What Constitutes a "Commercially Reasonable Procedure" When Obtaining Valuation Quotes? ▴ Question

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Concept

The question of what constitutes a “commercially reasonable procedure” for obtaining valuation quotes is a foundational query for any entity with fiduciary responsibilities. The term itself, steeped in legal and commercial precedent, points toward a standard of conduct that is fair, executed in good faith, and aligns with commonly accepted practices within a specific market. For fiduciaries, fund managers, and corporate directors, this is the bedrock of defensible valuation.

The objective is to construct a valuation process that is not only accurate but can also withstand scrutiny from regulators, auditors, and litigants. This requirement becomes particularly acute when dealing with assets that lack a readily available public market price, such as certain derivatives, private credit instruments, or illiquid equity stakes.

At its heart, commercial reasonableness is an operational discipline. It is the systematic implementation of policies and procedures designed to arrive at a fair value determination through a process that is both transparent and repeatable. The core idea, as supported by various legal interpretations, is that the procedure must be logical and appropriate for the specific asset being valued. For instance, the methodology for valuing a portfolio of publicly traded equities would differ substantially from that used for a bespoke, over-the-counter derivative contract.

The procedure must make sense as a means to accomplish the parties’ goals of achieving an objective valuation. This means the process must be tailored to the asset’s characteristics, the available data, and the market context.

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The Pillars of a Defensible Framework

A commercially reasonable valuation procedure rests on several key pillars that collectively ensure the integrity and defensibility of the final valuation. These principles form the essential architecture of any robust valuation governance system.

Independence ▴ The valuation process must be free from bias and conflicts of interest. This often involves segregating the personnel responsible for valuation from those with investment decision-making authority. For particularly complex or hard-to-value assets, engaging independent third-party valuation firms is a common practice to bolster objectivity.
Methodological Soundness ▴ The chosen valuation techniques must be appropriate for the asset in question. Accounting standards like ASC 820 provide a framework that includes market, income, and cost approaches. A commercially reasonable procedure involves selecting and consistently applying the most suitable methodology based on the nature of the asset and the availability of reliable data.
Verifiable Inputs ▴ The data and assumptions used in the valuation models are critical. ASC 820 establishes a fair value hierarchy that prioritizes inputs based on their observability. Level 1 inputs (quoted prices in active markets) are the most reliable, while Level 3 inputs (unobservable inputs) require the most judgment and, consequently, the most rigorous documentation and support. A reasonable procedure maximizes the use of observable inputs wherever possible.
Contemporaneous Documentation ▴ Every step of the valuation process must be documented as it occurs. This includes the rationale for selecting a particular valuation methodology, the sources of all quotes and data, communications with third-party valuation providers, and the deliberations of any valuation committee. This audit trail is indispensable for demonstrating that a reasonable process was followed.

A commercially reasonable procedure is the documented, systematic process of applying appropriate valuation techniques to reliable inputs to arrive at a defensible fair value determination.

Understanding these foundational concepts is the first step toward building an operational system for valuation that satisfies fiduciary duties and regulatory expectations. The focus is on the integrity of the process, recognizing that a sound process is the best defense for the resulting valuation. It is a proactive measure to ensure that when valuations are questioned, a firm can provide a clear and logical explanation of how the value was derived, supported by a comprehensive body of evidence.

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Strategy

Developing a strategy for obtaining valuation quotes requires moving from the conceptual understanding of commercial reasonableness to the design of a functional and resilient workflow. This strategy is an exercise in risk management, operational efficiency, and regulatory preparedness. The central aim is to create a system that consistently produces reliable valuations while being flexible enough to adapt to different asset types and market conditions. A well-defined strategy considers not just the “what” of valuation, but the “who,” “how,” and “when” of the entire process.

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Designing the Valuation Workflow

The architecture of a valuation workflow should be deliberate and codified in a formal valuation policy. This policy serves as the blueprint for all valuation activities. It should clearly outline the procedures for valuing every type of asset in a portfolio, from the most liquid to the most illiquid. A strategic approach to workflow design involves several key considerations.

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Establishing a Governance Structure

A formal governance structure is the command and control center of the valuation process. For many firms, this takes the form of a valuation committee. The composition and mandate of this committee are strategic decisions.

Composition ▴ The committee should include individuals with relevant expertise in finance, accounting, and risk management. Crucially, it should have members who are independent of the investment team to mitigate conflicts of interest.
Mandate ▴ The committee’s responsibilities should be clearly defined, including approving valuation methodologies, reviewing and approving all Level 3 asset valuations, overseeing third-party valuation providers, and reviewing the valuation policy at least annually.
Meeting Cadence ▴ The frequency of meetings should be dictated by the nature of the assets. A fund holding primarily Level 1 assets might meet quarterly, whereas a fund with significant Level 2 and Level 3 holdings should meet more frequently, such as monthly or whenever a significant event occurs.

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Sourcing and Managing Valuation Inputs

A critical component of the valuation strategy is the approach to sourcing and managing the inputs that feed the valuation models. This involves establishing a clear hierarchy of preferred data sources and a process for vetting them.

The selection of quote providers is a particularly important strategic decision. Not all sources are created equal, and the choice of provider should be aligned with the asset being valued and the desired level of independence.

Comparison of Valuation Quote Sources
Source Type	Level of Independence	Typical Asset Focus	Considerations
Broker-Dealer Quotes	Low to Medium	Level 2 & 3 Assets (e.g. corporate bonds, some derivatives)	May have potential conflicts if the broker is also a counterparty. It is best practice to obtain quotes from multiple, non-interested brokers.
Consensus Pricing Services	Medium	Level 2 Assets	Aggregate data from multiple contributors. The methodology and contributor pool should be understood.
Independent Valuation Firms	High	Level 3 Assets (e.g. private equity, complex derivatives)	Offers the highest degree of objectivity and is often preferred by auditors and regulators for hard-to-value assets.

