Levitt, Beresford on Congress, FASB and Fair Value; Breeden Calls for Merger of SEC, CFTC and PCAOB

It’s an exciting time when a former SEC Chairman and a former FASB chairman weigh in on issues involving Congress, FASB and fair value. Former FASB Chairman Denny Beresford, an FEI member and one of the founding inductees in FEI’s Hall of Fame (and a reader of this blog), brought to my attention the OpEd in today’s Washington Post by former SEC Chairman Arthur Levitt, Jr. on Congress, FASB and fair value.

Levitt's OpEd, entitled, Weakening A Market Watchdog: An Accounting Rule Change's Real Costs, talks about the pressure that was brought to bear on FASB to amend or provide further guidance on its rules on fair value measurement (aka mark-to-market accounting), particularly with respect to applying FAS 157, Fair Value Measurement, in inactive markets, and with respect to the accounting rules impacting other-than-temporary-impairment (OTTI). He notes that FASB Chairman Robert Herz was told at the March 12 Congressional hearing on mark-to-market accounting: "Don't make us tell you what to do, just do it," (Rep. Randy Neugebauer (R-Tex.)) and "If you don't act, we will," (Rep. Gary Ackerman (D-NY)).

"This is like being forced to give your boss several mulligans in a round of golf," says Levitt in the WashPost OpEd, adding, "And so last week, the FASB voted to propose allowing banks to obscure -- some might say bury -- the full extent of impairments on many of the bad loans and investments they made and securitized over the past few years."

NOTE: The proposals Levitt refers to are FASB's Proposed FSP FAS 157-e, Determining Whether a Market Is Not Active and a Transaction Is Not Distressed, and Proposed FSP FAS 115-a, FAS 124-a and EITF 99-20-b, Presentation of Other-Than-Temporary Impairments. The proposals were released by FASB on March 17 for a 15 day comment period, ending April 1. FASB confirmed in its Action Alert issued today that it will hold a board meeting on Thursday April 2 (in addition to its regularly scheduled board meeting on Wed. April 1) to "redeliberate" the proposals, "in light of the comments it has received." Presumably, in line with the commitment made by Herz and SEC Acting Chief Accountant Jim Kroeker to Congress at the March 12 hearing, FASB will not only 'redeliberate' but will vote to issue final rules, with or without some changes from the proposals for issues raised in comment letters; letters filed so far (in advance of the April 1 deadline) can be found here (fair value) and here (OTTI).

Levitt continues in his OpEd: "The FASB's proposal goes against what we know investors prefer: Stronger rules for the reporting of changes in the values of investments in income statements. Under the proposed rule, no matter how toxic the investment, whether it's a penny stock or the bonds of a government ward such as AIG, companies can choose to largely ignore the fundamental reasons behind the investments' decline. All that companies have to do is say they don't intend to sell those investments until their value rebounds. "

Before going on, it is interesting to focus on Levitt's statement that 'FASB's proposal goes against what we know investors prefer.' 'Investor' views are sometimes said to be elusive, and some look to groups like FASB's Investors Technical Advisory Committee (ITAC), heavily constituted by analysts, to represent 'investor' views (see, e.g. the ITAC comment letter to FASB on fair value in May 2008, and the ITAC letter to the SEC Nov. 2008). ITAC has generally taken views closest to what Levitt describes. There are other groups viewed as representing the investor view, or as proxies for investors, including groups I refer to as 'the four C's' - the Center for Audit Quality (CAQ), Council of Institutional Investors (CII), Consumer Federation of America (CFA), and the CFA Institute - which have taken to filing joint comment letters to the SEC, Treasury and the Fed and to Congress on issues concerning fair value. However, some or all of the four C's have supported, to varying degrees, issuance of further guidance on fair value in inactive markets and OTTI - see, e.g. testimony of CAQ's Executive Director Cynthia Fornelli at the March 12 Congressional hearing, in which she said:

"On Feb. 18, 2009, in response to recommendations in the SEC’s study on mark‐to‐market accounting as well as input received from FASB’s own Valuation Resource Group, FASB added multiple important projects to its agenda. Those agenda projects are intended to improve (1) the application guidance used to determine fair values and (2) disclosures of fair value estimates. (The FASB’s Valuation Resource Group is a group of valuation and accounting professionals who provide FASB staff and Board with information on implementation issues surrounding fair value measurements used for financial statement reporting purposes.)" She added, "One major criticism of fair value accounting is that it can be difficult to apply in illiquid markets. FASB’s projects on application guidance will address this concern by helping to: determine when a market for an asset or a liability is active or inactive; determine when a transaction is distressed; and apply fair value to interests in alternative investments, such as hedge funds and private equity funds. The project on improving disclosures about fair value measurements will consider requiring additional disclosures on such matters as sensitivities of measurements to key inputs and transfers of items between the fair value measurement levels. "

Additionally, other users of financial statements - who some may view as an equal proxy for investor views as some of the above organizations, including experts Vinny Catalano and Randy Schostag - have supported the call for further guidance on fair value in inactive markets.

Back to Levitt's OpEd, he adds: "[T]he real scandal here is not the decision by the FASB -- with which I strongly disagree but which others might be able to defend. Rather, it is how the independence of regulators and standard-setters is being threatened. This isn't just about the income statements of banks. It's about further eroding investor confidence, precisely at a moment when investors are practically screaming for more protection. "

Levitt continues: "Chairman Herz acquiesced, it appears, in order to keep Congress from invading FASB turf. Yet in seeking to protect its independence, the board has surrendered some of it in the bargain," and warns, "Every regulatory agency should take note: Independence from public pressure has a value, and when you give some of it away, you've lost something that takes years to rebuild. Just ask the Federal Reserve, which lost its reputation for independence from political pressure in the early 1970s and didn't regain it for a decade."

To further support his point, Levitt argues there was inadequate due process provided on the recent proposals. He states, "In the past, the FASB has made significant changes to its rules only after significant due process, including comment periods that often lasted for three months and a full discussion reflecting those public comments... The rule change agreed to by the FASB on Tuesday followed only one public meeting on this topic, and the board is giving investors just two weeks to comment, with a final vote the next day. This is a rush job. "

However, in considering Levitt's reference to there having been 'only one public meeting' on the issues of fair value and OTTI, as noted in CAQ Exec. Dir. Fornelli's testimony to Congress cited above, and in FASB's Feb. 18 press release, the call for further guidance on fair value in inactive markets had come from FASB's Valuation Resource Group, which met most recently in a public meeting on Feb. 5, and calls for further guidance on fair value and OTTI had come from the SEC's Dec. 30 Congressionally mandated study on mark-to-market accounting.

Additionally, FASB held roundtables on fair value and other issues arising in the credit crisis last fall, the SEC held roundtables on this subject last fall, and the FASB-IASB Financial Crisis Advisory Group has debated this subject at its meetings this year. So, all told, there have been numerous public meetings (at least in the form of roundtables) which led to FASB taking on the projects to issue guidance on fair value and OTTI. And, FASB had a hefty comment file (including this letter from FEI's Committee on Corporate Reporting) from the last time it proposed guidance on fair value in inactive markets- in the form of Proposed FSP FAS 157-d, released for public comment on Oct. 3, 2008 with a comment deadline of Oct. 9, approved by FASB in final form on Oct. 10 as FSP FAS 157-3. So, in many respects, the current proposals represent an evolution in thinking (or at least, an evolution in wording, now that 5 months of practical experience in applying the words in FSP FAS 157-3 are behind us), rather than, say, a new project starting from scratch.

The significant factor - in my personal view- of Congress' recent involvement was to persuade FASB to move up its timetable for issuing the fair value guidance which it had already agreed to issue, (at least in terms of fair value in inactive markets, if not OTTI), by drawing a line in the sand so to speak of 3 weeks from the March 12 hearing date, which perhaps not coincidentally aligns with the start of the G-20 meeting.

Levitt, Roper, Breeden, Others Testify To Senate
Levitt's views are highly regarded, and he opined on broader subjects in his testimony earlier today at the Senate Banking Commitee hearing on investor protection and market regulation.

Others testifying on his panel were former SEC Chairman Richard Breeden and former SEC Commissioner Paul Atkins. The first panel, as we noted in our blog post earlier today, included SEC Chairman Mary L. Schapiro. And the third panel included various representatives from the private sector, including Jim Chanos, founder of Kynikos Associates, (who, as noted in his wikipedia bio "rose to fame in the 1980s as a "short" - a short seller who had a knack of spotting stocks that he thought to be overvalued") - and famously was one of the first to identify weaknesses at Enron - author of an OpEd in the WSJ earlier this week entitled We Need Honest Accounting. Another panelist at the Senate hearing was Barbara Roper of the Consumer Federation of America (CFA, one of the 4 C's noted above).

