28734 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

SECURITIES AND EXCHANGE ADDRESSES: Comments may be Chief Accountants, or Jacob Sandoval, COMMISSION submitted by any of the following Branch Chief, at (202) 551–6918 or IM- methods: [email protected], Chief Accountant’s 17 CFR Parts 210 and 270 Office, Division of Investment Electronic Comments Management, Securities and Exchange • [Release No. IC–33845; File No. S7–07–20] Use the Commission’s internet Commission; or Jamie Davis or Thomas comment form (http://www.sec.gov/ Collens, Professional Accounting rules/interp.shtml); or RIN 3235–AM71 Fellows, at (202) 551–5300 or OCA@ • Send an email to rule-comments@ sec.gov, Office of the Chief Accountant, Good Faith Determinations of Fair sec.gov. Please include File Number S7– Securities and Exchange Commission. Value 07–20 on the subject line. SUPPLEMENTARY INFORMATION: The Paper Comments Commission is proposing for public AGENCY: Securities and Exchange comment 17 CFR 270.2a–5 (new rule • Commission. Send paper comments to Secretary, 2a–5) under the Investment Company ACTION: Proposed rule. Securities and Exchange Commission, Act. 100 F Street NE, Washington, DC SUMMARY: The Securities and Exchange 20549–1090. Table of Contents Commission (‘‘Commission’’) is All submissions should refer to File I. Introduction proposing a new rule (‘‘rule 2a–5’’) Number S7–07–20. This file number II. Discussion under the Investment Company Act of should be included on the subject line A. Fair Value as Determined in Good Faith 1940 (the ‘‘Investment Company Act’’ or if email is used. To help us process and Under Section 2(a)(41) of the Act 1. Valuation Risks the ‘‘Act’’) that would address valuation review your comments more efficiently, practices and the role of the board of 2. Fair Value Methodologies please use only one method. The 3. Testing of Fair Value Methodologies directors with respect to the fair value Commission will post all comments on 4. Pricing Services of the investments of a registered the Commission’s internet website 5. Fair Value Policies and Procedures investment company or business (http://www.sec.gov/rules/interp.shtml). 6. Recordkeeping development company (a ‘‘fund’’). The Comments are also available for website B. Performance of Fair Value proposed rule would provide viewing and printing in the Determinations requirements for determining fair value Commission’s Public Reference Room, 1. Board Oversight in good faith with respect to a fund for 2. Board Reporting 100 F Street NE, Washington, DC 20549, 3. Specification of Functions purposes of section 2(a)(41) of the Act. on official business days between the 4. Records of Assignment This determination would involve hours of 10:00 a.m. and 3:00 p.m. All C. Readily Available Market Quotations assessing and managing material risks comments received will be posted D. Rescission of Prior Commission Releases associated with fair value without change. Persons submitting E. Existing Staff No-Action Letters, Other determinations; selecting, applying, and comments are cautioned that we do not Staff Guidance, and Proposed Transition testing fair value methodologies; redact or edit personal identifying Period III. Economic Analysis overseeing and evaluating any pricing information from comment submissions. services used; adopting and A. Introduction You should submit only information B. Economic Baseline implementing policies and procedures; that you wish to make publicly 1. Current regulatory framework and maintaining certain records. The available. 2. Current practices proposed rule would permit a fund’s Studies, memoranda or other 3. Affected parties board of directors to assign the fair substantive items may be added by the C. Benefits and Costs and Effects on value determination to an investment Commission or staff to the comment file Efficiency, Competition, and Capital Formation of Proposed Rule adviser of the fund, who would then during this rulemaking. A notification of carry out these functions for some or all 1. General Economic Considerations the inclusion in the comment file of any 2. Benefits of the fund’s investments. This such materials will be made available 3. Costs assignment would be subject to board on the Commission’s website. To ensure 4. Effects on Efficiency, Competition, and oversight and certain reporting, direct electronic receipt of such Capital Formation recordkeeping, and other requirements notifications, sign up through the ‘‘Stay D. Reasonable Alternatives designed to facilitate the board’s ability Connected’’ option at www.sec.gov to 1. More Principles-Based Approach effectively to oversee the adviser’s fair receive notifications by email. 2. Assignment of Responsibilities to value determinations. The proposed Service Providers Other Than Investment FOR FURTHER INFORMATION CONTACT: Joel Advisers rule would include a specific provision Cavanaugh, Senior Counsel; Bradley 3. Not Permit Boards To Assign Fair Value related to the determination of the fair Gude, Senior Counsel; Thoreau A. Determinations to an Investment Adviser value of investments held by unit Bartmann, Senior Special Counsel; or E. Request for Comment investment trusts, which do not have Brian McLaughlin Johnson, Assistant IV. Paperwork Reduction Act Analysis A. Introduction boards of directors. The proposed rule Director, at (202) 551–6792, Investment would also define when market B. Policies and Procedures Company Regulation Office, Division of C. Board Reporting quotations are readily available under Investment Management; Kieran G. section 2(a)(41) of the Act. If rule 2a–5 D. Recordkeeping Brown, Senior Counsel, or David J. E. Proposed Rule 2a–5 Total Estimated is adopted, the Commission would Marcinkus, Branch Chief, at (202) 551– Burden rescind previously issued guidance on 6825 or [email protected], Chief F. Request for Comment the role of the board of directors in Counsel’s Office, Division of Investment V. Initial Regulatory Flexibility Analysis determining fair value and the Management; Securities and Exchange A. Reasons for and Objectives of the Proposed Actions accounting and auditing of fund Commission, 100 F Street NE, investments. B. Legal Basis Washington, DC 20549–8549. Regarding C. Small Entities Subject to Proposed Rules DATES: Comments should be submitted accounting and auditing matters: Jenson D. Projected Reporting, Recordkeeping, and on or before July 21, 2020. Wayne or Alexis Cunningham, Assistant Other Compliance Requirements

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28735

1. Policies and Procedures affects the accuracy of funds’ asset- fund’s valuation procedures.9 Properly 2. Recordkeeping based and performance-based fee valuing a fund’s investments also is a 3. Board Reporting calculations; 4 disclosures of fund fees, critical component of the accounting E. Duplicative, Overlapping, or Conflicting performance, NAV, and portfolio and financial reporting for investment Federal Rules 10 F. Significant Alternatives holdings; 5 and compliance with companies. Section 2(a)(41)(B) defines G. Request for Comment investment policies and limitations.6 As ‘‘value’’ for purposes of many of the VI. Consideration of Impact on the Economy a result, improper valuation can cause requirements of the Investment VII. Statutory Authority investors to pay fees that are too high or Company Act as: (i) With respect to to base their investment decisions on securities for which market quotations I. Introduction are readily available, the market value of inaccurate information.7 The Investment Company Act such securities; and (ii) with respect to requires funds to value their portfolio For these reasons, a number of the other securities and assets, fair value as investments using the market value of substantive requirements of the determined in good faith by the board their portfolio securities when market Investment Company Act relate to of directors.11 quotations for those securities are investment company valuation.8 The Commission last ‘‘readily available,’’ and, when a market Moreover, the federal securities laws comprehensively addressed valuation quotation for a portfolio security is not impose liability on funds, fund boards, under the Investment Company Act in readily available, by using the fair value and advisers for improperly valuing a pair of releases issued in 1969 and of that security, as determined in good fund investments and for making 1970, Accounting Series Release 113 faith by the fund’s board.1 The aggregate material misstatements regarding a (‘‘ASR 113’’) and Accounting Series value of a fund’s investments is the Release 118 (‘‘ASR 118’’).12 ASR 113 primary determinant of the fund’s net shares. On the other hand, if fund shares are asset value (‘‘NAV’’), which for many underpriced, selling shareholders will receive too 9 See, e.g., 15 U.S.C. 77l(a)(2); 15 U.S.C. 77k; 15 funds determines the price at which little for their shares, and purchasing shareholders U.S.C. 78j(b); 15 U.S.C. 80a–33(b); 17 CFR 240.10b– will pay too little for their shares. See generally 5; 17 CFR 270.22c–1(a); 17 CFR 210.4–01(a)(1); 17 their shares are offered and redeemed Investment Trusts and Investment Companies: CFR 275.206(4)–8. 2 (or repurchased). Accordingly, proper Hearings on S. 3580 Before a Subcomm. of the Section 206(1) of the Advisers Act makes it valuation, among other things, promotes Senate Comm. on Banking and Currency, 76th unlawful for an investment adviser to employ any the purchase and sale of fund shares at Cong., 3d Sess. 136–38 (1940) (discussing the effect device, scheme or artifice to defraud any client or of dilution on fund shareholders). prospective client. Section 206(2) of the Advisers fair prices, and helps to avoid dilution 4 Act makes it unlawful for an investment adviser to 3 See section 205 of the Investment Advisers Act of shareholder interests. Valuation also of 1940 (‘‘Advisers Act’’) (permitting a fund’s engage in any transaction, practice or course of adviser to receive compensation based upon the business that operates as a fraud or deceit upon any 1 Section 2(a)(41) of the Investment Company Act. total value of the fund and permitting certain client or prospective client. The Commission has See also Investment Company Act rule 2a–4. specified types of performance fee arrangements brought enforcement actions under sections 206(1) and/or 206(2) of the Advisers Act against advisers 2 The Investment Company Act requires with funds). 5 for material misstatements or omissions to a fund’s registered investment companies that issue See, e.g., Item 3 of Form N–1A (requiring annual board (such as the failure to disclose that the redeemable securities to sell and redeem their fund operating expenses to be disclosed in the adviser is not complying with the fund’s stated shares at prices based on the current net asset value fund’s prospectus as a percentage of the value of a valuation procedures) or willfully or recklessly of those shares. See section 22(c) of the Investment shareholder’s investment); Item 4(b)(2) of Form N– aiding and abetting the misvaluing of fund Company Act and rule 22c–1(a) thereunder. Rule 1A (requiring certain disclosures about fund investments. See, e.g., In re Morgan Asset 2a–4 defines the term ‘‘current net asset value’’ of performance in fund prospectuses); Item 4.1 and Management, et al., Investment Company Act a redeemable security issued by a registered Instruction 4.b. to Item 24 of Form N–2 (requiring Release No. 29704 (June 22, 2011) (settlement) (‘‘In investment company and provides, similar to disclosure of the fund’s NAV in its prospectus and re Morgan Asset Management’’). annual report); Item 6 of Form N–CSR and section 2(a)(41)(B), that ‘‘[p]ortfolio securities with 10 Rule 6–02(b) of Regulation S–X defines the respect to which market quotations are readily § 210.12–12 of Regulation S–X (requiring a schedule term ‘‘value’’ to have the same meaning as in available shall be valued at current market value, of the fund’s investments, including the value of the section 2(a)(41)(B) of the Investment Company Act. and other securities and assets shall be valued at investment, in the fund’s annual report). 11 Section 2(a)(41) of the Investment Company fair value as determined in good faith by the board 6 See Rule 22e–4(b)(1)(iv) (generally prohibiting Act defines ‘‘value’’ with respect to the assets of of directors of the registered company.’’ Rule 22c– an open-end fund from acquiring an illiquid registered investment companies. Section 59 of the 1(a) requires open-end funds to sell, redeem, or investment if such investment would cause more Investment Company Act makes section 2(a)(41) purchase shares at a price based on their current than 15% of such fund’s net assets to be invested applicable to BDCs. Section 2(a)(41)(A) provides the NAV next computed following receipt of an order. in illiquid investments). See also Liquidity Risk definition of ‘‘value’’ under the Investment Although closed-end funds are not subject to Management Release, supra footnote 3; Instruction Company Act for purposes of whether an issuer is rules 2a–4 and 22c–1 under the Investment 4 to Item 9(b)(1) of Form N–1A (requiring a fund an investment company under section 3, is a Company Act, section 23(b) limits the ability of to disclose any policy to invest more than 25% of ‘‘diversified company’’ or a ‘‘non-diversified closed-end funds to sell their common stock at a its net assets in a particular industry or group of company’’ under section 5, or exceeds certain price below current NAV. Section 23(c) of the industries). investment limitations under section 12. Section Investment Company Act provides for the 7 Fund advisers may have an incentive to 28(b) of the Investment Company Act contains repurchases of closed-end fund shares. The shares overvalue fund assets, for example, to increase fees, provisions for the valuation of the investments of of closed-end funds (including business but also in some cases may have incentives to face-amount certificate companies. Section development companies (‘‘BDCs’’)) that are listed undervalue fund assets, for example to smooth 2(a)(41)(B) defines value for all other purposes on an exchange often trade at a premium or reported returns or comply with investment under the Investment Company Act. Section discount to NAV. See Item 1.1(i) of Form N–2 policies and restrictions. See In re Piper Capital 2(a)(41)(A)(iii) provides that investments acquired (requiring closed-end funds whose securities have Management, et al., Investment Company Act after the last preceding quarter shall be valued at no history of public trading to include ‘‘a statement Release No. 26167 (Aug. 26, 2003) (Commission the cost thereof. In certain circumstances, section describing the tendency of closed-end fund shares opinion) (‘‘Piper’’) (‘‘the record shows that 2(a)(41) permits directors to determine in good faith to trade frequently at a discount from net asset Respondents determined to smooth or ratchet down the value of securities issued by controlled value’’). gradually the Fund’s NAV over a period of days. It companies even though market quotations are 3 See Investment Company Liquidity Risk appears that Respondents sought to prevent an available for such securities. Management Programs, Investment Company Act abrupt drop in the Fund’s NAV as a result of 12 Statement Regarding ‘‘Restricted Securities,’’ Release No. 32315 (Oct. 13, 2016) (‘‘Liquidity Risk updating the stale prices.’’). See also Gjergi Cici, et Accounting Series Release No. 113 (Oct. 21, 1969); Management Release’’) (adopting rule 22e–4 under al., Missing the Marks? Dispersion in Corporate Accounting for Investment Securities by Registered the Investment Company Act and noting ‘‘the risk Bond Valuations Across Mutual Funds, 101 J. Fin. Investment Companies, Accounting Series Release of shareholder dilution associated with improper Econ. 206 (2011) (observing evidence of price No. 118 (Dec. 23, 1970). In 1982, the Commission fund pricing’’). smoothing behavior in mutual funds and expressing codified ASR 113 and ASR 118 in the ‘‘Codification If fund shares are overpriced, selling shareholders concern that such smoothing may result in sub- of Financial Reporting Policies’’ as section 404.04: will receive too much for their shares, and optimal investment decisions) (‘‘Cici et al. 2011’’). ‘‘ ‘Restricted’ Securities’’ and section 404.03: purchasing shareholders will pay too much for their 8 See infra footnote 11. Continued

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28736 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

addressed a number of federal securities Commission stated that whenever particularly for thinly traded or more law and accounting topics related to the technical assistance is requested from complex assets.20 purchase of restricted securities by individuals who are not directors, the In addition, three significant funds, including how to determine fair findings of such individuals must be regulatory developments since 1970 value 13 for such securities. A year later, carefully reviewed by the directors in have fundamentally altered how boards, ASR 118 expressed the Commission’s order to satisfy themselves that the advisers, independent auditors (also views on certain valuation matters, resulting valuations are fair.16 referred to herein as ‘‘independent accountants’’), and other market including accounting and auditing, as Since ASR 113 and ASR 118 were participants address valuation for well as the role of the board in the issued, markets and fund investment determination of fair value. various purposes under the federal practices have evolved considerably. securities laws. The Commission acknowledged in Funds now invest in a greater variety of ASR 113 and ASR 118 that the board The first such development was the securities and other instruments, some enactment of the Sarbanes-Oxley Act of need not itself perform each of the of which did not exist in 1970 and may specific tasks required to calculate fair 2002 (the ‘‘Sarbanes-Oxley Act’’) and present different and more significant the adoption of rules mandated by the value in order to satisfy its obligations 17 valuation challenges. Furthermore, 21 under section 2(a)(41). However, under Sarbanes-Oxley Act. In particular, the advances in communications and Sarbanes-Oxley Act established the ASR 113 and ASR 118 the board technology have greatly enhanced the chooses the methods used to arrive at Public Company Accounting Oversight availability and currency of pricing Board (‘‘PCAOB’’). The PCAOB oversees fair value, and continuously reviews the 18 14 information. Today there is a greater the audits of companies that are subject appropriateness of such methods. In volume of data available that may bear addition, the Commission stated that to the federal securities laws, and on determinations of fair value, and new related matters, in order to protect the boards should consider all appropriate technologies have developed that factors relevant to the fair value of interests of investors and further the facilitate enhanced price discovery and public interest in the preparation of securities for which market quotations greater transparency.19 Many funds also are not readily available.15 Finally, the informative, accurate, and independent now engage third-party pricing services audit reports.22 The PCAOB also has the to provide pricing information, ‘‘Accounting, Valuation and Disclosure of authority to establish or adopt, among Investment Securities,’’ respectively. See other things, professional standards, Codification of Financial Reporting Policies, readily available have been considered’’). See also including audit and quality controls Investment Company Act Release No. 12376 (Apr. 2014 Money Market Fund Release, supra footnote standards, to be used by registered 15, 1982) (codifying certain existing Accounting 14, at n.896 (citing ASR 118). public accounting firms in the Series Releases, including ASR 113 and ASR 118). 16 ASR 118. ASR 113 and ASR 118 continue to be included in 17 See Use of Derivatives by Registered preparation and issuance of audit 23 the list of interpretive releases relating to the Investment Companies and Business Development reports. In addition, section 108 of the Investment Company Act found in 17 CFR part 271 Companies; Required Due Diligence by Broker- Sarbanes-Oxley Act established criteria as Investment Company Act Release Nos. 5847 and Dealers and Registered Investment Advisers necessary for the work product of an 6295, respectively. We refer to the releases herein Regarding Retail Customers’ Transactions in Certain as ASR 113 and ASR 118. Leveraged/Inverse Investment Vehicles, Investment accounting standard-setting body to be 13 We generally use the term ‘‘fair value’’ in this Company Act Release No. 33704 (‘‘Derivatives recognized as ‘‘generally accepted’’ for release as that term is used in the definition of Release’’) (Nov. 25, 2019) (noting the dramatic purposes of the federal securities laws.24 ‘‘value’’ in the Investment Company Act, that is, the growth in the volume and complexity of the value of securities for which no readily available derivatives markets over the past two decades, and 20 2014 Money Market Fund Release, supra market quotations exist. See section 2(a)(41) of the the increased use of derivatives by certain funds); footnote 14 (‘‘many funds . . . use evaluated prices Investment Company Act and supra footnote 11. Use of Derivatives by Investment Companies under provided by third-party pricing services to assist In contrast to the Investment Company Act, FASB the Investment Company Act of 1940, Investment them in determining the fair values of their Accounting Standard Codification Topic 820: Fair Company Act Release No. 29776 (Aug. 31, 2011) at portfolio securities’’). Value Measurement (‘‘ASC Topic 820’’) uses the 69 (noting that ‘‘[v]aluation of some derivatives may 21 Sarbanes-Oxley Act, Public Law 107–204, 116 term ‘‘fair value’’ to refer generally to the value of present special challenges for funds’’). Stat. 745. an asset or liability, regardless of whether that value The fund industry has grown tremendously in the 22 See Sarbanes-Oxley Act, supra footnote 21, at is based on readily available market quotations or intervening years. For example, in December 1969, Title I Sec. 101(a). on other inputs. Accordingly, when we use the term open-end funds had net assets of over $53 billion. fair value in the release we are using it to mean fair PCAOB auditing standards apply to the See H.R. Rep. No. 1382, 91st Cong., 2d Sess. 2 preparation or issuance of ‘‘audit reports,’’ which value as defined under the Investment Company (1970). As of August 31, 2019, there were 12,040 are defined to include documents, reports, notices, Act, unless we specifically note that we mean fair open-end funds registered with the Commission or other records that, among other things, are value under ASC Topic 820, such as in the sections with total net assets of nearly $28 trillion. (We prepared following an audit performed for purposes below that discuss proposed rescission of the estimate the number of registered investment of compliance by an issuer, broker, or dealer with accounting guidance. See also infra notes 30 and companies and their net assets by reviewing all the requirements of the securities laws. See PCAOB 141. Forms N–CEN filed with the Commission between rule 3200; PCAOB rule 1001(a)(vi). See also PCAOB 14 ASR 118 at 19988 (‘‘it is incumbent upon the June 2018 and August 2019.) Moreover, as of June rule 1001(i)(iii) (defining the term ‘‘issuer’’ to Board of Directors . . . to determine the method of 2019, there were 99 BDCs with $63 billion in total include issuers (as defined in Section 3 of the arriving at the fair value of each such security’’). net assets. (Estimates of the number of BDCs and Securities Exchange Act of 1934 (the ‘‘Exchange See also Money Market Fund Reform; Amendments their net assets are based on a staff analysis of Form Act’’)), the securities of which are registered under to Form PF, Investment Company Act Release No. 10–K and Form 10–Q filings as of June 30, 2019.) Section 12 of the Exchange Act, or that are required 31166 (July 23, 2014) (‘‘2014 Money Market Fund BDCs, which did not exist in 1970, must invest at to file reports under the Exchange Act or that file Release’’) at n.896 (citing ASR 118). In ASR 113, the least 70% of their assets in certain investments that or have filed registration statements that have not Commission similarly stated: may be difficult to value. See Section 55(a) of the yet become effective under the Securities Act of ‘‘It is the responsibility of the board of directors Act. 1933 (the ‘‘Securities Act’’), and that have not been to determine the fair value of each issue of 18 For example, FINRA’s TRACE introduced in withdrawn). restricted securities in good faith .... While the 2002 is an over-the-counter real-time price 23 See Sarbanes-Oxley Act, supra footnote 21, at board may, consistent with this responsibility, dissemination service for the fixed income market. Title I Sec. 101(c)(2). determine the method of valuing each issue of See https://www.finra.org/sites/default/files/ 24 The federal securities laws for this purpose are restricted securities in the company’s portfolio, it TRACE_Overview.pdf the Securities Act, the Exchange Act, the Sarbanes- must continuously review the appropriateness of 19 For example, the Electronic Municipal Market Oxley Act, the Trust Indenture Act of 1939, the any method so determined.’’ Access (‘‘EMMA’’) website, available since 2009, Investment Company Act, the Advisers Act, and the 15 ASR 118 at 19988 (‘‘it is incumbent upon the ‘‘provides free public access to objective municipal Securities Investor Protection Act of 1970, and the Board of Directors to satisfy themselves that all market information and interactive tools for rules, regulations and Commission orders appropriate factors relevant to the fair value of investors, municipal entities and others.’’ See thereunder. See PCAOB rule 1001(s)(ii); section securities for which market quotations are not https://emma.msrb.org/#. 3(a)(47) of the Exchange Act.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28737

Rule 30a–3 under the Investment 2. establish criteria for determining the in-depth expertise required to Company Act, which was adopted in when market quotations are no longer accurately fair value such complex part to implement certain requirements reliable for a particular portfolio investments. of the Sarbanes-Oxley Act, requires security; In recognition of these changes, we registered management investment 3. provide a methodology or are proposing a new rule to reflect the companies to maintain disclosure methodologies by which the fund increased role that subsequent controls and procedures and internal determines fair value; and accounting and auditing developments control over financial reporting.25 4. regularly review the play in setting fund fair value practices, Second was the adoption in 2003 of appropriateness and accuracy of the as well as the growing complexity of compliance rules under the Investment methodology used to determine fair valuation and the interplay of the Company Act and the Advisers Act value, and make any necessary compliance rule in facilitating board (together, the ‘‘Compliance Rules’’).26 adjustments.28 oversight of funds. The proposed rule The Compliance Rules were designed to Third was the issuance and also acknowledges the important role enhance compliance with the federal codification by the Financial that fund investment advisers now play securities laws by requiring funds and Accounting Standards Board (‘‘FASB’’) and expertise they now provide in the advisers to adopt and implement of ASC Topic 820 in 2006 and 2009.29 fair value determination process given written compliance policies and ASC Topic 820 defines the term ‘‘fair these and other developments. procedures that are reasonably designed value’’ for purposes of the accounting to prevent violation of the federal standards 30 and establishes a II. Discussion securities laws, to review those policies framework for the recognition, The proposed rule would provide and procedures annually for their measurement, and disclosure of fair requirements for determining fair value adequacy and the effectiveness of their value under U.S. generally-accepted in good faith with respect to a fund for implementation, and to designate a accounting principles (‘‘U.S. GAAP’’).31 purposes of section 2(a)(41) of the Act chief compliance officer (‘‘CCO’’) to be Taken together, we believe these and rule 2a–4 thereunder.32 We believe responsible for administering them.27 Of regulatory developments have that, in light of the developments particular relevance, the Commission significantly altered the framework in discussed above, to determine the fair stated that rule 38a–1 requires a fund to which funds, boards, fund investment value of fund investments in good faith adopt compliance policies and advisers, other fund service providers requires a certain minimum, consistent procedures with respect to fair value such as pricing services, and auditors framework for fair value and standard of that require the fund to: perform various functions relating to baseline practices across funds, which 1. Monitor for circumstances that may fair value determinations. We believe would be established by the proposed necessitate the use of fair value; that today determining fair value often rule. The proposed rule would also requires greater resources and expertise permit a fund’s board to assign fair 25 The Commission adopted rule 30a–3 and a than when the Commission issued ASR value determinations to an investment number of other rules in order to implement certain 113 and ASR 118 roughly fifty years adviser of the fund.33 Permitting a certification requirements of the Sarbanes-Oxley ago. In addition, we believe that Act, supra footnote 21, that are applicable to fund’s board to assign fair value companies filing reports under section 13(a) or regulatory changes during that period determinations to an investment adviser 15(d) of the Exchange Act, and to extend those have altered the way that boards, fund is designed to recognize the requirements to all registered management investment advisers, other fund service investment companies other than small business developments discussed above, investment companies registered on Form N–5. See providers, and auditors address including the important role that fund Certification of Management Investment Company valuation. Our views are also informed investment advisers now play and Shareholder Reports and Designation of Certified by significant outreach that the staff has expertise they now provide in the fair Shareholder Reports as Exchange Act Periodic conducted with funds, investment Reporting Forms; Disclosure Required by Sections value determination process, given 406 and 407 of the Sarbanes-Oxley Act, Investment advisers, audit firms, trade groups, fund these developments. However, when a Company Act Release No. 25914 (Jan. 27, 2003) directors, and others, particularly over fund’s board uses the services of a fund (adopting Investment Company Act rule 30a–3); the past two years. As part of these investment adviser as part of the fair Management’s Report on Internal Control Over discussions, many boards sought Financial Reporting and Certification of Disclosure value determination process, we believe in Exchange Act Periodic Reports, Investment additional clarity on how they can it is particularly important to establish Company Act Release No. 26068 (June 5, 2003) effectively fulfill their fair value a framework for boards to effectively (amending rule 30a–3). See also Certification of determination obligations while seeking oversee the investment adviser through Disclosure in Companies’ Quarterly and Annual the assistance of others. The staff Reports, Investment Company Act Release No. the proposed rule, in light of the 25722 (Aug. 30, 2002) (adopting Exchange Act rules understands that this is of particular adviser’s conflicts of interest and given 13a–15 and 15d–15 to require that certain Exchange focus in light of the increased that, in these circumstances, the fund’s Act filers have disclosure controls and procedures complexity of many fund portfolios and in order ‘‘to assist principal executive and financial board would satisfy its statutory officers in the discharge of their responsibilities in 28 obligation to determine fair value in making the required certifications, as well as to Compliance Rules Adopting Release, supra good faith through the framework of the discharge their responsibilities in providing footnote 26, at section II.A.2.c. accurate and complete information to security 29 The FASB issued Fair Value Measurements, proposed rule, including this board holders’’). Statement of Financial Accounting Standards No. oversight. 26 17 CFR 270.38a–1 and 17 CFR 275.206(4)–7. 157 (‘‘SFAS No. 157’’), in September 2006, and Accordingly, under the proposed rule, See also Compliance Programs of Investment codified it in 2009 as ASC Topic 820. fair value as determined in good faith 30 Companies and Investment Advisers, Investment See supra footnote 13 (describing the difference would require assessing and managing Company Act Release No. 26299 (Dec. 17, 2003) between what ‘‘fair value’’ means under the (‘‘Compliance Rules Adopting Release’’). Investment Company Act and under ASC Topic 27 Investment Company Act rule 38a–1 provides 820). 32 The rule would define ‘‘fund’’ as a registered that the policies and procedures must be reasonably 31 Id. Rule 4–01(a)(1) of Regulation S–X [17 CFR investment company or a business development designed to prevent violations of the federal 210.4–01(a)(1)] states that ‘‘[f]inancial statements company. Proposed rule 2a–5(e)(1). securities laws (as defined in the rule), and filed with the Commission which are not prepared 33 For purpose of the proposed rule, ‘‘board’’ Advisers Act rule 206(4)–7 provides that the in accordance with generally accepted accounting means either the fund’s entire board of directors or policies and procedures must be reasonably principles will be presumed to be misleading or a designated committee of such board composed of designed to prevent violations of the Advisers Act inaccurate, despite footnote or other disclosures, a majority of directors who are not interested and the rules thereunder. unless the Commission has otherwise provided.’’ persons of the fund. Proposed rule 2a–5(e)(3).

