A small Maryland company is selling to banks a service designed to help them value thinly traded securities held in their customers' accounts.
Securities Pricing and Research, Annapolis, uses the financial records of publicly traded companies as a yardstick.
Trusts, employee benefit plans, and even individual retirement accounts at banks often include shares of closely held companies or limited partnerships. The prices of these shares cannot be found in the newspaper.
But Securities Pricing officials say they must be valued nonetheless. Indeed, the Internal Revenue Service and other regulators require bankers to accurately price these securities each year.
"Just because something doesn't trade doesn't mean it's valueless," said Brad Davidson, founder and president of Securities Pricing. "It just doesn't have liquidity."
Full taxation of distributions, proper calculation of trust fees, and compliance with Internal Revenue Service rules for retirement plans all hinge on accurate valuation of assets, even if those assets are seldom traded.
"Banks are required by law to do it, and we're required to check on it," said an IRS official who asked not to be named. "The valuation is quite important when you start getting distributions. Taxability is our biggest interest."
That's because failing to fully value a security in tax documents, the most common error, would reduce the IRS' take when a distribution is made.
For $200, Securities Pricing will document the value of a non- or seldom-traded security. For those who need more than a onetime valuation, the company will value an asset quarterly for $250 a year or daily for $300 a year.
Mr. Davidson's company estimates share value for an untraded security by first calculating key business measures for analogous publicly traded companies.
Securities Pricing then derives a first-cut share price estimate by applying benchmark financial ratios - such as stock price per dollar of sales and price for each dollar of book value - to the data from an untraded company's books.
It then discounts the initial estimate share price by 43% to account for illiquidity - a figure derived from several academic studies, Mr. Davidson said.
Although almost everyone agrees that pricing individual non-traded securities can be a challenge, the significance of the problem is much tougher to gauge.
"It's the riskiest and most challenging-to-manage piece of the (trust and custody) business" for banks, said a bank regulator who asked not to be named. "From a public policy standpoint, I've got many more important things to worry about."
Securities Pricing's product "serves its purpose," said T. Kevin Whalen, director of unique asset valuation at Columbus, Ohio-based Banc One Corp., one of the company's largest customers.
But, he emphasized, the total dollar value of nontraded securities in bank-administered accounts is quite small.
"I'd be surprised if it's 1% (of assets) across the board" at Banc One, he said.