Roper testified that the SEC should drop its push to move U.S. companies from U.S. GAAP to International Financial Reporting Standards, and instead focus again on encouraging convergence of the two sets of standards (i.e. FASB and IASB standards).

Sounding a similar alarm regarding threats to FASB's independence as Levitt did in his OpEd, Roper told the Senators: "In arguing against adoption of the IFRS roadmap, CFA has in the past cited IASB’s lack of adequate due process and susceptibility to industry and political
influence. Unfortunately, FASB’s recent proposal to bow to industry pressure and weaken fair value accounting standards – and to do so after a mere two-week comment period and with no meaningful time for consideration of comments before a vote is taken – suggests that FASB’s vaunted independence and due process are more theoretical than real. We recognize and appreciate that leaders of this Committee have long shown a respect for the independence of the accounting standard-setting process. Moreover, we appreciate the steps that this Committee took, as part of the Sarbanes-Oxley Act, to try to enhance FASB’s independence."

She thus recommended: "[I]n light of recent events, CFA believes more needs to be done to shore up those reforms. Specifically, we urge you to strengthen the standards laid out in SOX for recognition of a standard-setting body by requiring that a majority of both the board itself and its board of trustees be investor representatives with the requisite accounting expertise."

Additionally, Roper called upon the Senators to "Ignore calls to weaken materiality standards and lessen issuer and auditor accountability for financial misstatements," referring to recommendations that had been made by the SEC Advisory Committee on Improvements to Financial Reporting or CIFiR.

I am sure others will summarize testimony of the many other panelists at today's Senate hearing. Before I leave this subject I'd like to highlight one quote from former SEC Chairman Richard Breeden's testimony: "It isn’t enough for regulators to write rules and give speeches. More time needs to be spent conducting examinations, analyzing results, discovering problems and, where necessary putting effective limits in place to prevent excessively risky activities. Directors and regulators need backbone, and a willingness to shut down a party that gets out of control. Regulators can’t catch all the frauds any more than police can catch all the drug dealers. Nonetheless, when failures happen it shouldn’t be acceptable to just ask for more resources without making the necessary corrections first. Regulators need accountability for performance failures just as much as any of us." He added, "While we need to demand better effectiveness from regulators, we must not shift the burden of running regulated businesses in a sound and healthy manner from management and the boards of directors that are supposed to oversee their performance."

I have a feeling Breeden's recommendations - which number a dozen - are going to receive a great deal of attention, from his call to merge the SEC, CFTC and PCAOB (rec. #1) to his call for increased proxy access (rec. #2), and his call to "Reverse or suspend the SEC decision to abandon U.S. accounting standards and to adopt so-called "International Financial Reporting Standards" for publicly traded firms headquartered in the U.S." (rec #3).

Beresford on Congress, FASB and Fair Value
As noted at the top of this post, former FASB Chairman Denny Beresford had pointed out to me Levitt's OpEd in the Washington Post regarding FASB, Congress and fair value.

I asked Denny if he'd like to share his reaction to Levitt's column with me and our blog readers. Here is what he said: "On the 157e proposal, I believe that one or more of the Board members thought they were already calling for what is in the new proposal when they issued the initial 'guidance' last fall. But they worded the guidance at that time too generally and companies were disinclined to apply the judgment that the FASB and SEC thought they should for fear of being second guessed by the auditors and the SEC. And the auditors were afraid of being second guessed by the PCAOB."

"The proposals may not be perfect," he continued, "but I think they are a major improvement in determining how fair value should be estimated when active market prices aren't readily available. Those who argue for the most conservative prices that can be found in the relatively few 'fire sales' of some of these complex securities seem to feel that the standard should call for 'market value,' however that would be defined, rather than "fair value," which is what SFAS 157 calls for."

Beresford closed, "There will undoubtedly be some unintended consequences of new rules that are rushed out like this. But many of us believe that current economic circumstances necessitate this kind of action." He added, "I do hope that the FASB doesn't require the new accounting to be applied in the first quarter but makes it mandatory for the second quarter and allows companies to do so in the first quarter if they can get it done in time."

Treasury Outlines Framework for Regulatory Reform; House, Senate Hearings Today

In testimony before the House Financial Services Committee earlier today, (see link to hearing) U.S. Treasury Secretary Tim Geithner outlined a framework for regulatory reform, focusing on four key areas:

• Addressing Systemic Risk,
• Protecting Consumers and Investors,
• Eliminating Gaps in Our Regulatory Structure, and
• Fostering International Coordination

Here is a link to related draft legislation provided by the U.S. Treasury Department for a "Resolution Authority for Systemically Significant Financial Companies Act of 2009."

Read more in this FEI Summary by Cady North, manager, Government Affairs in our Washington D.C. office. As noted by Cady, FEI is forming a working group among its members, to increase awareness regarding the administration's Financial Regulation Reform proposals, and provide a forum for information sharing and commenting on policy proposals among our members as the proposals move through the legislative process. If you are interested in learning more, please contact Cady North at FEI at cnorth@financialexecutives.org or 202-626-6803.

Senate Banking Hearing On Investor Protection ,Regulation Taking Place Today
Separately, SEC Chairman Mary L. Schapiro testified before the Senate Banking Committee earlier today at a hearing on Enhancing Investor Protection and the Regulation of Securities Markets. The hearing includes three separate panels, and is being webcast live, set to conclude at 2:30pm.

SEC’s Kroeker, Pleased With FASB Response, Tells Congress Swift Action Must Be Taken on Fair Value, OTTI, For 1Q

Testifying at a House Financial Services Committee hearing earlier today, the Securities and Exchange Commission’s Acting Chief Accountant, Jim Kroeker noted his support for FASB’s recent action to propose further guidance on fair value accounting, and on other-than-temporary impairment (OTTI). FASB seeks comment on those proposals by April 1.

Some highlights from Kroeker’s written testimony :

Two weeks ago, on March 12, this Committee's Subcommittee on Capital Markets,
Insurance, and Government Sponsored Enterprises held a hearing on the critical
topic of fair value accounting, at which I also testified. I believe that the hearing helped to further crystallize and advance the objective sought by market
participants for improved guidance on the measurement of fair value and
accounting for impairments.

There can be no doubt, and we at the Commission fully understand, the gravity and urgency of these issues as we all work in the public interest to address the global economic crisis. The hearing on March 12 underscored our own efforts for swift consideration and appropriate action, including action to address and, as appropriate, implement the critical recommendations the Commission staff identified in our Congressional study on mark-to-market accounting, which we conducted in consultation with the Department of the Treasury and the Federal Reserve.

Consistent with the sentiments we have clearly heard from many members of this Committee, I believe swift action must be taken to address the accounting for investment impairments and to improve the measurement guidance for illiquid assets for first quarter 2009 reporting. We are therefore pleased that the FASB has acted diligently and responsively to use their expertise as an independent standard-setter and expose amendments to the measurement of securities in inactive markets and the recognition of "other-than-temporary" security impairments. Following the FASB due process procedures, the proposed amendments were deliberated fully at an open public meeting of the full Board, were approved by a majority vote, and are now subject to public comment. On March 17, the FASB's amendments were made available for a 15-day public comment period ending April 1.

Kroeker later added:
While the Commission has broad authority and responsibility to prescribe
accounting standards, it has long relied on the FASB as a private sector
standard-setter and recognized the importance of the FASB’s independence. The
FASB, in turn, is obliged to consider, in adopting accounting principles, the
need to keep standards current in order to reflect emerging accounting issues
and changing business practices. I am hopeful that the FASB will continue, on a
timely basis, to enhance the tools available to assist preparers and auditors
when making these difficult judgments. As I testified on March 12, as the
principal advisor to the Commission on accounting and auditing issues, I and my
office remain ready to assist the Commission in any way it deems necessary.

GAAP-RAP Differences and Regulatory Capital
[Note: the term GAAP-RAP differences is commonly used to describe differences between regulatory accounting principles vs. GAAP; in this case it is not so much a different set of regulatory accounting principles per se, but special adjustments from GAAP to arrive at regulatory capital.]

