Thursday, October 30, 2008

FASB To Hold Roundtable Nov. 6 On Proposed Securitization Changes

Today’s FASB Action Alert announced that FASB will hold a roundtable on Thurs. Nov. 6 on its proposed changes to securitization and related consolidation rules. Specifically, the roundtable will feature respondents to FASB’s Exposure Drafts (ED) released earlier this year, including the Proposed Amendment of FAS 140 on Transfers of Assets, and the Proposed Amendment of FIN 46R, Consolidation of Variable Interest Entities. Although the proposed changes to recognition and measurement of balance sheet and income statement items in those proposals would not take effect until 2010 (technically, the beginning of each reporting entity’s first fiscal year that begins after November 15, 2009), FASB concurrently proposed enhanced disclosures that would take effect ‘as soon as practicable’ (meaning, potentially, this year end or early next year), set forth in Proposed FSP FAS 140-e and FIN 46R-e.

The proposed amendments to the accounting standards listed above include removal from FAS 140 of the concept of a Qualifying Special Purpose Entity (QSPE) – a vehicle used for some mortgage securitizations and other securitizations - and removal of the related exception that had been provided for QSPEs from applying the consolidation rules set forth in FIN 46R.

These proposed changes have been widely reported to potentially add back billions if not trillions of dollars of securitizations back on the balance sheets of financial institution and potentially other types of companies who used these vehicles to sell assets. See, e.g. “FASB Delays Rule Affecting Trillions in MBS,” by National Mortgage News Online (July 31, 2008) which said FASB considered (and later agreed) to move the date of its proposed changes to the securitization rules out another year (to 2010), and cites a letter from Rep. Spencer Bachus (R-Ala.) to FASB, which said “changes to securitization accounting potentially affects $10.5 trillion in securitized assets, including $7.2 trillion in mortgage-related securities.”

You can read the comments on proposed changes to FIN 46R, and comments on proposed changes to FAS 140; so far the comment file is light because the comment deadline is November 14; it is likely that constituents appearing on next week’s roundtable will file their comment letters by November 6. Separately, there are 30 comment letters on the proposed disclosures right now, because the comment deadline on the disclosure proposal was October 15.

If you are following the proposed changes to the securitization rules, and other proposals affecting the financial reporting landscape, come to FEI’s Current Financial Reporting Issues Conference Nov. 17-18 in NYC. Keynote speakers include SEC Chairman Christopher Cox, FASB Chairman Robert Herz, and IASB Chairman Sir David Tweedie. Technical update sessions at CFRI will feature senior staff of the SEC, FASB and IASB along with leading financial executives and auditors. Find out more at . And, check out our related programs taking place in NYC that week: FEI’s Hall of Fame Gala at the New York Stock Exchange Nov. 17, and IFRS: Strategies for a Single Set of Standards, sponsored by Deloitte Nov. 19. COMING SOON: Our blog will be moving to google blogger in November, you can take a sneak peak here; watch this space for updates! Enter your email address here if you’d like to receive our blog by email.

FASB Votes On Pension Disclosures, Bus Comb; SEC Roundtable

At yesterday’s FASB board meeting, the board reaffirmed the effective date for its upcoming FSP on Employers’ Disclosures about Postretirement Benefit Plan Assets will be fiscal years ending after December 15, 2009, with early application permitted. (In effect, FASB reaffirmed this extended date which it agreed to at its Sept. 24 board meeting, which is one year later than as originally set forth in Proposed FSP FAS 132R-a.) The board agreed to require the type of disclosures set forth in FAS 157, including a reconciliation of beginning and ending balances for fair value measurements of plan assets using significant unobservable inputs. In discussion at the board meeting, the board considered, but decided not to include, any differential treatment for private companies, and decided not to defer the effective date for private companies. The board authorized the staff to proceed to a ballot draft. Further details are in FASB’s Summary of Decisions Reached.

Business Combinations
Separately, FASB agreed at its board meeting yesterday that a proposed FSP should be issued regarding assets and liabilities arising from contingencies in a business combination (an FSP providing guidance on FAS 141R, Business Combinations). Details on the boards decisions on this matter are in FASB’s Summary of Decisions Reached. An interesting part of the discussion centered on litigation contingencies and potential convergence work between IASB and FASB on accounting for contingencies.

FASB Chairman Robert Herz noted that with respect to the two projects FASB will undertake on contingencies, the first being the current project on disclosure of contingencies (the proposed FAS 5 amendment released earlier this year), the second being recognition and measurement of contingencies, “I am more sanguine at this point on improvement in disclosures, that should be for all contingencies, not just acquired ones, than I am on a converged solution on recognition and measurement; we would hope we could get there, but fair value approaches to certain contingencies in this country, litigation ones, I think will be pretty tough unless we get the immovable object in our system [the legal system, to change],.. we... have to admit, unless we change our system here, we almost have to have a U.S. carve-out [on litigation contingencies], I don’t know how a U.S. company would adopt [IFRS] without the change.”

Board member Tom Linsmeier replied, “That’s why I’d hope we can join the conversation” in terms of trying to come up with a converged standard on contingencies, so that “our constituents are part of the process that IASB is thinking about… either we can get converged or we can’t, rather than put our constituencies in a [situation] what IASB does is said and done, and the only [option] is for a [U.S.] carve-out.”

Initial Highlights From SEC Roundtable on Mark-to-Market Accounting
FAS 141R (Business Combinations) was also referenced at the SEC’s roundtable on mark to market accounting which took place yesterday.

One of the most significant comments - in my view- was from panelist Chuck Maimbourg, SVP Accounting Policy at Key Bank, who said that his bank turned down an acquisition earlier this year when they realized how extensive a mark-down FAS 141R would require them to take on loans acquired, since the loans would have to be marked to fair value upon acquisition.

SEC Division of Corp Fin Chief Accountant Wayne Carnall, a moderator at the roundtable, asked Maimbourg, “You did not complete an acquisition because of FAS 141R accounting?” Maimbourg replied, “yes.” Carnall followed up: “Even though the economics made sense, accounting drove the decision?” Maimbourg again said yes. FAS 141R was just a small part of the discussion of fair value accounting during the roundtable.

Another significant comment - in my view - was a suggestion by Vin Colman of PwC, to address concerns of those who believe fair value accounting has exacerbated the credit crisis, that the SEC and FASB could:

- consider separating periodic changes in fair value (FV) into 2 components, incurred credit losses and other changes in FV, including liquidity discounts
- recognize, first, incurred credit losses in income, all other changes in Other Comprehensive Income (OCI), until the asset is sold or matures, and
- change the format of the income statement for more visibility of changes in FV and inclusion of OCI on face of the income statement

I am not saying the above suggestion is necessarily the way to go, but it was a substantive suggestion for consideration. See Colman’s written statement.

A number of panelists said they did not believe fair value or mark to market accounting was the root cause of the credit crisis, and that the SEC's study of mark-to-market accounting should consider root causes as well.

Additionally, various panelists suggested bank regulators try to address procyclicality concerns directly by amending capital requirements, rather than by changing the fair value accounting model.

However, the most vociferous opponent of the fair value accounting model in place under FASB Statement No. 157, Fair Value Measurement, former FDIC chairman William Isaac, said that even if bank regulators modified their approach to capital requirements, in recent months, it was not the bank regulators who precipitated the failure or takeover of major banks like Wachovia and WaMu, but the actions of ratings agencies and short sellers, who were making decisions based on fair value GAAP-based information, thus rendering the argument of separate treatment or backing out of fair value related results by regulators essentially moot in terms of calming the credit crisis.

The view of the investor community represented by the CFA Institute and others, was that the fair value accounting rules provide important transparency.

Isaac was asked by one of the moderators, SEC Corp Fin Director John White, to take an ‘investor’ point of view of the fair value accounting rules. Isaac said he was happy to do that, noting, “Nobody ever talks about the hundreds of billions of dollars pension funds have lost because of these rules, my aunt lost because money invested in banks, stable source of earning dividends, not a dot-com investor, got wiped out in banks, conservative banks..” He added, “I am concerned for the investor and all the unemployment [this is] going to cause,.. Treasury is handing out capital just about as fast as FASB and SEC are going to destroy it… These rules are destroying capital, and you are asking me to put more money in.” He noted the fair value accounting rules result in: “not real losses, but paper losses, when marking against computer models… our banking system doesn’t have 35 to 1 leverage, [a leverage ratio referenced by another panelist] a couple investment banks did, our banks are the best capitalized by far [compared to other countries], and you are destroying them by paper losses, not real losses.”

He added: “The words fair value, you can’t have those words, you can’t own those, I’m for fair value accounting, I don’t believe marking to a computer model of fire sale prices based on distressed sales is fair value; fair value is to look at cash flows, [and] probably [look at] losses if you have a default.” .

