The United States Securities and Exchange Commission (SEC) announced that James Kroeker, the governing body’s chief accountant since 2009, is stepping down.
“Jim has provided superb counsel on a range of accounting- and auditing-related matters and has always stressed the importance of accounting to our investor protection mission,” said SEC Chairwoman Mary L. Schapiro.
Kroeker served as staff director of the SEC’s study of fair value accounting standards, which Congress mandated in 2008. He has led efforts to analyze the adoption of International Financial Reporting Standards (IFRS), one step that could lead to the establishment of a global accounting standard.
Kroeker’s departure is also significant because of the timing. The SEC is currently debating and completing the full analysis of bringing IFRS to U.S. public company accounting standards. Business and governmental leaders are anticipating the SEC’s analysis and decision as it would require a large shift in standards, most notably fair value accounting.
Jim is one of the good ones. He will be missed. The SEC has not announced a timetable for his replacement.
In a Financial Times article, writers Nicole Bullock and Hal Weitzmanin note that new accounting standards before the Governmental Accounting Standards Board (GASB) could cause some U.S. states to “see the reported shortfalls in their public pension funds grow sharply.”
The debate over pension plan accounting has been especially sharp in recent years, as decades of underfunding coupled with stock market losses during the financial crisis widened funding gaps, causing states to push for benefit cuts.
One of the GASB’s proposals, which Bullock and Weitzmanin say is likely to pass, would require that pension funds report assets on a mark-to-market basis.
Currently, states employ a “smoothing” method, which allows for losses to be spread over a longer period of time. Though controversial, the technique has allowed government pensions to prevent reported assets from fluctuating wildly as market values change.
“That change is going to be fairly dramatic,” said Laura Quinby, research associate at the Center for Retirement Research at Boston College. “Currently actuarial assets are higher than market assets because the full losses from 2008-9 have not been phased in yet.” The new standards “will better reflect the economic reality,” said Robert Attmore, chairman of the GASB.
Filed under: Fair Value Accounting, Generally Accepted Accounting Principles, Real Estate
In an opinion piece published in American Banker, president and chief executive officer of the Community Bankers Association of Georgia spoke in favor of current legislation that would “provide relief for real estate-related assets by allowing community banks to amortize losses on commercial real estate loans and ‘other real estate owned’ (repossessed properties) over 10 years for regulatory capital purposes.” The Communities First Act, first introduced to Congress in 2011, “provides a broad range of much-needed regulatory and tax relief for community banks and their customers,” said Brown.
Current mark-to-market rules under generally accepted accounting principles (GAAP) require the immediate recognition of losses.
Decoupling GAAP from regulatory accounting practices, says Brown, would allow community banks to more easily spread real estate losses over a longer period of time and give them better opportunities to work with borrowers rather than foreclose.
“Regulatory, tax and paperwork requirements disproportionately burden community banks, which lack the scale of larger institutions over which to spread legal and compliance costs,” Brown continued.
This legislation could stimulate a struggling economy by allowing small community banks to lend more easily to consumers and small businesses, many of which have limited funding options currently.
Amidst additional disclosures regarding its $2 billion loss and subsequent investigations, Morgan Stanley analyst Betsy Graseck painted a slightly brighter picture for the banking giant, noting that investors could see an “upside surprise.”
Although banking regulators, the United States Securities and Exchange Commission (SEC), and, reportedly, the Federal Bureau of Investigation (FBI) have opened inquiries into JPMorgan Chase’s hedging activities surrounding the loss, Graseck believes that answers to three questions could be “key to getting investors back into [JPMorgan Chase].”
First, “who knew what and when?” asks Graseck. This information is “critical to understand who in the organization” was aware of any accounting changes related to the loss.
Second, Graseck would like to see “more specific details on the components of the trade, size of the trade, strategy employed, and how that strategy was executed over time.”
Lastly, Graseck feels Dimon and JPMorgan Chase should provide “more detail on the latest mark-to-market of the position, size, max loss, and color on how analysts can potentially better forecast [the] ultimate loss.” The mark-to-market positions taken by JPMorgan Chase were seen as exceptionally risky for such a large bank, thus troubling investors.
In the wake of the JPMorgan Chase $2 billion loss and fallout, Harvard Business Review writer James Lam lays out various rules and guidelines for managing risky behavior.
As noted by Mr. Lam, “If risky behavior can happen at the house of Morgan under the watchful eyes of Jamie Dimon, it can happen anywhere,” and companies should have policies in place – at all levels – to protect from deceit.
Setting clear policies is one of Lam’s five most important rules for managing risky behavior. “For enterprise risk management, key policies include a statement of risk appetite and explicit risk tolerance levels for critical risks,” says Lam. But, “the right people have to be setting the rules,” he says.
As an example of unclear policies designed by those set out to deceive investors and regulators, Lam offers up the case of former Enron Chief Executive Officer Jeffrey Skilling.
