8.5 Use of Pricing Services and Broker Quotes

Entities may use pricing service quotes or broker quotes to determine the fair value of certain assets, liabilities, or equity instruments. For example, mutual funds that carry large portfolios of investments at fair value and produce a daily NAV often obtain fair value information from third-party pricing service firms, brokers, or both.

The categorization in the fair value hierarchy of a broker quote or a quote obtained from a pricing service may be observable. However, without sufficient evidence, an entity cannot conclude that such quotes are observable and therefore represent Level 1 or Level 2 inputs. Likewise, an entity should not assume that such quotes are unobservable (i.e., Level 3 inputs). It is ultimately management’s responsibility to understand the fair value measurement techniques and inputs used so that it can (1) appropriately determine the level of the fair value hierarchy in which such fair value measurements are categorized and (2) conclude that the fair value measurements appropriately prioritize observable inputs.

If a quote from a pricing service or broker meets either of the following criteria, it is considered a Level 2 input:

• The entity can determine that market participants (i.e., a broker or others) have transacted, in an orderly transaction, for the asset or liability at the quoted price. For example, an entity might be able to corroborate the quoted price with the same or similar transactions that a broker or others have entered into. ASC 820-10-35-54I and 35-54J provide guidance on determining whether a transaction is or is not orderly when the market activity for an asset or liability has significantly declined (relative to normal market activity).1 If an entity is unable to determine whether a quoted price reflects a transaction that is or is not orderly, it must consider the quoted price in determining fair value, but the quoted price may not be the sole or primary basis for estimating fair value. In such cases, the quoted price needs to be significantly adjusted, potentially resulting in a Level 3 measurement.
• The entity can determine that the inputs the broker or pricing service used to arrive at the quoted price are observable and the Level 3 inputs used do not have a significant effect.

Depending on the item being measured at fair value, a quote from a broker or pricing service may represent one of many inputs or may be the only input into the fair value measurement. ASC 820-10-35-37A requires that “[i]n those cases, the fair value measurement [be] categorized in its entirety in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement.” See Section 8.1.2 for more information.

ASC 820-10-35-54D clarifies that a quoted price (e.g., a quote from a broker or pricing service) may not be determinative of fair value if the volume or level of market activity relative to normal market activity for the asset, liability, or equity instrument (or similar assets, liabilities, or equity instruments) has significantly declined. An entity should perform further analysis to determine whether it must significantly adjust the quoted price to measure fair value in accordance with ASC 820. For instance, if the only transactions underlying a quote are not orderly, the quote may not reflect fair value and little, if any, weight should be placed on it. In addition, a significant adjustment to the quoted price may be required if the price is not based on (1) current information that reflects orderly transactions or (2) a valuation technique that reflects market-participant assumptions (including assumptions about risks). Note that unobservable adjustments to a Level 2 input would render the entire measurement Level 3 if the adjustments are significant to the measurement in its entirety.

To determine whether a quote represents fair value, entities should also consider whether the quote is binding on the party making the quote or is available from more than one broker or pricing service. However, such facts do not necessarily indicate that the quote is “observable.” In other words, a binding quote does not necessarily meet one of the conditions described above. ASC 820-10-35-54M states that, when measuring fair value, an entity must take into account “the nature of a quote (for example, whether the quote is an indicative price or a binding offer) . . . when weighting the available evidence, with more weight given to quotes provided by third parties that represent binding offers.” See Section 10.8 for more information about the use of pricing services and broker quotes.