Isaac advocated that the SEC suspend FAS 157, noting in its place he’d prefer to see amortized historical cost, along with recording permanent impairment, and what assets could be sold for today (without marking them down to that number). See Isaac’s written statement.

We will post further highlights from the SEC roundtable in a summary on later this week.

Tuesday, October 28, 2008

SEC To Examine: How Is Fair Value Faring?

The SEC is slated to hear from investors, auditors, issuers and others at an Oct. 29 roundtable on mark-to-market (MTM) accounting. (Note: MTM is often called fair value (FV) accounting. Although there are technical differences between the two terms, fair value accounting as defined in FASB Statement No. 157 emphasizes use of an exit price or current sale price notion of ‘market value’ as the best reference point for fair value.)

Earlier this week, the SEC posted the agenda with links to panelists’ bios, and a related press release notes the roundtable will focus on four issues: (1) usefulness of mark-to-market accounting to investors and regulators, (2) effects of mark-to-market accounting on financial reporting by financial institutions, (3) potential market behavior effects from mark-to-market accounting, and (4) whether aspects of current accounting standards can be improved, and how.

The Oct. 29 roundtable is one mechanism being used to obtain feedback to inform the SEC’s Congressionally mandated study of the impact of mark-to-market accounting on financial institutions. As noted in SEC’s Spotlight page on Fair Value, the study, as set forth under Section 133 of the Emergency Economic Stabilization Act of 2008 (EESA), “shall consider at a minimum (1) the effects of such accounting standards on a financial institution's balance sheet; (2) the impacts of such accounting on bank failures in 2008; (3) the impact of such standards on the quality of financial information available to investors; (4) the process used by the Financial Accounting Standards Board in developing accounting standards; (5) the advisability and feasibility of modifications to such standards; and (6) alternative accounting standards to those provided in [FASB] Statement Number 157 [entitled, Fair Value Measurement].

Another feedback mechanism used by the SEC in connection with this study is the issuance of two separate requests for comment: the First Request for Comment, issued on October 8 was very general in nature and carried a November 13 comment deadline; the Second Request for Comment issued on October 20 invited comment on the four areas of focus slated for the Oct. 29 roundtable, and the comment deadline was October 28.

On the eve of the Oct. 29 roundtable, eighty-two comment letters have been posted so far. If you want to get a flavor for the two sides of the fence (note: very few are ‘on the fence’ although to some the jury is still out, and to others some modifications or tweaks may suffice rather than wholesale suspension or radical amendments of the fundamental tenets of existing accounting standards) here are a couple representative letters from each side of the fence:

Proponents of MTM/FV accounting as currently constructed: See, e.g. the Oct. 15 letter sent by the Four C’s to the SEC . We refer to the “Four C’s” as shorthand for the joint letter sent by the Center for Audit Quality, CFA Institute, Council of Institutional Investors, and Consumers Federation of America. The letter states: “We are writing to express grave concern regarding recent calls for the SEC to override guidance issued by the Financial Accounting Standards Board (FASB) and the Commission’s staff that would effectively suspend fair value or mark-to-market accounting. We believe such urgings are decidedly not in the public interest.”

They continue: “a move by the SEC to suspend fair value accounting would be a disservice to the capital markets, would be inconsistent with the views of investors, would harm the credibility and independence of the standards setting process, and would run counter to fundamental notice and comment principles. With third quarter financial statements now in process and year-end 2008 imminent, such a change could jeopardize already-fragile investor confidence.”

“No one disputes that these are trying economic times,” say the Four C’s. “However, the current crisis of liquidity, credit, and confidence was not caused by fair value accounting; rather, sound accounting principles helped expose the problem. Fair value accounting with robust disclosures provides more accurate, timely, and comparable information to investors than amounts that would be reported under other alternative accounting approaches.

The Four C’s conclude: “Investors have a right to know the current value of an investment, even if the investment is falling short of past or future expectations. It, therefore, is imperative at this critical juncture that we not engage in activities that would further obscure reality from investors and do more to damage confidence in the marketplace. We urge the SEC to be clear in rejecting urgings that are contrary to this imperative. “

Opponents of MTM/FV accounting as currently constructed: See, e.g. the written statement of Former FDIC Chairman William M. Isaac , scheduled to testify at the SEC’s Oct. 29 roundtable, in which Isaac notes that when he was at the FDIC, after studying for over a year whether to push for mark-to-market accounting, “We finally rejected the notion for three principal reasons: (1) mark-to-market accounting could be implemented on only a portion of the asset side of the balance sheet … to attempt to do so would produce very misleading results. (2) mark-to-market accounting would make it very difficult for banks to perform their fundamental function in our economy, which is to take relatively short-term money from depositors and convert it into relatively long-term loans for businesses and consumers. Banks necessarily have some mismatch in the maturities of their assets and liabilities – it is up to bank management, regulators, and investors to make sure the mismatch is not excessive. Accounting rules made to influence behavior are no substitute for good judgment and can interfere with appropriate business conduct. (3) mark-to-market accounting would be pro-cyclical (which is never a good thing in bank regulation) and would make it very difficult for regulators to manage future banking crises.”

Isaac makes his case powerfully, stating: “I believe it is beyond dispute that mark-to-market accounting has been extremely and needlessly destructive of bank capital in the past year and is a major cause of the current credit crisis and economic downturn. The rules have destroyed hundreds of billions of dollars of capital in our financial system, causing lending capacity to be diminished by ten times that amount.” Although he “welcome[s] the partial relief from mark-to-market accounting that the FASB and the SEC provided in the past couple of weeks,” Isaac says “it is much too little, much too late,” and recommends: “I believe the FASB and the SEC should immediately withdraw SFAS 157,” and that “the SEC … recommend in its report to Congress that we abandon mark-to-market accounting altogether.”

Predicting the reaction of others who hold a different view, Isaac noted: “Some advocates of mark-to-market accounting gasp at the thought of suspending the rules. They assume it would result in a loss of transparency and an overstatement of values.” He counters, “Quite to the contrary, it is the use of mark-to-market accounting, when markets are not functioning properly, that has produced terribly misleading accounting and disclosures that value assets well below their true economic value.” He proceeds to recommend alternatives to the current FV framework, and recommends changes relating to accounting standard-setting as well.

Another comment letter which is aligned with Isaac’s views is the three sentence comment letter filed by Susan Saidens. Saidens, who presents herself as holding a litany of professional certifications in accounting (CPA), fraud prevention and detection(CFE), business valuation (ABV) and more, asserts in her comment letter: “The real issue with Mark to Market accounting is that the revised definition of "fair value" in SFAS 157 is inappropriate. The idea of using an "exit" price is wrong, and everything follows from that. The definition of "fair value" in SFAS 157 should be changed.”

FASB’s Parent Body Asks SEC To Reject Calls to Override FASB Standards
We previously reported on the letter sent by the American Bankers Association (ABA) to SEC Chairman Christopher Cox which asked the SEC to override FASB’s recent guidance on fair value in inactive markets, contained in FASB Staff Position (FSP) No. 157-3. We also previously reported on the letter filed with SEC by the Four C’s, described more fully above, which urged the SEC to reject any calls for action that would serve to “further obscure reality from investors and do more to damage confidence in the marketplace.”

FASB stepped in with a number of letters of its own, including, as we previously reported, a letter sent by Robert Denham, chair of the Financial Accounting Foundation (FAF) which oversees FASB, to House Financial Services Chair Barney Frank, and more recently (on Oct. 27), a letter from FAF Chair Denham to SEC Chair Christopher Cox urging the SEC to reject requests to overrule FASB standards (particularly as relate to fair value and FASB’s proposed revisions to securitization accounting).

Denham tells Cox in the Oct. 27 letter: “As enacted, EESA does not contain any provisions to override Statement 157.” NOTE: Some may question this statement, if they believe ‘override’ is implied in the ability of the SEC to ‘suspend’ FAS 157, a power that is directly authorized in Section 132 of EESA, entitled “Authority to Suspend Mark-to-Market Accounting.”

The FAF letter continues: “Notwithstanding the U.S. Congress' rejection of any such provisions, we are aware of new appeals, this time to the … [SEC], to: override the recently issued FASB Staff Position (FSP FAS 157-3); suspend a proposal on the accounting for securitizations; and, pending Congressional review of the study mandated by the EESA, suspend work on any project that would require fair value in any future accounting standard.” NOTE: This appears to be an indirect reference to the express request made in the ABA letter to the SEC. FAF’s Denham continued: “For the reasons discussed in the balance of this letter, we believe that it would be detrimental to investor confidence to overturn a FASB standard or otherwise suspend or restrict the independent standard-setting activities of the FASB in the current economic environment and in response to political pressure from some financial industry groups.”