Skilling, upon his hire, insisted upon mark-to-market accounting for Enron’s balance sheets. As a result of marking the company’s financial positions to market, Enron’s actual cash generated was a mere 3% of reported income. “Appropriate risk, compensation, and financial policies will set the incentives and boundaries for employee behavior,” Lam concludes.
Nobel prize-winning economist Robert Engle has said that American banks, as a whole, are short $500 billion in capital, despite Basel III requirements that have increased capital requirements and tightened capital rules. In the Reuters “Counterparties” email, Ben Walsh describes the situation as laid out by Engle.
To make matters worse, European banks are even more capital-deficient according to Engle’s calculations. This is the result of derivative accounting rules that differ in Europe, notes Walsh.
Due heavily to the fallout surrounding JPMorgan Chase’s $2 billion hedge accounting loss, “there’s something of a bipartisan consensus for stronger bank capital requirements for America’s banks,” says Walsh.
Against the requests of banking officers like JPMorgan Chase’s Jamie Dimon, new capital regulations proposed by the Federal Reserve are likely to require that banks hold more equity. Additionally, with the Federal Reserve proposing mark-to-market accounting for banks’ securities portfolios, capital requirements are likely to climb even higher.
In an analysis of Public Company Accounting Oversight Board (PCAOB) data, Atlanta-based valuation and litigation consultancy firm Acuitas, Inc. found that fair value issues dominated the recent landscape of noted deficiencies in audits. The full report titled “Survey of Fair Value Audit Deficiencies,” analyzed three years of PCAOB data regarding audits and inspections.
Mark Zyla, managing director at Acuitas, Inc., said there were two significant trends that emerged from the report. First, “the percentage of audits that have deficiencies has more than doubled since 2009. Secondly, “fair value and impairment audit issues have contributed significantly to this increase in the number of these deficiencies.”
According to Zyla, “The information contained in the survey should benefit public entities and their auditors, and by extension, private entities and their auditors – by helping them understand the underlying causes of fair value measurements and impairment audit deficiencies, as reported by the PCAOB in their latest inspection reports.”
The United States Federal Reserve is proposing new capital rules for banks. These rules, which are capital requirements put in place by the Federal Reserve to mitigate volatility, would set a standard for how much cash and capital a bank must keep on hand to offset its debts and loans.
Almost immediately, large U.S. banks and lenders like Citigroup and Wells Fargo have decried the proposal, saying that “the net effect of the change will force them to hold more capital over and above the stated requirements,” according to an article by Shahien Nasiripour in the Financial Times. Additionally, “because of different accounting treatments, their foreign peers will have their capital levels protected from changes in the market value of some securities holdings,” Nasiripour continues.
The accounting treatment that concerns U.S. banks involves those portfolios designated as “available for sale.” These holdings, according to U.S. accounting rules, are to be booked using mark-to-market accounting.
European banks, as Citigroup and others have noted, are not required to mark these portfolios at market value.
In a contribution to Forbes and in Bain’s Global Private Equity Report 2012, Bain & Company said that the private equity industry’s recent positive returns were a result of a transition to mark-to-market accounting rules.
Private equity firms, says Bain, “promptly and aggressively wrote down their portfolio company net asset valuations” when equities took a tumble in late 2008. But following that, portfolio companies continued to be conservatively priced despite a public recovery. Meanwhile, portfolio values marked at market value continued to rise, helping boost quarterly gains throughout most of 2010 and 2011 for the private equity industry.
Currently, private equity is facing a new set of challenges, says Bain. “With private equity assets now appraised close to their intrinsic value, returns will become more volatile as they more closely track the ups and downs of the public markets,” the article reads. “Gross Domestic Product (GDP) growth, multiple expansion and leverage,” says Bain, “do not look nearly as favorable in the current recovery as they had in past ones.”
A Schumpeter blog at The Economist online recently discussed the convergence process between the United States-based Financial Accounting Standards Board (FASB) and the International Accounting Standards Board after a recent conference at Baruch College in New York. Top brass from the FASB and the Securities and Exchange Commission (SEC) were on hand to discuss the convergence process and potential adoption of International Financial Reporting Standards (IFRS) by the United States. The SEC is currently reviewing whether or not to adopt IFRS, with a decision expected fairly soon.
But The Economist’s bloggers remain pessimistic of such an adoption or merger. “A wholesale adoption of the international standards now seems off the table,” it reads. The FASB seems likely to remain in power, utilizing an “endorsement” of international standards instead.
“American critics of IASB make several points, many to do with fair-value or ‘mark-to-market’ accounting of financial instruments,” the editorial notes. The difference between the two schools of thought has narrowed, though a gap remains. The IASB still prefers that assets be booked at historical cost; the FASB has softened and is now considering a “three-bucket” approach which would book some assets, depending on their characteristics, at either market value or historical cost.