[Federal Register Volume 86, Number 3 (Wednesday, January 6, 2021)]
[Rules and Regulations]
[Pages 748-808]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-26971]



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Vol. 86

Wednesday,

No. 3

January 6, 2021

Part III





Securities and Exchange Commission





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17 CFR Parts 210 and 270





Good Faith Determinations of Fair Value; Final Rule

  Federal Register / Vol. 86 , No. 3 / Wednesday, January 6, 2021 / 
Rules and Regulations  

[[Page 748]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210 and 270

[Release No. IC-34128; File No. S7-07-20]
RIN 3235-AM71


Good Faith Determinations of Fair Value

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
adopting a new rule under the Investment Company Act of 1940 
(``Investment Company Act'' or the ``Act'') that will address valuation 
practices and the role of the board of directors with respect to the 
fair value of the investments of a registered investment company or 
business development company (``fund''). The rule will provide 
requirements for determining fair value in good faith for purposes of 
the Act. This determination will involve assessing and managing 
material risks associated with fair value determinations; selecting, 
applying, and testing fair value methodologies; and overseeing and 
evaluating any pricing services used. The rule will permit a fund's 
board of directors to designate certain parties to perform the fair 
value determinations, who will then carry out these functions for some 
or all of the fund's investments. This designation will be subject to 
board oversight and certain reporting and other requirements designed 
to facilitate the board's ability effectively to oversee this party's 
fair value determinations. The rule will include a specific provision 
related to the determination of the fair value of investments held by 
unit investment trusts, which do not have boards of directors. The rule 
will also define when market quotations are readily available under the 
Act. The Commission is also adopting a separate rule providing the 
recordkeeping requirements that will be associated with fair value 
determinations and is rescinding previously issued guidance on the role 
of the board of directors in determining fair value and the accounting 
and auditing of fund investments.

DATES: Effective date: This rule is effective March 8, 2021. Compliance 
dates: The applicable compliance dates are discussed in section II.G of 
this rule.

FOR FURTHER INFORMATION CONTACT: Zeena Abdul-Rahman, Senior Counsel; 
Joel Cavanaugh, Senior Counsel; Bradley Gude, Senior Counsel; Thoreau 
A. Bartmann, Senior Special Counsel; or Brian McLaughlin Johnson, 
Assistant Director, at (202) 551-6792, Investment Company Regulation 
Office, Division of Investment Management; Kieran G. Brown, Senior 
Counsel, or David J. Marcinkus, Branch Chief, at (202) 551-6825 or 
[email protected], Chief Counsel's Office, Division of Investment 
Management; Securities and Exchange Commission, 100 F Street NE, 
Washington, DC 20549-8549. Regarding accounting and auditing matters: 
Jenson Wayne or Alexis Cunningham, Assistant Chief Accountants at (202) 
551-6918 or [email protected], Chief Accountant's Office, Division of 
Investment Management, Securities and Exchange Commission; or Jeffrey 
Nick or Natalie Martin, Professional Accounting Fellows, at (202) 551-
5300 or [email protected], Office of the Chief Accountant, Securities and 
Exchange Commission.

SUPPLEMENTARY INFORMATION: The Commission is adopting 17 CFR 270.2a-5 
(new rule 2a-5) and 17 CFR 270.31a-4 (new rule 31a-4) under the 
Investment Company Act.