Perhaps a middle road to maintaining existing standards vs. suspending or overriding existing standards is expressed in a joint letter filed by the U.S. Chamber of Commerce, Financial Services Roundtable, Property Casual Insurers Association of America; American Council of Life Insurers; Mortgage Bankers Association; and American Insurance Association, which asks the SEC to issue guidance on use of judgment in applying FAS 157, Fair Value Measurement, in inactive markets.

New Global Advisory Group To Operate In Sunshine
In related news, a joint press release issued by FASB and the IASB on Oct. 20 provided further details on their Global Approach to Enhance Market Confidence. The two boards noted there will be a ‘rapid’ appointment of a new ‘high level advisory group’ to guide the standard-setters on accounting and disclosure matters related to enhancing market confidence. This follows on the boards’ Oct. 16 joint press release which announced the decision to form this high level Global Advisory Group (GAG).

I found it significant that the GAG will meet in the sunshine, as stated in the Oct. 20 press release: “the advisory group will meet in public session with webcasting facilities available to all interested parties.” By holding meetings open to the public, this group will differ from existing advisory groups formed previously by IASB and FASB to advise them on fair value accounting issues, which have met in private, releasing brief summary points identifying issues discussed (in the case of FASB), and releasing a draft discussion document (soon to be finalized), as well as brief summaries of meetings (in the case of IASB). Specifically, the existing groups are FASB’s Valuation Resource Group (VRG) and IASB’s Expert Advisory Panel (EAP). Whether the form or substance of any recommendations coming from the GAG will differ from previous output from the VRG or EAP due to the public nature of meetings is an unknown, but the fact that the meetings will be open to the public, to some, may enhance confidence in the process.

Will Existing Guidance On Fair Value Be Considered, or New Guidance Only?
The scope of the GAG appears fairly broad, as described in the Oct. 20 press release: “[to] conside[r] how improvements in financial reporting could help enhance investor confidence in financial markets… [and] identify[y] the accounting issues requiring urgent and immediate attention of the boards as well as issues for longer-term consideration.”

Based on the above description, it is not clear if any of the recent guidance issued by FASB, the IASB and SEC on fair value in inactive markets (i.e., the IASB EAP draft discussion paper released in the summer, the SEC-FASB joint clarification released on Sept. 30, or FASB Staff Position (FSP) No. 157-3 released on Oct. 10) will be open for discussion.

Questions to Consider
As the SEC embarks on its study of MTM/FV, and if the FASB-IASB’s GAG decides to take a look at the recent guidance on fair value on inactive markets and the underlying standards like FAS 157, based on my review of comment letters filed on FASB’s proposed fair value guidance (proposed FSP FAS 157-d) earlier this month, and comment letters filed in response to SEC’s request(s) for comment on mark-to-market accounting, I believe questions could potentially be presented for further analysis in three broad areas:

1. Questions about consistency between and among the separate sets of recently issued guidance on fair value in inactive markets issued by FASB (FSP FAS 157-3), the IASB (the draft discussion paper released this summer by IASB’s Expert Advisory Panel) and SEC (i.e. the SEC-FASB joint clarification published on Sept. 30.)

I hope Dr. Bill Lutz (viewed as sort of the ‘father’ of plain English, who is advising SEC on its 21st Century Disclosure Initiative) sits in on SEC’s Oct. 29 roundtable on fair value, since it is challenging to parse the words within the triangulation of statements made by the SEC, FASB and IASB in recent weeks in the separate guidance listed above as to whether each believes that their individual sets of guidance are “consistent” with the other, or whether some are simply acknowledging the ‘efforts’ of the other. More than a triangulation, maybe it’s a quadrangulation, considering wording contained in the joint statement of European regulators (CESR et al) published last week. (Hat tip to BNA for providing link to the European statement). One of the points made in various comment letters with SEC, FASB, and the IASB (see para. 24a in this IASB summary) has been on the level of consistency between and among the separate sets of guidance.

FASB board member Tom Linsmeier, serving as an observer at the PCAOB Standing Advisory Group (SAG) meeting last week, and slated to serve in a similar role at the SEC’s Oct. 29 roundtable, remarked on this issue of consistency. Linsmeier told the SAG, “The boards [FASB and the IASB], [at their] joint meeting on [Oct. 20 and 21], made a commitment going forward, at all times possible, to issue guidance in words that are identical, to limit the potential political or reporting arbitrage to the lowest common denominator.”

2. Questions about consistency between the recent guidance issued by FASB and the IASB vis-à-vis their underlying standards, including FAS 157, Fair Value Measurement. Some commenters on FASB’s proposed guidance (including the comment letter filed by FEI’s Committee on Corporate Reporting) suggested FASB modify certain language referencing current markets and related liquidity discounts to make it more applicable to inactive markets. FASB did not change the wording referencing observable transactions in current markets, but added a sentence to paragraph 11 of the final FSP noting the example contained in the FSP assumed there were observable transactions that were not forced or distressed.

However, the applicability of a scope sentence specifying there are observable transactions that are not forced or distressed in a guidance on “Determining Fair Value of a Financial Asset When the Market for that Asset is Not Active” may lead to questions. Further, the draft paper published by IASB’s Expert Advisory Panel (EAP) in July (version posted on IASB website Sept. 16) reached conclusions which some have questioned, including that there has been “Entities sometimes place undue emphasis on the distinction between active and inactive markets when measuring fair values,” and that “distress sales are rare.” According to Agenda Paper 5B presented at this week’s joint FASB-IASB meeting, the EAP draft paper is set to be posted in final form on IASB’s website this month. IASB did not formally request comment on the EAP draft paper, although it was posted on IASB’s website and comments were welcomed. However, comments received have not been publicly posted because this was not a formal request for comment, given that the EAP document is not ‘authoritative’ but is being published for ‘informational’ purposes. Similarly, FASB’s VRG is deemed a nonauthoritative group. More generally, some have noted a concern about the role of nonauthoritative or quasi-GAAP guidance, as expressed by the SEC Advisory Committee on Improvements to Financial Reporting (CIFIR) which issued its final report earlier this year.

3. Questions about whether there is a need for a fundamental reconsideration of the underlying standards, including but not necessarily limited to FAS 157, Fair Value Measurement, and IASB standards, particularly to the extent those standards as originally written emphasized the usefulness of data obtained in observable or hypothetical transactions in ‘current’ markets by relying on an express or implied presumption that current markets were orderly and active. The current market turmoil and questions about the potential procyclical effect of accounting (referenced in the joint statement of European regulators (CESR et al) cited above, as well as in the written statement of SEC panelist and former FDIC Chairman William Isaac and the comment letter filed with the SEC by Susan Saidens referenced above) have amplified the question of whether a presumption of orderly markets in the original accounting standards on fair value measurement raises the need to consider a fundamental amendment to those standards. Some may question if this ‘fresh look’ threatens the independence of the standard-setters, although others may argue it is worth doing a debriefing or ‘reality check’ some number of months or years after a new standard is issued, or the environment changes (or both), similar to some of the discussion held by the SEC Advisory Committee on Improvements to Financial Reporting (CIFIR or the “Pozen Committee’ for chair Robert Pozen). Others may posit the emphasis in any such fresh look or post-adoption review should be on the reliability and relevance of the resultant financial reporting.

Friday, October 24, 2008

Fair Value Concept Release Coming By Year-End, Practice Alert on Current Environment Likely Too, PCAOB Tells SAG

The Public Company Accounting Oversight Board intends to publish a Concept Release on fair value and use of specialists by the end of 2008, PCAOB staff told an advisory group yesterday.

Deputy Chief Auditor Jennifer Rand, presenting PCAOB’s 2008-2009 Accomplishments and Priorities to PCAOB’s Standing Advisory Group (SAG) yesterday said that “The staff has been following the developments in the current credit crisis and evaluating how the current economic environment may affect the development of new auditing standards.” She said PCAOB’s project to update existing auditing standards on fair value and use of specialists is a “high priority” and the first step will be issuance of the Concept Release for public comment, a step that sometimes precedes a formal rule proposal.

Fair Value: “As it relates to fair value,” said Rand, “this project encompasses updating the existing standards on auditing accounting estimates, auditing fair value measurements, and auditing derivatives and financial instruments. These are three separate standards under the Board's interim standards. In the specialists' project, we are evaluating the requirements regarding the auditor's use of specialists in instances where a company engages or employs a specialist and the auditor uses that specialist's work as evidential matter in performing an audit, and where an auditor itself engages a specialist and uses that specialist's work as evidential matter.”

Potential Practice Alert on current issues: Additionally, PCAOB is considering issuing guidance on Audit Considerations in the Current Economic Environment. Based on the SAG’s recommendations, it appears this guidance may be issued in the form of a Practice Alert (PA), likely by year-end. The PA would reference existing guidance in areas such as (but not necessarily limited to): (1) Fair value measurements (2) Other than temporary impairment (aka OTTI) (3) Credit derivatives (4) Going concern (5) Pensions/other postretirement benefits (6) Receivables (7) Inventory (8)Other asset impairments (9) Deferred taxes, and (10) Disclosures.

