FASB Proposes Changes in Repo Agreement Rules

The Financial Accounting Standards Board has issued an exposure draft outlining changes in the accounting standards for repurchase agreements such as the Repo 105 transactions that have been blamed for contributing to the collapse of Lehman Brothers.

FASB is soliciting input on its proposals to improve the accounting for repo agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. FASB is asking for comments on the proposals by Jan. 15, 2011.

“During the global economic crisis, concerns were expressed about a narrow aspect of existing guidance for determining whether a repo should be accounted for as a sale or as a secured borrowing,” said FASB acting chairman Leslie F. Seidman in a statement. “The proposals contained in this exposure draft seek to address these concerns by simplifying this guidance.”

Bankruptcy examiner Anton Valukas issued a report in March explaining how Lehman Brothers used repurchase agreements that it called Repo 105 to shift $50 billion off its balance sheet at the end of the first and second quarters of 2008 to temporarily hide its debts. The report called attention to the role of Lehman’s auditing firm, Ernst & Young, which has argued it wasn’t auditing the investment bank during those quarters. However, Ernst & Young has been sued by Lehman investors seeking to recover the money they lost from the collapse of the bank in 2008. FASB wrote to the leaders of the House Financial Services Committee in April saying it would work with the Securities and Exchange Commission and the International Accounting Standards Board on addressing the accounting issues with repo transactions (see Lehman Ex-CEO Confronts Accounting Questions).

In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. Topic 860, “Transfers and Servicing,” prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets.

The amendments in FASB’s proposed update are intended to simplify the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets, as well as implementation guidance related to that criterion.

The exposure draft is available at www.fasb.org.