NEW YORK ( a letter to the Financial Accounting Standards Board, hedge fund industry veteran Leon M. Metzger argues that the fair value of an asset is best defined as the estimated exit price for the specific entity that is holding that position.

He highlights differences in prices obtained by various types of traders, in particular market makers, institutional investors and retail traders. One size does not fit all, he said. “The exit price of a market maker is not necessarily the exit price of a price taker.”

FASB has proposed financial standards on fair value measurement and Sept. 7 was the last date for the public to comment. Once accepted, FASB standards become Generally Accepted Accounting Principles in the United States.

While FASB took fair value to mean exit price in a preliminary view in 1999, this time it is relying on the traditional definition- the price in a transaction taking place between hypothetical parties that are willing, knowledgeable and unrelated.

That is not the right definition according to Mr. Metzger, who seeks to find the correct economic approach to fair value rather than derive a model from current industry practice or other considerations such as tax statutes. He proposes that FASB go back to its 1999 definition.

Accounting Arbitrage

In addition, he takes issue with the FASB position on transaction costs. There is an inconsistency in how the draft treats explicit costs, such as fees or commissions, which are not to be taken into account in measuring fair value, and implicit costs such as liquidity, which necessarily show up in prices. Mr. Metzger suggests a consistent take.

In this analysis, too, he points to differences in the price obtained for the same asset by market makers and institutional and retail traders. For over-the-counter securities, FASB proposes that the most advantageous price available from dealers be taken as fair price.

But dealers might not readily divulge the price at which they would be willing to trade with a given party. For that reason, Mr. Metzger favors an estimate that can be an average of dealer quotes, instead of the most advantageous one, if the price taker believes that that will lead to a better estimate.

“Many traders seek to buy and sell financial instruments that are mispriced relative to fair value,” he wrote in the letter. “If FASB does not give proper guidance on how to measure fair value, accounting arbitrage opportunities will arise.”

How to value illiquid over-the-counter securities in hedge fund portfolios is a concern for both managers and investors (see ).

Contact Bob Keane with questions or comments at: