Coming of Age – The SEC Proposes Modernized Fund Valuation Practices

It has been 50 years since the SEC last addressed valuation practices for funds registered under the Investment Company Act of 1940, as amended (“ICA”). The SEC’s newly proposed rule[1] seeks to address the evolution of fund investment practices during that time. In particular, the proposed rule (Rule 2a-5) provides for the good faith determination of the fair value of a fund’s investments and grants boards the ability to assign good faith fair value determinations to the fund’s investment adviser, subject to board oversight and other conditions.

The ICA currently requires funds to value their investments using “readily available” market quotations of the securities. If a market quotation is not “readily available,” funds can use the fair value of a security as determined in good faith by the board. The proposed rule requires establishing criteria for determining when market quotations are no longer reliable and, hence, not readily available.

As proposed, in order to determine fair value in good faith certain functions must be performed. The functions include:

  • Adopting and implementing written policies and procedures pertaining to fair value determinations and associated recordkeeping;
  • Assessing and managing identified valuation risks, including conflicts of interest;
  • Choosing, applying and testing fair value methodologies; and
  • Approving, monitoring and assessing pricing services used by a fund.

Proposed Rule 2a-5 would also provide a board an alternative to making its own good faith fair value determinations. The proposal would permit a board to delegate the determinations to the fund’s investment adviser subject to the following conditions:

  • The adviser being overseen by the board;
  • Periodic reporting (i.e. at least quarterly) of the adequacy and effectiveness of the adviser’s process, including an assessment of valuation risks;
  • Prompt reporting to the board on matters that could materially affect the fair value of the fund;
  • Clearly defined and segregated roles and responsibilities of the adviser’s personnel; and
  • Additional recordkeeping by the adviser.

The comment period for the proposal ends on July 21, 2020. For more information on how CSS can help you stay ahead of regulatory change, please email us at: info@cssregtech.com and one of our regulatory experts will be in touch!

[1]  https://www.sec.gov/rules/proposed/2020/ic-33845.pdf

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