On September 30, 2008 the Office of the Chief Accountant of the
U.S. Securities and Exchange Commission and the Financial
Accounting Standards Board (the "FASB") jointly released
an interpretive memorandum regarding "mark-to-market"
accounting. The interpretation comes in the wake of concerns that
excessive accounting write-downs have brought many financial
institutions close to insolvency. Under the interpretation, sales
of securities that are made in "disorderly transactions"
are not determinative of the value of similar securities. Thus,
where forced or distressed sales of mortgage securities have taken
place in the market, other institutions are not necessarily
required to mark the securities in their own portfolios to the fire
sale price. Instead they may rely on other information, such as
management's internal assumptions as to expected cash flows and
risk, to determine the value of the mortgage securities in their
FASB Statement 157 (Fair Value Measurements) in essence requires
companies to employ a hierarchy of techniques when valuing assets
under U.S. generally accepted accounting principles. The most
representative valuation exists where there has been a quoted
market price in an active market for an identical asset (this is
known as Level 1). Where a Level 1 valuation is present, it must be
used. Level 2 occurs under similar circumstances except that the
asset being valued is not identical but similar to the asset sold
in the market. Finally, Level 3 applies in cases where an active
market for the security does not exist and the company must use
other inputs as to value.
An exception under Statement 157 states that Level 3 may be used
instead of Level 2 in situations where a distressed sale has taken
place. Many auditors have argued that, with the frequency and
consistency of sales that have taken place in the mortgage
securities market, these sales cannot be classified as
"distressed sales." The September 30th interpretation
makes it clear that, in certain circumstances, Level 3 is actually
a more accurate valuation than Level 2 and should therefore be
used. The interpretation dictates that only "orderly
transactions" should be viewed as determinative of fair market
value. Orderly transactions involve willing market participants and
allow for adequate exposure to the markets. Conversely, the
interpretation states that disorderly transactions are distressed
or forced liquidation sales, which should be perceived as taking
place in an inactive market; these sales "are not
determinative when measuring fair value." Factors that should
be considered in determining whether the market is inactive include
whether there is a large spread in the market between the asking
price and the bidding price, as well as whether there are
relatively few bidders in the market.
The interpretation makes it clear that the value of an investment
must be written-down in cases where impairment is not temporary.
Factors in determining whether a security is
"other-than-temporarily impaired" are the decline in
value, the period of time until anticipated recovery, and the
period of time that the decline has existed. In each case, the
greater the number, the greater the chance that the security should
not be viewed as temporarily impaired.
The interpretation states that the FASB is preparing to propose
additional interpretive guidance on fair value measurement under
U.S. GAAP later this week.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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The Canadian Office of the Superintendent of Financial Institutions ("OSFI") recently ruled that a bank cannot promote comprehensive credit insurance ("CCI") within its Canadian branches under the Insurance Business (Banks and Bank Holdings Companies) Regulations (the "Regulations").
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