Investment Reporting and Disclosure - Be in the Know as you Prepare for your 2010 Plan Year Filings.

Fair valuation of investments continues to be an area of focus for regulators and standard-setters, and the theme of recent Public Company Accounting Oversight Board (PCAOB) communications and reports demonstrates an ongoing scrutiny of auditors in this area. The fair value standards continue to evolve and expand the disclosure requirements, at a pace that is creating very real challenges for those responsible for the preparation of plan financial statements and related footnote disclosures. As evidenced by the issuance of Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2010-06, Improving Disclosures About Fair Value Measurements, the current FASB financial instruments project and other projects currently open under the FASB’s Emerging Issues Task Force (EITF), fair value disclosure requirements will continue to expand.

The Role of Plan Management

Accounting Standards Codification (ASC) 820 (FAS 157) established management’s responsibility for fair value measurements and disclosures in accordance with the standard, including the determination of fair value and classification of investments within the fair value hierarchy (i.e., Levels 1, 2 or 3). This includes cases where management may engage third parties (e.g., investment managers, custodians, trustees, pricing services, valuation specialists, etc.) to assist with such valuations. Although management may use the assistance of such service providers, they may not abdicate their responsibilities for fair valuation measurement and disclosure.

It is not uncommon for management to lack the requisite understanding of the investments contained in their plan’s portfolio. Certain investment products designed for employee benefit plans and their participants lack the transparency often available for other types of investments. While this does not relieve management of their responsibilities under the standards, it certainly compounds the burden associated with fulfilling these responsibilities. For this reason, the additional scrutiny currently associated with investment valuation may also highlight potential regulatory exposure that may exist for plan fiduciaries as well. This presents an opportunity for plan management and those with fiduciary responsibilities to consider consultations with their advisors to ensure appropriate due diligence processes and documentation are in place when selecting investment options, hiring service providers and fulfilling their ongoing oversight responsibilities in this regard.

It is commonplace for entities to utilize daily price feeds from well known pricing services (e.g., Bloomberg and IDC) for purposes of valuing Level 1 and certain less complex Level 2 securities. In response to customer and auditor requests, as well as their understanding of management’s responsibilities in connection with ASC 820, many of these pricing services continue to develop new products and services that expand the level of detail supporting the prices they provide. Management is encouraged to reach out to all of their service providers to request information regarding pricing methodologies, inputs and assumptions necessary to understand the valuation of their plan’s investments in a manner that allows them to fulfill their financial reporting and fiduciary responsibilities.

Expanded Fair Value Disclosures

ASU 2010-06, mentioned above, is effective for plan year reporting periods beginning after December 15, 2009. The related amendments to ASC 820 offer some much needed clarification related to disaggregation of investments introduced in ASC 820-10-65-4 (FSP FAS 157-4) and also expands other fair value disclosures as follows:

• Disaggregation of debt and equity securities by "class" (previously referred to as ‘major category’) based upon nature and risk, generally considering such factors as: activity/business sector, vintage, geographic concentration, credit quality or economic characteristics;
• Disclosure of valuation techniques and inputs used in developing fair value measurements;
• Disclosures should allow the reader to reconcile fair value measurement disclosures based upon class to line items on the face of the financial statements; and
• Disclosure of significant transfers between Level 1 and Level 2 categorizations, and the related policy for determining when transfers between categories are recognized (e.g., actual date of event triggering transfer, beginning of reporting period, end of reporting period); such significant transfers in and out should be presented on a gross basis.

Additional provisions within ASU 2010-06 related to expansion of roll forward details reconciling fair value of Level 3 investments will be effective for fiscal years beginning after December 15, 2010.

Reporting Participant Loans in Defined Contribution Plan Financial Statements

In September 28, 2010, the FASB issued ASU 2010-25, Plan Accounting – Defined Contribution Pension Plans (Topic 962): Reporting Loans to Participants by Defined Contribution Pension Plans, to amend ASC Topic 962, Plan Accounting – Defined Contribution Pension Plans. This ASU affirmed and codified the FASB’s original proposal to classify participant loans as notes receivable carried at amortized cost, rather than as investments subject to fair value measurement, in defined contribution plan financial statements. The amendments require that participant loans be segregated from plan investments and measured at their unpaid principal balance plus accrued but unpaid interest. As such, participant loans no longer require fair value measurement and are excluded from the disclosure requirements specified in ASC 825-10-50-10 through 16.

The amendments apply to all defined contribution plans that allow participant loans and should be applied retrospectively to all prior periods presented. The amendments are effective for fiscal years ending after December 15, 2010. Early adoption is permitted. It is also important to note, however, that based upon current Department of Labor (DOL) reporting requirements, participant loans will continue to be reported as investments on the supplemental schedule of assets (held at end of year) along with the plan’s assets held for investment purposes. In addition, the FASB exempted these notes receivable from the credit quality disclosures in ASU 2010-20.