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.

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