On April 21, 2020, the U.S. Securities and Exchange Commission (SEC) proposed a new rule focused on fund valuation practices. When adopted, the rule will apply to all registered investment companies which includes mutual funds, business development companies (BDCs) and unit investment trusts (UITs). The new rule also gives insight into the SEC’s thoughts on valuation governance and valuation best practice for private funds managed by registered investment advisers. 

Existing SEC valuation rules date back to 1969 and 1970. With the release of the proposed rule, SEC Chairman Jay Clayton stated, “Today’s proposal would improve valuation practices, including oversight, thereby protecting investors and improving market efficiency, integrity and fairness.”

Determining Fair Value in Good Faith

Section 2(a)(41) of the 1940 Investment Company Act mandates that a fund’s board determines fair value in good faith. The nature and character of investments has changed substantially over the past 50 years since the SEC released Accounting Series Releases (ASR) 113 and 118 in 1969 and 1970, and the proposed rule (labeled 2a-5) will rescind ASR 113 and 118. 

The proposal document highlights that “to determine the fair value of fund investments in good faith requires a certain minimum, consistent framework for fair value” and a “standard of baseline practices across funds.” 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 also preserving a crucial role for boards to fulfill their obligations under [the Investment Company Act].” Boards retain the responsibility for the good faith determination of fair value; however, they will now be allowed to delegate certain responsibilities to the fund adviser or other valuation specialists. The board will be 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 determination of fair value duties.

Alignment with Accounting Standards

The proposed rule is aligned with the requirements of Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) Topic 820 Fair Value Measurement. Further the proposed rule 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. 

While proposed rule 2a-5 is congruent with current accounting standards, it does not mirror ASC Topic 820 exactly. This is because the rule needs to fit within the statutory framework of the 1940 Investment Company Act (1940 Act) and give the SEC flexibility, if needed, should there be future changes to accounting standards which the SEC may not deem at that time to be consistent with the 1940 Act. That said, it is clear that if market quotations are available (Level I inputs), fair value is determined as P*Q (market price times quantity of shares). When market quotations are not readily available (Level II and III inputs), the principles espoused by ASC Topic 820 should be followed.

Board Valuation Responsibilities

As previously indicated, the board of a registered investment company (and by analogy the manager of a private fund) is required to determine fair value in good faith. Rule 2a-5 requires that a board directly, or through delegation, undertake the following:

  • Assess and manage valuation risks
  • Establish and apply fair value methodologies
  • Test fair value methodologies
  • Evaluate pricing services
  • Adopt and implement written fair value policies and procedures
  • Maintain records supporting fair value determinations

The board may choose to assign the determination of fair value for any or all individual investments to the investment adviser. 

In many ways the proposed rule codifies practices that have evolved over the past decades. Boards retain responsibility for oversight but may use advisers and other engaged valuation expertise to assist in fulfilling their fair value obligations.


Modernization of the existing SEC good faith fair value determination rules has been long expected. At a time of increased public market volatility and economic uncertainty resulting from public health actions taken in response to the COVID-19 pandemic, the need for experienced, independent and informed judgement when estimating fair value is required now more than ever. 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 and thereby providing investors with the fair value information they need. 

The SEC received almost 70 comment letters, most supporting the proposal (comment letters are available here). The proposal is available at: Good Faith Determination of Fair Value.

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