Statement on Good Faith Determinations of Fair Value under the Investment Company Act of 1940 Proposal

I appreciate the work of the Divisions of Investment Management and Economic and Risk Analysis, and the Offices of the Chief Accountant, General Counsel, and Compliance Inspections and Examinations on today’s proposed rulemaking.  Valuing securities for which no market value is available is one of the most important duties that the Investment Company Act places on fund boards.  It is also one of the more technically complicated tasks on the ever-lengthening list of board obligations.

Today’s proposal is a worthwhile step in the Commission’s efforts to ensure that fund boards are freed up wherever possible to focus their energies where they are most needed and best suited.  To that end, proposed rule 2a-5, among other things, would permit fund boards to assign fair valuation determinations to an adviser, subject, of course, to board oversight.  Relying on decades of staff guidance, boards already rely heavily on advisers to fair value securities.  Codifying boards’ ability to assign fair value determination responsibilities to advisers is a good step.  While I am happy to support this effort, its benefits may be diminished significantly by an overly prescriptive approach to ensuring adequate board administration of the fair valuation process.

Under the proposal, if a board chooses to fulfill its fair valuation duties itself, the board would be afforded a degree of flexibility in how, for example, it assesses and manages valuation risk and selects valuation methodologies.  A fund board that chooses to assign fair valuation duties to its adviser, on the other hand, would be bound by specific requirements as to how to oversee its adviser, including mandates about what and when the adviser must report to the board.  For example, boards would have to ensure that investment advisers report no less than quarterly on a range of issues (e.g., the assessment and management of material valuation risks, any material changes to the adviser’s process for overseeing pricing services, etc.) and within three days on any matters associated with the adviser’s valuation process that have or could have had a material effect on the fair value of fund investments.  Why is this level of prescription necessary?  Boards are perfectly able to ensure that they have a full picture of their advisers’ valuation activities without the Commission imposing a series of one-size-fits-all requirements in a new regulation.

The proposing release acknowledges that “few boards today are directly involved in the performance of the day-to-day valuation tasks required to determine fair value,” but instead “enlist the fund’s investment adviser to perform certain of these functions.”[1]  Boards therefore already have policies and procedures for supervising and overseeing advisers’ involvement in valuation.  Further, the general compliance rule for funds, rule 38a-1, building on boards’ statutory valuation mandate, “requires funds to adopt policies and procedures” to monitor when fair valuation is in order and maintain appropriate fair value methodologies.[2]  In other words, fund boards already have the experience and the wherewithal (as well as an existing legal obligation) to oversee, and ensure the adequacy, efficacy, and accuracy of, an adviser’s valuation processes.  Proposed rule 2a-5 should reflect that reality rather than trying to overlay unnecessary duplicative requirements on top of it.

I am eager to hear from commenters about whether this proposal got the balance right.  Will the new rule assist fund boards in efficiently and effectively meeting their valuation obligations and thus protect the fund and its investors?  The timing of this proposal during the COVID-19 crisis and attendant economic and market instability affords us the opportunity to learn from the very fresh-in-mind difficulties that funds and other market participants confront in valuing securities during highly volatile market conditions.  Would rule 2a-5 have helped, hurt, or had little impact on board valuation efforts had it been on the books during the monumental valuation challenges of recent weeks?  Would it have provided fund boards the necessary balance of flexibility and guidance about how to value securities during a time of profound market instability?  I also am interested in hearing how accurately the proposed obligations reflect current valuation practices and whether commenters believe that boards should be free to assign valuation duties to third parties other than the fund’s adviser.

Again, my thanks go to the agency’s staff who worked so hard on this proposal, including Dalia Blass, Paul Cellupica, Sarah ten Siethoff, David Bartels, Alison Staloch, Joel Cavanaugh, Bradley Gude, Thoreau A. Bartmann, Brian McLaughlin Johnson, Kieran G. Brown, David J. Marcinkus, Jenson Wayne, Alexis Cunningham, Jacob Sandoval, Jamie Davis, Thomas Collens, Lori Price, Narahari Phatak, Lauren Moore, Marie-Louise Huth, Song Brandon, Xanthi  Gkougkousi, and Elizabeth Pflaum.  I also want to thank commenters in advance for the insights and wisdom they will share as we look to next steps.