3. MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS

We generally classify our marketable securities as available-for-sale at the time of purchase and re-evaluate such designation as of each consolidated balance sheet date. Since we generally intend to convert them into cash as necessary to meet our liquidity requirements our marketable securities are classified as cash equivalents if the original maturity, from the date of purchase, is ninety days or less and as short-term investments if the original maturity, from the date of purchase, is in excess of ninety days but less than one year. Our marketable securities are classified as long-term investments if the maturity date is in excess of one year of the balance sheet date.

We report available-for-sale investments at fair value as of each balance sheet date and include any unrealized gains and, to the extent deemed temporary, unrealized losses in stockholders’ equity. Realized gains and losses are determined using the specific identification method and are included in other income (expense) in the statement of operations. Certain of our marketable securities are classified as trading securities and any changes in the fair value of those securities are recorded as other income (expense) in the statement of operations.

We conduct quarterly reviews to determine the fair value of our investment portfolio and to identify and evaluate each investment that has an unrealized loss, in accordance with the meaning of other-than-temporary impairment and its application to certain investments. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. In the event that the cost basis of a security exceeds its fair value, we evaluate, among other factors, the duration of the period that, and extent to which, the fair value is less than cost basis, the financial health of and business outlook for the issuer, including industry and sector performance, and operational and financing cash flow factors, overall market conditions and trends, our intent to sell the investment and if it is more likely than not that we would be required to sell the investment before its anticipated recovery. Unrealized losses on available-for-sale securities that are determined to be temporary, and not related to credit loss, are recorded in accumulated other comprehensive income (loss).

For available-for-sale debt securities with unrealized losses, we perform an analysis to assess whether we intend to sell or whether we would more likely than not be required to sell the security before the expected recovery of the amortized cost basis. Where we intend to sell a security, or may be required to do so, the security’s decline in fair value is deemed to be other-than-temporary and the full amount of the unrealized loss is reflected in the consolidated statement of operations as an impairment loss.

Regardless of our intent to sell a security, we perform additional analysis on all securities with unrealized losses to evaluate losses associated with the creditworthiness of the security. Credit losses are identified where we do not expect to receive cash flows sufficient to recover the amortized cost basis of a security.

We invest our available cash primarily in U.S. Treasury bill funds, money market funds, commercial paper, and U.S. federal and state agency backed certificates, including auction rate securities that have investment grade ratings. Auction rate securities are structured with short-term interest reset dates of generally less than 90 days, but with contractual maturities that can be well in excess of ten years. At the end of each reset period, which occurs every seven to twenty-eight days, investors can sell or continue to hold the securities at par value. If auction rate securities fail an auction, due to sell orders exceeding buy orders, the funds associated with a failed auction would not be accessible until a successful auction occurred, a buyer was found outside the auction process, the underlying securities matured or a settlement with the underwriter is reached. ArQule’s marketable securities portfolio includes auction rate securities of $2.3 million (at cost) at June 30, 2011 and $2.6 million (at cost) at December 31, 2010. These auction rate securities failed at auction due to sell orders exceeding buy orders.

The following is a summary of the fair value of available-for-sale marketable securities we held at June 30, 2011 and December 31, 2010:

June 30, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
U.S. Federal Treasury and U.S. government agencies securities-short term	$	8,680	$	4	$	—		$	8,684
Corporate debt securities-short term		47,546		24		(8	)		47,562
		56,226		28		(8	)		56,246
U.S. Federal Treasury and U.S. government agencies securities -long term		41,217		37		—			41,254
Total available-for-sale marketable securities	$	97,443	$	65	$	(8	)	$	97,500

December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
U.S. Federal Treasury and U.S. government agencies securities	$	12,184	$	2	$	(1	)	$	12,185
Corporate debt securities-short term		48,061		12		(20	)		48,053
Total available-for-sale marketable securities	$	60,245	$	14	$	(21	)	$	60,238

The Company’s available-for-sale marketable securities in a loss position at June 30, 2011 and December 31, 2010 were in a continuous unrealized loss position for less than 12 months.

