In recent months advocates of fair value accounting have been challenged by groups that blame fair value accounting for exacerbating the credit crises (by requiring banks to lower valuations of certain assets, including illiquid assets such as mortgage backed securities). The following is a chronological summary of key developments in the ongoing controversy pertaining to fair value measurements as prescribed under FASB Statement No. 157.
On October 7, 2008, the federal bank and thrift regulatory agencies announced a proposed rule that would allow banks to assign a 10% risk weight to claims on, and portions of claims guaranteed by, Fannie Mae (FNMA) and Freddie Mac (FHLMC). Claims include all credit exposures, such as senior and subordinated debt, and counterparty credit risk exposures, but do not include preferred or common stock.
The agencies believe reducing the risk weight (from 20%) is appropriate in light of the financial support the Treasury Department announced in September. Comments must be received by November 26, 2008.
Introduced in the House on October 2, 2008, H.R. 7242 would make technical corrections to the Pension Protection Act of 2006. However it does make a few changes to IRC Section 101(j), which was of course part of the PPA. One change is adding a new paragraph to the section regarding notice and consent. In essence consent and notice requirements will be found to be satisfied if met not later than 90 days after the later of the date of contract issuance or the date the applicable policyholder first becomes the owner of the contract. It also added 5-percent owners among exceptions based on insured’s status which currently include directors and highly compensated employees.
The bill, if enacted, will provide some needed clarifications. For example, employers who may still be awaiting responses from selected employees to notification and consent communications, will no longer have to wait for all responses before closing (i.e., for fear that they might taint the entire transaction). Policies applied for covering those employees who, within 90 days after the close, return proper affirmative documentation, may be retained. Conversely, policies covering employees who fail to return a response or who reject being covered during the succeeding 90 day period, presumably may be rescinded within that period without invalidating the broader program.
By replacing the prior language defining highly compensated employees …” is, at the time the contract is issued” with …”during the current or preceding year”, the bill expands who may be insured without endangering compliance.
While these changes are welcome, it should be noted that the bill fails to address some areas still in need of clarification (e.g., how long after an employer receives conforming, written consent from an employee may it initiate a purchase or exchange?).
The bill was referred to the House Education and Labor committee on October 2, 2008.
The Energy Improvement and Extension Act of 2008 is likely to be enacted. It is a voluminous piece of legislation that amends the Internal Revenue Code to extend and modify expiring provisions related to energy production and conservation and to provide for revenue enhancements. The costs of the bill would primarily be offset by eliminating the benefits of deferred taxation on compensation payable to certain offshore corporations, such as hedge funds managers. The bill would be effective with respect to fees for services rendered December 31, 2008 and also would apply to amounts deferred for services performed before 2009 to the extent the amounts are not otherwise included in taxable income prior to 2018.
The bill, if enacted, will have a negative impact on non-qualified deferred compensation plans covering certain offshore corporations, including hedge fund managers. The bill passed the House in May 2008 and then the Senate in September.
The Derivatives Market Reform Act was reintroduced by Representative Edward Markey (D-MA). The new measure is the fourth round for the bill (Markey initially introduced the legislation in 1994, and again in 1995 and 1999) with the latest version calling for the creation of a framework to improve supervision and regulation of the unregulated derivatives dealers and for certain reporting requirements for hedge funds. While hedge funds tend to play a limited role in COLI and BOLI policies, the bill, if enacted, would impact these investments. The bill was referred to the House Committee on Financial Services on October 3, 2008.
New Federal Rule of Evidence 502 was signed into law on September 19, which limits attorney-client privilege and work product waivers. In addition to adding clarity to some grey areas in evidence rules, the law also attempts to reduce the exorbitant costs (both time and money spent) associated with reviewing documents for privilege. It also provides a new rule to provide relief for some unintentional productions (if the privilege-holder took reasonable steps to both prevent disclosures in the first place and rectify the error).
While it would be nice to scale back costs related to document reviews, it may be unwise to relax the review process in reliance of this rule alone. It applies to all proceedings commenced after its enactment date and to all proceedings pending that date if “just and practicable”. There may also be some constitutional problems with some of the provisions that make federal privilege rules binding on state courts.
The New York State Insurance Department has announced that their regulators will be looking into insurers’ lending practices. It is also likely that other states will be reviewing insurers’ lending focusing on the insurers’ ability to manage the risk of lending securities to third parties. In the case of AIG, the Federal Reserve Board has agreed to take the place of third party borrowers that do not have the liquidity to provide cash collateral.
On October 3rd, the Internal Revenue Service released Internal Legal Memorandum 200840043 (ILM) expressing a troubling interpretation regarding the “investor control” doctrine applicable to variable insurance products. While ILM’s are not official precedent, they may offer insight as to how the Service may seek to apply doctrine prospectively.