Thursday, October 30, 2008

SEC: Back to the Drawing Board on Fair Value, Mark to Market

SEC's Cox Says Fair-Value Rule Needs `Further Work'

U.S. Securities and Exchange Commission Chairman Christopher Cox said an accounting rule blamed for pushing American International Group Inc. and other firms to the brink of collapse needs ``further work.''

``Illiquid markets are bringing new challenges to the measurement of fair value,'' Cox said today during an accounting conference at the SEC's Washington headquarters. ``These challenges have brought into focus the need for further work on improving the tools that companies have at their disposal to achieve transparent'' financial reporting, he said.

Cox's comments may provide an opening for business groups that want regulators to give financial companies more flexibility in valuing assets after more than $684 billion in losses since the start of 2007. Fair-value accounting forces firms to mark down holdings to current trading prices every quarter, which companies say makes no sense when markets are frozen.

Fair-value has been ``extremely and needlessly destructive of bank capital in the past year and is a major cause of the current credit crisis,'' said
William Isaac, a former chairman of the Federal Deposit Insurance Corp. ``Assets should not be marked to unrealistic fire-sale prices,'' he said.

The rules on fair-value accounting instruct companies to measure assets and liabilities assuming ``an orderly transaction between market participants.'' A forced or distress sale isn't an orderly transaction, the rules say.

Cox didn't endorse a suspension of fair-value accounting, a move that Isaac and some members of Congress have advocated.

`Independent and Deliberative'
The SEC chairman also said the Financial Accounting Standards Board should be free from outside pressure, and should consider changes to the rule in an ``independent and deliberative manner.'' The SEC oversees Norwalk, Connecticut-based FASB, which writes U.S. accounting standards.

American Bankers Association and the U.S. Chamber of Commerce have urged Cox to override FASB, which they say has been too rigid in interpreting accounting requirements.

The SEC is required to examine fair-value accounting under terms included in the $700 billion federal financial-rescue package enacted this month. The agency must submit a written report to Congress by Jan. 2 that evaluates how the rule can be improved and whether it has caused banks to fail.

Former executives of AIG, the insurer saved from collapse by an $85 billion Federal Reserve loan last month, told lawmakers the requirement forced the company to book unrealized losses on distressed mortgage-backed securities and
credit-default swaps.

`Historic Cost'
Placing a moratorium on the fair-value rule would be a mistake, said
Raymond Ball, a University of Chicago accounting professor. He cited Japan, which in the 1990s let its banks hide losses by holding assets at ``historic cost'' instead of current trading prices.

``Investors in the capital markets didn't know which were the strong banks and which were the weak banks,'' Ball said at the SEC conference. ``That inhibited the recovery of the economy.''

The accounting industry has defended the fair-value requirement, arguing in letters to the SEC and lawmakers that it gives investors transparency about the health of companies.

Isaac said accountants, who must sign off on companies' financial statements, are worried about getting sued if their clients go bankrupt. He said Congress should consider giving auditors protections from lawsuits when they base fair-value assessments on ``reasonable business judgment.''

``One important consequence of subjecting accountants to enormous potential liabilities is that the profession reacted by moving toward very rigid rules that leave little room for judgment,'' Isaac said.
By Jesse Westbrook and Ian Katz at Bloomberg

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