Wednesday, November 26, 2008
Immediate SEC Action Needed On Fair Value, ABA Tells Treasury; FEI, U.S Chamber Ask FASB To Take Certain Actions on Fair Value
Noting that Paulson acknowledged in a Nov. 20 speech that mark-to-market accounting has procyclical effects, ABA stated: “the consequences of these procyclical accounting standards are grave,” and calls for immediate action to be taken by the SEC, to be effective for year-end reporting. The three actions recommended by ABA, which it says “do not require a wholesale re-working of mark-to-market, but rather are clarifications that the SEC can and should make now,” include: (1) Other Than Temporary Impairment (OTTI): The accounting rules for OTTI should be based on credit impairment [rather than impairment in ‘fair value’ as determined under FAS 157] (2) Fair value definition: The definition of fair value should be based on willing buyer/willing seller rather than exit price, and (3) Mergers and acquisitions: The implementation date for the new business combinations rules [FAS 141R], which are controversial and are based on fair value, should be delayed.
ABA cc’d the following regulators on its letter to Paulson: the Chairmen of the SEC, Federal Reserve System, and Federal Reserve Bank of New York, as well as the Chairmen and Ranking Members of the House Financial Services Committee and the Senate Banking Committee. ABA’s letter follows on its earlier letters to FASB and the SEC.
FEI, U.S. Chamber, Ask FASB To Take Certain Actions On Fair Value
Separately, in a letter filed with FASB yesterday by FEI’s Committee on Corporate Reporting (CCR) and the U.S. Chamber of Commerce Center for Capital Market Competitivenes (CCMC), the two groups asked FASB to further delay the application of FAS 157 to nonfinancial assets and liabilities, and urges the board to consider related implications in FAS 141R, Business Combinations. Additionally, the letter makes a formal request under FASB’s Rules of Procedure for FASB to reconsider some aspects of FAS 157 in light of information learned about application of the standard during the credit crisis. For complete details, see the FEI CCR-US Chamber CCMC letter to FASB.
Banking Regulator Warnings: Back to the Future?
The ABA’s letter to Treasury yesterday essentially notes their view that the livelihood of the banking system and by extension the economy is at risk if some adaptation to the accounting rules for other than temporary impairment and fair value is not accomplished in time to apply to year-end reports. While not stated in exactly this way in the letter, Reuters’ (via FinancialWeek) summed up the message in ABA’s letter as, “FAS 157 Canceling Out TARP, Bankers Say.”
The role of fair value accounting [established in FAS 157 (fair value measurement) and FAS 115 (accounting for certain debt and equity securities, which specifies mark to market accounting for assets in trading accounts and those classified as available-for-sale; i.e. other than those for which there is a stated intent and ability to hold to maturity] vis-à-vis the health of banks and the TARP program was also a subject of discussion on Kudlow & Company Monday night. Kudlow’s guests included former FDIC Chairman William Isaac, who has been an outspoken critic of FAS 157 (including in WSJ op-eds and in his testimony at the SEC’s Oct. 29 roundtable.) To hear the discussion of accounting standards vis-à-vis TARP, fast forward to about 2:30 on the clip, right after CNBC economist Steve Liesman refers to the government’s four-pronged rescue of Citigroup as the Four Horsemen of the Apocalypse.
Toward the end of the clip, Isaac noted that the then-Secretary of the Treasury, Federal Reserve Board Chairman, and Chairman of the FDIC warned the SEC in 1992 about mark-to-market accounting. Such correspondence, including letters dated March 2, 1992 and March 24, 1992 is noted in former Citibank CEO Walter B. Wriston’s article which appeared in the Wall Street Journal on June 11, 1992: “Mark to Market: Wild Accountants Crazy Idea,” (a copy is available in the Walter B. Wriston Archives) and in “Battle of the Bean Counters,” Fortune, June 1, 1992. In fact, the Fortune article is particularly interesting in that it names many of the people who are active in these issues today, who were speaking on these issues back then, including former SEC Chief Accountant Don Nicolaisen and former Federal Reserve Board Governor Susan Bies (in different roles they held at that time). And my fellow Chase alums will enjoy seeing the reference to a 1992 Chase comment letter.)
The debate back in 1992 was over whether banks entire portfolios of debt and equity investments, or only portions thereof, should be required to be marked to market, due in part to an SEC concern about alleged selective sales of assets with gains and burying unrealized losses in assets carried at historical cost, also referred to as ‘cherry picking’ or ‘gains trading.’ The SEC asked FASB to address this issue, and the resulting standard, FAS 115, “Accounting for Certain Investments in Debt and Equity Securities” established the 3 tier hierarchy in which assets are fair valued except for those for which the entity has the intent and ability to hold those assets to maturity. As such, some may view FAS 115 as an ‘anti-abuse’ standard, in particular guidance that developed after it surrounding ‘tainting’ of the remaining portion of a held to maturity portfolio, when similar assets were sold that had previously been in a ‘hold to maturity’ portion of the portfolio. For some back to the future vibes, see paragraph 99-100 of FAS 115 about concerns of the standard ‘exacerbating the credit crunch’ and see para. 113 describe why the impairment methodology in FAS 115 was based on market values vs. the discounted cash flow methodology in FAS 114, Accounting by Creditors for Impairment of a Loan.”
FASB-IASB Roundtable on Accounting Issues In Financial Crisis
Yesterday, FASB and the IASB held the second in their series of three joint roundtables on accounting issues arising in the financial crisis. Among the primary questions raised to panelists were impairment triggers and fair value measurement.
FASB Chairman Robert Herz responded to some panelists’ suggestions of conforming impairment accounting in FAS 115 (market value) to that set forth in FAS 114 (based on discounted cash flows) as follows: “No doubt you can do that calculation…[using] estimated cash flows and stick in a discount rate, that’s what we do in 114, but I’ve heard users say, in a pejorative way, this is ‘happy cash flows’ with ‘happy (discount) rates’ [such as the discount rates] when first issued… [users] would rather, for accounting, have full fair value, not this calculated value.”
A number of panelists suggested moving to an ‘incurred loss’ model, in which an estimate of incurred credit losses would be separately categorized from the portion of a mark to market loss attributable to other factors, such as liquidity discounts in inactive markets. Some suggested the incurred loss go thru P/L (income statement) with the remainder going through equity by means of Other Comprehensive Income (OCI); some suggested, however, to not lose focus on that ‘other’ amount, to move the display of OCI to the income statement. Among those with specific recommendations in this area were Jerry de St. Paer of GNAIE, and numerous references were made to a recommendation of the Center for Audit Quality (CAQ), affiliated with the AICPA.
Many panelists said they support FAS 157 and fair value, but qualified their support that it worked in orderly, active markets, and that there should, in effect, be a redirection to another impairment model (e.g. similar to FAS 114 based on discounted cash flows) when markets are not liquid or orderly.
IASB board member Jim Leisenring noted that nothing precludes people today from disclosing additional information about what they estimated the true value or incurred loss for their assets to be, if they believed the fair values to not be the most representative number. Herz noted the SEC has tried to encourage additional disclosures through its series of "Dear CFO letters," although Herz added he had heard anecdotally that lawyers were advising their clients not to include any information that was not 'required,' lest they expose themselves to second guessing or litigation. Leisenring indicated there was virtually no chance the two boards would be able to put any change in recognition and measurement through, with due process, by the end of this year, and the only thing within the realm of possibity in his view was possible change on disclosures, particularly in light of the fact that companies were saying the fair value numbers have limitations, but they are not voluntarily providing additional disclosures.
