http://www.bloomberg.com/apps/news?pid=20601039&sid=aP4uPeND1UH4 Beware Bankers Spinning Story of Smooth Results: David Reilly Share | Email | Print | A A A Commentary by David Reilly Sept. 11 (Bloomberg) -- The financial results that companies give investors are supposed to paint a picture of how things are. Banks and their regulators want to turn that notion on its head so they can spin a smooth tale of how they would like things to be. Sadly, some accounting rule makers may be ready to appease banks and the politicians who back them. If that happens, financial results will change from a vital tool for investors to a vehicle catering to managers, regulators and employees. This would undermine the idea that the needs of investors drive markets, replacing it with a more corporatist outlook favored by companies and politicians in continental Europe and Japan. In other words, the goal of providing unbiased, impartial information about a companyâs worth would be trumped by a companyâs business model and the broader needs of the financial system. This battle over financial reporting is playing out in the debate over proposed accounting rules for how banks value things such as loans and bonds. The International Accounting Standards Board is hoping to have new rules in place by year-end. The Financial Accounting Standards Board in the U.S. is moving at a slower pace, though the boards hope to eventually agree to similar rules. Both groups have come under fire from banks and regulators in the past month, although the IASB has drawn the most heat. Thatâs happened even though the IASB has already bent too far to please the industry. Listen to Government In late August, French Finance Minister Christine Lagarde wrote to the European Commission decrying some of the proposed rules while saying the independent IASB must be made âmore responsiveâ to government wishes. Banks and their regulators meanwhile have claimed that proposals from both boards rely too much on mark-to-market accounting. The American Bankers Association yesterday wrote to Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke asking that they bring up the issue at the meeting later this month of the G-20 industrialized nations. The attacks go deeper, though, seeking to change the underpinnings of financial reporting and who it should serve. The accounting-rule changes should gauge the worth of a companyâs holdings based on its business model, according to a letter from the ABA last month. This would allow banks to overlook short-term changes in the value of a security because they decide to call themselves a long-term holder. No. 1 Audience The rules should also âimprove the decision usefulness and relevance of financial reporting for stakeholders, including prudential regulators,â according to a document issued last month by the Basel Committee on Banking Supervision, a group whose members are central banks. In other words, investors should no longer think that they are the main audience for financial statements. The practical result of such approaches would be to allow banks to report smoother results that supposedly reflect their long-term prospects. For banks, smoother profits would presumably lead to higher share prices. For regulators, less volatile results would supposedly make it easier to maintain financial stability. The problem, as investors know, is that life, and markets, arenât smooth. Conditions change, as do financial values. Because of this, investors need financial statements that provide information about the current state of a companyâs business and worth. The past two years, replete with unexpected failures of supposedly solid firms like Lehman Brothers Holdings Inc., have shown how vital that is. Creditors Count Plus, investors arenât just shareholders. They include creditors such as bondholders, who need to know what a company is worth today in case it goes under. Banks argue that their intent should matter. If a bank plans to hold, rather than trade, a security, it shouldnât have to worry about daily fluctuations in its value, they say. Both the IASB and FASB have given ground to this business- model view, although the FASBâs changes arenât as onerous for investors. The IASB, on the other hand, wants to give banks more chances to show holdings at their historical cost. In doing so, it also plans, unlike the FASB, to allow banks to completely ignore changes in the market value of some securities. This may result in banks reporting puffed-up equity, giving investors a false sense of comfort. Two banks, for example, may hold the same AAA-rated security, which has fallen, say, $5 from a face value of $100. One might report a value of $95, the other, $100. This would make it difficult for investors to make apples-to-apples comparisons among companies. Predicting Trouble It may also leave investors in the second bank smarting if it turns out markets correctly predicted looming trouble for the bondâs value. Oddly enough, the IASB has still come under fire from banks and regulators who argue the board is looking to increase, not decrease, the use of market values. This is because the IASBâs business-model approach wonât be allowed for securities that have low credit ratings. This reflects banksâ true desire to record the value of all holdings based on their own view of how the economy and business conditions will play out. That may suit their purposes and those of regulators who will countenance any fiction if it means markets are momentarily calm. It wonât do much for investors. Theyâll quickly discover that when bankers paint pictures of rainbows, there probably isnât a pot of gold at the end of it.