Valuation practices under the Investment Company Act were last addressed by the SEC in a comprehensive manner in a pair of releases issued in 1969 and 1970. Markets and fund investment practices have evolved significantly since that time. Many funds now engage third-party pricing services to provide pricing information, particularly for thinly traded or more complex assets. In addition, significant regulatory developments have altered how boards, investment advisers, independent auditors, and other market participants address valuation under the federal securities laws. This proposal recognizes and reflects these changes, including the important role that funds’ investment advisers may play and the expertise they may provide.

As proposed, new rule 2a-5 under the Investment Company Act of 1940 would establish requirements for determining the fair value in good faith of a fund’s investments. It would also permit boards to assign the determination to the fund’s investment adviser (subject to board oversight and certain other conditions). Finally, the rule would define “readily available” market quotations for purposes of the Investment Company Act.

Determining Fair Value in Good Faith

Proposed rule 2a-5 would require the performance of certain functions in order to determine fair value in good faith. These functions include:

• Periodically assessing and managing material risks associated with fair value determinations, including material conflicts of interest


• Choosing, applying, and testing fair value methodologies


• Overseeing and evaluating any pricing services used

The proposed rule would also require the adoption and implementation of written policies and procedures that address fair value determination and the maintenance of certain records.

Who Performs Fair Value Determinations

Under the Investment Company Act, securities and assets that do not have readily available market quotations are valued at fair value. This is typically determined in good faith by a fund’s board of directors. The proposed rule would confirm that a board can in fact make this determination itself. In addition, the rule would allow a board to assign the determination to the fund’s investment adviser. This assignment would be subject to additional conditions and oversight requirements. The adviser would be required to carry out the fair value determination functions described above. Additional requirements would apply, including:

• Board oversight of the adviser


• Periodic and prompt reporting to the board


• Clear specification of responsibilities and reasonable segregation of duties among the adviser’s personnel


• Keeping additional records relevant to the assignment to the adviser

Unit investment trusts do not have boards or investment advisers. Therefore, the proposed rule would require the trustee to determine fair value in good faith.

Readily Available Market Quotations

Under the Investment Company Act, fund investments must be fair valued where market quotations are not “readily available.” The new proposal would treat a market quotation as “readily available” only when that quotation is a quoted price (unadjusted) in active markets for identical investments that the fund can access at the measurement date. Also, the proposal provides that a quotation is not readily available if it is not reliable.

Rescission of Prior Commission Releases and Review of Relevant Staff Guidance

Given the proposal’s modernized approach to fund valuation, the SEC is considering rescinding two releases: Accounting Series Release 113 (ASR 113) and Accounting Series Release 118 (ASR 118). These releases provide SEC guidance on how to determine fair value for restricted securities, among other matters. The proposal also states that certain SEC staff letters and other staff guidance addressing fund valuation matters covered by the proposal would be rescinded or withdrawn in connection with any adoption of the rule.

The SEC seeks public comment on these proposed changes. The public comment period will be open for 60 days after publication in the Federal Register. You can submit comments using the form available on the SEC’s website or by e-mailing rule-comments@sec.gov with the proposed rules’ reference number in the subject line. You can also use the Federal Rulemaking Portal to submit comments or send your comments by mail to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. In all cases, be sure to reference File Number S7-07-20.

Sources:

SEC Proposes to Modernize Framework for Fund Valuation Practices (www.sec.gov)

Good Faith Determinations of Fair Value (www.sec.gov)