(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Fed Governor Cautions on Accounting for Special-Purpose Entities

The Federal Reserve Board reserves the right to apply its own "sound interpretation" to the application of generally accepted accounting principles to special-purpose vehicles, according to newly-appointed Governor Mark W. Olson. In recent remarks at the University of Miami School of Law's sixth annual Institute on Mergers and Acquisitions, he noted that the Federal Reserve Board has exercised this right and will continue to do so when necessary to ensure the transparency of an institution's risk profile and financial condition through the accuracy of its financial statements.

While special-purpose vehicles can serve as useful tools for structuring legitimate business transactions, he continued, recent events have shown that they can also be used to give the appearance that a company has shed risk that it has, in substance, retained. Gov. Olson emphasized that the use of special-purpose vehicles to create such an appearance, coupled with financial-engineering techniques, is not in the spirit of the accounting rules.

Accounting rules require consolidation of special-purpose vehicles when an independent third party has not assumed the substantive risks of ownership of the underlying assets. Although he assured the financial community that there does not appear to be a systematic problem with inaccurate treatment by bank holding companies of sales of loans to off-balance-sheet special-purpose entities, he did say that there have been instances when companies have not given appropriate consideration to this accounting requirement.

Gov. Olson emphasized that banking agencies have long recognized that exposures to risk can include interests in special-purpose vehicles and other entities that a banking organization does not consolidate. As a result, as part of the Federal Reserve Board's ongoing examination activities, supervisors have endeavored to take such exposures into account in assessing the condition of an institution.

Furthermore, in appropriate circumstances, when the Federal Reserve Board finds that a banking organization has effectively retained the substantive risks of assets it has transferred to a special-purpose vehicle, the bank will have to consolidate those assets in financial statements prepared in accordance with GAAP. At a minimum, he proclaimed, these statements must satisfy GAAP. But the central banker reiterated that the Federal Reserve Board will apply its own sound interpretation of those accounting principles based on a careful consideration of the underlying facts and circumstances and the economic substance of the transactions.