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28738 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

material risks associated with fair value on, among other things, the role of the third party service providers; and the determinations; selecting, applying, and fund board in fair value determinations extent to which third party service testing fair value methodologies; as well as guidance on certain providers rely on their own service overseeing and evaluating any pricing accounting and auditing matters. In providers (so-called ‘‘fourth party’’ services used; adopting and addition, the staff letters related to the risks); and implementing policies and procedures; board role in the fair value process • the risk that the methods for and maintaining certain records.34 would be withdrawn as discussed in determining and calculating fair value These required functions generally section II.E below.39 are inappropriate or that such methods reflect our understanding of current are not being applied consistently or practices used by funds to fair value A. Fair Value as Determined in Good correctly. their investments and we discuss each Faith Under Section 2(a)(41) of the Act Other than material conflicts of in detail below. When a board assigns We discuss below each of the required interest, the proposed rule does not the determination of fair value to an functions set forth in proposed rule 2a– identify the specific valuation risks to adviser for some or all of the fund’s 5(a) that must be performed to be addressed under this requirement. investments under the proposed rule, in determine in good faith the fair value of Rather, we believe that specific addition to board oversight, the rule the fund’s investments.40 valuation risks would depend on the would include certain reporting, facts and circumstances of a particular 1. Valuation Risks recordkeeping, and other requirements fund’s investments. The proposed rule designed to facilitate the board’s Proposed rule 2a–5 would provide also does not include a specific oversight of the adviser’s fair value that determining fair value in good faith frequency for the required periodic re- determinations.35 requires periodically assessing any assessment of a fund’s valuation risks, The proposed rule would apply to all material risks associated with the as we believe that different frequencies registered investment companies and determination of the fair value of the may be appropriate for different funds BDCs, regardless of their classification fund’s investments, including material or risks. We believe that the periodic re- or sub-classification (e.g., open-end conflicts of interest, and managing those assessment of valuation risk generally funds and closed-end funds, including identified valuation risks.41 We believe should take into account changes in BDCs 36), or their investment objectives that assessing and managing identified fund investments, significant changes in or strategies (e.g., equity or fixed valuation risks is an important element a fund’s investment strategy or policies, income; actively managed or tracking an for determining fair value in good faith market events, and other relevant index).37 In the case of a unit because ineffectively managed valuation factors. investment trust (‘‘UIT’’), because a UIT risks can make it more likely that a We request comment on the proposal does not have a board of directors or board or an adviser may incorrectly to require the assessment and investment adviser, a UIT’s trustee value an investment. management of the material risks would conduct fair value There are many potential sources of associated with fair value determinations under the proposed valuation risk. A non-exhaustive list of determinations. rule.38 the types or sources of valuation risk 1. Is this requirement appropriate? We are also proposing to rescind ASR includes: Should we further define what risks • 113 and 118, which provide guidance The types of investments held or would need to be considered or provide intended to be held by the fund; guidance on the types of valuation risks 34 • Proposed rule 2a–5(a). potential market or sector shocks or that a fund may face? Are there 35 42 Proposed rule 2a–5(b). dislocations; additional sources or types of valuation 36 An open-end fund is a management investment • the extent to which each fair value company that offers for sale or has outstanding risk that we should address? If so, what redeemable securities of which it is the issuer. See methodology uses unobservable inputs, sources? section 5(a)(1) of the Investment Company Act. A particularly if such inputs are provided 2. Should we require a certain 43 closed-end fund is a management investment by the adviser; minimum frequency for re-assessing company other than an open-end fund. See section • the proportion of the fund’s 5(a)(2) of the Investment Company Act. Section valuation risk (e.g., annually or 2(a)(48) of the Investment Company Act defines a investments that are fair valued as quarterly)? Should the rule specify types ‘‘business development company’’ as any closed- determined in good faith, and their of market events or investment strategy end investment company that operates for the contribution to the fund’s returns; purpose of making investments in securities • changes that would require a re- reliance on service providers that assessment of valuation risk? If so, what described in section 55(a)(1) through 55(a)(3) of the have more limited expertise in relevant Investment Company Act and that makes available events or changes should prompt such significant managerial assistance with respect to the asset classes; the use of fair value a review? issuers of such securities. methodologies that rely on inputs from 3. Should we provide any further 37 See proposed rule 2a–5(e)(1) (defining ‘‘fund’’ guidance on how valuation risk should to mean a registered investment company or 39 The staff’s review will include, but will not business development company). necessarily be limited to, the letters identified in be managed? 38 Proposed rule 2a–5(d). Section 4(2) of the that section. Investment Company Act defines a UIT as an 2. Fair Value Methodologies 40 These requirements would apply to a fund’s investment company that (1) is organized under a board that is determining fair value or, if the board Proposed rule 2a–5 would provide trust indenture or similar instrument, (2) does not assigns any fair value determinations to an adviser have a board of directors, and (3) issues only that fair value as determined in good as discussed below, to that adviser. redeemable securities, each of which represents an 41 faith requires selecting and applying in undivided interest in a unit of specified securities. Proposed rule 2a–5(a)(1). Valuation risk includes the risks associated with the process of a consistent manner an appropriate But see Form N–7 for Registration of Unit 44 Investment Trusts under the Securities Act of 1933 determining whether an investment must be fair methodology or methodologies for and the Investment Company Act of 1940, valued in the first place. Investment Company Act Release No. 15612, 42 Potential indicators of market or sector shocks 44 ASC Topic 820 refers to valuation approaches Appendix B, Guide 2, [52 FR 8268, 8295–96 (Mar. or dislocations could include a significant change and valuation techniques. In practice, many 17, 1987)] (Staff Guidelines stating that the board’s in short-term volatility or market liquidity, valuation techniques are referred to as methods fair value role under section 2(a)(41) is to be significant changes in trading volume, or a sudden (e.g., discounted cash flow method). As a result, performed by the UIT’s trustee or the trustee’s increase in trading suspensions. this release uses the terms ‘‘technique’’ and appointed person). See infra section II.D (rescission 43 See infra footnotes 209–210 and accompanying ‘‘method’’ interchangeably to refer to a specific way of staff guidance). text. of determining fair value and likewise uses the

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28739

determining (which includes Proposed rule 2a–5 also would circumstances that may necessitate the calculating) the fair value of fund require that the board or adviser use of fair value as determined in good investments. This requirement would consider the applicability of the selected faith.53 The use of fair value is required include specifying (1) the key inputs fair value methodologies to types of when market quotations are not readily and assumptions specific to each asset fund investments that a fund does not available. The rule would require the class or portfolio holding, and (2) the currently hold but in which it intends establishment of criteria for determining methodologies that will apply to new to invest in the future.49 This when market quotations no longer are types of investments in which the fund requirement is designed to facilitate the reliable, and therefore are not readily intends to invest.45 The proposed rule effective determination of the fair value available.54 For example, if a fund also would require the selected of these new investments by the board invests in securities that trade in foreign methodologies to be periodically or adviser. In addition, the proposed markets, the board or adviser generally reviewed for appropriateness and rule would require periodic reviews of should identify and monitor for the accuracy, and to be adjusted if the selected fair value methodologies for kinds of significant events that, if they necessary. Selecting and applying a appropriateness and accuracy, and occurred after the market closes in the methodology consistently—and adjustments to the methodologies where relevant jurisdiction but before the fund reviewing the methodology and necessary. For example, the results of prices its shares, would materially affect adjusting it if necessary—are all back-testing or calibration (as discussed the value of the security and therefore important elements to determining fair below) or a change in circumstances may suggest that market quotations are value in good faith.46 This is because an specific to an investment could not reliable.55 inappropriate methodology, or a necessitate adjustments to a fund’s fair We continue to believe that for any methodology that is applied value methodologies.50 As discussed particular investment there may be a inconsistently, increases the likelihood above, while the proposed rule would range of appropriate values that could that a fund’s investments will be require that the fair value methodologies reasonably be considered to be fair improperly valued. be consistently applied to the asset value, and whether a specific value Currently, ASC Topic 820 refers to classes for which they are relevant, should be considered fair value will valuation approaches, including the there can be circumstances where it is depend on the facts and circumstances market approach, income approach, and appropriate to adjust methodologies if of the particular investment. cost approach, as well as valuation the adjustments would result in a Accordingly, we expect that the techniques and methods as ways in measurement that is equally or more methodologies used may reflect this which to measure fair value.47 To be representative of fair value.51 The range of potential fair values and result appropriate under the rule, and in proposed rule’s requirement to apply in unbiased determinations of fair value accordance with current accounting fair value methodologies in a consistent within the range. standards, a methodology used for manner would not preclude the board or We request comment on the proposed purposes of determining fair value must adviser from changing the methodology requirement to establish and apply the be consistent with ASC Topic 820, and for an investment in such methodologies for determining and thus derived from one of these circumstances.52 calculating fair value. approaches. We recognize, however, The proposed rule also would require 4. This requirement includes several that there is no single methodology for the board or adviser to monitor for specified elements, discussed above, determining the fair value of an relating to the fair value methodologies. investment because fair value depends under the proposal, the methodologies selected Are these elements appropriate? Are on the facts and circumstance of each should maximize the use of relevant observable there additional elements that inputs and minimize the use of unobservable commenters believe should be included investment, including the relevant inputs. market and market participants.48 49 Proposed rule 2a–5(a)(2)(i). For example, the under this requirement? Should we board or adviser, as applicable, generally should modify or remove any of the proposed terms ‘‘methods’’ and ‘‘methodologies’’ address, prior to the fund’s investing in a new type elements? Should we require interchangeably. of investment, whether readily available market application of the methodologies in a 45 quotations will be used or if the investment may Proposed rule 2a–5(a)(2). Regarding the key need to be fair valued on occasion or at all times. reasonably consistent manner, or as inputs and assumptions specific to each asset class For certain types of investments, it should be clear consistently as possible under the or portfolio holding, it would not be sufficient, for that the asset will require a fair value at all times. example, to simply state that private equity circumstances? For others, however, market quotations may 5. Do commenters believe we should investments are valued using a discounted cash sometimes be readily available and sometimes not, flow model, or that options are valued using a so that periodically a fair value will need to be provide additional guidance relating to Black-Scholes model, without providing any determined. The board or adviser generally should this requirement? If so, on which additional detail on the specific qualitative and seek to identify sources of price inputs before the elements of the proposed requirement quantitative factors to be considered, the sources of fund invests in such asset classes, if possible, in should we provide additional guidance? the methodology’s inputs and assumptions, and a addition to determining an appropriate fair value description of how the calculation is to be methodology, and generally should document these For example, is the proposed performed (which may, but need not necessarily, decisions. requirement that boards or advisers take the form of a formula). 50 Proposed rule 2a–5(a)(2)(ii). ASC Topic 820– ‘‘select’’ a methodology sufficiently 46 Different methodologies may be appropriate for 10–35–25 provides a non-exhaustive list of events clear? different asset classes. Accordingly, this that may warrant a change or an adjustment to a 6. Are there investments for which it requirement would not require that a single valuation technique, including where (1) new methodology be applied in all cases, but instead markets develop, (2) new information becomes is not feasible to establish a that any methodologies selected be applied available, (3) information previously used is no methodology in advance? If so, how consistently to the asset classes for which they are longer available, (4) the valuation technique should the rule address such situations? relevant. improves, and (5) market conditions change. Boards Is it clear what new investment types a 47 See supra footnote 44. or advisers generally should seek to account for 48 See ASR 118 (‘‘Methods which are in accord such occurrences and consider specifying with this principle may, for example, be based on alternative sources. 53 Proposed rule 2a–5(a)(2)(iii). As discussed a multiple of earnings, or a discount from market 51 See ASC Topic 820–10–35–25. below, we are also proposing to define when market of a similar freely traded security, or yield to 52 Records supporting any such methodology quotations are readily available for purposes of maturity with respect to debt issues, or a changes would be required to be maintained under section 2(a)(41). combination of these and other methods.’’). the proposed recordkeeping provisions. See 54 Proposed rule 2a–5(a)(2)(iv). Consistent with the principles in ASC Topic 820, proposed Rule 2a–5(a)(6). 55 See ASC Topic 820–10–35–41C(b).

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28740 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

fund may ‘‘intend’’ to invest in? Should We request comment on the proposed considering price ‘‘challenges,’’ 63 we provide any further guidance on rule’s requirement to test the including how the pricing service this? What processes do funds currently appropriateness and accuracy of the fair incorporates information received from follow before investing in new types of value methodologies. pricing challenges into its pricing investments to help to ensure that, after 7. Should the rule require particular information; (iv) the pricing service’s making the investment, the board will testing types or minimum testing potential conflicts of interest and the be in a position to determine fair value frequencies? For example, should we steps the pricing service takes to if required? require tests to occur at least weekly, mitigate such conflicts; and (v) the monthly, or quarterly? If so, should the testing processes used by the pricing 3. Testing of Fair Value Methodologies frequency required be dependent upon service. The proposed rule would require the the type of instrument? Should the rule In addition, there may be times when testing of the appropriateness and require all funds to use certain types of pricing information from a pricing accuracy of the methodologies used to testing, such as back testing and service differs materially from the calculate fair value.56 This requirement calibration, at a minimum? Are certain board’s or adviser’s view of the fair is designed to help ensure that the types of methodology testing value of the investment, and the board selected fair value methodologies are inappropriate or irrelevant for certain or adviser may seek to contact the appropriate and that adjustments to the investment types? pricing service to question the basis for methodologies are made where 8. What other types of testing of fair the pricing information. As such, the necessary. We believe that the specific value methodologies are commonly proposed rule would require the tests to be performed and the frequency used? establishment of criteria for the with which such tests should be 9. Should the rule require specified circumstances under which price performed are matters that depend on actions based on the results of the challenges typically would be initiated the circumstances of each fund and thus testing? If so, what would those actions (e.g., establishing objective thresholds). should be determined by the board or be? We request comment on the proposed rule’s requirement to oversee pricing the adviser. The proposed rule would 4. Pricing Services require the identification of (1) the services. 10. Do commenters agree that the testing methods to be used, and (2) the To obtain valuation information, proposed rule should require oversight minimum frequency of the testing.57 We particularly for thinly traded or more of pricing service providers, if used? believe that the results of calibration complex assets, pricing services, may be Should the rule cover any service and back-testing can be particularly used. Pricing services are third-parties providers other than pricing services? If useful in identifying trends, and also that regularly provide funds with so, which service providers should be have the potential to assist in information on evaluated prices, matrix included? Should the rule further clarify identifying issues with methodologies prices, price opinions, or similar pricing estimates or information to assist in who qualifies as a pricing service? applied by fund service providers, 11. Should there be a specific including poor performance or potential determining the fair value of fund 60 requirement in the rule to periodically 58 investments. Accordingly, the conflicts of interest. For example, if a review the selection of the pricing specific methodology consistently over- proposed rule would provide that determining fair value in good faith services used and to evaluate other values or under-values one or more fund pricing services? investments as compared to observed requires the oversight and evaluation of 61 transactions, the board or adviser pricing services, where used. This 5. Fair Value Policies and Procedures should investigate the reasons for this provision is designed to help ensure Proposed rule 2a–5 would require difference. We recognize, however, that that pricing information received from written policies and procedures back-testing may be less useful for pricing services serves as a reliable addressing the determination of the fair portfolio holdings that trade input for determining fair value in good value of the fund’s investments (‘‘fair 59 faith. infrequently. value policies and procedures’’).64 The For funds that use pricing services, proposed rule would require the fair the proposed rule would require that the 56 Proposed rule 2a–5(a)(3). value policies and procedures to be board or adviser establish a process for 57 Id. Calibration can assist in assessing whether reasonably designed to achieve the approval, monitoring, and the fund’s valuation technique reflects current compliance with the requirements of market conditions, and also whether any evaluation of each pricing service proposed rule 2a–5 discussed above. adjustments to the valuation technique are provider. The board or adviser generally appropriate. ‘‘Calibration’’ for these purposes is the Requiring fair value policies and should take into consideration factors process for monitoring and evaluating whether procedures that would be tailored to the such as (i) the qualifications, there are material differences between the actual proposed rule’s requirements would price the fund paid to acquire portfolio holdings experience, and history of the pricing help to ensure that a board or adviser, that received a fair value under the Act and the service; (ii) the valuation methods or prices calculated for those holdings by the fund’s as applicable, determines the fair value techniques, inputs, and assumptions 62 fair value methodology at the time of acquisition. of fund investments in compliance with 58 used by the pricing service for different Back-testing involves a comparison of the fair the rule. Under the proposed rule, value ascribed to the fund’s investment against classes of holdings, and how they are where the board determines the fair observed transactions or other market information, affected as market conditions change; value of investments, the board- such as quotes from dealers or data from pricing (iii) the pricing service’s process for services. One common form of back-testing is approved fair value policies and ‘‘disposition analysis,’’ which compares a fair value procedures would be adopted and as determined using a fair value technique with the 60 See 2014 Money Market Fund Release, supra price obtained for the security upon its disposition footnote 14, at section III.D.2.b. implemented by the fund. Where the by the fund. 61 Proposed rule 2a–5(a)(4). 59 See In re Morgan Asset Management, supra 62 In considering a pricing service’s valuation 63 Price challenges involve, for example, the fund footnote 9 (back-testing by the fund ‘‘only covered methods or techniques, inputs, and assumptions, disagreeing with an evaluated price provided by a securities after they were sold; thus, at any given the fair value policies and procedures generally pricing service and providing additional time, the Valuation Committee never knew how should address whether the pricing service is information to the service suggesting that the many securities’ prices could ultimately be relying on inputs or assumptions provided by the provided evaluated price is not correct. validated by it.’’). adviser. 64 Proposed rule 2a–5(a)(5).

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28741

board assigns fair value determinations rule 2a–5? Should we provide any procedures, and any disclosures. They to the adviser under proposed rule 2a– further guidance on their interaction? also provide evidence to the fund’s 5(b), as discussed in section II.B, the fair auditors in performing their duties 6. Recordkeeping value policies and procedures would be related to the audit of the fund’s adopted and implemented by the Proposed rule 2a–5 would require that financial statements and assist the adviser, subject to board oversight under the fund maintain certain records.71 fund’s CCO in the preparation of rule 38a–1.65 Specifically, the proposed rule would compliance reports to the board. The require the maintenance of: Commission has brought enforcement Rule 38a–1 also would apply to a • fund’s obligations under the proposed Supporting Documentation. actions in cases where it alleged that rule. Rule 38a–1 requires a fund’s board, Appropriate documentation to support appropriate documentation relating to including a majority of its independent fair value determinations, including valuation was not maintained by a fund directors, to approve the fund’s policies information regarding the specific or adviser or obtained by auditors.73 and procedures, including those on fair methodologies applied and the assumptions and inputs considered The proposed requirement to value, and those of each investment maintain appropriate documentation to adviser and other specified service when making fair value determinations, as well as any necessary or appropriate support fair value determinations would providers, based upon a finding by the include documentation that would be board that the policies and procedures adjustments in methodologies, for at least five years from the time the sufficient for a third party to verify the are reasonably designed to prevent determination was made, the first two fair value determination. We understand violation of the federal securities laws.66 years in an easily accessible place; and that advisory personnel currently Rule 38a–1 also requires that the fund’s • Policies and Procedures. A copy of produce working papers supporting fair CCO provide an annual report to the value determinations that include, for 67 policies and procedures that would be fund’s board that must address any required under the proposed rule that example, calibration and back-testing material changes to compliance policies data as well as other information such 68 are in effect, or that were in effect at any and procedures. Rule 38a–1 would time within the past five years, in an as stale price analysis.74 These records encompass a fund’s compliance easily accessible place. would be required to be maintained as obligations with respect to proposed Funds and advisers currently are supporting fair value determinations.75 rule 2a–5, if adopted, and would require required to retain certain documentation We believe that it is appropriate for a fund’s board to oversee compliance 72 related to fund valuation. Documents the proposed rule to include a with the rule.69 To the extent that often provide the primary means to recordkeeping provision to facilitate adviser policies and procedures under demonstrate whether portfolio holdings compliance with the proposed rule and proposed rule 2a–5 would otherwise be have been valued in a manner to permit effective regulatory oversight. duplicative of fund valuation policies consistent with applicable law, any The proposed retention periods are under rule 38a–1,70 a fund could adopt valuation compliance policies and designed to be consistent with the the rule 2a–5 policies and procedures of recordkeeping requirements in rule 38a– the adviser in fulfilling its rule 38a–1 71 Proposed rule 2a–5(a)(6). Under the proposed 1(d), the compliance rule. As discussed obligations. rule, the fund would maintain the required records above, the compliance rule requires the We request comment on the proposed both where the board itself determines the fair value of investments and where it assigns fair value retention of, among other things, fair value policies and procedures determinations to an adviser under proposed rule compliance policies and procedures requirement. 2a–5(b), as discussed at infra section II.B.6. (which would include those relating to 72 12. Are there specific elements that Rule 38a–1(d) requires the maintenance of valuation) and certain records.76 We the proposed fair value policies and certain records, including copies of: All compliance policies and procedures adopted by the fund that believe that this recordkeeping procedures should include other than are in effect or were in effect at any time during the requirement would provide important the required elements of proposed rule last five years; materials provided to the board in investor protections and, because it 2a–5(a)? connection with their approval of fund and service would be consistent with current record 13. Are we sufficiently clear on the provider policies and procedures under the rule; the CCO’s annual report to the board; and any retention practices under to rule 38a– interaction between rule 38a–1 and the records documenting the board’s annual review of 1(d), would not impose overly policies and procedures under proposed fund and service provider compliance policies and burdensome recordkeeping costs. procedures under the rule. Rule 204–2 under the Advisers Act similarly requires an adviser to We request comment on the proposed 65 Proposed rule 2a–5(b). maintain copies of the adviser’s compliance 66 recordkeeping provisions. Rule 38a–1(a)(2). policies and procedures that are in effect or were 67 For UITs, the fund’s principal underwriter or in effect at any time during the last five years and depositor conducts the functions assigned to any records documenting its annual review of such 73 See In re Allied Capital Corp., Securities management company boards under rule 38a–1. policies and procedures. See 17 CFR 275.204–2. See Exchange Act Release No. 55931 (June 20, 2007) Rule 38a–1(b). This would continue if we adopt the also Compliance Rules Adopting Release, supra (settlement) (fund failed to maintain documentation proposed rule. footnote 26, at section II.D. The funds’ and advisers’ required under the Exchange Act). See also In the 68 See rule 38a–1(a)(4)(iii)(A). See also records may be retained electronically. See id. Matter of Carroll A. Wallace, Securities Exchange Compliance Rules Adopting Release, supra footnote (discussing rule 31a–2(f) under the Investment Act Release No. 48372 (Aug. 20, 2003) (Commission 26, at n.33. ‘‘Material’’ in this context is a change Company Act and rule 204–2(g) under the Advisers opinion) (partner of accounting firm engaged in that a fund director would reasonably need to know Act). improper professional conduct in recklessly failing in order to oversee fund compliance. See rule 38a– Other provisions of the federal securities laws to obtain sufficient competent evidential material to 1(e)(2). We have also said that ‘‘serious compliance require, among other things, that registered support statements in the auditors’ reports); In the issues’’ must be raised with the board immediately. investment companies maintain appropriate books Matter of Morgan Stanley, Securities Exchange Act See Compliance Rules Adopting Release, supra and records in support of the fund’s financial Release No. 50632 (Nov. 4, 2004) (settlement) footnote 26, at n.33. statements and preserve for a specified period (financial services firm failed to maintain sufficient 69 If adopted, rule 2a–5’s requirements would (generally six years) all schedules evidencing and underlying documentation supporting certain supersede the Compliance Rules Adopting Release’s supporting each computation of NAV. See valuations). discussion of specific policies and procedures Investment Company Act section 31(a) and rules 74 Stale price analysis can include an evaluation required regarding the pricing of portfolio securities 31a–1 and 31a–2. In addition, funds reporting of whether a price quote that may be used to and fund shares. Cf. Compliance Rules Adopting under the Exchange Act must make and keep books, support a fair value price is sufficiently timely to Release, supra footnote 26, at nn.39–47 and records, and accounts that accurately and fairly be useful. accompanying text. reflect their transactions and dispositions of their 75 Proposed rule 2a–5(a)(6)(i). 70 See generally footnote 108. assets in reasonable detail. 15 U.S.C. 78m(b)(2)(A). 76 See supra footnote 72.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28742 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

