On Dec. 30, 2008, three days ahead of a Congressionally imposed deadline, the U.S. Securities and Exchange Commission released its 211 page SEC study and recommendations on mark-to-market accounting. See related SEC press release. The formal title of the report is: Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-To-Market Accounting.
In brief, although the SEC does not recommend suspending FAS 157, Fair Value Measurement, or mark-to-market accounting, the SEC recommends that further improvements can be made to impairment standards and recommends further guidance on application of fair value accounting standards in illiquid or inactive markets. The SEC also recommends certain improvements to the standard-setting process, such as those recommended by SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR), such as formation of a Financial Reporting Forum consisting of users, preparers and others, to meet periodically with FASB, the SEC and PCAOB. Further details can be found in these FEI summaries: Six Areas Addressed In SEC Study On Mark-to-Market; and Eight Recommendations In SEC’s Report On Mark-to-Market Accounting
My two cents
Here are a few of my own observations (may I remind you of the disclaimer on the side of this blog):
- Exit value, market participants notion: Although the SEC staff concluded that FAS 157 should not be suspended, but that further guidance is needed, the report gives FASB a broad mandate by recommending: “In determining how to address the above issues, [e.g. impairment, fair value in illiquid markets] the FASB should consider which issues could be resolved through a review of the objectives of SFAS No. 157 and which issues would be best addressed by the valuation community.” Some of the SEC's roundtable panelists and commenters, including Kevin Spataro of Allstate (representing GNAIE at SEC's Nov. 21 roundtable) noted the concept of exit value and market participants, pushed forward by the requirement to determine hypothetical market participants' values in illiquid markets, essentially put you in a never-ending continuum of hypothetical values which were not necessarily consistent with the going concern notion. Support for a reexamination of FAS 157, in light of lessons learned through application in the real world during the past year-plus, was voiced in a joint comment letter filed with FASB on Nov. 25, 2008 by FEI’s Committee on Corporate Reporting and the U.S. Chamber of Commerce’s Center for Capital Market Competitiveness. (See FEI CCR-USCC CCMC letter.) The SEC’s Dec. 30 mark-to-market report also reiterated CIFiR’s call for a post-adoption or post-implementation review of accounting standards.
- Bright line? I found it interesting that the SEC refers to 45% as a minority in the following sentence: “From the sample of financial institutions studied …the Staff observed that fair value measurements were used to measure a minority of the assets (45%) and liabilities (15%) included in financial institutions’ balance sheets.” The report continues: ”The percentage of assets for which changes in fair value affected income was significantly less (25%), reflecting the mark-to-market requirements for trading and derivative investments,” and adds: “[F]or those same financial institutions, the Staff observed that fair value measurements did significantly affect financial institutions’ reported income.” Many charts are provided in the report, showing breakdowns by size and type of financial institution and the type and percent of assets carried at fair value with the change in fair value recorded in income vs. Other Comprehensive Income (OCI, a component of equity).
- “Directionally consistent” vs. pro-cyclicality: The SEC acknowledges that there was a diversity in views among panelists at its roundtables and in comment letters as to whether fair value accounting contributed to pro-cyclicality, although the SEC found a general consensus that fair value accounting per se was not the proximate cause of the credit crisis. However, a number of panelists and commenters have referred to fair value accounting as an ‘accelerant’ igniting liquidity spirals, and I am not sure how much comfort those in that camp will receive from the SEC’s finding that: “[W]hile fair value is used to measure certain assets such as trading securities and impairment losses on AFS [available for sale] securities, such declines in value were directionally consistent with the losses on the underlying loans and the current economic conditions, which impacted the value of these securities.”
Whether you agree or disagree with the SEC’s findings, or find yourself somewhere in the middle, the SEC is to be commended for writing a study on a complicated matter in plain English, including a section devoted to The Financial Reporting Framework, which the SEC describes as “a short primer …including the basic accounting concepts necessary to understand the issues discussed in this study.”
It can also be a pleasant addition to find an Appendix which is as interesting as the study itself; that is the case with the SEC’s summary of the 185 comment letters it received on this subject as of December 15, 2008, which appears in Appendix A of the report.
The SEC’s study on mark-to-market accounting may make a best seller’s list (among accountants, some lawyers, and public policy types, at least) as the FASB-IASB joint Financial Crisis Advisory Group begins to meet, and as FASB considers comments received on two proposals issued in December relating to impairment of certain financial instruments (Proposed FSP EITF 99-20-a) and proposed disclosures relating to fair value (Proposed FSP FAS 107-a). Congress will no doubt take an interest in the report, which it expressly required as part of the Emergency Economic Stabilization Act of 2008, as it continues to monitor the health and well-being of the economy.
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