Last month, subscribers to The Analyst's Accounting Observer received our report on the state of benefit plans in the S&P 500 Short version: they're in pretty good shape, but far from riskless. And we'll be monitoring them throughout the remainder of the year to assess the risks.

If you're an institutional investor and would like to take a free trial offer of the Accounting Observer, you're welcome to this report. Click here to register for the trial, and you can also register seven of your research comrades. Institutional investors only, please: if we can't find you in one of the major directories of investment research (StreetSight, BigDough), we won't honor your request.

The timing of that report was pretty fortunate: in March, the FASB proposed amping the disclosures about benefit plan assets. While we were working on the report, we got a first-hand look at the existing disclosures and their shortcomings in light of the market events of the past year. It gave us good feel for how the FASB's disclosures could benefit investors. The deadline for comments on the proposed FASB Staff Position was shortly after we completed the report, so I put together a comment letter of my own just in time for the deadline. It's available here for your reading.

The disclosures should be effective for the years ending after 12/15/08. I have no doubt that companies will vigorously oppose the proposal and at least try to stall for another year of grace. It's an iron rule of accounting standard-setting: the amount of corporate resistance is directly proportional to the amount of informational benefit a proposal will provide to investors. We'll see if it happens here.  

Further evidence that the world is getting to be a smaller place every day. And that the SEC's blueprint for moving the US to international financial reporting standards is just around the corner...

On June 16, the FASB will hold a forum at Baruch College, entitled "High-Quality Global Accounting Standards: Issues and Implications for U.S. Financial Reporting." Panelists will be "users of financial statements, representatives of small and large companies both public and private, auditors, regulators, educators, and others representing facets of the U.S. economy that would be affected if there were a move from U.S. Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS)."

If there were a move? Maybe we'll understand the "if" a little more after the SEC blueprint hits the 'net. I suspect that it will be out before this forum; it would make sense for the FASB to schedule such a production for a time frame after the SEC's plan becomes public.

Other international news: the FASB has signed a "Memorandum of Understanding" with their Chinese counterpart, the China Accounting Standards Committee, committing "to strengthen cooperation and communication between the two standards-setting organizations." More specifically:

• The two bodies will work to improve understanding technical issues "to facilitate economic interaction between the two countries";
• They'll exchange experience of accounting standard setting, implementation, and international convergence; and

   

• They intend to "exchange opinions regularly and build the technical foundation for sharing views on convergence of accounting standards."

This internationalization of accounting standards is happening faster than investors realize, because it hasn't resulted in changes to standards or financial statements - yet. That's typically how investors find out about what's going on in the accounting world - when it's after the fact and it's baked into the financials. When internationalization is in full swing, I suspect there will be a lot of head-scratching by investors.

A reminder, though I'm sure you know: it's Berkshire Hathaway's shareholder meeting weekend. The carnival of capitalism is a spring ritual for the true believers, and every year it becomes a bigger and bigger event. All the disciples of Buffett, who attend perhaps in hopes of channeling their inner billionaire, hang on every word looking for the version of investing truth they want, somewhere in his comments.

This year, it promises to be even more exciting: the search for hidden messages will be even more intense because of last week's announcement of the purchase of Wrigley by Mars and Berkshire.

(Author's note: I, and accounts I manage, own both Berkshire and Wrigley.)

I won't be attending the meeting. I used to go to it, back when it was small - oh, say only about 3,000 attendees. Intimate, by comparison to today's mob. The coverage of it has been terrific over the years: I can't say it's as good as being there, but being there isn't quite as good as being there, either. There's only one Buffett (and one Munger); their results speak for themselves, and they say a lot. I'll content myself with the media coverage, I guess. I understand that Fox Business channel will be covering it all weekend long, and capping it off with an hour-long interview with Buffett on Monday morning. (In case you're interested.)

You might reflexively think about a possible combination of US accounting standards and international accounting standards, but no - the urge to merge internationally is what's going on at Ernst & Young .

The firm announced the merging of "87 country practices in Western and Eastern Europe, the Middle East, India and Africa into a new EMEIA Area." That's not all: the 700 partners in the Far East practices supported a similar move across 15 countries and territories.

" The EMEIA Area will operate as a single unit, led by a single executive team and, where allowed by laws and regulations, be underscored by formal combinations of practices. The new Area will be a US$11.2 billion organization with more than 60,000 people. The 3,300 partners of EMEIA will vote on the integration by the end of May. The new EMEIA Area will be effective from 1 July 2008.

