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Last week, the FASB issued an Exposure Draft proposing amendments to FASB Statement No. 128, Earnings per Share. As with other recent proposals, the EPS changes are issued in conjunction with similar proposals of the IASB, which simultaneously issued its Exposure Draft on proposed amendments to IAS 33, Earnings per Share. The proposals reflect an effort to converge – to the extent possible – EPS guidance under US GAAP and IFRS.

Given that it is somewhat of a lost cause to attempt convergence on the calculation of earnings under US GAAP and IFRS, the FASB and the IASB have focused their efforts on clarifying the instruments that must be included in computing the “per share” amounts. The FASB is now proposing that when computing basic EPS, a company should only include the company’s current common shareholders, instruments that can currently become common shares with “little or no cost” to the holder of the instrument, or instruments that can currently participate in earnings along with the common shareholders. Under this proposed guidance, instruments such as mandatorily convertible securities would not be included in calculating basic EPS prior to conversion, unless the holders participate in current-period earnings along with the common shareholders.

Under FAS 128 today, when a company computes diluted EPS, it is to presume that any instruments which may be settled in either cash or stock will be settled in stock, except that the presumption can be overcome if the company demonstrates a past practice or policy that the instruments are settled in cash. Under the proposals, this exception is removed, forcing companies to always assume that cash or stock settled instruments will be settled in stock (except for instruments that can only be settled in stock in the event of bankruptcy but are otherwise settled in cash). The proposals also call for some changes to the treasury stock method and the reverse treasury stock method, provide some guidance on handling participating securities when computing diluted EPS and would provide that companies consider each quarter and year-to-date period as discrete when computing the number of incremental shares to include in the EPS denominator.

The comment period for both the FASB and the IASB proposals closes on December 5, 2008.

Consolidating SRO Insider Trading Surveillance

The one thing that always fascinates me about insider trading cases is that the perpetrators, who are typically smart, successful people, somehow think that they won’t get caught. I don’t think that these people realize the level of sophistication involved with the SEC’s and the exchange’s surveillance efforts, which are constantly on the lookout for unusual trading activity or trends.

Earlier this week, the SEC announced an effort to rationalize the insider trading surveillance efforts at the some of the SROs, with a proposal that FINRA will cover surveillance, investigation and enforcement with respect to insider trading for Amex and NASDAQ-listed securities (and securities listed solely on the Chicago Stock Exchange), while NYSE Regulation will maintain responsibility for the New York Stock Exchange and NYSE Arca. It appears that the remaining equity exchanges will retain their own responsibilities for surveillance, investigation and enforcement with respect to actions involving their own members.

Overall, this consolidation of regulatory authority over the major exchanges will mean less likelihood for transactions slipping between the cracks, and perhaps stonger investigative and enforcement efforts at the SRO level.

The proposed plan is out for comment for 21 days after publication in the Federal Register.

Tackling Systemic Risk: The CRMPG III Report

I think that one of the positive things to note about the financial crisis over the past year is that we have not yet seen any massive systemic failures within the financial world. Certainly there have been some major disruptions – such as the freezing of the auction rate securities market, the near-failure of Bear Stearns and some large bank failures – but we have not been faced with any sort of system-wide failures such as a massive inability to settle derivatives or widespread defaults spreading from institution to institution.

The Counterparty Risk Management Policy Group III – which is led by former New York Fed President (and current Goldman Sachs Managing Director) Gerald Corrigan and HSBC’s Douglas Flint, and includes senior management from a number of major financial institutions – released its report last week on how financial institutions can seek to contain systemic risks. The report is built around five precepts that organizations must adhere to when implementing the group’s detailed recommendations:

– a corporate governance culture balancing commercial success with disciplined behavior;
– effective risk monitoring of all positions on a real time basis;
– estimating the firm’s risk appetite;
– focusing on potential contagion risks; and
– enhancing oversight.

As with the group’s prior reports, this report should be useful for firms seeking to apply what has been learned from this latest financial crisis to make progress toward reducing the unprecedented level of systemic risk.

– Dave Lynn