Table of Contents

I. Introduction
II. Discussion
    A. Fair Value as Determined in Good Faith Under Section 2(a)(41) 
of the Act
    1. Periodically Assess and Manage Valuation Risks
    2. Establish and Apply Fair Value Methodologies
    3. Test Fair Value Methodologies for Appropriateness and 
Accuracy
    4. Pricing Services
    5. Fair Value Policies and Procedures
    B. Performance of Fair Value Determinations
    1. Board Oversight
    2. Board Reporting
    3. Specification of Functions
    C. Recordkeeping
    D. Readily Available Market Quotations
    E. Rescission of Prior Commission Releases
    F. Existing Commission Guidance, Staff No-Action Letters, and 
Other Staff Guidance
    G. Transition Period
    H. Other Matters
III. Economic Analysis
    A. Introduction
    B. Economic Baseline
    1. Current Regulatory Framework
    2. Current Practices
    3. Affected Parties
    C. General Economic Considerations
    1. Investment Adviser Role in Fair Value Determinations
    2. Board Considerations When Designating Fair Value 
Determinations
    3. General Discussion of Benefits and Costs of Good Faith 
Determinations of Fair Value
    D. Benefits and Costs
    1. Fair Value as Determined in Good Faith Under Section 2(a)(41) 
of the Act
    2. Performance of Fair Value Determinations
    3. Recordkeeping
    4. Readily Available Market Quotations
    5. Rescission of Prior Commission Releases and Guidance
    6. Cost Estimates
    7. Other Cost Considerations and Comments on Costs
    E. Effects on Efficiency, Competition, and Capital Formation
    F. Reasonable Alternatives
    1. Designation to Officers of Internally Managed Fund Not 
Permitted
    2. Safe Harbor
    3. Three-Tiered Approach
    4. More Principles-Based Approach
    5. Designation of the Performance of Fair Value Determinations 
to Service Providers Other Than Advisers, Officers, Trustees, or 
Depositors
    6. Not Permit Boards To Designate a Valuation Designee
IV. Paperwork Reduction Act
    A. Introduction
    B. Rule 2a-5
    C. Rule 31a-4
    D. Rule 38a-1
V. Final Regulatory Flexibility Analysis
    A. Need for the Rules
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Rule
    D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    1. Recordkeeping
    2. Board Reporting
    E. Agency Action To Minimize Effect on Small Entities
VI. Update to Codification of Financial Reporting Policies Statutory 
Authority

I. Introduction

    The Investment Company Act requires funds to value their portfolio 
investments using the market value of their portfolio securities when 
market quotations are ``readily available,'' and, when a market 
quotation for a portfolio security is not readily available or if the 
investment is not a security, by using the investment's fair value, as 
determined in good faith by the fund's board.\1\ Proper valuation, 
among other things, promotes the purchase and sale

[[Page 749]]