I think the issues raised in the FEI –U.S. Chamber letter to FASB and in the ABA letter to Treasury (which follows ABA’s earlier letters to the SEC and FASB) emphasize that extreme lessons have been learned in the current environment in applying theory to practice which need to be addressed. Among the takeaways from this real-life crucible of learning include the now widely acknowledged view (including as expressed recently by Treasury Secretary Paulson, as noted in ABA’s letter) that mark-to-market accounting does have procyclical effects.
And, while very few have claimed accounting ‘caused’ the economic crisis, more people have begun to refer to the fair value regime as a ‘powerful accelerant’ (including Jerry de St. Paer, Executive Chairman of GNAIE,, see the second bullet on pg. 48 of yesterday’s FASB-IASB roundtable handout, also expressed by Kevin Spataro of Allstate representing GNAIE at the SEC’s roundtable last week). The accelerant argument reflects the fact that there is a feedback loop caused by fire-sale prices in illiquid markets which, in applying FAS 115 and FAS 157, is driving writedowns of, in some cases, entire portfolios (reflecting an extrapolation or some call it ‘tainting’ of similar assets held), in turn driving sales of assets to meet capital requirements or other debt covenants or liquidity requirements, or to reduce portfolios of securities which the market views as risky and which are thought to be dragging down a company’s stock price.
Therefore, some would say the full scope of events has created a downward spiraling market (for assets ranging from housing to mortgages to more exotic securities and plain vanilla equities) with prices offered by buyers (and in some cases, accepted by sellers who by and large are under duress in this market) based on fear, perhaps fear of being left holding the bag on underwater assets when measured under the current construct of FAS 115 and FAS 157, even when the fundamentals such as cash flow on debt securities or other fundamental values of assets point to the assets themselves not being as ‘troubled’ as the ‘market’ prices or hypothetical ‘index’ prices would have one believe.
The role of market and individual psychology is an important consideration that can sometimes outweigh the traditional assumption that ‘the market’ is always ‘rational.’ ’ And, the role of emotion and psychology vs. rationality vis-à-vis the efficient market hypothesis has been pointed out numerous times over the past couple of years by at least one CFA, Vinny Catalano, former president of the New York State Society of Securities Analysts. His views give one pause in considering the views of ‘investor’ reps or ‘users’ who say they view ‘market prices’ as the most transparent and useful information about an asset. Market price may in some circumstances (e.g. rational, liquid markets) be a fair approximation of fair value, but as a number of panelists pointed out at yesterday’s FASB-IASB roundtable and SEC’s roundtable last week, that is not necessarily the case in illiquid markets, and indeed, some believe, can amount to misinformation.
Happy Thanksgiving to all our blog readers and your families, see you next week!
Tuesday, November 25, 2008
Over 70% of the budget is related to personnel, said Budget Director Bill Wiggins during today’s open board meeting, with approximately half the PCAOB’s headcount devoted to Enforcement. The budget includes a net hiring increase of 46 (gross hiring of about 100, given turnover rate of approximately 10% on its current headcount of approximately 500, said Wiggins).
Noting that the preliminary budget was developed in July, PCAOB’s Chief of Staff, Angela Desmond said that external events since that time, most significantly relating to the market downturn, will impact the PCAOB’s activities in 2009. She stated the budget includes money to implement recommendations of the U.S. Treasury Department’s Advisory Committee on the Auditing Profession (ACAP) (described further below), and that there is room for reallocation of funding within the PCAOB budget, within certain limits, (above which SEC approval would be required) to address changing circumstances.
Sixteen of ACAP’s recommendations were directed at the PCAOB, and to address those recommendations as well as those of PCAOB’s Standing Advisory Group, the budget projects an increased headcount in the Office of Chief Auditor (adding 9, currently staffed at 17) and Office of General Counsel (adding 4, currently staffed at 11) to address standard-setting and rule-making related recommendations, including considering potential changes to the form and content of the auditors report, whether to require engagement partner signature on the audit report, potential additional annual reporting requirements for audit firms, and review of the board’s interim standards.
Board member Dan Goelzer commented, “A lot has been said about the ACAP recommendations, let me ask, one recommendation [was to] establish a national fraud center. Of all the recommendations, that strikes me as the one that’s likely to have the biggest resource impact, presumably it means people and maybe facilities as well.” He noted significant resources could potentially be required by the fraud center.
PCAOB’s Deputy Budget Director Yoss Missaghian responded, “There is a provision in the budget to hire one individual mid year to help the board in thinking about scope, reach of the fraud center, [including] conversing with the SEC and other stakeholders.” She said the board expects the person they hire would “help develop a blueprint for the fraud center and lead it, [with] other resources added in 2010.”
Board member Charlie Niemeier voiced concern that , "In one significant area, the budget does not adequately analyze and provide for work that I believe we need to do to protect investors in U.S. securities. Specifically, I continue to have concerns about the scope of our inspections of non-U.S. firms." Goelzer concurred, noting that not only the inspections team will be impacted, but expanded activity in the international arena "puts more pressure on [PCAOB's Office of International Affairs] to deal with, negotiate with" other international regulatory bodies, and "there is a real risk we will not be able to accomplish our inspection goals, not because we don’t have enough inspection people" but because of the need to work out arrangments for cross-border inspection. Part of the expected expansion of international inspection work in 2009 relates to inspecting ‘substantial role firms’ - as described by staff, firms that don’t sign audit reports, but do a substantial amount of audit work (up to a 20% cutoff), which, PCAOB staff said, tend to be foreign firms. PCAOB staff said that among the projected new hires will be 2 more staff for the Office of International Affairs, adding the can get more resources to them if necessary.
Wiggins said the accounting support fee is estimated at $151.8 million, up from $134.5 million last year. He added, "We will have five months of operating resources for 2009 in the working capital reserve fund, to cover our costs until billing [of the support fee] occurs."
PCAOB Chairman Mark Olson said the PCAOB is “highly conscious our mission is supported by public companies... and in turn by their shareholders” [i.e. through the annual support fee], and described the budget as conservative, reflecting the board’s commitment to its mission and stewardship. The budget authorized by the PCAOB board today now goes to the SEC where it undergoes a separate approval process.
Sunday, November 23, 2008
Friday’s SEC roundtable on MTM (agenda, panelists), like the earlier roundtable held on October 29, is aimed at providing input – along with comment letters filed – as the SEC conducts its Congressionally mandated study on MTM (aka fair value or FV) accounting. In accordance with Section 133 of the Emergency Economic Stabilization Act of 2008 (EESA), the SEC’s study is due to be delivered to Congress by Jan. 2, 2009.
SEC Chairman Christopher Cox noted in his opening remarks at the Nov. 21 roundtable, “Already, the input that we’ve received … in response to our request for public comments has indicated that at a minimum there are areas where FV accounting could be improved,” specifically: (1) investors could be better served by a more streamlined model for addressing asset impairments, they observe the current framework for impairment can be difficult to apply, and may provide information of questionable utility, and (2) the current concept of mark-to-market accounting increases the transparency of information provided to investors; but, in inactive or illiquid markets, additional work is necessary to insure the reasonable application of the standards."
The discussion that took place at SEC's November 21 roundtable appeared to confirm the above points, particularly on the need for further guidance on impairment. Some panelists, including KPMG’s Sam Ranzilla, suggested the SEC consider offering guidance on impairment in the short-term; he further advised that if the SEC is not going to issue guidance by year-end, to make that known, so as to set preparers and auditor’s expectations accordingly. There were varying views on the need to amend FAS 157, Fair Value Measurement, or other standards (e.g. FAS 115, Accounting for Certain Investments in Debt or Equity Securities), such as to conform the valuation and impairment models closer to that set forth in FAS 114 (Accounting by Creditors for Impairment of a Loan), or whether further disclosure guidance (and additional disclosures) are needed.