Kroeker explained in his testimony that while “Section 121 of FDICIA requires that the accounting principles used in the reports and statements filed with banking regulators by insured depository institutions be no less stringent than U.S. GAAP… There are, however, instances in which the prudential banking regulators have determined that adjustments should be made to U.S. GAAP accounting results for regulatory capital purposes, thereby reflecting the important differences between the objectives of U.S. GAAP reporting and the objectives of regulatory capital requirements.” He added, “We understand that these adjustments are intended to reflect the solvency and safety and soundness of the financial institutions on an ongoing basis. This can be done, for instance, by seeking to limit volatility that is temporary in nature.” He then described various examples of where banking regulators back out, or add back certain items from bank capital as reported under GAAP, for purposes of determining regulatory capital.

In various prior hearings (SEC, FASB, FASB-IASB Financial Crisis Advisory Group, and previous Congressional hearings), some have called for increased action by banking regulators - if the regulators are uncomfortable with the impact on bank capital of fair value accounting under existing GAAP - rather than asking GAAP to change to meet regulators' needs. Others, however - particularly former banking regulators like former FDIC chairman William Isaac - have countered that trying to adjust out the impact of fair value or OTTI from regulatory capital would have a limited impact, since investors, depositors, and others (including short sellers) react to the reported GAAP numbers, not the adjusted regulatory capital numbers.

Additionally, some FASB board members - at FASB's March 16 board meeting - expressed a desire to issue guidance that would be responsive to concerns voiced by members of Congress and banks, [which were also identified in the SEC's Dec. 30 report to Congress on mark-to-market accounting] and at the same time help preparers and auditors arrive at more meaningful and reasonable fair value numbers.

Others testifying at the House Financial Services (HFS) Committee hearing today included bank regulators, and banking and business representatives.

Next up: tomorrow (Thursday, March 26), U.S. Treasury Secretary Tim Geithner is set to testify before the HFS Committee at a hearing on: Addressing the Need for Comprehensive Regulatory Reform.

Credit Rating Agency Roundtable Panelists, Sr. Staff Announced; Child Care Center Wins Award
Yesterday, the SEC announced the panelists for its April 15 roundtable on oversight of credit rating agencies.

The SEC also recently announced a number of appointments to the senior staff, including Didem A. Nisanci as Chief of Staff, and Julie Zelman Davis as Deputy Director of Legislative Affairs. Nisanci was formerly staff director for the U.S. Senate Banking Subcommittee on Securities, Insurance, and Investment, and Davis was formerly on the staff of Sen. Carl Levin (D-MI)

Earlier today, the SEC announced that the child development center at its Washington, D.C., headquarters, The Harbor at Station Place, has been awarded a Gold-level Leadership in Energy and Environment Design (LEED®) designation by the U.S. Green Building Council (USGBC).

According to SEC spokesman John Heine, The Harbor at Station Place, together with Bright Horizons (a national sponsor of educational centers which is contracted to provide the daily operations and management at The Harbor at Station Place) is in the process of becoming NAEYC accredited. He added The Harbor at Station Place takes registrations from the general public, but gives preference in any openings to SEC employees and federal government employees. For further information on The Harbor at Station Place, call 202-408-9271.

CFOs Exploring Alternatives to Layoffs, Amid Concern About Economy

In a survey of CFOs conducted during the week of March 3-9 by Financial Executives International (FEI) and Baruch College's Zicklin School of Business, confidence in the U.S. economy remained low, and many are taking action to protect their own businesses and workforce, but aiming to avoid layoffs if possible through alternative means such as salary freezes, elimination of bonuses, redistribution of responsibilities, shortened workweeks, and more. Read details in this FEI press release. Complete details are in this report published by FEI's research affiliate, the Financial Executives Research Foundation (FERF),

In other news, FERF published today a study entitled Trends in Income Tax Reporting Automation. The study, conducted by FERF Research Associate Thomas Thompson, Jr. consisted of interviews of senior financial executives about their own tax automation experiences.

"We heard that there are challenges to automating income tax reporting,” said Thompson. “Nevertheless, automation is emerging as the standard for companies that are committed to improving transparency and internal control.” On the other side of the coin, many executives commented that the primary obstacles to tax automation are time and budget, along with traditional “change management” issues.

Some of the benefits of tax automation noted in the study include:

• Reduced tax cycle time;
• Less effort and more accuracy associated with tax data collection and transaction entries;
• Increased process visibility and control;
• Greater regulatory compliance and process standardization;
• Increased financial transparency and comprehensive audit trails;
• Fewer deficiencies identified by reviews under Sarbanes-Oxley Section 404; and
• Freeing up of resources for more higher-value tasks, such as tax planning, modeling and analysis.

Daniel S. Jones, Managing Director of DS Jones & Company, a management consulting firm based in Connecticut, pointed out that a client with offices in 40 countries had a decentralized process where local tax executives and controllers handled their own reporting. “They were previously using Excel spreadsheet, but errors were fairly routine, and previous attempts to standardize were not successful.” After hiring a new Tax Director, the company decided to automate. This helped them standardize and ensure regulatory compliance, produced more accurate financial reporting and reduced process cycle time, allowing more time to do analysis.

U.S. FEI members may download the full study for free at the FERF Bookstore. Non-members can purchase FERF reports. Free FERF reports are one of the many benefits of FEI membership, along with our monthly magazine, Financial Executive, our bi-weekly electronic newsletter, FEI Express, our detailed web summaries of current developments, discounts for attending our conferences, and more! Thinking about joining FEI? New members who join by April 6 can attend our Summit conference in May for free! Feel free to contact me if you have questions about FEI membership at eorenstein@financialexecutives.org .

Treasury Releases Details on Public-Private Investment Program (PPIP) for Banks' Toxic Assets

In advance of U.S. Treasury Secretary Tim Geithner's remarks scheduled for 8:45 am EDT today, the Treasury Department released details on its three-pronged plan to purchase toxic assets from banks through a Public-Private Investment Program (PPIP). See Treasury's press release. Additional information, including a Fact Sheet, White Paper, and more, are in the process of being posted on the special website established by Treasury last month, www.financialstability.gov. See related news in our posts over the weekend, Three-Pronged Approach To Addressing Banks' Toxic Assets Unveiled, and The Turner Review: U.K. FSA Recommends Response to Global Credit Crisis. If you received this blog post from a friend, send an email to blogs@financialexecutives.org and write Sign Up in the subject line if you'd like to receive our blog by email.

Three-Pronged Approach To Addressing Banks' Toxic Assets Unveiled

Details of a three-pronged approach to relieve financial institutions of 'toxic' assets will be revealed by the U.S. Treasury Department as early as Monday, the WSJ and NYT report. Details are expected relating to the public-private investment fund in particular, part of the Financial Stability Plan first laid out by U.S. Treasury Secretary Tim Geithner on February 10. (As we previously reported, the government established a website, www.financialstability.gov with information on the plan, see especially the Fact Sheet announced on Feb. 10, and watch for updates on that site.) The three-pronged plan, according to Deborah Solomon and Damian Paletta in their article, U.S. Sets Plan for Toxic Assets (WSJ), will include:

1. creating an entity, backed by the Federal Deposit Insurance Corp., to purchase and hold loans.
2. expand[ing] a Federal Reserve facility to include older, so-called "legacy" assets. Currently, the program, known as the Term Asset-Backed Securities Loan Facility, or TALF, was set up to buy newly issued securities backing all manner of consumer and small-business loans. But some of the most toxic assets are securities created in 2005 and 2006, which the TALF will now be able to absorb.
3. establish[ing] public-private investment funds to purchase mortgage-backed and other securities. These funds would be run by private investment managers but be financed with a combination of private money and capital from the government, which would share in any profit or loss.

"All told, the three efforts are designed to unglue markets that have seized up as investors have stood on the sidelines," state Solomon and Paletta.

However, they add, "One big problem is that many of these assets no longer trade, which means it's very hard to put a price on them. Banks are unwilling to sell at too low a price, and investors are unwilling to take the risk. The Treasury's hope is that introducing private investors will help create market prices. Earlier attempts to have the government set the prices foundered because too high a price would have hurt taxpayers and too low a price would have hurt banks. Private investors, by contrast, could set a market price because they are unlikely to overpay and banks are unlikely to undersell."

Similarly, Edmund L. Andrews, Eric Dash and Graham Bowley report in Toxic Asset Plan Foresees Big Subsidies for Investors (NYT) that, "Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar. The result has been a paralyzing impasse. Banks, unwilling to sell their loans at fire-sale prices, have had less capital available to make new loans. Mortgage investors, unable to leverage their investments with borrowed money, have been unwilling to pay more than fire-sale prices. To break that impasse, the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing that has been utterly unavailable in today’s credit markets."

