Analysis

Mutual fund directors digest

Mutual Fund Directors Digest is a periodic digest that provides the latest developments and information for mutual fund directors. ​

Issue 4: Money fund rule

On July 23, 2014, the US Securities and Exchange Commission (SEC) issued its final rule on money market fund reform. The rule is intended to prevent heavy redemptions on money funds in times of crisis by, among other changes, giving directors tools to react to heavy redemptions and by increasing transparency into money funds.

This issue of the Digest focuses on the responsibilities of directors related to fees and gates for retail money funds; and it provides an overview of the new valuation guidance on determining the fair value of short-term and thinly traded securities, as well as the use of pricing services. It is clear from the final rule and release that the SEC has emphasized the importance of the role of directors in money market reform. Fund boards need to act and work effectively to ensure that they meet the compliance date of October 14, 2016 for amendments related to liquidity fees and gates.

Download the current issue for more information about the rule and the new responsibilities of directors.

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Issue 3: Fair valuation

The US Securities and Exchange Commission (SEC) issued its findings against the former directors of the Morgan Keegan funds in connection with the fair valuation of the funds’ securities. The SEC has used the case as a platform to reiterate its long-standing position that fund directors are ultimately responsible for fair valuations and that directors must actively ensure that fair valuations are appropriate and related processes are working as intended (insert footnote). In our opinion, the case — combined with other recent SEC communications (insert footnote) — sends a clear message that the SEC will remain focused on valuation issues, making this an opportune time for directors to revisit their funds’ valuation practices and their oversight processes governing fair value decisions.

Important themes from the case for directors to consider include the following:

  1. Fair value methodologies and written policies and procedures, including stale prices
  • Consideration: Fund valuation procedures often include the fair valuation factors provided in ASR 118. In light of the case, directors should consider whether additional guidance should be provided in their funds’ documented procedures. Such guidance may include, for example, identifying which factors should be given greater weight in fair valuing certain investment types and how to use the factors to determine the fair value of a security or asset class. Directors should also determine if their funds’ procedures address stale prices.

2.  Adherence to procedural requirements in practice

  • Consideration: The case stands as a reminder that documented procedures must be followed in practice. Directors should consider reviewing or performing a walkthrough with management of the procedural requirements attending fair valuation decisions, including relevant internal controls and action/decision points.

3.  Board reporting, including price overrides

  • Consideration: Directors may want to assure that they receive sufficient information regarding securities that are fair valued including, for example, the type of security fair valued and the methodology used to determine the fair valuation. Directors may want to specifically evaluate the reports they receive relative to price overrides, including whether a fair valuation reflects a price override and the reason(s) for the override.

With fair valuation likely to remain in the spotlight, we expect directors across the industry to continue to review the findings of the case, benchmark their funds’ fair valuation processes against it, and make a determination whether to revise their fair valuation practices. The Morgan Keegan case makes it clear that the SEC expects directors to understand how fair value prices are being determined and to provide clear guidance relative to fair value decisions.

 

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Issue 2: Intermediary controls

Increasing attention has been given to the use of Financial Intermediary Controls and Compliance Assessments (FICCA) as a means of enhancing fund oversight of intermediary relationships. FICCA is an independent internal controls attestation report that covers key focus areas relative to intermediary subaccounting services, such as transaction processing, reconciliations, and fee calculations. To complete a FICCA, an intermediary engages an independent accounting firm to examine its internal controls relating to specific service areas.
 
In light of the continuing shift towards intermediary subaccounting and the SEC’s focus in this area, directors may want to ask fund management if—as well as how—it has adapted to the changing landscape. Specific questions that fund directors may wish to consider include:

  1. What activities are being employed by management to oversee fund intermediaries?
  2. Which intermediaries currently providing subaccounting services for the funds are supplying a FICCA report and, if a FICCA is available, does the scope include the relevant control areas?
  3. For those intermediaries that are not supplying a FICCA report: 
    o   Has fund management requested one?
    o   Has the intermediary indicated why it does not plan to provide such a report?
  4. Is there an opportunity to enhance the content and/or timing of existing board reporting with the inclusion of a FICCA report?

To learn more about oversight practices designed to help mitigate these and other risks in connection with intermediary relationships, please download the report.

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Issue 1: The Omnibus Revolution

The shift to intermediary sub-accounting and the resulting proliferation of different intermediaries providing shareholder services has impacted the fund industry in a number of ways, including changes in economic models and more fragmented service structures. These developments underscore the need for enhanced oversight processes to monitor intermediary services and related compensation while also managing potential regulatory and other risks.

For directors, intermediary relationships typically warrant periodic discussion with fund management. Specifically, two key questions arise relating to how the risks associated with intermediary sub-accounting are being managed: What oversight is in place relative to the services provided by intermediaries, and what oversight is in place regarding the amount and nature of the fees being paid to intermediaries?

Download the PDF for more information about oversight practices designed to help mitigate these and other risks.

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