There were also varying opinions on whether regulatory accounting principles (RAP) should be adjusted to back out procyclical effects of fair value accounting, rather than amending Generally Accepted Accounting Principles (GAAP) to address bank regulatory issues. Chairman Cox, and various panelists, reiterated their support for the independence of the FASB and IASB.
In related news, FV was the focus of a breakfast panel at FEI’s Current Financial Reporting Issues conference last week, entitled: Current Financial Controversies: Legal and Auditing Perspectives. Appearing on the panel, presented by SmartPros Ltd., were Kenneth N. Goldmann, SEC Practice Director, J.H. Cohn LLP, and Michael R. Young, Co-Chair of the Securities Litigation Practice Group of Willkie Farr & Gallagher LLP. Panel moderator was Colleen Cunningham, Regional Managing Director, Resources Global Professionals, and former President & CEO of FEI.
We have posted some abbreviated highlights from the SEC’s Nov. 21 roundtable and the Nov. 18 FEI Current Financial Reporting Controversies panel; more details can be found in these FEI summaries: Highlights From SEC Roundtable On Mark-to-Market Accounting, and FEI CFRI Conference Features Panel on Fair Value.
Thursday, November 20, 2008
The joint project on leasing is one of the major convergence projects on FASB-IASB's Memorandum of Understanding (MOU). The MOU, dating back to the "Norwalk Agreement" in 2002, and updated several times since then (most recently, in Sept. 2008), outlines the plan of the two boards to achieve (on major projects, by 2011), "Convergence of accounting standards ... through the development of high quality, common standards over time."
According to the board’s technical plan, the DP on leasing is slated to be released for public comment 1Q09. Based on information contained in yesterday’s FASB board handout, the staff was prepared to recommend a 120 day comment period for the DP. However, the board did not formally address the comment period issue and was not formally requested to authorize the ballot draft yet, since they asked the staff to come back with further analysis of one issue: subleasing.
Although the current project is scoped to lessee accounting, FASB board members suggested doing a 'sense check' in terms of potential issues of symmetry in lessor accounting, including considering the board's views on insubstance purchase (sale) of assets vs. right of use. Additionally, board members suggested doing a 'sense check' of their views in the leasing project vis-a-vis the separate project on revenue recognition, and that consideration of these issues at this time (prior to issuing the DP) may be a useful approach.
A couple of the 14 issues taken up by FASB yesterday on leasing were deliberated for about an hour each; we have included highlights from one of those issues (measurement) below. For further details see this FEI summary, and for the official results look for the Summary of Board Decisions which FASB generally posts within a day of its board meetings, in FASB’s News Center. (Given the back-to-back FASB and IASB board meetings on leasing, I wonder if perhaps some kind of joint summary of board decisions will be published.)
Measurement of leases, including contingent rents
FASB board members spent over an hour discussing the issue of measurement of leases, including contingent rents. The three alternatives considered were: (1) probability weighting or expected outcome (preferred by the IASB board in an earlier vote), (2) best estimate, and (3) most likely amount (e.g. of rents to pay).
A great deal of the discussion revolved around a debate between whether the ‘best estimate’ could be skewed if someone presumed the most likely outcome was the minimum lease payments, and depending on how contingent lease payments such as performance based payments were estimated or probability weighted (e.g. contingent lease payments based on hitting certain sales targets)
The IASB is understood to be leaning toward a probability weighted or ‘expected outcome’ approach. FASB Chairman Robert Herz noted a probability weighted approach could be more complex than a best estimate approach.
FASB board and staff members asked the IASB project directors who participated in the meeting by phone to explain how, in practice, they believed a probability weighted approach would be performed. IASB project manager Rachel Knubley gave as an example, “We would say, if there is a 10% probability sales of 100, 50% probability of sales of 200 and 40% probability of sales of 300; take the probability weighted average of those three outcomes.”
IASB project manager Simon Peerless added, “In many cases, that will be best you can do, where you have more detailed forecasts, you should be required to use those, rather than just 3 points.”
FASB board member Larry Smith said, “If you ask [IASB board member Jim] Leisenring whether that would represent a probability assessment, he would say no.” The implication was that some may view probability weighted assessments as requiring a more complex, statistically based mathematical approach.
A FASB staff member asked the IASB staff: “In practice, do they do all those probabilities and show auditors those workpapers?”
IASB’s Knubley replied, “It depends, if you have warranties, you would be expected to present good [details], vs. … back of the envelope; lessees may have just one lease; [some may say] all we’re doing is a back of the envelope calculation.”
Herz responded to the IASB staff’s explanation that a back of the envelope calculation may be viewed as fulfilling a probability weighting requirement: “That is OK in a lot of jurisdictions, but if you use those words [probability weighted] in our jurisdiction, it will force people to come up with things they don’t believe in, just to satisfy auditors.” He added, “We would not preclude somebody [from using probability weighting to determine best estimate], but we don’t want to use words that make people do things they don’t do.”
Additionally, Herz observed, “One of the unfortunate problems, realities in the world, seems to be [that using] the same words would be nice, but the same words are not going to produce the same practice, we found … [we’re] not knocking the IASB, [but there is the] issue of auditing, enforcement, all that in other parts of the world” which have to be reckoned with.
FASB board member Larry Smith explained further the potential ramifications of requiring a probability weighted approach in the U.S., saying: “We are trying to avoid making people prepare excel spreadsheets up the wazoo, which they aren’t doing, and across the Atlantic, if they don’t require people to do those workpapers, and if they deem a back of the envelope estimate to be a probability outcome….”
Linsmeier added, “They [the IASB] have to understand it’s an application issue, and a witchhunt on looking for twenty different views [in a probability weighting].”
The IASB board will be presented with the same questions on November 20 which the FASB voted on November 19. Knubley suggested alternative views be provided in the DP.
Smith added, “We had an objective to minimize differences, if we don’t eliminate them all, but eliminate some, we’ve accomplished something.”
Tuesday, November 18, 2008
Drawing a distinction between convergence of regulations vs. one single regulatory body, he noted, “Securities regulations can and should be converged to a far higher degree than we have already attained. But it is unrealistic to think we could or should make them identical, because of differences in national laws, economic conditions, and objectives. These differences are healthy and normal. It is entirely reasonable for a nation to view its responsibility to its own citizens and markets as paramount. The Securities and Exchange Commission is responsible for the protection of American investors, and it will never compromise that mission. Nor should any other national regulator. One of the reasons for the remarkable success of IOSCO is that it understands this very well.”
Cox commented on the important role of the U.S.: “While the United States has some obvious and correctable regulatory gaps, we have also set the highest regulatory standards for our markets of any country on earth. We should use the power of those markets to help raise world standards — which is the aim of our nascent mutual recognition initiative. The flight to quality that is currently underway is but the latest reminder that in the long run, countries can only win the global competition for capital by protecting investors with stronger, more transparent markets. It is not mere coincidence that the world's largest capital market, by far, also has the world's highest standards.”
I hope to provide additional highlights from the conference later this week, meantime check out the reporting done by Francine McKenna, author of the Re:The Auditors blog, and if you have a subscription to BNA, see the articles by Steve Burkholder IASB, FASB Heads Stress Need for BoardsTo Cooperate During Current Global Crisis and Denise Lugo Controllers Say No to Adopting IFRSWithout More Accounting Convergence. In CFO.com, see IFRS Requires a Soft Touch by Marie Leone, Wrinkles in the IFRS Roadmap by Sarah Johnson and David McCann, and SEC: IFRS Early Adoption Will Cost $32 Million by Sarah Johnson and Marie Leone. NOTE: In a session I attended at the FEI conference yesterday, panel moderator Eric Smith of Credit Suisse noted his company estimated it would cost $200 million and take 18 months to implement IFRS in the U.S.