14. Are there any additional types of that the Commission’s prior guidance believe are consistent with the more records that we should require? If so, recognized that determinations of fair modern approaches to fair value and which records and why? value often require significant resources compliance with the federal securities 15. Where the board assigns fair value and specialized expertise, and that in laws described below. determinations to an adviser under many cases it may be impracticable for Accordingly, the proposed rule would proposed rule 2a–5(b), should the rule directors themselves to perform every permit a fund’s board of directors to require the adviser, rather than the fund, one of the necessary tasks without to maintain these records? assistance. We expect that today assign the fair value determination 16. Are the proposed retention determining fair value requires even relating to any or all fund investments periods sufficient to evidence greater resources and expertise than to an investment adviser of the fund, compliance? Why or why not? Should when ASR 113 and ASR 118 were which would carry out all of the we require a longer (e.g., six years) or issued. For this reason, in addition to functions required in paragraph (a) of shorter (e.g., four years) retention providing requirements for determining the proposed rule, subject to certain period? fair value in good faith generally, the requirements enumerated in proposed 17. Are key terms used in this aspect proposed rule also is designed to paragraph (b).82 A fund’s board could of the proposal sufficiently provide boards and advisers with a make this assignment to a fund’s understandable? For example, as stated consistent, modern approach to the primary adviser or one or more sub- above, ‘‘appropriate documentation to allocation of fair value functions, while advisers. For example, for a fund with support fair value determinations’’ also preserving a crucial role for boards a sub-adviser responsible for managing under the proposed recordkeeping to fulfill their obligations under section a portion of the fund’s portfolio, the requirement would include 2(a)(41) of the Act. board could assign the determination of documentation that would be sufficient Under the proposed rule, a board may fair value for the investments in that for a third party to verify the fair value choose to determine fair value in good portion of the fund’s portfolio to that determination. Should we define these faith for any or all fund investments by sub-adviser. As a result, a multi- or other terms or provide further carrying out all of the functions required manager fund could have multiple guidance relating to them? in paragraph (a) of the proposed rule, advisers assigned the role of including, among other things, determining fair value of the different B. Performance of Fair Value monitoring for circumstances that investments that those advisers manage. Determinations necessitate fair value, selecting Where the board assigns fair value The Act assigns boards a critical role valuation methodologies, and applying determinations to multiple advisers, the in connection with determinations of those methodologies.80 However, a fair value.77 Although the Commission board would not be required to take this fund’s policies and procedures adopted has previously taken the position that a approach. We understand that, for under rule 38a–1 should address the fund’s board may not delegate the practical reasons, few boards today are added complexities of overseeing determination of fair value to anyone directly involved in the performance of multiple assigned advisers in order to be else,78 the Commission has also the day-to-day valuation tasks required reasonably designed to avoid violating recognized that compliance with the Act to determine fair value. Instead they the federal securities laws.83 Any board does not require the board to perform enlist the fund’s investment adviser to assignment under the proposed rule each of the specific tasks required to perform certain of these functions, would be subject to board oversight and calculate fair value itself.79 We believe subject to their supervision and certain reporting, recordkeeping, and oversight.81 other requirements designed to facilitate 77 Section 2(a)(41)(B)(ii) provides that, when This allocation of functions is the board’s ability effectively to oversee market quotations are not readily available, ‘‘value’’ consistent with the framework created the adviser’s fair value determinations. means ‘‘fair value as determined in good faith by by the ASRs. We continue to believe the board of directors.’’ Rule 2a–4 contains the same We discuss each of these requirements definition of fair value as section 2(a)(41)(B)(ii). 17 that allocating day-to-day below. CFR 270.2a–4. The Commission has discussed the responsibilities to an investment We request comment generally on the board’s role in determinations of fair value in a adviser, subject to robust board role of the board of directors when it number of Commission releases, including ASR oversight, is appropriate and consistent 113, ASR 118, the Compliance Rules Adopting does not assign the fair value with the requirements of Act. The Release, supra footnote 26, and the 2014 Money determination to an adviser to the fund. Market Fund Release, supra footnote 14. proposed rule is designed to provide a In addition to their role under the Act, boards consistent framework for this allocation 18. For boards that elect to conduct may have liability under antifraud provisions of the between boards and advisers, and to fair value determinations themselves, federal securities laws if a fund’s prospectus or should we provide any guidance on the other disclosures regarding valuation are not provide enhanced protections which we consistent with the fund’s valuation practices. See, level of assistance they can receive from e.g., 15 U.S.C. 77k(a)(1). carefully reviewed by the directors in order to service providers, while fulfilling their 78 See, e.g., 2014 Money Market Fund Release, satisfy themselves that the resulting valuations are obligations under section 2(a)(41)? Do supra footnote 14, at nn.890 and 896 and fair.’’ See also ASR 113 (‘‘The actual calculations accompanying text; In the Matter of Seaboard may be made by persons acting pursuant to the we need to provide any guidance on Associates, Inc. (Report of Investigation Pursuant to direction of the board.’’). how a board should obtain and oversee Section 21(a) of the Exchange Act), Investment 80 As discussed above, in this circumstance, the such assistance if needed? If so, what Company Act Release No. 13890 (Apr. 16, 1984) fund would, on behalf of the board, adopt and guidance should we provide? (‘‘The Commission wishes to emphasize that the implement policies and procedures and keep directors of a registered investment company may records consistent with the requirements of not delegate to others the ultimate responsibility of paragraph (a) of the proposed rule. See proposed 82 As noted above, because a UIT does not have determining the fair value of any asset not having rule 2a–5(b). a board of directors or an investment adviser, a a readily ascertainable market value, such as oil and 81 For example, for a fund that issues redeemable UIT’s trustee would conduct fair value gas royalty interests.’’). securities, value must be calculated at least once determinations under the proposed rule. See 79 The Commission stated in ASR 118 that the each business day for each portfolio holding in proposed rule 2a–5(d). See also supra footnote 38. board ‘‘may appoint persons to assist them in the order to calculate the fund’s NAV. 17 CFR 270.22c– 83 See rule 38a–1. These challenges include, for determination of [fair] value, and to make the actual 1(b)(1). Making these fair value determinations by example, how to address reconciling differing calculations pursuant to the board’s direction’’; themselves would therefore likely be impracticable opinions on the same investment (if applicable) and however, ‘‘the findings of such individuals must be for most, if not all, boards of such funds. establishing clear reporting structures.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28743

1. Board Oversight monitor such conflicts, and take Boards should probe the Where the board assigns fair value reasonable steps to manage such appropriateness of the adviser’s fair 89 determinations to an adviser, the conflicts. In so doing, the board value processes. In particular, boards proposed rule would require the board should serve as a meaningful check on should periodically review the financial to satisfy its statutory obligation with the conflicts of interest of the adviser resources, technology, staff, and respect to such determinations by and other service providers involved in expertise of the assigned adviser, and overseeing the adviser. Boards should the determination of fair values.90 In the reasonableness of the adviser’s approach their oversight of fair value particular, the fund’s adviser may have reliance on other fund service providers, determinations assigned to an an incentive to improperly value fund relating to valuation.93 In addition, investment adviser of the fund with a assets in order to increase fees, improve boards should consider the adviser’s skeptical and objective view that takes or smooth reported returns, or comply compliance capabilities that support the account of the fund’s particular with the fund’s investment policies and fund’s fair value processes, and the valuation risks, including with respect restrictions.91 Other service providers, oversight and financial resources made to conflicts, the appropriateness of the such as pricing services or broker- available to the CCO relating to fair fair value determination process, and dealers providing opinions on prices, value. the skill and resources devoted to it.84 may have incentives (such as Boards should also consider the type, Further, in our view effective oversight maintaining continuing business content, and frequency of the reports cannot be a passive activity. Directors relationships with the adviser) or may they receive. The proposed rule would should ask questions and seek relevant otherwise be subject to pressures to require reporting to the board (both information. The board should view provide pricing estimates that are periodically and promptly) regarding oversight as an iterative process and favorable to the adviser.92 In overseeing many aspects of the adviser’s fair value seek to identify potential issues and the adviser’s process for making fair determination process as a means of opportunities to improve the fund’s fair value determinations, the board should facilitating the board’s oversight as value processes.85 The proposed rule understand the role of, and inquire discussed below. While a board can would require the adviser to report to about conflicts of interest regarding, any reasonably rely on the information the board with respect to matters related other service providers used by the provided to it in summaries and other to the adviser’s fair value process, in adviser as part of the process, and materials provided by the adviser and part to ensure that the board has satisfy itself that any conflicts are being other service providers in conducting its sufficient information to conduct this appropriately managed. oversight, it is incumbent on the board oversight.86 Boards should also request to request and review such information follow up information when appropriate 89 See, e.g., Governance Release, supra footnote as may be necessary to be fully informed and take reasonable steps to see that 87 (‘‘ . . . state law duties of loyalty and care . . . of the adviser’s process for determining matters identified are addressed.87 oblige directors to act in the best interest of the fund the fair value of fund investments. when considering important matters the Act We would expect that boards engaged entrusts to them, such as approval of an advisory Further, if the board becomes aware of in this process would use the contract and the advisory fee.’’). material matters (whether the board appropriate level of scrutiny based on 90 See, e.g., id. (‘‘. . . the Act and our rules rely identifies the matter itself or the fund’s the fund’s valuation risk, including the heavily on fund boards of directors to manage the CCO or adviser or another party extent to which the fair value of the conflicts of interest that advisers have with funds they manage.’’). See also Division of Investment identifies the issue), we believe that in fund’s investments depend on Management, SEC, Protecting Investors: A Half fulfilling its oversight duty the board subjective inputs. For example, a Century of Investment Company Regulation, 252 must inquire about such matters and board’s scrutiny would likely be (1992) (‘‘the [Investment Company] Act . . . take reasonable steps to see that they are different if a fund invests in publicly imposes requirements that assume the standard 94 equipment of a corporate democracy: a board of addressed. traded foreign companies than if the directors . . . whose function is to oversee the We request comment on this aspect of fund invests in private early stage operations of the investment company and police the proposal: companies. As the level of subjectivity conflicts of interest. . . [W]e believe that independent directors perform best when required 19. Should we permit boards to fulfill increases and the inputs and the statutory function to fair value one assumptions used to determine fair to exercise their judgment in conflict of interest situations’’); see also Investment Company Institute or more fund investments in good faith value move away from more objective Independent Directors Council, Fair Valuation by assigning that fair value measures, we expect that the board’s Series: The Role of the Board at 10 (2006) (‘‘IDC determination to an adviser to the fund level of scrutiny would increase Role of the Board’’), available at http://www.ici.org/ _ _ _ as described above? Would the correspondingly.88 pdf/06 fair valuation board.pdf (‘‘Investment professionals, for example, can be important proposed rule change the services We also believe that, consistent with sources of information about the value of securities. provided by advisers with respect to their obligations under the Act and as At the same time, conflict of interest concerns may valuation and, if so, would such a fiduciaries, boards should seek to be raised when investment professionals assign fair change have any implications for the identify potential conflicts of interest, valuations that dramatically boost a fund’s performance. These concerns may be heightened board’s consideration of the advisory when the compensation of the investment contract under section 15(c) of the Act 84 See generally Investment Company professionals is based on the fund’s performance. Governance, Investment Company Act Release No. To address these potential concerns, boards may (e.g., changes in compensation)? If so, 26520 (July 27, 2004) (‘‘Governance Release’’). want to consider whether investment professionals are there additional responsibilities 85 See, e.g., Derivatives Release, supra footnote responsible for managing a particular fund should under the proposed rule for which 17, at section II.C. have sole or primary authority for determining advisers would seek additional 86 Proposed rule 2a–5(b)(1). securities valuations for that fund.’’). compensation? 87 For example, we have stated that independent 91 See, e.g., Piper, supra footnote 7. For conflicts directors should ‘‘bring to the boardroom ‘a high of the fund’s portfolio manager, see infra footnote degree of rigor and skeptical objectivity to the 120 and accompanying text. 93 See In re Morgan Asset Management, supra evaluation of management and its plans and 92 Cf. In re Morgan Asset Management, supra footnote 9 (‘‘the Valuation Committee left pricing proposals,’ particularly when evaluating conflicts of footnote 9, at 7 (broker-dealer ‘‘induced to provide decisions to lower level employees in Fund interest.’’ See Governance Release, supra footnote interim price confirmations that were lower than Accounting who did not have the training or 84. the values at which the Funds were valuing certain qualifications to make fair value pricing 88 For a discussion of fund fair value risks bonds, but higher than the initial confirmations that determinations’’). generally, see supra section II.A.1. the [broker-dealer] had intended to provide’’). 94 Proposed rule 2a–5(b)(1)(ii).

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28744 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

20. The rule would permit boards to to perform the functions described in process.97 While some of the reports assign the determination of fair value paragraph (a), such as a person currently provided may be useful for only to an adviser to the fund. Are there appointed by the trustee? Should we, for boards, others may contain detailed other parties to which we should permit example, allow the trustee to assign trade-by-trade information, or other day- boards to assign such determinations? these determinations to the UIT’s to day operational data that may not be For example, would it be appropriate to sponsor, principal underwriter, or effective in facilitating the board’s allow boards to assign these depositor? Would these or any other oversight. We believe that it is determinations to pricing vendors or parties be better equipped to determine important for the board to receive accounting firms? Are there any parties the fair value of investments? If the rule relevant and tailored information from that fund boards currently rely upon to were to permit the trustee to assign the adviser to ensure that the board has help make fair value determinations that these determinations to another person, sufficient insight and data to exercise could adequately be relied upon in the should we require that person to report the oversight contemplated by the same way as a fund adviser? If we do to the trustee like the adviser would to proposed rule. We also believe that permit other parties to be assigned the a board for management companies? these reports should familiarize determination of fair value under the What kind of oversight responsibilities directors with the salient features of the final rule, what safeguards, if any, should the trustee have? Are there other adviser’s process and provide them with should we include to ensure that the modifications to the proposed rule that an understanding of how that process determinations of fair value in good we should make to apply it to UITs addresses the requirements of rule 2a– faith are conducted consistent with the given their unmanaged nature and 5. Therefore we are proposing the board proposed rule? For example, should we different governance structure compared reporting requirements discussed only permit assignment to non-advisers to other funds? below.98 These requirements are if they have a fiduciary duty to the fund 25. Is our proposed requirement that intended to help ensure that boards or if they are regulated by the a board ‘‘oversee’’ the adviser sufficient? receive the amount and type of Commission? Why or why not? Should we prescribe in rule 2a–5 information that they find most valuable 21. As proposed, the rule would additional steps to mitigate the risk of in overseeing the adviser.99 require that an assignment to an conflicts of interest and other issues The proposed rule would require the investment adviser cover all elements of related to the fair value process, such as adviser’s reports to include such paragraph (a) for a given investment or a third party review of the fair value information as may be reasonably investments. Should we permit the process, or an attestation by the adviser? necessary for the board to evaluate the 100 assignment of particular elements of If so, what should those steps be? What matters covered in the reports. This paragraph (a) to an investment adviser additional costs would they add, and requirement is designed to provide the or different advisers? If so, what who would bear those costs? fund’s board with sufficient context for safeguards should we include to ensure 95 the matters covered in the report. This that the determinations of fair value in 26. As noted above, the proposed rule would define ‘‘board’’ as either the context is necessary in order to facilitate good faith are conducted consistent the board’s oversight by providing them with the proposed rule? fund’s entire board of directors or a designated committee of such board with enough information to determine 22. The proposed rule would permit whether to ask additional questions or boards to assign the determination of composed of a majority of directors who are not interested persons of the fund.96 request additional information, as fair value in good faith to the fund’s appropriate. For example, we do not primary investment adviser or one or Are there any actions required in the proposed rule that we should require believe that it would be consistent with more sub-advisers. Should we allow the proposed rule for the adviser to boards to assign this process to sub- the full board, rather than a committee, to perform? report that there is a new material advisers, or only allow the fund’s conflict of interest without the context 27. Would boards assign the fair value primary investment adviser to fulfill necessary for the board to evaluate what determination to an investment adviser this role? Why or why not? Should we effect the conflict would have on the with respect to some investments and impose any obligations for the adviser to adequacy and effectiveness of the determine the fair value of other oversee any assigned sub-adviser? If so, adviser’s process for determining fair investments themselves? If so, what what obligations? For example, should value. The content of the periodic or types of investments would boards most we require in the rule that a fund must prompt reports and supplemental likely assign to an adviser and under establish reconciliation procedures to information under the proposal could what circumstances, and which would address situations where sub-advisers take the form of narrative summaries, have differing views on the fair value of they fair value themselves? Should we provide any additional guidance as to a fund investment? 97 See ‘‘Practical Guidance for Fund Directors on 23. Should we limit the assignment to how boards would determine the fair Valuation Oversight,’’ Report of the Mutual Fund a single adviser in order to minimize the value of fund investments where the Directors Forum (June 2012) (available at https:// issues relating to having multiple board does not assign those mfdf.org/images/Newsroom/Valuation-web.pdf) determinations to an adviser? (‘‘MFDF Valuation Report’’) at 14–15. advisers assigned determinations of fair 98 value under the Act? If so, why? This would be in addition to any reports 2. Board Reporting required under rule 38a–1. See Compliance Rules Conversely, should we require Adopting Release, supra footnote 26, at section additional safeguards in the case of Effective information flow is a critical II.A.2.c. multiple assigned advisers? If so, what part of a board’s oversight of an adviser 99 The requirements we propose in this document should they be? For example, should we to whom it has assigned fair value would be minimum requirements and fund boards could always ask for additional reporting from require specific policies and procedures determinations. We understand that advisers. See infra footnote 110 and accompanying or reports, beyond those already boards currently receive a variety of text. required, or those that would be reports from the adviser outlining the 100 Proposed rule 2a–5(b)(1). This is similar to the required, under rule 38a–1 or the operation of the fund’s valuation approach we have adopted with regard to money market stress testing and proposed with regard to proposed rule? board oversight of derivatives risk managers. See 24. Should we permit or require 95 See supra footnote 33. 2014 Money Market Fund Release, supra footnote anyone other than the trustee of a UIT 96 Proposed rule 2a–5(e)(3). 14, and Derivatives Release, supra footnote 17.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28745

graphical representations, statistical proposed rule.105 This requirement designed to help the board oversee the analyses, dashboards, or exceptions- would keep boards informed of such adviser’s use of pricing services, if based reporting, among other methods. changes or deviations, which may show applicable, and to help ensure that that the methodologies need to be pricing information received from a. Periodic Reporting updated or adjusted, and provide an service providers serves as a reliable Proposed rule 2a–5 would require the opportunity for a board to ask questions input for determining fair value in good adviser, at least quarterly, to provide the regarding the reasons for any change or faith. board a written assessment of the deviation. • Other Requested Information. Any adequacy and effectiveness of the • Testing Results. The results of any other materials requested by the board adviser’s process for determining the testing of fair value methodologies as related to the adviser’s process for fair value of the assigned portfolio of part of the required fair value policies determining the fair value of fund investments.101 We understand that the and procedures.106 As discussed above, investments.110 materials currently prepared for boards the requirement to test the These requirements collectively are for purposes of board meetings can appropriateness and accuracy of the designed to help ensure that boards include detailed information regarding methodologies used to calculate fair obtain the information that they need to the fair value process, including a list of value is designed to help ensure that the exercise their statutory and fiduciary each individual portfolio holding that selected fair value methodologies are duties and to oversee an adviser. They received a fair value since the prior appropriate and that adjustments to the are intended to supplement, not replace, board meeting (e.g., during the methodologies are made where this oversight. Boards should critically quarter).102 Although some boards may necessary. review the information provided to find this specific information useful, we • Resources. The adequacy of them, particularly with regard to an are not proposing to mandate this level resources allocated to the process for adviser’s reporting on its own conflicts of detailed reporting because we believe determining the fair value of the fund’s of interest, and request any information that the board’s oversight may be better assigned investments, including any that they feel is necessary to conduct facilitated through the use of more material changes to the roles or that oversight. For example, in addition targeted forms of reporting designed to functions of the persons responsible for to the specific items listed above,111 a identify trends, exceptions, or outliers, determining the fair value.107 The board could review and consider, if adviser’s assessment of the adequacy of relevant: and generally provide a sufficient • overview of the current state of the fair these resources may inform a board in Summaries of adviser price value process.103 Accordingly, the determining the level of scrutiny to challenges to pricing information proposed rule would require the apply in overseeing an adviser’s fair provided by third-party vendors and of adviser’s periodic reports to provide the value determinations. price overrides, including back-testing adviser’s evaluation of the adequacy and • Pricing Services. Any material results related to the use of price effectiveness of its process for changes to the adviser’s process for challenges and overrides; • Specific calibration and back- determining fair value. The periodic overseeing pricing services,108 as well as testing data, including in the case of reports would be required to, at a any material events related to its back-testing whether fair value prices minimum, include a summary or oversight of such services, such as moved in the same direction (relative to description of the following changes of service providers used or price overrides.109 This information is the prior market prices) as the portfolio information: holdings’ next actual market prices, • Material Valuation Risks. The 105 whether fair value prices were closer to assessment and management of material Proposed rule 2a–5(b)(1)(i)(B). For example, a report could discuss when key inputs or the portfolio holdings’ next actual valuation risks that would be required assumptions are changed and the reasons for the market prices than the prior market under the proposed rule. This would changes. We believe that both a material change and prices (regardless of the direction), and include any material conflicts of interest the reason for it would be information that may be whether the difference between the fair of the investment adviser and any other reasonably necessary for the board to evaluate such changes. value prices and the subsequent prices service provider.104 As discussed above, 106 Proposed rule 2a–5(b)(1)(i)(C). was greater than pre-established we believe that assessing and managing 107 Proposed rule 2a–5(b)(1)(i)(D). For example, tolerance levels; 112 identified valuation risks is an an adviser should disclose to the board when the • Reports regarding portfolio holdings important element for determining fair adviser seeks to hire a new pricing service to cover for which there has been no change in value in good faith because valuation a new asset type or when replacing a person with a background in valuation with a person without price or for which investments have risks that are not effectively managed that background in a position of authority regarding been held at cost for an extended period can make it more likely that the adviser the adviser’s fair value process. See also proposed of time (‘‘stale prices’’); has incorrectly valued an investment. rule 2a–5(b)(2). • Reports regarding portfolio holdings • Material Changes to or Material 108 If the board assigns the fair value whose price has changed outside of determination to an adviser under the proposed Deviations from Methodologies. Any rule, the board would generally be aware of an material changes to, or material adviser initially appointing, and the establishment conflicts occur, we are proposing to require this deviations from, the fair value of the process for overseeing, a pricing service as reporting. methodologies established under the part of its oversight and approval of the adviser’s 110 Proposed rule 2a–5(b)(1)(i)(F). policies and procedures under rule 38a–1. As a 111 Boards and fund CCOs may also consider result, we are not specifically proposing to require requesting or including items such as the examples 101 Proposed rule 2a–5(b)(1)(i). that information be included in these periodic given in the bullet list below, if relevant, as part of 102 See MFDF Valuation Report, supra footnote reports. the CCO’s annual reports to the board under rule 97, at 14. 109 Proposed rule 2a–5(b)(1)(i)(E). There may be 38a–1(a)(4)(iii). 103 Fund boards could always request additional times when pricing information from a pricing 112 See supra footnote 57. In these cases, reports information if they so choose. Proposed rule 2a– vendor differs materially from the adviser’s view of on back-testing could indicate whether fair value is 5(b)(1)(i)(F). the then-current fair value of the portfolio holding, being compared to actual sales prices or to pricing 104 Proposed rule 2a–5(b)(1)(i)(A). See supra and the adviser may seek to contact the pricing information from pricing services and dealers. In section II.A.1 discussing this process. For example, vendor to question the basis for the pricing the latter case, the reports could state whether the adviser could discuss instances where it information. Because this difference in pricing dealer prices are actual bids or firm commitments challenged the pricing information provided by an suggests that further inquiry is needed to assess the or are indicative or accommodation quotes that affiliated or third party vendor. adequacy of the fair value process when these merely represent the opinion of the dealer.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28746 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

predetermined ranges over a set period information on each individual portfolio intended to mandate reporting in of time; holding that received a fair value during circumstances where, at the time the • Narrative summaries or reports on the quarter or certain such holdings? matter was detected, it did not seem that pricing errors, including the date of any 32. We are proposing to require that the matter would materially affect the error, the cause, the impact on the all price overrides be reported as fair value of the assigned portfolio but fund’s NAV, and any remedial actions supplemental information to the board the matter later ended up having such taken in response to the error; as part of the periodic report. Should we an effect. • Reports on the adviser’s due limit which price overrides must be We are proposing to require the diligence of pricing services used by the reported, and, if so, how? Alternatively adviser to provide these reports fund; or in addition, should we require promptly, but in no event later than • The results of testing by the fund’s reporting regarding all price challenges, three business days after the adviser independent auditor provided to the even those that do not lead to overrides? becomes aware of the matter, rather than audit committee; 33. Is there additional specific waiting until the next periodic report.116 • Reports analyzing trends in the information that we should require to be We believe it is appropriate that the number of the fund’s portfolio holdings part of these periodic reports? Are there board receive prompt reports regarding that received a fair value, as well as the any other reports that some boards matters that materially affect fair value percent of the fund’s assets that received currently receive that should be determinations because the proposed a fair value; and required under the proposed rule? rule would allow the board to assign to • Reports on the number and 34. In light of their importance, an adviser fair value determinations materiality of securities whose fair should the rule impose specific otherwise allocated to the board under values were determined based on requirements beyond reporting the Act, and there may arise an issue of information provided by broker-dealers; regarding pricing services? For example, such importance that requires prompt the broker-dealers most frequently used should any pricing services used be board attention. We recognize that the for this purpose; and the results of back- explicitly approved by the board? kind of matters that may require this testing on the information they Should there be a required finding or prompt reporting (i.e., outside of the provided. report by the adviser as to pricing periodic reports) may vary. Some We request comment on our proposed services’ adequacy and effectiveness? situations may warrant an immediate requirement that advisers periodically report, while in other cases it may be b. Prompt Board Reporting provide a written evaluation of the appropriate for the adviser to take some adequacy and effectiveness of the We also believe that it is important for additional time to evaluate how to adviser’s process for determining the the adviser to notify the board of certain address the matter before engaging the fair value of the assigned portfolio of issues as they arise that may require board. We believe that requiring such a investments, including, at a minimum, their immediate attention. Proposed rule report to be ‘‘prompt,’’ but in no event certain specified summaries or 2a–5 would require that the adviser later than three business days after the descriptions. promptly report to the board in writing adviser becomes aware, balances the 28. Is the proposed periodic reporting on matters associated with the adviser’s need for the board to be timely informed requirement appropriate? What process that materially affect, or could of material valuation issues, while resources would be required for an have materially affected, the fair value allowing the adviser to evaluate and adviser to provide the required quarterly of the assigned portfolio of investments, respond appropriately. assessment of the adequacy and including a significant deficiency or a We also understand, however, that effectiveness of the adviser’s process? material weakness in the design or there may be some circumstances when Are there additional or different matters implementation of the adviser’s fair an adviser becomes aware of an issue that we should require advisers to value determination process or material that may affect fair value of the portfolio address in the periodic reports? Are changes 113 in the fund’s valuation but that the materiality of a given event there some items that we should not risks.114 These reports, like the periodic may be in question. In such a case, an require? If so, which, and why? reports discussed above, also must adviser may need additional time to 29. Should we require a different include such information as may be determine and verify whether an event minimum reporting frequency for reasonably necessary for the board to has or could materially affect the fair periodic reports? Should we, for evaluate the matter covered in the value of the portfolio assigned to the example, require advisers to provide report. adviser. Accordingly, we believe that if these reports monthly or in connection ‘‘Could have materially affected’’ is an adviser needs some reasonable with each regularly scheduled board intended to capture certain amount of time after becoming aware of meeting? Should we require some or all circumstances where, for example, a the matter to verify and determine its of the specified information to be matter was detected which affected one materiality, that verification period provided less frequently, such as security and which may not be material would not be counted as part of the annually? on its own, but, had the matter not been ‘‘prompt’’ trigger period. In general, we 30. Is what should be included in an identified, could have materially believe that this verification and final assessment clear? Should we include affected the larger assigned portfolio of determination process should be additional guidance to explain what this investments or some subset of that completed within three business days or entails? Are the other key terms used in portfolio.115 This concept is not less, including the day that the adviser the proposal, such as ‘‘assess,’’ and became aware of the triggering event. ‘‘material’’ sufficiently understood or is 113 For example, a significant increase in price Therefore, any prompt reports generally further guidance advisable for those challenges or overrides likely would reflect a should occur no more than three terms? Should they be defined in the material change to the fund’s valuation risks that business days after the adviser becomes rule, and, if so, how? Should the rule should be promptly reported to the board, 114 use different terms, and, if so, which Proposed rule 2a–5(b)(1)(ii). 115 See PCAOB AS 2201 An Audit of Internal and ‘‘reasonable possibility’’). See also Sarbanes- terms? Control Over Financial Reporting That is Integrated Oxley Act, supra footnote 21, at Title III Sec. 31. Are there circumstances in which with An Audit of Financial Statements, Appendix 302(a)(5). boards should receive specific A—Definitions .A7 (defining ‘‘material weakness’’ 116 Id.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28747

