Three part series exposes billions of dollars in concealed corporate liabilities, allowed by accounting regulators

Current accounting system emphasizes "voluntary" accounting of corporate environmental liabilities, leaving investors in the dark. Will regulators leave it to courts to define corporate duties of proper accounting?

I recently completed a three part blog series regarding how existing accounting rules leave investors without adequate information about companies' liabilities.

To summarize briefly, part one of the series highlights how current accounting rules leave a great deal of flexibility for companies in deciding whether to investigate, estimate and disclose environmental liabilities. As a result, even the chair of the American Bar Association committee on environmental financial disclosure concludes that in a recent paper prepared for legal community that taking a "don't ask don't tell" approach to potential environmental liability seems like a rational response in light of the rules.

In part two we discuss the suggestion that, despite the lack of specific requirements for disclosure under the accounting rules, companies may need to investigate, estimate and disclose more because of the duties of directors and officers of the company. For example, directors may have a legal obligation to ensure that the company is adequately tracking its liabilities that may affect its finances, and officers have a duty under the Sarbanes-Oxley act section 302 to ensure that financial statements "fairly present" the finances of the company. Under existing accounting procedures is unlikely that any company with substantial environmental liabilities is fairly presenting their financial condition if they rely strictly on some of the accounting rules, such as the ones requiring only reporting of the "known minimum". However, the fatal flaw in relying on the courts to police corporate accounting is that this is not a preventive strategy, and does not guide corporate activity on a day-to-day basis. Instead, it is a strategy that could take many decades to clarify corporate obligations to adequately inform investors. In the meantime, many companies will continue to conceal billions of dollars in liabilities from investors

In part three, we examine the opportunities for regulators to establish clearer rules that would require companies to disclose additional information relevant to liabilities. The corporate legal community has widely opposed improved accounting rules proposed by the Financial Accounting Standards Board based on an argument that such rules could lead to publication of information that could be used by plaintiffs to actually increase the amount of liability companies would have to pay out. However, we identify some possible accounting and disclosure requirements that would improve the current state of disclosure while being, on balance, more useful to investors than any prejudicial impact -- in legal terms "more probative than prejudicial." Such additional requirements would include an interpretive guidance issued by the Securities and Exchange Commission to require disclosure of certain "sustainability" issues that face companies; a requirement for companies to calculate and disclose benchmarks of their estimated liabilities, through examination of publicly available examples of similar liabilities experienced by other companies, and the use of external consultants to develop estimates of the company's liabilities based on nonprivileged information.

You can read the full series on my Corporate Disclosure Alert blog.

Update:
Following up on this blog post, I wrote to the FASB Board members on October 22, 2009. Contingent liability predictions should be "more probative than prejudicial"; they should not avoid prediction entirely. http://tr.im/CEAy

- Sanford Lewis