The following is a summary of the fair value of trading securities we held at June 30, 2011 and December 31, 2010:

June 30, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
Auction rate securities	$	2,300	$	—	$	(396	)	$	1,904
Total trading securities	$	2,300	$	—	$	(396	)	$	1,904

December 31, 2010	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Security type
Auction rate securities	$	2,600	$	—	$	(446	)	$	2,154
Total trading securities	$	2,600	$	—	$	(446	)	$	2,154

The underlying collateral of our auction rate securities consists of student loans, supported by the federal government as part of the Federal Family Education Loan Program (FFELP).

At June 30, 2011 and December 31, 2010, the Company’s auction rate securities are included in marketable securities-long term and total $1,904 and $2,154, respectively. The net increase in fair value of our auction rate securities of $31 and $47 in the three and six months ended June 30, 2011, respectively was recorded as a gain in other income (expense) in the statement of operations.

In January 2011, we adopted a newly issued accounting standard which requires additional disclosure about the amounts of and reasons for significant transfers in and out of Level 1 and Level 2 fair value measurements. This standard also clarified existing disclosure requirements related to the level of disaggregation of fair value measurements for each class of assets and liabilities and requires disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring Level 2 and Level 3 measurements. In addition, effective for interim and annual periods beginning after December 15, 2010, this standard further requires an entity to present disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. As this accounting standard only requires enhanced disclosure, the adoption of this standard did not impact our financial position or results of operations and will not affect them in the future.

The following tables present information about our assets that are measured at fair value on a recurring basis for the periods presented and indicates the fair value hierarchy of the valuation techniques we utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. We value our level 2 investments using quoted prices for identical assets in the markets where they are traded, although such trades may not occur daily. These quoted prices are based on observable inputs, primarily interest rates. Fair values determined by Level 3 inputs are unobservable data points for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. There were no transfers in or out of Level 1 or Level 2 measurements for the periods presented:

	June 30, 2011		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	23,133	$	23,133	$	—	$	—
Marketable securities—short term		56,246		—		56,246		—
Marketable securities—long term		43,158		—		41,254		1,904
Total	$	122,537	$	23,133	$	97,500	$	1,904

	December 31, 2010		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents	$	16,871	$	16,871	$	—	$	—
Marketable securities—short term		60,238		—		60,238		—
Marketable securities—long term		2,154		—		—		2,154
Total	$	79,263	$	16,871	$	60,238	$	2,154

Due to the lack of market quotes relating to our auction rate securities, the fair value measurements for our auction rate securities have been estimated using an income approach model (discounted cash flow analysis), which is exclusively based on Level 3 inputs. The model considers factors that reflect assumptions market participants would use in pricing including, among others, the collateralization underlying the investments, the creditworthiness of the counterparty, the expected future cash flows, liquidity premiums, the probability of successful auctions in the future, and interest rates. The assumptions used are subject to volatility and may change as the underlying sources of these assumptions and markets conditions change.

Due to the lack of market quotes relating to our auction rate put option, the fair value measurements for our put option at June 30, 2010 were estimated using a valuation approach commonly used for forward contracts in which one party agrees to sell a financial instrument (generating cash flows) to another party at a particular time for a predetermined price, which is based on Level 3 inputs. In this approach the present value of all expected future cash flows is subtracted from the current fair value of the security, and the resulting value is calculated as a future value at an interest rate reflective of counterparty risk. On June 30, 2010, the company exercised the auction rate put option and in July 2010, UBS AG redeemed at par value all of the Company’s auction rate securities held by UBS AG that were outstanding at June 30, 2010.

The following tables roll forward the fair value of our auction rate securities and put option, whose fair values are determined by Level 3 inputs for the periods presented:

	Amount
Balance at December 31, 2010	$	2,154
Gain on auction rate securities	47
Settlements	(297)
Balance at June 30, 2011	$	1,904

	Amount
Balance at March 31, 2011	$	2,072
Gain on auction rate securities	31
Settlements	(199		)
Balance at June 30, 2011	$	1,904

	Amount
Balance at December 31, 2009	$	59,791
Loss on auction rate securities and put option	(615		)
Settlements	(33,850		)
Balance at June 30, 2010	$	25,326

	Amount
Balance at March 31, 2010	$	53,074
Loss on auction rate securities and put option	(123		)
Settlements	(27,625		)
Balance at June 30, 2010	$	25,326