The New York Times –Late Edition – Final – 1
Under pressure from banks and legislators, the Securities and Exchange Commission issued an interpretation of an accounting standard that could make it easier for banks to report smaller losses, or perhaps even profits, when they announce results for the third quarter, which ended Tuesday.
The move on Tuesday drew praise from the American Bankers Association, which had complained to the S.E.C. that auditors were forcing banks to value assets at unrealistically low ”fire sale” prices, rather than at the higher values the banks believe the assets should be worth in an orderly market.
Some congressmen had pressed to order a suspension of the fair-value rule, known as S.F.A.S 157, as part of the bailout bill that the House defeated on Monday but that may be revived later in the week. That bill stopped short of that, but did require a study of the rule and authorized the S.E.C. to suspend it.
The S.E.C. said it was interpreting, not changing, the mark-to-market rule. Nonetheless, the immediate praise from the bankers could reduce the pressure to drop the rule and make it easier for some legislators to change their votes.
The statement was issued jointly by the commission’s chief accountant and the staff of the Financial Accounting Standards Board.
While the rule has been criticized by many banks, others have argued that the problem was caused by the banks’ purchase of risky assets.
In a report earlier this year, Dane Mott and Sarah Deans, analysts for, argued that ”blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.”
On Tuesday, they said there was ”nothing new” in the S.E.C. statement, but some other analysts thought it could make a difference.
Companies have long been required to mark many financial assets to their fair value, but rule 157 clarified how that was to be measured, saying that market values should be used if they are available.
Many mortgage securities have plunged in value, forcing large write-offs by financial institutions that own them. Bankers have argued that the current market prices are far below what the securities should be worth, and say that they should not be forced to take write-downs that are sure to be reversed later.
The rule had exceptions, saying that ”distress sales” need not be used as the basis for reporting, but it was unclear how broadly that could be interpreted. Some auditors argued that more than one or two sales at a level provided a real market price, and thus should be used for valuing that security and similar ones.
”More and more of our members in recent weeks have raised concerns that a number of accounting firms were mistakenly interpreting S.F.A.S. 157 in a way that required marking assets to fire-sale values,” Edward L. Yingling, the president of the American Bankers Association, said as he praised the S.E.C. for the interpretation. ”This guidance will help auditors more accurately price assets that are difficult to value under current market conditions.”
Mr. Yingling said the bankers had held ”a productive meeting” on Thursday with staff members from both the S.E.C. and the accounting board, as well as representatives of the major accounting firms.
Under rule 157, there is a hierarchy of valuation techniques. The first is when there is an active market for a security, which must always be used. If there is no such market, level two is based on prices of similar securities. Only if those are not available is level three to be used, which depends on the company’s model of value in the absence of a usable market price.
”They’re saying that in some cases, using level three might be more appropriate than using level two,” said Patrick Finnegan, the director of the financial reporting policy group of the CFA Institute, a group of securities analysts.
The statement did that by providing more definition of what was an inactive market, whose prices sometimes can be ignored, and of what constituted a disorderly market.
”The results of disorderly transactions are not determinative when measuring fair value,” the statement said. ”The concept of a fair-value measurement assumes an orderly transaction between market participants. An orderly transaction is one that involves market participants that are willing to transact and allows for adequate exposure to the market. Distressed or forced liquidation sales are not orderly transactions, and thus the fact that a transaction is distressed or forced should be considered when weighing the available evidence. Determining whether a particular transaction is forced or disorderly requires judgment.”
Banks could use the phrase ”adequate exposure to the market” to justify not using privately negotiated sales of mortgage securities to value similar securities held by others. Mr. Finnegan pointed to the sale this year byof mortgage-related securities at 22 cents on the dollar. The sale was made to a private equity firm, and details of which securities were included was not disclosed.
”This is probably giving you some leeway,” he said. ”With this guidance, you could say I can ignore that transaction and use a level three approach. While it is not disorderly, it does not meet the definition of orderly.”
Mr. Finnegan said that while investors might not agree with those decisions, the interpretation would be acceptable so long as it was accompanied by adequate disclosures.
”Investors can be well served if they understand that, from quarter two to quarter three, management has developed a different interpretation of fair value, and they provide a reconciliation of the changes,” he said.
Companies now must report on assets moved between levels, but it is not clear if they would have to disclose that the move came about because of a different interpretation of the rule, rather than a change in the availability of market information.