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SEC proposed updates to fund valuation practices – rule 2a-5

The Securities and Exchange Commission (SEC) issued press release 2020-93 on April 21, 2020, proposing a modernization on fair valuation practices and review of the role of the board of investment companies registered under the Investment Company Act of 1940 (the Act). The proposal is intended to address the changing market developments and the requirements surrounding fund valuations for investment companies. Under the proposed rule, investment companies would see an increase in the variety of asset classes held, and an increase in the volume and type of data inputs allowed for valuation. Certain requirements would be required to comply with the proposed rule, further outlined below. Comment period on this proposal will be open until July 21, 2020.

Those impacted: Registered investment company or business development company (a “fund”)

Reasoning: To safeguard investors by increasing market efficiency, coherence and objectivity

Additional factors: Due to market and practice evolvement since the last SEC Issuances in 1969 and 1970, valuation practices are to be updated to reflect these considerations. Notable factors that have changed: 1) the use of third-party pricing vendors; 2) significant federal regulatory developments; 3) development of investment advisers’ expertise

What: Proposed new rule 2a-5 under the Investment Company Act of 1940

Purpose: Determining fair value of investments in good faith (level 2 and 3 investments)

Updates: Expanded valuation obligation for fund boards due to market changes:

Internally designated fund board required to perform certain functions

  • Risk assessments of valuation determinations
  • Select, apply and test fair value methodologies
  • Approval, monitoring and evaluation of any pricing services used
  • Adopt and implement policies and procedures
  • Maintain certain records sufficient for a third party to verify the fair value determination

OR

Fund’s investment adviser assigned valuation functions by internal fund board

  • Timely and periodic specific reporting by the adviser to the board
  • Clear specification of responsibilities (title and function) and reasonable segregation of duties among the adviser’s personnel
  • Additional recordkeeping
  • Internal fund board must actively oversee this process

AND

Definition of readily available market quotations

(for purposes of the Act) (level 1 investments)

  • “The proposal would treat a market quotation as “readily available” only when that quotation is a quoted priced (unadjusted) in active markets for identical investments that the fund can access at the measurement date. The proposal would also provide that a quotation is not readily available if it is not reliable.” – SEC press release 2020-93

Where:

View the SEC full proposal

View the SEC press release

Notes:

  1. For investments held by unit investment trusts, which do not have a board of directors or investment advisers, the trustee would be required to determine fair value in good faith
  2. Accounting Series Release 113 (ASR 113) and Accounting Series Release 118 (ASR 118) (both provide guidance on how to determine fair value for restricted securities) and certain staff letters/staff guidance addressing fund valuation matters covered by the proposal will be rescinded in any adoption of the rule

For more information on this topic or to learn how Baker Tilly specialists can help, contact our team.

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