Why has there been so much more attention on disclosing litigation in financial reports?
Steve Stanton: Both FASB and the SEC have stated publicly that the existing rules do not provide sufficient information to assess the likelihood, timing and magnitude of potential losses. In public speeches the SEC staff has stated that they may question lack of historical disclosure of the existence or amount of contingencies when settlements are disclosed in future periods. The SEC staff has noted they are concerned that for reasonably possible loss contingencies—which require disclosure of possible ranges of loss, if reasonably estimable—some companies may be too readily taking the position that a reasonable estimate of the loss cannot be made, in order to avoid disclosing that information.

Additionally, this heightened focus by the SEC will likely lead to increased scrutiny by external auditors and users of financial statements. Directors should also anticipate that plaintiff counsel will be reading their disclosures carefully.

What are the issues GCs and directors should be alert to?
Mike McConnell: Companies face a balancing act in drafting loss contingency disclosures. On one hand, they need to comply with accounting rules and SEC reporting requirements, and provide full and fair disclosure for investors. However, estimating the likelihood of litigation losses is often a subjective and predictive affair, and doing so with precision can be difficult or impossible, especially in the early stages of litigation. Negative consequences can flow not only from understating the likelihood of a loss, but also from over- or underestimating a loss. Given the estimate is inherently subjective and imprecise, the inclusion of an estimate or a range of loss may unintentionally suggest a level of reliability that could be construed to be misleading. Companies should also be wary of disclosing confidential information, including strategy or assessments about litigation, to outside auditors or in public filings. Public filings are, of course, available to opposing parties, so the company’s position in ongoing litigation can be harmed if legal strategy is revealed, and settlement negotiations can be affected by disclosure of an estimated loss amount.

Auditors are considered outside parties, so companies should also be mindful of the dangers of arguably waiving attorney-client privilege or work product protections. Furthermore, company counsel should be familiar with the “treaty” between auditors and attorneys from the 1975 American Bar Association “Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information,” which discusses the protection of attorney-client privilege and largely sets the structure for dialogue between auditors and lawyers.

What roles should GCs and directors have in disclosure of loss contingencies?
Stanton: Directors should be sure they are well informed about material litigation and other contingencies and understand the process their companies use to determine the accounting and disclosures for litigation and other loss contingencies.

McConnell: We would suggest the following:

• Monitor whether the company has effective processes and controls for identifying and evaluating loss contingencies.
• Make inquiries of management, in-house counsel, outside counsel and external auditors about potentially material loss contingencies. For particularly significant matters, directors should consider having status reports at each board meeting.
• Focus closely on these disclosures when reading drafts of public filings, especially on disclosures of reasonably possible loss contingencies where contingent loss amounts are not reasonably estimable and thus not disclosed.
• Be sure you are satisfied that the company is striking the right balance between complying with the accounting rules and the desire to provide full and transparent information to the investing public while not jeopardizing attorney-client privilege or damaging the company’s competitive or litigation position.

Contact Steve Stanton at sstanton@navigant.com and Mike McConnell at mmcconnell@jonesday.com. To read an unabbreviated version of this article, visit www.navigant.com/gccorner.

What we also discovered in putting the list together was that in some instances, it became impossible to separate the captain from the team. This year’s D100 is a case in point: Our editors and board of advisors were nearly unanimous in our selection of President Barack Obama as this year’s most powerful corporate governance influence. And yet, to do justice to the seismic shift his policies have brought about in the boardroom, we also had to recognize the many other  “New Voices” in the Administration who are now leading the greatest financial reform of American business since the 1930s.

So, we ask that in the pages ahead you pay more attention to who counts, and less to how we count, in arriving at our final selection of individuals and institutions that have met the requirement to be “most influential.” We think you’ll agree it’s an intricate and impressive mosaic where the whole equals much more than the sum of its parts, which may or may not be greater than 100.

