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Champ Offers Valuation Guidance

In a recent post for Fund Board Views, former Director of the SEC’s Division of Investment Management and Deputy Director of the Office of Compliance Inspections and Examinations Norm Champ offered boards advice in fulfilling their valuation obligations. Champ began by reminding directors of their obligations under the Investment Company Act regarding the fair valuation of securities for which market quotations are not readily available.

He also highlighted language in the 2014 money market funds reform, released while Champ was Director of the Division of Investment Management, that stated that the board “has a non-delegable responsibility to determine whether an evaluated price provided by a pricing service, or some other price, constitutes a fair value for a fund’s portfolio security.” The SEC later released an FAQ that clarified that the language “was not intended to change the general nature of the board’s responsibility to oversee the process of determining whether an evaluated price provided by a pricing service, or some other price, constitutes a fair value for a fund’s portfolio security or limit a board’s ability to appropriately appoint others to assist in its duties.” Champ noted the Morgan Keegan case which he said “generated understandable concern among directors that they would be held liable for valuation decisions even though they are not on-site at the fund making valuation decisions every day.” However, he sought to reassure boards that “SEC personnel understand that directors are not conducting valuations of securities themselves.

Champ also offered advice in how boards should approach valuation. First, he suggested that boards establish “robust” valuation policies and procedures. Next, he advised that boards should “set up reasonable systems of information and reporting to the board or some other method of verifying that valuations are correct” and “consider valuation at as many meetings as possible” given the regulatory focus. Further, Champ suggested that boards “require that the fund regularly test the effectiveness of the valuation processes and report the results of these tests to the directors or a committee charged with valuation responsibility.” He noted that boards should document valuation mistakes and errors and the steps taken to resolve the issues because “SEC examination staff will be skeptical of a record that shows perfect compliance with any policy and procedure, including valuation.” Lastly, he recommended that boards update the policies and procedures regularly “to reflect any exceptions” because “stale and outdated procedures were worse than no procedures at all.”

Champ did not miss an opportunity to criticize the SEC (as he did recently regarding the possibility of third-party exams) for adding responsibilities to boards, noting that when he was at the SEC, “it worried me that the default policy solution on many tough issues is to add board responsibility to approve or disprove an action. The problem with the approach of additional responsibility is that I have never seen the Commission take away any duties from boards, leaving directors with an awfully full plate.”