The strategic selection of valuation sources, balancing independence with expertise, is fundamental to the credibility of the entire valuation process.

The strategy must also account for situations where market data is scarce or unreliable, particularly during periods of market stress. A dysfunctional market may make it impossible to use a market price to value an asset on a single date. The valuation policy should therefore include contingency plans, such as the use of alternative valuation techniques like a discounted cash flow analysis, when primary methods are not viable.

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Execution

The execution of a commercially reasonable valuation procedure is where strategy is translated into auditable action. This is the operational phase, governed by the principle that every step, decision, and input must be documented and defensible. Effective execution hinges on a disciplined adherence to the established valuation policy and a commitment to creating a contemporaneous and comprehensive audit trail. For fiduciaries, this is the evidentiary basis that demonstrates that duties were discharged with care and diligence.

The Operational Playbook for Valuation

A detailed operational playbook is essential for ensuring consistency and completeness in the valuation process. This playbook should provide step-by-step guidance for personnel involved in valuation, leaving little room for ambiguity.

Asset Identification and Classification ▴ The first step in any valuation cycle is to identify all assets that require valuation and classify them according to the ASC 820 fair value hierarchy (Level 1, 2, or 3). This classification determines the subsequent valuation approach.
Application of Valuation Methodology ▴ For each asset, the specific valuation methodology prescribed in the valuation policy is applied. For Level 2 and 3 assets, this involves initiating the process of obtaining quotes or engaging third-party valuation firms.
Quote Solicitation and Management ▴ When soliciting quotes from broker-dealers or other sources, a standardized process should be followed. Requests should be sent to an approved list of providers. It is best practice to solicit multiple quotes (e.g. three to five) to establish a reliable range and identify potential outliers.
Review and Analysis of Inputs ▴ All received quotes and data must be critically reviewed. This includes comparing quotes to one another, to recent transaction prices, or to model-based valuations. Any significant discrepancies or outliers must be investigated and documented.
Valuation Committee Review ▴ For all Level 3 assets and any other assets deemed high-risk or complex, the valuation committee must conduct a formal review. The committee should challenge the assumptions and inputs used and formally approve the final valuation.
Documentation and Record-Keeping ▴ Throughout the process, a detailed record is maintained. This collection of documents, often called a “valuation file,” is the ultimate proof of a commercially reasonable procedure.

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The Anatomy of a Valuation File

The valuation file is the cornerstone of a defensible process. It should be maintained for each asset and each valuation period, providing a complete history of how the fair value was determined.

Essential Components of a Valuation File
Document Type	Purpose	Key Information
Valuation Checklist	Ensures all procedural steps were followed consistently.	Sign-offs from preparers and reviewers; confirmation of adherence to policy.
Quote Documentation	Provides evidence of the data sourced.	Copies of emails, screenshots, or data feeds from quote providers, including the provider’s name and the date and time of the quote.
Third-Party Valuation Reports	Details the analysis performed by an independent firm.	The full report, including the scope of work, methodologies used, key assumptions, and the final valuation conclusion.
Internal Memos and Analyses	Documents internal deliberations and decisions.	Rationale for selecting a valuation methodology, analysis of outlier quotes, adjustments made to inputs, and justification for any overrides.
Valuation Committee Minutes	Records the governance and oversight process.	Attendees, discussion points, challenges raised, and formal approval of valuations.

The quality of the documentation directly reflects the quality of the valuation process itself; a complete audit trail is the ultimate expression of commercial reasonableness.

Executing a valuation procedure with this level of rigor transforms the concept of commercial reasonableness from an abstract legal standard into a tangible set of operational controls. It ensures that the firm can not only produce accurate valuations but can also confidently defend them to any interested party, demonstrating a commitment to transparency, objectivity, and fiduciary care.

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References

Lowenstein Sandler LLP. “HFLR Program Explores Valuation of Illiquid Assets and Valuation Governance.” 2021.
Society of Actuaries. “Actuarial Methods for Valuing Illiquid Assets.” 2011.
Cole Schotz. “What Does ‘Commercially Reasonable Determinants of Value’ Mean Under Section 562 of the Bankruptcy Code?” 2010.
Clifford Chance. “Financial Collateral Arrangements ▴ Valuing Collateral in a ‘Commercially reasonable manner’.” 2022.
Merriam-Webster. “Commercially Reasonable Definition & Meaning.” Merriam-Webster Legal Dictionary.
Carta. “What is ASC 820? A Guide to Fair Value Measurements.” 2025.
Deloitte. “10.4 Inputs to Valuation Techniques.” DART ▴ Deloitte Accounting Research Tool.
Private Equity Wire. “How to value illiquid investments.” 2024.
U.S. Securities and Exchange Commission. “SEC Adopts New Rule for Fund Valuations.” 2020.
Financial Accounting Standards Board. “ASU 2022-03 ▴ Fair Value Hedging ▴ Portfolio Layer Method.” 2022.

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Reflection

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System Integrity as a Strategic Asset

Ultimately, the framework for establishing a commercially reasonable valuation procedure is an investment in institutional integrity. It is the construction of an internal system of checks, balances, and verifiable evidence designed to produce a specific output ▴ a valuation that is not only numerically sound but procedurally unimpeachable. The discipline of maintaining this system, from the formal governance of a valuation committee to the granular detail of an audit file, transforms a compliance necessity into a strategic asset.

It provides the confidence to navigate complex markets, the credibility to satisfy investors and regulators, and the resilience to withstand challenges. The question for any fiduciary is how their current operational framework measures against this standard of systemic robustness.