In this case, the plaintiff class alleged that K-tel violated FAS 121 and FAS 5 when it filed the March 30, 1998 10-Q on May 8, 1998 by representing that its net tangible assets were in excess of $4 million. This is the minimum required for listing on Nasdaq. The basic defense of K-tel and the signatories to this 34 Act report was that this was alleging fraud by hindsight since the alleged failures to report these matters in the March 30, 1998 10-Q was based on the write-off of these amounts in 34 Act filings for subsequent periods.

Generally, FAS 121 relates to the accounting for the impairment and disposal of long lived assets and certain identifiable intangibles. FAS 5 establishes standards of financial accounting and reporting for loss contingencies and it requires accrual by a charge to income (and disclosure) for estimated losses from a loss contingency if the information is available prior to the issuance of the financial statements and the amount of loss can reasonably be estimated. 

In this case, K-tel had formed an infomercial subsidiary in 1997. Plaintiffs contended that by March 31, 1998 K-tel should have realized that its infomercial subsidiary was going to be closed and that it should have written off $1,498,000, which was the cost of the non-usable infomercials and other media items purchased by the subsidiary in the March 31, 1998 quarterly financials. The defendants argued that the complaint contained no particularized allegations supporting this number or the asset or assets subject to an FAS 121 assessment, and that the complaint failed to allege with particularity the acts which would have triggered an FAS 121 assessment as at March 31, 1998.  

The majority held: "'Long lived assets' include items such as land, buildings, equipment and furniture. Further 'identifiable intangibles' include items such as patents, franchises and trademarks." The majority then went on to hold that the assets listed by the class were neither long term assets nor identifiable intangibles and, therefore, as a matter of law the plaintiffs had failed to allege facts which triggered FAS 121. 

The dissent sharply disagreed. First, it noted that accounting standards are not bright line rules and that application of them requires judgment calls. Second, to identify the specific assets which should have been subject to a write-off pursuant to FAS 121 at the outset of a litigation was unfair to the plaintiffs and this went beyond the particularity requirements of the Reform Act. The dissent then pointed out that the details of the operations of, and accounting for, an off balance sheet corporate entity is something that only the corporate insiders would have access to. 

In dismissing the claim based on FAS 5, the majority noted that the complaint did not explain what specific information was available and how any loss could be reasonably estimated for the March 10-Q or the June 10-K and, thus, these allegations did not contain the requisite particularity. The dissent stated that to require the plaintiffs, at the beginning stages of litigation and without the benefit of discovery, to identify the specific terms of the alleged contracts which were no longer operative was unfair. 

The significance of this case is whether courts will continue to give a restrictive, narrow reading to the pleading requirements of the Reform Act in light of the public sentiment toward financial professionals and company officers resulting from the recent Enron, WorldCom and other financial reporting improprieties. In addition, it will be intresting to see how the heightened disclosure and financial reporting requirements of the Sarbanes-Oxley Act will affect courts' views towards alleged violations of GAAP.

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