SEC Proposes Fund Valuation Practice Modernization

On April 21, 2020 the US Securities and Exchange Commission (SEC) proposed a new rule focused on fund valuation practices. The rule, if adopted, will be applicable to all registered investment companies and business development companies. Existing SEC valuation rules date back to 1969 and 1970. SEC Chairman Jay Clayton stated, “Today’s proposal would improve valuation practices, including oversight, thereby protecting investors and improving market efficiency, integrity and fairness.” We see the proposed rule as providing clarification as to the valuation obligations of boards and fund managers and most importantly additional emphasis on the importance of having a strong independent valuation process.  

The new rule highlights that “to determine the fair value of fund investments in good faith requires a certain minimum, consistent framework for fair value and standard of baseline practices across funds.” The SEC states that “in addition to providing requirements for estimating fair value in good faith, the proposed rule is designed to provide boards and advisers with a consistent, modern approach, to the allocation of fair value functions” while maintaining the oversight role and statutory duty boards are expected to fulfil. Boards are required to manage and oversee the risks in the valuation process and ensure proper documentation of valuation conclusions but can use qualified experienced resources, including third-party valuation support, to exercise their “good faith” duties.

The proposed rule aligns with the requirements of Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) Topic 820 Fair Value Measurement. It further aligns with 2018 Public Company Accounting Oversight Board (PCAOB) audit standards which require greater scrutiny when fair value is determined using pricing services or broker quotes. 

Public market volatility and economic uncertainty resulting from public health actions taken in response to the COVID-19 pandemic highlight the need for experienced, independent and informed judgement with estimating fair value. Alternative investment managers best serve their investors by providing relevant, reliable and transparent information. The SEC’s proposed rule to modernize the valuation framework should further assist investors by improving overall fair value policies and processes.  

The SEC is seeking comments on the proposal by July 21, 2020. The proposal is available here.