Additional reporting from the conference can be found in SEC’s Cox Urges Global Regulators to Cooperate More by Emily Chasan of Reuters, and SEC Publishes IFRS Roadmap by Michael Cohn in WebCPA. (If I see links to other publications I will add them to this post or a future post.)
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Sunday, November 16, 2008
Root Causes of Crisis
The G-20 noted their consensus view on root causes of the credit crisis included unsound risk management practices, increasingly complex and opaque financial products, excessive leverage, inconsistent and insufficiently coordinated macroeconomic policies, and inadequate structural reforms. Additionally, the G-20 observed: “policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.”
Action Plan Based on Five Principles for Reform
The G-20 Declaration includes an Action Plan that details priority actions (to be accomplished by March 31, 2009) and medium-term actions to be taken consistent with 5 common principles of reform:
1. Strengthening Transparency and Accountability
2. Enhancing Sound Regulation – including with respect to Regulatory Regimes, Prudential Oversight, and Risk Management,
3. Promoting Integrity in Financial Markets
4. Reinforcing International Cooperation
5. Reforming International Financial Institutions (IFIs), including the IMF, and expanding the Financial Stability Forum to a broader membership of emerging economies
The G-20 finance ministers, working in coordination with G-20 leadership (currently Brazil, the U.K. and the Republic of Korea) have been tasked with overseeing actions taken by regulators, IFIs, accounting-standard setters and others to accomplish these reforms.
Actions to be Taken by Accounting Standard-Setters and Regulators
Under the heading: Strengthening Transparency and Accountability, the G-20 asks that accounting standard-setters and regulators take the following actions. (Note: additional actions for regulators are described in other sections of the action plan.)
Immediate Actions by March 31, 2009
- The key global accounting standards bodies should work to enhance guidance for valuation of securities, also taking into account the valuation of complex, illiquid products, especially during times of stress.
- Accounting standard setters should significantly advance their work to address weaknesses in accounting and disclosure standards for off-balance sheet vehicles.
- Regulators and accounting standard setters should enhance the required disclosure of complex financial instruments by firms to market participants.
- With a view toward promoting financial stability, the governance of the international accounting standard setting body should be further enhanced, including by undertaking a review of its membership, in particular in order to ensure transparency, accountability, and an appropriate relationship between this independent body and the relevant authorities.
- Private sector bodies that have already developed best practices for private pools of capital and/or hedge funds should bring forward proposals for a set of unified best practices. Finance Ministers should assess the adequacy of these proposals, drawing upon the analysis of regulators, the expanded FSF, and other relevant bodies.
- The key global accounting standards bodies should work intensively toward the objective of creating a single high-quality global standard. * Regulators, supervisors, and accounting standard setters, as appropriate, should work with each other and the private sector on an ongoing basis to ensure consistent application and enforcement of high-quality accounting standards.
- Financial institutions should provide enhanced risk disclosures in their reporting and disclose all losses on an ongoing basis, consistent with international best practice, as appropriate. Regulators should work to ensure that a financial institution' financial statements include a complete, accurate, and timely picture of the firm's activities (including off-balance sheet activities) and are reported on a consistent and regular basis.
- In addition the G-20 state: “In consultation with other economies and existing bodies, drawing upon the recommendations of such eminent independent experts as they may appoint, we request our Finance Ministers to formulate additional recommendations, including in the following specific areas:
1. Mitigating against pro-cyclicality in regulatory policy;
2. Reviewing and aligning global accounting standards, particularly for complex securities in times of stress;
3. Strengthening the resilience and transparency of credit derivatives markets and reducing their systemic risks, including by improving the infrastructure of over-the-counter markets;
4. Reviewing compensation practices as they relate to incentives for risk taking and innovation;
5. Reviewing the mandates, governance, and resource requirements of the IFIs [International Financial Institutions, e.g. the Financial Stability Forum and the IMF]; and
6. Defining the scope of systemically important institutions and determining their appropriate regulation or oversight.
Some may observe that the SEC’s release of its proposed IFRS Roadmap on November 14 may be viewed as a step consistent with point 2 above (aligning global accounting standards, generally). More specifically, with respect to aligning global standards for complex securities, FASB and the IASB have a number of initiatives currently under way, including a series of roundtables and a high level advisory group, and the SEC is currently conducting a study of the impact of mark-to-market (fair value) accounting which Congress requested the SEC to report on by Jan. 2. In related news, the second in a series of SEC’s roundtables on MTM is slated to take place on Friday, Nov. 21. (See our prior post on SECs Oct. 29 MTM roundtable.)
Officials Note Some Changes May Seem Technical, Mundane, But Are Not
A press briefing by Senior Administration Officials at the White House yesterday on the results of the G-20 meeting included references to the accounting-related recommendations. One official said, “I'm going to turn to my colleague in a moment to walk us through some of the very concrete steps and measures and decisions that were adopted … let me point out that a number of these may sound very technical or very mundane. I can assure you they are not. These technical changes, these agreements to change practices or enhance rules and regulations, this is the stuff of financial markets reform.”
The next “Senior Administration Official” stated, according to the transcript: “Well, after that description of what I'm going to talk about, I'm sure you're all on the edge of your seat. (Laughter.) This is my life. I've been living this stuff. I want you to get all excited about it.” The official added: “So there was, for a leaders meeting… probably a more detailed and more substantive discussion of a number of topics … given the nature of this broader subject than you would have expected. And within the context of strengthening transparency and accountability, the leaders had a conversation about the need for better disclosure. And as part of the action plan, there was a specific commitment made that by March 31st of 2009, regulators and accounting standard setters should have required enhanced disclosure of complex instruments by firms to market participants. So a very specific -- one of many of the 47 -- but a very specific request that kind of makes sense as you think about some of the challenges we have had over the last year and how they've been driven by the lack of transparency and the complexity of a number of these products.”
The level of engagement of the G-20 officials in discussing accounting-related matters was specifically commented on by the senior administration official, who described one aspect of the G-20 summit as: “not so much the content of the actions, because people don't follow valuation of securities and FASB and accounting standards so closely -- but how detailed and concrete and immersed in the detail these leaders were. They weren't talking at this level and saying, oh, experts will deal with this. This was a very detailed discussion by the leaders themselves about what needed to be done, both at the most specific level and also, stepping back, the affirmation of these core principles.”
Commitment to an Open Global Economy; Caution on Over-Regulation
The G-20 reaffirmed their commitment to an open global economy. As noted in the Declaration, they stated, “We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems.”
Additionally, the G-20 state: “Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.” See the Declaration for a full discussion of the G-20 views on maintaining an open global economy and other matters.
Next Meeting By April 30
The G-20 agreed to meet again by April 30, 2009. President George W. Bush hosted yesterday’s G-20 summit in Washington, DC, we cited the President’s opening remarks in our post on Friday. President-elect Barack Obama did not attend this weekend’s G-20 meeting (he has been quoted as emphasizing the U.S. has one administration and one President at a time), however he sent former Secretary of State Madeleine Albright and former Congressman Jim Leach to meet privately with representatives of the G-20 nations. Albright and Leach noted in a statement, as reported in this Reuters article in the New York Times, "The president-elect believes that the G20 summit of leaders from the world's largest economies is an important opportunity to seek a coordinated response to the global financial crisis.”
