Fair Valuation And Mutual Fund Directors: New Guidance From The SEC*

In June, I began a series of Client Alerts on Fair Valuation and Mutual Fund Directors. The third installment in the series was released in July. Although I was not certain what path the series would take, I knew where it would end—with an irrefutable argument that it was past time for the SEC to address the use of pricing services to fair value securities, particularly fixed-income securities.

In policy arguments, as in comedy, timing is everything. The SEC stole my punch line when it recently issued new guidance on the use of pricing services. The guidance is buried in the bowels (an apt phrase in this instance) of the SEC's July 23 release adopting money market fund reforms (the "Release"). A section providing "Guidance on the Amortized Cost Method of Valuation and Other Valuation Concerns" begins at page 270 of the 869-page release.1 The SEC tacked much of the 11 pages of guidance onto section 404.05 of the Codification of Financial Reporting Policies (the "CFRP").

Given the context, directors may be forgiven for hoping that this guidance is limited to money market funds. The Release states, however, that (unless otherwise noted) "this guidance is applicable to all registered investment companies and business development companies."2

This Client Alert provides a summary of the guidance "applicable to all registered investment companies." The first section summarizes guidance previously provided by the SEC and its staff that has been added to the CFRP. The second section summarizes new guidance regarding use of evaluated prices from pricing services; the third section summarizes new guidance on the use of amortized cost. A proper assessment of the guidance will need to wait for later Client Alerts, after we have had more time to reflect on these reforms.

1. Previous Guidance Codified by the Release

   Much of the guidance included in the Release is already in section 404 of the CFRP. In fact, the amount of repetition in the revised section may confuse a first-time reader. For example, subsection 404.03.b.iv (Securities Valued "in Good Faith") already stated, "it is incumbent upon the board of directors to satisfy themselves that all appropriate factors relevant to the value of securities for which market quotations are not readily available have been considered and to determine the method of arriving at the fair value of each such security." New subsection 404.05.c.2 (Other Valuation Matters) quotes this statement verbatim, both in footnote 896 and in the sentence immediately following this footnote. Like Lewis Carroll's Bellman, when it comes to valuation guidance, "What [the SEC] tell[s] you three times is true."3

   New subsection 404.05.c also contains some existing guidance not previously included in the CFRP, particularly:

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