aware of the event, but the adviser may, advisers need more than three business calculation of specific fair values.120 In to the extent necessary, take limited days to make such a materiality many circumstances, the fund’s additional time (but in no event more decision? Is three days too long? Should portfolio manager may be the most than three business days) for the we specify a time for making materiality knowledgeable person at an investment verification and final determination decision in the rule? adviser regarding a fund’s portfolio process. 41. The proposed rule would require holdings. For this reason, it may be We request comment on our proposed all reports to be in writing, including appropriate for portfolio managers to requirement regarding prompt reporting prompt reports. Should we provide that provide input into the process for on certain matters associated with the in the case of prompt reports, advisers determining the fair value of fund adviser’s process that materially affect, could make oral reports so long as investments. On the other hand, because or could have materially affected, the adequate records are kept? portfolio management personnel are fair value of the assigned portfolio of 42. Should we require that, if the often compensated in part based on the fund’s investments. report is not made to the full board, the returns of the fund, a portfolio 35. Are the proposed prompt designated board committee make a manager’s incentives may not be fully reporting requirements appropriate? Are report to the full board within a aligned with the fund’s with respect to there additional or different matters that specified time frame, such as at the next determination of fair value, and a we should require advisers to address in regularly scheduled meeting? portfolio manager therefore should not their prompt reports? 43. Should we permit the adviser to be making the fair value 36. Should the trigger for prompt make prompt reports to a pre-identified determinations.121 reporting be tied to a specific bright line individual director? What controls Further, we believe that a fund or instead be dependent on facts and should we require if we did permit this? generally should consider the extent of circumstances? For example, instead of For example, should that director be influence portfolio managers may have the trigger being when the adviser required to be one of the independent on administration of the fair value becomes aware of the matter should it directors? process, and seek to provide instead be when the event occurs? If so, independent voices and administration would advisers reasonably be able to 3. Specification of Functions of the process as a check on any know when such events occur such that If the board assigns the fair value potential conflicts of interest to the they could report in a timely fashion? determination requirements for one or extent appropriate.122 Separation of Alternatively, should it be when the more fund investments to an adviser, functions facilitates these important adviser determines and verifies the the proposed rule would require the checks and balances, and funds could impact of the event regardless of how adviser to specify the titles of the institute this proposed requirement long it takes after the adviser becomes persons responsible for determining the through a variety of methods, such as aware of the matter? fair value of the assigned investments, independent reporting chains, oversight 37. Are the standards of ‘‘materially including by specifying the particular arrangements, or separate monitoring affecting’’ or ‘‘could have materially functions for which the persons systems and personnel. The proposed affected’’ sufficiently understood? identified are responsible.117 If the rule would require reasonable Should we provide more context on adviser uses a valuation committee or segregation of functions, rather than what these terms mean, specifically as similar body to assist in the process of taking a more prescriptive approach, they relate to the context of material determining fair value, the fair value such as requiring funds to implement weaknesses? Should we instead adopt a policies and procedures generally strict protocols regarding different standard, such as one that uses should describe the composition and communications between specific specific triggers, to identify matters for role of the committee, or reference any personnel, to allow funds to structure prompt reporting? If so, which triggers? related committee governance their fair value determination process For example, should we instead require documents as appropriate. In addition, and portfolio management functions in reporting when a specific number of the fair value policies and procedures ways that are tailored to each fund’s price overrides have occurred? also should identify the specific facts and circumstances, including the 38. Should we identify any other personnel with duties associated with size and resources of the fund’s adviser. issues that the adviser should report price challenges, including those with In this regard, the reasonable promptly to the board? For example, the authority to override a price, and the segregation requirement is not meant to instead of requiring any changes to the roles and responsibilities of such indicate that portfolio management fund’s fair value methodologies to be persons, and establish a process for the must necessarily be subject to a reported during the periodic reports, review of price overrides.118 communications ‘‘firewall.’’ We should we instead require that they also In addition, the proposed rule would recognize the important perspective and be reported promptly? Alternatively, are require the adviser to reasonably insight regarding the value of fund there matters that would be required to segregate the process of making fair holdings that portfolio management be reported promptly that should value determinations from the portfolio instead be reported as part of the management of the fund.119 One 120 Id. at 4 (fund’s portfolio manager ‘‘actively periodic report? screened and influenced a broker-dealer to change significant source of potential adviser the price confirmations [and] failed to advise . . . 39. Is the specified timeline for conflicts of interest in the fair value when he received information indicating that the prompt reporting appropriate or should determination process is the level and Fund’s prices for certain securities should be we consider different time frames? For kinds of input that fund portfolio reduced.’’). example, should we require that an 121 In addition, as the person most directly managers or persons in related functions responsible for the fund’s investments, the portfolio adviser report to the board within 1 or have in the design or modification of manager may also be concerned about the 10 business days? Should the time fair value methodologies, or in the reputational or career implications of the fund’s frame be different for certain types of performance, or its compliance with investment circumstances? If so, which ones? limitations, which can provide an incentive to 117 Proposed rule 2a–5(b)(2). smooth returns or otherwise misvalue portfolio 40. Will advisers be able to make the 118 See also proposed rule 2a–5(a)(4). holdings. appropriate determinations in the 119 See In re Morgan Asset Management, supra 122 See Liquidity Risk Management Release, supra limited time discussed above? Will footnote 9. footnote 3, at section III.H.1.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28748 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

personnel can provide. Accordingly, provided to the board required by the concepts of ASC Topic 820 when this segregation requirement would not rule and (2) a specified list of the evaluating whether market quotations prevent portfolio managers from investments or investment types whose are readily available.128 providing inputs that are used in the fair fair value determinations have been The proposed rule would provide that value determination process, as noted assigned to the adviser pursuant to the a market quotation is readily available 123 above. Instead, this reasonable requirements of the proposed rule. In for purposes of section 2(a)(41) of the segregation requirement is designed to each case, these records would be Investment Company Act with respect help reduce and manage potential required to be kept for at least five years to an investment only when that conflicts of interest. Keeping the after the end of the fiscal year in which quotation is a quoted price (unadjusted) functions reasonably segregated in the the documents were provided to the in active markets for identical context of fair value determinations board or the investments or investment investments that the fund can access at should help mitigate the possibility that types were assigned to the adviser, the the measurement date, provided that a these competing incentives diminish the first two years in an easily accessible quotation will not be readily available if effectiveness of fair value 124 place. it is not reliable.129 Fair value, as determinations. As discussed above, funds must create defined in the Act, therefore must be We request comment on this proposed and retain certain documentation, used in all other circumstances.130 As requirement. including the reports that advisers make discussed previously, we believe that 44. Should the rule require assigned to the fund board.125 Further, we believe for a fair value methodology to be advisers to reasonably segregate the that a clear identification of the appropriate under the proposed rule, it process of making fair value investments or investment types that the must be determined in accordance with determinations from the portfolio board has assigned to the adviser would U.S. GAAP. As mentioned above, U.S. management of the fund? Would this facilitate the board’s oversight of the pose any difficulty for particular types adviser’s fair value determinations.126 GAAP requires funds to maximize the of entities, for example funds managed These proposed recordkeeping use of relevant observable inputs and by small advisers? requirements are designed to achieve minimize the use of unobservable 45. Is there a better way to prevent these objectives and to facilitate inputs. However, under U.S. GAAP conflicts between a portfolio manager’s compliance, and related regulatory there are circumstances where incentives and a fund’s interest, for oversight, with the proposed rule. otherwise relevant observable inputs 131 example, in determination of We request comment on these become unreliable. Consistent with investment values that do not result in proposed additional recordkeeping this, a quote would be considered dilution of purchasing or redeeming requirements. unreliable under proposed rule 2a–5(c) investors? Should we provide any 46. Are there any additional types of in the same circumstances where it additional clarification regarding the records that we should require the fund would require adjustment under U.S. proposed reasonable segregation to maintain in connection with the GAAP or where U.S. GAAP would requirement? If so, what changes should assignment process? Why or why not? require consideration of additional we make? Should we add or change any 47. Should we apply any or all of the inputs in determining the value of the specific requirements? For example, proposed recordkeeping requirements of security. For example, under current should we prohibit portfolio this section to the adviser, rather than U.S. GAAP, funds looking to the management from having any the fund? If so, which requirements? proposed rule would use previous involvement in the fair value process or 48. Are the holding periods sufficient closing prices for securities that should we generally prohibit their to evidence compliance? Why or why principally trade on a closed foreign involvement outside of certain not? Should they be different (e.g., six market to calculate the value of that situations beyond making fair value years)? security, except when an event has determinations? If so, what level of occurred since the time the value was involvement should we permit? Further, C. Readily Available Market Quotations established that is likely to have should we exempt smaller advisers from The board’s role in the valuation of a resulted in a change in such value.132 In this requirement or clarify that this is a portfolio holding for purposes of fair key risk and thus, where feasible, such value depends on whether or not market 128 We acknowledge that specific references and personnel should be segregated, without quotations are readily available for such principles in U.S. GAAP may change over time. making segregation an explicit a holding. Under section 2(a)(41) of the When referencing ASC Topic 820 throughout this regulatory requirement? Are there release, we intend to reference the accounting topic Investment Company Act, if a market on Fair Value Measurements within U.S. GAAP and effective steps, other than segregation, quotation is readily available for a the principles therein. that funds currently use to manage the portfolio holding, it must be valued at 129 Proposed rule 2a–5(c). ASC Topic 820 defines potential conflicts of portfolio the market value. Conversely, if market level 1 inputs as ‘‘[q]uoted prices (unadjusted) in management personnel that the rule quotations are ‘‘not readily available,’’ active markets for identical assets . . . that the should require instead of segregation? If reporting entity can access at the measurement the holding’s value must be fair value as date.’’ ASC Topic 820–10–20 (emphasis added). In so, what are they and why should they determined in good faith by the ASR 113, the Commission interpreted ‘‘readily be required instead? board.127 available market quotations’’ to refer ‘‘to reports of Neither the Investment Company Act current public quotations for securities similar in 4. Records of Assignment all respects to the securities in question.’’ Despite nor the rules thereunder currently Under the proposed rule, in addition the respective references to ‘‘securities similar in all define ‘‘readily available.’’ However, we respects’’ in the Commission’s prior guidance and to the records that would need to be understand that industry practice has ‘‘identical assets’’ in ASC Topic 820, we view these kept as part of a good faith developed to incorporate many of the respective definitions as being substantively the determination of fair value generally, a same. fund must also keep records related to 130 Proposed rule 2a–5(e)(2). See also supra 123 Proposed rule 2a–5(b)(3). section II.A.2. the fair value determinations assigned to 124 Proposed rule 2a–5(b)(3). 131 See ASC Topic 820–10–35–41C (outlining the adviser. Specifically, the fund 125 See supra section II.A.6. circumstances when a reporting entity shall make would be required to: (1) Keep copies of 126 Proposed rule 2a–5(b)(3). an adjustment to a Level 1 input). the reports and other information 127 Section 2(a)(41). 132 See id. at b.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28749

such circumstances, the fund would the measurement date? Should some U.S. GAAP provides authoritative need to fair value the security. other standard be used, such as ‘‘readily standards applicable to the As we have stated previously, access’’ or ‘‘reasonably access’’? measurement of fund investments and evaluated prices are not, by themselves, related disclosures for financial D. Rescission of Prior Commission readily available market quotations.133 reporting purposes. For example, ASC Releases In addition, ‘‘indications of interest’’ Topic 946 requires that investment and ‘‘accommodation quotes,’’ for In ASR 113 and ASR 118, the companies measure investments in debt example, would not be ‘‘readily Commission provided specific guidance and equity securities, as well as other available market quotations’’ for the for funds regarding the ‘‘inclusion’’ (or investments, at fair value.140 ASC Topic purposes of proposed rule 2a–5.134 recognition), ‘‘valuation’’ (or 820, in turn, defines ‘‘fair value’’ as ‘‘the We request comment on our proposed measurement), and disclosure of price that would be received to sell an definition of when market quotations investment securities.135 Since the asset or paid to transfer a liability in an are readily available for purposes of Commission issued that guidance, we orderly transaction between market section 2(a)(41) and rule 2a–4. believe that developments in the FASB participants at the measurement 49. Is the proposed definition of when accounting standards have modernized date.’’ 141 ASC Topic 820 also provides market quotations are readily available the approach to accounting topics a framework for measuring fair value as under the Investment Company Act addressed in ASR 113 and ASR 118. well as principles for financial appropriate? Should we look elsewhere Further, as noted above, market and statement disclosures.142 than or in addition to ASC Topic 820? fund investment practices have evolved The Commission historically has 50. How should we address considerably.136 As a result, the fund- recognized FASB pronouncements as investments in pooled vehicles, such as specific accounting guidance for authoritative for financial reporting registered investment companies, that recognition, measurement, and purposes in the absence of any contrary are valued at NAV, not at a market disclosure provided in those statements Commission determination.143 In price? Do funds currently treat such may no longer be necessary. Financial Reporting Release No. 70,144 investments as securities that are fair Several examples illustrate how FASB the Commission stated its determination valued? What would be the burdens on accounting standards have addressed that the FASB and its parent boards of funds that invest substantially the topics covered in the ASRs. First, organization, the Financial Accounting in such vehicles (e.g., funds of funds)? ASR 118 provides guidance related to Foundation, satisfied the criteria in To the extent that a board assigned the the ‘‘inclusion,’’ or recognition, of section 19(b) of the Securities Act and, determination of fair values of such securities in a portfolio. Today, U.S. accordingly, FASB financial accounting investments to a fund’s adviser, would GAAP provides authoritative standards and reporting standards are recognized the adviser’s use of NAV involve the applicable to the recognition of as ‘‘generally accepted’’ under the conflicts of interest or other concerns investments by investment companies federal securities laws.145 As a result, underlying paragraph (b) of the for financial reporting purposes.137 For registrants are required to comply with proposed rule? example, ASC Topic 946: Financial those standards for recognition, 51. Would this provision cause any Services—Investment Companies (‘‘ASC measurement and disclosure in compliance issues with other elements Topic 946’’) requires that an investment preparing financial statements filed of the proposed rule, ASC Topic 820, or company recognize security purchases with the Commission, unless the any other provision of the federal and sales as of the date on which the Commission provides otherwise.146 securities laws? investment company agrees to purchase Accordingly, we believe ASR 113 and 52. This definition is designed to or sell the investment.138 It also ASR 118 are not necessary to clarify track concepts in U.S. GAAP. Should provides that securities acquired in fund obligations with respect to these we instead expressly refer to U.S. GAAP private placements and tender offers are accounting topics. We further believe in the rule text to ensure that required to be recognized as of the date that, because the guidance contained in consistency with U.S GAAP in case of the investment company obtained legal ASR 113 and ASR 118, on the one hand, changes over time? For example, should rights and obligations relating to the and U.S. GAAP, on the other, require the rule instead provide that ‘‘market transferred securities.139 funds to reach similar results with quotations are readily available for In addition, ASRs 113 and 118 respect to the recognition, measurement, purposes of section 2(a)(41) of the Act provide guidance related to the and disclosure of fund portfolio with respect to an investment only valuation and disclosure of securities holdings, such guidance is not when the investment’s value is for financial reporting purposes. Again, necessary to supplement the determined under generally accepted requirements of U.S. GAAP. We believe accounting principles of the United 135 See ASR 113 (‘‘1. The Problems of Valuation’’ that the measurement concepts under States based solely on quoted, and ‘‘2. The Problems of Portfolio Management’’); ASR 118. ASR 118 refers to the concepts of 140 See ASC 946–320–35–1 and ASC 946–325– unadjusted prices in active markets for ‘‘inclusion’’ and ‘‘valuation’’ of securities in the 35–1. identical investments that the fund can portfolio, which we believe are equivalent to the 141 As noted above, the term ‘‘fair value’’ is used access at the measurement date?’’ U.S. GAAP concepts of recognition and in sections II.A and II.B as defined in ASC Topic measurement, respectively. 820. See supra footnote 13. 53. Should the Commission define 136 readily available market quotations via See supra section I. 142 ASC Topic 820 defines fair value at ASC 820– 137 Rule 2a–4(a)(2) under the Investment 10–20. See also ASC Topic 820–10–50. rulemaking as proposed, or should we Company Act provides that, for purposes of 143 See Rule 4–01(a)(1) of Regulation S–X [17 CFR instead provide interpretive guidance? calculating the NAV of a redeemable security, 210.4–01(a)(1)]. See also ASR 150 (Dec. 20, 1973) 54. Do practitioners understand what ‘‘changes in holdings of portfolio securities shall be and ASR 4 (Apr. 25, 1938). it means in this context for the fund to reflected no later than in the first calculation on the 144 Policy Statement: Reaffirming the Status of the first business day following the trade date.’’ The FASB as a Designated Private-Sector Standard have access to identical investments at ‘‘first business day following the trade date’’ is Setter, Investment Company Act Release No. 26028 commonly referred to as T+1. We believe that our (Apr. 25, 2003) [68 FR 23333 (May 1, 2003)] (‘‘FR– 133 See 2014 Money Market Fund Release supra proposed rescission of ASR 113 and ASR 118 is 70’’). footnote 14, at text accompanying n.895. consistent with the provisions of rule 2a–4. 145 15 U.S.C 77s(b). 134 See Liquidity Risk Management Release, supra 138 See ASC 946–320–25–1. 146 See FR–70, supra footnote 144; rule 4–01(a)(1) footnote 3, at nn.800–801 and accompanying text. 139 See ASC 946–320–25–2. of Regulation S–X.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28750 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

ASC Topic 820 are consistent with the the improper valuation of fund related to the use of amortized cost in Investment Company Act and the investments that materially affects the valuing portfolio securities with Commission’s prior statements that fair NAV of the shares being offered or, in maturity dates of 60 days or less.154 Is value is the amount that an owner of a the case of an open-end fund, redeemed, there other valuation guidance that the portfolio holding might reasonably could violate the anti-fraud provisions proposal should address? Do funds or expect to receive upon its ‘‘current of the federal securities laws.151 advisers look to any other guidance on sale.’’ 147 As a result, we propose to We do not propose to modify the valuation that would be relevant for the rescind the Commission’s prior Commission’s prior guidance regarding Commission to address? 148 the use of the amortized cost method guidance in ASR 113 and ASR 118. 59. Our proposal to rescind ASR 118 because the Commission recently Additionally, in light of the Sarbanes- would eliminate the Commission’s considered this topic in the 2014 Money Oxley Act giving the PCAOB the statement in that release regarding Market Fund Release, and we do not authority to establish or adopt verification by an independent believe that further guidance in this area professional standards for auditors, accountant of all quotations for is required at this time.152 subsequent to the release of the securities with readily available market Commission guidance in ASR 118, we 55. Do commenters agree that all of quotations at the balance sheet date. no longer believe that it is necessary to the guidance provided in ASR 113 and Should we maintain that position retain the specific requirement in ASR ASR 118 has been rendered unnecessary regarding independent verification of 118 for an independent accountant of a by subsequent developments, including quotations for all securities for which fund to verify all quotations for developments in the fund industry, market quotations are available? What securities with readily available market subsequent Commission statements, are the benefits or costs associated with quotations at the balance sheet date. rulemakings, and developments related independent verification of quotations Accordingly, we are proposing to to U.S. GAAP, and the requirements of for all portfolio investments? rescind ASR 118, including this specific the proposed rule, if adopted? Is there requirement.149 any guidance contained in either of ASR 60. Is there any other Commission In addition to the discussions in ASR 113 and ASR 118, accounting or valuation rule (such as rule 6.02(b) of 113 and ASR 118 regarding accounting, otherwise, that commenters believe it is Regulation S–X) or guidance that we auditing, and the role of the board in necessary or desirable to retain? should consider rescinding or amending determining fair value, these releases 56. To the extent prior guidance has in light of the proposal? If so, why? also discuss other matters. Because we not already been incorporated into U.S. E. Existing Staff No-Action Letters, believe that many of these statements GAAP, is there any prior guidance that Other Staff Guidance, and Proposed would be superseded by the rule we are should be recommended for Transition Period proposing here, or have also been incorporation into U.S. GAAP by the superseded by subsequent requirements FASB? In addition to the proposal to rescind 57. We have previously stated that fair under U.S. GAAP, we propose to ASR 113 and ASR 118, certain staff value is what ‘‘the owner might rescind ASR 113 and ASR 118 in their letters and other staff guidance 150 reasonably expect to receive . . . upon entirety. We continue to believe that addressing a board’s determination of [a] current sale.’’ 153 Are the concepts of fair value and other matters covered by 147 ‘‘current sale’’ in ASR 118 and ‘‘exit In ASR 118 the Commission stated that, as a proposed rule 2a–5 would be general principle, fair value of a security would be price’’ in U.S. GAAP identical? If not, withdrawn or rescinded in connection the amount that a fund might reasonably expect to what are the differences between the receive for the security upon its current sale. (The with any adoption of this proposal. two standards and how should we ‘‘current sale’’ standard also is referred to as the Upon the adoption of any final rule, address such gap? ‘‘exit price’’ standard.) In U.S. GAAP, ASC Topic some letters and other guidance, or 820 defines fair value as the price that would be 58. The proposal does not address the received to sell an asset or paid to transfer a liability views the Commission has expressed portions thereof, would be moot, between market participants at the measurement superseded, or otherwise inconsistent date under current market conditions (an exit with the final rule and, therefore, would price). adoption of rule 22e–4 on liquidity risk management programs. The discussion in ASR 113 be withdrawn or rescinded. If 148 We also are proposing to make conforming under the heading ‘‘3. The Problem of Disclosure’’ commenters believe that additional amendments to 17 CFR 210.6–03 (rule 6–03 of has been rendered obsolete by the repeal of Form Regulation S–X). N–8B–1 and the adoption of our current disclosure letters or other guidance, or portions 149 The proposed rescission would eliminate the forms. See, e.g., Investment Company Registration thereof, should be withdrawn or Commission’s auditing guidance to verify all and Report Forms and Reporting Requirements, rescinded, they should identify the quotations of securities with readily available Revision of Forms, Reports and Regulations, letter or guidance, state why it is market quotations at the balance sheet date, Investment Company Act Release No. 10378 (Aug. implicating the auditor’s requirement to test the 28, 1978) (‘‘Forms N–1 and N–2 . . . replace Form relevant to the proposed rule, how it or valuation assertion for all securities. This proposal N–8B–1’’); Registration Form Used by Open-End any specific portion thereof should be does not impact the statutory requirement in Management Investment Companies; Guidelines, treated, and the reason therefor. Based section 30(g) of the Investment Company Act, Investment Company Act Release No. 13436 (Aug. on the proposed rule, staff letters and which requires the independent public accountant 22, 1983) (Form N–1A replaces Form N–1); Form to verify securities owned, either by actual N–1A; Form N–2. guidance that would be withdrawn or examinations, or by receipt of a certificate from the 151 See also ASR 113. rescinded would include, but would not custodian, which implicates the auditor’s 152 See 2014 Money Market Fund Release supra necessarily be limited to, all of the staff requirement to test the existence assertion for all footnote 14. See also Accounting Series Release No. letters and other staff guidance listed securities. The statutory requirement under section 219, Valuation of Debt Instruments by Money 30(g) of the Investment Company Act remains Market Funds and Certain Other Open-End below. distinct from the requirements in auditing Investment Companies, (May 31, 1977) (stating that, standards established by the PCAOB. under certain circumstances, funds may determine 154 See 2014 Money Market Fund Release, supra 150 The discussion of liquidity in ASR 113 under the fair value of debt securities that mature in 60 footnote 14. These views were codified in the the heading ‘‘2. The Problems of Portfolio days or fewer by using the amortized cost method). ‘‘Codification of Financial Reporting Policies’’ at 153 Management’’ has been rendered moot by the ASR 118. section 404.05.c.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28751

Name Date Topic

Paul Revere Investors, Inc...... Feb. 21, 1973 ...... Delegation to a board valuation committee. The Putnam Growth Fund and Putnam International Eq- Jan. 23, 1981 ...... Fair value of portfolio securities which trade on a uities Fund, Inc.. closed foreign exchange. Form N–7 for Registration of Unit Investment Trusts Mar. 17, 1987 ...... Fair value for UITs to be determined by the trustee or under the Securities Act of 1933 and the Investment its appointed person. Company Act of 1940, Investment Company Act Re- lease No. 15612, Appendix B, Guide 2. Investment Company Institute ...... Dec. 8, 1999 ...... Fair value generally. Investment Company Institute ...... Apr. 30, 2001 ...... Fair value generally. Valuation Guidance Frequently Asked Questions (FAQ 1 2014 ...... Fund directors’ responsibilities when determining only). whether an evaluated price provided by a pricing service, or some other price, constitutes fair value.