"To entice private investors like hedge funds and private equity firms to take part," write Andrews, Dash and Bowley, "the F.D.I.C. will provide nonrecourse loans — that is, loans that are secured only by the value of the mortgage assets being bought — worth up to 85 percent of the value of a portfolio of troubled assets. The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money, according to industry officials. Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent. The government would receive interest payments on the money it lent to a partnership and it would share profits and losses on the equity portion of the investment with the private investors."

In related news, Brian Blackstone reports in WSJ.com, Bernanke Says Capital Rules May Need to Change. His article cites form a speech given by Federal Reserve Board Chairman Ben S. Bernanke yesterday to the Independent Community Bankers of America (ICBA), in which Bernanke said:

• some aspects of existing capital rules and accounting standards may unduly magnify the ups and downs in the financial system and the economy.
• as many institutions and auditors will attest, determining the appropriate valuation of illiquid or idiosyncratic assets can be very challenging, especially in highly strained market conditions.
• The economic downturn also has renewed the debate concerning the appropriate levels of loan loss reserves over the cycle.
• the issues surrounding procyclicality are not easy, and their consideration will require a careful balancing of important public policy interests.
• Policymakers should review existing capital rules and accounting standards to determine whether these rules and standards could be modified to reduce their potential to have unduly procyclical effects without weakening their ability to achieve their fundamental objectives.

Acknowledging recent efforts of FASB (see our related summaries here, here and here) Bernake added, "I'm pleased to note that the Basel Committee and the Financial Stability Forum already have work under way to address excessive procyclicality in capital regulations, and that the Financial Accounting Standards Board is issuing new guidance that relates to market-to-market accounting in inactive markets and other-than-temporary impairments."

Separately, in a wide-ranging speech at the ICBA gathering on Thursday, FDIC Chairman Sheila C. Bair noted that in testimony before the Senate Banking Committee earlier this week, "I said that while a new systemic risk regulator may be a good idea, what we really need to do is end too big to fail." To accomplish this, she said:

• We need to reduce systemic risk by limiting the size, complexity, and concentration of our financial institutions.
• We need to create regulatory and economic disincentives for systemically important financial firms. For example, we need to impose higher capital requirements on them in recognition of their systemic importance, to make sure they have adequate capital buffers in times of stress.
• We also need to impose greater market discipline by creating a legal mechanism for the orderly resolution of a large troubled institution similar to the one for FDIC insured banks. The ad hoc response to the banking crisis is because we don't have a playbook for taking over an entire complex financial organization.

[Note to self: this may be a watershed moment in history, when two of the most powerful chairmen of government agencies are women: FDIC Chairman Sheila C. Bair, and SEC Chairman Mary L. Schapiro.]

In related news, in the run-up to the G-20 meeting set to begin April 2, we see action on both sides of the Atlantic (and Pacific). See our separate post today, The Turner Review: U.K. FSA Recommends Response to Global Banking Crisis.

The Turner Review: U.K. FSA Recommends Response to Global Banking Crisis

In the run-up to the G-20 meeting which begins on April 2, we see action on both sides of the Atlantic (and Pacific). (See our separate post today on developments in the U.S., Three-Pronged Approach To Addressing Banks' Toxic Assets Unveiled.)

Earlier this week, the U.K. Financial Services Authority (FSA) released The Turner Review: A Regulatory Response to the Global Banking Crisis. Props to Martin Wolf and Jennifer Hughes of the Financial Times for reporting on issuance of the FSA's report, in Wolf's article on March 20, Why The Turner Report is a Watershed for Finance, and Hughes article March 19, Accounting Plan Sparks Strong Debate.

As noted in the FSA's press release, "Lord Turner, chairman of the FSA, was asked by the Chancellor of the Exchequer to review the events that led to the financial crisis and to recommend reforms. The Review identifies three underlying causes of the crisis:
· macro-economic imbalances,
· financial innovation of little social value and
· important deficiencies in key bank capital and liquidity regulations"

" These were underpinned by an exaggerated faith in rational and self-correcting markets," the FSA states. Therefore, the Turner Review "stresses the importance of regulation and supervision being based on a system-wide "macro-prudential" approach rather than focusing solely on specific firms."

Concurrent with release of The Turner Review (aka the Review), the FSA issued a Discussion Paper (DP 09-2) to obtain comment by June 18 on the recommendations in the Review.
As summarized in this FSA newsletter: "The [Turner] Review sets out a wide-ranging series of changes that are needed to banking regulation and associated supervisory practice. In some areas the FSA can and will take action on its own, but in others international agreement will be needed. In particular:

• fundamental changes are needed in the regulatory approach to capital, liquidity and accounting;
• there needs to be a system-wide approach to identify and deal with macro-prudential risks, to complement stronger micro-prudential supervision of individual firms;
• changes need to be made to the scope of regulation to make sure that the economic substance of activities are regulated, not the legal form; and
• the international framework for the regulation and supervision of cross-border banks needs strengthening in the light of the crisis. As part of this the Review recommends a new European body which will be both a standard setter and overseer in the area of supervision.

"Hard-wired procyclicality" and inadequate capital buffers were among the factors which exacerbated the financial crisis, according to the Turner Review. Additionally, the report states that the growth of financial services as a % of GDP was fueled by "illusory effects" of mark-to-market in a rising market, specifically, that: "mark-to-market accounting helped fuel a self-reinforcing cycle of irrational exuberance," and there were 'harmful effects' of 'rent extraction.'

On this second point, the report notes: 'some and perhaps much of the structuring and trading activity involved in the complex version of securitised credit, was not required to deliver credit intermediation efficiently. Instead, it achieved an economic rent extraction made possible by the opacity of margins, the asymmetry of information and knowledge between end users of financial services and producers, and the structure of principal/agent relationships between investors and and companies and between companies and individual employees." The report continues: "when the crisis broke, banks did not have sufficient capital buffers to absorb losses, creating the danger of a self-reinforcing feedback loop between weak lending capacity, economic recession, and credit losses."

The Turner Review (the 'report') concludes these and other factors have implications for regulation, and offers seven recommendations to creating a sounder banking system:
1. Increasing the quantity and quality of bank capital.
2. Significant increases in trading book capital: and the need for fundamental review.
3. Avoiding procyclicality in Basel 2 implementation.
4. Creating counter-cyclical capital buffers.
5. Offsetting procyclicality in published accounts.
6. A gross leverage ratio backstop.
7. Containing liquidity risks: in individual banks and at the systemic level.

The accounting-related recommendations are discussed in Section 2.2. of the report (beginning on printed page 61; pdf page 63). These include consideration of: Dynamic Provisioning for loan loss provisions, described as: "a statistical method to allow for losses inherent within the portfolio which have not yet materialised. In economic upswing, it builds up a buffer by requiring provisions higher than recognised by standard ‘incurred loss’ accounting. In economic downswing, it allows some losses to be met from the accumulated buffer."

However, the report states "there are legitimate concerns that if management were able to provision in advance for future possible loss, it would have a cushion which it could use to hide the impact of losses subsequently arising, including losses which were idiosyncratic in nature, i.e. linked to bad decisions made by the individual bank, rather than reflective of a general economic downturn."

Yet, the report states (printed pg 65, pdf pg 67) that while the current approach of marking the trading book to market and provisioning for incurred losses in the banking book, "is appropriate viewed from an idiosyncratic perspective – an individual bank operating in a reasonably stable financial and economic environment – from the point of view of regulators, and of systemic financial risk, it has serious disadvantages. On both the trading book and banking book side, it can fuel systemic procyclicality."

Therefore, the Turner Review recommends "creation of a non-distributable Economic Cycle Reserve, which would set aside profit in good years to anticipate losses likely to arise in future." This is described in detail on pg printed pg 66 (pdf pg 68) of the report, which concludes:

"The appropriate way forward on accounting now needs careful debate between
regulators and the bodies which ultimately set published account standards (the
International Accounting Standards Board and the Financial Accounting Standards
Board). But the FSA position is in principle clear: we believe it important that
the counter-cyclical approach to bank capital is reflected in a significant way
in highly visible published account figures, creating strong shareholder and
management awareness of the need to assess profitability in the light of the
position in the economic cycle."

FASB-IASB Update
The subject of dynamic provisioning has been discussed by the FASB-IASB Financial Crisis Advisory Group, and the topic of loan loss provisions is on the agenda for this week's FASB-IASB joint board meeting in London (see agenda papers 7, 7A-7E on provisioning).

