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SEC Letter on Fair Value

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  • Baker, John
    The staff of the Securities and Exchange Commission recently issued an interpretive letter on the obligation of investment companies and their directors to
    Message 1 of 1 , May 8, 2001
      The staff of the Securities and Exchange Commission recently issued
      an interpretive letter on the obligation of investment companies and their
      directors to determine in good faith the fair value of the funds' portfolio
      securities when market quotations are not readily available. Investment
      Company Institute, SEC No-Action Letter (Apr. 30, 2001). Together with a
      1999 letter, to which this letter is a sequel, this is the most important
      guidance on fund valuation since 1970.

      Mutual funds are required to value their portfolio securities daily
      in order to calculate the purchase and redemption prices of their shares.
      (Valuation is also important for other reasons, such as calculating fund
      performance, and the letter applies to all investment companies, not just
      mutual funds.) Funds generally value securities with respect to which
      market quotations are readily available by using their closing prices. If
      market quotations are not "readily available," however, securities must be
      valued at "fair value as determined in good faith by the board of

      The new letter primarily addresses the circumstances under which
      "fair value" pricing must be used. In particular, there have been a number
      of instances where worldwide market conditions have changed after the
      closing of overseas markets but before funds valued their securities. For
      funds calculating their net asset value (NAV) using closing prices,
      therefore, there was an arbitrage opportunity for short-term investors,
      significantly disadvantaging those funds and their long-term holders. The
      new letter states that funds should continuously monitor for events that
      might necessitate the use of fair value prices and, where a significant
      event (i.e., an event that will affect the value of a portfolio security)
      has occurred after the market has closed but before the NAV calculation, the
      security must be valued using fair value pricing. (The letter presents this
      position as a continuation of existing interpretations and does not
      acknowledge that it changes the position expressed in Release No. 33-7512
      (Mar. 13, 1998) that a fund may use fair value under those circumstances but
      is not required to do so.) Conversely, the letter states that funds must
      exercise reasonable diligence to obtain market quotations for their
      portfolio securities before they may properly conclude that market
      quotations are not readily available.

      The letter also addresses the "good faith" requirement when
      securities are fair valued. In the staff's view, a board acts in good faith
      when its fair value determination is the result of a sincere and honest
      assessment of the amount that the fund might reasonably expect to receive
      for a security upon its current sale, based upon all of the appropriate
      factors that are available to the fund.

      I have put the new letter on the Yahoo Groups web site, and it can
      be accessed from


      John M. Baker <JBaker@...>
      Stradley, Ronon, Stevens & Young, LLP Http://www.stradley.com
      1220 19th Street, N.W., Suite 700, Washington, DC 20036
      (202) 822-9611 Fax (202) 822-0140
      FundLaw Listowner Http://groups.yahoo.com/group/fundlaw
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