Concerns over political influence overshadow FASB's changes to fair value

US auditors and investors are concerned that accounting standards are being dictated by politicians rather than independent standard setters.

Eyebrows have been raised by the latest amendments by the Financial Accounting Standards Board (FASB) to fair-value measurements and other than temporary impairment (OTTI).

The FASB proposed the changes on March 16, four days after FASB chairman Robert Herz was told to ease standards by the US Congress' House Financial Services Subcommittee.

Paul Kanjorski, chairman of the subcommittee, said: "We can no longer deny the reality of the pro-cyclical nature of mark-to-market accounting. It has exacerbated the ongoing economic crisis. If the regulators and standards setters do not act now to improve the standards, then the Congress will have no other option than to act itself."

The rules were adopted on April 2, after little more than two weeks of consultation.

"Financial institutions wanted more guidance and leeway; this is what they lobbied Congress for," said Wallace Enman, a senior accounting specialist at Moody's Investors Service in New York.

The International Accounting Standards Board (IASB) has not been immune from political pressure either. In October 2008, the European Commission pushed for changes to IAS 39 in order to allow the reclassification of financial instruments. The rule was amended on October 13, after just 10 days.

One chairman of a European accounting standards board claimed the IASB and the FASB had been "ambushed" by politicians and pressurised into changing their rules on fair-value accounting.

"It's clear that political pressure is being exerted and due process is being shortened. As a result, we're seeing a lot of hasty and piecemeal changes being put forward," observed Vincent Papa, London-based senior policy analyst at the CFA Institute Centre.

"We would be concerned if this was to continue, as you need an independent and accountable standard setter to have high quality standards," he warns.

Nevertheless, investors are relieved that the FASB's latest amendments to fair value are not as drastic as first expected. In its original form, the FASB's literature would have instructed institutions to presume all transactions are distressed unless proven otherwise, granting banks greater freedom to ignore market prices when valuing assets. Analysts estimated this could have enabled banks to artificially boost their balance sheets by as much as 20%.

"It's not as bad as it could be," concedes Richard Clayton, director of research at CtW Investment Group, a Washington-based independent shareholder activist group. Clayton also underlines the benefits of the stringent disclosure standards imposed by the FASB: financial statements still have to display valuations under the previous rules as well as details of inputs and models used to achieve valuations.

"Fortunately, the final rules were accompanied by requirements for additional disclosures regarding companies' use of internal subjective evaluation models. These disclosures should help to minimize any decline in investor confidence in the validity of companies' financial statements resulting from the looser rules," agrees Enman.

And while the proposals fell short of granting institutions sweeping powers to use internal valuations, analysts say they were effective in clarifying when institutions are permitted to use models.

"Previously, there tended to be a default amongst practitioners to look at the most recent transaction price in valuing securities. With the revised rules, the FASB has given practitioners and auditors more substantive guidance in determining when individual transactions are distressed and therefore can be ignored or be adjusted," explains Enman.

The FASB's changes to OTTI were seen as a particular boon for banks. Under the new rules, institutions will be able separate impairment losses due to credit deterioration - which would appear in earnings - from impairment losses related to other market factors - which would appear in other comprehensive income - if they intend to hold the debt security for the time being.

However, Papa warns the changes to impairment may concede too much ground to banks. "We remain concerned about their changes to impairment. It makes it easier to make the judgement that an impairment has not occurred. Also, we have various concerns around separating credit from other losses." he comments.

The US banking sector has welcomed the FASB's changes, which institutions will be able to employ for reporting periods starting after June 15, with early adoption allowed for periods starting after March 15.

Edward Yingling, chief executive of the American Bankers Association (ABA) wrote on the ABA's website on April 2: "Today's decision should improve information for investors by providing more accurate estimates of market values."

The IASB has invited comment on the FASB's amendments. However, in a press release on April 2, the IASB expressed its preference "to prioritise the comprehensive project" - a reference to a joint venture from the IASB and FASB to align their standards on fair value - "rather than making piecemeal adjustments". A draft version of the "comprehensive project" is due to be published within the next six months.

See also: Banks win slack from FASB on fair value