of fund shares at fair prices, and helps to avoid dilution of 
shareholder interests.\2\ Improper valuation can cause investors to pay 
fees that are too high or to base their investment decisions on 
inaccurate information.\3\ We are adopting new 17 CFR 270.2a-5 (``rule 
2a-5'' or ``final rule'') in response to the developments in markets 
and fund investment practices since the Commission last comprehensively 
addressed valuation 50 years ago. These include developments in the 
accounting and auditing literature,\4\ the growing complexity of 
valuation, and intervening regulatory developments such as the 
development of ASC Topic 820 and the interplay of 17 CFR 270.38a-1 
(``rule 38a-1'' or ``the compliance rule'') in facilitating board 
oversight of funds and the valuation process.\5\ In addition, funds now 
invest in a greater variety of securities and other instruments, some 
of which did not exist in 1970 and may present different and more 
significant valuation challenges.\6\ For example, funds that invest 
primarily in fixed income instruments (which may require fair value 
determinations for some or all of the portfolio assets) have expanded 
from around $800 billion in assets to over $4.5 trillion in just the 
last 20 years.\7\
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    \1\ Section 2(a)(41) of the Investment Company Act. See also 17 
CFR 270.2a-4 (``rule 2a-4''). We generally use the term ``fair 
value'' in this release as that term is used in the definition of 
``value'' in the Investment Company Act, that is, the value of 
securities for which no readily available market quotations exist. 
See section 2(a)(41) of the Investment Company Act. In contrast to 
the Investment Company Act, FASB Accounting Standard Codification 
Topic 820: Fair Value Measurement (``ASC Topic 820'') uses the term 
``fair value'' to refer generally to the value of an asset or 
liability, regardless of whether that value is based on readily 
available market quotations or on other inputs. Accordingly, when we 
use the term fair value in this release, we are using it to mean 
fair value as defined under the Investment Company Act, unless we 
specifically note that we mean fair value under ASC Topic 820, such 
as in the sections below that discuss rescission of the accounting 
guidance.
    \2\ See Good Faith Determinations of Fair Value, Investment 
Company Act Release No. 33845 (Apr. 21, 2020) [85 FR 28734 (May 13, 
2020)] (``Proposing Release''), at n.2.
    \3\ See Id. at nn.1-11 and accompanying text.
    \4\ See Securities and Exchange Commission Codification of 
Financial Reporting Policies, Statement Regarding ``Restricted 
Securities,'' Investment Company Act Release No. 5847 (Oct. 21, 
1969) [35 FR 19989 (Dec. 31, 1970)], Financial Reporting 
Codification (CCH) section 404.04 (Apr. 15, 1982) (``ASR 113''); 
Investment Companies, Investment Company Act Release No. 6295 (Dec. 
23, 1970) [35 FR 19986 (Dec. 31, 1970)], Financial Reporting 
Codification (CCH) section 404.03 (Apr. 15, 1982) (``ASR 118''). ASR 
113 and ASR 118 continue to be included in the list of interpretive 
releases relating to the Investment Company Act found in 17 CFR part 
271 as Investment Company Act Release Nos. 5847 and 6295, 
respectively. We refer to the releases herein as ASR 113 and ASR 
118.
    \5\ See Proposing Release, supra footnote 2, at nn.17-31 and 
accompanying text.
    \6\ See Use of Derivatives by Registered Investment Companies 
and Business Development Companies; Required Due Diligence by 
Broker-Dealers and Registered Investment Advisers Regarding Retail 
Customers' Transactions in Certain Leveraged/Inverse Investment 
Vehicles, Investment Company Act Release No. 33704 (Nov. 25, 2019) 
[85 FR 4446 (Jan. 24, 2020)] (noting the dramatic growth in the 
volume and complexity of the derivatives markets over the past two 
decades, and the increased use of derivatives by certain funds); Use 
of Derivatives by Investment Companies under the Investment Company 
Act of 1940, Investment Company Act Release No. 29776 (Aug. 31, 
2011) [76 FR 55237 (Sept. 7, 2011)], at 69 (noting that 
``[v]aluation of some derivatives may present special challenges for 
funds''); see also Use of Derivatives by Registered Investment 
Companies and Business Development Companies, Investment Company Act 
Release No. 34084 (Nov. 2, 2020) [85 FR 83162 (Dec. 21, 2020)] 
(``Derivatives Adopting Release'') at n.1 and accompanying text. The 
fund industry has grown tremendously in the intervening years. For 
example, in December 1969, open-end funds had net assets of over $53 
billion. See H.R. Rep. No. 1382, 91st Cong., 2d Sess. 2 (1970). As 
of September 11, 2020, there were 12,680 open-end funds registered 
with the Commission with total net assets of over $27 trillion. See 
infra footnotes 496 through 497 and accompanying text. Moreover, as 
of September 2020, there were 97 business development companies 
(``BDCs'') with $62 billion in total net assets. See infra footnote 
497 and accompanying text. BDCs, which did not exist in 1970, must 
invest at least 70% of their assets in certain investments, which 
may be difficult to value. See section 55(a) of the Act.
    \7\ See 2020 Investment Company Institute Fact Book at data 
table 3 available at https://www.icifactbook.org/data/20_fb_data. 
See also Proposing Release, supra footnote 2 (discussing the fund 
industry changes since the issuance of ASR 113 and 118).
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    We proposed rule 2a-5 in April 2020 and received more than 60 
comment letters on the proposal.\8\ Most commenters supported the 
Commission's goal of modernizing the regulatory framework for fund 
valuations.\9\ Commenters generally agreed that the proposed framework 
for making a fair value determination was reasonable and consistent 
with current practice, but several requested additional flexibility 
regarding certain proposed requirements.\10\
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    \8\ See Proposing Release, supra footnote 2. The comment letters 
on the Proposing Release (File No. S7-07-20) are available at 
https://www.sec.gov/comments/s7-07-20/s70720.htm.
    \9\ See, e.g., Comment Letter of Fidelity Investments (July 21, 
2020) (``Fidelity Comment Letter''); Comment Letter of the American 
Bar Association (July 20, 2020) (``ABA Comment Letter''); Comment 
Letter of Franklin Resources, Inc. (July 21, 2020) (``Franklin 
Comment Letter''); Comment Letter of Charles E. Andrews, James G. 
Ellis, Pablo R. Gonz[aacute]lez Guajardo, Vanessa C.L. Chang, John 
G. Freund, and Christopher E. Stone (July 21, 2020) (``American Fund 
Trustees Comment Letter''); Comment Letter of the New York City Bar 
Association (July 21, 2020) (``NYC Bar Comment Letter''). However, 
some commenters objected to the proposal. See Comment Letter of 
Douglas Scheidt (May 29, 2020) (``Scheidt Comment Letter 1'') and 
(June 29, 2020) (``Scheidt Comment Letter 2''); Comment Letter of 
Michael Cohan, David Jessup, Jr., and Shenghang Jiang (July 21, 
2020) (``University of Miami Comment Letter'').
    \10\ See, e.g., Comment Letter of J.P. Morgan Asset Management 
(July 15, 2020) (``JPMAM Comment Letter''); Comment Letter of the 
Vanguard Group (July 21, 2020) (``Vanguard Comment Letter''); 
Comment Letter of the Investment Company Institute (July 16, 2020) 
(``ICI Comment Letter''); Comment Letter of the Asset Management 
Group of the Securities Industry and Financial Markets Association 
(July 21, 2020) (``SIFMA AMG Comment Letter''); Comment Letter of 
Capital Research and Management Company (July 21, 2020) (``Capital 
Group Comment Letter'').
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    We are adopting rule 2a-5 and companion 17 CFR 270.31a-4 (``rule 
31a-4'' and, together with rule 2a-5, the ``rules'') with certain 
modifications from the proposal to address the comments we received, 
including targeted revisions to address issues noted with respect to 
certain of the more prescriptive elements of the proposed rule. We are 
also rescinding the Commission's previously issued guidance on the role 
of the board of directors in determining fair value and the accounting 
and auditing of fund investments as proposed and, in a change from the 
proposal, are superseding certain of the guidance on thinly traded 
securities and the use of pricing services the Commission issued in 
2014.\11\
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    \11\ Money Market Fund Reform; Amendments to Form PF, Investment 
Company Act Release No. 31166 (July 23, 2014) [79 FR 47736 (Aug. 14, 
2014)] (``2014 Money Market Fund Release'').
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II. Discussion