Regulators & Rulemakers

Team Obama
It is often written that reasonable people may disagree, and with Americans and their Presidents, it is practically a way of life. But even an unreasonable person could only conclude that this President and his Administration are having a profound and lasting influence over the boardroom. President Barack Obama has demonstrated an enormous capacity for calm in uncertain times. His relative youth leads to frequent comparisons to John F. Kennedy and his communications skills to those of Ronald Reagan. But it is his aggressive response to the unparalleled economic challenges that greeted him at the dawn of his young presidency that harkens back to an earlier figure of towering influence,  Franklin D. Roosevelt.

FDR’s massive social and financial reform programs—the creation of Social Security as part of the New Deal, the establishment of the Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Company (FDIC)—helped restore confidence in the nation’s banking system coming out of the Great Depression. One could plausibly take major portions of FDR’s New Deal and substitute his name with President Obama’s.  The implementation of the $787-billion American Economic Recovery Act one month after Obama took office, coupled with his handling of the Troubled Asset Relief Program (TARP), which sought to strengthen the financial sector by buying up the assets and equity from troubled banks, has clearly helped the nation avoid further financial disaster and put the economy on the path to recovery.

And finally, turning again to the FDR playbook, Obama assembled a team of wise men and women, formidable economic and business minds, whose decisions are having a lasting effect on the role of the corporate director. Preeminent among them was the choice of Rahm Emanuel as chief of staff. Described as a veritable “influence machine,” within the Administration and Congress, the former Congressman from Obama’s home state of Illinois is known as a hard-charging, brutally candid, sometimes combative, acutely intelligent man who can get things done and knows the ways of the Capitol and the boardroom.

The Enforcers
Perhaps second only to Obama in terms of her influence on boards and corporate governance, career regulator Mary Schapiro heads up the 75-year-old SEC. Before the crisis, the agency’s very existence was in question: “Obsolete,” “out of touch,” and “behind the times” were just some of the many terms uttered by detractors. The Commission, under former chairman Christopher Cox, was pilloried for missing the Madoff scandal.

As former SEC chairman and Directorship 100 Hall of Famer, Arthur Levitt described her: “She has the skills, the intellect, and the character to be a superb SEC chair.” But Schapiro will face a new kind of challenge in the role, not just that of proving her own qualifications, but also instituting a significant remodeling of the SEC itself, as she works to bring it into the new regulatory era.

Moving swiftly to address regulatory concerns in the wake of the financial crisis, the SEC has rolled out a series of proposals that could embody the biggest change to the rules of the game for directors in some time. Schapiro, who is no stranger to the boardroom, having served on the boards of Duke Energy and Kraft Foods, has overseen proposed rule changes on proxy access, broker voting, say on pay, and new requirements for disclosure on executive compensation and director qualifications. It’s now up to her and fellow commissioners Kathleen Casey, Elisse Walter, Luis Aguilar, and Troy Paredes to determine the final regulations that emerge from the proposals.

Other key players Schapiro has brought into the SEC include Senior Advisor Kayla Gillan, Chief Accountant James Kroeker, and Director of Enforcement Robert Khuzami. Gillan was a founding board member of the Public Company Accounting Oversight Board (PCAOB) and former general counsel to CalPERS. Kroeker joined the SEC as deputy chief accountant in 2007 from Deloitte and Touche where he had been a partner in the firm’s national accounting services group. Kroeker recently said that the proposed road map for the convergence of International Financial Reporting Standards,pushed to the back burner amid the larger issues of market reform, would be restored as another top priority. Khuzami is a former federal prosecutor, has pledged to improve the SEC’s enforcement performance by creating specialized units to provide “structure and resources for staff to ‘get smart’ about certain products, markets, regulatory regimes, practices and transactions.”