The integration of the Far East Area creates a US$1.2 billion organization, with more than 20,000 people. The new structure will also be effective from 1 July 2008.

That doesn't make the firm suddenly bigger or grow more quickly. And it doesn't really change too much for the investor. What's interesting though, is that it gives a couple glimpses inside the auditing world that investors rarely get. First, the sheer size of a Big Four organization is something investors rarely contemplate. The EMEIA area alone will be an $11.2 billion organization, meaning it's hugely important to the firm as a whole: last year, E&Y's global revenues were $21.1 billion. That puts them in the same league as Electronic Data Systems or Constellation Energy Group; ahead of JC Penney or Tyco. Yet investors rarely consider the size and reach of these firms that are acting as their agents in the auditing of financial statements.

The other glimpse: note that these practices were under the E&Y tent, but as different country practices. It's not like all of the firms within the firm are necessarily as uniform as investors might believe. Going forward, there should now be a high degree of consistency and uniformity in the way these practices operate within E&Y. That's something that should matter when say, a Peoria-based audit client has a significant business unit in the Middle East that's audited bythe EMEIA arm of E&Y. Yet investors never wonder much about how the audit gets done until a failure shows up. Nor is there much information available about how the audit gets done.   

Former Fannie Mae CEO Franklin Raines, along with former CFO Tim Howard and former controller Leanne Spencer, settled with its regulator, the Office of Federal Housing Enterprise Oversight,  last Friday.

Recall that Fannie Mae famously abused its accounting for derivative transactions and fee recognition, and has taken years to bring its financials statements back up to the present. According to the OFHEO release, Raines will pay $24.7 million, comprised of:

"The proceeds from the sale of Fannie Mae stock, valued at $1.8 million to be donated to programs and initiatives to assist homeowners threatened with the loss of their homes or related initiatives to assist homeownership, as approved by OFHEO.

Payment of $2 million to the United States Government.

Surrender and relinquishment of claims related to stock options with a value of $15.6 million when they were issued.

Other benefits lost in association with the above estimated at $5.3 million."

It's easy to picture Mr. Raines standing in a corner, with his head hung in shame. In reality, he's probably doing a victory dance: originally, OFHEO had hoped to win $115 million from him. And the Washington Post paints a very different picture of the composition of that $24.7 million:

"The agreement includes stock options worth $15.6 million at the time they were issued; those options are currently under water. They entitled Raines to buy shares at prices of $77.10 and higher. Fannie Mae's shares are currently trading at about $29, so the options Raines is surrendering would not produce any benefit to him unless the share price rose dramatically, according to sources familiar with the settlement who spoke on the condition of anonymity because they did not want to be seen as criticizing the regulator.

OFHEO said Raines's settlement also includes the payment of $2 million to the federal government. That sum would be covered by a Fannie Mae insurance policy, the sources said.

The settlement also includes proceeds from the sale of stock worth $1.8 million, to be donated to programs aimed at assisting financially strapped homeowners. Those are shares Raines had been fighting in court to obtain from Fannie Mae."

Doesn't seem to carry quite the same sting, does it? Not only is the settlement vastly reduced from the original amount of damages sought, the party that Franklin injured - Fannie Mae and its shareholders - wind up picking up the tab for his malfeasance. The terms were similar for Howard.

Is this a great country or what? It's getting to be a weird country, that's for sure.

Last week's Barron's contained a good story  by Andrew Bary on gains being recognized by investment banks on their marked-down debt. I've been a bit surprised by the number of people who've asked about this in the following week: it's not new news. I wrote dedicated reports about it last March, again in June, and once more in November. And it's not as scary as it sounds - Bary's piece was sharp and insightful, and shows that there's a skeptical audience out there when it comes to including such gains in the earnings stream that investors should capitalize. And he quoted some other knowledgable folks who believe this kind of earnings element should not be capitalized by investors.

