SEC Releases Results of Study on Fair Value Accounting Rules
Financial Services Task Force Update 02/02/09 John P. Vail, James J. Gatziolis
Fair value accounting, also known as "mark-to-market" accounting, is a way to measure assets and liabilities that appear on a company's balance sheet and income statement on the basis of the price one could expect to receive for such assets and liabilities on the open market. Huge losses reported by financial firms on subprime assets have led to a vigorous debate over the appropriateness of fair value accounting in the current economic market where banks and investment banks have been forced to reduce the value of their mortgages and mortgage-backed securities to reflect current market prices. Critics of fair value accounting believe that these write-downs have helped to accelerate and intensify the current financial crisis, while proponents believe that use of fair value accounting is necessary in order to continue to provide investors with the most accurate information possible and that the suspension or easing of fair value accounting rules would simply mask huge losses in asset values.
SFAS No. 157
Although financial institutions have long been required to report the value of certain assets at fair value, in 2006, in the wake of Enron's collapse, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 157, Fair Value Measurements ("SFAS No. 157") in order to provide a uniform definition of "fair value," establish a framework for measuring fair value in generally accepted accounting principals ("GAAP") and to expand disclosures about fair value measurements. SFAS No. 157 resulted in a more uniform application of the methods used to determine fair value by prioritizing the use of market pricing information over other valuation methods. Because SFAS No. 157 places a higher priority on the use of market pricing information, critics argue that, in the current economic crisis it has forced financial institutions to value assets based on severely reduced market prices, which do not reflect the actual long-term value of the assets.
SEC Study on Fair Value Accounting
When the Emergency Economic Stabilization Act of 2008 was signed into law on October 3, 2008, it mandated that, within 90 days, the Securities and Exchange Commission ("SEC") complete a study on fair value accounting standards as provided by SFAS No. 157. On December 31, 2008, a report on the results of this study was delivered to Congress by the SEC.
In the report, the SEC recommends against the suspension of fair value accounting standards. The report indicates that the primary reason for this recommendation is because fair value accounting provides the most transparent financial reporting of an investment to investors and, therefore, suspension of fair value accounting would likely increase investor uncertainty and could tip the market back into freefall. Although the SEC reported that it was in favor of the continued application of fair value accounting standards, it also recommended that certain actions be taken in order to improve the existing practice of fair value accounting. In particular, the report makes the following eight recommendations:
- SFAS No. 157 should be improved but not suspended.
- Existing fair value and mark-to-market requirements should not be suspended.
- Additional measures should be taken to improve the application and practice relating to existing fair value requirements.
- The accounting for financial asset impairments should be readdressed.
- Implement further guidance to foster the use of sound judgment.
- Accounting standards should continue to be established to meet the needs of investors.
- Additional formal measures to address the operation of existing accounting standards in practice should be established.
- Address the need to simplify the accounting for investments in financial assets.
For more information regarding the SEC's findings, the press release regarding the study along with a link to the SEC's full report can be found at http://www.sec.gov/news/press/2008/2008-307.htm.
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For more details or if you have any questions, please contact John Vail at 312-715-5042 / John.Vail@quarles.com, Jim Gatziolis at 312-715-5049 / James.Gatziolis@quarles.com or your Quarles & Brady attorney.