SEC Chief Accountant Kroeker, Key Player in Fair Value Negotiations, Steps Down

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.

The Economist: U.S. Adoption of IFRS “Seems Off the Table”

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.

IASB Publishes Proposed Due-Process Enhancements

The International Accounting Standards Board (IASB) has published proposed due-process enhancements, seeking to clarify some of the steps the board takes when making ruling decisions. The proposed revisions explain in further detail how the board will assess the potential impact of a new rule, lays out a method of post-implementation reviews, and details how the board will conduct outreach activities.

Facing political backlash from global economic leaders as well as the United States Securities and Exchange Commission, the IASB is seeking to diffuse any tensions that may still be present in heated discussions on the integration of United States-based Generally Accepted Accounting Principles (GAAP) with International Financial Reporting Standards (IFRS).

Political tension, stemming from the global financial crisis and both boards’ decisions to make sudden sweeping changes to mark-to-market accounting regulations, has been a driving force to make the standards-setting process more transparent. Agreeing on mark-to-market accounting standards has been a major impediment in merging global and domestic reporting standards.

This move comes on the heels of a similar move by the Financial Accounting Standards Board’s overseer last year. The domestic due-process enhancement is now on its second performance review.

Mark-to-Market for Pension Plans Draws Closer Look from SEC

Companies that have recently switched to the mark-to-market method of pension accounting have caught the attention of the United States Securities and Exchange Commission (SEC).

The SEC has raised concerns that these companies may be using disclosures that are not consistent with U.S. Generally Accepted Accounting Principles (GAAP) and may be confusing to investors.

Major American companies like AT&T, Honeywell, and Verizon have led the change to mark-to-market, allowing them to recognize gains and losses immediately as opposed to “smoothing” gains and losses over a period of years, called cost amortization. This change allowed companies like these to retroactively apply losses of 2008 and 2009 to previously reported balance sheets.

“A number of companies that have done that [moved to mark-to-market pension accounting] have then gone on to select a non-GAAP method of disclosure for pensions, that then takes out the actual return on plan assets and adds back the expected return on plan assets,” SEC Chief Accountant Jim Kroeker said recently.

“Unfortunately in doing that, they haven’t then included the amortization of prior deferred losses.” The issue for investors, says Kroeker, is that these non-GAAP disclosures may seem to represent actual pension gains and losses rather than expected asset returns. Mark-to-market itself may not be entirely misleading, said Kroeker, but that it might be “useful to an investor” if companies disclosed more plainly whether numbers are actual performance or expected performance.

Tweedie, Herz, and Cherry Speak on U.S. Adoption of IFRS

In a panel discussion of three former accounting standards setters – Sir David Tweedie, the former chairman of the International Accounting Standards Board (IASB), Bob Herz, the former chairman of the Financial Accounting Standards Advisory Board (FASB), and Paul Cherry, the former chairman of the Canadian Accounting Standards Board (AcSB) – spoke about the potential for the United States to adopt International Financial Reporting Standards (IFRS) and the political pressures facing standards setters today.

The US Securities and Exchange Commission (SEC) is still debating and has not yet sent down a decision on whether or not to adopt IFRS. Tweedie noted how important the U.S. is to international synchronization of accounting standards, noting that other major economies such as Japan, China, and India are hinging their decisions on IFRS adoption on the United States’ decision. “The world is waiting,” said Tweedie.

Herz spoke at length regarding the role of politics in standards setting, bringing up the proposed amendment to the Dodd-Frank act that would have required fair value accounting much more broadly in U.S. reporting standards.

Pressure from Congress is often pointed to as the main reason for the removal of fair value in 2009. “Some people would take the view that politicians should just stay out of standard setting and leave it completely to the independent standard setters and the like,” said Herz, “but it’s not the real world. People have the right to go to their elected officials and complain about things if they don’t like what’s happening.”

SEC Seeks Fair Value Disclosure on Structured Notes

In a letter sent to banks across the country, the United States Securities and Exchange Commission (SEC) is requesting additional disclosures regarding structured notes, a type of debt obligation with additional embedded derivative components.

The letter asked banks to include their own estimates for the securities’ market value at the time of sale. Additionally, the letter asked banks to clarify the market value: how a secondary market was set up, how the bank uses proceeds from sales of structured notes, and how important structured notes are to the bank’s overall funding needs.

