A Securities and Exchange Commission chief accountant kicked the stool that many corporate attorneys rely on for withholding information from investors about unresolved legal conflicts.

Wayne Carnall, chief accountant for the SEC's Division of Corporation Finance, told an audience at a New York Bar Association Conference that they should be careful not to lean too heavily on a long-standing treaty between lawyers and auditors when deciding what to report about litigation contingencies in financial statements. Carnall was referring to the 1975 “Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information,” commonly known as the “treaty” between the American Bar Association and the American Institute of Certified Public Accountants.

The treaty is intended to preserve attorney-client confidences by providing a structure for the dialogue between auditors and corporate counsel regarding how to present in financial statements information about pending or potential litigation. It serves as the template for the inquiry letter auditors send to corporate attorneys and any outside legal counsel to get information important to financial statement disclosures. It specifically cautions attorneys against providing certain kinds of information to outside auditors, especially any estimates about the range of potential loss from a litigation unless legal counsels believes the probability of inaccuracy is only slight.

Michael Young, a partner with the law firm Willkie Farr & Gallagher found Carnall's caution a bit alarming. “For the last 35 years, the so-called treaty has played a significant role in the structure of the dialogue between auditors and company counsel on litigation,” he says. “In fact, the written part of the dialogue is largely scripted by the treaty.”

The SEC is on a mission to wring more disclosure out of public companies regarding pending or unresolved litigation to improve compliance with U.S. Generally Accepted Accounting Principles, especially Accounting Standards Codification Topic 450, Contingencies. The Financial Accounting Standards Board started the process back in 2007 on behalf of investors who complained they were too often blindsided by large settlements with no advance warning.

FASB issued a proposal that would have required companies to make estimates about the possible outcomes of unresolved disputes and publish some ranges as to the possible damage. Corporate attorneys pushed back that such disclosures would compromise their positions and give their legal adversaries too much information. FASB revamped the proposal to drop the requirement for estimates but still push for more advance warning about disputes the company may be managing in the wings. Its second proposal also met heavy resistance, prompting FASB to turn to the SEC and see if it could get more information out of companies by more rigorously enforcing the standard currently in the books.

Young says Carnall warned the attorneys in the room that the treaty is not a defense against proper disclosure because GAAP trumps the treaty in terms of authoritative requirements about what goes in the financial statements. Carnall echoed early remarks from the SEC that the staff is keeping a close eye on contingency disclosure to improve compliance with existing rules.

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