In the recent 893-page money market fund release (“Release”), the SEC weighed in with valuation guidance for short-term debt securities and thinly-traded holdings. While it was not the stand-alone guidance that many expected last year, the Commission noted that guidance was necessary because of the nature of money market fund portfolio securities, the reliance by funds on pricing services, and general valuation comments received in response to the money market fund proposal.
The Release addresses the use of amortized cost valuation for short-term debt securities. The Commission was not swayed by comments that market-based valuations for the securities held by money market funds are not meaningful, reminding the industry that using amortized cost pricing in other types of funds for securities with maturities of 60-days or less requires a finding that the amortized cost is the fair value of the security. The Commission acknowledged that existing guidance regarding how frequently amortized cost value should be compared to fair value may be unclear. The guidance in the Release permits a fund to use amortized cost only when it can “reasonably conclude, at each time it makes a valuation determination, that the amortized cost value of the portfolio security is approximately the same as the fair value of the security as determined without the use of amortized cost valuation.” The context of the Release suggests that daily comparison of amortized cost to fair value is not restricted solely to money market funds and will apply to other funds using amortized cost to value securities with maturities of 60 days or less.
The Commission reminded fund directors that that the board has a “non-delegable” responsibility to determine the fair value of a fund’s portfolio securities. While fund boards are responsible for determining the fair value of these securities, the board can be assisted by others such as a valuation committee or the investment adviser in actual calculations using methodologies approved by the fund board. The Release cautions that evaluated prices provided by pricing services are not market prices and that boards must determine that the pricing service’s price constitutes fair value. The Release lays out the following considerations to assist fund boards regarding how to use evaluated prices from a pricing service in determining fair value:
- “consider the inputs, methods, models, and assumptions used by the pricing service to determine its evaluated prices, and how those inputs, methods, models, and assumptions are affected (if at all) as market conditions change”;
- “assess, among other things, the quality of the evaluated prices provided by the service and the extent to which the service determines its evaluated prices as close as possible to the time as of which the fund calculates its net asset value”; and
- “consider the appropriateness of using evaluated prices provided by pricing services as the fair values of the fund’s portfolio securities where, for example, the fund’s board of directors does not have a good faith basis for believing that the pricing service’s pricing methodologies produce evaluated prices that reflect what the fund could reasonably expect to obtain for the securities in a current sale under current market conditions.”
The relevant valuation guidance can be found starting on page 278 of the SEC’s money market fund release. The Forum will host a workshop on October 15 entitled Board Oversight of the Fair Value Process - What Fund Directors Need to Know, covering these and other valuation-related issues.