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Seow's work to help protect investors
September 7, 1998

Risk is inherent in any investment. But in 1994, investors in Procter & Gamble found out that they'd risked more than they realized, when the company lost $102 million on bad derivatives decisions - investments that were hidden from shareholders.

"Investors are in the dark about derivatives," says Gim Seow, an associate professor of accounting, "because derivatives do not get recorded on corporate financial statements."

That will change as of June 15 next year, because of a new requirement by the Financial Accounting Standards Board (FASB), a private independent body that sets and interprets generally acceptable accounting principles.

Seow, one of eight staff members who developed the statement, has co-written a training manual on derivatives as part of a fellowship at the FASB to prepare auditors in public accounting firms and financial statement preparers for the new rules.

It will teach the do's and don'ts, Seow says, to conform with the FASB's Statement 133, which requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. The manual will assist companies in applying standard accounting practices for derivatives, as they comply with the requirement.

Investors have good reason to be concerned about the use of derivatives, says Seow. While derivatives are designed to manage risk, they carry their own.

"Derivatives are basically financial contracts that are written on other items," he says. "In return for a premium up-front, a company or financial institution would accept some risk. It is a bet on what might happen in the financial markets."

It has been common practice for investment bankers to design derivative contracts so that it would appear that no money was exchanged up front. Companies waited until they settled the contract before they reported gains or losses, and they never explained how those were obtained.

In 1997, $50 trillion changed hands through derivative contracts, he says. "Statement 133 will make companies act more cautiously about using derivatives, because they will have to report those contracts to the public."

The new accounting standard will make it easier for investors to assess a company's risk exposure. "But we will have to wait two years before that happens," he says.

"While a few companies have indicated an interest in adopting the new standard early," he adds, "others are struggling with issues such as the Year 2000 computer problem and the new European currency, which could prevent them from immediate compliance with Statement 133."

Luis Mocete