I believe we'll soon be hearing about the SEC's plans for allowing companies to use International Financial Reporting Standards here in the United States. The Public Company Accounting Oversight Board, a sort of subsidiary of the SEC that provides oversight of the accounting firms that audit publicly-traded companies, issued its strategic plan on March 31. Some of the goals listed in the document indicate how seriously the PCAOB is taking the pending convergence of US and international accounting regimes. Mentioned as a development that may impact the PCAOB's programs and operations:

"...The SEC has undertaken certain rulemaking initiatives related to the acceptance of financial reporting in IFRS. In particular, the SEC adopted rule amendments allowing foreign private issuers to prepare their financial statements inaccordance with IFRS, without a reconciliation to U.S. GAAP. Based on this rule change, the PCAOB has devoted and plans to continue to devote resources to, among other things, training staff in IFRS. If the SEC were to require U.S companies, or give them the option, to prepare their financial statements under IFRS as opposed to U.S. GAAP, the PCAOB would have to devote additional resources to IFRS training to supplement the training described above, as well as possibly recruiting individuals with knowledge and expertise in IFRS. In addition, the Board would have to evaluate the need for any additional adjustments to its programs and consider the need for new initiatives to prepare for such a significant transition in financial reporting and address any concomitant risks related to public company auditing. In any event, the PCAOB plans to consider its relationship with the International Accounting Standards Board (“IASB”) to stay abreast of accounting developments and enhance the IASB’s appreciation for the effect of its work on public company auditing."

One doubts that this would be at the top of the PCAOB's list of possible developments that could impact its operations if it wasn't likely to become a reality. Also, the PCAOB expects to inspect 72 non-US registered accounting firms in 2008. That number is projected to grow 40% in 2009 to 101.

It seems as if the IFRS groundwork is being put into place, quietly. Stay tuned.

Also: a hearty, walloping "thanks!" to Business Week for naming The AAO Weblog in its "Financial Blogs: Best of the Bunch" roundup in this week's issue. It's an honor.

If I haven't mentioned it lately, I'll say it again: Statement 157 is nothing new under the sun. While those who would like to blame accounting for their mistakes (and that's what it does: the accounting shows their mistakes) continue to bleat about the unfairness of fair value reporting, the fact remains that Statement 157 had nothing to do with changing the measurement of fair values. It changed the disclosures: now we can look at reported values and know how much they were the results of quoted markets or black magic. It was always that way - it's just that until Statement 157, we never had a good idea of the prevalence of black magic in financial reporting.

With all the misguided bashing of Statement 157 going on , it's hard to remember that it hasn't even become effective yet . Not until this quarter.

Last Friday, the SEC put in its two cents. The Division of Corporation Finance released a letter it had sent earlier in the month to unspecified financial institutions regarding their pending application of Statement 157. The letter is not an amendment of Statement 157; it's an amplification of Statement 157. The FASB cannot tell companies what to include in the "Management's Discussion & Analysis" section of SEC filings: that's the SEC's turf. Therefore, Statement 157 didn't include any mention of what kinds of disclosures to make in the MD&A. That will be particularly of interest to investors when firms have to use "unobservable inputs" (Level 3) to estimate the fair values of assets. This letter fills that guidance void:

"If you conclude that your use of unobservable inputs is material, please disclose in your MD&A, in a manner most useful to your particular facts and circumstances, how you determined them and how the resulting fair value of your assets and liabilities and possible changes to those values, impacted or could impact your results of operations, liquidity, and capital resources. Depending on your circumstances, the following disclosure and discussion points may be relevant as you prepare your MD&A:

    • The amount of assets and liabilities you measured using significant unobservable inputs (Level 3 assets and liabilities) as a percentage of the total assets and liabilities you measured at fair value.
    • The amount and reason for any material increase or decrease in Level 3 assets and liabilities resulting from your transfer of assets and liabilities from, or into, Level 1 or Level 2.
    • If you transferred a material amount of assets or liabilities into Level 3 during the period, a discussion of:
          - the significant inputs that you no longer consider to be observable; and
          - any material gain or loss you recognized on those assets or liabilities during the period, and, to the extent you exclude that amount from the realized/unrealized gains (losses) line item in the Level 3 reconciliation, the amount you excluded.
    • With regard to Level 3 assets or liabilities, a discussion of, to the extent material:

So much has been written on the passing of Bear Stearns and its merger with JP Morgan Chase , it's almost impossible to add much worthwhile to the discussion. I would say, however, that the most cogent analysis of the deal-making by the Fed - including the blatant shafting of shareholders - was provided by Andrew Ross Sorkin in his post on the NY Times DealBook blog .

