MFDF Fair Valuation Resources Center

The SEC recently proposed a new rule, Good Faith Determinations of Fair Value,  that would establish a framework for mutual fund fair valuation practices.  The Mutual Fund Directors Forum is reviewing the proposed rule and its implications for the role of fund directors. The Forum has also collected various commentary and resources on the rule proposal that may be helpful to fund directors and industry partners. The Forum’s Fair Valuation Resources Center will be updated frequently.

Proposed Rule 2a-5 Highlights for Fund Boards

  • Under the proposed rule, a fund’s board may perform the prescribed functions to determine fair value of an investment or the fund board may assign any fair valuation determinations to an investment adviser (or subadviser). 
  • The rule would require a board (or adviser to which board assigned responsibility) to assess and manage material risks associated with fair value determinations; select, apply and test fair value methodologies; oversee and evaluate any pricing services used; adopt and implement policies and procedures; and maintain certain records.
  • The proposed rule would permit a fund’s board to assign the determination of fair value to the fund’s investment adviser, subject to additional conditions and oversight requirements, including specific reporting by the adviser both periodically and promptly; clear specification of responsibilities and reasonable segregation of duties among the adviser’s personnel; and additional recordkeeping.
  • The proposal makes clear that a board’s effective oversight of this process must be active. The SEC specified how boards might fulfill their fair valuation oversight responsibilities including: boards should seek to identify potential conflicts of interest, monitor such conflicts, and take reasonable steps to manage such conflicts; boards should probe the appropriateness of the adviser’s fair value processes; and boards should consider the type, content and frequency of the reports they receive regarding the aspects of the adviser’s fair value determination process.
  • The comment period for the proposal will be open until July 21, 2020.

SEC Rule Proposal

Commissioner Hester Peirce Statement

Law Firm Commentary

Simpson Thacher: Lawyers at Simpson Thacher thoroughly parse the rule proposal and anticipate potential controversial provisions. They note that the proposed rule’s provisions regarding when market quotations are not “readily available” for purposes of valuations require close attention and its requirements on  due diligence to be conducted on pricing services “could call for much more extensive and frequent investigation of pricing services than is common practice today.”

Stradley Ronon: In this in-depth review, lawyers from Stradley outline several questions and considerations about the rule proposal and its potential impact on fund boards and advisers, including: Does the proposal clarify the board’s role in the valuation process? Could the SEC use the new rule to bring enforcement actions against boards for improper oversight and assignment to the adviser? Will the SEC make additions to the rule to benefit boards, such as recognizing the role of directors’ reasonable business judgment in the valuation context?

Goodwin Procter: This thorough review breaks up the SEC’s proposal into sections, discussing background information on the proposal and the previous valuation framework; key components of the proposal and how to interpret requirements; the SEC’s proposed rescission or withdrawal of certain prior SEC releases and SEC staff guidance and alternatives that the SEC considered.

K&L Gates: In its comprehensive review, K&L Gates lawyers tease out specific considerations for boards and fund advisers on each component of the proposal. In a table at the end of its client alert, K&L Gates presents a clear comparison between the rule proposal and the current valuation framework, highlighting new responsibilities for boards and advisers around reporting and recordkeeping, among others.

Sullivan: The client alert thoroughly breaks down the proposal’s reporting requirements and what boards may ultimately receive from the adviser. The Sullivan alert also discusses board monitoring of potential conflicts of interest and how boards may oversee the adviser. “[It] is noted that pricing services or broker-dealers providing opinions on prices may have incentives or pressures to provide pricing estimates that are favorable to the adviser. Therefore, boards should ask questions relating to possible conflicts of interest of both the adviser and other service providers and ensure that it is comfortable any such potential conflicts are being appropriately managed.”

Faegre Drinker: Lawyers at Faegre Drinker offer practice points relating to the proposal. They note that most fund boards likely will take advantage of the proposed rule and assign their fair value responsibilities to the adviser, “who in most cases is already fair valuing fund securities under board supervision.”  They note, however, that the proposal “would still require the board to engage in “active oversight” of the adviser with regard to the fair value process, and that the board “will still find itself performing a significant level of oversight over the fair value process under the proposed rule.”

Wilmer Hale: Lawyers from Wilmer Hale list indications for fund advisers and boards and note that the proposed rule would “formalize a board’s responsibility for approval of pricing vendors, which may result in greater scrutiny and input into the methodologies used by those vendors.”

Auditor Commentary

KPMG: The auditing and consulting firm writes that the SEC’s proposal would simplify regulatory requirements while maintaining fair value integrity. In particular, KPMG notes that the SEC’s proposed withdrawal of previous guidance and its moving to FASB accounting guidance and PCAOB auditing guidance will simplify the requirements.

Deloitte:  The auditing firm writes that the proposal’s requirement that the board or the adviser establish a process to monitor and evaluate the pricing services “may help to align management’s or the board’s responsibilities with respect to pricing services with the auditor’s responsibilities reinforced in the recently issued PCAOB standards.” Deloitte also observed that the SEC’s proposal to rescind previous guidance eliminates the requirement for auditors to test the valuation of 100% of the fund’s portfolio, “meaning that auditors will have the option to follow PCAOB guidance and potentially utilize sampling techniques in testing the valuation of the portfolio in certain situations.”

MFDF Resources:

Upcoming Forum Webinar: Risk-based Governance and Reporting: SEC Looks for Boards to Focus on Pricing When it Matters Most

Join Deloitte partners on June 2, 2020 as they highlight the impact of the SEC's new valuation rule proposal for boards, advisers, and auditors. The webinar will broadcast live from 2 pm - 3 pm (ET).

Forum Webinar: Current Board Priorities: Valuation Rule and COVID-19 Considerations

Ropes & Gray LLP partners Paulita Pike, Elizabeth Reza and Adam Schlichtmann discussed the details of SEC's new valuation rule proposal and the challenges faced by board in the COVID-19 environment. The webinar originally aired May 5, 2020.

Forum White Paper: Practical Guidance for Fund Independent Directors on Valuation Oversight