defense organizations sit on the DRI board. These are the International Association of Defense Counsel and the Federation of Defense and Corporate Counsel.

DRI is affiliated with defense organizations in every state and with local defense organizations in some larger cities. Altogether it has relationships with more than 60 state and local defense organizations. We don't have statistics that enable us to measure the total number of defense lawyers in all the organizations, but we believe the total number of defense lawyers in all the defense organizations is probably something of the magnitude of 45,000 to 50,000.

The LCJ Comments were circulated for approval prior to filing with the FASB not only to LCJ and DRI, but also to the International Association of Defense Counsel, the Federation of Defense and Corporate Counsel, and the Association of Defense Trial Attorneys. Their representatives read the LCJ Comments and signed off on them.

Editor: Why did these organizations feel that it was important to file a comment with the FASB?

Phillips: Because they are defense-oriented, their membership includes lawyers who represent companies that face the prospect of having to disclose information about their litigation contingencies under the Amendment. They were concerned about the Amendment's potential impact on the attorney-client privilege and work-product protection (the Privileges) and the benefits provided to plaintiffs by the required disclosures. They felt it was important to step in and make their voices heard.

Editor: The mission of LCJ is to maintain a level playing field between defendants and plaintiffs. Do you feel it could fairly be said that the Amendment will radically tilt the litigation playing field in favor of plaintiffs?

Phillips: Clearly it has an extremely sweeping effect. As we point out in the comment, the delicate balance of information between what you have to disclose and what you can keep confidential has evolved in American jurisprudence over generations of experience, and the Amendment threatens to throw that entire system out the window because it severely tilts the playing field in favor of plaintiffs. And, there's no reciprocal requirement for plaintiffs to provide information about their evaluation of the case to the defendants. One function of the work product doctrine is to keep the one side from freeloading on the other side's work. The Amendment permits plaintiffs to freeload. They get inside information from defendants as to potential damages and other quantitative and qualitative information in the form of quarterly snapshots of the defendant's assessment of a case as it proceeds, which could impact settlement discussions and discovery requests. But the plaintiffs would still get to keep all of that kind of information hidden.

Editor: Do you have instances where taking a snapshot at a particular stage in a proceeding would have been misleading?

Phillips: Oh, definitely. I've got several different types of cases. I've got one that involved a suit against a city here in Texas. About the time that we sued the city there was a question about sovereign immunity. We took the position that there was no immunity based on a doctrine that had been around since 1970. Just after we filed that suit, a case went up to the Texas Supreme Court presenting a question of whether that doctrine was still valid, and ultimately it wasn't, which totally changed our analysis of the lawsuit. We had to go back and figure out another way that the city wasn't immune. If I had known how our Supreme Court would rule at the time we filed our suit, the snapshot given to the client at that time would have been quite different.

The same thing can happen if the legislature changes the governing statutes. It has been known to do that and sometimes make the changes retroactive. I've also faced numerous situations where the rulings the court makes along the way can completely change the snapshot. I've got a securities fraud suit right now that has been up to the Fifth Circuit twice, and both decisions have created a new snapshot as far as what is at issue with the case. Now that the District Court has it back, it has further narrowed the case by getting rid of some of the claims on our motion to dismiss so the snapshot has again changed. With each snapshot, the evaluation of the case changes because the new posture of the case will impact what gets submitted to the jury and what evidence the jury will hear.

Editor: The LCJ Comment talks about qualitative disclosures and quantitative disclosures and the fact that snapshot- type disclosures along the way would be misleading.

Phillips: I want to be careful with the word "misleading." The concern in the LCJ Comment is misleading investors. Lawyers make evaluations of the case throughout the litigation. It's not that those evaluations are misleading to our clients because we're able to explain to them that the snapshot represents the current posture of the case and that events will occur in the future that may affect the outcome. The concern reflected in the LCJ Comment is that the users of financial statements are not going to have that understanding because they will get just that snapshot. They won't have the sophisticated understanding that the clients have that those things can change over time. And disclosing to investors all of the information about events that could change the evaluation poses a serious risk to the Privileges.

Editor: How are the Privileges affected if your clients are required to make the disclosures required by the Amendment?

Phillips: If quantitative information has come from a communication between the client and the lawyers, the mere fact of disclosure would breach the attorney-client privilege. Additionally it poses a potential risk of at least a partial waiver of the attorney-client privilege as to that information. That risk is going to be different across different jurisdictions because they have different rules about waiver. It is arguably a subject-matter waiver because it has been disclosed outside of the attorney-client relationship, which could allow the other party to come in and try to get additional discovery on that subject on the basis that the privilege is waived on that subject, so just disclosing that information on financial statements could cause a problem.

As to the qualitative information in financial statements, especially on a going-forward basis, revealing legal strategies, such as a motion that's intended to be filed may be harmful. It provides the other side with the advantage of knowing what the defendant is planning to do. Such information is ordinarily protected by the Privileges and could lead to a subject-matter waiver finding depending on the jurisdiction in which the case is pending.

Additionally, because the Exposure Draft greatly expands financial statement disclosures with respect to litigation contingencies, lawyers will undoubtedly be asked to expand the information they provide to auditors. The existing treaty between the ABA and the AICPA relates to what information needs to be disclosed to make the auditors happy and to avoid waiver of the attorney-client privilege. In its comments with respect to the Exposure Draft, the AICPA points out the treaty will have to be revised to reflect the Amendment .

Editor: The Exposure Draft provides that an exemption will be provided in the "rare" cases where the information "could affect to the entities' detriment the outcome of the contingency itself,"

Phillips: I don't think that the need for exemption will be as "rare" as FASB expects. Every time a company needs to disclose the quantitative and qualitative litigation information required by the Amendment, it is going to be something that "could affect to the entities' detriment the outcome of the contingency itself," because sharing that information with the other side gives it an advantage they wouldn't otherwise have. Additionally, even if the exemption is invoked, the Exposure Draft still requires certain minimum disclosures that still threaten the Privileges.

Editor: The Exposure draft also suggests aggregation as a way to present information in order to conceal the specifics.

Phillips: The draft is not clear as to how qualitative disclosures can be aggregated. Quantitative disclosures with respect to major litigation where high damages are possible cannot be hidden by aggregation because the addition of a large amount will be evident when the estimated exposure is first set forth in the financial statements.

Editor: The argument is made that proposal doesn't really benefit users of financial statements.

Phillips: The opening statement of the FASB in the Exposure draft states that financial statements are not very helpful in regard to litigation contingencies, but it does not cite any statistical or anecdotal evidence to back up that statement. The Amendment itself does not provide any evidence that the current disclosure regime is somehow lacking. In fact, Professor Joseph Grundfest from Stanford Law School submitted a comment to FASB summarizing a study in which he found that published announcements about the outcome of litigation frequently generate no statistically significant stock price responses.

Editor: Does your firm intend to be involved, either on behalf of the parties you represent or on behalf of the firm itself, in the roundtables that are planned?

Phillips: We haven't talked to LCJ about who from that organization would participate in the roundtables. It looks like the roundtables will not take place until the first quarter of 2009.

Please email the interviewee at rich.phillips@tklaw.com with questions about this interview.