The American Bankers Association has asked the Securities and Exchange Commission (SEC) to use its authority to override the Financial Accounting Board's (FASB) additional guidance on fair value, FAS 157-3. In a strongly worded letter to SEC Chairman Christopher Cox, Edward L. Yingling, President and CEO of the bankers' group said that the guidance, "basically ignores what we believe to be the intent of the SEC's release of September 30, 2008."
FASB Staff Position (FSP) FAS 157-3 says that that the use of a reporting entity's own assumptions about future cash flows and appropriately risk-adjusted discount rates are acceptable when "relevant inputs are not observable."
"Regardless of the valuation technique used," the FSP says, "an entity must include appropriate risk adjustments that market participants would make for nonperformance and liquidity risks." The guidance also says that while brokers' quotes may be an appropriate input, "They are not necessarily determinative if an active market does not exist for the financial asset."
Yingling writes that, although "the FASB had the opportunity to provide useful guidance with FSP FAS 157-3, . . . it apparently still refuses to recognize the realities of the current situation." He says that the new FASB guidance requiring "liquidity risk, from the buyer's perspective, to be included in the cash flow calculation," brings the guidance back to distressed sale values. "The FSP is circular," he writes.
The FASB and the SEC acknowledged in their joint statement (see below) that "the concept of a fair value measurement assumes an orderly transaction between market participants. . . . 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."
Yingling asks the SEC to replace FSP FAS 157-3 with guidance that clarifies that fair value in an illiquid market does not include distressed sales, to suspend the proposal for accounting for securitizations, and to suspend projects by accounting standard setters that would require fair value in any future accounting standards, pending Congressional review of fair market value accounting.
Following the September 30 joint statement, auditors and groups representing investors opposed changes to fair value rules in comment letters addressed to the FASB. Blaming mark-to-market accounting for the crisis "is akin to blaming a window for the weather seen through it," said Cindy Fornelli, executive director of the Center for Audit Quality, quoted by the Financial Post. "Mark-to-market accounting merely communicates information about the value of assets at a given point of time."
Excerpt from SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting (September 30, 2008):
- Can management's internal assumptions (e.g., expected cash flows) be used to measure fair value when relevant market evidence does not exist?
Yes. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable. Statement 157 discusses a range of information and valuation techniques that a reasonable preparer might use to estimate fair value when relevant market data may be unavailable, which may be the case during this period of market uncertainty. This can, in appropriate circumstances, include expected cash flows from an asset.
- Are transactions that are determined to be disorderly representative of fair value? When is a distressed (disorderly) sale indicative of fair value?
The results of disorderly transactions are not determinative when measuring fair value. 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.