SAG members agreed the above list of topics was worthwhile, noting the topic of “going concern” should address special considerations under the government rescue program (e.g. TARP, guarantees, etc.). SAG members also asked the PCAOB to be clear whether it is simply reiterating existing guidance – and if so, the guidance could be released in the form of a Practice Alert – or, if the guidance amends existing standards, to release it first in the form of a proposal for public comment.

Elizabeth S. Gantnier, Director of Quality Control at audit firm Stegman & Company explained, “Usually the first question after you read [newly issued] guidance is: is there something new, something that doesn’t exist elsewhere?” She added, “The year-end audits are already under way with regard to interim (quarterly reviews) and planning, (thus) time is of the essence.” She advised the PCAOB to “make sure the guidance is clear that we are either reiterating something that already exists, or emphasizing a current economic condition, and not providing new guidance to address an ambiguity; and if we are creating new guidance, to be sure the reader understands that pretty transparently.”

Audit fees: Two SAG members expressed their views on the impact of the current market turmoil on auditing and related audit fees. Dick Dietrich, Chair of the Department of Accounting & Management Information Systems at The Ohio State University, said, “I have heard there is tremendous downward pressure this year (on audit fees), I think we are talking about (doing more) and restoring integrity, one thing you might want to consider is, how you can have investors and audit committees understand that paying more to auditors to make sure these issues are addressed, may be one of the best uses of stockholders’ funds?” Ernie Baugh, National Director of Professional Standards, Mayer Hoffman McCann P.C., said “I agree with Dick on the comment about audit fees going up, if they don’t go up this year, then somebody is not doing what they ought to be doing, and I think our clients should anticipate that.”

Small Co Guidance on AS5: Additional guidance is set for release by year-end, said staff, in the form of updated Guidance for Auditors of Smaller Public Companies, relating to Auditing Standard No. 5, An Audit of Internal Control over Financial Reporting That is Integrated With an Audit of the Financial Statements (AS5). The small company guidance, initially released last year, will incorporate comments received and will take into account information gleaned from PCAOB’s inspection findings.

Other matters discussed at the two-day SAG meeting (held Oct. 22-23) included PCAOB’s consideration of two recommendations made by the U.S. Treasury Advisory Committee on the Auditing Profession (ACAP) relating to Audit quality indicators, and Engagement partner signature on the audit report.

In brief, although audit committees and investors were interested in seeing audit quality indicators, SAG members noted it may not be easy to define a set of audit quality indicators which would ‘faithfully present’ the audit quality which it purports to represent. Additionally, as pointed out by Bob Tarola, SVP and CFO, W.R. Grace and Company, the metrics could be misinterpreted in reaching conclusions or comparisons among audit firms. For example, one firm may spend higher hours auditing a particular company than a comparable company, but the first company may have a more sophisticated financial reporting group, or the audit firm may apply more automated audit technology which reduces the number of manual hours at the first client.

On the subject of Engagement partner signatures (vs. the current practice of ‘the firm’ signing the audit opinion), investors supported adding such a signature to enhance transparency and accountability, auditors were less in favor of such a change since it is the firm that takes responsibility for the audit opinion, and puts its full resources behind the opinion – and all the partners are at risk (at a minimum, financial risk) in the event of litigation relating to that opinion. Issuers were somewhat in the middle of the two camps.

A guest panelist, Janice Hester Amy, senior portfolio manager at Calsters, indicated that investor requests for audit firm rotation may go down if investors had a way of seeing whether the firms rotated engagement partners in accordance with the Sarbanes-Oxley Act.

Bob Kueppers, Deputy CEO of Deloitte, suggested that if transparency were the objective, a potential solution may be to disclose, but not require ‘signature’ of, the name of the engagement partner.

David Becker of Cleary, Gottlieb, Steen & Hamilton (formerly General Counsel at the SEC under Chairmen Arthur Levitt, Jr. and Harvey Pitt) observed, “There is a difference between signing [an audit opinion] and providing information [e.g. the name of the engagement partner], and even though you can’t precisely trace all the threads of liability, signing is a form of representation or acknowledgement of responsibility for the statement that is made, it is an assertion, and absent something that in effect immunizes you from liability will mean that the person signing is regarded as the speaker for the purpose of the representation.”

“Whether you think [it’s a] good thing or a bad thing,” said Becker of a potential disclosure or signature requirement to name the engagement partner, “I don’t think its realistic to say, an audit committee, having gotten a communication from someone saying, ‘we understand the audit team you are considering hiring has as lead partner involved in a restatement or two restatements,’ to assume that won’t have consequences for the person named, of course it will, the audit committee will say to the firm, you’ve got a fair number of partners… we’d rather take the guy without restatements associated with his name than the one with restatements.” He summed up, “You may think it’s a good or bad thing, but it’s not nothing.” NOTE: In a similar vein, some SAG members said an unintended consequence could be that some engagement partners, if they wish to avoid being associated with restatements in a regime in which their name is publicly disclosed in an SEC filing, may be incented to avoid encouraging their clients to restate in instances where restatement would be the proper course to take, thereby potentially hurting, rather than helping, investors. Observation: This could have broader policy and market ramifications than just for investors or creditors in a particular company(ies).

SAG Members Encourage More Transparent Standard-Setting Process
During the discussion of PCAOB’s standard-setting priorities, a number of SAG members suggested the PCAOB could be more transparent by making its deliberations public during the development of a standard, not only at the meeting where the board votes to release a proposed or final standard. The AICPA’s Auditing Standards Board (ASB) which previously set audit standard for public company audits (prior to PCAOB’s formation) and continues to set audit standards for private company audits, was referenced as a positive example of such transparency.

Ernie Baugh, National Director of Professional Standards, Mayer Hoffman McCann P.C said that in briefly reviewing the PCAOB’s proposed risk assessment standards that were just released, he was “somewhat astounded by something not there,” noting there was a very detailed comparison to IAASB (standards), but the AICPA standards (that have been) effective for a year and implemented by virtually all the (audit) firms [i.e., for their private company clients] are hardly mentioned at all.” He added, “it would be really good if we knew where they (the current AICPA standards and the proposed PCAOB standards) were the same, and where they were different.”

In a related comment, Baugh said, “I’ve been involved with standard-setting bodies over 20 years now… and in all of my previous experience, standard setting has been done in the open, in sunshine, this process can benefit from performing in the same manner, it would be very beneficial if you got input as you are developing standards, as opposed to only after they are developed.”

Lynn Turner, former SEC Chief Accountant, agreed, saying, “I remember when twice I was on the ASB, the AICPA did a phenomenally good job talking about standards in public meetings -- why they were going where they were, rather than just going to a public meeting to vote.” He added, “It would behoove this board to adopt the same type of transparency; the transparency you’ve got is a huge step down from what’s been there in the past, and it well serves investors.”

Vin Colman, PwC’s National Office Professional Practice Leader, said, “I was pleased with what Lynn [Turner] talked about around the standard-setting process, I would also encourage the board to think about the process,” and suggested taking a look at the ASB’s process, and other standard-setting processes as examples. Further, Colman asked, “An overarching question is… what are the guiding principles that set the priorities… is it reactionary or judgments?” One such overarching principle that could be considered, he suggested, could be international convergence; another could be cost-benefit. “If we had some kind of framework, it would be helpful,” he said.

Learn More, Network At Our Upcoming Events
Further details from this week’s PCAOB SAG meeting can be found in this FEI Summary. You don’t have to be an FEI member to sign up for our blog, but you do have to be a member to read our detailed online summaries – so why not consider joining FEI (video)? Besides access to our detailed summaries, you’ll get our bi-weekly electronic newsletter, FEI Express, receive reports from the Financial Executives Research Foundation (FERF), FEI’s award-winning Financial Executive Magazine, and support FEI’s advocacy efforts on behalf of financial executives. You’ll also get a member discount at conferences like our Current Financial Reporting Issues (CFRI) conference Nov. 17-18 in NYC, featuring SEC Chairman Christopher Cox, FASB Chairman Robert Herz, and IASB Chairman Sir David Tweedie, and more! Early bird registration rates for CFRI close Oct. 27, see more details at And, consider signing up to attend FEI’s Hall of Fame Gala, taking place the evening of Nov. 17 at the New York Stock Exchange in NYC. This year’s Hall of Fame inductees are former Federal Reserve Board Governor Susan Schmidt Bies and former J.P. Morgan & Co. Vice Chairman John F. Ruffle. Proceeds from this black-tie event benefit the work of FEI’s research affiliate – the Financial Executives Research Foundation (FERF), further details are at .

