Measuring Fair Value of Assets Subject to Contractual Sale Restrictions

ASU 2022-03 provides clarification on contractual restrictions

In the past there has been diversity in practice in whether contractual restrictions have been factored into the measurement of fair value for an equity security. Specifically speaking, whether a discount should be included as an adjustment to the estimate. Examples of such restrictions include lock-up agreements, market standoff agreements, and sale restrictions between shareholders.

Accounting Standards Update (“ASU”) 2022-03 clarifies that a contractual restriction should not be considered because it is a characteristic of the reporting entity holding the equity security. Although it may impact the behavior of the holders of the security, it doesn’t affect the security itself. Therefore, the security should be valued at the quoted price without further adjustment, even if it cannot be sold by the reporting entity on the measurement date.

Considerations for estimating the discount for legally restricted securities

This is not true for a legally restricted security that cannot be sold on a national exchange or Over-the-Counter (OTC) regardless of who holds it, because this is a security specific restriction (versus entity specific restriction). Market participants would consider this inability to sell in the pricing and therefore this is considered a characteristic of the asset that should be factored into the valuation.

When estimating the discount for legally restricted securities, consider:

• The nature and duration of the restriction;
• The extent to which buyers are limited by the restriction;
• Qualitative and quantitative factors specific to both the instrument and the holder.

Include disclosure of the nature, remaining duration of the restriction, and circumstances that could cause a lapse in the restriction.

This ASU is applicable to public business entities for 2024 and other entities for 2025. This amendment should be applied prospectively, with additional transition guidance for investment companies. Early adoption is permitted.

Questions on this topic? Contact your Keiter Opportunity Advisor or the Financial Services Industry team.