Former SEC Staff Accountant Named IASB Member; Strong Defender of Fair Value Accounting

Former SEC staff accountant Patrick Finnegan has been appointed a member of the IASB to a term that expires in 2014. Mr. Finnegan was also previously CFA Managing Director for the Financial Reporting Policy Group. He has been a consistently a strong defender of fair vale accounting against criticisms that mark-to-market accounting is pro-cyclical and contributed to the financial crisis.

In a letter to the SEC in connection with the Commission’s study of mark-to-market accounting, the new IASB Member said that fair value provides the best representation of economic reality. It provides an early warning system, he noted, and is the only accounting regime that can facilitate the timely correction from previous bad decisions. He does not consider current accounting standards and the application of fair value accounting by financial institutions, in particular, to be one of the causes of the crisis. He also believes that the pro-cyclical effects of fair value are overstated.

The idea that concealing mark-to-market losses will re-instill investor confidence and be an antidote to pro-cyclicality is based on the misconception that observed net income volatility is the sole stimulus to investor perception of the risk of financial institutions. He contended that a more effective way of restoring confidence and ensuring investors do not misinterpret firm performance is to enhance financial statement presentation to enable investors to distinguish between core operating earnings from gains or losses of holding assets. This should be coupled with meaningful disclosures that can convey the inherent uncertainty and margin of error on the valuation of complex financial instruments

In comments at an SEC roundtable on fair value accounting, the then CFA official said that investors are not in favor of accounting by management intent for the simple reason that it allows the issue of moral hazard to creep into the preparation of financial statements. Users are interested in understanding how the economic activities in which the businesses are engaged flow through and affect the reported accounts, he stressed, and not in how management may adjust economic activities to paint a picture as opposed to what actually happened. In his SEC comment letter, Mr. Finnegan said that investors are opposed to the suspension of fair value and believe fair value contributes to transparency in financial institution.

Noting that fair value standards are critical to the integrity of the financial markets, he said that the emphasis should be on helping investors to interpret reported values. Rather than suspension of fair value, he recommends the improvement of fair value reporting presentation and enhancement of associated disclosures. He urged political leaders to resist the temptation to impose regional carve-outs of financial reports since this will reduce the comparability of financial reports for investors.