Important Notice for Subscribers
If you have not seen it already, please see the important notice for subscribers at the bottom of our Nov. 14 post, regarding changes to this blog taking effect Monday, Nov. 17.
Friday, November 14, 2008
Excerpted below is the Summary provided in the first couple pages of SEC’s 165-page proposal:
“The Securities and Exchange Commission (“Commission”) is proposing aRoadmap for the potential use of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board by U.S. issuers for purposes of their filings with the Commission. This Roadmap sets forth several milestones that, if achieved, could lead to the required use of IFRS by U.S. issuers in 2014 if the Commission believes it to be in the public interest and for the protection of investors. This Roadmap also includes discussion of various areas of consideration for market participants related to the eventual use of IFRS in the United States. As part of the Roadmap, the Commission is proposing amendments to various regulations, rules and forms that would permit early use of IFRS by a limited number of U.S. issuers where this would enhance the comparability of financial information to investors. Only an issuer whose industry uses IFRS as the basis of financial reporting more than any other set of standards would be eligible to elect to use IFRS, beginning with filings in 2010.”
Although perhaps coincidental, (after all, the roadmap was approved for release by the Commission on Aug. 27) issuance of the proposed IFRS roadmap today coincides with the start of the two-day G-20 economic summit in Washington, D.C. (Alan Rappeport of CFO.com reported on Oct. 31, citing SEC spokesman John Nester, that the roadmap was expected to be published the first week in November, and Tim Reason of CFO.com reported on Nov. 6 that the roadmap was expected to be published on Friday Nov. 7. I noted my personal opinion in this blog on Nov. 11 that, after reading the IASCF's Nov. 11 letter to the G-20, I believed "The likelihood [of issuing the roadmap coincident with the G-20 meeting] may have increased in light of the imminent announcement of the formation of the IASCF Monitoring Board, which is expected to be announced 'during the next few weeks,' according to the IASCF letter to the G-20.")
In remarks welcoming the G-20 members tonight, President George W. Bush said, “Tomorrow's discussion will be the first in a series of meetings… focus[ing] on five key objectives:
1. understanding the causes of the global crisis
2. reviewing the effectiveness of our responses thus far
3. identifying principles for reforming our financial and regulatory systems
4. launching a specific action plan to implement those principles, and
5. reaffirming our conviction that free market principles offer the surest path to lasting prosperity.
Read the President’s complete remarks. Here is a list of delegates to the G-20 meeting.
Want to learn more about IFRS and the latest regulatory developments? It’s not too late to register for FEI’s Current Financial Reporting Issues (CFRI) conference taking place Monday and Tuesday Nov. 17 and 18 in NYC, with updates from the SEC, FASB and IASB - info is at www.financialexecutives.org/cfri. And, for a deep dive in IFRS, register for the follow-on session, IFRS: Strategies for Adopting a Single Set of Standards, sponsored by Deloitte, taking place Wed. Nov. 19 in NYC.
Important News for Subscribers
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In a letter posted on the Financial Accounting Standards Board (FASB) website today, Robert Denham, President of the board of Trustees of the Financial Accounting Foundation (FAF) (which oversees the FASB), sent a letter to U.S. President George W. Bush on Nov. 13, asking President Bush to share the letter with members of the G-20 attending the Summit on Financial Markets and the World Economy taking place today and tomorrow in Washington, DC.
Following are some of the points in the FAF letter to President Bush, G-20:
- We understand that current issues relating to international accounting standards will be discussed at this [G20] meeting as part of a comprehensive examination of the global financial crisis.
- The FAF believes that the complex task of setting accounting standards is best done by the experts who comprise the FASB and International Accounting Standards Board (IASB).
- We are very concerned about recent efforts in the United States and abroad that contemplate political solutions to perceived flaws in certain accounting standards.
- Political pressures have been brought to bear on the IASB to urgently review and revise its standards, particularly relating to ‘mark-to-market’ (fair value) accounting. The IASB has already departed from its normal due process to make one such revision in response to this pressure and is being asked by the European Commission to further review its standards for certain financial instruments and to complete its deliberations in time for year-end financial reporting.
- High-quality accounting standards are best achieved when the standard-setting process is independent and free of political influence.
- We believe that any legislative outcome that would permit accounting standards to be overturned through a political process will create uncertainty, greatly undermine investor confidence, and dangerously compromise the credibility of financial reporting at a time when the capital markets are under great duress and in need of greater transparency.
- We encourage the G-20 to support independent standard setting via a robust due process free from political interference. This support will do more to restore confidence in the capital markets than legislating accounting standards in a way that reduces the reliability and transparency of financial information presently available to investors.
- We previously reported that the International Accounting Standards Committee Foundation (IASCF) sent a letter to President Bush and the G-20. (See IASCF letter to President Bush, G-20.)
Here are some interesting articles in today’s papers about the G-20 meeting:
Nations to Talk Finance, as Pillars of Power Shift, by Mark Landler, NYT
France’s Finance Minister [Christine Lagarde] in a Critical Role at Global Economic Talks, by Nelson D. Schwartz and Katrin Bennhold, NYT
Bush Speaks in Defense of Markets, by Sheryl Gay Stolberg and Robert Pear, NYT.
That G-20 Show, Wall Street Journal Editorial
Treasury Refocuses TARP
Earlier this week, U.S. Treasury Secretary Henry Paulson provided an update on the state of the financial system and Treasury’s strategy for continued implementation of the Emergency Economic Stabilization Act of 2008 (EESA). Signed into law on Oct. 3, EESA provides $700 billion for various programs implemented and to be implemented by Treasury and the other regulatory agencies to help stabilize the economy, particularly the financial markets which have been roiled during the credit crisis. Actions taken so far have included injecting capital into banks through the Capital Purchase Program (CPP), and expanding the Fed’s Commercial Paper Funding Facility (CPFF).
Based on Paulson’s Nov. 12 remarks, Treasury has refocused TARP much more on capital injections, and has pretty much decided not to go the route originally envisioned, of purchasing troubled mortgage and other assets as originally described in this Sept. 20 Fact Sheet. Questions had previously been raised in Congressional hearings and elsewhere about how the proposed purchases of troubled assets would work, how the pricing mechanisms would be handled, and so forth, so as not to offer too low a price to be of any assistance to banks, and yet not offer too high a price to unduly disadvantage taxpayers, as noted in this post.
As noted in Treasury Redefines Rescue Program by Peter Whoriskey, David Cho and Binyamin Appelbaum in the Washington Post yesterday, some of the funds may be directed at loosening consumer credit by assisting providers of credit cards and auto loans. However, that does not necessarily mean direct funding for the auto industry, as noted in the article, Chances Dwindle on Bailout Plan for Automakers, by David Herszenhorn in today’s NYT.
Congressional hearings this week have honed in on the issue of the deployment of TARP or EESA funds so far, and have questioned the ability of the private sector to modify mortgages to stem the tide of foreclosures. Michael R. Crittenden reports on today’s House Oversight and Government Reform Committee, Subcommittee on Domestic Policy hearing in his article on wsj.com this afternoon: Lawmakers Grill Kashkari on Changes in TARP Plan, and Louise Story wrote in her article, Lawmakers Debate Pitfalls of Loan Modification Nov. 13 in the NYT, about the House Financial Services Committee hearing which took place earlier this week, during which lawmakers heard varying views about how easy or difficult it was to modify securitized mortgages.
This just in: Zachary A. Goldfarb of the WashingtonPost reported this afternoon: Government to Speed Cash to Mortgage Giant After Massive Losses, noting: “The government is expected to inject $14 billion into Freddie Mac, the mortgage finance company under federal control, after it reported today that it lost $25 billion from July through September. “ He adds, “The numbers are astounding. The company's losses, when combined with those since the housing downturn started, eviscerate nearly all the company's earnings over the past decade.” See Freddie Mac’s Nov. 14 press release, and Fannie Mae’s Nov. 10 press release.
