Financial Disclosure and SFAS 157: Seeking Transparency in a Perfect Storm

Fri Feb 27 20:24:38 UTC 2009
By Dr. Sharon Brown-Hruska with former NERA Vice President Shuchi Satwah

Improving transparency has been the impetus for fair value accounting, which prescribes current valuations and increased financial disclosures in order to increase the relevance and reliability of information found in financial statements. Statement of Financial Accounting Standard No. 157, Fair Value Measurements, issued in September 2006 (SFAS 157), requires expanded disclosures about fair value measurements of assets and liabilities by implementing a hierarchy of inputs that places current market prices at its pinnacle. While SFAS 157 met with broad support during its development and upon its release, it has come head on into a perfect storm in which market illiquidity and a credit crisis have combined to undermine confidence in fair value accounting.

This article from Capital Markets Law Journal examines the role played by SFAS 157 and fair value accounting rules in the ongoing crisis in financial markets. Dr. Brown-Hruska and Ms. Satwah discuss the role of financial reporting and the evolution of fair value accounting as reflected in the professional accounting literature. The authors then provide an overview of SFAS 157 and describe the controversies surrounding it as it applies to structured products whose underlying collateral included subprime assets. The authors consider how, in the present crisis, the determination of fair value was confounded by illiquidity in the market-based inputs that SFAS 157 prefers. They conclude by considering the economic basis for fair value accounting and examine how market efficiency intersects with valuation and reporting practices.

This article was published in Capital Markets Law Journal, (Oxford University Press, London), 2009, Vol. 4(2): 133-154.