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Bridging the credibility gap: eight corporate liability accounting loopholes that regulators must close

Sanford Lewis, Esquire
June 2009

The current financial crisis has highlighted the failure of the federal regulatory system to ensure honest accounting. The meltdown of trillions of dollars of value followed upon regulatory failures earlier in the decade. This report examines one group of regulatory loopholes that continue to render corporate financial statements and disclosures a highly approximate and unreliable indicator of value. Among other things, the regulatory flaws encourage companies to conceal damaging scientific findings from investors, fail to disclose estimates of the range of potential liabilities, and place undue reliance on litigators, in conflict with their obligations to protect privileged information. Drawing on case studies of disclosures about asbestos and nanotechnologies, this report offers practical solutions to bridge this regulatory accounting gap.
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The eight loopholes identified by this study, which ought to be closed by the Securities and Exchange Commission (SEC) and the Federal Accounting Standards Board (FASB) include the following:

  • SHORTSIGHTEDNESS. Taking the short view and thereby effectively avoiding disclosure or estimation of potential longer term liabilities.

  • CONCEALED SCIENCE. Concealing emerging science that forewarns of potential liabilities in the future.

  • THE KNOWN MINIMUM. Disclosing only the “known minimum” of potential liabilities, even though a more realistic assessment might be so much larger that it would indicate the potential for a total wipe out of shareholder value.

  • PRIVILEGING SECRECY. “Privileging” concealment, by using attorney-client privileges as a shield against generating a public estimate of liability for investors.

  • INCONSISTENT ESTIMATES. Providing inconsistent liability estimates to insurers and investors, with larger estimates of liabilities typically provided to insurers than to investors.

  • HIDDEN ASSUMPTIONS. Using hidden assumptions to minimize estimates of liability.

  • MISSING BENCHMARKS. Refusing to benchmark liabilities against other companies whose published litigation results may demonstrate realistic estimates of liability.

  • RISK-FREE PROXIES. Refusing to allow shareholders to place on the annual proxy ballot questions requesting disclosure of specific risks of concern to investors.