We also are proposing a one-year III. Economic Analysis action will promote efficiency, transition period to provide time for competition, and capital formation. A. Introduction funds and their advisers to prepare to The proposed rule would provide a come into compliance with proposed The proposed rule would provide consistent framework for boards to rule 2a–5. Accordingly, we propose that requirements for determining fair value comply with their obligations under the effective date of any adoption of this in good faith for purposes of section section 2(a)(41) of the Investment proposal would be one year following 2(a)(41) of the Act and rule 2a–4 Company Act and would permit boards the publication of the final rule in the thereunder. This determination would to assign fair value determinations to an Federal Register. We propose to rescind involve assessing and managing investment adviser, which would carry ASR 113 and 118 at that time, and the material risks associated with fair value out all of the functions required under identified guidance would be determinations; selecting, applying, and the proposed rule, subject to oversight withdrawn. testing fair value methodologies; and other conditions. Permitting a evaluating any pricing services used; fund’s board to assign fair value We request comment on the proposed determinations to an investment adviser rescissions and transition period. adopting and implementing certain written policies and procedures; and recognizes the developments discussed 61. Are there any other staff letters or maintaining certain records.155 The in Section I above, including the guidance pieces that should be proposed rule would permit a fund’s increased complexity of many fund rescinded or withdrawn should board of directors to assign the fair portfolios and the in-depth expertise proposed rule 2a–5 be adopted? value determination relating to any or needed to accurately fair value such complex investments. The proposed 62. Alternatively, should the all fund investments to an investment rule also recognizes the important role Commission codify any staff letters or adviser of the fund, which would carry out all of the functions required under that fund investment advisers now play other staff guidance pieces, for example, and the expertise they provide in the FAQ 2 in the 2014 Valuation Guidance the rule, subject to board oversight and certain reporting, recordkeeping, and fair value determination process given Frequently Asked Questions? If so, market and regulatory developments commenters should identify the other requirements designed to facilitate the board’s ability to effectively oversee over the past fifty years. Permitting a positions and explain why commenters fund’s board to assign fair value believe they should be codified. the adviser’s fair value determinations.156 Finally, the proposed determinations to the adviser would 63. Do commenters agree that a one- rule would define when market allow the board to focus its time and year transition period to provide time quotations are readily available for attention on other matters related to the for funds and their advisers to prepare purposes of section 2(a)(41) of the fund, such as the oversight of the to come into compliance with proposed Act.157 We are sensitive to the economic investment adviser. This could lead to rule 2a–5 is appropriate? Should the effects that may result from the a more efficient use of boards’ resources period be shorter or longer? proposed rule, including the benefits, and therefore improve funds’ costs, and the effects on efficiency, governance for the benefit of fund 64. Should the transition period be investors. The proposed rule would the same for all funds that would be competition, and capital formation.158 Section 2(c) of the Investment Company impose one-time costs to funds to subject to proposed rule 2a–5, as review the proposed rule’s requirements proposed? Alternatively, should we Act requires us, when engaging in rulemaking that requires us to consider and modify their fair value practices, adopt tiered transition periods for policies and procedures, reporting, and smaller entities? For example, should or determine whether an action is consistent with the public interest, to recordkeeping to comply with the we provide an additional six months in also consider, in addition to the proposed rule. Further, to the extent the transition period for smaller entities protection of investors, whether the that fair value determinations would be (or some other shorter or longer period)? assigned to a fund’s investment adviser, the investment adviser may have to 65. Instead of a fixed transition period 155 See proposed rule 2a–5(a). incur ongoing costs to satisfy the new of one year, should we tie the transition 156 See proposed rule 2a–5(b). period to the fiscal year end of funds? 157 See proposed rule 2a–5(c). fair value obligations. The investment For example, should the transition 158 Our analysis of the proposed rule takes into adviser ultimately may pass through account the rescission of ASR 113 and ASR 118 as some of these ongoing costs to funds period instead start for each fund at the well as the withdrawal and rescission of certain and their investors. beginning of its fiscal year end after the staff letters and other guidance addressing a board’s We discuss the potential effects of the one-year period following adoption of determination of fair value and other matters proposed rule as well as possible any rule? covered by proposed rule 2a–5 (see Sections II.D. and II.E. above). alternatives to the proposed rule in

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28752 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

more detail below. Where possible, we are not readily available.161 Finally, the many of the requirements of the have attempted to quantify the costs, Commission stated that whenever proposed rule are generally similar to benefits, and effects on efficiency, technical assistance is requested from current practice. We request data and competition, and capital formation individuals who are not directors, the other information on current fund expected to result from the proposed findings of such individuals must be practices in Section III.E below.169 rule. In some cases, however, we are carefully reviewed by the directors in Fair Value Calculation. Most fund unable to quantify the economic effects order to satisfy themselves that the boards do not play a day-to-day role in because we lack the information resulting valuations are fair.162 The the pricing of fund investments.170 necessary to provide a reliable estimate. 2014 Money Market Fund Release stated Typically, an investment adviser to the Where we are unable to quantify the that funds ‘‘may consider evaluated fund or other service providers perform economic effects of the proposed rule, prices from third-party pricing services, the actual day-to-day fair value we provide a qualitative assessment of which may take into account these calculations.171 In addition to the potential effects and encourage inputs as well as prices quoted from performing day-to-day calculations, commenters to provide data and dealers that make markets in these investment advisers also typically assist information that would help quantify instruments and financial models.’’ 163 the board in developing the fund’s fair the benefits, costs, and the potential The 2014 Money Market Fund Release value methodologies.172 impacts of the proposed rule on also stated that ‘‘evaluated prices Fair Value Practices—Assess and efficiency, competition, and capital provided by pricing services are not, by manage risks. It is our understanding formation. themselves, ‘readily available’ market that boards play an important role in quotations or fair values ‘as determined identifying and managing the fund’s B. Economic Baseline in good faith by the board of directors’ valuation risks.173 Examples of 1. Current Regulatory Framework as required under the Investment valuation risks that funds often address Company Act.’’ 164 In addition, the include changes in market liquidity, To understand the effects of the Commission discussed in that release reliance on a single source for pricing proposed rule, we compare the the factors that the fund’s board of data, reliability of data obtained from proposed rule’s requirements to the directors may want to consider ‘‘before pricing services for securities that are current regulatory framework and deciding to use evaluated prices from a not traded on exchanges, reliability of current industry practices. As discussed pricing service to assist it in data provided by credit rating agencies, in greater detail in Section I above, the determining the fair values of a fund’s use of internal information provided by regulatory framework regarding fair portfolio securities.’’ 165 portfolio managers to estimate fair value determinations and the role of the Finally, the Compliance Rules values, use of internally developed board of directors in the determination Adopting Release stated the of fair value is set forth in the Commission’s view that rule 38a–1 169 Funds have discretion in the type of Investment Company Act and the rules requires compliance policies and disclosures they provide regarding their fair value procedures with respect to fair value.166 determinations. Our review of N–1A, 485APOS, thereunder. The Commission has also 485BPOS, N–2, and POS 8C Forms filed with the expressed its views on the role of the 2. Current Practices Commission between January 1, 2019 and board regarding fair value under the December 31, 2019 showed that only 13% of the Investment Company Act in several Our understanding of boards’ current open-end funds and closed-end funds disclose information related to board’s fair value practices, releases, including ASR 113 and ASR fair value practices is based on fund disclosures, staff discussions with out of which 37% explicitly state that the 118, the 2014 Money Market Fund investment adviser assists the board in the fair Release, and the Compliance Rules industry representatives, staff’s value determinations. Nevertheless, the results of Adopting Release.159 experience, and review of relevant our review should be interpreted with caution industry publications and academic because funds’ disclosures of fair value practices Section 2(a)(41) of the Investment papers.167 We expect that fund’s are unstructured and results may be sensitive to the Company Act defines the value of assets algorithm used to identify those disclosures. policies and procedures generally reflect 170 See, e.g., Investment Company Institute, for which market quotations are not 168 their fair value practices. We discuss Independent Directors Council, ICI Mutual readily available as fair value as below our understanding of current Insurance Company, An Introduction to Fair determined by the board of directors in practices but acknowledge that practices Valuation, Spring 2005 (‘‘ICI Fair Valuation good faith. As discussed above, the may vary across funds and through Report’’), at 7. Nevertheless, ‘‘[t]here may be Commission acknowledged in ASR 113 circumstances at a particular fund group that leads time. We lack detailed data on the fair a board and adviser to determine that it is desirable and ASR 118 that the board need not value practices of each individual fund for an independent director to be involved in day- itself perform each of the specific tasks and fund board, but, based on available to-day decision-making, whether as part of the required to calculate fair value in order inputs, we preliminarily believe that adviser’s valuation committee or by reviewing and to perform its role under section ratifying the committee’s decisions daily.’’ See MFDF Valuation Report, supra footnote 97, at 9. 2(a)(41). However, ASR 113 and ASR 161 See supra footnote 15. 171 See, e.g., MFDF Valuation Report, supra 118 stated that the board should choose 162 ASR 118 supra footnote 16. footnote 97, at 4. the methods used to arrive at fair value 163 2014 Money Market Fund Release, supra 172 See, e.g., K&L Report, supra footnote 167, at and continuously review the footnote 14. 14; MFDF Valuation Report, supra footnote 97, at 164 appropriateness of such methods.160 In Id. 11. 165 Id. 173 See, e.g., MFDF Valuation Report, supra addition, the Commission stated that 166 Compliance Rules Adopting Release, supra footnote 97, at 6–8; Deloitte Insights, 2019. Fair boards should consider all appropriate footnote 26, at 74718. valuation pricing survey, 17th edition, executive factors relevant to the fair value of 167 See, e.g., Investment Company Institute, summary (‘‘Deloitte Survey’’), at 10. We lack securities for which market quotations Independent Directors Council, ICI Mutual information on how the Deloitte survey sample was Insurance Company, The Role of the Board, Spring constructed or how the survey data was collected 2005 (‘‘ICI and IDC Report’’); K&L Gates, Mutual and so we cannot speak to the representativeness 159 See supra footnotes 1, 12, 14, and 26. See also Fund Valuation and Liquidity Procedures, 2013 of the sample or the unbiasedness of the survey Section I for a discussion of other aspects of funds’ (‘‘K&L Report’’); K&L Gates, Mutual Fund Pricing responses. Nevertheless, the results of the survey regulatory framework that are related to boards’ fair and Fair Valuation, 2016; MFDF Valuation Report, are largely consistent with the Commission staff’s value role (e.g., the Sarbanes-Oxley Act and ASC see supra footnote 97. experience and in line with practices as described Topic 820). 168 See, e.g., ICI and IDC Report, supra footnote in prior Commission staff’s letters. See, e.g., staff 160 See supra footnote 14. 167, at 6–7. letters in Section II.E.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28753

models to value securities, extensive use valuing securities and make any clearly established functions that help of matrix pricing, the process necessary adjustments.181 Further, the board provide oversight of the surrounding the adviser’s price funds generally monitor the investment advisers’ valuation overrides, timely identification of circumstances that may necessitate the practices.188 If used, the structure of the material events, and valuation risks use of fair values.182 For example, many valuation committees can differ across arising from new investments.174 Funds’ funds establish triggering mechanisms funds. Finally, fund policies and valuation practices generally focus on in their policies and procedures to procedures may include ‘‘escalation mitigating potential conflicts of interest monitor circumstances that require the procedures’’ that describe the of the investment adviser as well as use of fair value methodologies, and circumstances under which certain third-party pricing services may be used conflicts of interest of other parties that investment adviser personnel or board assist the board with fair value to identify those triggering events.183 Fair Value Practices—Test fair value members should be notified when fair determinations (e.g., portfolio value issues arise that are not addressed managers).175 In particular, some methodologies. We understand that in existing fair value policies and investment advisers currently have in funds generally test the appropriateness procedures.189 place processes to address potential and accuracy of the internally selected conflicts of interest when portfolio methodologies used to value securities. Fair Value Practices—Evaluate management personnel provides input Funds may utilize methods such as Pricing Services. We understand that regarding valuation for a fund.176 back-testing to review the funds frequently use third-party pricing Valuation risks can change with appropriateness and accuracy of the service providers to assist in changes in market conditions and methodologies used.184 We understand determining fair values.190 Before changes in fund investments. Hence, that many funds use systems to identify engaging a pricing service, boards may funds may periodically review any security valuations that may require review background information on the previously-identified valuation risks.177 additional attention, such as security vendor, such as the vendor’s operations Some boards meet with the fund’s chief prices that have not changed over a and internal testing procedures, risk officer or members of the risk period of time and changes in prices emergency business continuity plans, 185 committee on a periodic basis to discuss beyond a certain threshold. and methodologies and information Fair Value Practices—Identify the valuation of the portfolio securities used to form its recommended responsibilities. Based on our as part of the assessment and valuations.191 Boards may develop an understanding of current industry management of previously identified understanding of the circumstances in risks.178 practices, we believe that funds generally allocate fair value which third-party pricing services Fair Value Practices—Establish fair would provide assistance in securities value methodologies. Further, it is our functions,186 which may be reflected in valuation.192 In reviewing the understanding that funds that invest in a written charter or the fund’s valuation 187 performance of these pricing services, securities that are fair valued have in policies and procedures. As boards also may seek input from the place written policies and procedures discussed above, an investment adviser fund’s adviser or the pricing service that detail the methodologies used when to the fund assists the board with the calculating fair values.179 The day-to-day fair-value process. This itself, including probing whether the methodologies often establish a allocation of valuation functions can investment adviser performed adequate suggested ranking of the pricing sources help boards understand and monitor the due diligence when selecting the 193 that an adviser should use when valuing level of involvement of portfolio service. In particular, boards may securities, and different rankings can be managers in the valuation process. consider whether the adviser tests established for different types of Portfolio managers can provide valuable prices received from pricing services securities.180 Many funds periodically inputs to the valuation of fund against subsequent sales or open prices, review the appropriateness and securities, but they are subject to whether the pricing services are accuracy of the methodologies used in conflicts of interest. Some boards create periodically reviewed, and to what separate valuation committees with extent the pricing service considers 174 See, e.g., MFDF Valuation Report, supra adviser input. Funds may establish footnote 97, at 6–8. 181 According to the Deloitte survey, 72% of procedures for ongoing monitoring of 175 According to a Deloitte survey, ‘‘22 percent of survey participants performed periodic reviews of the pricing services—including pricing survey participants noted that their boards seek to valuation models relating to private equity identify areas in the valuation process where there investments to determine the appropriateness and service’s presentations to the board, might be a conflict of interest and provide oversight accuracy relative to the investment being valued, investment adviser’s due diligence, and relative to these conflicts.’’ See Deloitte Survey, and 56% of participants reported that the valuation on-site visits to the pricing service—to supra footnote 173, at 10. The cited statistic does models used for private equity investments are not imply that the remaining funds do not have explicitly subject to internal control policies and determine whether the pricing service policies in place to manage conflicts of interest of procedures. According to the same survey, 63% of continues to have competence in investment advisers but it means that any such survey participants made a change or revision to valuing particular securities and policies may not be valuation specific. their valuation policies over the last year. See maintains an adequate control 176 See, e.g., MFDF Valuation Report, supra Deloitte Survey, supra footnote 173, p. 9 and 14. footnote 97, at 9. 182 See, e.g., MFDF Valuation Report, supra 177 See, e.g., MFDF Valuation Report, supra footnote 97, at 5. 188 See, e.g., ICI and IDC Report, supra footnote footnote 97, at 8. 183 See, e.g., ICI and IDC Report, supra footnote 167, at 8–10. 178 According to a Deloitte Survey, 34% of survey 167, at 6–7 and 10–11; MFDF Valuation Report, 189 See, e.g., ICI and IDC Report, supra footnote participants reported that the board or one of its supra footnote 97, at 5. 167, at 7. subcommittees met with the chief risk officer or 184 See, e.g., ICI Fair Valuation Report, supra 190 See, e.g., MFDF Valuation Report, supra members of the risk committee to discuss valuation footnote 170, at 17–18. footnote 97, at 10; ICI and IDC Report, supra matters. See Deloitte Survey, supra footnote 173, at 185 See, e.g., ICI and IDC Report, supra footnote footnote 167, at 10–11. 10. 167, at 6–78. 191 See, e.g., ICI and IDC Report, supra footnote 179 See, e.g., ICI and IDC Report, supra footnote 186 See generally MFDF Valuation Report, supra 167, at 11. 167, at 6–7; MFDF Valuation Report, supra footnote footnote 97, at 9; ICI and IDC Report, supra footnote 192 See, e.g., MFDF Valuation Report, supra 97, at 5. 167, at 8–10. footnote 97, at 10. 180 See, e.g., MFDF Valuation Report, supra 187 See, e.g., ICI and IDC Report, supra footnote 193 See, e.g., MFDF Valuation Report, supra footnote 97, at 5. 167, at 10. footnote 97, at 11.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28754 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

environment.194 Further, boards may the effect of the fair value on the fund’s 3. Affected Parties seek to understand the circumstances NAV, and the rationale for the decision under which the adviser may override to fair value.202 Some board reports may The proposed rule would affect all the prices obtained by the pricing also include security-specific funds that invest in securities that must service provider.195 information in cases where investment be fair valued under the Act, those funds’ boards of directors, investment Board Reporting. As part of their advisers override prices provided by 203 advisers, and investors. Table 1 below current fair value practices, boards may pricing services. Finally, some funds presents descriptive statistics for the review on a periodic basis reports also include in board reports the minutes of, or summary memoranda and funds that could be affected by the regarding the fair value of fund other written documentation from, proposed rule. As of January 2020, there securities.196 Many boards review fair valuation committee meetings held were 13,733 registered investment value determinations quarterly but some during the prior period.204 companies: (i) 12,379 open-end funds; boards review the determinations more Valuation reports may vary depending or less frequently depending on the type (ii) 666 closed-end funds; (iii) 674 UITs; on the volume and complexity of fair and (iv) 14 variable annuity separate of fund securities and the market value determinations.205 For example, conditions.197 Boards also may have ad- accounts registered as management some boards require a case-by-case 207 hoc discussions on valuation matters companies. As of the same date, (i) review of each asset that received fair open-end funds held total net assets of outside of their regular meetings.198 value, whereas other boards require the Boards may consider the information $28,184 billion; (ii) closed-end funds adviser to provide a report on an asset held total net assets of $301 billion; (iii) they want in valuation reports, and, in that was assigned a fair value and this UITs held total net assets of $1,883 some circumstances, a board member report is intended to provide a sample billion; and (iv) variable annuity may play an active role in shaping the of the methodology that is used by the content of the valuation reports given to investment adviser.206 separate accounts registered as the board.199 The content of reports the Recordkeeping. It is our management companies held total net boards receive depends on the type of understanding that most funds currently assets of $234 billion. As of September fund and fund investments.200 The type retain records related to fair value 2019, there were 98 BDCs with $64 of general information that the boards determinations as required by section 31 billion in total net assets.208 Not all may receive include a summary of back- and the rules thereunder of the funds hold investments that must be fair testing data and an analysis of the Investment Company Act. These records valued under the Act. In addition, for impact of fair values on the fund’s generally include identifying those funds that hold investments that NAV.201 The reports also may include information for each portfolio security, must be fair valued under the Act, the more specific information about data used for pricing, and any other extent of those investments varies. securities that are more difficult to information related to price Hence, the proposed rule would affect value, such as the fair values assigned determinations and fund valuation only a subset of the funds listed in Table to each security, the size of the holding, policies and procedures. 1 below.

TABLE 1—DESCRIPTIVE STATISTICS FOR FUNDS

Number of Total net assets funds (in billion $) (1) (2)

Open-end funds ...... 12,379 28,184 Closed-end funds ...... 666 301 UITs ...... 674 1,883 Management company separate accounts ...... 14 234 BDCs ...... 98 64

Total ...... 13,831 30,666 Sources: Form 10–K; Form 10–Q; Form N–CEN

194 See, e.g., MFDF Valuation Report, supra 201 See, e.g., ICI and IDC Report, supra footnote as of January 2020. Open-end funds are series of footnote 97, at 11. 167, at 12. trusts registered on Form N–1A. Closed-end funds 195 See, e.g., MFDF Valuation Report, supra 202 See, e.g., ICI and IDC Report, supra footnote are trusts registered on Form N–2. UITs are variable footnote 97, at 10–11. 167, at 12–13. annuity separate accounts organized as UITs 196 See, e.g., ICI and IDC Report, supra footnote 203 See, e.g., ICI and IDC Report, supra footnote registered on Form N–4, variable life insurance 167, at 12–13. 167, at 13. See also Deloitte Survey, supra footnote separate accounts organized as UITs registered on 197 See, e.g., MFDF Valuation Report, supra 173, at 10, noting that 74% of the participants in Form N–6, or series, or classes of series, of trusts the 2019 survey reported that their boards receive footnote 97, at 10. See also Deloitte Survey, supra registered on Form N–8B–2. Separate accounts price challenge information as part of the valuation footnote 173, at 10, stating that 26% of the registered as management companies are trusts participants mentioned that the board held a reports. registered on Form N–3. valuation discussion in the prior 12 months with 204 See, e.g., ICI and IDC Report, supra footnote management outside of a regularly scheduled 167, at 13. 208 Estimates of the number of BDCs and their net meeting to address a valuation matter or question. 205 See, e.g., MFDF Valuation Report, supra assets are based on a staff analysis of Form 10–K 198 See, e.g., MFDF Valuation Report, supra footnote 97, at 14. and Form 10–Q filings as of September 2019, which footnote 97, at 14. 206 See, e.g., MFDF Valuation Report, supra are the most recent available filings. Our estimates 199 See, e.g., MFDF Valuation Report, supra footnote 97, at 14. include BDCs that may be delinquent or have filed footnote 97, at 14. 207 We estimate the number of registered extensions for their filings, and they exclude 8 200 See, e.g., MFDF Valuation Report, supra investment companies by reviewing the most recent wholly-owned subsidiaries of other BDCs and footnote 97, at 14. filings of Forms N–CEN filed with the Commission feeder BDCs in master-feeder structures.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28755

To understand the extent of current not invest in these kinds of securities or percentage of fund assets are valued boards’ involvement in the valuation of hold fewer of them. using Level 3 inputs.213 funds’ investments and the extent to Table 2 provides descriptive statistics Finally, untabulated analysis shows which the proposed rule would affect on funds’ investments in securities that 28% of the funds only report funds’ operations, we examine funds’ measured based on Levels 1, 2, and 3 securities valued using Level 1 inputs.214 Consequently, we estimate investments under the U.S. GAAP fair inputs using Form N–PORT data as of 209 that approximately 9,986 funds could be value hierarchy. For purposes of this January 2020.211 As Table 2 shows, economic analysis, we treat investments affected by the proposal, of which 9,501 there are 11,436 funds with $24,338 215 that are valued using Level 1 inputs as are not UITs. Nevertheless, even billion in net assets that filed Form N– though the proposed rule would be investments for which readily available 212 PORT. About 63% of fund assets are relevant for all funds with investments market quotations would be available, valued using Level 1 inputs. and investments valued using Level 2 valued using non-Level 1 inputs, not all Nevertheless, the average percentage of of those funds would have to materially and 3 inputs as investments that would securities valued using Level 1 inputs change their practices under the be fair valued in good faith by the fund’s varies with the type of fund, ranging 210 proposed rule. As discussed in more board of directors. We therefore from 26% for closed-end funds to 99% detail below, the effects of the proposed expect that funds that hold more for ETFs registered as UITs. About 33% rule would depend on the extent to securities that are measured using Level of fund assets are valued using Level 2 which funds’ current practices differ 2 and 3 inputs would be more affected inputs, and this percentage varies with from the requirements of the proposed by the proposed rule than funds that do the type of fund. Only a small rule.

TABLE 2—DESCRIPTIVE STATISTICS FOR FUNDS BY ASC 820 FAIR VALUE HIERARCHY

Total net Number of assets Average level Average level Average level Average ‘‘N/A’’ funds (in billion $) 1 Inputs 2 Inputs 3 Inputs Inputs

(1) (2) (3) (4) (5) (6)

Open-end funds ...... 10,841 23,429 63% 33% 0.2% 1% Closed-end funds ...... 577 303 26% 60% 4% 9% ETFs registered as UITs ...... 5 389 99% 0% 0% 0%

209 According to ASC 820, assets and liabilities smaller than the number of open-end funds, closed- 214 28% = (3,209 open-end funds with securities are classified as using Level 1, Level 2, or Level 3 end funds, ETFs registered as UITs, and separate valued using only Level 1 inputs that filed Form N– inputs. Level 1 inputs are ‘‘quoted prices accounts registered as management companies that PORT + 29 closed-end funds with securities valued (unadjusted) in active markets for identical assets filed Form N–CEN (i.e., 13,067 in Table 1) because, using only Level 1 inputs that filed Form N–PORT or liabilities that the reporting entity can assess at as of the N–PORT data collection date, N–PORT + 5 ETFs registered as UITs with securities valued the measurement date.’’ Level 2 inputs are ‘‘inputs only covered large fund groups. Large fund groups using only Level 1 inputs that filed Form N–PORT other than quoted prices included within Level 1 are funds that together with other investment + 3 variable annuity separate accounts registered as that are observable for the asset or liability, either companies in the same ‘‘group of related investment management companies with securities valued directly or indirectly.’’ Level 3 inputs are companies’’ have net assets of $1 billion or more using only Level 1 inputs that filed Form N–PORT)/ ‘‘unobservable inputs for the asset and liability.’’ as of the end of the most recent fiscal year of the 11,436 funds that filed Form N–PORT. See supra See Financial Accounting Standards Board, Fair fund. Filing Form N–PORT will begin in April 2020 footnote 211. Value Measurement (Topic 820). for small fund groups. See Amendments to the 215 9,986 funds = 13,733 registered investment 210 See proposed rule 2a–5(c). See also supra Timing Requirements for Filing Reports on Form companies that filed Form N–CEN from Table 1 Section II.C. N–PORT, Interim Final Rule, Release No. IC–33384; above¥3,845 registered investment companies that 211 UITs (other than the ETFs registered as UITs) File No. S7–02–19. Nevertheless, large fund groups filed Form N–CEN and are estimated to hold and BDCs do not file Form N–PORT, and thus are represent 84% of all open-end funds, closed-end securities valued using only Level 1 inputs + 98 excluded from Table 2. funds, ETFs registered as UITs, and separate BDCs from Table 1 above. 3,845 = 28% * 13,733 We estimate the statistics in Table 2 by reviewing accounts registered as management companies in registered investment companies that filed Form N– the most recent filings of Forms N–PORT filed with terms of total net assets (84% = $24,338 billion total CEN from Table 1 above. See supra footnote 214 for the Commission as of January 2020. The average net assets in Table 2/$29,093 billion total net assets the estimation of the 28%. ratio of securities by fair value hierarchy (i.e., for open-end funds, closed-end funds, ETFs This calculation assumes that the distribution of Columns 3 to 6 in Table 2) is retrieved from Item registered as UITs, and variable annuity separate securities valued using Level 1 inputs for registered C.8 of Form N–PORT. Our analysis excludes funds accounts registered as management companies in investment companies that filed Form N–PORT is with non-positive net assets and funds with total Table 1). similar to the distribution of securities valued using assets less than net assets because these Total net assets in Form N–CEN also may be Level 1 inputs for registered investment companies observations are likely data errors. The Average different than total net assets in Form N–PORT that filed Form N–CEN. This calculation also Level 1, Level 2, and Level 3 Inputs is the average because Form N–CEN reports average net assets assumes that all 98 BDCs in our sample hold a non- ratio of Level 1, Level 2, or Level 3 long positions estimated over the reporting period while Form N– zero amount of securities valued using Level 2 and divided by the fund’s total gross assets across all PORT reports point-in-time net assets as of the Level 3 inputs because BDCs are required to invest funds within each fund category. Open-end funds reporting date. at least 70% of their assets in private or public U.S. are series of trusts registered on Form N–1A. 213 Securities that are valued at NAV, and thus do firms with market values of less than $250 million, Closed-end funds are trusts registered on Form N– not have a level associated with them, are classified and these investments usually are securities valued 2. ETFs registered as UITs are series, or classes of as ‘‘N/A’’ in Form N–PORT. These investments using Level 2 or Level 3 inputs. See 15 U.S.C. 80a– series, of trusts registered on Form S–6. Separate have no level under the U.S. GAAP fair value 54(a). accounts registered as management companies are hierarchy and for purposes of this analysis we Under the proposed rule 2a–5(d), if the fund is trusts registered on Form N–3. assume they are securities for which there are no a unit investment trust, the fund’s trustee must The last row in Table 2 represents the sum of the readily available market quotations. Nevertheless, carry out the requirements related to fair value previous rows within the same column for Columns the valuation of those securities arguably requires determinations. Hence, UITs would not bear one- 1 and 2, and it represents the asset-weighted less effort than the valuation of securities valued time costs associated with oversight and reporting average of the previous rows within the same using Level 2 and 3 inputs because funds’ NAVs are (see proposed rule 2a–5(b)) because the trustees of column for columns 3 to 6. easily obtainable. About 1% of the fund assets are UITs would perform all fair value determinations. 212 The number of open-end funds, closed-end classified as ‘‘N/A’’ securities. 9,501 = 9,986 affected funds×485 affected UITs. 485 funds, ETFs registered as UITs, and separate The sum of the average using Level 1, 2, 3, and = 674 UITs that filed Form N–CEN ¥ (1×28% of accounts registered as management companies that ‘‘N/A’’ within each fund category may not sum up funds that only report securities valued using Level filed Form N–PORT (i.e., 11,436 in Table 2) is to one hundred percent due to rounding error. 1 inputs).

