Reserved About Stepping Into Fair Value?

Being smart people, we are all aware of the sea change/blip in the financial reporting regulations that is bearing down on corporations. I am referring to the end of the world/no big deal of fair value estimating that has been foisted upon/given to us by the FASB in the forms of FAS 157, FAS 141R and looming changes in FAS 5. Why am I sounding the alarm/not worrying about this change (and what is it with these / lines)?

I’ve been speaking to clients, and am getting what seem to be opposing reactions.

The newswires highlight the differences in opinion. Mr. Schwarzman and the WSJ want us to believe that the current financial chaos is a result of FASB Fair Value Estimating requirements. Others say, these types of regulations have been a long time coming, but it is what is needed. Now, I don’t want to be (too) political, but I believe that the real cause of the chaos is deregulation of the financial markets that did not account for the creativity/greed (there I go again) of all of the smartest guys in the room. The examples are widely known. Too bad I did not get that MBA 20 years ago; I might actually be able to make some sense of all of this instead of just forming an opinion.

What I do see with some certainty is the potential impact on environmental contingencies in transactions and eventually, on environmental reserves. I have spoken to clients who long ago incorporated fair value estimates for their contingencies. I have spoken to others who think that the FASB is out of their minds and think the changes will never happen. Who is right? I don’t know.

But like I said, I have opinions, and some of them may make sense. So here goes:

  • FASB has been going through a rule-making process for FAS 5 for a couple of years. How do we know? It is in the nature of the inquiries that the SEC is making around environmental reserves. From experience, this is typical of how EPA approaches the environmental regulation-making process – gather information, make the rule, enforce. 
  • The second facet of rule making is the need to get the regulated community’s attention. Well, we have had three fines and convictions that had the common element of manipulation of environmental reserves. 
  • Once a federal agency decides to regulate something, it will get regulated. The only uncertainty will be the level of enforcement that will be used to back it up.
  • The changes are a big opportunity for the accounting firms. I have friend in the environmental business who have been hired by one of the accounting firms. And, clients tell me that the auditors are much more interested in reserve estimates than they have been in the past.
  • FAS 141 R opens up a whole new realm of contingencies (non-contractual) that need to be accounted for in a transaction. It is not a big stretch to anticipate that the FAS 5 changes, when they come, will incorporate the same contingencies more specifically.
  • The comments provided to FASB regarding the changes will have little impact. For example, the complaint that the disclosure requirements give advantages to plaintiffs would appear to be negated by the ills the regulation was conceived to address.

For some corporations, the response to these regulations is going to require some giant steps. If the company has inconsistent estimating for asset retirement obligations, for example, they will have a long way to go. So will the sale or acquisition of a business, especially when you imagine the gap that may be present between the seller’s contingency estimates developed under the old rules and the buyer’s estimates developed under the new rules: We have seen it already. In my business we have noted for years that environmental reserves are not accurate reflections of the actual liabilities.

So what we have is a situation that demands planning and anticipation. For some, there will be an initial period of pain, but it makes you stronger. The changes are inevitable, and complaining that the US legal system puts us at a disadvantage will not delay the implementation for long: The “harmonization” with IASB is coming, count on it. Far better to implement these changes incrementally. They seem overdue. 

Dennis Shelly leads ARCADIS’ Transaction Services Practice in North America. He has more than 30 years of professional experience and provides strategic due diligence, environmental management and compliance services to corporations, financial groups and their counsel. Shelly also has extensive experience conducting and managing environmental due diligence services on transactions of all sizes on a local to global scale.