TARP Overseers
Another example of Obama’s preference for brains over politics was his reappointment of Sheila Bair to chair the FDIC. Another fiscally conservative Republican, on Bair’s watch alone this year, 94 banks have failed, creating a new challenge:  how to replenish the fund. Bair has also been an integral part of the team overseeing TARP. Neil Barofsky is a former New York assistant attorney general confirmed by the Senate in December as special inspector general. Dubbed the “TARP Cop,” his job is to figure out how and where the $700-billion TARP funds are spent, reporting directly to the President and providing updates to the Congressional Oversight Panel chaired by bankruptcy expert and Harvard Law School professor, Elizabeth Warren. COP’s first report, released in February, casti-  gated then-Treasury Secretary Henry Paulson for his performance and lack of transparency, reporting that the Treasury Department  had overpaid by $78 billion for the assets it bought from banks.

Interestingly, while Obama sponsored and was a strong proponent of  “say on pay” legislation while a senator, since appointing Kenneth Feinberg special master of compensation, he has appeared unwilling to make the issue a top priority. Feinberg, who has immersed himself in some of the country’s most troublesome and high-profile cases, is considered a superb choice, both in terms of skill and temperament, by Capitol Hill insiders. His most noteworthy case was the 33 months of pro-bono work he did following the 2001 terrorist attacks to determine how much each victim would receive from the federal government’s September 11th Victim Compensation Fund.

Feinberg may in fact be perfectly suited for a job that most compensation specialists see as thankless, and possibly as a “no win” situation. As the Obama Administration’s comp expert, Feinberg was called on to monitor the compensation of executives in what were once some of America’s most prestigious corporations, now TARP recipients, including American International Group (AIG), Bank of America, Citibank, Chrysler, GMAC, and General Motors.

Fed to the Rescue
To prevent American capitalism from spiraling deeper into the abyss, nine months after President Obama made his first Cabinet announcement, he re-nominated Ben Bernanke as Federal Reserve chairman. The former Princeton economics professor was selected by Bush in 2005 to succeed Alan Greenspan. In 2008 after the market crashed, Bernanke invoked emergency powers, slashed interest rates, and spent trillions of dollars to right the financial system. Just last month, he declared the recession “likely over.” Though he seldom gives interviews, Bernanke is never far from the public eye and has been a stalwart in the transition between presidential administrations and in the effort to stem the economic slide.

When then President-elect Obama named his economics team, it included players who, like Bernanke, were already steeped in the crisis details, demonstrated a studied understanding of Depression-era economics, or some combination of both. Enter Treasury Secretary Timothy Geithner and Chief White House Economic Advisor Lawrence H. Summers. Geithner, who is currently pushing legislation to provide more systematic regulation of financial institutions, including new limits on executive compensation, recently told one interviewer that he is optimistic major reforms will be passed.

Prior to his appointment replacing Henry Paulson, Geithner was president of the Federal Reserve Bank of New York and part of the team central to the critical negotiations that resulted in Bear Stearns being tucked into JPMorgan Chase, Merrill Lynch going to Bank of America, Lehman Bros. disappearing, and Citigroup and other struggling banks getting a lifeline.

Summers, the former Harvard University economist who became its president following his tenure as Treasury Secretary to President Clinton, is director of the Cabinet’s National Economic Council. The group was established in 1993 to coordinate and ensure that the President’s economic policy agenda is carried out.

Rounding out the team, Paul Volcker, the former Fed chief under Clinton, was selected to chair the president’s economic recovery advisory board. And Christina Romer, a former UC Berkeley economist, who administration sources suggest is well- regarded by both parties, chairs the Council of Economic Advisers. Her appointment was seen as a further triumph of brain over politics in Obama’s approach to talent recruitment.

The results of this sometimes-contentious public dialogue have far-reaching implications for corporate directors and the rest of the American business community. At the most basic level, the pronouncement issued by FASB last spring gives enhanced guidance to companies and their external auditors regarding the application of fair value, with a specific emphasis on the use of judgment. Beyond this concrete change, the fair-value debate has also created fresh questions and new public scrutiny around the role of FASB as an independent standard setter.

On the Mark?
The term “fair value” accounting, also known as “mark-to-market,” refers to the practice of using available market information to estimate the price an asset would be worth if it were sold or the cost to settle a liability. The basic principle of using market information to value at least some assets dates back over thirty years. During the last 15 years, FASB has adopted standards that have expanded and refined the application of fair-value accounting, because it has been widely viewed as an important driver of increased transparency. Put simply, applying market information to value assets and liabilities gives investors relevant information about the economic realities of the companies in which they choose to invest.

