Receiving a price for a financial instrument can feel like the end of the valuation process.
But a price is not automatically reliable simply because it came from an external source.
Depending on the instrument, a third-party price may be based on recent market activity, comparable transactions, observable inputs, a valuation model, a broker’s judgment—or some combination of these factors.
The real question is not simply, “Did we receive a price?”
It is:
“Do we understand enough about this price to determine whether it provides relevant and reliable evidence of fair value?”
That distinction becomes especially important for complex, thinly traded, or hard-to-price financial instruments.
Not all third-party prices are the same
Third-party pricing information generally comes from several types of sources.
Pricing services
Under PCAOB AS 2501, pricing services are organizations that routinely provide uniform pricing information to users, generally through subscriptions.
These services may develop prices using:
Quoted market prices
Recent transactions
Transactions involving similar instruments
Market-maker information
Observable market inputs
Valuation models
Broker or dealer quotes
Combinations of multiple approaches
Some prices may be closely connected to observable market activity. Others may be evaluated prices developed using models and judgment.
Broker or dealer quotes
A broker quote is pricing information obtained from a broker or dealer. Its usefulness may depend on whether the broker actively trades the type of instrument, whether the quote reflects current market conditions, and whether the broker would transact at that price.
A binding quote that a broker is prepared to execute is different from a nonbinding indication provided for informational purposes.
Instrument-specific valuations
A pricing service may also be engaged to develop a customized value for a specific instrument that it does not routinely price for all subscribers.
PCAOB guidance notes that when a pricing service is individually engaged to develop this type of price, it may be treated as a specialist for audit purposes rather than as a routine pricing service.
Understanding which type of information has been received is the first step toward evaluating it.
What makes pricing-service information more reliable?
PCAOB AS 2501 identifies several factors that affect the reliability of pricing information provided by a pricing service.
Experience and expertise
Does the service have relevant experience with the type of instrument being valued? Is this an instrument the service prices routinely, or is it outside its usual coverage?
A provider that regularly prices a class of actively traded corporate bonds may have a different information base than one evaluating a unique, highly structured instrument.
Methodology
Is the pricing methodology consistent with the applicable financial-reporting framework?
When a service uses transactions involving similar instruments, firms should understand how those instruments were selected, why they were considered comparable, and how differences were addressed.
When recent transactions are unavailable, the valuation may depend more heavily on models and significant assumptions.
Relationship with the company
Could company management directly or indirectly control or significantly influence the pricing service?
The ability to challenge a price does not, by itself, indicate improper influence. Price challenges are a normal part of many valuation-control processes. The important consideration is whether the relationship creates a concern about the objectivity of the information.
Relevance matters as much as reliability
A source may be credible while still producing information that is not sufficiently relevant to a particular instrument.
Relevant questions include:
Is the price based on a transaction involving the same instrument?
If not, how similar are the instruments used as references?
When did the relevant transaction occur?
Have market conditions changed since then?
Do the reference instruments have similar seniority, maturity, collateral, covenants, liquidity, and credit risk?
Were observable or unobservable inputs used?
Does the price reflect market conditions as of the measurement date?
For a complex or illiquid instrument, a price based on a superficially similar security may require additional analysis before it can support a fair-value conclusion.
When multiple pricing services agree
Receiving similar prices from several services can provide useful corroboration—but agreement alone is not always enough.
Under PCAOB AS 2501, auditors may need less information about each service’s methods and inputs when all of the following conditions are present:
There are recent trades in the instrument or substantially similar instruments
Several pricing services routinely price the instrument type
Prices are reasonably consistent across the services
The pricing information is generally based on observable inputs
When those conditions are not met, additional audit procedures may be needed to evaluate the valuation method and the reasonableness of observable and unobservable inputs.
This is an important distinction. Three similar prices may be persuasive when they are independently supported by active market evidence. They may be less persuasive if all three services rely on the same stale transaction, broker indication, or underlying data source.
What makes a broker quote stronger?
PCAOB AS 2501 identifies several factors affecting the relevance and reliability of a broker quote.
The broker’s relationship with the company
Is the broker unaffiliated, or does management have the ability to influence it?
