Yesterday, the SEC delivered a report to Congress recommending against the suspension of fair value accounting standards, and instead recommending improvements to existing practices. The report, mandated by the Emergency Economic Stabilization Act of 2008, suggests reconsidering accounting for impairments and the development of additional guidance for determining fair value of investments in inactive markets.
As previously noted, the SEC study, conducted in collaboration with the Federal Reserve and the Treasury, focused on the mark-to-market standards specifically, and fair value accounting more generally.
As mandated by the EESA, the study focused on six areas:
- The effects of such accounting standards on financial institution’s balance sheets;
- The impacts of such accounting on bank failures in 2008;
- The impacts of such standards on the quality of financial information available to investors;
- The process used by the Financial Accounting Standards Board in developing accounting standards;
- The advisability and feasibility of modifications to such standards; and
- Alternative accounting standards to those provided in the Statement of Financial Accounting Standards No. 157.
While some have argued that fair market accounting played a part in the recent economic turmoil, the study found that these accounting measures played no meaningful part in the bank failures. Rather, the report says, the bank failures were a result of “growing probable credit loss, concerns about asset quality, and in certain cases, eroding lender and investor confidence.”
Although the report does not recommend suspending the existing fair value rules, it does recommend several improvements to their application:
- Development of additional guidance and other tools for determining fair value in illiquid or inactive markets;
- Enhancement of existing disclosure and presentation requirements;
- Educational efforts, including those to reinforce the need for management judgment in the determination of fair value estimates;
- Examination by the FASB of the impact of liquidity in the measurement of fair value, including whether additional application and/or guidance is warranted; and
- Assessment by the FASB of whether the incorporation of credit risk in the measurement of liabilities provides useful information to investors.
According to the SEC, data for the study was obtained from a cross-section of financial institutions, and public comment was received from a similarly broad cross-section of market participants through a public comment letter process and a series of three round-table discussions.
In announcing the study, outgoing SEC Chairman Cox stated that “The Office of the Chief Accountant and Division of Corporation Finance, in consultation with the Department of the Treasury and the Federal Reserve, have produced a valuable study of many of the critical issues surrounding the use of fair value accounting in the extraordinary market conditions of the past year.”