Tuesday, October 21, 2008

PCAOB Proposes 7 New Risk Assessment Standards, 120-Day Comment Period

The PCAOB board just voted unanimously to release for a 120-day comment period, a suite of 7 proposed risk assessment standards, and related conforming amendments to other interim standards. PCAOB staff mentioned there will be an appendix outlining each proposed standard, focusing on changes to the existing standards, and another appendix will note major differences from related IAASB International Standards on Auditing (ISAs).

Board member Dan Goelzer asked, “To what extent will these change the way big firms audit and how will that correlate with cost of audit?”

Staff member Keith Wilson replied, “[There is] not any intent to reinvent the wheel,” adding the PCAOB is “trying to take into account improvements that have been made, particularly by the large firms, and to hopefully help create some improvements in that process.”

“I don’t know that we would find that there would be a lot of new requirements or the formulations in standards would generate a significant amount of increased audit effort, but that’s another area we seek comment on, when auditors look at that, do they have a different perspective, what’s the perspective of others as well on value of procedures, perceived effort,” said Wilson.

Goelzer added, “It is important we get those comments, we’ve been at this for 6 years, we find people sometimes have a different view on the impact on auditing and cost of auditing of these proposals than we have.”

PCAOB generally posts same-day press releases confirming the results of their board meetings on, and we will report additional highlights from today’s PCAOB board meeting in a summary on

Monday, October 20, 2008

Make a Difference

I’ve been waiting for this day (my birthday) to provide a link to John Ondrasik’s song, 100 years. Gives you something to think about. Ondrasik, who has performed under the name Five for Fighting, is also the founder of, which encourages people to make a difference through supporting charities. Another way to help shape the direction of history is by exercising your right to vote. And, for followers of this blog, you can make a difference by putting your views and analysis into the hands of policy makers by filing a comment letter on proposed rules, such as FASB’s Exposure Documents, IASB’s [Documents] Open to Comment, SEC’s Proposed Rules and Other Orders and Notices, and PCAOB’s Proposed Rules (public co's), AICPA Auditing Standards Board's (ASB) Exposure Drafts of Proposed Statements (nonpublic co's), and the IAASB's Exposure Drafts & Consultation Papers. The PCAOB is slated to vote tomorrow (Oct. 21) on whether to release a new proposal for public comment on the auditor's assessment of and response to risk. And, one of the most watched for proposals is SEC’s upcoming proposal on the IFRS roadmap, which the Commission voted to release earlier this year. Stay updated on these issues by subscribing to our blog. You can also find us on AccountingWeb Bloggers Crew and Securities Mosaic Blogwatch.

Friday, October 17, 2008

SEC Announces Oct. 29 Roundtable On Mark To Market, Comments Roll In

Yesterday, the SEC announced the first of two roundtables will take place on October 29, relating to SEC’s study of mark to market (MTM) accounting. The MTM (aka fair value) study is being conducted in accordance with Section 133 of the Emergency Economic Stabilization Act of 2008 (EESA), which requires the SEC to consult with Treasury and the Fed and to complete the study by Jan. 2, 2009.

The SEC's comment letter file on MTM is already a busy place, a month ahead of the Nov. 13 comment deadline on the SEC’s related Request for Comment (see Federal Register version), including some letters which actually predate EESA, and some more recent letters like the Oct. 13 letter from the American Bankers Association (ABA) which we noted previously in this blog.

A letter we expect to see posted shortly is the joint letter sent to the SEC on October 14 by the Center for Audit Quality (CAQ), the CFA Institute (an analysts association), the Council of Institutional Investors (CII), and the Consumer Federation of American (CFA) – we’ll call them the Four C’s. (See Four C’s joint letter).

The Four C’s wrote, “We are writing to express grave concern regarding recent calls for the SEC to override guidance issued by the Financial Accounting Standards Board (FASB) and the Commission’s staff that would effectively suspend fair value or mark-to-market accounting. We believe such urgings are decidedly not in the public interest.”

The above statement by the Four C’s and further discussion in their letter has been viewed by some as a direct response to ABA’s Oct. 13 letter, which indeed asked the SEC to “override” FASB’s Oct. 10 guidance on fair valuing in inactive markets and to suspend future accounting rules on fair value pending completion of SEC’s study, however, the ABA did not ask for a generic ‘suspension’ of fair value accounting.

There are others, however, who have argued for a full suspension of MTM, including a bipartisan group of 60 members of Congress who wrote SEC Chairman Christopher Cox on September 30. The letter may have helped cement inclusion of Section 132 of EESA, signed into law on October 3, which reiterates the SEC’s authority to suspend fair value accounting, but left the decision in the SEC’s hands. The Congressional letter is currently not in the SEC comment file but can be found on Congressman John Shadegg’s website.

In response to the September 30 Congressional letter, a joint statement was issued by three of the Four C’s on October 1, which said: “The Center for Audit Quality, Council of Institutional Investors and the CFA Institute – representing the nation’s public company auditors, institutional investors and chartered financial analysts – are united in opposing any suspension of “mark-to-market” or “fair value” accounting.”

The Four C’s October 14 letter to the SEC added, “Investors have a right to know the current value of an investment, even if the investment is falling short of past or future expectations. It, therefore, is imperative at this critical juncture that we not engage in activities that would further obscure reality from investors and do more to damage confidence in the marketplace. We urge the SEC to be clear in rejecting urgings that are contrary to this imperative.” (emphasis added, see below)

It is difficult to argue with a desire for information on the “current value” of an investment, or for a glimpse at “reality,” concepts emphasized by the Four C’s. (Note: if they add 3 more like-named organizations, they could be the Seven C’s, apropos in discussions about liquidity.) On this topic, some have argued that inclusion of liquidity discounts in computing ‘fair value’ in inactive markets results in a fair value that distorts, rather than represents, economic reality. On this point, we have frequently cited Vinny Catalano, a CFA and former President of the New York Society of Securities Analysts, who cites behavioral aspects that have challenged fair value assumptions which rely on the ‘efficient markets’ hypothesis. See e.g. Catalano’s blog posts: “From Chaos To Insanity: The Imperative of Logic,” (Sept. 17); “The Real Risks of Deleveraging,” (includes reference to “feedback loops gone wild”) (Sept. 16); “The Fear Side of the Greed and Fear Cycle” (Sept. 10), and “You Can’t Treat a Virus With Antibiotics” (March 20).

Some alternative mechanisms for fair value in inactive markets were put forth in a number of comment letters on FASB’s recent proposal on this issue (the proposal which ultimately was issued in the form of final FSP FAS 157-3 on October 10.) See, e.g. the comment letter filed by Congressman Mark Steven Kirk, referencing the comment letter(s) filed by Wintrust Financial Corporation. Wintrust’s comment letter 28A recommended that FASB consider using an ‘intrinsic value’ concept, similar to that used by the Home Owners Loan Corporation in the 1930s, to come up with reasonable values, including, e.g. by considering the estimated rent roll of the property, vs. relying on fire sale appraisal values. Wintrust’s comment letter 28 suggested that FASB use a ‘mark to value’ principle (also noted in the Sept. 30 Congressional letter to the SEC), instead of ‘mark to market’ in inactive markets. FEI’s Committee on Corporate Reporting (CCR) was among those who offered suggestions as well.

As the SEC’s MTM study progresses, it will be interesting to see if they expand the scope of their study to consider the impact of the existing MTM accounting rules more generally on all entities, not only with respect to financial institutions. Perhaps one can interpret the Act (EESA) as having sufficient flexibility for the SEC to expand the scope of the study; alternatively, perhaps the SEC does not need a Congressional mandate to do so, if, e.g. they were to determine it is more efficient and effective to apply a broader scope to the study, since many of the same issues will apply to different types of issuers. Besides the upcoming Oct. 29 roundtable, the SEC held a roundtable on fair value accounting earlier this year (in July), see our related summaries here and here.

Thursday, October 16, 2008

FASB, IASB Form Jt. Adv. Group On Credit Crisis; Release DP On Fin. Stmt Pres.

Earlier today, FASB and the IASB jointly announced they are forming an advisory group “comprising regulators, preparers, auditors, investors and other users of financial statements” to review reporting issues related to the credit crisis.

Separately, FASB and the IASB released today their joint Discussion Paper on the Financial Statement Presentation Project. The comment deadline is April 14, 2009. Further information is in their press release , the Discussion Paper, and in their “Snapshot,” a 6 page summary of highlights from the Discussion Paper.

Wednesday, October 15, 2008

CORRECTION: FASB Votes to PROPOSE Delaying FIN 48 For All Private Cos

Please note we have corrected our earlier post today to clarify that FASB voted to PROPOSE delaying FIN 48 for all private entities (i.e. nonpublic companies), and that the proposal will be released for public comment and FASB will then deliberate a final decision. See FASB's Summary of Decisions Reached for the official results of the meeting.