    The final rule provides requirements for determining fair value in 
good faith with respect to a fund for purposes of section 2(a)(41) of 
the Act and rule 2a-4 thereunder.\12\ We believe that, in light of the 
developments discussed above and in the Proposing Release, to determine 
the fair value of fund investments in good faith requires a certain 
minimum, consistent framework for fair value and standard of baseline 
practices across funds, which the final rule establishes.\13\
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    \12\ The final rule defines a ``fund'' as a registered 
investment company or a business development company. Rule 2a-
5(e)(1).
    \13\ One commenter stated that rule 2a-5 does not require the 
Commission to exercise its exemptive authority under section 6(c). 
Comment Letter of Jack Murphy (July 20, 2020) (``Murphy Comment 
Letter''). We agree and are relying on our authority under other 
provisions of the Investment Company Act, including our authority 
under section 38(a) of the Act, to adopt rule 2a-5. In any event, we 
believe the final rule's provisions are necessary or appropriate in 
the public interest and consistent with the protection of investors 
and the purposes fairly intended by the Act. Accordingly, we believe 
section 6(c) also provides additional authority for the final rule.
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    Under the final rule, fair value as determined in good faith will 
require assessing and managing material risks associated with fair 
value determinations; selecting, applying, and testing fair value 
methodologies; and overseeing and evaluating any pricing services used. 
These required functions generally reflect our understanding of current 
practices used by funds to fair value their investments, and we discuss 
each in detail below.
    The final rule also permits a fund's board \14\ to designate a 
``valuation designee'' to perform fair value determinations.\15\ The 
valuation

