On December 3, 2020, the SEC adopted a new rule under the Investment Company Act of 1940 (the “Act”), which will establish both the framework for fund valuation practices and the function of the board of directors regarding the fair value of a business development company (“fund”) or the investments of a registered investment company. The rule is intended to simplify how fund boards can meet the requirements of their valuation obligations considering market developments, such as an increase in both the type and volume of information used in valuation determinations and the increase in the variety of asset classes held by funds.
Under the Act, new rule 2a-5 will:
allow a fund’s board of directors to appoint certain parties to conduct the fair value determinations as most fund boards do not play a day-to-day role in the pricing of fund investments. If the board designates the determination of fair value to a valuation designee, the designee will perform these operations for certain or all of the fund’s investments. The designee will be subject to additional conditions including:
board oversight requirements
prompt and regular reporting to the board
other conditions established to facilitate the board’s ability successfully to monitor the designee’s fair value determinations
provide requirements for determining fair value of a fund’s investments (where market quotations are not readily available) in good faith. This determination will include managing and evaluating material risks related to fair value determinations; applying, selecting, and testing fair value methodologies; and overseeing and reviewing any pricing services used
incorporate a specific provision concerning the determination of the fair value of investments held by unit investment trusts, which do not have boards of directors
identify instances when market quotations are readily available
Related to rule 2a-5, the SEC is also adopting rule 31a-4, a separate rule under the Act, which provides the recordkeeping requirements associated with fair value determinations. The rule will require funds or their advisers to keep appropriate documentation to support fair value determinations and documentation related to the designation of the valuation designee.
Lastly, on the compliance date, the SEC will rescind two previously issued releases, Accounting Series Release 113 (ASR 113) and Accounting Series Release 118 (ASR 118). Both address related matters, including: 1) the accounting and auditing of fund investments, and 2) the role of the boards of directors in determining fair value for restricted securities. Certain SEC guidance, including staff letters and other staff guidance related to the matter, will also be rescinded or withdrawn on the compliance date.
Rules 2a-5 and 31a-4 will become effective 60 days after publication in the Federal Register. The SEC is adopting an eighteen-month transition period beginning from the effective date of the rules to provide adequate time for funds and valuation designees to prepare for compliance with rules 2a-5 and 31a-4. The SEC also will provide funds with the option of voluntarily complying with the rules prior to the compliance date when the rules become effective. Funds that choose to rely on rules 2a-5 and 31a-4 before to the compliance date may rely only on rules 2a-5 and 31a-4 and must disregard all SEC and staff letters and other guidance that will be withdrawn or rescinded on the compliance date in determining fair value in good faith under section 2(a)(41) of the Act and rule 2a-4.