The broker’s market activity
Is the broker a market maker that actually transacts in the same type of instrument?
A quote from an active participant may provide different evidence than an estimate from a party with limited involvement in the market.
Timeliness
Does the quote reflect market conditions as of the financial-statement date?
In fast-moving markets, even a relatively recent quote may require consideration of events occurring between the quote date and the measurement date.
Whether the quote is binding
Would the broker transact at the quoted price?
A binding quote generally provides stronger evidence than a nonbinding or indicative quote, although all facts and circumstances still matter.
Restrictions, limitations, and disclaimers
Does the quote include language indicating that it is:
Indicative only
Not executable
Subject to additional review
Based on limited information
Not intended for valuation or financial-reporting purposes
These limitations do not necessarily make a quote unusable. They do affect how much weight it can support.
PCAOB guidance states that broker quotes generally provide more relevant and reliable audit evidence when they are timely, binding, free of restrictions or disclaimers, and provided by unaffiliated market makers that transact in the same instrument type.
Eight questions to ask before relying on a price
Before using a third-party price, firms should be prepared to answer:
1. What type of price is it?
Is it a quoted market price, an evaluated price, a binding broker quote, a nonbinding indication, or a customized valuation?
2. What is the price based on?
Was it developed from recent trades, comparable instruments, observable inputs, a model, broker information, or unobservable assumptions?
3. How current is the supporting information?
Does the price reflect market conditions at the measurement date?
4. Is the instrument routinely priced?
Does the provider regularly price this instrument type, or did the valuation require specialized, instrument-specific work?
5. How comparable is the supporting market evidence?
If similar instruments were used, were differences in credit quality, structure, maturity, liquidity, collateral, and contractual terms appropriately considered?
6. Is the quote executable?
If the information came from a broker, is the quote binding or merely indicative?
7. Are there limitations or disclaimers?
What does the provider say the price can—and cannot—be used for?
8. Is there conflicting evidence?
Do recent trades, other pricing services, market indices, internal models, or borrower developments support or contradict the price?
The goal is not to reject every price that requires judgment. It is to understand the evidence well enough to assign it appropriate weight.
Who remains responsible for the valuation?
Using an external price does not automatically transfer responsibility for the fair-value conclusion to the provider.
For registered investment companies and business development companies subject to SEC Rule 2a-5, the board or its valuation designee must oversee and evaluate pricing services used in the fair-value process. A valuation designee may receive assistance from a pricing service, fund administrator, adviser, accountant, or other party, but remains responsible for performing the designated fair-value determination.
Other entities should look to their applicable accounting, regulatory, governance, and audit requirements. More broadly, management remains responsible for the financial statements and the estimates reflected in them.
External pricing information can be important evidence. It does not remove the need for appropriate review, challenge, and documentation.
What should firms document?
A supportable valuation file should make clear:
The source of each price
The type of pricing information received
The price date and measurement date
The provider’s relevant experience
The known methodology and significant inputs
The market evidence supporting the price
Whether the quote is binding or indicative
Relevant limitations or disclaimers
Comparisons with other pricing sources
Significant differences among sources
Price challenges and their outcomes
Evidence supporting or contradicting the selected price
The rationale for the final conclusion
Not every instrument will require the same amount of work. The level of analysis should reflect the instrument’s complexity, liquidity, observability, and risk of material misstatement.
A price should begin the analysis - not end it
Third-party pricing can give firms access to valuable market information, specialized methodologies, and broader data resources.
But the source, methodology, inputs, timing, comparability, and limitations behind a price determine how much support it actually provides.
The strongest valuation process does not merely collect a number. It evaluates the evidence behind that number, considers information that may contradict it, and documents why the final conclusion is reasonable.
Harvest provides independent and transparent valuations for simple to hard-to-price financial instruments. Through experienced valuation professionals, specialized resources, documented inputs, and clear methodologies, Harvest helps financial-reporting teams develop supportable valuation conclusions.
Need an independent perspective on a financial instrument or third-party price? Contact Harvest Investments to learn how its valuation professionals can support your team.
