The FASB on March 23, 2022, voted 4 to 3 to finalize a proposal that clarifies the rules for measuring equity securities that are under contractual sale restrictions.
Under the provisions, an entity would not consider any contractual restriction on the sale of an equity share when measuring the share’s fair value because the restriction is not considered to be part of the share’s unit of account.
The guidance will take effect in 2024 for public companies and in 2025 for private companies that are calendar year-end filers. Earlier application will be permitted.
“There is no black and white answer; I think the [proposal] is the best answer,” FASB member Gary Buesser, an analyst, said. “You see in some instances where there’s a 10 percent discount for a six month lock up period, to me it doesn’t reflect economic reality. As a former equity [portfolio manager] I would have loved to have bought publicly traded stock at a 10 percent discount, I would have done it all day long – you know five star fund pretty quickly, so I don’t think that’s true – the 10 percent discount,” he said. “If you look at it from a [net asset value] perspective, you say no discount the buyer is overpaying; the flip side to that coin, is if you include a 10 percent discount, the seller is being short changed, so I think it is a two sided argument, and therefore I think reducing complexity, increasing comparability is my point.”
FASB Chair Richard Jones, Vice Chair James Kroeker, and board member Fred Cannon dissented, citing – among other points – concerns that the result of the net asset value (NAV) could be misrepresented by investment companies.
“[It] won’t be reflecting the underlying economic value of the funds; in my view that’s not in the best interest of the investing public,” said Cannon, also an analyst. “NAVs as Jim [Kroeker] pointed out are the primary metric used by investors to make investment decisions in these funds – they often do not, I believe, go to the proxies and other documents to look at things, and we know from the money market fund crisis that we know that misstated NAVs can cause significant risk.”
Qualitative and quantitative disclosures will be required to help users better understand the existence of contractual sale restrictions and the liquidity risk it presents to the entity’s investments in equity securities.
The decisions relate to proposed Accounting Standard Update (ASU) No. 2021-005, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions, which was issued in September 2021 to solicit public feedback. The proposal generated 28 comment letters.
The comment letter feedback was also mixed, with a lack of consensus in any industry or stakeholder group, according to board meeting papers. Two trade groups representing the investment company industry held opposite views, with one trade group stating that it supports proposal and the other trade group stating that it supports the alternative view floated in the proposal by dissenting board members.
Those in agreement with the proposal – among other reasons – said it would provide less complexity and subjectivity in the estimate; reduce operational cost and complexity; and provide greater comparability across reporting entities.
Among reasons respondents that were not supportive of the proposal cited is that “the difficulty in measuring an appropriate discount is not a compelling reason to ignore the economics of the contractual restrictions on sale.”
This article originally appeared in the March 24, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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