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28756 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

TABLE 2—DESCRIPTIVE STATISTICS FOR FUNDS BY ASC 820 FAIR VALUE HIERARCHY—Continued

Total net Number of assets Average level Average level Average level Average ‘‘N/A’’ funds (in billion $) 1 Inputs 2 Inputs 3 Inputs Inputs

(1) (2) (3) (4) (5) (6)

Management company separate ac- counts ...... 13 217 73% 26% 0% 0%

Total/Average ...... 11,436 24,338 63% 33% 0% 1% Source: Form N–PORT

As of January 2020, there were 1,921 understand that, typically, boards increase assets under management and investment advisers that provide determine the methodologies used to ultimately increase investment advisers’ portfolio management services to funds fair value fund investments, but rely on compensation.223 Investment advisers and these investment advisers managed the adviser for the day-to-day also have incentives to mismeasure fund assets equal to $28,517 billion.216 calculation of fair values.220 investments in a way that would result Finally, as of December 2018, there Nevertheless, fund investment in smooth reported fund performance were 57.2 million U.S. households and advisers have conflicts of interest, over time to lower the funds’ perceived 101.6 million individuals owning U.S. which could bias the fair value risk.224 Finally, investment advisers registered investment companies that process.221 In particular, investment may mismeasure fund investments as a could be affected by the proposed advisers have incentives to inflate fund result of expending less effort to value rule.217 asset values (or deflate fund liability assets than the effort required to ensure values) because they typically receive a 225 C. Benefits and Costs and Effects on accurate and unbiased valuations. management fee that is calculated as a Efficiency, Competition, and Capital The degree of conflicts of interest may percentage of the value of assets under Formation of Proposed Rule vary across funds. In particular, management.222 Relatedly, investment investment advisers’ incentives to 1. General Economic Considerations advisers have incentives to inflate fund misreport fund investments may be Unbiased and accurate valuation of asset values because investors tend to more pronounced for funds that face fund investments is important because invest more in funds that performed higher competition to attract new it affects the prices at which fund well in recent periods, which would investors and for actively managed securities are purchased or sold in the funds that face higher demands from secondary market and also affects the 220 See, e.g., MFDF Valuation Report, supra investors to beat certain benchmarks. footnote 97, at 2. prices at which fund securities are 221 Some academic literature suggests that fund Relatedly, investment advisers’ purchased or redeemed in the primary fair values are not always measured in an accurate incentives to underinvest in effort may market. The valuation of fund securities and unbiased way. See, e.g., Vikas Agarwal et al., be higher for funds whose performance is also important because it can affect Private Company Valuations by Mutual Funds, is more difficult to measure and (Working Paper, 2019) available at https://ssrn.com/ funds’ fee and performance calculations, abstract=3066449; Rahul Bhargava et al., Exploiting evaluate, and thus investment advisers’ and also can affect funds’ compliance International Stock Market Correlations with Open- performance is also more difficult to with regulatory requirements. Finally, End International Mutual Funds, 25 J. Bus. Fin. & measure and evaluate (e.g., funds that properly valuing a fund’s investments is Acct. 765 (1998); Scott Cederburg & Neal Stoughton, hold complex investments).226 Boards of Discretionary NAVs, (Working Paper, 2019) a critical component of the accounting available at https://www.wu.ac.at/fileadmin/wu/d/i/ directors currently serve as a check on and financial reporting for investment finance/BBS-Papers/SS2019/20190515_ the conflicts of interest of the adviser companies.218 STOUGHTON.pdf; John M. R. Chalmers et al., On Under the Investment Company Act, the Perils of Financial Intermediaries Setting 223 See, e.g., Judith Chevalier & Glenn Ellison, whenever market quotations are readily Security Prices: The Mutual Fund Wild Card Risk Taking by Mutual Funds as a Response to Option, 56 J. Fin. 2209 (2001); Nandini Chandar & Incentives, 105 J. Pol. Econ. 1167 (1997); Erik R. available, these market quotations must Robert Bricker, Incentives, Discretion, and Asset Sirri & Peter Tufano, Costly Search and Mutual Valuation in Closed-End Mutual Funds, 40 J. Acct. be used to determine fund asset Fund Flows, 53 J. Fin. 53, 1589 (1998). values.219 Whenever market quotations Res., 1037 (2002) (‘‘Chandar and Bricker 2002’’); Jaewon Choi et al., Sitting Bucks: Zero Returns in Portfolio managers also have incentives to inflate are not readily available, the value must Fixed Income Funds, (Working Paper, 2019) fund asset values and thus increase fund be the fair value of fund holdings as available at https://papers.ssrn.com/sol3/papers. performance because fund performance is cfm?abstract_id=3244862; Cici et al. 2011, supra positively related to the portfolio managers’ determined by the board in good faith. compensation and negatively related to the This fair value determination can footnote 7; Vladimir Atanasov et al., Mismarking Fraud in Mutual Funds, (Working Paper, 2019) probability that a portfolio manager will be involve the use of complex available at http://www.fmaconferences.org/ terminated. See, e.g., Judith Chevalier & Glenn methodologies, multiple data sources, Glasgow/Papers/Fraud_in_OpenEndMutualFunds_ Ellison, Career Concerns of Mutual Fund Managers, and various assumptions. Today, we 2018_1126.pdf. 114 Q.J. Econ. 389 (1999); Linlin Ma et al., Portfolio 222 See, e.g., Joseph Golec, Regulation and the Manager Compensation in the U.S. Mutual Fund Rise in Asset-Based Mutual Fund Management Industry, 74 J. Fin. 587 (2018). 216 Based on Item 5.D. of Forms ADV filed with Fees, 26 J. Fin. Res. 19 (2003) for evidence on the 224 See, e.g., Cici et al. 2011, supra footnote 7. the Commission as of January 2020. percentage of mutual funds that use asset-based 225 Investment advisers may have incentives to 217 Investment Company Institute, 2019 Fact management fees. underinvest in effort (or ‘‘shirk’’) because they do Book: A Review of Trends and Activities in the In addition to explicit contracts that link not internalize the benefits accruing to the fund Investment Company Industry, available at https:// investment advisers’ compensation to fund size, board of directors and fund investors from the _ www.ici.org/pdf/2019 factbook.pdf, accessed on there may be implicit contracts that provide expenditure of effort to estimate accurate and December 5, 2019. incentives to investment advisers to mismeasure unbiased fair values. See, e.g., David Brown & 218 See Section I above for more discussion on the fund investments. For example, investment advisers Shaun Davies, Moral hazard in asset management, importance of accurate and unbiased valuation of may mismeasure fund investments to meet or beat 125 J. Fin. Econ. 311 (‘‘Brown and Davies 2017’’). fund securities. certain benchmarks. See, e.g., Chandar and Bricker 226 See, e.g., Brown and Davies 2017, supra 219 See section 2(a)(41) and rule 2a–4. 2002, supra footnote 221. footnote 225.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28757

and the other service providers involved periodic valuation reports and the that funds’ investment advisers already in the calculations of fair values.227 promptness and content of ad hoc assist the board with respect to many of As discussed in Section I above, since valuation reports the board receives. those functions subject to the board’s ASR 113 and 118 were first issued The proposed rule would require oversight. roughly fifty years ago, funds’ quarterly periodic reporting as well as Under the proposed rule, fund boards investment practices have changed, the prompt reporting no later than three would have discretion to assign the fair regulatory framework under which business days after the adviser becomes value determination to an investment funds operate has evolved, and there aware of certain matters relevant to fair adviser to the fund, who would carry have been significant advances in value. Also, the proposed rule specifies out all of the functions that would be technology and communication. The the matters that the adviser must, at a required under the rule. When deciding proposed rule would provide an minimum, cover in its periodic whether to assign fair value updated framework for valuation under reporting to the board. Finally, rule 38a– determinations to an investment adviser the Investment Company Act that is 1 requires the maintenance of records to the fund, a board would consider more suitable to current market realities. related to the fund’s compliance certain trade-offs. In particular, fund The proposed rule retains the important policies and procedures for five boards’ decisions to oversee investment safeguard of board oversight of fair years.231 The proposed rule would advisers’ fair value determinations value determinations, while making apply the same retention period, but it instead of determining fair value more efficient use of boards’ time and would require the maintenance of themselves would depend on the expertise and recognizing the important records that are specific to fair value amount of investments that must be fair role of fund investment advisers in the determinations.232 Further, the valued, the nature and complexity of the fair value determination process. proposed rule would require the adviser valuation of those investments, the type The proposed rule differs from the to maintain copies of the reports and of fund, the investment adviser’s current regulatory framework and funds’ other information provided to the board willingness to assume additional fair current practices in the following ways. under the rule whenever the board value responsibilities, and the fund’s First, under the current regulatory assigns the determination of fair value current practices. Boards of funds that framework, funds have flexibility to to an investment adviser to the fund. hold more securities that must be fair determine their fair value policies and Second, we understand that funds’ valued and harder-to-value securities procedures, reporting, and current practices regarding their fair may be more likely to assign these fair recordkeeping requirements. The value policies and procedures, value determinations to an adviser and proposed rule would differ from the reporting, and recordkeeping are oversee the process of determining fair current regulatory framework because it generally consistent with the value by the assigned adviser because would mandate more specific fair value requirements of the proposed rule. investment advisers may be better practices, policies and procedures, Nevertheless, there is variation in funds’ suited to value certain investments. It reporting, and recordkeeping fair value practices, and the practices of may also depend on the type of fund. requirements and those requirements certain funds may be more or less For example, a board of an open-end would be explicitly imposed on funds extensive and thorough than the fund that must calculate NAVs on a and performed by boards or advisers.228 requirements of the proposed rule. daily basis may be more likely to assign In particular, the proposed rule would Consequently, the proposed rule would to an investment adviser the prescribe more specific elements that impose uniform minimum requirements determination of fair values (on which fair value policies and procedures on all affected funds related to their fair fund’s NAV is based) than the board of adopted under the rule must address as value policies and procedures, a fund that calculates value less compared to the current framework reporting, and recordkeeping. regularly. The decision to oversee under rule 38a–1.229 For example, in Third, under the current regulatory investment advisers’ fair value addition to the fair value policies and framework, boards choose the determinations would also depend on procedures that are required pursuant to methodologies used to determine the investment advisers’ willingness to rule 38a–1, the proposed rule would fair value of the funds’ investments, assume the assigned responsibilities. require the written policies and continuously review the Such willingness would depend on procedures to be reasonably designed to appropriateness of such methods, investment advisers’ valuation expertise address, in the context of consider all appropriate factors relevant and experience, whether the investment methodologies, the selection and to the fair value of securities for which advisers have available resources to application of a methodology in a market quotations are not readily satisfy their new obligations, and the consistent manner, the specification of available, and carefully review the extent to which the investment advisers which methodologies apply to new findings of individuals that are not could pass through to the fund and its types of fund investments in which a directors whenever technical assistance investors any higher costs associated fund intends to invest, and testing of the is requested from those individuals.233 with the increased responsibilities. appropriateness and accuracy of the In addition, it is our understanding that Finally, a board’s decision to assign selected methodology, including some boards currently ratify all or some responsibilities under the proposed rule identifying the testing methods and of the fair value calculations of an would depend on the expected costs of minimum frequency of testing.230 In investment adviser to the fund. Under compliance, which would ultimately addition, unlike under proposed rule the proposed rule, boards may assign a depend on how different funds’ current 2a–5, there is currently no requirement fair value determination to an practices and policies and procedures regarding the frequency and content of investment adviser of the fund, who are from the requirements of the would carry out all of those proposed rule. 227 See supra footnote 175. functions.234 It is our understanding We lack detailed and representative 228 See proposed rule 2a–5(a) and (b). information on funds’ current fair value 229 Compare proposed rule 2a–5(a)(1)–(5) with 231 practices and we do not have visibility Compliance Rules Adopting Release, supra footnote See rule 38a–1(d). See also supra footnote 72. 26. See also supra footnote 28 and accompanying 232 See proposed rule 2a–5(a)(6) and (b)(3). into boards’ decision-making processes text. 233 See supra Section III.B.1. when seeking the investment advisers’ 230 See proposed rule 2a–5(a)(2), (3), and (5). 234 See proposed rule 2a–5(b). assistance with fair value

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28758 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

determinations.235 Further, boards’ reporting, and recordkeeping reporting, and recordkeeping to comply decision-making processes with respect requirements differ more from the with the statute.238 Relatedly, the to seeking the investment advisers’ proposed rule’s requirements. The proposed rule and the rescission of assistance with fair value proposed rule could have a larger effect existing no-action letters and guidance determinations is complex. Hence, we on smaller funds because of economies would increase certainty because funds are unable to accurately estimate the of scale in the adoption and would follow a single rule rather than number of fund boards that would implementation of the proposed rule’s following various no-action letters and assign responsibilities to an adviser requirements. In particular, as discussed guidance when determining fair values, under the proposed rule instead of the in detail in Section III.C.3 below, there which could ultimately reduce boards making fair value determinations are certain fixed costs associated with compliance costs.239 Lower costs of in good faith themselves. Nevertheless, the implementation of the proposed compliance for funds ultimately could we believe that most boards would rule’s requirements, such as testing and benefit fund investors to the extent that assign these responsibilities to an preparing methodologies, policies and any cost savings would be passed down investment adviser to the fund because procedures, and training materials, and to them in the form of lower fund the investment adviser has valuation those fixed costs would be less operating expenses. experience and expertise and is burdensome for larger funds, who could In addition, the proposed rule would involved with the fund’s operations on spread those costs across a larger benefit funds and their investors a daily basis and, thus, may be better amount of assets under management. because it would allow boards to suited than the board to deal with fair Finally, whenever the fair value allocate more fair value responsibilities value matters that arise on a daily basis. determinations would be assigned to the to an investment adviser to the fund, Further, advisers already provide fund’s investment adviser, the and thus could free board resources tied significant assistance with the fair value requirement to reasonably segregate the to valuation and redirect them to determinations to the board of directors investment adviser’s process of making oversight or other matters in which and so funds would not be required to fair value determinations from the board action may be more valuable.240 significantly modify their operations if portfolio management could be more In particular, for funds whose boards of they choose to assign fair value costly for smaller investment advisers directors would assign the fair value determinations to an investment adviser than for larger ones. The reason is that determinations to an investment adviser to the fund under the proposed rule. As smaller investment advisers could lack to the fund, the boards would no longer a result, for the purpose of our economic the staff and resources to segregate be required to choose the methodologies analysis, we assume that all funds that portfolio management personnel from used to determine the fair value of the have some securities that would need to those making fair value determinations funds’ investments, continuously be fair valued would be affected parties. as efficiently as larger advisers or might review the appropriateness of such We expect that the effects of the only be able to meet this requirement by methods, consider all appropriate proposed rule could differ across funds. hiring additional personnel. factors relevant to the fair value of In particular, under the proposed rule, We discuss the benefits and costs of securities for which market quotations if the fund is a unit investment trust, the the proposed rule as well as the effects are not readily available, and carefully fund’s trustee must carry out the fair on efficiency, competition, and capital review the findings of individuals that value determinations.236 Hence, UITs formation in detail below. are not directors whenever technical would not bear any costs associated 2. Benefits assistance is requested from those with oversight and reporting. We expect individuals. We lack detailed data on The proposed rule would mandate the effects of all other aspects of the rule boards’ current practices and so we are specific fair value functions, including to be similar for UITs and other funds. unable to estimate these cost savings but written policies and procedures, Further, the proposed rule would have we request comment on this point in reporting, and recordkeeping that funds larger effects on funds that currently do Section III.E. below.241 not utilize advisers in the fair value would have to have in place to comply Finally, the proposed rule would process but would choose under the with the statute, and would define require all funds to adopt specific which securities are considered to have proposed rule to assign the fair value policies and procedures related to fair readily available market quotations determination of fund investments to an value determinations. In addition, under section 2(a)(41) of the Act. This investment adviser to the fund. In whenever the board assigns the fair increased specificity could reduce addition, the proposed rule would also value determination relating to a fund compliance costs in that funds may have a larger effect on funds for which investment to an investment adviser, the expend less effort and time to design a larger percentage of their investments policies and procedures, reporting, and do not have readily available market 238 Nevertheless, we acknowledge that because recordkeeping under the proposed rule quotations because those funds would the proposed rule is principles based, the than trying to determine appropriate be required to determine the fair value possibility still exists that some funds may put in compliance under the statute alone.237 place additional policies and procedures, reporting, of a larger percentage of their For funds whose current practices are and recordkeeping that are not required by the investments in compliance with the more burdensome than the proposed proposed rule. 239 Academic literature provides evidence rule. The proposed rule would also have rule’s requirements, this increased larger effects on funds whose current consistent with the idea that uncertainty has specificity also could reduce negative effects on investment and growth. See, e.g., fair value policies and procedures, compliance costs to the extent that Nicholas Bloom et al., Uncertainty and Investment funds might be less likely to put in Dynamics, 74 Rev. Econ. Stud. 391 (2007); Nicholas 235 The industry reports cited in Section III.B.2 Bloom, The Impact of Uncertainty Shocks, 77 above only provide qualitative information on place overly burdensome and Econometrica, 623 (2009); Scott R. Baker et al., certain aspects of funds’ current practices. See also unnecessary policies and procedures, Measuring Economic Policy Uncertainty, 131 Q. J. supra footnote 173 for a discussion of limitations Econ. 1593 (2016). of the Deloitte survey data. Finally, funds have 237 Any such benefits could be at least partially 240 This benefit would not accrue to UITs because discretion in the type of disclosures they provide limited by the fact that mandating specific fair under the proposed rule the trustees of UITs would regarding their fair value determinations. See supra value functions for all funds could lead to the carry out the requirements of the proposed rule. See footnote 169. adoption of fair value functions that are appropriate proposed rule 2a–5(d). 236 See proposed rule 2a–5(d). for most but not all funds. 241 See supra footnote 235.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28759

proposed rule would require the board’s have in place practices related to fair because certain aspects of the one-time effective oversight of the investment value determinations, those practices costs are fixed costs that could be adviser’s conflicts of interest related to differ across funds and also may differ spread across multiple funds in the case fair value determinations. To the extent from the proposed rule’s requirements. of fund complexes. that certain funds’ fair value policies In particular, the types of policies and As discussed above, out of the 13,831 and procedures currently are less procedures that funds have in place funds, we estimate that 9,986 would be thorough than the policies and related to fair value determinations, the affected the proposed rule, and thus procedures of the proposed rule and frequency and content of periodic board incur the one-time costs associated with certain boards’ oversight of the reporting, the promptness and content the proposed rule.245 We estimate that investment advisers’ conflicts of interest of ad hoc board reporting, and the 70% of the one-time costs would be is less effective than under the proposed extent and duration of recordkeeping attributable to funds reviewing and rule, the proposed rule could decrease may differ under the proposed rule updating the current practices and the likelihood that fund investments compared to current practices. related policies and procedures to would be inaccurately fair valued.242 Our staff estimates that the one-time comply with the proposed rule’s This is because the proposed rule could incremental costs necessary to ensure requirements; 15% of those costs would create a more robust valuation compliance with the proposed rule be attributable to funds reviewing and framework and could help to address would range from $100,000 to $600,000 updating current recordkeeping any conflicts of interest of the per fund, depending on the current fair processes to align with the proposed investment adviser, which could result value practices of the fund.244 These rule’s requirements; and the remaining in more accurate and unbiased asset estimated costs are attributable to the 15% of those costs would be attributable prices. Any such effects likely would be following activities: (i) Reviewing the to funds reviewing and updating the more pronounced for investors of funds proposed rule’s requirements; (ii) current board reporting processes to that are not publicly traded (e.g., open- developing new (or modifying existing) comply with the proposed rule’s end funds and BDCs) because there is policies and procedures, reporting, and requirements. Hence, we estimate the no secondary market for the shares of recordkeeping requirements to align aggregate one-time costs of the proposed those funds and fund investors can only with the requirements of the proposed rule to range between $991.3 million trade at NAV, which is determined by rule; (iii) integrating and implementing and $5.9 billion.246 the fund’s fair value determinations. those policies and procedures, For funds whose boards would assign Nevertheless, this may not have a reporting, and recordkeeping the fair value determinations to the significant effect because it is our requirements to the rest of the funds’ funds’ investment advisers, those one- understanding that many funds activities; (iv) preparing new training time costs would be borne by the currently have in place fair value materials and administering training investment adviser, and could be practices that are similar to the sessions for staff in affected areas; and ultimately passed through to the fund proposed rule’s requirements and (v) independent board members shareholders in the form of higher boards oversee the investment adviser’s consulting their independent counsel on management fees. For funds whose assistance with fair value calculations. whether fair value determinations boards determine the fair values should be assigned to the fund’s 3. Costs themselves, those one-time costs could investment adviser and how to set up be ultimately passed through to the fund The proposed rule would impose one- appropriate policies and procedures, shareholders in the form of higher time costs on funds and their reporting, and recordkeeping operating expenses. We expect that the 243 investors. We expect that funds requirements. We expect that the one- vast majority of the boards would assign would incur one-time costs to review time incremental cost necessary to fair value determinations relating to an the proposed rule’s requirements and ensure compliance with the proposed investment adviser to the fund, and so modify, as necessary, their fair value rule would depend on the fund’s the majority of the one-time costs would practices, policies and procedures, and current fair value practices and the be borne by the fund’s investment recordkeeping to comply with the amount and valuation complexity of adviser, and ultimately could be passed proposed rule. Funds whose boards fund investments that must be fair through to the fund shareholders in the would assign the fair value valued. In particular, the one-time costs form of higher management fees. determinations to the investment would be closer to the lower end of the The proposed rule also could impose adviser would also incur one-time costs range for funds whose current practices ongoing costs on all funds that hold to review the proposed rule’s are more similar to the requirements of securities without readily available requirements and modify their oversight the proposed rule and funds with fewer market quotations because those funds and reporting procedures to comply and easier-to-value fund investments. with the rule. Even though we Further, the one-time costs would be 245 See supra footnote 215. understand that most funds currently closer to the lower end of the range for 246 991.3 million = (485 UITs that would be funds that belong to fund complexes affected by the proposed rule × $100,000 minimum 242 See supra Section III.C.1. for a discussion one-time costs of the proposed rule × 85%) + (9,501 open-end funds, closed-end funds, variable annuity related to investment advisers’ conflicts of interest. 244 The one-time cost estimates used in the 243 The proposed rule requires funds to evaluate separate accounts, and BDCs that would be affected economic analysis may differ from the cost × any pricing services that assist funds with the fair estimates in Section IV below because (i) the cost by the proposed rule $100,000 minimum one-time value determinations. See proposed rule 2a–5(a)(4). estimates in the economic analysis capture all costs costs of the proposed rule). 85% = 70% of the one- To the extent that the proposed rule’s requirements associated with the proposed rule while the cost time costs attributable to reviewing fair value related to pricing services differ from funds’ current estimates in Section IV capture only costs related practices and policies and procedures + 15% of the practices, the proposed rule could have second- to information collection burdens and (ii) the cost one-time costs attributable to reviewing order effects on pricing services’ operations because estimates in the economic analysis capture recordkeeping practices. See supra footnote 215. pricing services could adjust their operations to incremental costs associated with the proposed rule 5.9 billion = (485 UITs that would be affected by cater to their clients’ new demands. Because we while the cost estimates in Section IV capture total the proposed rule × $600,000 maximum one-time believe that funds’ current practices are generally costs. Hence, the cost estimates in Section IV below costs of the proposed rule × 85%) + (9,501 open- similar to the proposed rule’s requirements related serve as an upper bound of costs related to end funds, closed-end funds, variable annuity to the evaluation of pricing services, we believe that information collection burdens for funds that do not separate accounts, and BDCs that would be affected the proposed rule would not have significant effects have in place currently any practices that are by the proposed rule × $600,000 maximum one- on pricing services. similar to the proposed rule’s requirements. time costs of the proposed rule).

