The Exxon Valdez Crashes into Fair Value Accounting

The Supreme Court's slap at the "stark unpredictability" of punitive damages in the oil tanker case highlights the challenge of making companies report future lawsuit liabilities to investors.

Levine, who says about a quarter of his practice involves litigation, still says it is possible to apply valuation techniques to litigation. “Valuation is expected future cash flow divided by risk,” he says. If it isn’t possible to discount the future liability of a lawsuit from cash flows, he says, then investors need as much information as possible to decide how much to increase the risk factor. “Obviously, that is subjective, but the beauty of the market is that it reaches a consensus.”

But that’s little solace to advocates of tort reform. Steve Hantler, former assistant general counsel for DaimlerChrysler, and now Director of Free Enterprise and Entrepreneurship with the Marcus Foundation, believes that plaintiff’s attorneys deliberately put pressure on the value of company shares in an effort to force companies to settle faster.

Under current accounting rules, companies are only required to take a financial charge for a contingent loss if it appears probable that the loss has occurred and its amount can be reasonably estimated. If those conditions are not met, companies must disclose the loss contingency only if there is a reasonable possibility that a loss has occurred.

Under the new rule, companies would have to disclose all loss contingencies unless their likelihood is remote. And companies also would be required to disclose any contingency — no matter how remote — that is expected to be resolved within a year and could have a severe impact on the company’s financial position, financial results, or cash flow.

Hantler says he supports the idea of having companies disclose their actual litigation losses to shareholders after the fact, but says the FASB proposal is “a bad idea” that is likely to give plaintiff’s lawyers more ammunition against companies. “There’s so much room for mischief if companies have to report something, even if they think [the case against them] is utterly frivolous.” In a worst case scenario, says Hantler, he could even imagine plaintiff’s lawyers filing frivolous lawsuits “trying to set them up for [subsequent] fraud lawsuits or poor record-keeping suits.”

By expressing the court’s preference for a maximum ratio of 1:1, says Hantler, the Exxon ruling “will certainly help” corporate attorneys try to control punitive damages, “but it doesn’t solve the problem of punitive damages,” says Hantler. “We have seen some judges in state courts ignore a [2003] Supreme Court ruling that said 9:1.”

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