(The article featured below is a selection from Federal Securities Law Reporter, which is available to subscribers of that publication.)

SEC Issues Report and Recommendations on Mark-to-Market Accounting

The SEC has issued a report to Congress advising that SFAS No. 157, Fair Value Measurements, should not be suspended, but that improvements should be made to the application of fair value. The 211-page report, which was mandated by the Emergency Economic Stabilization Act, outlines eight key recommendations by the staff of the Division of Corporation Finance and the Office of the Chief Accountant.

The staff explained that SFAS No. 157 does not require mark-to-market or fair value accounting. Various accounting standards require fair value accounting of which mark-to-market accounting is a subset. SFAS No. 157 establishes a common definition of the term fair value for financial reporting and provides for expanded disclosures when preexisting standards require or permit the use of fair value.

The debate over fair value measurements extends to the international community as well. The International Accounting Standards Board and the Financial Accounting Standards Board have created a global advisory group to coordinate efforts to address fair value measurements.

The staff concluded that a return to practices that existed prior to the issuance of SFAS No. 157 would be a return to reliance on conflicting guidance and would reduce comparability and the consistency of fair value measurements. The staff also found that SFAS No. 157 did not result in an increase in the use of fair value and that the application of the common definition of fair value did not have a significant impact on financial statements when it was adopted.

The suspension or the elimination of fair value and mark-to-market accounting requirements would not be advisable, according to the staff. The requirements were developed over several decades and in some cases addressed specific weaknesses during previous market events. The standards were subject to extensive due process and their elimination could erode investor confidence in financial reporting. The staff also noted that the existing accounting standards generally require mark-to-market accounting only for certain derivatives and investments that financial institutions hold for trading purposes.

The study found that substantially all of the banks that failed applied fair value accounting to a minority of their assets. The losses recorded as a result of applying fair value accounting did not have a significant impact on their capital. Fair value accounting cannot be considered to have been a proximate cause of their failure, the staff advised.

The staff recommended that FASB consider which issues could be resolved through a review of the objectives of SFAS No. 157 and which would best be addressed by the valuation community. The staff said that FASB's Valuation Resource Group and the IASB's Expert Advisory Panel may be the best parties to recommend immediate guidance to both boards.

The Valuation Resource Group was formed in response to an invitation to comment on valuation guidance for financial reporting purposes issued on January 15, 2007. The group is comprised of 20 valuation specialists, auditors, preparers and investors who provide FASB with information on the implementation of fair value measurements used for financial statement reporting purposes. The staff suggested that FASB may wish to consider changes to the way it uses the Valuation Resource Group and whether its role should be expanded to function like the Emerging Issues Task Force.

The application of SFAS No. 157 to liabilities has been a significant concern, according to the report. FASB should continue its efforts to address fair value measurement issues related to the valuation of liabilities.

The staff also recommended that FASB reassess current impairment accounting models for financial instruments and whether to narrow the number of existing models. Accounting for impairments was identified as one of the most significant areas in need of improvement, according to the report. The staff noted that the treatment of impairments for investment under U.S. GAAP is not consistent with the reporting of impairments under international financial reporting standards. FASB and the IASB have initiated efforts in this regard.

The SEC and the Public Company Accounting Oversight Board should consider whether statements of policy would be appropriate with respect to the application of judgment in making fair value measurements. The use of judgment in accounting, auditing and regulation has increased as the focus has turned to more objectives-based standards and the increased use of fair value estimates. The guidance should keep pace, the staff said. The Committee on Improvements to Financial Reporting recommended that the SEC and the PCAOB issue such policy statements.

The staff concluded that U.S. GAAP should continue to be developed for the benefit of investors rather than other users of financial information. The objective of general purpose financial reporting is to provide information to investors that is useful in making investment decisions. The Committee on Improvements to Financial Reporting stated that the financial reporting system is best served by recognizing the preeminence of the perspectives of investors because they are the primary users of financial reports. U.S. GAAP should not be modified to serve the needs of others at the expense of investors, according to the report. The staff also recommended the adoption of the Committee's recommendation for the establishment of a financial reporting forum, the use by FASB of a post-adoption review process and the establishment of a formal policy for standard setting when a near-immediate response in needed.

The final recommendation emphasizes the importance of simplifying the accounting for investments in financial assets. Much of the complexity is due to multiple models that accommodate mixed attribute accounting for financial instruments. The boards should work to simplify the accounting for investments in financial instruments and should explore the feasibility of reporting all financial instruments at fair value, according to the report.