FASB relaxes mark-to-market rules

New guidelines announced by the Financial Accounting Standards Board, in response to recent pressure amid increasing write-downs and stock drops, will give GPs more room to maneuver in pricing investments.

The Financial Accounting Standards Board voted Thursday to relax the current mark-to-market rules, which require assets to be valued at prices reflecting current market conditions, and allow firms to use “significant” judgment when determining the price of their investment.

Under the new guidelines, which will apply to the second quarter that began in April, assets can be valued at what they would sell for in an “orderly” sale, as opposed to a forced or distressed sale.

The move was greeted with relief by many. Shares in banks such as Citigroup and Bank of America as well as in diversified REITs rose following the news.

Private equity GPs have lately struggled with assigning “fair value” to portfolio investments.

Many firms, banks and lawmakers – including Blackstone chairman Stephen Schwarzman and former Treasury secretary Robert Rubin – have claimed the previous rules are partly to blame for the current financial crisis, with 3i one of the latest private equity firms announcing further expected write-downs as it moves from holding portfolio companies at cost to valuing them on a mark-to-market basis.

The new guidelines come in the wake of a 12 March US House Financial Services Committee hearing in which FASB chairman Robert Herz was urged by lawmakers to revise the fair value rules. “I heard you – I heard you – very clear,” Herz said during the hearing. “We could have the guidance in three weeks. Whether it would fix things is another question – I hope so.”

Five days later FASB issued its new proposals and sought out comments on the plan ahead of today’s vote. The rule amendment, known as FASB-157e, establishes a two-step process to determine whether a market is not active and a transaction is not distressed, and lets firms to use their own valuation techniques in to value assets in distressed markets.

Specifically it provides a list of seven factors that indicate that a market is not active. Among these are: if the markets have few recent transactions; price quotations are based on old information, or vary substantially over time or among market makers; there are abnormal liquidity risk premiums for quoted prices or abnormally wide bid-ask spreads; indexes that previously were highly correlated with the fair values of the asset are now uncorrelated with recent fair values; or if little information is released publicly.

Warren Hirschhorn, managing director for accounting and valuation firm Duff & Phelps, said when the proposed change was announced that the seven indicators of illiquid markets  would allow auditors to exercise more judgment when determining a financial asset’s trading price. “By giving seven factors you try to keep to the principles,” he said. “It doesn’t say you have to meet all seven, it says you follow these and after evaluating all factors and considering the significance and relevance of each, the reporting entity shall use its best judgment.”