Subject: Comments to the Office of the Chief Accountant FASB Re: FSP FAS157-d and the SEC Fair Value Conference.

October 9, 2008

Dear Sir:

I am writing today on the last comment day for the FASB's proposed FSP on FAS157 to ask the Office of the Chief Accountant to address the following issues.

These issues provide the opportunity for interpretive guidance that is more the mission of the SEC and your office than the current FASB deliberations.

In some cases the current FASB deliberations need to be adjusted while time permits by general directional guidance from the SEC OCA.

1. Recognition versus Measurement versus Disclosure

The scope of FAS157 excludes recognition, the manner in which debits and credits incorporating fair values are presented in the Issuer's financial statements.

Presenting fair value changes in Earnings for some financial items such as those presented on the liability portion of the balance sheet remains troublesome, notwithstanding the attempts of Professor Petroni during the SEC's Fair Value conference to claim otherwise.

The SEC Chief Accountant should consider altering mandatory recognition in Earnings and expand permissible recognition to Comprehensive Income.
In particular it would be considered that recognition of certain fair value changes in Other Comprehensive Income (as described in FAS130) would achieve the goal of Income Recognition without making Earnings meaningless or impossible to interpret.

2. Comprehensive Income equals the Sum of Earnings and Other Comprehensive Income

In part to amplify the point made in item 1. above I wish to offer a counterweight and refutation of the position taken by Jane Adams, a hedge fund executive, during the Fair Value Conference. Ms Adams is a former accounting regulator and the author of the widely read accounting document on Mixed Attributes in Financial Reporting. Her position boils down to the notion that changes or flows ALWAYS should be reported in Earnings.

Fair Value conference commentators disagreed with this view, and I do as well but for a different reason.

My reasoning is to ask the SEC to evaluate the nature of the changes, or flows, that have been reported in FAS130 type Other Comprehensive Income to date. The purpose of a review would be to determine whether as an empirical matter, on an "ad hoc" basis, the formulation of accounting rules have resulted in certain types of flows being clustered in Other Comprehensive Income rather than Earnings. My research shows that this is the case.

In addition the ad hoc similarity of certain OCI items should lead the SEC to set a new priority for the FASB - the reopening of FAS130 to result in a "FAS130-revised" Statement.

My own research as an accounting and risk management professor and professional, with the benefit of a prior career in international banking, is that most financial statement preparers see most FAS130 items as economic and measurable flows which either reflect accounting measurement decisions that do not have "traditional" Earnings attributes, are inherently risky and thus sufficient for financial reporting but insufficient for Earnings recognition, are not necessary to evaluate the profitability of the Issuer, or would lead to financial statement users having a reduced level of transparency due to the inclusion of the FAS130 OCI measure in Earnings. While there are other factors this are the primary attributes of FAS130 items.

I have been able to group OCI entries in clusters according to their economic attributes - a possible outcome not envisioned in FAS130 - and so describe them with reliability, consistency and comparability across SEC Issuers.

Much more interesting is that the grouping attributes of OCI items are clearly different than the grouping attributes of EArnings variables.
There is clear evidence that OCI and Earnings as significantly different. And this in turn supports that they should be presented separately, and furthermore that they do not represent the same types of "flows." That is to say, Earnings by and large present a traditional flow character that is not shared by the flow variable placed in OCI.

One major difference to consider is that Earnings realize realized transactions, at least in part, or transactions whose cash results will soon settle in the cash account. OCI entries however seem dominated more by non-transactional items (they are accounting allocations based on transactions) or items that are "unrealized."

Unrealized and measured items may effect the share price of the SEC Issuer, but lie outside of the traditional P/E relationship. I am explaining this at a conceptual level in a paper I can make available in a Working Paper format. I am currently testing the notion in empirical studies.

FAS130 as originally issued identified OCI as the item necessary to insure that Comprehensive Income could be reconcile to Earnings. This was based on an accounting model where the components of Earnings are specified (revenues, expenses, gains and losses) but there is no separate rule for Earnings. FAS130 further describes that the OCI's attributes are not formulated in detail in FAS130 itself. Rather as other related standards have been issued, certain accounting flows measured in those standards are allocated to OCI rather than to Earnings.

Examples of OCI measures include:
1. a. Certain FAS52 items known as Cumulative Translation Adjustment ("CTA") entries, with or without related hedging gains and losses under FAS133 hedging of Net Investment in Foreign Operations, an accounting election under FAS133 (an election that should be distinguished from a FAS133 Cash Flow Hedge (Special) Hedge Accounting election; 1. b. Certain remeasured FAS52 changes in carrying value of capital provided to foreign operations if that capital is in the form of certain debt instruments (these remeasured amounts are not fair values); 2. Certain FAS115 items reflecting changes in Fair Value of Available-for-Sale Securities; 3. Certain FAS133 derivative and hedging instruments changes in Fair Value under FAS133 Cash Flow Hedge (Special) Hedge Accounting elections; d. Certain flows associated with remeasurement of net Pension exposures (actuarial assumptions are used in part).

These items all reflect the common attribute that they are measures that a non-accountant would describe in Plain English as a financial engineering measures. A secondary commonality of the items listed above is the attribute that the flows may not result in a future Earnings recognition event, and/or may never result in an attendant cash flow. OCI measures also reflect varying degrees of the use of "deferral accounting" among other attributes.

The commonality of OCI measures' attributes has arisen on an "ad hoc" basis. However the regularity of the commonality suggests the opportunity to re-open FAS130 in order to provide a measurement framework for items that might qualify for OCI recognition as opposed to Earnings recognition, if conditions are met.