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28760 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

would be required to comply with the adviser’s assistance with fair value management of any material conflicts of proposed rule’s policies and procedures, calculations and boards currently interest of the investment adviser, reporting, and recordkeeping review periodic and ad-hoc reports including the requirement to reasonably requirements. Nevertheless, we believe related to fair value determinations segregate the investment adviser’s that funds’ incremental ongoing costs prepared by the fund’s investment process of making fair value associated with this aspect of the adviser. Hence, we do not believe that determinations from the portfolio proposed rule would be limited to the this aspect of the proposed rule would management, and funds currently have extent that, as discussed in Section impose any significant incremental in place policies to manage conflicts of III.B.2. above, funds currently have in ongoing costs on boards and fund interest of investment advisers that may place practices, policies and procedures, investors compared to the ongoing costs not be valuation specific. reporting, and recordkeeping associated under current practices.248 We 4. Effects on Efficiency, Competition, with fair value determinations that are acknowledge, however, that to the and Capital Formation similar to the proposed rule’s extent boards’ current oversight of requirements. Certain funds might put investment advisers’ fair value Under the proposed rule, boards may in place policies and procedures, calculations and boards’ current assign fair value determinations to an reporting, and recordkeeping to comply practices with respect to review of investment adviser and oversee the with the proposed rule that are more valuation reports is inconsistent with investment adviser’s fair value costly than the funds’ current practices, the proposed rule’s requirements, funds determinations instead of determining while other funds might set up policies would bear ongoing costs to comply fair value themselves, which could free and procedures, reporting, and with the proposed rule. board resources tied to valuation and recordkeeping as a result of the Relatedly, to the extent that fair value redirect them to oversight or other proposed rule that would result in lower determinations would be assigned to an matters. As a result, the proposed rule ongoing costs than the costs of current investment adviser to the fund, such could lead to more efficient use of practice. We acknowledge that funds investment advisers would incur boards’ resources and therefore improve whose practices, policies and ongoing costs to satisfy their new fair funds’ governance for the benefit of procedures, reporting, and value obligations. Those costs would be fund investors. The proposed rule also recordkeeping are less costly than the attributable to adopting and could improve the efficiency of fund proposed rule’s requirements would implementing policies and procedures, operations because it would allow bear additional ongoing costs under the reporting, and recordkeeping to ensure boards more flexibility to oversee the proposed rule. We lack detailed data on compliance with the proposed rule’s investment advisers’ fair value funds’ fair value practices, policies and requirements. The magnitude of those determinations instead of determining procedures, reporting, and costs would depend on how investment fair values themselves. recordkeeping, and so we are unable to advisers’ current practices compare to As discussed above, the proposed rule estimate the net incremental ongoing the requirements of the proposed rule. would mandate specific fair value costs of the proposed rule on funds, but Investment advisers could demand policies and procedures and effective we request comment on this topic in higher fees as a compensation for the oversight of an assigned investment Section III.E. below.247 increased valuation responsibilities. adviser, which could ultimately The proposed rule also would Depending on the level of competition improve the efficiency of funds’ asset mandate more detailed and specific in the fund investment adviser industry, prices. The proposed rule could improve the efficiency of asset prices policies and procedures, reporting, and those higher fees could be passed on to because it could create a more robust recordkeeping than the current fund investors in the form of higher valuation framework and it could help regulatory framework, which could fund fees. We lack data to estimate any mitigate any conflicts of interest of the decrease funds’ flexibility to design cost increases and the pass-through rate investment adviser, which ultimately policies and procedures, reporting, and of those cost increases to fund investors could result in more accurate and recordkeeping that better meet their but we request comment on this issue in unbiased asset prices. A potential preferences. Consequently, funds could Section III.E. below. bear costs to implement practices (e.g., Finally, to the extent that the board increase in asset price efficiency could improve boards’ monitoring of funds’ quarterly periodic reporting) that are would assign the fair value and investment advisers’ performance incompatible with the way they would determinations relating to any or all of and could benefit capital formation approach these matters absent rule 2a– fund investments to the investment because more accurate and unbiased 5. Any such costs could be borne adviser, the proposed rule would prices permit the allocation of resources ultimately by fund investors in the form provide the adviser—which has to their most efficient use. Nevertheless, of higher operating expenses. conflicting interests—a greater role in we believe that any such effects likely For funds whose boards would assign fair value determinations relative to would be small because many funds the fair value determinations to the current practices.249 Nevertheless, we currently have in place fair value funds’ investment advisers, the believe that any impact from such proposed rule could impose additional practices that are generally similar to conflicts would be limited because the ongoing costs associated with boards’ the proposed rule’s requirements and proposed rule contains explicit oversight of the investment adviser’s fair boards oversee the investment adviser’s requirements related to the value determinations and review of assistance with fair value calculations. identification, assessment, and board reports. Nevertheless, we believe We do not believe that the proposed that funds’ incremental ongoing costs rule would have any material effects on 248 We do not believe that the proposed rule associated with this aspect of the would result in cost savings associated with boards’ competition because the effects of the proposed rule would be limited to the involvement in the determination of fair values rule likely would be small in light of the extent that boards or funds currently because we believe that boards would reallocate proposed rule’s similarities to current have in place policies to ensure time and attention to overseeing the adviser’s fair practices. In particular, as discussed in value determinations or other activities unrelated to appropriate oversight of an investment fair valuing fund investments. Section III.C.3. above, the main costs 249 See supra Section III.C.1. for a discussion arising from the proposed rule are the 247 See supra footnote 235. related to investment advisers’ conflicts of interest. one-time costs to comply with the rule.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28761

Even though these costs could be more determinations.250 In addition, if certain valuation services for the fund, those burdensome for smaller fund funds within a fund complex would use service providers, unlike an adviser to a complexes, we believe that these costs the additional flexibility afforded by a fund, may not owe a fiduciary duty to would not affect competition in the more principles-based approach to set the fund, and thus their obligation to fund industry, especially when up policies and procedures, reporting, serve the fund’s and its shareholders’ considering that these are one-time costs and recordkeeping arrangements that best interests is limited. Hence, such an that can be amortized over a number of are different from one another, such alternative approach could compromise years and because we believe that only flexibility could increase the cost of the integrity of the fair values. board oversight. This could occur few funds would incur costs at the 3. Not Permit Boards To Assign Fair because a board that is shared across higher end of the cost range estimate Value Determinations to an Investment funds within a fund complex would not (i.e., between $100,000 and $600,000). Adviser Consequently, we believe that the be able to apply a similar framework proposed rule would not affect across the various funds it oversees. As discussed in more detail above, competition in the fund industry. Further, a more principles-based unlike the current regulatory approach would not mandate a framework, the proposed rule would In addition, the proposed rule’s permit fund boards to assign the fair requirement to reasonably segregate the minimum prescribed set of fair value policies and procedures, reporting, and value determinations to an investment investment adviser’s process of making recordkeeping, unlike the proposed rule adviser. In addition, relative to the fair value determinations from the that would provide a consistent current regulatory framework, the portfolio management likely would framework for funds to apply. proposed rule would mandate more more significantly affect those smaller Consequently, not all funds necessarily specific fair value policies and investment advisers that lack the staff would put in place adequate policies procedures, reporting, and and resources necessary to effect such and procedures, reporting, and recordkeeping. As an alternative to the segregation as efficiently as larger recordkeeping to achieve accurate and proposed rule, we considered not advisers and would otherwise need to unbiased fair value determinations. permitting fund boards to assign the fair hire additional personnel. Nevertheless, value determinations to an investment we do not believe that this requirement 2. Assignment of Responsibilities to adviser to the fund but instead only of the proposed rule would have a Service Providers Other Than requiring funds to adopt the policies material effect on competition in the Investment Advisers and procedures, reporting, and fund investment adviser industry Under the proposed rule, the board recordkeeping as described in the because many smaller investment may assign the fair value determinations proposed rule. We also considered advisers to funds currently have in to an investment adviser to the fund, requiring boards periodically to ratify place processes to address the potential which would carry out all of the the fair value determinations calculated conflicts of interest whenever portfolio functions required under the rule. As an by the fund’s adviser using the management personnel provides input alternative, we considered allowing the methodology determined by the board. to valuation. board to assign the fair value Such an approach could prescribe D. Reasonable Alternatives determinations to service providers minimum requirements with respect to other than the investment adviser, such valuation policies and procedures, 1. More Principles-Based Approach as a pricing service provider. Such an reporting, and recordkeeping. approach would provide additional Nevertheless, such an approach would The proposed rule mandates the flexibility to the board to assign the fair not allow funds the flexibility to performance of certain prescribed value determinations to appropriate leverage the fair value expertise of the functions to determine the fair value of persons. As a result, this alternative investment adviser and assign a role to fund investments in good faith. As an could free up board resources tied to the the fund’s board that is more in line alternative to the proposed rule, we determination of fair value and redirect with the board’s experience and considered a more principles-based them to oversight, in situations where expertise. Relatedly, we believe that approach that would not specify the an adviser was unwilling or unable to such an approach would not result in types of fair value functions that must accept the responsibility to determine more efficient use of boards’ time and be performed, but instead would only the fair value of fund investments and more efficient fund operations, and state that funds should have in place another third party was available to would not result in improvements in policies and procedures, reporting, and accept the assignment. Nevertheless, fund governance, which would recordkeeping that would allow fair such an approach potentially could ultimately benefit fund investors. values to be determined in good faith by limit a board’s ability to effectively the board of directors or the investment E. Request for Comment oversee the service provider that adviser. The benefits of such an performs the fair value determinations We request comment on all aspects of approach would be that funds would because the board does not have the our economic analysis, including the have more flexibility to tailor their same level of visibility, access to potential costs and benefits of the policies and procedures, reporting, and information, and control over the proposed rule and alternatives thereto, recordkeeping to their valuation needs. actions of service providers other than and whether the proposed rule, if Nevertheless, under such an approach the investment adviser. Further, even adopted, would promote efficiency, funds could be less certain on how to though service providers may have a competition, and capital formation. comply with the proposed rule. To the contractual obligation to perform Commenters are requested to provide extent this alternative would reduce empirical data, estimation certainty for funds, it could increase 250 We acknowledge that under the proposed rule, methodologies, and other factual compliance costs to the detriment of funds could face some uncertainty regarding how support for their views, in particular, on fund investors, and it would not to comply with the proposed rule’s requirements. costs and benefits estimates. In addition, adequately ensure that the board Nevertheless, we believe that a more principles- based approach than the proposed rule would we request comment on the following: provides sufficient oversight over the increase further any uncertainty regarding how to 58. Is our understanding regarding investment adviser’s fair value comply with the proposed rule’s requirements. boards’ current fair value practices

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28762 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

correct? If not, please describe boards’ that the proposed rule would not have activities that would give rise to ongoing current fair value practices. In significant effects on pricing services? If costs for funds under the proposed rule, particular, how do boards determine the not, please describe any effects the and an estimate of the costs associated fair values of fund investments in good proposed rule would have on pricing with each activity. Would these costs faith? What type of assistance do boards services. differ by fund? If yes, in which ways? receive with respect to fair value 62. Do UITs’ exposures to investments Which of these costs would be borne by determinations? Who assists the board that use Level 1, 2, and 3 inputs differ the board and which by the investment with the fair value determinations? To from the exposure of other registered adviser to the fund? What percentage of what extent and under what investment companies? What these costs would be passed down to circumstances does information from percentage of UITs hold investments fund investors in the form of higher pricing services assist the board with that use Level 1, 2, and 3 inputs operating expenses or higher fair value determinations? What kinds respectively? management fees? of services do pricing services provide? 63. In which ways do funds’ current 68. Would the proposed rule increase What percentage of fund boards receive practices differ from the policies and the fees of investment advisers or assistance with the fair value procedures, reporting, and trustees of UITs? If yes, why and how? determinations? Does this percentage recordkeeping and other activities Please provide an estimate of the differ with the type of fund or with the mandated by the proposed rule? Is our increase in the investment advisers’ or type of fund investments? What types of understanding correct that current trustees’ fees. fair value practices and policies and funds’ practices are largely similar to 69. What would be the effects of the procedures do funds have in place? the policies and procedures, reporting, proposed rule, including any effects on What types of reports related to and recordkeeping and other efficiency, competition, and capital valuation do fund boards currently requirements of the proposed rule? formation? Would the proposed rule be receive and how frequently do they 64. Are there any costs and benefits of beneficial or detrimental to funds and receive these reports? What types of the proposed rule that are not discussed their investors? Would the proposed records related to valuation do funds in the economic analysis? If so, please rule affect competition in the fund retain? For how long do they retain describe the types of costs and benefits industry? If yes, why? Would the these records? Do these practices differ and provide a dollar estimate of these proposed rule affect the efficiency of the with the type of fund or with the type costs and benefits. prices of fund investments? If so, in 65. Please provide any estimates of of fund investments? which way? the board time and other savings arising 59. Is our assumption correct that the 70. Would a more principles-based from the assignment of fair value vast majority of current and prospective approach relative to the proposed rule determinations to an investment adviser fund boards would assign fair value be preferable? If yes, why? If we did to the fund under the proposed rule. determinations to an investment adviser adopt such an approach, what What is the source of these savings? under the proposed rule? If not, what safeguards would be necessary to ensure How would the board utilize any percentage of current and prospective that fair value determinations are not savings as the result of the assignment funds would assign the fair value influenced by conflicts of interest? of the fair value determinations to an determinations to an investment adviser 71. Would it be preferable to allow the investment adviser to the fund under to the fund? Do these percentages vary board to assign the fair value the proposed rule? Would the boards with the type of fund or with the type determinations to service providers engage in additional activities at of fund investments? What factors other than the investment adviser, such meetings or would the boards instead would boards consider when deciding as a pricing service provider? If yes, spend less time on fund matters? Please whether to assign the fair value why? provide dollar estimates (mean, median, determinations to an investment adviser 72. Would it be preferable to not standard deviation, minimum, and to the fund? permit boards to assign fair value maximum) of these savings? Would 60. What percentage of fund determinations to an investment adviser independent board members have these savings differ by fund? If yes, in to the fund but only mandate fair value valuation experience and expertise? which way? policies and procedures, reporting, and Please provide data on the percentage of 66. Please provide a list of activities recordkeeping requirements that are fund independent board members that that would give rise to one-time costs similar to the proposed rule’s have valuation experience and expertise for funds under the proposed rule. Also requirements? If yes, why? by fund type. please provide dollar estimates (mean, 61. Are there any entities affected by median, standard deviation, minimum, IV. Paperwork Reduction Act Analysis the proposed rule that are not discussed and maximum) of the one-time costs in the economic analysis? In which that funds would incur. Would these A. Introduction ways would those entities be affected by costs differ by fund? If yes, in which Proposed rule 2a–5 would result in the proposed rule? Please provide an ways? What percentage of these costs new ‘‘collection of information’’ estimate of the number and size of those would be borne by the board and what requirements within the meaning of the affected entities and of the nature and percentage by an investment adviser to Paperwork Reduction Act of 1995 magnitude of the effect. Is our the fund? What percentage of these costs (‘‘PRA’’).251 The title for the new assessment correct that the effects of the would be passed on to fund investors in collection of information would be proposed rule on UITs would be similar the form of higher operating expenses or ‘‘Rule 2a–5 under the Investment to the effects of the proposed rule on higher management fees? Company Act of 1940, Fair Value.’’ The other funds, except for the fact that UITs 67. Is our understanding correct that Commission is submitting these would not bear any costs associated the incremental ongoing operating costs collections of information to the Office with oversight and reporting and their for funds would be minimal under the of Management and Budget (‘‘OMB’’) for trustees would not receive any of the proposed rule? If not, please provide an review in accordance with 44 U.S.C. benefits associated with assigning fair estimate of the number of funds that 3507(d) and 5 CFR 1320.11. An agency value determinations to an investment would bear ongoing costs under the adviser? Is our understanding correct proposed rule. Also, please describe the 251 44 U.S.C. 3501–3520.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28763

may not conduct or sponsor, and a rule 2a–5, of which 9,501 are not value policies and procedures by person is not required to respond to, a UITs.254 Compliance with rule 2a–5 adjusting the current systems for collection of information unless it would be mandatory for any fund that implementing and enforcing the displays a currently-valid control would need to determine fair value compliance policies and procedures of number. under the Act. To the extent that records the fund (if the requirements are not The proposed rule would provide would be required to be created and assigned) or the adviser’s (if the requirements for determining fair value maintained under the rule are provided requirements are assigned). While funds in good faith for purposes of section to the Commission in connection with and advisers have policies and 2(a)(41) and rule 2a–4 thereunder. This examinations or investigations, such procedures in place to address determination would involve assessing information would be kept confidential compliance with the federal securities and managing material risks associated subject to the provisions of applicable laws (among other obligations), with fair value determinations; law. including fair value determinations, selecting, applying, and testing fair B. Policies and Procedures they would need to update their existing value methodologies; evaluating any policies and procedures to account for Proposed rule 2a–5 would require the pricing services used; adopting and the specific requirements of proposed adoption and implementation of fair implementing policies and procedures; rule 2a–5. To comply with this value policies and procedures, which and maintaining certain records. The obligation, we believe that fund boards would address the process for the proposed rule would permit a fund’s or advisers (by assignment by the board) determination of the fair value of the would use in-house legal and board of directors to assign the fair fund’s investments under the proposed value determination relating to any or 255 compliance counsel to update existing rule. The fair value policies and policies and procedures to account for all fund investments to an investment procedures are designed to help ensure the requirements of proposed rule 2a–5. adviser of the fund, which would carry that the determination of fair value is For purposes of these PRA estimates, we out all of these requirements, subject to carried out effectively and to facilitate assume that either the fund or the board oversight and certain reporting, board oversight. The policies and adviser would review the fair value recordkeeping, and other requirements procedures, as proposed, must be policies and procedures annually (for designed to facilitate the board’s ability reasonably designed to achieve example, to assess whether the fair effectively to oversee the adviser’s fair compliance with the certain value methodology requires value determinations. As relevant here, requirements of the proposed rule, adjustments). We therefore have the rule would require, on a per fund which are: (1) Periodically assessing any estimated initial and ongoing burdens basis, the adoption and implementation material risks associated with the of certain policies and procedures determination of the fair value, associated with the proposed policies designed to address the process for including material conflicts of interest, and procedures requirement. As determining fair value in good faith, and managing those identified valuation discussed above, we estimate that keeping of certain records regarding the risks; (2) selecting and applying in a approximately 9,986 funds may rely on fair value process, and, if the board consistent manner methodologies for the proposed rule and therefore would assigns the adviser to determine fair determining and calculating the fair require these funds or their advisers to value, adviser reporting to the board in value; (3) testing the appropriateness adopt and implement fair value policies both periodic and as needed reports and accuracy of the fair value and procedures. with some extra recordkeeping.252 methodologies that have been selected; Table 1 below summarizes the The respondents to proposed rule 2a– and (4) selecting and overseeing pricing proposed PRA initial and ongoing 5 would be registered investment service providers, if used. burden estimates associated with the companies and BDCs.253 We estimate We believe that the fund’s board or policies and procedures requirements that 9,986 funds would be affected by adviser likely would establish the fair under proposed rule 2a–5.

TABLE 1—FAIR VALUE POLICIES AND PROCEDURES PRA ESTIMATES

Internal Initial Annual initial Internal annual Internal external external Wage rate 2 burden burden hours 1 time costs cost cost hours burden burden

Establishing and implementing 6 hours 2 hours ...... × $329 (senior manager) ...... $658.00 $3,000.00 $1,000.00 rule 2a–5 policies and proce- dures. 6 hours 2 hours ...... × 466 (ass’t general counsel) ...... 932.00 ...... 3 hours 1 hour ...... × 530 (chief compliance officer) ... 530.00 ...... 3 hours 1 hour ...... × 365 (compliance attorney) ...... 365.00 ...... Reviewing and updating rule 2a– ...... 3 hours ...... × 329 (senior manager) ...... 987.00 ...... 1,000.00 5 policies and procedures...... 3 hour ...... × 466 (ass’t general counsel) ...... 1,398.00 ...... 1 hour ...... × 530 (chief compliance officer) ... 530.00 ......

252 Proposed rule 2a–5(a) and (b). information for the securities industry compiled by effects of inflation. See Securities Industry and 253 See proposed rule 2a–5(e)(1) (defining the Securities Industry and Financial Markets Financial Markets Association, Report on ‘‘fund’’). Association’s Office Salaries in the Securities Management & Professional Earnings in the Industry 2013. The estimated wage figures are 254 See supra footnote 215 and accompanying Securities Industry 2013 (‘‘SIFMA Report’’). modified by Commission staff to account for an 255 See supra Section II.E.2. text. 1,800-hour work-year and inflation, and multiplied The Commission’s estimates of the relevant wage by 5.35 to account for bonuses, firm size, employee rates in the tables below are based on salary benefits, overhead, and adjusted to account for the

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28764 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

TABLE 1—FAIR VALUE POLICIES AND PROCEDURES PRA ESTIMATES—Continued

Internal Initial Annual initial Internal annual Internal external external Wage rate 2 burden burden hours 1 time costs cost cost hours burden burden

Total annual burden per ...... 13 hours ...... 5,400.00 ...... 2,000.00 fund. Number of affected funds ...... 9,986 ...... 9,986 ...... 9,986

Total annual burden ...... 129,818 hours ...... 53,924,400 ...... 19,972,000 Notes: 1. Includes initial burden estimates annualized over a three-year period. 2. See SIFMA Report, supra footnote 254.

C. Board Reporting or could have materially affected the fair required elsewhere under the 258 The proposed rule would require, if value of the assigned portfolio of proposal. UITs could not assign fair the board assigns the fair value investments. These reports would be value determinations to an adviser determinations to an adviser of the required to include such information as under the proposed rule because they fund, that the adviser report to the may be reasonably necessary for the are unmanaged and therefore would not fund’s board in writing (1) a quarterly board to evaluate the matters covered in be subject to this collection of report containing an assessment of the the report.256 The periodic reports that information.259 We estimate that 9,501 adequacy and effectiveness of the would be required by the proposed rule funds would utilize the proposed rule adviser’s process for determining the would have a minimum of five items and therefore be subject to these fair value of the assigned portfolio of required as part of the report,257 and the requirements.260 investments and (2) promptly (but in no prompt reports must include material Table 2 below summarizes the event later than three business days weaknesses in the design or proposed PRA initial and ongoing after the adviser becomes aware of the implementation of the adviser’s fair burden estimates associated with the matter) on matters associated with the value determination process or material board reporting requirements under adviser’s process that materially affect changes in the fund’s risks as would be proposed rule 2a–5.

TABLE 2—BOARD REPORTING PRA ESTIMATES

Internal Initial Annual initial Internal annual 1 Internal external external burden burden hours Wage rate time costs cost cost hours burden burden

PROPOSED ESTIMATES

Adviser written reports 2 ...... 0 hours 8 hours ...... × $329 (senior manager) ...... $2,632 $2,000 $2,000 0 hours 1 hour ...... × 17,860 (combined rate for 4 di- 17,860 ...... rectors). 0 hours 1 hour ...... × 365 (compliance attorney) ...... 365 ......

Total annual burden per ...... 10 hours ...... 20,857 ...... 2,000 fund. Number of funds ...... × 9,501 ...... × 9,501 ...... × 9,501

Total annual burden ...... 95,010 hours ...... 198,162,357 ...... 19,002,000 Notes: 1. See SIFMA Report, supra footnote 254. 2. See supra footnotes 245–247 and accompanying text.

D. Recordkeeping considered when making fair value proposed rule and (4) a specified list of determinations and (2) copies of the the investments or investment types Proposed rule 2a–5 would require the policies and procedures as required whose fair value determination has been maintenance of certain records, elsewhere under the proposed rule.261 assigned to the adviser.262 We estimate specifically (1) appropriate Further, if the board assigns fair value that 9,986 funds would be subject to the documentation to support fair value determinations to an adviser, the fund proposed rule and therefore to these determinations, including information must maintain copies of (3) the reports requirements.263 regarding the specific methodologies and other information provided to the Table 3 below summarizes the applied and the assumptions and inputs board as required elsewhere under the proposed PRA initial and ongoing

256 See proposed rule 2a–5(b)(1); supra section 260 See supra footnote 215. 263 While only 9,501 of these 9,986 funds would II.B.2 (discussing the proposed board reporting 261 See proposed rule 2a–5(a)(6); supra section be subject to the last two of these recordkeeping requirements). II.A.6. requirements, we believe that this distinction is 257 See proposed rule 2a–5(b)(1)(i). 262 See proposed rule 2a–5(b)(3); supra section immaterial for this purpose and would result in 258 See proposed rule 2a–5(b)(1)(ii). II.B.6. only a de minimis lowering of the estimate. See also 259 See proposed rule 2a–5(d). supra footnote 215 and accompanying text.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28765

burden estimates associated with the recordkeeping requirements under proposed rule 2a–5.

TABLE 3—RECORDKEEPING PRA ESTIMATES

Internal Initial Annual initial Internal annual Internal external external Wage rate 2 burden burden hours 1 time costs cost cost hours burden burden

PROPOSED ESTIMATES

Establishing recordkeeping poli- 1.5 ...... 5 ...... $62 (general clerk) ...... $31 $1,800 $1,800 cies and procedures. 1.5 ...... 5 ...... 95 (senior computer operator) .. 47.50 ...... Recordkeeping ...... 0 hours 2 hours ...... × 62 (general clerk) ...... 31 0 0 0 hours 2 hours ...... × 95 (senior computer operator) .. 47.50 ......

Total annual burden per ...... 5 hours ...... 157 ...... 600 fund. Number of funds ...... × 9,986 ...... × 9,986 ...... × 9,986

Total annual burden ...... 49,930 hours ...... 1,567,802 ...... 5,991,600 Notes: 1. For ‘‘Establishing Recordkeeping Policies and Procedures,’’ these estimates include initial burden estimates annualized over a three-year period. 2. See SIFMA Report, supra footnote 254.

