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SEC Position on Mutual Fund Fair Value Released

New Obligations for Mutual Fund Directors?

By John M. Baker, Esq.


The staff of the Securities and Exchange Commission recently issued an interpretive letter on the obligation of investment companies and their directors to determine in good faith the fair value of the funds’ portfolio securities when market quotations are not readily available. Investment Company Institute, SEC No-Action Letter (Apr. 30, 2001). Together with a 1999 letter, to which this letter is a sequel, this is the most important guidance on fund valuation since 1970.

Mutual funds are required to value their portfolio securities daily in order to calculate the purchase and redemption prices of their shares. (Valuation is also important for other reasons, such as calculating fund performance, and the letter applies to all investment companies, not just mutual funds.) Funds generally value securities with respect to which market quotations are readily available by using their closing prices. If market quotations are not “readily available,” however, securities must be valued at “fair value as determined in good faith by the board of directors.”

The new letter primarily addresses the circumstances under which “fair value” pricing must be used. In particular, there have been a number of instances where worldwide market conditions have changed after the closing of overseas markets but before funds valued their securities. For funds calculating their net asset value (NAV) using closing prices, therefore, there was an arbitrage opportunity for short-term investors, significantly disadvantaging those funds and their long-term holders.

The new letter states that funds should continuously monitor for events that might necessitate the use of fair value prices and, where a significant event (i.e., an event that will affect the value of a portfolio security) has occurred after the market has closed but before the NAV calculation, the security must be valued using fair value pricing. (The letter presents this position as a continuation of existing interpretations and does not acknowledge that it changes the position expressed in Release No. 33-7512 (Mar. 13, 1998) that a fund may use fair value under those circumstances but is not required to do so.)

Conversely, the letter states that funds must exercise reasonable diligence to obtain market quotations for their portfolio securities before they may properly conclude that market quotations are not readily available.

The letter also addresses the “good faith” requirement when securities are fair valued. In the staff’s view, a board acts in good faith when its fair value determination is the result of a sincere and honest assessment of the amount that the fund might reasonably expect to receive for a security upon its current sale, based upon all of the appropriate factors that are available to the fund.

I have put the new letter on the Yahoo Groups web site, and it can be accessed from http://groups.yahoo.com/group/fundlaw/files/


Copyright 2001, John M. Baker, Esq., Stradley, Ronon, Stevens & Young, LLP, 1220 19th Street, N.W., Suite 700, Washington, DC 20036 – (202) 822-9611- Fax (202) 822-0140 This article was originally posted to the FundLaw List, http://www.egroups.com/group/fundlaw. To subscribe to FundLaw, send a blank e-mail to fundlaw-subscribe@egroups.com


 

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