KPMG; The private investment trust “Off-Balance Sheet” Report

 

The SEC’s OBS Report: Pensions

A few nuggets from the SEC’s report on off-balance sheet financings, focused on their study of pensions…

Note that the private investment trust mandate in performing the study didn’t originally include pension accounting; rather, they were to concern themselves with things like the kinds of special purpose entities used by Enron to achieve intended accounting “optical” in their financial statements. The SEC expanded its scope to include pension and other postretirement benefits obligations because the existing accounting for the full obligations is opaque. One of the peculiarities of pension accounting is that pension assets and pension liabilities are presented on a sponsor’s balance sheet on a “net” basis – so the full extent of pension assets and obligations is never displayed, only a residual. Thus, pension accounting shares an attribute of the Enron-style financings: the firm’s true rights and obligations are not shown on the balance sheet.

So – what did the SEC’s study show? The Commission examined financial statements of 200 issuers; of them, 48% reported defined benefit plans requiring Statement 87-style accounting, and another 44% reported other postretirement benefit plans (for benefits like health care costs) requiring Statement 106 accounting. With regard to pensions, 81% of the 100 largest issuers in the study sponsored pension plans; 74% of them sponsored other postretirement benefit plans.

Some truly huge numbers: the companies in the study reported $86 billion in “underfundedness” for pension plans; extrapolating that to the population of U.S. registrants yielded $201 billion of underfunded pensions buried in publicly-traded firms’ balance sheets. The projection for the underfunding of other postretirement benefit plans was worse: $336 billion. (Pages 53 – 57)

The study suggests that the underfunding could be worse: it included a survey of the discount rates used in figuring the present value of the two kinds of benefit obligations. Without seeing the detailed justification for a particular discount rate, it’s difficult to make a judgment as to whether or not a discount rate was grooved to be as high as possible. In comparing the reported discount rates to benchmarks such as the Bloomberg fair value index bond yields for maturities of 10 years to 30 years, or the S&P Credit week Corporate Industrial AA bond Yields for maturities of 10 years to 25 years, the SEC found that the firms, on average, had rates that were at the high end.

The SEC’s recommendation regarding retirement arrangements: the FASB should add a project to its agenda to rethink the accounting for them. Considerations: “gross presentation” of assets and obligations in the sponsor’s balance sheet; eliminating deferral of actuarial gains and losses; and “live” valuation of assets. Sounds simple, but don’t hold your breath.

KPMG; The SEC’s “Off-Balance Sheet” Report

Some week!

There’s the unfolding drama at KPMG: will the Justice Department indict the firm for its tax shelter transgressions, giving the fourth-largest public accounting firm a veritable death sentence a la Andersen? Or will it devise a punishment that is so overbearing that they’ll wish they were indicted? Or will nothing happen?

It’s an interesting tension: if the Justice Department indicts KPMG, driving them out of business, then we’re down to three major auditors. Thousands of employees that had nothing to do with the skanky tax products will be looking for new employers. Hardly justice, it would seem. When Andersen went under, there were four firms to take on their audits – an extremely trying situation for auditors and audited. If KPMG were to go extinct, their share of the audit business would suddenly have to be distributed to just three firms. The resulting dislocation would make this year’s Section 404 internal control reviews look like the lazy, hazy, crazy days of summer.

If the Justice Department does nothing, then they might be seen as backing off from their case for fear of economic consequences: it might be as if they are saying to all of the Big Four firms “you’re too big to fail.” Not a signal they’d want to send, I think. And if that signal were to be sent, there could be consequences down the road. Behaviour of auditors might become too client-favourable, as opposed to shareholder-favoured.

So, it’s a guessing/waiting game to see what happens. In the meantime, you might better spend your time with this: the SEC’s long-awaited off-balance sheet financing study, required by Sarbanes-Oxley in 2002. It’s the last really big report required by the Act.

At 115 pages, it’s too big to cover in just one posting. And I have been on the road for most of this week, with little time to read it. So I will be selecting bits and pieces from the report from time to time over the next week or so. Unless there’s nothing in it worth passing on to you, which I find hard to imagine. Stay tuned.