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Proposal to Trim Fair Value Disclosures Threatens Post-Crisis Reform Measure

The FASB has tentatively decided to scale back some disclosures that once were considered key to understanding how to measure hard-to-value assets and liabilities. The board wants to cut the disclosures because they result in boilerplate answers or give misleading information to investors, but some analysts still find the information they give essential.

The FASB’s move to erase some disclosure rules about how companies measure hard-to-value assets and liabilities could undo some of the standard-setter’s work in response to the 2008 financial crisis.

The FASB on March 4, 2015, voted to remove some disclosure requirements from Topic 820, Fair Value Measurement, formerly SFAS No. 157.

Although the decision was not unanimous, board members supporting the move said the disclosure requirements were often met with boilerplate responses from companies that offered little substance. Others said the emphasis on the information gave investors and analysts misleading information about market risk. (See Fair Value Disclosure Rules May Drop Some Information on Hard-to-Price Assets in the March 6, 2015, edition of Accounting & Compliance Alert. )

The FASB’s March 4 decision is a long way from being finalized. It’s not clear when the board might publish a proposal with the changes it just agreed to. But if the revised disclosure rules are adopted, they would erase footnotes the standard-setter instituted after the financial crisis, when the markets demanded more information about the data businesses used to determine the shrinking value of many assets. The fair value measurements came under much scrutiny during the crisis, when the markets for some financial instruments dried up and became hard or impossible to price.

The FASB’s move to scale back this information is perplexing to some long-time observers of the board.

“I can’t say any time I get an annual [report] or anybody else gets an annual that’s where I go first, that’s where the bodies are buried,” said Jack Ciesielski, president of the Baltimore investment research firm R.G. Associates Inc. “But this stuff, it has value. It’s just you don’t know when it’s going to have value.”

After the financial crisis, the FASB in January 2010 published Accounting Standards Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820)—Improving Disclosures about Fair Value Measurement, and in May 2011 issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, as updates to Topic 820.

ASU No. 2010-06 established disclosure requirements in financial statement footnotes that matched SEC requests for fair value information in the management discussion and analysis section of regulatory filings. In March 2008, the SEC established the requirement through a piece of interpretive guidance, the Dear CFO Letter Sample Letter Sent to Public Companies on MD&A Disclosure Regarding the Application of SFAS 157 (Fair Value Measurements). The letter essentially codified the practice the SEC staff was developing as the crisis was heating up to get more details from banks in their regulatory disclosures about the instruments on their balance sheets.

The letter was published shortly after investment bank Bears Stearns Cos. had to be acquired by JPMorgan Chase & Co. in an emergency deal that was struck just as the financial crisis was escalating. After the crisis, senior regulatory officials acknowledged that they had a poor understanding of the types of instruments on bank balance sheets and the risks commercial and investment banks faced as they tried to fund their trading activities with collateral that was rapidly losing value.

Topic 820 spells out how companies should estimate the fair value of assets and liabilities by using both available, quantifiable data such as market prices and also judgments and estimates. The standard separates the measurements into a three-tier fair value “hierarchy” depending on how much judgment is used.

Instruments valued according to the Level 1 method are considered the easiest to value because they’re from price quotes from active markets. The Level 2 method uses a broader range of information than publicly quoted prices, and depending upon the asset or liability being measured, can rely on price quotes from inactive markets, interest rates, and a variety of methods used to price options and other derivatives contracts. Assets and liabilities measured according to the Level 3 method are considered the toughest to value because their measurements are based on information that isn’t publicly available or observable. The values derived from it are typically considered the least reliable.

The board on March 4 voted to scrap disclosures for the policy for timing of transfers between levels; the internal valuation processes for Level 3 fair value measurements; and the amount of and the reasons for transfers between Level 1 and Level 2. In addition, private companies would not have to disclose the change in unrealized gains and losses included in earnings related to recurring Level 3 fair value measurements.

Sandy Peters, head of the financial reporting policy group at the CFA Institute, said she was concerned about the proposed removal of disclosures about why a set of assets or liabilities move from Level 1 to Level 2. Movement typically signals that either the market changed or management misclassified the measurements.

“If I’m an investor and I know the market, I’m asking what the securities did, what changed,” Peters said. “It gives you insight into what the securities were and why they were that way.”

She also said she disagreed with the idea of loosening disclosures about Level 3 measurements for private companies. The FASB in recent years has been scaling back disclosure requirements for private companies because investors and creditors typically can more easily contact a private company’s top management and ask for more details than is provided in their financial statements.

Not all investors have this access, however, Peters said.

“The short answer is, I need to know the degrees of uncertainty associated with the measurement,” she said.

Robert Herz, chairman of the FASB during and immediately after the financial crisis, when the board published SFAS No. 157 and the 2010 update to fair value measurement disclosures, said the disclosures were important at the time, but that doesn’t mean they must stay intact.

“It was put in that time, in that environment,” he said. “It’s six years later now. I think it’s healthy now to look at that again.”

Herz also said he was “big believer” in the FASB’s due process and that the board did sufficient research to conclude that some disclosures could be trimmed.

“I know they talk to a lot of people, including the users. I’m sure that’s what they did and came to the conclusion that [the disclosures] could be scaled back some instances,” he said.

The SEC, which meets regularly with the FASB on its standard-setting decisions, declined to comment.

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