FASB Adopts Staff Position on Mark-to-Market Accounting

On October 10, the Financial Accounting Standards Board (FASB) finalized its new FASB Staff Position 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active(FSP 157-3). This new FSP clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. Some of the key principles illustrated include:

• determining fair value in a dislocated market depends on facts and circumstances, and may require the use of significant judgment about whether individual market transactions are forced liquidations or distressed sales and therefore poor indicators of fair value;
• when relevant observable market data is not available, the use of assumptions about future cash flows and discount rates may be appropriate in determining fair value; and
• the value of broker quotes in determining fair value depends on facts and circumstances, particularly when an active market does not exist.

FSP 157-3 is effective immediately, including with respect to prior periods for which financial statements have not been issued.

FSP 157-3 comes on the heels of the joint guidance regarding Statement 157 that was issued by the SEC and FASB on September 30. The joint guidance was apparently intended to give companies more flexibility in valuing financial assets in inactive markets. While FSP 157-3 purports to be "consistent with and amplif[y]" that guidance, some observers believe that it does not go far enough in permitting illiquid assets to be valued by means other than the "mark-to-market" principles embodied by Statement 157.

For this reason, on October 13, the American Bankers Association sent a letter to the Securities and Exchange Commission requesting that the SEC override FSP 157-3 and "address in a more meaningful way the problems of using fair value in dysfunctional markets." This is an extraordinary request, and it seems unlikely that the SEC will take any such action in the very short term. However, the SEC has begun its study of the impact of fair value accounting standards, which is required by the Emergency Economic Stabilization Act of 2008 to be completed by January 2, 2009. As part of that study, the SEC will consider both the advisability of modifications to fair value accounting standards, and possible alternative accounting standards to those provided in Statement 157.