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Time for Investors to Panic! SEC Abandons Sound Accounting Practices

Stock-Markets / Market Manipulation Oct 03, 2008 - 09:36 AM GMT

By: Andrew_Butter

Stock-Markets

Best Financial Markets Analysis ArticleThe SEC about-face on Mark to Market…the lunacy continues. This means it's time to run away.

I was not the only one who has been saying that the accountancy rules that mandated Mark to Market valuation of assets caused the Credit Crisis. And that this was making things worse.


But I don't think that anyone suggested you can forget about doing proper valuations and audits (I certainly didn't).

That's in effect what the 30th September "clarification" from SEC and FASB says.

QUOTE: From the SEC and FASB press release "Clarifications on Fair Value Accounting" of 30th September 2008:

"Can management's internal assumptions (e.g. expected cash flow) be used to measure fair value when relevant market evidence does not exist?"

Answer: YES.

This is a crude and inept attempt to move FASB 175 towards the concepts outlined in International Valuation Standards (IVS) in 2000. At least that's the right direction but it doesn't even move the goalposts as far as IFRS (International Financial Reporting Standards) IAS 39, which still are miles away from IVS.

And the net result is a step back towards chaos.

Nonsense IN Nonsense OUT

What this “clarification” says in plain English is that an auditor can legally accept whatever nonsense predictions about expected future cash flow, that the management dishes up, and then do an income capitalization valuation to arrive at "Fair Value".

That's not an audit, that's a license to conceal, which is in effect a license to steal.

One day reality is going to bite. The reality is that 95% of a valuation is getting everyone to believe it.

The problem right now which is why banks are not lending to each other and LIBOR is going through the roof is that banks don't believe the audits and valuations of counter-parties (any more than they believe their own valuations).

Suspending any semblance of independent rational regulation of the audit and valuation process will make matters worse, not better.

So according to SEC and FASB now markets don't matter anymore?

Markets don't matter in totalitarian states, instead the State decides prices and value. Is that where US is heading?

The vague language about whether or not "relevant market evidence exists" is the final nail in the coffin of any credibility in an audit does according to SEC and FASB rules.

If you think the performance of Arthur Andersen looking after the interests of shareholders was inept and possibly crooked, well this is ten times worse.

Think about it, what that says in plain English is if no relevant market information exists, you can just make up the value, toss a coin if you like, take a (legal) kick-back from the management, anything goes.

In a system of regulation where the interests of shareholders are properly protected every valuation should be based on an independent (i.e. not just mouthing what the management says), evaluation of market information.

A valuation is simply an estimate of what the market will pay, this debate is simply about when.

The decision on whether to consider information from the market today (i.e. Mark to Market), or information from markets yesterday (if there is not a good reason to believe that markets are working today) doesn't mean that you can base a valuation on "no market-derived data".

If "no relevant market data exists", well then by definition there is none to base the valuation on. So what is it, the SEC are saying that either relevant market data exists, in which case you have to mark to market, or it doesn't in which case anything goes.

Didn't they ever hear about the color gray?

Why not just do it properly?

International Valuation Standards are the most carefully considered valuation standard devised by man, and are approved by all valuation institutes worldwide (including US institutes).

IVS mandates that if you do an income capitalization valuation to work out either Market Value (what Fair Value approximates to sometimes) or Other than Market Value (a concept that has so far eluded the SEC and FASB for the past eight years), every single number that is relied on for arriving at the valuation should be "market-derived".

Since 2000 International Valuation Standards, the IMF and the World Bank have been saying that the valuations used by banking regulators are “fundamentally flawed” and “bound to be misleading” (for example see the letter from IVSC to the Bank of International Settlements of 30 th July 2003 on the BIS website) .

Not content with engineering the housing bubble and the credit crunch, now the SEC and FASB just want to make things worse.

Time to Run and hide

If that's the way they want to play it then my advice is to get the hell out of US stocks, bonds, anything, run and hide. All semblance of protecting the rights of shareholders, investors and counter-parties has been officially tossed out of the window.

Take your losses, RUN!

Stopping the lunacy?

By the way, if anyone wants to stop this lunacy, the solution is simple. Adopt International Valuation Standards as the benchmark for valuing assets.

IVS provides an elegant and transparent methodology for valuing assets when markets are not working properly, that can be relied on to return the correct value whenever markets start to work.

If ever they adopt IVS or a variant of it, then that will be a sign to pile your money back in.

But not a moment before.

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

Copyright © 2008 Andrew Butter

Andrew Butter Archive

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