Separately, the IASB on Friday issued a Request for Views on FASB's recent proposals on fair value in inactive markets and other-than-temporary impairment (OTTI). The IASB states "Feedback from interested parties will be considered by the IASB before deciding whether to publish formal proposals for public comment," adding, " Any proposed changes in International Financial Reporting Standards (IFRSs) will be subject to due process."

The comment deadline on IASB's Request for Views is April 20, and the comment deadline to FASB on its Proposed FSPs on fair value and OTTI is April 1. As noted at FASB's board meeting last week, the board plans to meet on April 2 to decide on final standards in this area. Further background on FASB's proposals can be found here, here and here.

Obama On Regulation

At a press conference earlier today, President Barack Obama spoke on the A.I.G. bonus situation, and on regulation more generally. You can read about it in this Transcript of the President's remarks, link courtesy of The New York Times, thru this post in The Caucus, the NYT Politics & Government Blog, "Obama Criticizes A.I.G. Bonuses, Calls for Greater Regulation." Here are highlights of the President's remarks pertaining to regulation generally:

"Now, keep in mind -- I think it's very important to remind ourselves that
there are a whole bunch of folks now who are feigning outrage about these
bonuses that a year ago, or two years ago, or three years ago, said, well, we
should never meddle in these compensation plans; these are the best and the
brightest; they know what they're doing; that's part of the market -- and now,
suddenly they're outraged.

The point that I've been trying to make consistently has been that we
believe in the free market, we believe in capitalism, we believe in people
getting rich, but we believe in people getting rich based on performance and
what they add in terms of value and the products and services that they create.
And it's appropriate for us to have some regulatory mechanisms in place to
ensure that we never have a situation where the government has to step in, or
you've got taxpayers who are having to foot the bill for other people's
mistakes.

That requires some regulatory framework. And my hope is that one of the
lessons we learn here is, is that putting smart regulations in place --
oversight, transparency, accountability -- those things are not anti-market,
they're pro-market. When, last year, Barney Frank and I worked to allow
shareholders to at least cast a non-binding vote on compensation packages, there
were some people who attacked us saying government has no business doing that.
Well, look, all we're trying to say is you've got to be accountable to somebody.
And it's that measure of accountability that I think is part of what has made
America strong, and we have to get back to those kinds of values.....

I want to repeat something that I said before the joint session: My
interest is not protecting banks. My interest is protecting the American people;
the people's 401(k)s; ordinary folks who have a credit line with a bank for
their small business; people whose pension funds are invested in some of these
financial institutions. The prospect of all of that unraveling would have been
unacceptable -- an unacceptable risk.

Now, what we're trying to do is get ourselves in a position where we make
sure that going forward we're not held hostage to all these bad decisions that
were made by these huge institutions in the past, and that we create a system
where they can't make all these bad bets, they can't issue these insurance
policies one on top of the other without having the assets to back them
up.

That's the kind of regulatory reform that we need. That's what these folks
are going to be talking to the folks on the Hill about. And I am confident that
we can strike the right balance that allows our financial system to stabilize,
allows people to innovate in the financial markets, but don't allow them to put
everybody else's savings, everybody else's well-being, other people's jobs,
other people's homes at risk. And that's the task that lies before us and I'm
confident with can get it done."

In related news, Congressional hearings on regulatory reform are continuing apace, with a full committee hearing of the House Financial Services (HFS) Committee taking place yesterday on Perspectives on Regulation of Systemic Risk in the Financial Services Industry, a hearing by HFS today on American International Group’s Impact on the Global Economy: Before, During, and After Federal Intervention, and a hearing today in the Senate Banking Committee (SBC) on Lessons Learned in Risk Management Oversight at Federal Financial Regulators. Coming up: HFS has numerous hearings scheduled, including a hearing slated for March 20 on Federal and State Enforcement of Financial Consumer and Investor Protection Laws, and another hearing scheduled for March 26 on Addressing the Need for Comprehensive Regulatory Reform, at which U.S. Treasury Secretary Tim Geithner is scheduled to speak. See lists of additional HFS and SBC hearings.

Additionally, SEC Commissioner Elisse Walter suggested five 'Principles to Help Guide Financial Regulation Reform" in a speech she gave earlier this month to the Institute for International Bankers. The principles enumerated by Walter are:

• Principle 1: The objectives of managing systemic risk and protecting investors should both be maintained and pursued in a balanced manner.
• Principle 2: The current regulatory framework should be restructured to eliminate gaps and overlaps and to increase market transparency, so that important products and market actors are not beyond the oversight of regulators.
• Principle 3: Consumers should receive the same level of protection when they purchase comparable products and services, regardless of the financial professional involved.
• Principle 4: Important gatekeepers should be regulated to minimize conflicts of interests, increase transparency, and foster competition.
• Principle 5: No matter what new shape is constructed for financial regulation, it must incorporate strong enforcement powers for regulators to pursue wrongdoing and deter future misconduct, but those powers must be in addition to—not in lieu of—regulatory authority.

FASB Releases Proposed FSPs on Fair Value, OTTI

On March 17, 2009 the Financial Accounting Standards Board released two proposed FASB Staff Positions (FSPs) to provide guidance on fair value in inactive markets and other-then-temporary impairment (OTTI), respectively. The following documents were posted on FASB's website Tuesday night, March 17:

FASB News Release

Proposed FASB Staff Position FAS 157-e, Determining Whether a Market Is Not Active and a Transaction Is Not Distressed (Comment Deadline: April 1, 2009)

Proposed FASB Staff Position FAS 115-a, FAS 124-a, and EITF 99-20-b, Recognition and Presentation of Other-Than-Temporary Impairments(Comment Deadline: April 1, 2009)

The FSPs were approved for release at FASB's March 16 board meeting, with a comment deadline of April 1, so that the board can meet on April 2 to finalize the FSPs. The commitment to issue guidance by April 2 was made by FASB Chairman Robert Herz and U.S. Securities and Exchange Commission Acting Chief Accountant Jim Kroeker at a Congressional hearing on March 12. The April 2 deadline coincides with the start of the G-20 meeting.

At the conclusion of FASB's March 16 board meeting, FASB Chairman Robert Herz said “[We should] encourage people to write in, and staff should be reaching out.”

COSO Seeks New Chair

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) has extended the deadline for applications for the position of Chairman of the COSO Board until this Friday, March 20, 2009. COSO's current chair, Professor Larry Rittenberg of the University of Wisconsin, completed a three-year term in 2008, and continues to serve on an interim basis.

COSO was formed in 1985 to sponsor the National Commission on Fraudulent Financial Reporting (aka the Treadway Commission), an independent private-sector initiative, which studied the causal factors that can lead to fraudulent financial reporting and issued a number of reports, research studies, and sets of guidance, including the 1992 Internal Control-Integrated Framework and subsquent guidance documents.

COSO's five founding sponsoring organizations are: the American Institute of CPAs (AICPA), the American Accounting Association (AAA), Financial Executives International (FEI), the Institute of Internal Auditors (IIA), and the Institute of Management Accountants (IMA).

FEI President and CEO Marie Hollein is FEI's representative on the COSO board.

COSO requests that applications (resume and cover letter) be sent by email by March 20 to Jeff Thomson, President & CEO, IMA jthomson@imanet.org. Further information about COSO and a link to the COSO Chair Position Description can be found in this FEI summary.

FASB To Propose Guidance On OTTI, Fair Value March 17; Comments Due April 1

At its board meeting earlier today, the Financial Accounting Standards Board voted to propose two FASB Staff Positions (FSPs) to provide guidance on:
o fair value in inactive markets, and distressed transactions, and
o other-then-temporary impairment (OTTI)

As noted in FASB’s Summary of Board Decisions posted following today’s meeting, the board plans to issue the Proposed FSPs on March 17 for a 15-day comment period, ending April 1.

Also according to FASB’s Summary of Board Decisions, the board “expects to discuss the comments it receives at its meeting on April 2, 2009,” or, as stated more affirmatively in the board handout for today’s meeting – and consistent with FASB Chairman Robert Herz’ and SEC Acting Chief Accountant Jim Kroeker’s commitment made at last week’s House Financial Services Committee hearing, so that the Board can finalize the proposed FSP[s] at its Board meeting on April 2.”

At the conclusion of the board meeting, FASB Chairman Robert Herz said “[We] encourage people to write in, and staff should be talking to [constituents]… reaching out.”

