SEC Staff Letter on Blockage Factors in Fair Value Estimation

Home | Previous Page

April 11, 2001 Mr. Mark V. Sever Chair, Accounting Standards Executive Committee American Institute of Certified Public Accountants 1211 Avenue of the Americas New York, NY 10036-8775 Dear Mark: Based on your letter dated March 13, 2001, I understand that the Accounting Standards Executive Committee (AcSEC) has decided to pursue a project addressing whether it is appropriate to use a blockage factor in estimating fair value, and what methodology should be used to measure a blockage factor. I want to reiterate that the SEC staff does not support the use of blockage factors, and, thus, this project being undertaken by AcSEC until such time as broader guidance on valuation models and methodologies used to measure fair value is completed. The Investment Company Act of 1940 (the 1940 Act) requires a registered investment company to value securities using market quotations when they are readily available. Therefore, we do not believe it is appropriate to discount or mark-up a readily available market price for an unrestricted security solely because an investment company holds a large quantity of the outstanding shares of an issuer or holds an amount that is a significant portion of the security's average trading volume. FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities , also prohibits the adjustment of quoted market prices in the determination of fair value. Similar guidance can be found in APB Opinion No. 25, Accounting for Stock Issued to Employees , which requires quoted market prices to be used to measure compensation cost. The staff is concerned that a block of stock could create earnings management opportunities. For example, a block of stock may be acquired, and a discount from the market value may be recorded. In many cases, that stock will not be sold as a block, but instead in smaller amounts, creating gains, and increasing earnings reported to investors. This practice decreases the quality of earnings. While not authoritative, we have noted that the Joint Working Group of Standard Setters' Recommendations on Accounting for Financial Instruments and Similar Items would not permit blockage adjustments. Moreover, we have noted that the FASB technical staff's comments on the International Accounting Standards Committee's Exposure Draft, Business Combinations , included "why should an enterprise be allowed to discount...market value?" The FASB staff also commented that any adjustments to market value may promote "undesirable accounting." The SEC staff does not support AcSEC's pursuit of a valuation project focused solely on blockage. Even if AcSEC completes a project on blockage, SEC registrants will continue to be precluded from applying a blockage factor in estimating the fair value of unrestricted investments if a quoted price in an active market is available. Accounting Series Release (ASR) No. 118 states that the last quoted sale price should generally be used without adjustment. ASR 113 provides
guidance with respect to restricted securities. If you have any questions or would like to discuss these issues further, please contact Jackson Day or David Kane at (202) 942-4400. Sincerely, Lynn E. Turner Chief Accountant

http://www.sec.gov/info/accountants/staffletters/acsec041101.htm

Home | Previous Page

Modified: 07/25/2001