Fraud claims could freeze fair value ‘in its tracks’

BVWireIssue #66-4
March 26, 2008

After the subprime meltdown and the recent run on Wall Street banks (see last week’s BVWire), two schools of comment seem to be developing—one that keeps pointing to the “folly” of fair value accounting, and the other that says the financial reporting system is responding precisely as it should.  The frustration of the former is “understandable,” says a new article by Michael Young, a corporate securities attorney with Wilkie Farr & Gallagher (New York City).  While the recent economic news hasn’t been pleasant, “one benefit to fair value accounting—and FAS 157 in particular—is that it has given outside investors real-time insight into market gyrations…that, under old accounting regimes, only insiders could see.”   But at least one feature of the subprime aftermath has the potential to be “completely counterproductive,” Young warns:

It is the extent to which our system of litigation and regulatory oversight results in unjustified assertions of ‘fraud’ against those who were doing their best under circumstances that were exceedingly difficult. … For the very aspects of fair value accounting that make it susceptible to second guessing—the absence of concrete data, the need for judgment, the importance of predictions—are likely to increasingly become more prominent features of financial reporting generally.

If our highly litigious systems do penalize auditors, financial administrators, and valuation analysts for “good faith” judgment calls gone bad—then “continued progress in financial reporting…will foreseeably be frozen in its tracks,” Young says in his article.  Young will join FASB Chair Bob Herz at a conference on the “Challenges Arising from Fair Value and Other New Accounting,” to be held in Manhattan on April 11, 2008 by the Directors Roundtable. Registration is free.

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