Blackstone Group Chairman Stephen Schwarzman vigorously campaigned against fair value, calling it “pro-cyclical.”

Investor demand for increased transparency has only grown over the years. The savings and loan failures of the 1980s spurred the wider application of fair-value rules. With the passage of the Sarbanes-Oxley Act of 2002, the audit committees of corporate boards were given a more prominent role in the hiring of external auditors and greater oversight of the audit process, including the application of fair-value accounting. As fair value was increasingly viewed as an important tool for improving investor access to valuable information, there was a perceived lack of a single, consistent definition for the term, or clear guidance for its application. In order to address those concerns, in 2006 FASB promulgated FAS 157. This action by FASB did not “create” fair-value accounting or somehow tighten standards; rather, FAS 157 simply established a uniform definition of what “fair value” means and provided a consistent framework for its continued application.

The introduction of FAS 157 was hardly noticed by those outside the accounting profession. In 2006, when the standard was issued, the capital markets were strong and asset holders were apparently satisfied with the prospect of marking the value of assets to the pricing information provided by markets prevailing at that time. For calendar year-end companies, the new standard would apply to financial statements for the period beginning Jan. 1, 2008, and in 2006 there was no reason to assume that 2008 would pose a problem with respect to market values. But the world was about to change.

The Fair-Value Spiral
By late 2007 and into 2008, the global credit crisis began to take hold. Asset-backed securities, particularly those tied to sub-prime mortgages, began to collapse in value as the housing market softened. Securities that had been considered relatively safe investments were suddenly revealed as highly risky. As the markets for these assets seized up, financial institutions were forced to take substantial write-downs. The write-downs reflected losses in the underlying value of assets that then led to the collapse in the market valuation of these firms, raising concerns about their ability to meet their regulatory capital requirements.
In the face of the growing crisis, the financial industry and others began seeking emergency remedies. Among the various options, attention quickly zeroed in on fair-value accounting. One of the dilemmas critics of the accounting model raised was, what happened when the market became illiquid and pricing information scarce?

In April 2008, Steve Forbes, who would become a leading fair-value opponent, published an opinion piece urging the Bush administration to temporarily suspend mark-to-market accounting. Blackstone Group Chairman Stephen Schwarzman vigorously campaigned against fair value, calling it “pro-cyclical.” Former Federal Deposit Insurance Corporation chairman William Isaac, along with former House Speaker Newt Gingrich, joined this chorus of voices calling for changes to, or suspension of, fair value. Trade associations including the American Bankers Association (ABA), the Independent Community Bankers Association (ICBA), and others stepped into the fray, arguing that fair value is not the most relevant measurement for financial instruments.

On the other side of the issue, proponents of fair value accounting, including the Council of Institutional Investors (CII), the Consumer Federation of America, and the Chartered Financial Analysts (CFA) Institute, as well as the Center for Audit Quality, issued a series of open letters and public statements arguing that fair-value accounting was not the cause of the credit crisis, nor would its suspension resolve it. Rather, these groups argued that fair-value accounting provides investors with critical transparency into the economic realities of public companies. They argued further that undue outside pressure should not be allowed to compromise the independent standard setting process.

The fair-value debate continued to intensify over the fall and into the winter of 2008-2009 as the financial crisis deepened. When Congress approved the Emergency Economic Stabilization Act, creating the Troubled Asset Relief Program (TARP) to protect the solvency of 19 of the nation’s largest financial institutions, it directed the Securities and Exchange Commission to study the issue.

In December, the SEC issued its report, which concluded that fair-value accounting had not caused the credit crisis and argued against suspending or substantially changing the standards. Rather, the report indicated that bank failures in the United States appeared to be the result of growing probable credit losses, asset quality concerns, and, in certain cases, eroding lender and investor confidence. While the SEC was clear in its judgment, the debate continued.