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SEC Issues Expanded Valuation Guidance

Posted by Sean Cunniff, investment management research leader, Deloitte Center for Financial Services, Deloitte Services LP, on August 27, 2014

As part of the SEC's recent bold reforms to the rules applicable to money market funds, the SEC also quietly expanded its guidance related to the use of amortized cost to value short-term securities. The guidance can be found within section III of the lengthy release, available here in its entirety.

The use of amortized cost is prevalent in money market funds and other registered investment companies that hold short-term instruments, and has been a frequent topic of discussion throughout the money market rulemaking process. The final rule release, which is consistent with the SEC's money market reform goals, includes the Commission's view on whether and how amortized cost can be used to value short-term securities. The Commission also affirmed that their guidance on amortized cost applies broadly to the entire fund industry.

The implication is clear – if you are responsible for pricing a fund that holds short-term securities, it's smart to set time aside to read the ruling to reassess your valuation policies and procedures and related amortized cost method process and controls.

Here are some key points on the expanded guidance. It:

  • Focuses on the use of the amortized cost method (ACM) for securities having maturities with less than 60 days (longer-term securities are barred from the ACM for valuation).
  • Applies to registered investment companies and business development companies that invest in short-term securities and value them using the ACM.
  • Emphasizes that the decision whether or not the ACM represents fair value should be reconsidered each time the fund makes a valuation determination, and must be based on real data about actual market conditions: such as credit, liquidity, or interest rate conditions in the relevant markets, as well as issuer-specific circumstances.
  • Clarifies that amortized cost, or the penny rounding method (i.e., pricing to the nearest one percent), is appropriate when such measurement is approximately the same as fair value.
  • Highlights the role of the fund board and reiterates that while directors can appoint others to assist in valuation, they cannot delegate the duty to determine fair valuation.
  • Discusses the use of third-party pricing services and suggests that boards may want to consider the inputs, methods, models and assumptions used by the third party, and evaluate how they evolve as market conditions change.

The key takeaway is that the valuation guidance in the SEC's final money market rule applies to short- term securities in all funds, and it shows the importance that the SEC places on valuation issues.

Paul Kraft, a Deloitte partner and U.S. mutual fund and investment adviser practice leader said, "The guidance provides a framework for funds and their boards to evaluate their valuation policies, procedures, and practices across all asset classes and it is a clear indication that it is a good time to do so."

If you are interested in some common industry practices related to valuation, please check out our eleventh edition of the Deloitte Fair Value Pricing Survey. We also look forward to our next iteration of our annual survey coming soon – please check back for the full report at the end of September.

As used in this document, "Deloitte" means Deloitte LLP and its subsidiaries. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

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