SEC Proposes to "Modernize" Fund Valuation Practices

Steven Lofchie Commentary by Steven Lofchie

The SEC proposed a regulatory framework for fund valuation practices which clarifies how a fund's Board of Directors can satisfy obligations concerning fair value determination.

Fair Value Determination

Under proposed Rule 2a-5 of the Investment Company Act, the SEC would mandate the implementation of written procedures for conducting fair value determinations and the maintenance of related records. The written procedures would be required to include certain functions such as:

  • regularly conducting assessments and mitigating material risks related to fair value determinations (e.g., risks relating to material conflicts of interest);
  • establishing and reviewing fair value methodologies; and
  • monitoring and examining pricing services.

The proposed rule would allow a fund's Board of Directors to designate the fund's investment adviser to perform the valuation functions set out above, subject to additional conditions, including:

  • oversight by the Board;
  • an obligation for the adviser to make "periodic and prompt" reports to the Board;
  • a concise outline of responsibilities and delegation of duties to the adviser's staff; and
  • the adviser maintaining certain required records.

Readily Available Market Quotations

The SEC stated that fund investments must be fair-valued when market quotations are not "readily available." A market quotation would be regarded as "readily available" only if the quotation (i) is in active and accessible markets for identical investments and (ii) can be regarded as reliable.

Comments on the proposal must be submitted by July 21, 2020.

Commissioner Statement

Commissioner Hester M. Peirce stated that the proposal is a "good step" in codifying the practice that a Board may delegate fair value determinations to an adviser. She expressed concern, however, that the proposal would implement an overly prescriptive approach on Boards that do so. She questioned whether the reports that the Board would be required to obtain on a quarterly basis were really necessary. She also asked that commenters consider how Rule 2a-5 would function during a period of extreme market volatility, as during the current pandemic.

Commentary

The press release headline for this action is "SEC Proposes to Modernize Framework for Fund Valuation Practices." On February 14, the SEC issued a proposal to "modernize" key market infrastructure; on January 30, proposed to "modernize" financial disclosure and, to close out last year, proposed to "modernize" the auditor independence rules. See SEC Press Releases for 2020. Earlier, the SEC proposed to "modernize" the use of derivatives by registered investment companies (November 25, 2019), the "shareholder proposal rule" (November 5, 2019) and advertising by investment advisers (November 4, 2019). See 2019 SEC Press Releases.

Way back in the Dodd-Frank era, every rule adoption or amendment would be about "reforming" regulation, and, if the new regulation was particularly complicated and convoluted, it would be about "common-sense reform."

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