FASB Votes To PROPOSE Delaying FIN 48, Uncertain Income Taxes, For ALL Private Entities

CORRECTED POST: FASB voted to PROPOSE this expanded deferral. At its board meeting earlier today, FASB reconsidered its October 1 decision to propose a one year deferral of FIN 48, Uncertain Income Taxes, for only certain pass-through entities, and instead, voted today that the proposed further deferral of FIN 48 should apply to ALL private entities (i.e., non-public companies).

In reaching today’s decision, FASB considered four different approaches to potentially deferring FIN 48 for certain pass through entities vs. all private entities, and agreed on ‘alternative 4’ in the board handout, to defer FIN 48 for “all private entities, whether or not they are pass-through entities.”

As noted in FASB’s Summary of Decisions Reached, there will be a 30 day comment period on the proposal, which will be issued in the form of a proposed FASB Staff Position (proposed FSP). We will also provide further highlights from the board meeting in a summary on

Today was the last board meeting for board member George Batavick, whose term ended on June 30 of this year; he stayed on until a new board member was named. Next week, new board member Marc Siegel joins the board. FASB Chairman Robert Herz said, "We thank George for (his service on the board) the last few months and moreover the last five years for being a terrific collegauge." Batavick said, "It has been a great honor, great pleasure to serve (the board)... we should all be very proud of the vital role we play in improving financial reporting."

SEC Letter To FASB Provides Guidance On OTTI For PPS

Late yesterday (Oct. 14), staff of the SEC’s Office of the Chief Accountant (OCA) issued a letter to FASB as an immediate clarification - deemed an 'intermediate step in addressing practice issues" pending further action by FASB - regarding accounting treatment of OtherThan Temporary Impairment (OTTI) for Perpetual Preferred Securities (PPS). We have posted a copy of the letter on our website here; we understand it is in the process of being posted on SEC’s website under Staff Letters to Industry.

Monday, October 13, 2008

Amer. Bankers Ass'n Asks SEC To Override FASB's New Fair Value Guidance

Shortly after I posted “What's The Impact Of FASB's New Guidance On Fair Value?” I received a copy of a press release issued by the American Bankers Association (ABA) which said: “The American Bankers Association sent a letter today to SEC Chairman Cox requesting that among other things, the SEC override the Financial Accounting Standards Board Staff Position issued last week on how banks and their auditors are required to apply FASB Statement No. 157. The letter urges the SEC to address in a more meaningful way the problems of using fair value in dysfunctional markets. The letter also notes that yesterday 15 European countries moved to make the types of accounting changes ABA has been advocating, but that FASB on Friday, as a practical matter, failed to implement.” See ABA Letter to SEC.

Donna Fisher, ABA Senior Vice President, Tax and Accounting told us: “To my knowledge, this is the first time the American Bankers Association has made a request like this. We did not make this decision lightly.”

What's The Impact of FASB's New Guidance on Fair Value?

From the divergent headlines coming out about the new FASB fair value guidance issued on Friday Oct. 10, FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active," one may wonder if “Accounting Board Adopts Guidance to Ease Crisis,” as reported by AP’s John Christoffersen, or if “FASB Approves Fair-Value Guidance, Avoids Flexibility,” as reported by Ian Katz on Bloomberg Oct. 10.

It may not be that easy to tell which take is right, and the truth may lie somewhere in between. For instance, one can look to the discussion that took place at the October 10 FASB board meeting (detailed in this FEI Summary) particularly with respect to the effective date of the new guidance, in which FASB board members alluded to ‘two groups’ of companies, those that had essentially been interpreting FAS 157, Fair Value Measurement, all along in a manner consistent with the FSP, and those who had not, with the implication that companies that had interpreted FAS 157 consistent with the FSP would not have significant changes. (A number of comment letters on the proposed FSP noted that point as well – i.e. they did not believe the FSP would cause much to change - although some called for modifications to the proposed guidance for that reason.)

Further consideration of the potential impact of the new guidance may also center on a new sentence added to paragraph 11 of the final FSP (FSP FAS 157-3) which was not in the proposed version of the FSP (Proposed FSP FAS 157-d), which states: “Also, this example assumes that the observable transactions considered in determining fair value were not forced liquidations or distressed transactions.” The ‘assumption’ that observable data does not come from ‘forced liquidations or distressed transactions” is interesting in that the title of the guidance is directed at determining the fair value of an asset ‘when the market for that asset is not active.’ As further detailed in the FEI Summary, FASB decided, consistent with earlier discussion of a FASB advisory group (the Valuation Resource Group), to retain the principles based approach of providing ‘indicators’ or ‘factors’ to consider in determining if the market for an asset was inactive, rather than a bright line definition of inactive markets. However, some may ask if the parenthetical definition of ‘forced transaction’ in paragraph C25 of FAS 157 (including the reference to a seller ‘experiencing financial difficulty’) would have any application to determining whether a ‘forced liquidation’ or ‘distressed transaction’ exists, and how that impacts the consideration of observable inputs or implied or extracted inputs from observable data for those assets.

Among other points of note in the final FSP is insertion of the word ‘relevant’ in the paragraph 11 of the final FSP, shown in the amended paragraph A32C of FAS 157, in which the example now states (new words added to the final FSP vs. proposed version highlighted in bold/italics] “Entity A determines that an income approach valuation technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates, which would now require significant adjustments.21a “ [Note: footnote 21a in the FSP references paragraphs 20, 21 of FAS 157 which define ‘valuation technique’ including ‘observable’ and ‘unobservable’ inputs.]

Other changes in the final FSP include a new point number 4 in the example (i.e. in the amendment to para. A32D of FAS 157), regarding the need to consider not only quoted prices, analyst reports and indexes, but also “information about the performance of the underlying mortgage loans, such as delinquency and foreclosure rates, loss experience, and prepayment rates.” Additionally, in response to comments received on the proposed FSP, FASB now explains the basis of how it arrived at a the 20 percent and 22 percent discount rates in the example shown in the FSP, by adding an explanation in footnote 21d, and adding more narrative to the amended paragraph A32E.

In determining the impact of the new guidance, some may weigh the changes FASB made in the final FSP such as those listed above, vis-à-vis some of the specific suggested wording changes supplied in some of the 100 comment letters filed on the proposed FSP. For example, the American Banker’s Association (ABA) had said in its comment letter: “[R]easonable judgment should be applied in determining what a representative liquidity premium would be for a functioning market, so that the liquidity premium is not distorted based on the illiquidity of a frozen market…. [W]e believe the proposed FSP would be more helpful if it included guidance for determining when observable evidence represents market participants not forced or compelled to transact.” And, FEI’s Committee on Corporate Reporting (CCR) had suggested in its comment letter that the following words be added to example in the FSP which would amend para. A32C of FAS 157, in which FEI CCR suggested [suggested new words in bold/italics]: “Entity A determines that an income approach (present value technique) that maximizes the use of observable inputs in an active market and minimizes the use of unobservable inputs or observable inputs in markets that are either inactive or disorderly will be equally or more representative of fair value than the market approach used at prior measurement dates.” The letter added: "[FEI] CCR would support the issuance of the FSP if Paragraph A 32C is amended as noted above. Alternatively, CCR would not object if the FASB decides not to issue the FSP, since we believe it does not currently improve upon, and may conflict with, the guidance provided in the SEC-FASB joint statement."

Now that FASB has issued FSP FAS 157-3, and the SEC and FASB issued their ‘joint clarification’ of fair value on September 30, is there still a need for further guidance or clarification of FAS 157 (Fair Value Measurement) and/or other fair value standards? As announced last week, the SEC has already commenced its study of the impact of the fair value or ‘mark-to-market’ accounting standards, a study required by Section 133 of the recently enacted Emergency Economic Stabilization Act of 2008. Additionally, senior bankers spoke out last week at a meeting of the International Institute of Finance (IIF), as reported by Ian Katz in Bloomberg Oct. 12, Citigroup's Rhodes Says Modify Rule When Markets Fail, in which Citigroup Senior Vice Chairman William Rhodes reportedly said: “Nobody wants to throw [FAS 157] out, but I think in times of illiquid markets, sometimes you need some modifications,'' and Deutsche Bank AG Chief Executive Officer Josef Ackermann, (IIF’s chairman) reportedly “urged an ‘immediate high-level dialogue’ on fair-value accounting issues.” Some other recent commentary evidencing a range of views can be found in: Reverse Leverage of Mark-to-Market Wrecks Banks, by John M. Berry in Bloomberg, Oct. 12, and Don't Write Mark-to-Market's Obituary Just Yet, by Jonathan Weil, in Bloomberg Oct. 8. Additionally, we previously reported that the G7 Plan of Action, released on Friday, shows accounting and disclosure as one of the elements on the global radar screen as part of the plan for stabilizing global markets.