Separately, the President’s Working Group (PWG) on Financial Markets announced today PWG Initiatives to Strengthen OTC Derivatives Oversight and Infrastructure. In related news, the SEC announced: SEC Chairman Cox Statement on MOU With Federal Reserve, CFTC to Address Credit Default Swaps.
The SEC also confirmed today that the second of its two mark to market roundtables will take place on Nov. 21 (see our earlier report on SEC's Oct. 29 roundtable).
Hoogervorst, Goldschmid Tapped to Lead High Level Global Advisory Group
Separately, the Financial Accounting Standards Board and the International Accounting Standards Board announced on November 14 that Hans Hoogervorst and Harvey Goldschmid have agreed to co-chair the FASB-IASB Advisory Group formed to consider financial reporting issues arising from the global economic crisis.
Hoogervorst is Chairman of the Netherlands Authority for the Financial Markets (AFM), is Vice-Chairman of the Technical Committee of the International Organization of Securities Commissions (IOSCO) and is a former Minister of Finance in the Netherlands.
Goldschmid is a former commissioner of the U.S. Securities and Exchange Commission, is a member of the governing board of the Center for Audit Quality (CAQ), affiliated with the AICPA, is a senior counsel at Weil, Gotshal and Manges, and teaches law at Columbia University.
COSO’s monitoring guidance is being developed by a project team led by Grant Thornton, under the oversight of a broad-based task force consisting of representatives of COSO’s five sponsoring organizations – AAA, AICPA, FEI, IIA, and IMA - and other experts. An Exposure Draft of the proposed guidance was issued for public comment earlier this year, and COSO is preparing to issue final guidance by year-end.
Learn more about the concepts underlying the new guidance and practical aspects by registering for a free webcast sponsored by FEI and Grant Thornton taking place on Dec. 2 at 2:00 PM EST entitled: COSO’s New Guidance on Monitoring Internal Control: What You Need To Know . (NOTE: when you follow the registration links, use Company Code 710004.) Trent Gazzaway, Grant Thornton's managing partner of corporate governance, who represented Grant Thornton as the project leader on creating the new guidance, will lead this presentation. Moderating the webcast is FEI Senior Advisor Michael P. Cangemi. Michael serves as FEI’s representative on the COSO board. The webcast will also feature a Q&A during which participants can submit questions online.
Wednesday, November 12, 2008
FASB staff noted that most commenters on the proposed FSP asked that it not be effective until 1Q 2009. However, FASB staff stated they believe the modifications voted on today (prior to the vote on the effective date) would address certain concerns with the proposed requirements, and facilitate making the FSP effective essentially at year-end.
A total of over 20 issues were discussed today regarding changes to (or decisions not to change) disclosure requirements in the proposed FSP, outlined on pdf pages 26-35 of today’s board handout. Further details will likely be provided in the FASB Summary of Board Decisions which FASB began posting this year the day of or the day following board meetings, found in FASB’s News Center.
FASB staff member Pat Donoghue said the staff’s plan is to make the changes agreed to this week, and send it out to external reviewers (fatal flaw review) by Monday, asking for a one week turnaround. Staff then plans to get pre-ballot draft to the board during Thanksgiving week, and expects to issue the FSP no later than December 15 (including production time, according to Donoghue). The FSP discussed by FASB today relates to disclosures only.
Separately, FASB will redeliberate its proposed amendments to FAS 140 and FIN 46R (including the removal of QSPEs) which were proposed in the form of Exposure Drafts (EDs) entitled Proposed Statement, Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140, and Proposed Statement, Amendments to FASB Interpretation No. 46(R). The effective date proposed on those broader amendments is 2010 (technically: as of the beginning of a reporting entity’s first fiscal year that begins after November 15, 2009); and the comment deadline on the broader amendments is Nov. 14.
Hear the latest on FASB, SEC and IASB developments at next week’s FEI conference: Current Financial Reporting Issues. See the agenda and registration info at www.financialexecutives.org/cfri.
Tuesday, November 11, 2008
The IASCF letter reviews IASB actions under way to address the credit crisis, including a series of roundtables being convened by the IASB and FASB in London on Nov. 14, Norwalk CT on Nov. 25 and Tokyo on Dec. 3 to identify financial reporting issues highlighted by the global financial crisis.
Additionally, the IASCF letter states: “efforts to improve financial reporting should be led and completed expeditiously by the IASB in order to ensure a globally coordinated approach,” and notes: “The IASB has already taken a number of significant steps to improve accounting guidance based on the recommendations particularly of the Financial Stability Forum (FSF) but also of other stakeholders and commentators.”
In light of these actions, the IASCF Trustees advise the G20: “any steps taken outside the well-established and supported standard-setting process to amend fair value accounting would further undermine already scarce confidence in financial markets.” This language sounds somewhat akin to that in a letter sent by FAF Chairman Robert Denham (the FAF board of trustees oversees the FASB) to SEC Chairman Christopher Cox last month.
The subject of accounting (including mark-to-market or fair value accounting) and its role in the credit crisis, and the need to conform global accounting standards to create a level playing field, is one topic likely to come up at the special meeting of the G20 this week, according to material prepared by Jenilee Guebert, Senior Researcher, G20 Research Group of the University of Toronto Munk Centre for International Studies at Trinity College. See G20 Economic Summit: Plans for the Special Meeting on November 15, 2008. See also Nations Strive for a Single Voice on Financial Crisis, But Rival Agendas Make it Tough to Act in Unison, by Bob Davis in the Nov. 10 Wall Street Journal.
Will SEC IFRS Roadmap Be Announced at G20 Meeting?
Could issuance of SEC’s proposed IFRS Roadmap which the SEC voted to release for public comment on Aug. 27 coincide with the G20 special meeting taking place in Washington DC on November 15? The likelihood may have increased in light of the imminent announcement of the formation of the IASCF Monitoring Board, which is expected to be announced “during the next few weeks,” according to the IASCF letter to the G20.
The IASCF proposed formation of a Monitoring Board earlier this year, to include representatives from public authorities. The SEC, IOSCO, EU, and Japan FSA jointly announced in June they support the formation of such a Monitoring Board which would, among other things: participate in the selection and approval of IASCF Trustees, hear regular reports from the IASCF Trustees on their oversight of the IASB, and “ensure the independence of the IASB, while reinforcing the public interest oversight provided by the IASCF Trustees.”
The independence of the IASB was reportedly questioned during a hearing of the Treasury Committee of Britain's House of Commons, as reported in this article by Marie Leone today in CFO.com.
Agencies have not waited for formal restructuring to increase lines of communication, as evidenced this year by SEC’s MOU with the Fed, SEC’s Mutual Cooperation Agreement with the CFTC, and SEC’s MOU with the DOL.
However, concern with the causes of the credit crisis experienced over the past year-plus, and further concern with the potential effectiveness of the $700 billion rescue package signed into law in October are prompting further discussions about the potential need for a systemic risk regulator.
Here are some recent cites on this topic:
“Schumer Outlines Regulatory Reform Plan, Calls for Contemplating Single Regulator,” by Stephen Joyce in today’s BNA Daily Report for Executives. Joyce reports that Sen. Charles Schumer (D-NY) told a SIFMA conference yesterday: “The financial difficulties faced by the American International Group Inc. highlight the need for the U.S. government to contemplate adopting a single regulator for its financial services industry.” Schumer reportedly added, “We need to look closely at unifying and simplifying our regulatory structure, perhaps moving toward a single regulator. In this era of global markets and global actors, we cannot return to the older model of separate businesses with separate regulators. We must consider whether a more unified financial regulatory system could provide more efficient regulation.” BNA’s Joyce also noted the idea of a single national regulator for financial services is opposed by many state insurance and banking regulators.