“The SEC finally understands these products,” said Frank Partnoy, formerly a Morgan Stanley derivatives structurer and current professor at the University of San Diego. “I’m very encouraged by these questions that the SEC is asking. The secondary market for structured notes is completely opaque,” he continued. “We believe issuers should consider prominently disclosing the difference between the public offering price of the note and the issuer or its affiliate’s estimate of the fair value,” the SEC said in the letter.

The SEC made reference to an observation that banks had provided values they believed to be inflated “for a limited period of time immediately following an offering,” and asked banks to further explain how the price affects pricing and trading.

A Welcome Delay

This is a welcome relief, and arguably, the right thing to do given today’s set of facts.

It’s the BASEL endorsement and encouragement of the holding of sovereign bonds as “ risk-free” that have lead to a lot of the pain in Europe. BASEL increased the holdings of risk-free sovereigns in the banks.

The SEC’s decision to delay the potential ruling is prudent and appropriate.

[$$] SEC Delays Call on Accounting Rules – The Wall Street Journal, December 6, 2011

Systemic Risk Council Essential

William M. Isaac, former chairman of the Federal Deposit Insurance Corporation (FDIC) during the saving and loan collapse of the 1980s, wrote an open letter to Senator Bob Corker (R-TN) in Forbes.
In the letter, Isaac maintains that, “Mark-to-market accounting senselessly destroyed over $500 billion of capital in our financial system, panicking the markets as banks reported massive paper losses while still producing large cash-basis profits.”
Mr. Isaac then argues that systemic risk oversight of accounting rules issued by the Financial Accounting Standards Board (FASB) and the Security Exchange Commission (SEC) is essential, “…particularly now that the FASB is proposing to extend mark-to-market accounting to nearly the entire balance sheet of banks, including loans. It is clear that the FASB is living in an ivory tower world in which accounting rules are divorced from economic and business reality, and the SEC has failed to provide effective government oversight.”
“If this proposal by FASB moves forward, it will spell the end of banking as we know it and will make it next to impossible for smaller businesses and consumers to obtain medium- and long-term credit,” Isaac cautions.
Isaac wrote the letter in support of Senator Coker’s amendment to the Financial Regulatory Reform Bill calling for, in part, a systemic risk council. He fears that if a systemic risk council is not give the authority to examine accounting pronouncements by the SEC and FASB, “the next crisis will be just around the corner.”
A systemic risk council was included in the Senate version of the financial regulatory reform bill recently passed. Its exact function is still being debated.
In conclusion, Bill Isaac rocks.

Brown Proposes Fair Value Amendment

Senators Sharrod Brown (D-OH) and Edward Kaufman (D-DE) have offered an amendment to the Restoring American Financial Stability Act of 2010 that would essentially require the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB) or both to establish a rule that publicly traded companies list all assets and liabilities on the balance sheet and that these be recorded at fair value.
Historically accounting standards have allowed off balance sheet financing via leases and repurchase agreements. It was recently learned that Lehman Brothers used repurchase accounting to remove liabilities from the balance sheet in a maneuver to increase leverage.
The amendment, if adopted and passed, would also present an obstacle to the effort to merge FASB ad IASB standards. The FASB prefers fair value basis, however the International Accounting Standards Board (IASB) is opposed.
The American Institute of Certified Public Accounts, the Center for Audit Quality, the Chartered Financial Analyst Institute, the Council of Institutional Investors, the Investment Company Institute, the Financial Executives International, and the U.S. Chamber of Commerce have objected to the Brown amendment. Their stated position, in part, is:

We believe political influences that dictate one particular outcome for an accounting standard without the benefit of a public due process that considers the views of investors and other stakeholders would have adverse impacts on investor confidence and the quality of financial reporting, which are of critical importance to the successful operation of the U.S. capital markets.

New Mark-to-Market Rules for Money Funds

In May the Securities and Exchange Commission will start requiring that money funds hold more liquid and high-quality assets.

Under the new rules, a fund will now need to disclose monthly its actual “mark-to-market” net asset value, on a 60-day lag. This is known as a fund’s “shadow NAV.” Currently the shadow NAV is reported only twice a year.

Funds will also need to shorten the average maturities of their holdings. The maximum weighted average maturity of a fund’s portfolio is shortened to 60 days from 90 days. Funds will also have to maintain 10% of assets in securities that mature in one day and 30% in securities that mature in one week.

These new rules are in response to when the Reserve Primary Fund “broke the buck” in 2008 when share values dropped below $1 and touched off a withdrawal panic.

These new rules will make it harder to earn any income in a sorry market and in a low interest rate environment.