CASE 1-2 POLITICIZATION OF ACCOUNTING STANDARDSA NECESSARY ACT?

On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008.

This Act mandated that the SEC conduct a study on mark-to-market accounting standards.

The SEC had a 90-day period in which to conduct the study.

On December 30, 2008, the SEC released the Report and Recommendations Pursuant

to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-to-

Market Accounting.

The Executive Summary of the SEC report included these comments:

The events leading up to the Congressional call for this study illustrated the need for

identifying and understanding the linkages that exist between fair value accounting

standards and the usefulness of information provided by financial institutions. In the

months preceding passage of the Act, some asserted that fair value accounting, along with

the accompanying guidance on measuring fair value under SFAS No. 157, contributed to

instability in our financial markets. According to these critics, fair value accounting did so

by requiring what some believed were potentially inappropriate write-downs in the value of

investments held by financial institutions, most notably due to concerns that such writedowns

were the result of inactive, illiquid, or irrational markets that resulted in values that

did not reflect the underlying economics of the securities. These voices pointed out the

correlation between U.S. GAAP reporting and the regulatory capital requirements of

financial institutions, highlighting that this correlation could lead to the failure of longstanding

financial institutions if sufficient additional capital is unavailable to offset

investment write-downs. Further, they believed the need to raise additional capital, the

effect of failures, and the reporting of large write-downs would have broader negative

impact on markets and prices, leading to further write-downs and financial instability.

Just as vocal were other market participants, particularly investors, who stated that fair

value accounting serves to enhance the transparency of financial information provided

to the public. These participants indicated that fair value information is vital in times

of stress, and a suspension of this information would weaken investor confidence and

result in further instability in the markets. These participants pointed to what they

believe are the root causes of the crisis, namely poor lending decisions and inadequate

risk management, combined with shortcomings in the current approach to supervision

and regulation, rather than accounting. Suspending the use of fair value accounting,

these participants warned, would be akin to shooting the messenger and hiding from

capital providers the true economic condition of a financial institution.

The recommendations and related key findings of the SEC report were the following:

1. RecommendationSFAS No. 157 Should Be Improved, but Not Suspended

2. RecommendationExisting Fair Value and Mark-to-Market Requirements Should Not

Be Suspended

3. RecommendationAdditional Measures Should Be Taken to Improve the Application

of Existing Fair Value Requirements

4. RecommendationThe Accounting for Financial Asset Impairments Should Be Readdressed

5. RecommendationImplement Further Guidance to Foster the Use of Sound Judgment

6. RecommendationAccounting Standards Should Continue to Be Established to Meet

the Needs of Investors

7. RecommendationAdditional Formal Measures to Address the Operation of Existing

Accounting Standards in Practice Should Be Established

8. RecommendationAddress the Need to Simplify the Accounting for Investments in

Financial Assets

In April 2009, the FASB issued three staff positions intended to provide additional application

guidance and enhance disclosures regarding fair value measurement and impairments of securities.

The new rules made it easier for banks to limit losses. The FASB in effect ratified proposals

it had put out for comment two weeks earlier.

The FASB was criticized for politicization of accounting standards. Some saw it as an

erosion of the independence of the accounting standard-setting process.

Required

a. The Emergency Economic Stabilization Act of 2008 was passed during a time of

substantial stock market declines in the United States and the world. In your opinion,

was Congress correct in directing a review of an accounting standard? Discuss.

b. Did the SEC play a proper role in addressing the standards that governed mark-tomarket

accounting? Discuss.

c. Did the SEC have the authority to change mark-to-market accounting for U.S. GAAP?

Discuss.

d. Did the FASB follow its usual procedures in addressing the mark-to-market issue? Discuss.

e. Is politicization of accounting standards justified under material economic turmoil?