E. Proposed Rule 2a–5 Total Estimated board reporting, and recordkeeping collection of information. Therefore, Burden requirements, amortized over three each fund required to comply with the years, would result in an average rule would incur an average annual As summarized in Table 4 below, we aggregate annual burden of 274,758 burden of approximately 27.51 hours, at estimate that the total hour burdens and hours and an average aggregate annual an average annual monetized time cost time costs associated with proposed rule monetized time cost of $253,654,559. of approximately $25,401, and an 2a–5, including the burden associated We also estimate that, amortized over external cost of $4,503 to comply with with the adoption and implementation three years, there would be external proposed rule 2a–5. of fair value policies and procedures, costs of $44,965,600 associated with this

TABLE 4—PROPOSED RULE 2A–5 TOTAL PRA ESTIMATES

Internal burden External Internal hour burden time cost cost burden

Policies and Procedures ...... 129,818 hours ...... $53,924,400 $19,972,000 Board reporting ...... 95,010 hours ...... 198,162,357 19,002,000 Recordkeeping requirements ...... 49,930 hours ...... 1,567,802 5,991,600

Total annual burden ...... 274,758 ...... 253,654,559 44,965,600 Number of funds ...... ÷ 9,986 ...... ÷ 9,986 ÷ 9,986

Average annual burden per fund ...... 27.51 hours ...... 25,401 4,503

F. Request for Comment minimize the burden of the collections 30 and 60 days after publication of this of information on those who are to release; therefore a comment to OMB is We request comment on whether respond, including through the use of these estimates are reasonable. Pursuant best assured of having its full effect if automated collection techniques or to 44 U.S.C. 3506(c)(2)(B), the OMB receives it within 30 days after Commission solicits comments in order other forms of information technology. publication of this release. Requests for to: (1) Evaluate whether the proposed Persons wishing to submit comments materials submitted to OMB by the collections of information are necessary on the collection of information Commission with regard to these for the proper performance of the requirements of the proposed rules and collections of information should be in functions of the Commission, including amendments should direct them to the writing, refer to File No. S7–07–20, and whether the information will have OMB: MBX.OMB.OIRA.SEC_desk_ be submitted to the Securities and practical utility; (2) evaluate the [email protected], and should send a Exchange Commission, Office of FOIA accuracy of the Commission’s estimate copy of their comments to, Vanessa Services, 100 F Street NE, Washington, of the burden of the proposed Countryman, Secretary, Securities and DC 20549–2736. collections of information; (3) determine Exchange Commission, 100 F Street NE, V. Initial Regulatory Flexibility whether there are ways to enhance the Washington, DC 20549–1090, with Analysis quality, utility, and clarity of the reference to File No. S7–07–20. OMB is information to be collected; and (4) required to make a decision concerning The Commission has prepared the determine whether there are ways to the collections of information between following Initial Regulatory Flexibility

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28766 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

Analysis (‘‘IRFA’’) in accordance with requirements are designed to help writing. Funds would also be required section 3(a) of the Regulatory Flexibility ensure compliance with the other to keep certain additional records in Act (‘‘RFA’’).264 It relates to proposed requirements.267 such circumstances. We therefore rule 2a–5. All of these requirements are believe that there are three principal discussed in detail in section II of this reporting, recordkeeping, or other A. Reasons for and Objectives of the release. The costs and burdens of these compliance requirements associated Proposed Actions requirements on small funds and with the proposed rule: (1) The The Commission is proposing new investment advisers are discussed below establishment and implementation of rule 2a–5 in order to address practices as well as above in our Economic policies and procedures, including and the role of the board of directors Analysis and Paperwork Reduction Act establishing and applying fair value with respect to the fair value of the Analysis, which discuss the applicable methodologies, (2) recordkeeping investments of fund. Under section costs and burdens on all funds and requirements, and (3) board reporting 2(a)(41), the board must determine in investment advisers.268 requirements. good faith the fair value of fund assets for which no market quotations are B. Legal Basis 1. Policies and Procedures readily available. The proposed rule is The Commission is proposing new The policies and procedures that designed to specify how a board or rule 2a–5 under the authority set forth would be required under the proposed adviser must make good faith in sections 2(a), 6(c), 31(a), 31(c), and rule would need to be reasonably determinations of fair value as well as 38(a) of the Investment Company Act of designed to achieve compliance with when the board can assign this function 1940 [15 U.S.C. 80a–2(a), 80a–6(c), 80a– the requirements of the rule. to an adviser to the fund, while still 30(a), 80a–30(c), and 80a–37(a)]. Specifically, these requirements include ensuring that fund investments are C. Small Entities Subject to Proposed (1) the assessment and management of valued in a way consistent with the Rules risks associated with the determination Investment Company Act. of fair value, (2) establishing and The proposed rule would provide For purposes of Commission applying fair value methodologies, (3) requirements for determining fair value rulemaking in connection with the testing fair value methodologies, and (4) in good faith for purposes of section Regulatory Flexibility Act, an evaluating pricing services.271 Further, 2(a)(41) of the Act and rule 2a–4 investment company is a small entity if, if the board assigns fair value thereunder. This determination would together with other investment determinations under the proposed rule involve assessing and managing companies in the same group of related to an investment adviser to the fund, the material risks associated with fair value investment companies, it has net assets adviser’s policies and procedures must determinations; selecting, applying, and of $50 million or less as of the end of meet certain requirements. In addition testing fair value methodologies; its most recent fiscal year (a ‘‘small to the other requirements above, these evaluating any pricing services used; fund’’).269 Commission staff estimates policies and procedures must specify adopting and implementing policies and that, as of December 2019, the titles of the persons responsible for procedures; and maintaining certain approximately 38 registered open-end determining the fair value of assigned records. The proposed rule would mutual funds, 8 registered ETFs, 30 investments, including by specifying the permit a fund’s board of directors to registered closed-end funds, 2 UITs, and particular functions for which they are assign these requirements to an 14 BDCs (collectively, 92 funds) are responsible, and reasonably segregating investment adviser to the fund for some small entities.270 the process of making fair value or all of the fund’s investments, subject D. Projected Reporting, Recordkeeping, determinations from the portfolio to board oversight and certain reporting, and Other Compliance Requirements management of the fund.272 recordkeeping, and other requirements These requirements are designed to Proposed rule 2a–5 would require fair designed to facilitate the board’s ability implement the proposed rule’s value determinations under the Act be effectively to oversee the adviser’s fair requirements effectively which, in turn, made according to a specific process for value determinations. The proposed are designed to protect investors from affected funds, including those that are rule would also define when market improper valuations. They are also small entities. This process would quotations are readily available under designed to facilitate the board’s include the adoption of policies and section 2(a)(41) of the Act. Lastly, the oversight of these functions when they procedures reasonably designed to proposed rule would have the trustee of are assigned to an adviser to the fund. achieve compliance with the a UIT carry out the requirements of the These requirements will impose requirements of the proposed rule and proposed rule. The requirements burdens on all funds, including those certain recordkeeping requirements. that are small entities. The specifics of associated with the fair value as Further, the proposed rule would permit determined in good faith and readily these burdens are discussed in the certain fund boards to assign fair value Economic Analysis and Paperwork available market quotations are determinations to an adviser to the fund designed to protect investors from Reduction Act sections above.273 if the adviser, in addition to the above, There are different factors that would improper valuations and reflect our adopts certain policies and procedures, view of current market best practices.265 affect whether a smaller fund incurs makes certain reports to the fund’s costs related to this requirement that are The requirements associated with the board regarding the fair value process in assignment of responsibilities to an on the higher or lower end of the adviser are designed to ensure that the estimated range. For example, we would 267 See supra sections II.A.6 and II.B.4. expect that smaller funds—and more board effectively oversees an assigned 268 See supra section III and IV. These sections specifically, smaller funds that are not adviser, including receiving sufficient also discuss the professional skills that we believe information to do so.266 The policies compliance with the proposed rule would entail. 271 and procedures and recordkeeping 269 See rule 0–10(a) under the Investment Proposed rule 2a–5(a)(1)–(5). Company Act [17 CFR 270.0–10(a)]. 272 See proposed rule 2a–5(b)(2). 270 This estimate is derived an analysis of data 273 See supra section III.C.3. This section, along 264 5 U.S.C. 603(a). obtained from Morningstar Direct as well as data with section IV, also discusses the professional 265 See supra sections I, II.A, and II.C. reported to the Commission for the period ending skills that we believe compliance with this aspect 266 See supra section II.B. December 2019. of the proposal would entail.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28767

part of a fund complex—may not have whether a smaller fund incurs costs reporting mechanism that would meet existing policies and procedures that relating to this requirement that are on all the elements that would be required include all of the elements that would the higher or lower end of the estimated under the proposed rule. Also, while we be required of policies and procedures range. For example, we would expect would expect larger funds or funds that under the proposed rule. Also, while we that smaller funds—and more are part of a large fund complex to incur would expect larger funds or funds that specifically, smaller funds that are not higher costs, via increased advisory fees are part of a large fund complex to incur part of a fund complex—may not have for advisers to take on this higher costs related to this requirement recordkeeping systems that would meet responsibility on behalf of such funds, in absolute terms relative to a smaller all the elements that would be required related to this requirement in absolute fund or a fund that is part of a smaller under the proposed rule. Also, while we terms relative to a smaller fund or a fund complex, we would expect a would expect larger funds or funds that fund that is part of a smaller fund smaller fund to find it more costly, per are part of a large fund complex to incur complex, we would expect a smaller dollar managed, to comply with the higher costs related to this requirement fund to find it more costly, per dollar proposed requirement because it would in absolute terms relative to a smaller managed, to comply with the proposed not be able to benefit from a larger fund fund or a fund that is part of a smaller requirement because it would not be complex’s economies of scale.274 fund complex, we would expect a able to benefit from a larger fund smaller fund to find it more costly, per 281 2. Recordkeeping complex’s economies of scale. dollar managed, to comply with the The recordkeeping requirements of proposed requirement because it would E. Duplicative, Overlapping, or the proposed rule are designed to help not be able to benefit from a larger fund Conflicting Federal Rules ensure compliance with the rule’s complex’s economies of scale.278 Other than as discussed below, requirements and aid in oversight. The Commission staff has not identified any 3. Board Reporting proposed rule would require the fund to federal rules that duplicate, overlap, or keep the following records: (1) The requirement for board reporting conflict with proposed rule 2a–5. As Appropriate documentation to support by the fund’s adviser is designed to discussed in more detail above,282 rule fair value determinations, including ensure that the board can exercise 38a–1 also would apply to a fund’s information regarding the specific sufficient oversight over the fair value obligations under the proposed rule. methodologies applied and the process. The proposal would require Rule 38a–1 requires a fund’s board, assumptions and inputs considered two general types of reports, a periodic including a majority of its independent when making fair value determinations one and a prompt one. Periodic reports directors, to approve the fund’s policies for at least five years from the time the would consist of the adviser’s quarterly and procedures, including those on fair determination was made, the first two assessment in writing of the adequacy value, and those of each investment years in an easily accessible place and and effectiveness of the adviser’s fair adviser and other specified service (2) A copy of the fair value policies and value process for determining the fair providers, based upon a finding by the procedures that are in effect, or were in value of the assigned portfolio of board that the policies and procedures effect at any time within the past five investments, including some specific are reasonably designed to prevent 275 years, in an easily accessible place. summaries and descriptions. The violation of the federal securities Further, should the board assign the fair prompt reporting requirement would laws.283 Rule 38a–1 also requires that value determination, the fund must require advisers to promptly inform the the fund’s CCO provide an annual keep, in addition to the records above, board, but in no event later than three report to the fund’s board that must copies of the reports and other business days after the adviser becomes address any material changes to information provided to the board for at aware of the matter, of matters that compliance policies and procedures.284 least five years after the end of the fiscal materially affect or could materially Ultimately, we do not believe that the year in which the documents were affect the fair value of the assigned proposed rule adds cumulative made, the first two years in an easily portfolio of investments, including a regulatory burdens on small funds accessible place and a specified list of significant deficiency or material without any gain in regulatory benefits. the investments or investment types weakness in the design or The proposed rule would differ from the whose fair value determination has been implementation of the adviser’s fair requirements of rule 38a–1 in that assigned to the adviser, in each case for value determination process or material proposed rule 2a–5 would mandate that at least five years after the end of the changes in valuation risks.279 funds, including small funds, adhere to fiscal year in which the determinations These requirements will impose more specific fair value practices as well were provided to the board or the burdens on all funds, including those as policies and procedures, reporting, investments or investment types were that are small entities. The specifics of and recordkeeping requirements not assigned to the adviser, the first two these burdens are discussed in the currently required in the text of rule years in an accessible place.276 Economic Analysis and Paperwork 38a–1. As we state above, however, to These requirements will impose 280 Reduction Act sections above. There the extent that adviser policies and burdens on all funds, including those are different factors that would affect procedures under proposed rule 2a–5 that are small entities. The specifics of whether a smaller fund incurs costs these burdens are discussed in the would otherwise be duplicative of fund related to this requirement that are on valuation policies under rule 38a–1, a Economic Analysis and Paperwork the higher or lower end of the estimated Reduction Act sections above.277 There range. For example, we would expect 281 are different factors that would affect See supra section III.C.1. that smaller funds—and more 282 See supra section II.A.5. specifically, smaller funds that are not 283 Rule 38a–1(a)(2). 274 See supra section III.C.1. part of a fund complex—may not have 284 See rule 38a–1(a)(4)(iii)(A). ‘‘Material’’ in this 275 Proposed rule 2a–5(a)(6). an advisory agreement that has a context is a change that a fund director would 276 Proposed rule 2a–5(b)(3). reasonably need to know in order to oversee fund 277 See supra section III.C.3. This section and compliance. See rule 38a–1(e)(2). We have also said section IV also discuss the professional skills that 278 See supra section III.C.1. that ‘‘serious compliance issues’’ must be raised we believe compliance with this aspect of the 279 See supra section II.B.2 and II.B.3. with the board immediately. See Compliance Rules proposal would entail. 280 See supra section III.C.3. Adopting Release, supra footnote 26, at n.33.

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28768 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

fund could adopt the rule 2a–5 policies result in investor protection benefits, that it is appropriate to correlate the and procedures of the adviser in and these benefits should apply to costs associated with the proposed rule fulfilling its rule 38a–1 obligations to investors in smaller funds as well as with the fund’s actual fair value process, avoid any duplication.285 investors in larger funds. We therefore and not necessarily with the fund’s size do not believe it would be appropriate in light of our investor protection F. Significant Alternatives to exempt small funds from the objectives. The Regulatory Flexibility Act directs proposed rule’s requirements, or to Finally, with respect to the use of the Commission to consider significant establish different requirements performance rather than design alternatives that would accomplish our applicable to funds of different sizes standards, the proposed rule generally stated objective, while minimizing any under these provisions to account for uses performance standards for all funds significant economic impact on small resources available to small entities. We subject to the proposed rule, regardless entities. We considered the following believe that all of the proposed elements of size. We believe that providing funds alternatives for small entities in relation of rule 2a–5 should work together to with the flexibility permitted in the to our proposal: (1) Exempting funds produce the anticipated investor proposal with respect to designing that are small entities from the proposed protection benefits, and therefore do not specific fair value process is appropriate reporting, recordkeeping, and other believe it is appropriate to except because of the fact-specific nature of compliance requirements, to account for smaller funds because we believe this making fair value determinations. resources available to small entities; (2) would limit the benefits to investors in G. Request for Comment establishing different reporting, such funds. recordkeeping, and other compliance We also do not believe that it would 73. The Commission requests requirements or frequency, to account be appropriate to subject small funds to comment regarding this analysis. We for resources available to small entities; different reporting, recordkeeping, and request comment on the number of (3) clarifying, consolidating, or other compliance requirements or small entities that would be subject to simplifying the compliance frequency. Similar to the concerns our proposal and whether our proposal requirements under the proposal for discussed above, if the proposal would have any effects that have not small entities; and (4) using included different requirements for been discussed. We request that performance rather than design small funds, it could raise investor commenters describe the nature of any standards. protection concerns for investors in effects on small entities subject to our We do not believe that exempting small funds in that small funds face the proposal and provide empirical data to small funds from the provisions in same conflicts of interest that can lead support the nature and extent of such proposed rule 2a–5 would permit us to to mispricing and otherwise harm effects. We also request comment on the achieve our stated objectives, investors that larger funds do. estimated compliance burdens of our principally to protect investors from We do not believe that clarifying, proposal and how they would affect improper valuations. Further, the board consolidating, or simplifying the small entities. reporting and additional recordkeeping compliance requirements under the VI. Consideration of Impact on the provisions of proposed rule 2a–5 only proposal for small funds, beyond that Economy affect fund boards that assign fair value already proposed for all funds, would For purposes of the Small Business determinations to a fund adviser and, permit us to achieve our stated Regulatory Enforcement Fairness Act of therefore, the rule would require funds objectives. Again, this approach would 1996 (‘‘SBREFA’’), the Commission to comply with these specific raise investor protection concerns for must advise OMB whether a proposed requirements only if they assigned investors in small funds. We believe, as regulation constitutes a ‘‘major’’ rule. responsibilities to their adviser. outlined above in the discussion of the Under SBREFA, a rule is considered However, we expect that most funds proposed rule and the guidance contained in this release, that the ‘‘major’’ where, if adopted, it results in holding securities that must be fair or is likely to result in: valued will do so. Therefore if a board requirements of the proposed rule are, • to some extent, current industry practice An annual effect on the economy of to a small entity does not do this and $100 million or more; instead performs its statutory function under existing rules, with some changes • from current practice. As a result, we A major increase in costs or prices directly, then the small entity would not for consumers or individual industries; be subject to these provisions of think that the proposed rule could result in a reduction in the current burdens or proposed rule 2a–5. • Significant adverse effects on experienced by small entities to the We estimate that 72% of all funds competition, investment, or innovation. would be subject to the proposed rule in extent that they are subject to the We request comment on whether our making fair value determinations.286 proposed rule. proposal would be a ‘‘major rule’’ for The costs associated with proposed This estimate indicates that some funds, purposes of SBREFA. We solicit rule 2a–5 would vary depending on the including some small funds, would be comment and empirical data on: unaffected by the proposed rule. fund’s particular circumstances, and • The potential effect on the U.S. However, for small funds that would be thus the proposed rule could result in economy on an annual basis; affected by our proposed rule, providing different burdens on funds’ resources. In • Any potential increase in costs or an exemption for them could subject particular, we expect that a fund that prices for consumers or individual investors in small funds to a higher does not have policies and procedures, industries; and degree of risk than investors to large reporting, or recordkeeping practices • Any potential effect on competition, funds that would be required to comply similar to those proposed in the rule investment, or innovation. with the proposed elements of the rule. would need to modify those practices. Commenters are requested to provide As discussed throughout this release, Thus, to the extent a fund that is a small empirical data and other factual support we believe that the proposed rule would entity already has a fair value process for their views to the extent possible. that is consistent with the requirements VII. Statutory Authority 285 See supra section II.A.5. of the proposed rule, we believe it 286 See supra footnote 214 and accompanying would incur relatively low costs to The Commission is proposing new text. comply with it. However, we believe rule 2a–5 under the authority set forth

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules 28769

in sections 2(a), 6(c), 31(a), 31(c), and companies shall be valued in (i) The process for the approval, 38(a) of the Investment Company Act of accordance with certain provisions of monitoring, and evaluation of each 1940 [15 U.S.C. 80a–2(a), 80a–6(c), 80a– the Code of the District of Columbia. pricing service provider, and 30(a), 80a–31(c), and 80a–37(a)]. * * * * * (ii) Criteria for initiating price challenges; List of Subjects PART 270—RULES AND (5) Fair value policies and procedures. 17 CFR Part 210 REGULATIONS, INVESTMENT Adopting and implementing written COMPANY ACT OF 1940 policies and procedures addressing the Accountants, Accounting, Banks, determination of the fair value of fund banking, Employee benefit plans, ■ 3. The authority citation for part 270 investments that are reasonably Holding companies, Insurance continues to read, in part, as follows: designed to achieve compliance with companies, Investment companies, Oil Authority: 15 U.S.C. 80a–1 et seq., 80a– the requirements described in and gas exploration, Reporting and 34(d), 80a–37, 80a–39, and Pub. L. 111–203, paragraphs (a)(1) through (4) of this recordkeeping requirements, Securities, sec. 939A, 124 Stat. 1376 (2010), unless section; and Utilities. otherwise noted. (6) Recordkeeping. Maintaining: 17 CFR Part 270 * * * * * (i) Appropriate documentation to ■ 4. Section 270.2a–5 is added to read support fair value determinations, Investment companies, Reporting and as follows: including information regarding the recordkeeping requirements, Securities. specific methodologies applied and the For the reasons set out in the § 270.2a–5 Fair value determination and assumptions and inputs considered preamble, title 17, chapter II of the Code readily available market quotations. when making fair value determinations, of Federal Regulation is proposed to be (a) Fair value determination. For as well as any necessary or appropriate amended as follows: purposes of section 2(a)(41) of the Act adjustments in methodologies, for at (15 U.S.C. 80a–2(a)(41)) and § 270.2a–4, least five years from the time the PART 210—FORM AND CONTENT OF determining fair value in good faith determination was made, the first two AND REQUIREMENTS FOR FINANCIAL with respect to a fund requires: years in an easily accessible place; and STATEMENTS, SECURITIES ACT OF (1) Assess and manage risks. (ii) A copy of policies and procedures 1933, SECURITIES EXCHANGE ACT Periodically assessing any material risks as required under paragraph (a)(5) of OF 1934, INVESTMENT COMPANY ACT associated with the determination of the this section that are in effect, or were in OF 1940, INVESTMENT ADVISERS ACT fair value of fund investments effect at any time within the past five OF 1940, AND ENERGY POLICY AND (‘‘valuation risks’’), including material years, in an easily accessible place. CONSERVATION ACT OF 1975 conflicts of interest, and managing those (b) Performance of fair value identified valuation risks; determinations. The board of the fund ■ 1. The authority citation for part 210 (2) Establish and apply fair value must determine fair value in good faith continues to read, in part, as follows: methodologies. Performing each of the for any or all fund investments by Authority: 15 U.S.C. 77f, 77g, 77h, 77j, following, taking into account the fund’s carrying out the functions required in 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), valuation risks: paragraph (a) of this section. The board 77nn(25), 77nn(26), 78c, 78j–1, 78l, 78m, (i) Selecting and applying in a may choose to assign the fair value 78n, 78o(d), 78q, 78u–5, 78w, 78ll, 78mm, consistent manner an appropriate determination relating to any or all fund 80a–8, 80a–20, 80a–29, 80a–30, 80a–31, 80a– 37(a), 80b–3, 80b–11, 7202 and 7262, and methodology or methodologies for investments to an investment adviser of sec. 102(c), Pub. L. 112–106, 126 Stat. 310 determining (and calculating) the fair the fund, which would carry out all of (2012), unless otherwise noted. value of fund investments, including the functions required in paragraphs * * * * * specifying: (a)(1) through (5) of this section, subject ■ 2. Section 210.6–03 is amended by (A) The key inputs and assumptions to the requirements of this paragraph revising paragraph (d) to read as specific to each asset class or portfolio (b). If the board of the fund does not follows: holding; and assign fair value determinations to an (B) Which methodologies apply to adviser to the fund, the fund must adopt § 210.6–03 Special rules of general new types of fund investments in which and implement the policies and application to registered investment a fund intends to invest; procedures required under paragraph companies and business development (ii) Periodically reviewing the (a)(5) of this section and maintain the companies. appropriateness and accuracy of the records required by paragraph (a)(6) of * * * * * methodologies selected and making any this section. (d) Valuation of investments. The necessary adjustments thereto; (1) Oversight and reporting. The board balance sheets of registered investment (iii) Monitoring for circumstances that oversees the adviser, and the adviser companies, other than issuers of face- may necessitate the use of fair value; reports to the fund’s board, in writing, amount certificates, and business and including such information as may be development companies, shall reflect all (iv) Establishing criteria for reasonably necessary for the board to investments at value, with the aggregate determining when market quotations are evaluate the matters covered in the cost of each category of investment no longer reliable; report, as follows: reported under §§ 210.6–04.1, 6–04.2, (3) Test fair value methodologies. (i) Periodic reporting. At least 6–04.3, and 6–04.9 or the aggregate cost Testing the appropriateness and quarterly, an assessment of the of each category of investment reported accuracy of the fair value methodologies adequacy and effectiveness of the under § 210.6–05.1 shown that have been selected, including investment adviser’s process for parenthetically. State in a note the identifying the testing methods to be determining the fair value of the methods used in determining the value used and the minimum frequency with assigned portfolio of investments, of investments. As required by section which such testing methods are used; including, at a minimum, a summary or 28(b) of the Investment Company Act of (4) Evaluate pricing services. description of: 1940 (15 U.S.C. 80a–28(b)), qualified Overseeing pricing service providers, if (A) The assessment and management assets of face–amount certificate used, including establishing: of material valuation risks required

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2 28770 Federal Register / Vol. 85, No. 93 / Wednesday, May 13, 2020 / Proposed Rules

under paragraph (a)(1) of this section, value of the assigned portfolio of (c) Readily available market including any material conflicts of investments, including a significant quotations. For purposes of section interest of the investment adviser (and deficiency or material weakness in the 2(a)(41) of the Act (15 U.S.C. 80a– any other service provider); design or implementation of the 2(a)(41)), a market quotation is readily (B) Any material changes to, or adviser’s fair value determination available only when that quotation is a material deviations from, the fair value process or material changes in the quoted price (unadjusted) in active methodologies established under fund’s valuation risks under paragraph markets for identical investments that paragraph (a)(2) of this section; (a)(1) of this section; the fund can access at the measurement (C) The results of the testing of fair (2) Specify responsibilities. The date, provided that a quotation will not value methodologies required under adviser specifies the titles of the persons be readily available if it is not reliable. paragraph (a)(3) of this section; responsible for determining the fair (d) Unit investment trusts. If the fund (D) The adequacy of resources value of the assigned investments, is a unit investment trust, the fund’s allocated to the process for determining including by specifying the particular trustee must carry out the requirements the fair value of assigned investments, functions for which they are of paragraph (a) of this section. including any material changes to the responsible, and reasonably segregates roles or functions of the persons (e) Definitions. For purposes of this the process of making fair value section: responsible for determining fair value determinations from the portfolio under paragraph (b)(2) of this section; (1) Fund means a registered management of the fund; and (E) Any material changes to the investment company or business adviser’s process for selecting and (3) Records when assigning. In development company. overseeing pricing services, as well as addition to the records required in (2) Fair value means the value of a material events related to the adviser’s paragraph (a)(6) of this section, the fund portfolio investment for which market oversight of pricing services (such as maintains copies of: quotations are not readily available changes in the service providers used or (i) The reports and other information under paragraph (c) of this section. price overrides); and provided to the board as required under (3) Board means either the fund’s (F) Any other materials requested by paragraph (b)(1) of this section; and entire board of directors or a designated the board related to the adviser’s (ii) A specified list of the investments committee of such board composed of a process for determining the fair value of or investment types whose fair value majority of directors who are not assigned investments; and determination has been assigned to the interested persons of the fund. (ii) Prompt board reporting. The adviser pursuant to this paragraph (b), By the Commission. adviser reports promptly (but in no in each case for at least five years after event later than three business days the end of the fiscal year in which the Dated: April 21, 2020. after the adviser becomes aware of the documents were provided to the board Vanessa A. Countryman, matter) on matters associated with the or the investments or investment types Secretary. adviser’s process that materially affect were assigned to the adviser, the first [FR Doc. 2020–08854 Filed 5–12–20; 8:45 am] or could have materially affected the fair two years in an easily accessible place. BILLING CODE 8011–01–P

VerDate Sep<11>2014 20:22 May 12, 2020 Jkt 250001 PO 00000 Frm 00038 Fmt 4701 Sfmt 9990 E:\FR\FM\13MYP2.SGM 13MYP2 jbell on DSKJLSW7X2PROD with PROPOSALS2