As the paradigm shifts to the new fair value standard, many accountants and CFOs alike are writhing over the flexibility of the framework and the implications it might have for them, not to mention its impact on them. Taking responsibility for the valuation of illiquid assets that can and do trade is one thing – the valuation of purely theoretical assets is entirely another. Several examples of these assets exist in the current accounting environment under SFAS 141 (customer relationships, developed technology, non-compete agreements, etc) and many more appear to be in the pipeline as a result of SFAS 141R (contingent assets and liabilities) and SFAS 157 (no one knows yet). The problem: the valuation of these assets is primarily driven by the assumptions developed by people, not markets. As a result it is impossible to determine the true, or intrinsic, value of these assets at any particular point in time.
That said, these theoretical assets are “creeping” onto the balance sheet in a time of severe economic contraction. Many expect the coming years to be a period of heightened litigation. For executive managers (CEO, CFO)—who are required to certify and approve of the integrity of their company’s financial reports under Section 302 of Sarbanes Oxley—it is a frightening time. Understandably they (and their attorneys) are exploring every possible avenue to mitigate risk. Enter the valuation professional. Increasingly, public companies are pressing their valuation providers to officially support their analyses by providing their consent to be named in the SEC filings. From what I have been told by our attorneys, this essentially thrusts the valuation provider into the role of expert, which has a special definition under securities laws (this is called “expertising”). It also creates enormous exposure for said valuation provider. You can’t really blame management and their attorneys for attempting to spread the risk and shore up the values, given their comfort level in the numbers. It’s led to the concept of replacing specific values with ranges of reasonable values (see the post called “The Perils of False Precision” dated October 8, 2008But until that happens, I can see a mad dance of passing the hot potato in terms of someone taking responsibility for the “integrity” of the numbers. Here is where the valuation providers need to redefine themselves - away from positioning as synthetic “market makers” that render intrinsic values and more toward becoming consultants who assist management in arriving at reasonable estimates. Unfortunately, the “expertising” trend implies that the provider is serving in the former role. This is undoubtedly a very dangerous place to be. The good news is that the larger firms (big four, HLHZ, etc) have adamantly resisted pressure to consent. The bad news is that smaller valuation firms, desperate for the business and mostly uninformed about the potential consequences, have started engaging in this practice. Hopefully this does not result in an acceptable risk mitigation practice for companies which in turn would result in a squeeze-out of the solid, high-ranking valuation firms in favor of the desperate, bottom-feeding ones.
I don’t think this will happen with the Fortune 1000 companies. The brand value and unified front of the Big Four and large valuation houses will make sure of that. However, the broader undefined universe of small and mid-cap companies is another story entirely. We have had some success in diffusing these situations by connecting the clients who are pushing for consent with attorneys from reputable law firms who have been in the same situation and fully understand the valuation provider’s exposure. These professionals act as our advocates and provide the reputational value sometimes necessary to firmly illustrate consenting is not prudent, and is not market. We certainly hope this hot potato doesn’t become accepted practice, but we shall see.
That said, these theoretical assets are “creeping” onto the balance sheet in a time of severe economic contraction. Many expect the coming years to be a period of heightened litigation. For executive managers (CEO, CFO)—who are required to certify and approve of the integrity of their company’s financial reports under Section 302 of Sarbanes Oxley—it is a frightening time. Understandably they (and their attorneys) are exploring every possible avenue to mitigate risk. Enter the valuation professional. Increasingly, public companies are pressing their valuation providers to officially support their analyses by providing their consent to be named in the SEC filings. From what I have been told by our attorneys, this essentially thrusts the valuation provider into the role of expert, which has a special definition under securities laws (this is called “expertising”). It also creates enormous exposure for said valuation provider. You can’t really blame management and their attorneys for attempting to spread the risk and shore up the values, given their comfort level in the numbers. It’s led to the concept of replacing specific values with ranges of reasonable values (see the post called “The Perils of False Precision” dated October 8, 2008But until that happens, I can see a mad dance of passing the hot potato in terms of someone taking responsibility for the “integrity” of the numbers. Here is where the valuation providers need to redefine themselves - away from positioning as synthetic “market makers” that render intrinsic values and more toward becoming consultants who assist management in arriving at reasonable estimates. Unfortunately, the “expertising” trend implies that the provider is serving in the former role. This is undoubtedly a very dangerous place to be. The good news is that the larger firms (big four, HLHZ, etc) have adamantly resisted pressure to consent. The bad news is that smaller valuation firms, desperate for the business and mostly uninformed about the potential consequences, have started engaging in this practice. Hopefully this does not result in an acceptable risk mitigation practice for companies which in turn would result in a squeeze-out of the solid, high-ranking valuation firms in favor of the desperate, bottom-feeding ones.
I don’t think this will happen with the Fortune 1000 companies. The brand value and unified front of the Big Four and large valuation houses will make sure of that. However, the broader undefined universe of small and mid-cap companies is another story entirely. We have had some success in diffusing these situations by connecting the clients who are pushing for consent with attorneys from reputable law firms who have been in the same situation and fully understand the valuation provider’s exposure. These professionals act as our advocates and provide the reputational value sometimes necessary to firmly illustrate consenting is not prudent, and is not market. We certainly hope this hot potato doesn’t become accepted practice, but we shall see.
