ASU 2026-03: Contractual Sale Restrictions and Fund NAV

Key Takeaways

• ASU 2026-03 creates a narrow exception to ASC 820 for investment companies within the scope of ASC 946.
• After adoption, investment companies must reflect contractual sale restrictions in the fair value of affected equity securities and disclose the related discount.
• The amendments are effective for annual periods beginning after December 15, 2027, including interim periods within those annual periods. Early adoption is permitted on or after September 9, 2026.
• The guidance is applied prospectively to all restricted equity securities on the adoption date, with any adjustment recognized in current-period earnings.
• The exception applies only to equity securities held by Topic 946 investment companies. The ASU 2022-03 model remains unchanged for other entities.
• The change may affect NAV, subscriptions, redemptions, fees, incentive allocations, distributions, and performance reporting.

What ASU 2026-03 Requires for Restricted Equity Securities

ASU 2026-03 applies to investment companies within the scope of ASC 946 that hold equity securities at fair value and cannot sell them on the measurement date because of a contractual sale restriction. Once the guidance is adopted, the fund must reduce fair value for the effect of the restriction by applying a discount that reflects what market participants would demand. It may no longer simply use the quoted price of otherwise identical unrestricted shares as the fair value of the restricted shares.

ASC 820 normally requires an active-market quoted price to be used without adjustment. ASU 2026-03 creates a narrow exception to that rule. The exception applies whether the valuation would otherwise use Level 1, Level 2, or Level 3 inputs. It does not create a new hierarchy category. The resulting measurement must still be classified under the existing ASC 820 framework based on the observability and significance of the restriction adjustment. The requirement is mandatory when material, but the Financial Accounting Standards Board (FASB) did not prescribe a valuation model or a standard discount.

A contractual restriction does not change the principal or most advantageous market for the security. The fund starts with the market price and then estimates the incremental effect of the restriction from market participants' perspective. Relevant evidence may include the restriction's nature and remaining term, transfer rights, conditions that could cause it to lapse, the volatility and liquidity of the unrestricted security, the ability to hedge the exposure, comparable transactions, and the support for the selected method and assumptions. The analysis should not count the same liquidity effect twice. It also cannot create a blockage discount based only on the size of the fund's holdings. The ASU does not change the accounting for legal or regulatory restrictions that are characteristics of the security. Those restrictions were already reflected in fair value. The new exception mainly addresses contractual restrictions such as lock-up and market-standoff agreements, including restrictions that are specific to the holder. FASB did not define the term contractual sale restriction. Funds will therefore need to use judgment when deciding whether a particular transfer limitation falls within the new guidance.

Why FASB Changed the Fair Value Guidance for Investment Companies

Before ASU 2022-03, practice was mixed. Some entities discounted equity securities for contractual sale restrictions, and others did not. ASU 2022-03 removed that diversity. It clarified that such a restriction is a characteristic of the reporting entity that holds the security rather than of the security itself, so the restriction should be excluded from fair value. The standard also added related disclosure requirements.

Over time, investment company stakeholders came to see that this treatment did not reflect how market participants would price the affected securities. They argued that it could overstate the net asset value (NAV), distort performance reporting and management fees, and produce uneven outcomes for investors who buy, redeem, or remain in the fund. The concern grew more pressing because companies stayed private longer and went public at higher valuations, so post-IPO lock-ups carried a larger potential economic effect.

FASB acted quickly. It took about five months to move from the initial agenda request to a final standard, and it concluded that a narrow exception for ASC 946 investment companies was the most practical response.

Why Fair Value and NAV Matter for Investment Companies

For many companies, fair value is mainly a financial reporting measure. For investment companies, it often has a much more direct economic role. It drives NAV and may determine the price used to issue or redeem fund interests. Depending on the fund's governing documents, it may also affect reported returns, management fees, incentive allocations, distributions, and the information investors use to allocate capital. In practice, NAV can serve as an accounting measure, a transaction price, and an economic measure at the same time.

How Do Contractual Sale Restrictions Affect NAV and Redemptions?

When NAV is overstated, a redeeming investor can receive more than the investor's economic share. Unless the governing documents or transaction mechanics offset the effect, value can move from the remaining investors at the time of redemption. A fund may pay the redemption with cash, other liquid holdings, new subscriptions, or permitted borrowing rather than selling the restricted shares. That funding choice does not remove the dilution. It may leave the remaining investors with less liquidity and greater exposure to the restricted position. Later performance will affect their final returns, but a later decline is not needed for the value transfer to occur.

The broader issue is the integrity of the NAV used on the transaction date. Some board members noted that a discount for an entity-specific restriction will reverse over the life of the investment and will not change cumulative income or cash flow. That may be true over the full holding period, but investors transact at the NAV established on a particular date. The ASU requires the fund to reflect the restriction at that date. Because the guidance does not prescribe a method, two funds holding the same restricted position may still reach different reasonable estimates. Strong governance, careful calibration, and clear disclosure will remain important.

ASU 2026-03 Disclosure Requirements for Investment Companies

After adoption, a fund must disclose the amount of the discount attributable to contractual sale restrictions that is included in the fair value of its equity securities. This is added to the existing disclosures about the fair value of the restricted securities, the nature and remaining duration of each restriction, and the circumstances that could cause it to lapse. Funds must also consider ASC 820 guidance on how much information should be combined or presented separately.

The disclosures are required in both annual and interim financial statements. The ASU uses the same effective date for public and nonpublic investment companies. A security pledged as collateral is excluded from this disclosure only when the sale restriction results from the pledge and the security is covered by disclosures required under another Topic. The measurement rule is different. A fund does not separately reflect the restriction in fair value when the economic effect is already included in another transaction, such as a secured borrowing. This prevents the same effect from being counted twice.

When Is ASU 2026-03 Effective?

The amendments are effective for annual reporting periods beginning after December 15, 2027, and for interim reporting periods within those annual periods. Early adoption is permitted on any date on or after September 9, 2026. A fund does not need to wait for the beginning of an annual or interim reporting period.

Transition is prospective. On the adoption date, a fund applies the guidance to all equity securities, including securities that are already subject to contractual sale restrictions. Any resulting adjustment is recognized in current-period earnings and the amount is disclosed in the first period of application. No positions remain grandfathered. Different adoption dates may temporarily produce different measurements for similar holdings across funds. FASB accepted that possibility because it wanted each adopting fund to use one measurement model for all of its restricted positions and avoid recasting earlier NAVs.

How Investment Companies Can Prepare for ASU 2026-03 Implementation

For many funds, identifying the securities in scope will be only the first step. Management will need a complete inventory of sale restrictions and a consistent process for distinguishing contractual restrictions from legal or regulatory restrictions, other transfer limits, and restrictions whose economic effect is already reflected in another transaction.

The valuation work will require coordination among fund management, valuation committees, investment teams, administrators, third-party valuation specialists, auditors, and boards. Funds will need to select and calibrate an ASC 820 valuation method, document the market-participant assumptions, reassess the fair value hierarchy classification, avoid overlap with other valuation adjustments, and isolate the incremental discount that must be disclosed.

Controls will also be needed over annual and interim disclosures, the transition-date adjustment, and any effect on NAV-based transactions, management fees, incentive allocations, distributions, and reported performance. The revised measurement may also affect investors who use the NAV practical expedient or apply the equity method to an interest in the investment company.

For more information, contact our team below.