Read highlights of the board’s discussion today in these FEI summaries:

FASB Votes To Propose Additional Guidance on Fair Value In Inactive Markets, Distressed Transactions,

FASB Votes To Propose Additional Guidance on Other-Than-Temporary-Impairment (OTTI)

Under Pressure

Under pressure from Congress, called upon to issue guidance on fair value (mark-to-market) accounting in inactive markets within three weeks (by the start of the G-20's April 2 meeting), as we reported here, and prodded further by this letter to SEC Chairman Mary Schapiro sent by Rep. Spencer Bachus (R-AL), Ranking Member of the House Financial Services Committee, and Rep. Roy Blunt (R-MO) on March 11, which states: "The SEC has the power to force FASB to act or to act in their place where necessary," adding, "we urgently request the SEC to take immediate action," FASB has moved quickly to schedule an open board meeting for this morning, Monday March 16 at 8am, during which the FASB board will be presented with some proposals from its staff relating to fair value (mark-to-market) and other-than-temporary-impairment (OTTI).

As shown in the board handout for this morning's meeting, the FASB staff will propose to the board issuing a Proposed FASB Staff Position (FSP FAS 157-x, Determining Whether a Market is Not Active and a Transaction is Not Distressed) which would provide a two step approach to determining when significant adjustment to observable prices (such as market prices or dealer quotes) should be made in determing the fair value of an asset under FAS 157, Fair Value Measurement. First, the Proposed FSP would provide a list of factors for determining - using significant judgment, as emphasized in the board handout - whether the market for an asset is inactive. If the answer to that question is 'yes' - or as stated in the board handout: "If after evaluating all the factors the sum of the evidence indicates that the market is not
active, the reporting entity shall apply step 2." (emphasis added; I wonder if some people may believe that use of the words 'all' and 'sum' in the preceding sentence, particularly in combination, could lead to an overly prescriptive reading or implementation vs. if the intent was that one or more factors could be present, and should be assessed and weighed as a whole).

The second step in the proposed FSP - if FASB should vote to issue the proposed FSP as suggested by its staff, subject to change for the board's discussion at this meeting - would be, as shown in the board handout: "The reporting entity shall presume that the quoted price is associated with a distressed transaction unless the reporting entity has evidence that indicates that both of the following factors are present for a given quoted price:

a. There was a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities (for example, there was not a regulatory requirement to sell).

b. There were multiple bidders for the asset. " (emphasis added)

It will be interesting to see how the board views the above points in Step Two of the FASB's staff's suggested approach shown in the board handout. It is possible that some people may view the above two factors as being so broad as to potentially negate virtually every rebuttable presumption that a transaction in an inactive market is distressed, i.e. if there is literally more than one bidder ('multiple bidders') and in the absence of a regulatory requirement to liquidate the particular asset.

According to the board handout, the staff intends to recommend to the FASB board releasing the proposed FSP for a 15 day comment period, to facilitate considering comment letters in time to vote on a final standard at a board meeting on April 2nd. Separately, the board handout also contains the staff's recommendations to be considered by the board on OTTI. FASB's meeting will be webcast, and FASB helpfully posts Summaries of Board Decisions in its News Center , generally within 48 hours of board meetings.

In related news, the G-20 posted on March 14 a Progress Report on the Immediate Actions of the Washington Action Plan prepared by the UK Chair of the G20. (See G-20 Progress Report .) The first page of the six page report is devoted to accounting and disclosure related issues under the heading: Strengthening Transparency and Accountability.

'Groups Urge PCAOB to Tell Auditors Not to Be Too Negative on Fair Value,' BNA Reports

The PCAOB is also at the receiving end of some pressure relating to auditing of fair value numbers. The above-titled article, appearing in BNA's Daily Report for Executives on Friday, stated: "A group of banking and business groups urged the [Public Company Accounting Oversight Board in a March 4 letter to ensure auditors are not being too strict on fair value accounting with the companies they audit."

"Simply put, the left hand should not use a club to remove the instrument of reasonable accounting reforms from the right hand," said the letter, according to BNA, noting the letter was sent to PCAOB Chairman Mark Olson from 15 groups that included the U.S. Chamber of Commerce, the American Bankers Association, the Mortgage Bankers Association, the American Council of Life Insurers, and the heads of five Federal Home Loan Banks." BNA added that the letter continued by urging the PCAOB "to issue 'guidance and standards' on how it will inspect the audits of fair value accounting, particularly in light of further guidance on accounting for fair value in illiquid or inactive markets offered by the [FASB] and the [SEC]."

The PCAOB has previously published a number of Staff Audit Practice Alerts (APA's) relating to fair value, including APA No. 3, published Dec. 5, 2008 on Audit Considerations in the Current Economic Environment, and APA No. 2 published Dec. 10, 2007 on Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists.

SEC To Meet On Uptick Rule on April 8

The SEC has been under pressure in other areas than fair value, including some calling for reinstatement of the uptick rule relating to short sales. On Friday, the SEC posted a Sunshine Act Notice announcing that it will hold an open commission meeting on April 8 at which the commission will consider: "whether to propose short sale price test rules." This development was reported by Ronald D. Orol in Marketwatch Friday evening.

Madoff Pleads Guilty

On the subject of those feeling under pressure, alleged (and now admitted) Ponzi schemer Bernard L. Madoff pled guity on Thursday to 11 counts of fraud. Reuters coverage of the Madoff Scandal is very broad, including the article "Madoff Says Felt Compelled to Deliver 'At Any Cost," by Martha Graybow, and a link to what Reuter's describes as Madoff's statement-'How I Did It' (technically the Plea Allocution of Bernard L. Madoff). Madoff is presently in jail awaiting sentencing; Chad Bray reported on WSJ.com Friday evening Madoff Appeals Jailing, including that "A hearing before a three-judge appellate panel is set for March 19."

Madoff's victims clearly feel under pressure as well, as do regulators in the continuing investigation into how clues such as statements delivered to the SEC by investigator/analyst Harry Markopolous did not result in regulatory action to stop the fraud sooner; however, Madoff admits on pg 3 of his statement "knowingly giving false testimony to the SEC," and admits on pg 4 the "filing of false and misleading certified audit reports and financial statements with the SEC," which he states he "knew were false and that they would also be sent to clients." Madoff's statement (pg 2) describes how he created the 'split strike conversion strategy' "to falsely give the appearance to clients that I had achieved the results I believed they expected."

There is absolutely nothing funny about the Madoff scandal, but those wishing to find a respite from some of the pressure may wish to turn to Bernard Madoff's Blog (aka 'fake Bernard Madoff's Blog.')

FASB, SEC Commit To Provide Fair Value (Mark-to-Market) Guidance By April 2

At a Congressional hearing on mark-to-market accounting on March 12, 2009, FASB Chairman Robert Herz, and SEC Acting Chief Accountant Jim Kroeker, committed to providing guidance on fair value accounting in illiquid markets within three weeks. It appeared Congress was asking for final - not proposed guidance - within the three-week timeframe, which ends on April 2, coinciding with the start of the next G-20 meeting.

The promise was extracted from the standard-setters after the FASB chairman initially said he anticipates releasing proposed guidance in early April, and final guidance by the end of second quarter.

Rep. Paul Kanjorski (D-PA), chair of the Capital Markets Subcommittee of the House Financial Services Committee, noted in his opening remarks, “Mark-to-market accounting did not create our economic crisis, and altering it will not end the crisis. But improving the application of a fundamentally sound principle that is having profound adverse implications in a time of global financial distress is imperative. Therefore, our hearing today is about getting Financial Accounting Standards Board and the Securities and Exchange Commission to do the jobs they are required to do.” He added, “Emergency situations require expeditious action, not academic treatises. They must act quickly.”

“There are three pieces of legislation presently pending in Congress,” noted Kanjorski, with respect to mark-to-market accounting or accounting standard-setting generally (e.g. HR 1349 co-sponsored by Rep. Ed Perlmutter (D-CO) and Rep. Frank Lucas (R-OK) which would create a Federal Accounting Oversight Board). Kanjorski added, “I guarantee you one of those pieces of legislation is going to become law before early April.

Rep. Gary Ackerman (D-NY) responded to FASB’s current timetable, “If you are going to act, you’ve got to do it real quick.”

Herz responded, “I have heard you very clear, we will go back and consider exactly how.”

Ackerman asked, “Can you do this in three weeks?”

