Fair Value Measurements

6 Months Ended

Jun. 30, 2011

6. Fair Value Measurements

As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction. ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under which assets and liabilities measured at fair value will be classified are as follows:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

As required by ASC 820, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Financial Assets and Liabilities

The following table sets forth by level within the fair value hierarchy the Company’s assets and liabilities owned, at fair value, including $5,212 of money market funds included in cash and cash and equivalents that are pledged as collateral for a letter of credit, and financial instruments sold but not yet purchased at fair value as of June 30, 2011 and December 31, 2010:


June 30, 2011	Level 1(1)		Level 2(2)		Level 3(3)		Total
Financial assets, at fair value:

Money market funds included in cash and cash equivalents	$	10,413	$	—	$	—	$	10,413
U.S. treasury securities included in deposits with clearing organizations		11,000		—		—		11,000
Corporate equities and derivatives included in other assets		27,926		—		—		27,926
Investments in securities		—		—		10,562		10,562


	$	49,339	$	—	$	10,562	$	59,901


Financial liabilities, at fair value:

Corporate equities and derivatives included in other liabilities	$	17,046	$	—	$	—	$	17,046


	$	17,046	$	—	$	—	$	17,046


December 31, 2010	Level 1(1)		Level 2(2)		Level 3(3)		Total
Financial assets, at fair value:

Money market funds included in cash and cash equivalents	$	9,674	$	—	$	—	$	9,674
U.S. treasury securities included in deposits with clearing organizations		11,960		—		—		11,960
Corporate equities and derivatives included in other assets		20,143		823		—		20,966
Investments in securities		—		—		11,442		11,442


	$	41,777	$	823	$	11,442	$	54,042


Financial liabilities, at fair value:

Corporate equities and derivatives included in other liabilities	$	17,661	$	—	$	—	$	17,661


	$	17,661	$	—	$	—	$	17,661


(1)		All of the Company’s assets and liabilities included in Level 1 of the fair value hierarchy are exchange traded securities or have quoted market prices in active markets for identical assets or liabilities.

(2)		Level 2 assets represent publicly traded shares that are restricted as part of an initial public offering and are valued based on the quoted market price less any discount for that restriction.

(3)		Level 3 assets represent 17.6% and 21.2% of all financial assets measured at fair value at June 30, 2011 and December 31, 2010, respectively (see below for further information).

The following table provides a reconciliation of the beginning and ending balances for the major classes of financial assets and liabilities measured at fair value using significant unobservable inputs (Level 3):


	Investments
	in
	Securities
	Assets
Balance, January 1, 2011	$	11,442
Total gains/(losses), realized and unrealized		(180	)
Redemptions		(700	)


Balance, June 30, 2011	$	10,562

The Company’s Level 3 financial assets are comprised of auction rate securities (“ARS”). The Company’s ARS are backed by United States Department of Education-guaranteed student loans issued under the Federal Family Education Loan Program (“FFELP”). The Company’s ARS are marketable securities with long-term stated maturities (during years 2034-2040) for which the interest rates are reset through periodic short-term auctions every 35 days, depending on the issue. As a result of the liquidity issues in the global credit and capital markets, all of the auctions for all of the Company’s ARS have failed since February 2008. A failed auction is not a default of the debt instrument and the ARS holder continues to receive interest payments when the auctions fail. All of the Company’s ARS are current with respect to the receipt of interest payments according to the stated terms of each ARS indenture. The Company believes that it has the ability and intent, if necessary, to hold its ARS investments until such time as the auctions are successful, the issuer redeems the securities, or another market for ARS develops. Since the ARS markets began failing on February 14, 2008, $96,275 of the Company’s ARS securities have been redeemed by issuers or the Company’s brokers at par.

At June 30, 2011, there was insufficient observable ARS market information available to determine the market value of the Company’s investments in ARS. Therefore, the Company has continued to designate the ARS as Level 3 financial assets under ASC 820 and estimated the Level 3 fair values for these securities by using the income method, incorporating assumptions that market participants would use in their estimates of fair value. The Company calculated income by developing a discounted cash flow model based on the expected cash flows from the ARS compared to a market rate. Based on the Company’s analysis, the weighted average economic life was estimated to be approximately four years. For the fair market interest rates used in its discounted cash flow, the Company used a current market rate for liquid debt instruments of similar underlying assets and credit quality, with spreads of approximately 150bps-250bps over the London Interbank Offered Rate.

The Company has classified the remaining $11,300 in par value ARS as available-for-sale securities. At June 30, 2011, the Company’s calculation of fair value of the ARS implied an impairment of fair value of approximately $738, which has been recorded through accumulated other comprehensive loss on the condensed consolidated statement of financial condition, and the carrying fair value of the ARS was approximately $10,562.

Non-Financial Assets and Liabilities

Non-financial assets and liabilities subject to fair value measurements include customer relationships included in other intangible assets and a contingent liability included in other liabilities. At June 30, 2011 and December 31, 2010, there was significant unobservable information used to determine the market value for these non-financial assets and liabilities. Therefore, the Company has continued to designate the customer relationships’ intangible assets and the contingent liability as Level 3 non-financial assets and liabilities, respectively, under ASC 820.

The Company reviews other intangible assets for impairment on an annual basis and whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of the Company’s finite-lived intangible assets is evaluated by comparing the current and forecasted cash flows associated with the assets to the assets’ carrying values. The fair value of the Company’s customer relationships’ intangible assets were $3,569 at December 31, 2010 and $2,517 at June 30, 2011. For the six months ended June 30, 2011, the Company determined that one of its customer relationships’ intangible assets was deemed to be non-recoverable. The Company used the market approach to determine the fair value of this intangible asset and, as a result, recorded $337 of impairment charges in other general and administrative expenses. For the six months ended June 30, 2010, no impairment was recorded against the Company’s customer relationships intangible assets.

The Company’s non-financial liabilities include a contingent liability for accrued contingent consideration related to the acquisition of Optionetics. The accrued contingent consideration is payable for a period of five years following the acquisition and is based on the profitability of the business acquired and the number of funded brokerage accounts referred to the Company’s brokerage services segment in the year the contingent consideration is paid. Depending on the level of performance, the contingent consideration can range from zero to $7,000 for each of the first five years following the acquisition date of May 4, 2009. The fair value is based on the estimated projected future performance of Optionetics, the time remaining on the liability and the estimated market debt rate for the Company. The fair value of the contingent liability was $8,876 at December 31, 2010 and $2,601 at June 30, 2011.

- Definition

This item represents the complete disclosure regarding the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments, assets, and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the Company is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risk is are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

+ References+ Details

optionsXpress Holdings, Inc. 10-Q