American Capital Avoids Loss With Fishy Math

One exemption is that the stock investment is considered to be "inactively traded." But if the stock is traded on a public exchange, such as ECAS on the London Stock Exchange, this exemption typically cannot be applied, the sources say.

The other exemption from Level I valuation is that the publicly traded stock is somehow not an identical version of the stock owned by the firm conducting the valuation. One way the stock might not be identical is if it is considered to be "restricted stock," the sources say.

This second exemption may in fact apply to American Capital's investment in ECAS, even though the company made no mention of it to investors on the call. According to the May prospectus from the ECAS initial public offering, American Capital has agreed to a lockup period of not selling its ECAS shares for 12 months.

However, being in a lockup period for an IPO doesn't automatically allow you to declare your stock as being "restrictive" and apply looser Level II valuations, the accounting sources say. Technically, American Capital owns common stock. The company restricted itself from trading the securities by signing the lockup agreement.

Nonetheless, it appears American Capital decided to head to Level II valuations. Why? Because "control premiums" are not allowed under Level I calculations, the sources say, thus preventing American Capital from bumping up the investment's value, as it could with Level II.