The Price of Everything but the Value of Nothing

Broker quotes and pricing services have long been the Achilles heel of valuation of infrequently traded investments.

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A lack of rigor means banks, hedge funds and even credit funds too often accept quotes that don’t undergo scrutiny.

No longer. The Public Company Accounting Oversight Board (PCAOB) has come to the conclusion others reached long ago: The emperor may be wearing no clothes.

In its proposed new guidance for auditors on assessing the relevance of pricing information from brokers and pricing services, the PCAOB says it’s no longer enough to rely on indicative prices or quotes with limitations. Quotes must reflect actual trades, or a willingness to transact without limiting conditions.

In fact, the considerations where valuations use brokers’ quotes or pricing services are three-fold: prices are (i) contemporaneous, (ii) actionable (if a broker) and (iii) congruent—they need to be quotes for trading a similar size, or unit of account, to the holding being valued.

Even where fair values are based on quoted prices or transactions in active markets for the same or similar financial instruments, auditors are required to evaluate the process. Where there are no appropriate recent transactions to support the valuation, the auditor will evaluate the appropriateness of the valuation method and the reasonableness of observable and unobservable inputs used by the pricing service, or, in the case of brokers, whether quotes are timely, binding and without restrictions, limitations or disclaimers.

Effectively, auditors need to see that valuations are based, if not on actual transactions, then on a robust pricing model. Simply taking the broker’s or pricing service’s word for it won’t be sufficient. It will be up to asset holders to provide evidence to the auditor, but brokers, too, are likely to feel increasing pressure from their clients to meet that need.

Furthermore, the impact of the change will also be felt outside the United States, because the guidance will apply to audits of any entities with a Securities and Exchange Commission (SEC) registration, wherever they’re based. In addition, it’s likely to prove increasingly uncomfortable for auditors in other jurisdictions to continue to blindly accept broker quotes or pricing service data now that the shakiness of their foundations is being exposed.

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