Financial Services Alert:
FASB Addresses Fair Value of Alternative Investments
A September 30, 2009 standards update from the Financial Accounting Standards Board (“FASB”) ASUNo 2009-12 , Investments in Certain Entities That Calculate Net Asset Value per Share, (the “Update” or “ASU”) provides guidance on how to determine the fair value of investments in hedge funds, private equity funds, venture capital funds, offshore fund vehicles and funds-of-funds (collectively, “alternative investments”). It also provides guidance on how alternative investments should be classified in the fair value hierarchy. Finally, it requires enhanced disclosure in financial statements.
Before this update, the fair value of alternative investments was derived in a variety of ways. Some investors estimated fair value to be the net asset value per share (“NAV”), while others believed the NAV should be adjusted to account for any gates, lockups or other restrictions on the ability of the fund manager to sell the subject investment at will.
This update permits, but does not require, as a practical expedient, the use of an investment’s NAV as the fair value, provided the NAV is calculated as of the reporting entity’s year end. If the NAV is not calculated as of the same measurement date, the NAV would have to be adjusted for significant market events that have occurred subsequent to the measurement date. FASB decided that the NAV provided by the investee is the most relevant estimate of fair value available that would not require undue cost and effort for an investor that holds alternative investments. It is important to note that, under current standards, fund managers still have the obligation to determine the fair value of investments which, in certain circumstances, may require them eschew the practical expedient allowed by the ASU.
Statement of Financial Accounting Standards No. 157, which is now included under Topic 820 of the FASB’s Accounting Standards Codification, set forth a fair value hierarchy that categorizes the inputs to valuation techniques into three levels:
- Level 1, Valuations based on unadjusted market prices in active markets for identical assets or liabilities;
- Level 2, Valuations based on quoted prices in markets that are not active; or for which all significant inputs are observable; and
- Level 3, Valuations based on unobservable inputs.
In what appears to be a change in conventional interpretation, the ASU clarifies that, if the reporting entity is able to redeem the investment at the measurement date, the investment should be classified as a Level 2 measurement. If the reporting entity can never redeem its investment at NAV, the investment would be considered a level 3 investment. For investments that may be redeemable at a future date, the reporting entity should consider the length of time until the investment will become redeemable in determining whether to classify it as having been measured under Level 2 or 3 of the hierarchy. Previously, most entities had concluded that, with the exception of publicly traded funds, the NAV reported for most investments in this category were based on Level 3 inputs.
The enhanced disclosures of the ASU require, by major category of investment (1) the fair value of investments and a description of the significant investment strategies of the investee; (2) an estimate of the period over which the investee may liquidate the underlying investments (e.g., one to three years); (3) the amount of the unfunded commitments; (4) a general description of the terms and conditions needed for redemption (e.g., quarterly redemption, 90 days notice); (5) circumstances where the investment may not be redeemable (e.g., lockups or gates); (6) for those investments with restrictions, the best estimate of when the restriction might lapse; and (7) any other restrictions on the ability to sell.
Anchin will continue to make you are aware of matters of importance to the financial services community as they arise. This alert is for informational purposes only; it is not meant to be a comprehensive analysis of the subject matter and is not intended to provide accounting or other conclusions with respect to the matters discussed in this alert. For additional information on this topic, please contact your Anchin relationship partner or Jeffrey I. Rosenthal, partner-in-charge of Anchin's Financial Services Group at 212.840.3456. |