The two items, providing a partial measurement framework for OCI items and addressing the recognition issue more than justifies a new FASB standard. However the overall policy direction should first be placed on the table by the SEC Chief Accountant, just as the SEC Chief Accountant first demanded that the FASB create a comprehensive recognition standard for derivatives and hedging activities (this resulted in, first FAS119 on mandatory disclosures followed by FAS133 Accounting for Derivatives and Hedging Activities.)

If the SEC's long-term plan is to eliminate OCI as a separate recognition item, which would reflect the position of Ms Adams, then it is high time to say so, and get on with the rule by having the SEC Chief Accountant issue a rule that would eventually result in the elimination of OCI as it is identified in FAS130.

We are worried that the technical arguments in favor of OCI have not yet been explored and that at the same time the FASB is operating from a conceptual basis reflecting the current views of the FASB members as opposed to those in office when the Concepts statements were issued (mostly in the 1970s) and FAS130 was issued (in the mid 1990s). If the SEC determines that the FASB is irrevocably committed to eventually deleting OCI from the accounting model used in practice under GAAP then it should fall to the SEC to either contradict this hidden agenda or support it, for the benefit of all FASB constituents, one way or the other.

I am interested in working with the SEC on any studies that might be conducted on this topic. I am in favor of retaining OCI as a separate measure from Earnings for at least the near term.

3. FSP FAS157-d on Illiquid Markets and the Planned FSP FAS157-c on Liabilities

The difficulty of applying FAS157 to items carried on the Balance Sheet has prompted FSP FAS17-c on Liabilities which has not yet been completed.

FSP FAS157-c is an item that invites a recognition discussion but recognition is outside the scope of FAS157. In particular the changes in fair value of Liabilities that will nonetheless be settled by repayment of amounts due represent flows that might qualify more as OCI items and less as Earnings. (Here I also disagree with Professor Petroni's statements during the SEC Fair Value Conference, but we should observe that her comments were constrained by the model statement that "flows should be recognized in Earnings.")

The proposed use of OCI for changes in fair value of liability items can accommodate many "intuitions" and thus minimizes counterintuitive Earnings entries without decreasing the quality of the financial statements.

The proposed FSP FAS157-c on Liabilities would currently open "Fair Value" to what in Plain English we would call the acquisition cost for the entity's own financial items - presumably the open market repurchase of stock or its own debt liability instruments. Yet the market for "liability instruments" can also be inactive, illiquid or just right out non-existent. In the US, as compared with, say, the Eurobond markets, secondary market prices on debt instruments are sometimes rare or nonexistent - the entire debt issue is placed and essentially "held to maturity" by the investor.

The SEC should encourage the FASB in its deliberation of FSP FAS157-d to include these notions or to work quickly to issue FSP FAS157-c on or about the same time to make sure that they are consistent.

4. The September 16 IASB Working or Draft Document on Fair Value Measures for use in IFRS reporting.

The SEC should ensure that notions of measurement in illiquid markets under the IASB draft that either excluded in the final version of FASP FSP 157-d or not considered in the current deliberations are the subject of an SEC action. An SEC SAB might be appropriate.

In general I wish to encourage the SEC to use this as an opportunity to retain its position as the de facto global leader in accounting standard setting (albeit in the US with the mechanisms of the FASB and the AICPA in place). It should also be encouraged to use this opportunity to achieve convergence on this one topic as soon as possible and in this demonstrate either that the American and the England-based accounting standard setters can work hand-in-hand or that the latter are willing to accept the leadership of the US SEC ....that leadership is demonstrable by setting the agenda and the timetable for these considerations.

5. SEC Chairman's comments on Convergence with IFRS (from 2010 to 2016 in the current timetable)

The SEC Chief Accountant should consider a white paper study, possibly with the SEC Office of Economic Analysis, to consider whether, or how, feasibility of the proposed convergence is impacted by these current market events.

The recent PWC white paper on workability of the SEC Chairman's proposed convergence timetable should be receive either an SEC commentary or be counter-balanced by the SEC's own study.

Maybe the timetable should be deferred, or cancelled or proceed as hoped. Maybe convergence for financial institutions should occur at a different pace than for all other financial statement preparers. For large global financial institutions, the impact of quasi-nationalization or the substitute of government liquidity for market liquidity should be evaluated as to its impact on the FAS157 measurement model and also the convergence to a global accounting model.

These choices require careful reconsideration. And a study is in order.

6. What is Mark-to-Market Accounting ?

Many commentators in the press and members of Congress have misunderstood the current state of the accounting model.

If Mark-to-Market Accounting is firstly, the use of FAS157, then this is measurement and disclosure only, not recognition.

If Mark-to-Market Accounting is secondly, placing FAS157 measurement changes to Earnings, then in fact that model is not only "not required" but its use also is an election (for example under FAS115 or FAS159 , etc.) or cannot yet be used (marking to market for recognition real estate exists in the UK and Australia but not yet the US).

The SEC Chief Accountant could issue a clarifying white paper to describe the model correctly for, at a minimum, the benefit of Members of Congress who do not yet have the necessary financial acumen, but could acquire it with OCA's help, at least narrowly for the current string of hearings.

7. Postponed Effective Date of FAS157 or non Financial Items

The SEC Chief Accountant should act immediately to postpone the effective date of FAS157 for non financial items and require that the FASB engage the FASB Valuation Resource Group in a consideration of measurement issues related to these items.


Thank you for receiving this email communication. Please call on me if I can be of any help.

Louis LeGuyader
East Islip, New York