The Financial Accounting Standards Board has issued revised valuation guidance
on valuing financial assets and liabilities when the volume and level of
activity for the asset or liability have significantly decreased. FASB Staff
Position FAS 157-4 (Apr. 9, 2009). The new guidance applies to entities that
value financial assets at fair value, specifically including investment
companies. FSP FAS 157-4 replaces the guidance FASB issued in October, FSP FAS
157-3, on valuing financial assets in inactive markets. It generally is more
deferential to current market conditions and prices than was the proposed
version, Proposed FSP FAS 157-e. It also drops 157-e's proposed two-step
process for determining whether a market transaction is orderly.

As a basic principle, FSP FAS 157-4 states that fair value is the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed sale) between
market participants at the measurement date under current market conditions.
The last four words are crucial: Regardless of the weight to be given to
individual market transactions, and regardless of the period of time that the
reporting entity intends to hold the asset or liability, the valuation process
is intended to determine the point that is most representative of fair value
under current market conditions (that is, in the inactive market).

In applying 157-4, the reporting entity must first determine whether there has
been a significant decrease in the volume and level of activity for the asset or
liability when compared with normal market activity for the asset or liability
(or similar assets or liabilities). A series of factors that may suggest such a
decrease is provided. Unlike 157-3 and the proposed 157-e, 157-4 uses this
somewhat convoluted wording ("a significant decrease in the volume and level of
activity . . . in relation to normal market activity") instead of "inactive
market."

If the entity concludes there has been such a significant decrease in the
volume and level of activity, transactions or quoted prices may not be
determinative of fair value (for example, there may be increased instances of
transactions that are not orderly). Further analysis of the transactions or
quoted prices is needed, and a significant adjustment to the transactions or
quoted prices may be necessary to estimate fair value. However, it is not
appropriate to conclude that all transactions are not orderly (that is,
distressed or forced). Circumstances that may indicate that a transaction is not
orderly include, but are not limited to:
a. There was not adequate exposure to the market for a period before the
measurement date to allow for marketing activities that are usual and customary
for transactions involving such assets or liabilities under current market
conditions.
b. There was a usual and customary marketing period, but the seller marketed
the asset or liability to a single market participant.
c. The seller is in or near bankruptcy or receivership (that is, distressed),
or the seller was required to sell to meet regulatory or legal requirements
(that is, forced).
d. The transaction price is an outlier when compared with other recent
transactions for the same or similar asset or liability.

An entity shall evaluate the circumstances to determine whether the transaction
is orderly based on the weight of the evidence. This is a significant change
from the proposed 157-3, which required the entity to presume that a quoted
price was associated with a distressed transaction unless the entity had
evidence that (a) there was sufficient time before the measurement date to allow
for usual and customary marketing activities for the asset and (b) there were
multiple bidders for the asset.

Once the entity has reached its conclusions as to whether a transaction is
orderly, it should apply them as follows:

a. If the weight of the evidence indicates the transaction is not orderly, an
entity shall place little, if any, weight (compared with other indications of
fair value) on that transaction price when estimating fair value or market risk
premiums.

b. If the weight of the evidence indicates the transaction is orderly, an
entity shall consider that transaction price when estimating fair value or
market risk premiums. The amount of weight placed on that transaction price when
compared with other indications of fair value will depend on the facts and
circumstances such as the volume of the transaction, the comparability of the
transaction to the asset or liability being measured at fair value, and the
proximity of the transaction to the measurement date.

c. If an entity does not have sufficient information to conclude that the
transaction is orderly or that the transaction is not orderly, it shall consider
that transaction price when estimating fair value or market risk premiums.
However, that transaction price may not be determinative of fair value (that is,
that transaction price may not be the sole or primary basis for estimating fair
value or market risk premiums). An entity shall place less weight on
transactions on which it does not have sufficient information to conclude
whether the transaction is orderly when compared with other transactions that
are known to be orderly. In its determinations, an entity need not undertake
all possible efforts, but shall not ignore information that is available without
undue cost and effort.

The new guidance is effective for interim and annual periods ending after June
15, 2009, and shall be applied prospectively, with early adoption permitted for
periods ending after March 15, 2009.

FSP FAS 157-4 is available online at

http://www.fasb.org/pdf/fsp_fas157-4.pdf

For my post on Proposed FSP FAS 157-e, see

http://groups.yahoo.com/group/FundLaw/message/1230

For registered investment companies specifically, the Securities and Exchange
Commission has posted a bibliography of SEC guidance on valuation, available
online at

http://www.sec.gov/divisions/investment/icvaluation.htm


John M. Baker <JMB@...>
Stradley Ronon Stevens & Young, LLP http://www.stradley.com
1250 Connecticut Avenue, NW, Suite 500
Washington, DC 20036
202.419.8413
202.822.0140 fax
FundLaw Listowner http://groups.yahoo.com/group/fundlaw