Friday, October 10, 2008

FASB Releases Final FSP FAS 157-3 on Fair Value; G7 'Plan of Action' References Accounting

This evening, FASB released final FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.” This FSP was issued in record time, as part of the response of standard-setters to provide guidance for applying the fair value accounting rules in inactive markets, as have been experienced during the recent market turmoil. For further background on this FSP, see our two posts from earlier today, here and here, relating to comment letters filed (including the comment letter filed by FEI's Committee on Corporate Reporting (CCR), and summarzing the discussion at today's FASB board meeting.

Separately, the Group of Seven Finance Ministers (G7) issued a statement today, entitled, “G7 Plan of Action” in which the last of five items on the list references accounting. That item states: “Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.”

In related news, see announcement released by the IASB today, “[IASCF] Trustees Support IASB’s accelerated steps on the credit crisis."

FASB Plans To Issue Final FSP On Fair Value 'Today or Tomorrow'

UPDATE: CORRECTED NAME OF FASB STAFF MEMBER BELOW. At its board meeting earlier today, the Financial Accounting Standards Board voted to proceed with issuing a final FASB Staff Position (FSP) on fair valuing in inactive markets, and FASB project director Russell Golden told the board they plan to be able to issue the final FSP ‘today or tomorrow.’ The board agreed with the staff’s proposed approach to making certain changes to the final FSP based on comments received on Proposed FSP No. 157-d, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active.”


Transaction-based, not ‘market based’ determination of distressed assets

FASB staff member Cristofer Anderson [staff name corrected from our earlier post; we apologize for error], who led the staff presentation at the board meeting, cited language from the SEC-FASB joint clarification of fair value published on September 30, which discusses orderly transactions and distressed transactions, and concluded, as described by Anderson, “Determining whether a particular transaction is … [distressed] requires judgment. “
FASB Technical Director Rusell Golden said, “We understand that some people might have interpreted the [SEC-FASB joint clarification published in the SEC] press release to say that disorderly markets equal distressed transactions,that was not our intent.

Anderson told the board, “The [FASB] staff believes that the determination that a market transaction is distressed or disorderly should be made at the individual transaction level, and should not be assumed to have occurred based on an entity’s conclusion that an entire market for the asset is distressed.” He added, “Based on the feedback received from constituents, the staff has included language in the [final] FSP for the board’s consideration to provide clarification on distressed sales. "

Wording developed by Board member Leslie Seidman will be added to the final FSP, described informally in plain English at the board meeting (more formal wording will be in the ballot draft sent to board members later today) by Seidman as follows: (1) you can’t just dismiss any prices in market that is experiencing dislocation or disorderliness, and (2) you can’ t automatically embrace any old price in a market, that is disorderly or dislocated; it’s going to require significant judgment, and the rest of the FSP hopefully goes thru a thought process in those cases where it’s inactive, but you do have some data to look at.”

Board member Tom Linsmeier, calling into the board meeting from China, asked, “Are we going to clarify a distressed market does not mean distressed sales, necessarily - that you are looking at transctions, not markets?” Seidman replied, “Yes, I think so.” Linsmeier said, “I think it’s important to make clear we are not talking about markets, but individual transactions, and when we go to the individual transaction level, there is judgment, of both types that you are talking about.” Herz later said, “it gets down to that level, rather than saying ‘everything is inactive’.”
IASB board member James Leisenring, an observer at the FASB board meeting, said, “I think that would be very constructive, I think the whole exercise is very constructive frankly, from an international perspective,” adding, “I got a letter this morning from somebody who should know better, who said all transactions should be ignored because the markets are distressed; that’s just not what 157 says, nor could it remotely be called fair value, so I think it will be very helpful, [to add to the FSP the clarification] you suggest.” The title of the FSP will likely change to reflect this transaction-based vs. market-based determination of ‘disorderly/distressed’ as well.

[NOTE: Reference should be made to FASB’s Summary of Decisions Reached which will be posted later today in FASB’s news center and in the final FSP when it is issued, to see if the reference will be to ‘individual’ transactions per se vs. types of transactions or assets. The thrust of the change is apparently to preclude overgeneralization of ‘distressed markets’ to all types of transactions in those markets.] without looking at the markets for particular types of transactions or assets.]

Changes relating to the example in the FSP
Anderson said “a number of comment letters provided suggestions, staff made changes” to the FSP, a few include: (1) adding additional detail on use of indicative broker quotes, and (2) the reporting entity’s rationale for weighing the different [factors/inputs] for use of the discount rate in the valuation technique.

Clarification will be added to the FSP that, “In determining whether an other than temporary impairment (OTTI) exists, this FSP does not amend or change the requirement in EITF 99-20 to use market participant (MP) cash flows, not contractual flows, to determine of OTTI has occurred.”

NOTE: Anderson said changes discussed at the meeting were just those in broad categories, he said additional changes are being made by the staff in response to comment letters, but they were not described in detail during the board meeting.

Some commenters wanted expanded disclosures relating to this FSP. Staff said they will NOT add new disclosures in the FSP but said they plan to bring to the board another disclosure project in the next 2-3 weeks, with the goal of some additional disclosures being required for year-end reporting.

A number of areas of concern noted in comment letters will NOT be changed, said staff, including:

  • The board will NOT address whether fair value is the appropriate measurement attribute in this FSP – that is beyond the scope of this FSP (and FAS 157), which are focused on HOW to measure fair value, not when to use fair value as the measurement attribute
  • the board will NOT include liabilities in the scope of the FSP,
  • the board will NOT change the effective date proposed – i.e. it will be effective upon issuance for financial statements not yet issued,
  • the board will NOT define “inactive’ vs. ‘active’ markets, but the ‘indicators’ or factors that can be considered will essentially be copied from the example section of the FSP to the guidance section .

Further details from today’s FASB board meeting will be posted later today in a summary on (FEI members only will be able to access the detailed summary, check out the benefits of FEI membership! And be sure to check out FEI’s Current Financial Reporting Issues (CFRI) conference taking place Nov. 17-18 in New York City at, including the special package for conference registration and first year membership in FEI! The Chairman of the SEC, FASB and IASB will be at CFRI – you should be there too! And, check out the FEI Hall of Fame Gala Nov. 17 at, the 2008 Hall of Fame inductees are Susan Schmidt Bies and John F. Ruffle. And, there's more, check out the workshop sponsored by Deloitte: IFRS: Strategies for Adopting a Single Set of Standards," on Nov. 19 in NYC. All of these programs are described further on FEI's website under Networking Events.

Close To 100 Comment On FASB Fair Value Proposal, Up For Vote Today; SEC Seeks Comment on MTM

FASB has received close to 100 comment letters (91 posted as of 9:00 pm Oct. 9) on its proposed guidance for Determining the Fair Value of a Financial Asset in a Market That is Not Active, released last week in the form of a Proposed FASB Staff Position (FSP), Proposed FSP FAS 157-d. The number of comment letters is sure to inch closer to 100 since FASB is still in the process of posting comment letters, including the letter filed by FEI’s Committee on Corporate Reporting (CCR) (see FEI CCR letter, referred to as “the FEI letter” below).

A vote is expected at today’s FASB board meeting on whether FASB wishes to proceed in finalizing the FSP, and any potential changes it will make in light of the comment letters received. FASB fast-tracked the proposed fair value guidance (released on October 3, with a comment deadline of October 9 and vote on October 10) in an effort to be responsive to requests for guidance on applying FASB’s fair value standard, FAS 157, Fair Value Measurement, under current market conditions characterized by illiquidity.

The proposed FSP was released for public comment a few days after the U.S. Securities and Exchange Commission and the FASB issued a joint clarification on applying the fair value rules in inactive markets, published in an SEC press release on September 30 (see SEC-FASB joint clarification on Fair Value.) See also this FEI statement issued October 8, commending the response to the credit crisis, which references the SEC-FASB joint clarification and SEC’s recent announcement that it has launched its Congressionally mandated study of the impact of mark-to-market (also called fair value) accounting.

The approximately 100 comment letters filed on FASB’s proposed FSP reflect diverse views on the usefulness of the proposed FSP as currently drafted, ranging from some saying the proposal would overly ‘relax’ fair value standards, to others saying the proposal provides insufficient guidance. Similarly, there is a debate evident in the comment letters over whether FASB should retain the fundamental approach of FAS 157 which relies on ‘exit values’ obtained in observable or hypothetical transactions made by ‘market participants’ in the ‘current market,’ (see, e.g. letters from Deutsche Bank, Moody’s Investors Service) or whether that fundamental approach should potentially be changed to more rationally apply the guidance in today’s illiquid markets and to avoid contributing to a procyclical reaction or downward spiral of market prices and related accounting valuations (see, e.g. letters from U.S. Bancorp, the Group of North American Insurance Enterprises(GNAIE), and The Real Estate Roundtable).

