SEC roundtable looks at fair value in retrospect

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Panelists at a July 9 Securities and Exchange Commission roundtable from affected communities that included auditors and corporate financial officers exchanged views on the challenges of implementing fair value standards, principally FAS 157, during the past few months, conducting what Thomas J. Linsmeier, of the Financial Accounting Standards Board called a "welcome post mortem" after a "baptism of fire."

Most panelists applauded the standard for the transparency and consistency of the results but found that many challenges remained, and agreed that both internal and external auditors would need some additional common guidance from the SEC, FASB, and the Public Accounting Oversight Board (PCAOB). Charles Holm, representing the Federal Reserve Bank said that the Bank was concerned about the impact of the standard on smaller financial institutions before they could build a strong infrastructure. Some preparers found the valuation of illiquid assets to be particularly difficult and questioned the economic impact of the standard.

Panelists at the opening session of the roundtable discussed the implementation of FAS 157 on large financial institutions. Joseph Price of Bank of America said that the application of the standard was "tough, laborious, and hard to set up" particularly for collateralized debt obligations (CDOs) where you had to set up complex models to find the most observable value among thousands of cusips. The preparer then faced the potential of being second-guessed on trades on thinly traded indexes.

While "there is a lot of data out there" on which to base a fair value estimate, Russell B. Mallet of PricewaterhouseCoopers told the panel, "it took a lot of effort and work to get behind it" to produce the appropriate output. "You can no longer just go to the broker quotes and pricing samples," he said. He also emphasized that FAS 157 is "principles based and does not provide the answer for every fact pattern."

The "exit price objective" of the standard benefits investors, Matthew Shroeder of Goldman Sachs Group, Inc. told the group.

Other panelists addressed the presentation of fair value on the balance sheet and the income statement. James S. Tisch of Loews Corporation said that he thought the income statement had become "unusable" and asked, "How can you monetize debt in one quarter?"

Jane Adams of Maverick Capital agreed that the presentation of fair value is important, and that some adjustment to the income statement presentation might be useful.

When asked if the standard had economic impact, Tisch argued that companies tended to adjust their behavior to accounting rules. "Level 3 investments [as defined in FAS 157] would not have appealed to investors" if there had been a fair value standard. "Rule makers need to understand" the impact of their standards on business behavior, he said.

When asked if he thought the standard was pro-cyclical, Shroeder that he didn't think FAS 157 was pro-cyclical, and in any case it was better than denial, and the situation that prevailed in Japan for a decade when it did nothing to work its way out of a financial crisis.

"It is essential that accounting be neutral," Adams said, responding to the same question. Most panelists agreed with her that FAS 157 was neutral.

Panelists who participated in the second session discussed the impact of FAS 157 on all public companies. Leonard Cotton of Centerline Capital Group said that fair value was a good idea for liquid assets but not for illiquid assets, particularly when the institution held assets for the long term like real estate.

Harold Shroeder of Carlson Capital recommended an even more aggressive approach to fair value so that it would apply to the entire balance sheet and "reflect what you did do."

Wes Williams of Crowe Chizek and Company LLC, a member of the PCAOB, said that FAS 157 was the most relevant standard but it was not perfect. It presented challenges for smaller issuers when they needed to value illiquid assets because they often did not have the resources to set up the models and would need to depend on outside experts. "That presents its own problems," he said, including getting the necessary information on time.

While generally enthusiastic about fair value, Gary Kaburek, Corporate Vice President and Chief Accounting Officer at Xerox Corporation, found that from the preparer's perspective the FAS 157 disclosures were all over the place. Other areas he thought the standard setters should address included volatility, sensitivity models, and the changes in mind set that are required to implement the standard. He cited the need to think in terms of hypothetical transactions and developing skill sets for the longer term as two examples.

Addressing the intellectual challenges of FAS 157 from the auditor's perspective Mallet said that different auditors took different approaches where there was a need to exercise judgment, although most firms had developed internal guidance for their engagement teams before the audits.

Williams suggested some areas where standard setters could consider providing additional guidance that would remain relevant over time. A definition of "persuasive evidence" would be helpful to auditors as well recommendations for approaches to "auditing intent," "forecasting recovery" and evaluating hedge funds.

Both Williams and Sam Gutterman of the American Academy of Actuaries emphasized the need to educate corporate officers, boards, auditors, and the investment community on fair value. "Models must be transparent; meaningful disclosures are needed," Gutterman said. Looking to the future, he expects that dealing with the challenges of implementing FAS 157 will create the "ideal environment for standard setters to learn lessons."

In his concluding remarks SEC Chairman Christopher Cox called the roundtable "an exceptionally useful forensic analysis of how FAS 157 has performed . . . a success beyond our expectations."

Cox said that he would call meetings of standard setting boards to consider preparing additional guidance among other things. He would also recommend that FASB and the other boards evaluate a subject that was discussed at length during the roundtable, the reporting of credit risk on the balance sheet under FAS 157. The potential exists under the new standard that as the risk that companies won't pay back their debts rises, their reported liabilities actually decrease -- and may even provide an earnings boost.

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