“Treasury Plan Likely Starting Point For Dealing With Regulatory Reform,” by Joyce E. Cutler in today’s BNA Daily Report for Executives. Reporting from the American Bankers Association Annual Meeting, Cutler noted: “The current financial crisis undoubtedly will result in a new regulatory structure, with the Treasury Department's reform plan a likely roadmap, Public Company Accounting Oversight Board Chairman Mark Olson and Office of Thrift Supervision Director John M. Reich Jr., said Nov. 10.”
Statement of Sen. Chris Dodd, Chairman of Senate Banking Committee, Nov. 6, 2008: Senator Dodd confirmed his intention to stay on as chairman of the Senate Banking Committee, and described various priorities of the committee. Among those priorities, Dodd noted: “the primary legislative focus of the Committee must and will be to modernize our nation’s framework of financial regulation. If we are going to regain the confidence of investors, consumers, and businesses here at home and around the world, they must have confidence that our financial institutions are properly capitalized, regulated, and supervised.”
“Democrats Prepared to Act Fast on Car Aid, Regulation,” by Damian Paletta, Josh Mitchell, and Neal Boudette, Wall Street Journal, Nov. 6, notes: “House Financial Services Chairman Barney Frank said in an interview that he is weighing tougher rules on shareholder rights and stricter conditions on the $700 billion financial rescue package. Mr. Frank added that a central point of Democrats' plans would be the creation of a ‘systemic-risk regulator.’ It could have unprecedented powers over a wide range of financial institutions, from insurance firms to hedge funds, with responsibility for protecting the soundness of the whole financial system, not just one sector. He likened that to the establishment of the Securities and Exchange Commission, charged with maintaining fair markets and investor protection, five years after the market crash of 1929.”
WSJ’s Paletta, Mitchell and Boudette add: “Beyond the possible creation of a systemic-risk regulator, lawmakers are considering consolidation of some financial regulators. This will likely depend on the views of the Obama administration. One possible scenario would be merging the Office of the Comptroller of the Currency, which regulates national banks, and the Office of Thrift Supervision, which regulates savings and loans… SEC Chairman Christopher Cox, who is expected to leave by February, has pushed for his agency to be merged with the Commodity Futures Trading Commission. Such a move could make it easier for lawmakers to set tougher limits on complex financial products such as credit-default swaps, which are under much more scrutiny amid the financial turmoil.”
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Monday, November 10, 2008
A list of members of the Obama-Biden TEAB, including this link to a seating chart of Friday’s TEAB meeting, can be found in the article, “Obama Pledges Quick Action on Economic Stimulus,” by Jonathan Weisman in the weekend edition of the Wall Street Journal.
Among top contenders for U.S. Treasury Secretary in the Obama-Biden administration, according to various press reports, are former Treasury Secretary Lawrence Summers and New York Fed President Timothy Geithner. Former Federal Reserve Board Chairman Paul Volcker, a member of the TEAB, has also been rumored by some as a possible choice. See, e.g. “Summers and Geithner: A Reading List” posted Nov. 6 in David Leonhardt’s Economix blog, and “Summers and Geithner, Two Contenders for Treasury Job, Have Close Career Ties,” by Deborah Solomon and Michael Phillips in the weekend WSJ.
Over at the U.S. Securities and Exchange Commission, as reported Kara Scannell in Friday’s Wall Street Journal, “SEC Exodus May Soon Accelerate.” Scannell notes that Division of Corporation Finance Director John White announced last week he will be leaving the SEC at the end of the year to return to private practice, and she states: “SEC Chairman Christopher Cox has said he plans to leave after the end of the Bush administration, and a new chairman could be named soon.” Among possible candidates for the chairmanship, says Scannell, are former Commissioner Harvey Goldschmid, currently teaching at Columbia Law School, and AFL-CIO Associate General Counsel Damon Silvers, currently a member of the PCAOB Standing Advisory Group (SAG). Other possible candidates for the position, noted in an article in Bloomberg on Friday by Jesse Westbrook, “Obama's Pick for SEC Is `Urgent' Task, Lawmakers Say,” could include former Fidelity Investments Vice Chairman Robert Pozen, who chaired the SEC’s Advisory Committee on Improvements in Financial Reporting, aka CIFiR or the Pozen Committee, FDIC director Martin Gruenberg, as well as William Brodsky, chief executive officer of the Chicago Board Options Exchange; Mellody Hobson, president of Ariel Capital Management; and Gary Gensler, a former Treasury Department undersecretary and partner at Goldman Sachs Group Inc.
Last week, Obama announced the members of his Transition Project Team, headed by John Podesta, Valerie Jarrett and Peter Rouse, and announced the selection of Rahm Emanuel to serve as White House Chief of Staff. A transition website has been set up by the Obama-Biden team at http://www.change.gov/.
As reported in by Dan Eggen in Saturday’s Washington Post, “Bush, Obama to Meet on Monday.” President George W. Bush and President-elect Obama are slated to discuss today, according to Eggen, “the economy, the wars in Iraq and Afghanistan, and other challenges the new administration will face in January.”
Transition planning has been going on since prior to the election, as noted in this Fact Sheet: Ensuring a Smooth and Effective Presidential Transition released by the White House on Oct. 28.
While moving to effect a smooth transition, Obama also acknowledged at his press conference on Friday, “The United States has only one government and one president at a time.” This was also noted by transition team co-chair Podesta in an interview with FoxNews on Sunday.
Financial Executives International (FEI) issued a statement last week, congratulating Obama and Biden on their election to the White House, noting, “We look forward to working with our Nation’s new leadership and representatives to develop sound finance and taxation policies for American companies.” Additionally, FEI said: “Across the country, our members operate as the preeminent professionals on taxation and accounting standards from the perspective of large and small as well as public and privately-held companies. With our membership of 15,000 senior financial executives representing 8,000 companies, FEI has worked closely with both Democratic and Republican Administrations and Congresses for more than 75 years, and is eager to continue to do so with the new Administration.” Read the FEI statement.
Friday, November 7, 2008
Among the proposed changes are removal of the concept of Qualified Special Purpose Entities (QSPEs), a structure used to obtain off-balance-sheet treatment for certain mortgage and other securitizations; this change has been reported to potentially add back trillions of dollars of mortgage-related and other assets to financial institutions and others. The proposed effective date for these changes is 2010.
Included among the panelists at FASB’s roundtable yesterday were auditors, issuers and investors as well as SEC Deputy Chief Accountant Jim Kroeker and representatives of the Federal Reserve, Fannie Mae, Freddie Mac, the American Securitization Forum, CFA Institute, and others.
The comment deadline on the proposed amendments to the securitization rules is November 14; FASB Technical Director Russell Golden said they are anxiously awaiting comments and will move rapidly to redeliberate the proposals. Separately, he noted that FASB would begin redeliberations next week on the separate proposal containing disclosures that may be required as early as this year-end (Proposed FSP FAS 140-e and FIN 46R-e ); the comment deadline on the disclosure proposal was October 15.
Implied Obligations; Abundance of Caution
One panelist asked, “If you are an SEC registrant, don’t you have an obligation if there is an intention to potentially support obligations, aren’t you misleading investors if you don’t disclose the possibility of that, under a 10b-5 test of omitting information?” (Reference to Rule 10b-5 of the Securities Act of 1934.)
