The Securities and Exchange Commission has
updated its guidance to preparers of financial statements about what they should plan to say in Management Discussion and Analysis regarding their measurement of fair value, especially given continuing market turmoil.
The SEC Division of Corporation Finance published a sample of the letter on its Website for the benefit of any who may not have received the letter personally. The letter advises companies to think carefully about whether they are disclosing enough regarding their use of market information and judgments in valuing assets and liabilities under
Financial Accounting Statement No. 157: Fair Value Measurements, especially for instruments that are thinly traded in the current stormy market environment.
The letter pays particular attention to fair-value measurements involving derivatives and to measurements based on broker prices. For pricing based on broker assistance, the letter advises companies to elaborate on the extent to which the broker price is based on live transactions or other inputs, such as the use of models.
With respect to derivatives, the letter notes companies are required to provide plenty of disclosure around instruments they elect to report at fair value under
FAS 159: The Fair Value Option, but not for instruments they’re already required to report at fair value. In the letter, the staff suggests plenty of explanation for how the measurements were reached.
David Larsen, managing director at Duff & Phelps, said the recent guidance doesn’t change anything the SEC said in March when it published its
first FAS 157 letter to CFOs, but elaborates on the interplay between market pricing and modeling when market activity has evaporated. Level 1 under the FAS 157 hierarchy relies solely on market prices, and Level 3 relies solely on modeling; Level 2 offers a hybrid approach.
“Is it better to have bad Level 2 input or good Level 3 input in determining fair value?” he said. “If you’re using broker quotes, are they based on anything or are they just someone’s opinion?”