And, the New York State Banking Department is recommending “that instruments with no observable inputs (i.e. Level 3 under FAS 157) should be recorded at the lower of cost or fair value when inputs were last observable.”

The actual number of comment letters filed to date on the proposed FSP understates the level of interest in this subject, due to the “understandably short time frame for comments and not lack of interest,” notes the comment letter filed by the American Bankers Association (see ABA comment letter). The ABA letter was among those that asked for further clarification of certain matters, in the proposed FSP or in the future, such as: “What is a distressed sale? What is a forced liquidation? When is a market so seized that it is appropriate to conclude any sales are distressed/forced? What level of evidence is needed in a principal-to-principal market with no public data?” Similarly, the letter from Glass Lewis & Co. was among those recommending further clarifications of terms such as ‘inactive’ be provided.

A number of comment letters (e.g., Credit Suisse, Citigroup) asked that the scope of the FSP be expanded to include liabilities as well as assets. Additionally, Citigroup commented on the proposed effective date of the guidance: “We are concerned that, due to time constraints, it is not possible to implement the modeling techniques described in the FSP to a large number of positions before issuance of the third quarter financial statements. We therefore ask that the FSP would permit rather than require application of the guidance in calendar year third quarter financial statements. However, the mandatory adoption date of the FSP should be in periods ending subsequent to the issuance of the FSP.”

The FEI Committee on Corporate Reporting letter (“FEI letter”) noted that FEI “appreciate[s] FASB’s intent via the proposed FSP to clarify the application of FAS 157 in an inactive market.” However, FEI is also “concern[ed] with the example provided in the proposed FSP, because it still produces a fair value measurement that reflects a transaction price in an illiquid market and thereby undermines the potential benefit of the clarification provided by the SEC-FASB [September 30] announcement.” FEI continues, “[A]s currently written, we interpret the example [in the proposed FSP] to indicate that those cash flows are required to be discounted using rates that reflect current market participant assumptions including those related to credit and liquidity risk. We believe that the end result of this interpretation is a measure of fair value that is still reflective of a distressed sale vs. a transaction between a willing buyer and willing seller under the requirements of FAS 157.” FEI therefore recommends the FSP be revised “to clarify its intent and make it consistent with the thrust of the SEC-FASB joint statement which recognized the validity of considering management’s cash flow analysis, intent and ability to hold financial instruments as part of the total mix of information to be considered measuring fair value in inactive markets, along with the application of professional judgment.” Specific wording changes are suggested for the FSP by FEI.

Additionally, the FEI letter addresses the relationship between and relative standing of the SEC-FASB joint clarification published on September 30 and the proposed FSP, and “recommend[s] the FASB or SEC considers formalizing the joint clarification by publishing it in the form of a Staff Accounting Bulletin (SAB) or by noting publicly that it will be reiterated in an SEC staff announcement at an upcoming EITF meeting.” FEI also “suggest[s]… the final FSP should explicitly state it does not amend or supercede the SEC-FASB joint clarification,” and that “FASB should consider incorporating the SEC-FASB clarification as an attachment to the FSP if that would assist in treating the SEC-FASB clarification as part of GAAP today and the codification of GAAP permanently.”

"In conclusion," states the letter from FEI's Committee on Corporate Reporting (CCR), "CCR would support the issuance of the FSP if Paragraph A 32C is amended as noted [in the letter]. Alternatively, CCR would not object if the FASB decides not to issue the FSP, since we believe it does not currently improve upon, and may conflict with, the guidance provided in the SEC-FASB joint statement."

On the international front, the IASB is trying to move swiftly to converge toward U.S. GAAP’s treatment of transfers or reclassifications from trading to held for investment type categories which have differing income statement treatment of changes in market value. We previously noted the IASB’s recent statement on its current response to the credit crisis, there have also been a number of articles recently in Accountancy Age on happenings in Europe and the U.S. regarding fair value, including “Fair Value Suspension Would be ‘Obfuscation,’” citing a related Letter to the Editor of the Financial Times by Jane Fuller, Chair of the CFA Society [of the U.K.’s] Accounting Advocacy Committee. AccountancyAge states: “[CFA Society’s] Fuller said the SEC's clarification had punctured some of the myths about fair value accounting: 'management's cash-flow assumptions can be used to establish fair value and that distressed sales do not represent the "orderly" transaction between "willing" parties required for simple mark-to-market valuations.'” See also “Fair Value: Victim of a Witch Hunt” by Gavin Hinks & David Jetuah in AccountancyAge.

For further discussion of FAS 157’s methodology vs. potential alternatives, see Prof. Tom Selling’s blog, The Accounting Onion. Another blog with insightful commentary on FAS 157 is the AAOweblog, written by analyst Jack Ciesielski.

SEC Seeks Comment on Fair Value (aka “Mark-to-Market”)
Broc Romanek of blog reported yesterday that the SEC posted a Request for Comment relating to its Congressionally mandated study of fair value (mark-to-market) accounting (see: SEC Spotlight on Fair Value Accounting.) The comment deadline is 30 days after the release (request for comment) is published in the Federal Register. As we previously reported, an FEI Statement issued on October 8 noted that FEI “support[s] the SEC's decision to commence its study of the impact of mark-to-market accounting so quickly after enactment of EESA, as announced by the SEC on October 7.”

Interesting, and I think a first in terms of a ‘study,’ is that the SEC has posted a toll-free number on the aforementioned Spotlight page “for questions on the mark-to-market accounting study,” stating the number is 877-732-9488. 732 correlates with “SEC” on your keypad, presumably the rest of the number was randomly assigned, although I bet there are some folks out there who can figure out an interesting abbreviation (or song) relating to fair value or mark to market accounting that correlates to the rest of the number. (I tried calling the number early this morning, it took me to a recorded message by the SEC's Office of Investor Education and Advocacy, providing basic facts like the website location of info on the SEC's fair value/MTM study, and messages can be left on that line.)

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Wednesday, October 8, 2008

FEI Commends Response To Credit Crisis

(Oct. 8, 2008) This afternoon, Financial Executives International (FEI), the leading advocate for the views of corporate financial management, representing over 15,000 members who serve as CFOs, Treasurers, Controllers, and other senior financial executives, issued a statement commending the recent actions taken by Congress, the Administration and regulatory agencies in response to the credit crisis.


FEI commends the U.S. Senate and the House of Representatives for passing the Emergency Economic Stabilization Act of 2008 (EESA), and President George W. Bush for quickly signing it into law.

FEI has historically supported the important tax provisions in the economic recovery package, particularly the two-year extension of the Research & Development (R&D) Tax Credit and the Alternative Minimum Tax (AMT) relief for individual taxpayers.

FEI also appreciates the joint efforts of the U.S. Securities and Exchange Commission (SEC) and Financial Accounting Standards Board (FASB) in providing additional clarity in applying the existing fair value accounting standards in illiquid markets (as issued on September 30). Furthermore, we support the SEC's decision to commence its study of the impact of mark-to-market accounting so quickly after enactment of EESA, as announced by the SEC on October 7.

Read the full FEI statement.

Tuesday, October 7, 2008

Grundfest, Beller Among Panelists at Oct. 8 SEC 21CDI Roundtable

Former SEC commissioner Joe Grundfest, now of Stanford Law School, and former SEC Corp Fin Director Alan Beller, now of Cleary Gottlieb Steen & Hamilton, are among panelists slated to appear at tomorrow’s SEC Roundtable on Modernizing the Securities and Exchange Commission's Disclosure Systems, which relates to SEC’s 21st Century Disclosure Initiative (we’ll call it “21CDI” ). The fact that the SEC posted the list of panelists & detailed agenda last week was perhaps overshadowed by all the Emergency Economic Stabilization Act goings-on.

Robert (Bob) Sorrentino, Director of Accounting Policy and External Reporting at Xerox Corporation and an alternate member of FEI’s Committee on Corporate Reporting (CCR), and Steve Bochner of Wilson Sonsini, a member of the SEC Advisory Committee on Smaller Public Companies, are among the diverse group of panelists.

One of the more interesting panelist bios is that of Esther Dyson, Chairman, EDventure Holdings, which states: “Despite a BA in economics from Harvard (1972), it was [while working at] Forbes [Magazine] that [Dyson] learned to read a balance sheet…”

A related SEC Notice/Request for Comment on the 21st Century Disclosure Initiative has a comment deadline of October 22. The questions are indicative of the fact that an entirely new model for SEC’s disclosure system is being considered, including the “Company File System” approach, which is described further in the 21 CDI FAQ’s and Strategic Plan.