Pricing sources for determining fair value of investments
The SEC staff has recently shown increasing interest in how companies are using pricing service information to determine the fair value of their investment securities. Third party pricing services are commonly used by financial institutions to estimate the fair value of their investment securities. The SEC staff is focused on securities that are not actively traded, as well as those for which there is no observable data upon which to estimate fair value (e.g., private-label mortgage backed securities, collateralized mortgage obligations, collateralized debt obligations). When an exchange traded price is not available, the pricing services are exercising a degree of discretion and judgment to reach an estimate.
This may explain why the SEC staff is looking closer at this issue, asking whether companies sufficiently understand the methods used by the pricing services to determine the fair value measurements so that management can comply with generally accepted accounting principles and properly disclose the fair value information required in the financial statements and in MD&A disclosures. The staff also has expressed concern as to whether companies have designed and implemented appropriate internal controls over the fair value measurements and disclosures when a pricing service is involved.
This issue was recently addressed in a speech presented at the 2011 AICPA National Conference on Current SEC and PCAOB Developments on December 5, 2011 by Jason K. Plourde, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission. This topic is vitally important for issuer banks, but privately-held banks would also benefit from reading it.
For more information about this topic, please contact John Keyser, national director of Financial Institutions Services, McGladrey & Pullen, LLP, 702.759.4046.