“We probably could,” said Herz, adding, “I have to talk to the other members of my board.” Ackerman pressed him as to when that discussion would take place; Herz responded “When I get back tonight.”

Addressing a question to Herz and Kroeker, Ackerman said, “With the right cooperation between the two of you, can you do this in three weeks?”

Kroeker answered, “We can absolutely work with the FASB, we expect action within weeks, not months, my staff stands ready to assist the Commission in any way possible if we don’t see that action.”

Herz observed, “We could have the guidance in three weeks; whether it will fix things, I don’t know.”

Ackerman responded, in effect, that wasn’t the question he was asking, but whether “It can, and will be done in three weeks?”

“Yes,” answered both Herz and Kroeker.

Herz later couched his response by noting that he was one member of a five member board at FASB.

Rep. Tom Price (R-GA) asked, “Do we need to bring the other four board members in here?”

Herz replied the other board members were probably listening to the hearing (webcast), and in terms of meeting the Congressmen’s request, added, “We will do everything we can.”

Investors, Bankers Share Views
The second panel of the day included investor representatives (Jeff Mahoney, General Counsel, Council of Institutional Investors, and Cindy Fornelli, Executive Director, Center for Audit Quality) banking and financial services representatives Thomas Bailey, Chairman, Pennsylvania Association of Community Bankers, and President and Chief Executive Officer, Brentwood Bank, and Lee Cotton, Past President, Commercial Mortgage Securities Association) policy analyst ( Tanya Beder, Chairman, SBCC Group, and Robert (Bob) McTeer, Distinguished Fellow, National Center for Policy Analysis) as well as former FDIC Chairman William Isaac.
When asked by a Congressman, “What would you have us do?” Fornelli replied, “A two pronged approach, one on the regulatory capital side with the banking regulators, the other is addressing these application problems with fair value accounting, both in the proposals FASB talked about with how to give better guidance to how to apply valuations in illiquid markets, and also on OTTI, which we heard about this morning, which I don’t think is [currently being worked on] by the FASB. Mahoney said he would support more robust disclosures.

Fornelli noted, “The SEC currently allows that disclosure in footnotes and MD&A,” adding, “one recommendation CAQ made in its Nov. 2008 letter [to the SEC] was for the SEC to give even more clarity around that.”

Isaac said, “I’m all for all the disclosures you want to make, but don’t run these mark-to-market losses through income and balance sheet, what we do need is bank examiners and accountants in there, with their sleeves rolled up, giving these things true economic value so we all know what they are.”

Rep. Spencer Bachus, Ranking Member of the House Financial Services Committee, noted he had first called for this hearing in October of 2008, when he received a letter from then-Financial Accounting Foundation (FAF) Chairman Robert Denham. He said the letter “basically told me to butt out.. said we don’t need any political interference; that was also the same day we passed TARP [referring to the Emergency Economic Act of 2008], and the reason for his letter [was], Rep. Roy Blunt (R-MO) and I included in the legislation a study of mark-to-market accounting and determine if it was destroying [capital/valuations] or loan provisioning.” At the end of the hearing, Bachus asked that the FAF letter be entered into the record of the hearing. (Another item being added to the record of the hearing, at the request of Rep. Lucas, was written testimony from Former Speaker of the House Newt Gingrich.

Bachus also mentioned he was a follower of panelist Bob McTeer’s Blog, particularly his post, My Mark-to-Market Nightmare.

Legislative Solution Threatened If Improvements To Accounting Standards Don’t Materialize
Although numerous Congressmen said they did not believe Congress should get directly involved in setting accounting standards, Kanjorski said at the close of the first panel that if FASB and the SEC do not deliver what they promised to deliver (i.e. fair value guidance within three weeks), he would call a followup hearing when Congress returns from its Easter/Passover recess in mid-April. “At that time,” added Kanjorski, if the guidance on fair value in inactive markets is not done, “we will work on legislation expeditiously to cure the problem.”

He reiterated at the end of the hearing, referring to the standard-setters and regulators that had appeared on the first panel (Herz, Kroeker and Bailey) and referring to the current rules for mark-to-market accounting (fair value), “We expect those three gentlemen to show the American people, show the street, that they can function; I was very serious, as soon as we get back from Easter break, we will have a hearing, if we are not notified in the meantime that there is a change in the rule.”

Further details on the hearing, including the discussion regarding other-than-temporary-impairment (OTTI), credit vs. liquidity writedowns, banking regulators’ ability to adjust capital requirements, and more, can be found in this FEI summary. NOTE: Only FEI members can download the detailed summary, one of the benefits of FEI membership, in addition to our other networking, education and advocacy activities. (For an example of advocacy efforts, see the joint comment letter filed by FEI’s Committee on Corporate Reporting and the U.S. Chamber of Commerce Center for Capital Market Competitiveness Nov. 25, 2008 on fair value.) Learn more about FEI membership, including our special offer to attend FEI’s Summit Conference May 4-6 at the Gaylord Texan Resort in Grapevine TX for free, if you become a new member by April 6, and feel free to email me for more information at eorenstein@financialexecutives.org.

Testimony Posted For Mark-To-Market Hearing; Sen. Dodd Considers ‘Breakers,’ Niederauer Sees MTM As ‘Gas On A Fire’

Talk about transparency: all of the testimony has been posted to the House Financial Services Committee website in advance of its hearing today on mark-to-market accounting (MTM). (The hearing begins at 10a.m., watch for a summary in the FEI blog.)

I found no real surprises in the prepared written testimony, which falls into four buckets:

1. Standard-setters and regulators: FASB Chairman Robert Herz, SEC Deputy Chief Accountant Jim Kroker, and OCC Deputy Comtroller for Regulatory Policy, Kevin Bailey, (collectively, Panel 1 at the hearing) whose written testimony appears to me to be pretty much 'stay the course' - i.e., as SEC recommended in its Dec. 30, 2008 report to Congress, and as FASB announced on Feb. 18 it will proceed to do, FASB is developing 'application guidance' for companies and their auditors to apply the existing standards such as FAS 157, Fair Value Measurement, in inactive markets.
2. Investor reps: Panelists on panel 2 who are traditionally referred to on these sorts of panels as 'investor reps,' include Jeff Mahoney of the Council of Institutional Investors, and Cynthia Fornelli of the Center for Audit Quality.
3. Bankers: current and former bankers and banking regulators regulators like Tom Bailey, Lee Cotton and William Isaac, who urge action ranging from further guidance (Bailey and Cotton) to suspension of FAS 157 (Isaac).
4. Policy analysts: Tonya Beder, of SBCC Group, and Robert McTeer of the National Center for Policy Analysis, who says , "Much of our recent wealth destruction has resulted from slavish adherence to an accounting dogma that never should have applied to banks and other regulated financial intermediaries in the first place."

Put on your Decoder Rings
Allow me to throw in my two cents: I hope the Congressmen, regulators, bankers and others won't 'talk past each other' at this crucial hearing, which is easy to do, when dealing with a highly technical subject replete with its own lingo.

Indeed, former SEC Chairman Christopher Cox was fond of referencing in speeches his desire to cut back on jargon and simplify reporting so investors would not have to turn to 'decoder rings.' At the same time, he wisely noted, there is a need to write clear standards so the people applying them will not be subject to 'gotcha's.' (See Cox' speech at the New York Economic Club, Dec. 12, 2005.)

Here's some of the jargon to watch out for:

1. the definition of fair value, and whether FAS 157, which became effective in 2008, really 'changed' anything. As much of the testimony states, (and as analyst Jack Ciesielski states in his post about the hearing in his AAOWeblog earlier this week, The Lynch Mob Forms), FAS 157 did not require any new assets to be marked to market or carried at fair value, it simply created a 'consistent defintion' for how to apply fair value. Thus, while no new assets were required to be carried at fair value, how did the 'new, consistent' definition of fair value differ from the old methods? A plain English dialogue over 'what changed' in terms of actual practice in how fair value was applied pre- and post-157 may be enlightening.
2. the generic concept of 'fair value' vs. the specific definition and requirements relating to fair value set forth in FAS 157. That is, someone can be 'pro fair value' and still believe there should be improvements to FAS 157. As some of the panelists note in their testimony (see especially Beder and Isaac), there have historically and continue to be (in some sectors of professoinal practice in the valuation field) a number of methodologies to arrive a 'fair value' - with market values being just one of them.
3. 'application guidance' vs. 'improvement' vs. 'modification'. Here is where all the panelists and Congressmen could conceivably walk out of the room thinking they reached a consensus for 'improving' e.g. FAS 157, but could have polar opposite views on what 'improve' really means, e.g. does 'improve' mean 'modify' - which to some implies an amendment of the fundamental principles in a standard? Or, does 'improve' mean provide 'application guidance' issued to preparers and auditors under the belief that the implementation issues are resident at their end, in the application of a standard, vs. being resident in the standard itself? Note that the Emergency Economic Act of 2008 asked the SEC to study and opine on whether there should be a suspension - or modification - of FAS 157. The SEC's answer was clear that they did not believe there should be a suspension of FAS 157. On the question of 'modification' - that appears to be more of a gray area.

