Mark-to-market accounting II

On Thursday, April 2, the FASB met to discuss a new staff position, FSP, addressing the issue and in part modifying the system, addressing objections to M2M.

The FSP outlined how a reporting entity could determine whether a market is inactive and whether a transaction is not distressed in the sense pertinent to the application of SFAS 157. In terms of Angel’s metaphor, this is an effort to exorcise the ghost of Arthur Anderson from future auditor/reporting-entity interactions.

It established a two-step process. The first step involves the consideration of seven factors that would indicate the inactivity of a market. These factors are:
• Few recent transactions (based on volume and level of activity in the market)
• Price quotations are not based on current information
• Price quotations vary substantially either over time or among market makers (for example, some brokered markets)
• Indexes that previously were highly correlated with the fair values of the asset are demonstrably uncorrelated with recent fair values
• Abnormal (or significant increases in) liquidity risk premiums or implied yields for quoted prices when compared with reasonable estimates (using realistic assumptions) of credit and other nonperformance risk for the asset class
• Abnormally wide bid-ask spread or significant increases in the bid-ask spread
• Little information is released publicly (for example, a principal-to-principal market).

The proposed FSP said that the entity shall consider the significance and relevance of each factor, yet it cautions that the list is not all-inclusive; “other factors may also indicate that a market is not active.”

If the entity concludes after step 1 that the market is not active, it has created a rebuttable presumption that a quoted price is associated with a distressed transaction. Yet it must as step 2 consider evidence that would rebut that presumption. This would be evidence that (a) there was sufficient time before the measurement date to allow for usual and customary marketing activities for the asset and (b) there were multiple bidders for the asset. If both of those factors are present, then the presumption of distress is defeated.

In the absence of one or the other of those defeating factors, the presumption of distress prevails. “When that is the case, the reporting entity must use a valuation technique other than one that uses the quoted prices without significant adjustment.

The board told its staff, "you're doing good work, but you need to go back to the drawing board and modify this a bit." That's actually my paraphrase.

Specifically, the board said the staff should “eliminate the proposed presumption that all transactions are distressed (not orderly) unless proven otherwise.” The final FSP should also require an entity to disclose a change in valuation technique, and the related inputs, resulting from the application of this FSP and to quantity the effects of that change if practicable.