Mutual Fund Directors Digest – Issue 3

This issue of Mutual Fund Directors Digest addresses the implications for fund directors in connection to 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

a. 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

a. 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

a. 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.

Mutual Fund Directors Digest
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