United States: Current Status Of "Mark-to-Market" Accounting Standards

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the "Act"). Although the Act authorizes and mandates the Treasury Department to address a series of important issues, of key concern to financial institutions is the current status of "mark-to-market" accounting standards. This issue was addressed both by the Act and also by the Financial Accounting Standards Board (the "FASB") and the Securities Exchange Commission (the "SEC") in the days leading up to and right after the signing of the Act into law. This Alert relates to the current status of the "mark-to-market" discussion.

1. The Act. The Act contains a provision that grants the SEC the authority to suspend "mark-to-market" accounting standards. Its advocates believe suspending the standards will help stave off securities-related writedowns that have forced many U.S. banks to mark down the value of mortgage-related securities because of the lack of liquidity caused by inactive markets.

Although the SEC arguably already had the authority to suspend asset-valuing accounting rules, the Act specifically provides the SEC with the authority to suspend the application of Statement Number 157 of the FASB ("FASB 157") if the SEC determines that such action is necessary or appropriate in the public interest and is consistent with the protection of investors.

2. Required Study of Applicability of Mark-to-Market to Financial Institutions. The Act also requires the SEC, in consultation with the Board of Governors of the Federal Reserve System (the "Fed") and the Secretary of the Treasury, to conduct a study on mark-to-market accounting standards as such standards are applicable to financial institutions. Under the Act, the SEC is required to submit to Congress a report of the study before the end of the 90-day period beginning on the date of the enactment of the Act, which report is to contain the findings and determinations of the study, including such administrative and legislative recommendations as the SEC determines appropriate.

3. SEC and FASB Joint Guidance on Mark-to-Market. Most importantly, on September 30, 2008, the FASB and the SEC's Office of the Chief Accountant jointly issued guidance on the application of FASB 157's fair value measurements "in the current market environment." This guidance suggested that the SEC would issue further, more substantive guidance in the very near future.

Based on this initial guidance, it is acceptable for companies to derive a value in the absence of an active market through the use of "estimates that incorporate current market participant expectations of future cash flows," while considering "appropriate risk premiums." Depending on the more substantive guidance to be issued, this guidance appears to allow more flexibility in the valuation of certain assets, including the use of management estimates that take into account projected cash flows, rather than the currently deadly "market prices" standard.

4. Proposed FASB Staff Position. Further, on October 3, 2008, the FASB issued a proposed staff position to help explain and, if necessary, simplify FASB 157 to deal with how an institution may determine fair value in a market with limited or no activity.

The FASB has requested comments on the proposed staff position by October 9, 2008.¹ It is anticipated the FASB will issue a final position as early as October 10, 2008. Importantly, the proposed staff position would be effective upon issuance and would apply to prior periods for which financial statements have not been issued. Any revisions resulting from a change in the valuation technique would be accounted for as a change in accounting estimate.²

5. Battleground Positions. Proponents of FASB 157's suspension suggest that because the vast majority of loans supporting the securities at issue are not in foreclosure and are performing, a better approach is to value these securities based on projected cash-flows and not an unknown market value in a market where there are no buyers.

Opponents to the rule's suspension [see a joint statement by The Center for Audit Quality, The Council of Institutional Investors and The CFA Institute issued on October 1, 2008] argue that suspending the rule would only delay resolving genuine doubts about the value of the assets. More specifically, opponents note that "investors have a right to know the current value of an investment, even if the investment is falling short of past or future expectations."

6. Questions Remaining. First, of course, the substantive guidance to be issued by the SEC [see 3 above] and the FASB's final staff position [see 4 above] will be crucial. It will be useful, however, only if the bank regulators and accounting firms embrace it.

Second, of much interest to financial institutions is the study to be conducted by the SEC, in consultation with Treasury and the Fed [see 2 above]. For now, any suspension of the mark-to-market rules by the SEC would only affect companies registered with the SEC. Banks would still be subject to the rules and regulations of their primary regulators. It is important to banks that the result of the SEC study be "in consultation with" federal bank regulators in an effort to obtain the agreement of those regulators with the SEC on the applicability of those rules.

We will continue to monitor events and will keep you apprised as things progress.

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