Having tied itself in knots with accounting for derivatives, the Financial Accounting Standards Board (FASB) in mid-October refloated a concept that dealers and users thought they'd helped defeat a year ago. By a six to one vote, the FASB ordered the preparation of an exposure draft by next June that would mark to market most derivatives portfolios. Under the new plan, gains and losses would be reported in earnings or as adjustments to shareholder equities. None of the current deferrals, or matching of hedge positions, would be sanctioned.

Predictably, derivatives users are girding up to fight again. The main objection: that derivatives instruments are the only assets that would be stated at market values. "We understand that FASB has a problem, and is under pressure to come up with some accounting improvements, but this direction is not the right answer," notes a vice president at a U.S. money center bank. "There is nothing wrong with the current model that cannot be fixed."

FASB's latest proposals will prolong the marathon on derivatives accounting, which has already lasted two years. If adopted by the board, the exposure draft is sure to be strenuously attacked. One form of criticism will be spearheaded by the one dissenting FASB member, Jim Leisenring, who objected that interest rate swaps with embedded options would not have to be marked to market, while vanilla swaps would. Leisenring believes that loophole will spur a wave of user migrations away from standard interest rate swaps.

Corporates would be well advised to closely follow the terms of the Security and Exchange Commission's release last month of a cease and desist order with Gibson Greetings. The agency clearly promises to be harsh on companies that buy derivatives without also having the internal systems and accounting and reporting procedures to measure the risks involved. It also made it clear that companies cannot defend themselves by using current accounting conventions or by asserting that they were deceived by derivatives dealers, in this case Bankers Trust, which sold them the derivatives.

In spelling out how Gibson had failed to "satisfy their obligations" under the law, Colleen Mahoney, SEC deputy enforcement chief, declared that all companies have to disclose "changes in the nature, terms and risks associated with the company's derivatives" on a quarterly and annual basis, and mark them to market. The agency forced Gibson, a maker of cards and party favors, to admit that it erred in using deferred accounting on derivatives when it created a misleading result. "I think it is a pretty clear message that people need to be perhaps more vigilant in terms of derivatives disclosure," notes Henry Hu, a law professor at the University of Texas at Austin.

Hoping to ease anxieties over derivatives, the Federal Reserve Bank of NY and no less than six Wall Street trade groups some months ago unveiled a set of voluntary "best practice" guidelines called "Principles and Practices for Wholesale Financial Transactions." An important consortium of local government derivatives users has just branded the principles soft and misleading. The Government Finance Officers Association, the National Association of State Treasurers and the Association of State Auditors, Comptrollers and Treasurers last month warned that "they may adversely affect your transactions with your broker/dealer," as well as adversely impact the legal rights of end-users. What the three state and local government bodies specifically objected to was that the guidelines imposed no obligation on broker/dealers to determine the "suitability" for a local government portfolio. As such, they would not have given West Virginia or Orange County rights of recourse for their multimillion losses. These critics advise muni users to go beyond the principles and make their broker/dealers sign a specific advisory agreement that covers the suitability question.