Let the Fair Value Scrutiny Begin

The SEC starts studying how mark-to-market accounting affected this year's bank problems.
Sarah JohnsonOctober 7, 2008

The Emergency Economic Stabilization Act gave the Securities and Exchange Commission 90 days to study the effects of fair-value accounting. And today, the regulator announced that it will hold roundtables on the subject, appointing deputy chief accountant James Kroeker, a former Deloitte & Touche partner, to oversee the project.

Under the law signed by President Bush last week, the SEC was tasked with putting together a report by Jan. 2, after conferring with the Treasury secretary and the Federal Reserve System’s board of governors.

The study will examine the effects of mark-to-market accounting on financial institutions’ balance sheets and on the recent round of bank failures. The SEC will also review if FAS 157, the standard for measuring fair value of financial assets and liabilities, has improved the information companies provide to investors.

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The SEC’s work could result in a complete revamping of fair-value rules, as Kroeker and his team will have to review how the Financial Accounting Standards Board comes up with its rules as well as look at how complicated it would be to change FAS 157. The study will also note alternative methods to the standard.

Issued in 2006, FAS 157 has come under fire recently, particularly by financial institutions that had to take large writedowns as their financial assets sank in value during the credit crisis. The standard defines fair value, and provides a framework for measurement along a three-step hierarchy. Under the third level, assets that are thinly traded or not at all are held up against “unobservable inputs.” It is under this method that fair-value critics say the accounting standard creates too much volatility and leads to a pro-cyclical, downward effect on the economy.

The new law also gave the SEC the authority to suspend mark-to-market accounting if the regulator deems such a move “necessary or appropriate in the public interest.” Shortly before the legislation’s passing, the SEC and FASB came out with guidance clarifying how FAS 157 should be applied. While providing no changes to current rules, the guidance gave the okay to companies using their internal models and assumptions for estimating the fair value of financial assets and liabilities that have no current market.