Dodd Says Congress Should Not Set Accounting Standards, But Breakers Should Be Considered

Senator Chris Dodd (D-CT), responding to a question at the U.S. Chamber of Commerce 3rd Annual Capital Markets Summit on March 11, 2009 said it is worth considering whether a ‘breaker system’ could provide some relief on mark-to-market (MTM) accounting. Dodd’s comments came during a brief Q&A following his formal remarks. In connection with the Capital Markets Summit, the U.S. Chamber Center for Capital Market Competiveness issued a declaration entitled: Eight Actions to Restore and Strengthen Capital Markets.

Doug Barnert, Executive Director of the Group of North American Insurance Enterprises (GNAIE), raised the question on MTM at the Chamber program. Noting that the House Financial Services Committee was slated to conduct a hearing on MTM on March 12, Barnert asked Dodd if the Senate Banking Committee was planning to do the same, and what his position was on the matter. He added, “There are two camps that are the most obvious, which are (1) suspend all MTM, and (2) don’t do anything, everything is OK- rosy picture type. I think you’ll find most people in this room don’t fall into either one of those camps, but believe some legitimate action can take place; some needs to be long-term, well thought out, like the regulatory reform you are talking about, but some needs immediate action. And so the question is, without legislating accounting standards, what type of actions do you think the Congress can take on moving forward on this?”

Dodd, whose home state of Connecticut includes the Financial Accounting Standards Board, based in Norwalk, CT, responded, “”First of all, I’ve been over the years - although I have only chaired this committee the last two years, but as a member of the committee, even when Dick Shelby was chairing the committee, or Paul Sarbanes or others, I have vehemently opposed the Congress getting in the business of setting accounting standards.” He continued, “Be careful what you wish for - once you set that precedent, you open up that door, the idea that by a vote of 51 to 49 in the Senate we sort of set a FASB standard, is frightening to me, because then it becomes… as dangerous as it can be.”

He continued, “MTM is a very legitimate question, and certainly there have been legitimate ones in the past as well; I’m not suggesting those advocating … are incorrect, but … I urge you not to get Congress involved,” and repeated, “be careful what you wish for.”

Dodd described the procyclical environment as “spirally down …at warp speed.”

As a potential solution, he noted, “I had a long chat with Gene Ludwig, and he suggested something that had some appeal: we should have a breaker system, [to be able to] step in and provide some relief.” NOTE: Ludwig, a former Comptroller of the Currency, is the founder and CEO of Promontory Financial Group, and also serves as a member of the FASB-IASB Financial Crisis Advisory Group (FCAG).Read more about FCAG here, including a link to FCAG's request for comment due April 2, and links to summaries of the most recent (March 5) FCAG meeting by Steve Burkholder courtesy of BNA.

It appeared from Dodd’s remarks at the Chamber’s Capital Markets Summit that the concept of ‘breakers’ (akin to ‘circuit breakers’) were being given serious consideration in some circles. He stated, “Some thought is going into that - to see if there isn’t some breaker system regulators could have used.”

However, striking an analogy with actions taken on short sales, Dodd noted that former SEC Chairman Christopher Cox suspended short selling for a time, but “there was a problem with that, .. [it] created more problems than it solved.” He added, you “can’t pull it back and forth,” or you “get the kind of reactions you saw when that occurred.” He also noted “the uptick rule might be helpful at a moment like this,” noting that SEC Chairman Mary Schapiro has testified she would consider reimposing it.

Closing his response on the issue of MTM, Dodd said, “I am in the category of finding some kind of mechanism - not to be used at any old time - but to put brakes on … [rather than having things] spinning out of control.”

You can view the exchange between Barnert and Dodd on the question of mark-to-market accounting if you go to 03:13:15 on the Chamber’s archived webcast.

NYSE-Euronext’s Niederauer: MTM Like "Gas On A Fire”
Another keynoter at the Chamber Capital Markets Summit who touched on the topic of MTM was NYSE-Euronext Chairman Duncan Niederauer. “To go back to the MTM question,” said Niederauer, referencing the question posted to Sen. Dodd earlier, he said, “we’ve got to balance ideals with reality.”

Noting recent remarks of Berkshire Hathaway Chairman Warren Buffett, Niederauer added, “We might say with a long-term view, MTM was right, but it came along - as Mr. Buffett has said, at a very bad time.”

Niederauer compared the timing of implementation MTM accounting – under the new measurement regime introduced in FAS 157, Fair Value Measurement, which became effective in 2008 – to “one downturn away from effectively bringing gas to a fire.”

He noted MTM can have a broad impact on a company’s balance sheet, and added, “Not to say MTM rules were not right, [but] the question is, do we relax them for a moment?”

Niederauer also made some specific suggestions for areas of focus. You can see Niederauer in person when he gives a keynote address at FEI’s Summit conference May 4-6 at the Gaylord Texan Resort in Grapevine, Texas. Become a new member by April 6, and attend our Summit conference for free – includes free CPE! If you have questions about FEI membership or the Summit conference, contact me at eorenstein@financialexecutives.org or 973-765-1046.

NYSE's Niederauer Warns: Don’t Let IFRS Become The Next Sarbanes-Oxley

In a keynote address on March 11, 2009 at the U.S. Chamber of Commerce 3rd Annual Capital Markets Summit, NYSE-Euronext Chairman Duncan Niederauer raised some cautions about a potential move of U.S. companies to International Financial Reporting Standards (IFRS) as contemplated in the U.S. Securities and Exchange Commission’s Proposed IFRS Roadmap, released for public comment in November, 2008. (NOTE: SEC’s comment deadline is April 20; see the comment file.)

“We should not allow the transition to IFRS to become the next Sarbanes-Oxley,” Niederauer told the Chamber conference, adding “it cannot be the accounting firms’ next big opportunity which they turned Sarbanes-Oxley into… and it cannot be a bane for small companies.”

He observed, “A lot of people do studies that say it doesn’t cost much for small companies [to implement IFRS].” However, he noted many of the NYSE-Euronext issuers are small companies, adding, “let me tell you… it costs a lot more than what the acdemics’ studies say.” [On the subject of academic studies, the comment letter filed by FASB and its parent foundation, the FAF on the SEC’s proposed IFRS roadmap included 2 academic studies, see link to their letter below.]

He also noted that the cost of implementation or transition to IFRS is usually “much more” than what a company may be quoted initially by an audit firm.

NOTE: Neiderauer recommended more specific types of focused action in a variety of regulatory areas. Hear more of his ideas by seeing his keynote at FEI’s Summit conference May 4-5 at the Gaylord Texan Resort in Grapevine, Texas. (If you become a new member of FEI by April 6, you can attend our Summit conference for free-includes free CPE! Email me if you’d like more info on FEI membership or our Summit conference eorenstein@financialexecutives.org.)
More IFRS NewsIn other IFRS news, the Financial Accounting Standards Board and its parent, the Financial Accounting Foundation, posted its comment letter on March 11 on the SEC’s proposed IFRs Roadmap. (See FAF-FASB comment letter on IFRS Roadmap)

Among other prominent organizations filing comment letters recently was the New York State Society of CPAs. (See NYSSCPAs letter on IFRS Roadmap).

Separately, FEI’s research affiliate, the Financial Executives Research Foundation (FERF) published a new study on March 9, entitled: International Financial Reporting Standards: A Project Plan for U.S. Companies.

The report, released by FERF in conjunction with Resources Global Professionals, notes: “While many financial executives have begun the initial stages of convergence with International Financial Reporting Standards, early adoption in 2009 for qualifying companies will be difficult, if not impossible, due to the significant time requirements.”

The new study is the first in an information series FERF is publishing to provide practical professional education on IFRS. The data for the study was primarily compiled from a gathering of representatives from 30 U.S.-based public companies during which the discussion focused on challenges and best practices related to IFRS. Read more about the new report in this FEI press release and download the report from FERF’s bookstore.