Wednesday, 20 August 2014

Financial Reporting for IP Intangibles: protecting investors from infringement risks

It's not often that the IP Finance weblog gets the chance to post a response to a response to a response to an original post, but Efrat Kasznik's initial piece on Financial Reporting for Intangibles drew this response from Janice Denoncourt. An anonymous reader then came back this an observation that
"IP is an asset, and one can see that its value should be estimated and reported. However if you are going to 'shine a light' and in particular try to protect investors, then I wonder whether there should be responsibility to report whether a company knows it is likely to be infringing third party rights. This would be very onerous and I would be against making this mandatory. However the 'effect of IP' on value clearly works both ways, and shouldn't investors be protected from this risk too?" 
Janice now responds as follows:
"You are referring to litigation risk. The simple answer is that, as a minimum, current litigation involving the company must be disclosed if it will have a material effect on the company’s financial results. For example, litigation against a company that represents a tiny percentage of the company’s assets would probably not need to be disclosed. It is certainly more difficult to deal with the disclosure of potential litigation risks, eg the risk of being sued for IP infringement in the future. If the board determines that the risk of litigation is high, then appropriate measures should also be taken to limit or eliminate the risk eg obtain a licence. Strong disclosure of litigation risk (bad news) will tend to lower a company’s share price. If there is high risk of litigation, one would also expect the company to publish a more detailed disclosure to explain the impact. 
A company will look at using meaningful cautionary language to minimise the impact of the disclosure, yet still comply with the spirit of the law. The “generally accepted accounting principles” (GAAP) standards used by companies provide that it must set up a ‘reserve fund’ for potential estimated losses due to pending litigation or explain why it has departed from GAAP. Failure to disclose material litigation can result in civil fines, suspended share trading and possibly criminal charges. The regulator can also seek an injunction requiring the company to disclose the litigation. 
As for your second point -- the effect of IP value on the business -- I suggest that, as a starting point, one needs to ensure that the narrative disclosure aligns with the numeric intangible figure in the financial statements. If the intangible figure has increased or decreased significantly from the previous year, the company need to explain why. Basically, directors always need to explain the money".


Anonymous said...

That's very interesting. I've often wondered whether voluntary guidelines should be in place to help companies with this. The guidelines would for example recommend a minimum level of freedom to operate analysis of the company's activities and the disclosure of significant results from these. Investors and third parties could then see whether that analysis had been done, and ask why not if they were interested in the company. The broader idea is to set up clearly defined norms which would help to derisk investments in complex technology areas where patents (one's own and third party ones) are an important determinant of value.

Richard Milchior said...

This concerns the last point about disclosing litigation.

To give you a point of reference, in France lawyers receive each year a letter from the auditors asking them to disclose any pending litigation- which includes IP- and to asses the risk from a financial point of view.

Due to the ethical rules , we can not answer to them; However we inform the client of the request of its auditors and provide him with the answers.
Then it becomes the duty of the clients to decide if they want to provide their auditors with a copy of our letter . It is usually done and according to the level of the risk you will or not find in the auditor's report a detailed or general information about the pending litigation and the relevant financial risks.

I do not know what is the situation in other countries bu tI think that other readers can certainly provide such information