Investors Feel The Regulator Is Giving Companies Leeway For Avoiding Big Writedowns
ONCE again, the Securities and Exchange Commission is fuelling suspicions that it has crafted yet another new accounting loophole for financial institutions trying to avoid big writedowns. Now for the strange part: The confusion, which centres on how the SEC interprets the rules for mark-to-market accounting, is unnecessary. That’s because, this time, there doesn’t seem to be any such loophole.
The SEC could clarify this point. It refuses to do so, choosing to stay silent when asked where it stands. That, in turn, is fanning concerns that maybe the SEC really is trying to give large banks and insurance companies a free pass. Given the SEC’s recent track record, it’s hard to blame investors for thinking this way.
Here’s what happened. On March 28, the SEC’s staff released a much-anticipated letter to unspecified companies that hold lots of hard-to-value financial instruments. The impetus was a new Financial Accounting Standards Board rule called Statement 157, which for most companies took effect last quarter.
While Statement 157 doesn’t expand the use of fair-value accounting, it does require companies to disclose how much of their financial instruments are valued using quoted market prices, how much are measured using valuation models, and how much come from models using inputs that aren’t observable in the market.
In its letter, the SEC’s staff recommended a broad range of disclosures companies should make in the discussion-and-analysis sections of their next quarterly reports, when describing how they calculated the values of those assets and liabilities. That part isn’t what drew the firestorm, though. Rather, it was these two introductory sentences. (The emphasis below is mine.) “Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, UNLESS THOSE PRICES ARE THE RESULT OF A FORCED LIQUIDATION OR DISTRESS SALE,” the letter said. “Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability.”
The reaction was a flurry of press and analyst reports, concluding that the SEC had cut Wall Street firms a huge break. Here are a couple examples.
“The distress sale caveat looks like an escape clause,” the Financial Times wrote March 31 on its Alphaville blog, under the headline “Marking to moral hazard”. “To wit: if asset prices fall too much, just ignore the price falls. In fact, create, buy or hold, whatever structured rubbish you like in the future because it doesn’t have to lose its value if you don’t want it to.”
Dennis Gartman, an economist in Suffolk, Virginia, and editor of the Gartman Letter, wrote this in a March 31 note to clients: “We’ve asked friends in the business for their take, and after two days we’ve come to the conclusion that markto- market has quietly died with this letter, and with it transparency in financial accounting.” Actually, the SEC’s letter merely repeated what Statement 157 already says. Or so it seems. The standard says “a fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market participants”. It goes on to say an orderly transaction “is not a forced transaction,” such as “a forced liquidation or distress sale”. That’s the same language the SEC’s staff used.
The reason for this exception? Take a situation like the 2006 collapse of Amaranth Advisors. — Bloomberg
The SEC could clarify this point. It refuses to do so, choosing to stay silent when asked where it stands. That, in turn, is fanning concerns that maybe the SEC really is trying to give large banks and insurance companies a free pass. Given the SEC’s recent track record, it’s hard to blame investors for thinking this way.
Here’s what happened. On March 28, the SEC’s staff released a much-anticipated letter to unspecified companies that hold lots of hard-to-value financial instruments. The impetus was a new Financial Accounting Standards Board rule called Statement 157, which for most companies took effect last quarter.
While Statement 157 doesn’t expand the use of fair-value accounting, it does require companies to disclose how much of their financial instruments are valued using quoted market prices, how much are measured using valuation models, and how much come from models using inputs that aren’t observable in the market.
In its letter, the SEC’s staff recommended a broad range of disclosures companies should make in the discussion-and-analysis sections of their next quarterly reports, when describing how they calculated the values of those assets and liabilities. That part isn’t what drew the firestorm, though. Rather, it was these two introductory sentences. (The emphasis below is mine.) “Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, UNLESS THOSE PRICES ARE THE RESULT OF A FORCED LIQUIDATION OR DISTRESS SALE,” the letter said. “Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability.”
The reaction was a flurry of press and analyst reports, concluding that the SEC had cut Wall Street firms a huge break. Here are a couple examples.
“The distress sale caveat looks like an escape clause,” the Financial Times wrote March 31 on its Alphaville blog, under the headline “Marking to moral hazard”. “To wit: if asset prices fall too much, just ignore the price falls. In fact, create, buy or hold, whatever structured rubbish you like in the future because it doesn’t have to lose its value if you don’t want it to.”
Dennis Gartman, an economist in Suffolk, Virginia, and editor of the Gartman Letter, wrote this in a March 31 note to clients: “We’ve asked friends in the business for their take, and after two days we’ve come to the conclusion that markto- market has quietly died with this letter, and with it transparency in financial accounting.” Actually, the SEC’s letter merely repeated what Statement 157 already says. Or so it seems. The standard says “a fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market participants”. It goes on to say an orderly transaction “is not a forced transaction,” such as “a forced liquidation or distress sale”. That’s the same language the SEC’s staff used.
The reason for this exception? Take a situation like the 2006 collapse of Amaranth Advisors. — Bloomberg
(Source: Economic Times 3rd April)
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