SEC Allows Special Accounting for “Perpetual Preferred”

It will allow companies to delay writedowns after questions are raised about valuation.
Stephen TaubOctober 15, 2008

The Securities and Exchange Commission has agreed to allow issuers to delay writedowns on “perpetual preferred securities” that are showing paper losses.

The valuation losses on these securities could amount to more than $640 billion, according to Bloomberg News, which first reported on the letter that SEC chief accountant Conrad Hewitt mailed yesterday to Financial Accounting Standards Board Chairman Robert Herz.

Hewitt wrote, in answer to a number of inquiries from companies, that issuers may account for the perpetual preferred securities as debt, allowing them to postpone writing down any deterioraton of their value. The new interpretation goes into effect immediately, which means it would impact the September quarterly reports, which some banks have already released.

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The accounting method for these securities had created a debate, since they are issued without maturity dates. According to Bloomberg, auditors felt they should be treated as equity and issuers wanted to deem the assets to be debt. Hewitt wrote that issuers can treat them as debt “if there has been no evidence of deterioration in the credit of the issuer,” such as a decline in cash flows from the investment or a downgrade in the security’s rating below investment grade.

The SEC’s interpretation adds to the controversy over the virtues of fair-value accounting, which some critics have blamed, in part, for the global financial crisis and lending freeze. In fact, one component of the government’s $700 billion bailout package requires the SEC to study the impact fair-value has had on financial institutions.

Donna Fisher, senior vice president for tax and accounting of the American Bankers Association, called the action “really good news” in an interview with Bloomberg. “We are making some headway,” she said. “The SEC is recognizing that there are problems in the rules.”