SEC’s Kroeker, providing the usual disclaimer he was speaking only for himself, noted, “I’m not a securities attorney nor do I practice as an attorney at the Commission.” However, he added, “MD&A has significant requirements for disclosure; when you cross that threshold for actions you may take but are not committed to take, I leave that to attorneys.”
FASB’s Golden asked what kind of evidence auditors look to now under the current requirement in FIN 46R to consider implicit arrangements.
KPMG Partner Kimber Bascom replied that besides rep letters (letters of representation signed by management), “You can look to other things, the economics of situations.”
“Out of an abundance of caution,” said Bascom, “we have concluded the literature drives us, once you have taken an action you did not have to take, we conclude you have taken on all that type of risk.” He added, “If I think you are going to step in and provide support, the conclusion about accounting isn’t being driven by the preparer but by the auditor,” acknowledging that is not the way the system is supposed to work (i.e. it is management or the preparer that takes responsibility for the financial statements).
Disclosures May Be Required This Year
Panelists at the roundtable debated whether it was feasible to provide all the proposed disclosures FASB is looking for by this year-end, particularly given other requirements set to take effect this year-end on disclosures of credit derivatives and certain guarantees (set forth in FSP FAS 133-1 and FIN 45-4, and FAS 163). Some panelists suggested moving the effective date of the proposed securitization disclosures to first quarter 2009 instead of year-end 2008.
Challenges noted included access to information that may reside with third parties, and the sheer volume of information. A number of panelists noted it takes time to build and test “SOX compliant” systems to collect the data to comply with new disclosure requirements (i.e. referencing the internal control reporting requirements set forth in Section 404 of the Sarbanes-Oxley Act.)
Views on how soon the expanded disclosures were needed, and how expansive they should be, varied. One panelist said, “I think if you are engaged in an activity that is rather complex, as a potential investor or current investor… my need for information [increases] … pile it on.”
FASB board member Larry Smith said, “From my days as an auditor, at some companies I was on, we would have reams and reams of paper to explain the judgments we made.” He added, “I think what we are asking for is impossible, we need to get practical in what you are asking preparers to explain.” He discussed, in particular, practical challenges to providing a sensitivity analysis when there are many interdependent factors, and questioned if a generic or boilerplate disclosure would be useful.
To address concerns about timing of the new disclosures, FASB staff may meet with investors and issuers to determine which of the proposed disclosures are most important to users of financial statements, and which are practicable vs. impracticable for preparers of financial statements to provide, in terms of year-end reporting.
Accounting Changes, Including Removal of QSPEs
Separately, the proposed changes that would impact how securitizations and certain other transfers of assets are treated in the financial statements would take effect in 2010. As background, the accounting exception currently provided in Generally Accepted Accounting Principles (GAAP), specifically in FAS 140 and FIN 46R, permits off-balance-sheet or ‘sale’ treatment for QSPEs based on a presumption that QSPEs would be passive vehicles – not actively managed.
However, the subprime mortgage crisis – unforeseen when FAS 140 and FIN 46R were written, and by all accounts, unforeseen by most everyone - resulted in calls for modifications of mortgages to help borrowers avoid foreclosure and default. Questions arose last year about permissible activities in QSPEs, including loan modifications, in order to not threaten sale treatment under GAAP.
Last year, Rep. Barney Frank (D-MA), chair of the House Financial Services Committee, asked the SEC for a clarification as to whether FAS 140 prohibited mortgage modifications when default was ‘reasonably foreseeable’ but had not actually occurred. SEC Chairman Christopher Cox responded with a letter (see SEC letter to Rep. Frank) that effectively said there was no such prohibition in FAS 140, but detailed in an attachment by Chief Accountant Conrad Hewitt that reference should be made to FAS 140’s discussion of what constitutes a ‘passive’ trust. Some questioned how to interpret the SEC’s letter; see related Center for Audit Quality (CAQ) Alert, citing a letter sent by Sen. Charles Schumer (D-NY) to the Big 4. As the mortgage crisis deepened and actions to try to stem the crisis accelerated, the American Securitization Forum (ASF) issued a streamlined framework for mortgage modifications (see ASF Framework), and the SEC sent a letter to the American Institute of CPAs (AICPA) and Financial Executives International (FEI) in January, 2008, stating the SEC “will not object to continued status as a QSPE if Segment 2 subprime ARM loans are modified pursuant to the specific screening criteria in the ASF Framework.” (See SEC letter to AICPA and FEI.
As has become increasingly evident over time, the power to arrange mortgage modifications appears to have been heavily restricted by the legal terms of the securitization trusts, separate and apart from any accounting considerations. For example, requirements set forth in trust’s governing documents may require obtaining the approval of a majority of a trust’s shareholders or investors for any changes to the terms and powers of the trust and parties under the trust, including, potentially, the powers of the servicer or other parties to modify the underlying mortgages. Recent events this fall, including the taking into conservatorship of Fannie Mae and Freddie Mac, and FDIC take-overs of failed banks, may provide more ability to get past some of these roadblocks to modifications, as reported in the article, “GSEs May Be Forced to Deal on Loan Mods” by Joe Adler and Emily Flitter in the American Banker on Sept. 10. More recently, the Emergency Economic Stabilization Act of 2008 (EESA) signed into law on Oct. 3 provides funding and new powers for government action to stem the crisis.
Some panelists at the roundtable yesterday asked FASB to hold off making any change to the securitization and consolidation rules pending completion of the FASB-IASB joint project on consolidations, so companies wouldn’t be asked to change twice. (Additionally, investors would have a more comparable stream of information.)
Alan Teixeira of the IASB staff said the IASB expects to release their Exposure Draft on consolidation this month, noting they were also trying to be responsive to a request of the Financial Stability Forum to focus on this issue. FASB Chairman Robert Herz pointed out that the scope of IASB’s upcoming proposal was broader than the scope of the present FASB proposal, with the IASB addressing consolidation of voting interest entities as well as variable interest entities; therefore further consideration would be required before FASB could converge to that standard.
After users on the panel commented, SEC’s Kroeker observed, “We heard clearly from users around this table” about concerns with waiting until 2011 for completion of the joint FASB-IASB project on consolidation accounting, since that timing could stretch as a practical matter to 2012, 2013, with additional time provided before the standard becomes effective, adding up potentially to a total of 5-6 years from now.
Freddie Mac estimated the cost for them to implement the proposed changes to the securitization standards would be $55 million dollars, and would take 18 months to implement, said panelist Tim Kviz. (Also cited in Freddie Mac's comment letter.) Kviz noted, “For 12 million loans we guarantee, very few of those are on our balance sheet, they are not our loans, to get access to that information requires changes to our contracts, that can’t be done over night, might have to wait till end of term [of each contract, which], could be a year.” He continued, “to have to turn around and do it again for a potentially different model in IFRS, I don’t see the benefit in that.”
FASB Chairman Robert Herz noted it is ultimately the investors, not the company that bears the cost of obtaining the information. Investor panelist Tony Sondhi indicated the money spent to implement these changes would be worthwhile, even if it would result in a disclosure package as big as the Manhattan telephone book, which, he noted, he found very useful when he lived in Manhattan. FASB board member Larry Smith later commented, “I don’t know how you marry information for users on a disaggregated basis, vs. the number of assets that are going to be consolidated; never mind the Manhattan phone book, you’ll get the whole northeast phone book.”
Additional highlights from the roundtable, including a discussion of a linked presentation model, comments on use of examples, and issues relating to private companies can be found in this FEI Summary. If you’d like to receive our blog by email, sign up here.