And there's a wave of electrons and ink coming your way on the findings of the bankruptcy administrator in the case of New Century Financial, whose 581-page report sent reporters riffling through its pages yesterday. (No, I haven't read it yet. Maybe I'll settle for the executive summary.)

There's another story that contains elements of both stories, in a way. Yesterday, the SEC issued a cease-and-desist order to JP Morgan Chase for its negligence in the case of National Century Financial Enterprises, an issuer of asset-backed securities for which JPM had acted as trustee - a role it inherited when it acquired Bank One, which initially had been trustee for the now-failed health care finance outfit.

According to the administrative proceedings, during the period of 1999-2002, National Century Financial - whose name is creepily similary to New Century Financial - "offered and sold nearly $3.5 billion in asset-backed notes to qualified institutional buyers. NCFE and the programs collapsed in November 2002 when investors and others discovered that NCFE had made large improper transfers among program accounts and caused collateral shortfalls. The collapse caused investor losses of approximately $2.6 billion."

Seems like so long ago now - and so many other asset-backed foibles, it's hard to distinguish them from each other. This one might be memorable for another unsavory reason: the ex-CEO of the firm has been convicted of witness tampering in the fraud trial.

How did the fraud take place? In short, NCFE was kiting cash in the reserve accounts of the asset-backed notes:

"A principal feature of the scheme that allowed NCFE to hide investor losses was the transfer of huge amounts of Reserve Account funds on or around the first and last business day of every month (“Month-End Transfers”). The indentures required that the programs maintain Specified Balances in the Reserve Accounts totaling approximately 17% of the value of the outstanding notes issued by the program. However, even though the indenture trustees for the NCFE programs had the ability to look at the balances in the Reserve Accounts at any time, the indentures only required the programs to report on the balances in Reserve Accounts as of one day of the month, called the “Monthly Payment Date.” The largest program for which JPMorgan Chase served as asset-backed indenture trustee was reported on by NCFE and tested by JPMorgan Chase as of the last business day of the month. The largest program for which Bank One served as asset-backed indenture trustee was reported on by NCFE and tested by Bank One as of the first business day of the month. As a result of this structure, NCFE was able to kite large amounts of funds back and forth between the programs to make it appear that the programs were maintaining the Specified Balances. In fact, NCFE was consistently and severely depleting the balances in these Reserve Accounts without telling investors."

Neither Bank One nor, later, JP Morgan Chase caught on - and that was their undoing:

"The Month-End Transfers were large, recurring, and contrary to the requirements of the indentures. In participating in the Month-End Transfers that were contrary to the requirements of the indentures, Bank One and JPMorgan Chase were negligent and should have known that NCFE was misusing the Month-End Transfers."

Let's hope that JP Morgan Chase is a bit more attentive to the sensitive details of the far more complicated acquisition of Bear Stearns - and whatever trustee role it will be assuming in connection with Bear's asset-backed obligations. This story should further convince investors that where there's securitized assets, there's bound to be some stink somewhere.

And it should also convince investors ...

Last week the FASB issued Statement 161, "Disclosures about Derivative Instruments and Hedging Activities." It requires firms to put in their financial statements what should have been in them from the start of Statement 133, back in 2000. Perhaps most notably, it requires this most basic of disclosures:

"An entity with derivative instruments shall disclose information to enable users of the financial statements to understand:
     a. How and why an entity uses derivative instruments
     b. How derivative instruments and related hedged items are accounted for under this Statement and related    interpretations
     c. How derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows."

Simple, eh? If an annual report was really supposed to be an exercise in communicating with shareholders, this would be a natural place to begin. Any illumination on those fundamental issues would help investors - provided they don't wind up being boilerplate. But - an annual report (or an interim report, at that) is not an exercise in communication with the firm's owners. It's an exercise in compliance. It's a shame that it requires a FASB statement to get the most basic communications on derivatives done right.

Of course, it doesn't stop there. The standard also requires much more tabular disclosure about fair values of derivatives positions and the geography of derivative instruments, and gains and losses therefrom, within the financial statement package. For anyone who's ever tried to pick this stuff out of financials, the standard will be a blessing - if proper "compliance" occurs.

We'll have to wait a while to see how effective it is. The standard won't go into effect until years and interim periods beginning after November 15, 2008. While earlier adoption is encouraged, it's not often that firms are fans of increasing their disclosures on most financial instruments. Don't hold your breath waiting for early adopters to pop up in 2008, especially in times of stress in financial markets.