Nov. 28, 2011
It is important, particularly for public companies, for the reported fair value of securities to be accurate. For exchange-traded securities and U.S. Treasuries, the risk of inaccurate fair-value estimates typically is low. For investments in government agencies and municipalities, the risk is increased and often requires additional effort to determine that the fair-value estimates are accurate. Some entities have invested in more complex or volatile securities, resulting in a higher risk of inaccurate fair values. Such instruments might include nonagency collateralized mortgage obligations (CMOs) and pooled trust-preferred securities (TPS). Understanding the inputs, valuation methods, and assumptions is an important part of the process of determining the fair value.
Management often relies on third-party pricing services for the fair-value estimates of securities; however, the responsibility for the accuracy of the values remains with management. Therefore it is important, particularly for public companies, for management to evaluate the accuracy of fair values and not simply accept the fair values such third-party servicers provide. Some entities employ personnel capable of evaluating and challenging third-party pricing sources, but the many without such in-house resources are much more reliant on outside sources.
Just as with other accounting estimates, management should maintain internal controls over fair-value estimates of securities. This topic was discussed at a recent meeting of the Standing Advisory Group of the Public Company Accounting Oversight Board, during which a participant commented that lack of appropriate controls over determining securities’ fair values is an area “ripe for material weaknesses.” Of course, the depth of internal controls over fair-value estimates should be commensurate with the complexity of the securities.
Controls that management might have in place include:
- In-house personnel capable of monitoring the financial markets and projecting the impact of market changes on securities;
- Obtaining – and reviewing – the inputs, methods, and assumptions used by management’s source of fair values, which may be a third-party provider; or
- Obtaining fair values from a third-party pricing source (other than the original third-party provider) to corroborate the fair-value estimates. For complex investments, such as nonagency CMOs and pooled TPS, this control should include review of the inputs, methods, and assumptions used to determine the fair-value estimates.
Given that many entities have a calendar year-end (Dec. 31), this is an opportune time to review internal controls in the area of securities fair-value estimates.
For more information, please contact your Crowe audit engagement team or your external auditor.