Saturday, March 29, 2008

SEC Openly Invites Corporations To Lie

Can you trust quarterly earnings reports?


The Securities and Exchange Commission sent out a Letter On Fair Value Measurements, (Financial Accounting Standards No. 157) that is tantamount to being an open invitation to lie. Let's take a look at what some are saying about that letter.

Floyd Norris at the New York Times writes If Market Prices Are Too Low, Ignore Them.

The Securities and Exchange Commission is out today with a letter to companies that own a lot of financial instruments whose current market value must be reported to shareholders. For more than a few companies, disclosing market values is neither easy nor convenient.

The issue is the application of SFAS 157, which governs the way companies compute fair value of assets. The rule sets out three categories of assets, with different ways to value them. Category 1 includes assets with easily observable market values. I.B.M. stock closed today at $114.57, and it is not easy to justify a different value if your quarter ended today. Category 2 is a little fuzzier, where there are observable markets that provide a good guide to prices of your asset, even though there is no direct market. And then there is Category 3, which is essentially mark to model.

But one part of the letter stood out to me, providing an excuse for companies to ignore a market value if they don’t like it (italics added):

“Under SFAS 157, it is appropriate for you to consider actual market prices, or observable inputs, even when the market is less liquid than historical market volumes, unless those prices are the result of a forced liquidation or distress sale. Only when actual market prices, or relevant observable inputs, are not available is it appropriate for you to use unobservable inputs which reflect your assumptions of what market participants would use in pricing the asset or liability....”

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