[[Page 750]]

designee can be the adviser of the fund or, in a change from the 
proposal, an officer of an internally managed fund.\16\ When a board 
designates the performance of determinations of fair value to a 
valuation designee for some or all of the fund's investments under the 
final rule, the final rule requires the board to oversee the valuation 
designee's performance of fair value determinations. To facilitate such 
oversight, the final rule also includes certain reporting and other 
requirements.\17\ The final rule acknowledges that, consistent with 
longstanding practice, these valuation designees often play an 
important and valuable role in carrying out the day-to-day work of 
determining fair values. Under the final rule, the board remains 
responsible for the fair value determinations required by the statute. 
Where the board designates a valuation designee to perform fair value 
determinations under the final rule, the board will fulfill its 
continuing statutory obligations through active oversight of the 
valuation designee's performance of fair value determinations and 
compliance with the other requirements of the final rule.\18\
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    \14\ For purpose of the final rule, ``board'' means either the 
fund's entire board of directors or a designated committee of such 
board composed of a majority of directors who are not interested 
persons of the fund. Rule 2a-5(e)(3).
    \15\ See infra footnotes 138-140 and accompanying text 
(discussing the change from the proposed ``assign'' to the term 
``designate'' in the final rule).
    \16\ Rule 2a-5(e)(4).
    \17\ Rule 2a-5(b).
    \18\ One commenter stated his belief that the Commission would 
need to use exemptive authority to ``shift[ ] the statutory fair 
valuation responsibilities'' away from fund directors. Scheidt 
Comment Letter 2. But see Murphy Comment Letter. As discussed above, 
we emphasize that the final rule does not in fact shift the 
statutory fair valuation responsibilities away from directors. 
Rather, the final rule establishes the requirements the board must 
meet to fulfill its continuing statutory obligations.
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    Also, as proposed, the final rule applies to all registered 
investment companies and BDCs, regardless of their classification or 
sub-classification (e.g., open-end funds and closed-end funds),\19\ or 
their investment objectives or strategies (e.g., equity or fixed 
income; actively managed or tracking an index).\20\ In the case of a 
unit investment trust (``UIT''), because a UIT does not have a board of 
directors or adviser, a UIT's trustee, or, in a change from the 
proposal, the UIT's depositor must conduct fair value determinations 
under the final rule.\21\
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    \19\ An open-end fund is a management investment company that 
offers for sale or has outstanding redeemable securities of which it 
is the issuer. See section 5(a)(1) of the Investment Company Act. A 
closed-end fund is a management investment company other than an 
open-end fund. See section 5(a)(2) of the Investment Company Act. 
Section 2(a)(48) of the Investment Company Act defines a ``business 
development company'' as any closed-end investment company that 
operates for the purpose of making investments in securities 
described in section 55(a)(1) through 55(a)(3) of the Investment 
Company Act and that makes available significant managerial 
assistance with respect to the issuers of such securities.
    \20\ See rule 2a-5(e)(1) (defining ``fund'' to mean a registered 
investment company or business development company).
    \21\ Rule 2a-5(d). Section 4(2) of the Investment Company Act 
defines a UIT as an investment company that (1) is organized under a 
trust indenture or similar instrument; (2) does not have a board of 
directors; and (3) issues only redeemable securities, each of which 
represents an undivided interest in a unit of specified securities. 
But see Form N-7 for Registration of Unit Investment Trusts under 
the Securities Act of 1933 and the Investment Company Act of 1940, 
Investment Company Act Release No. 15612, Appendix B, Guide 2 (Mar. 
9, 1987) [52 FR 8268, 8295-96 (Mar. 17, 1987)] (Staff Guidelines 
stating that the board's fair value role under section 2(a)(41) is 
to be performed by the UIT's trustee or the trustee's appointed 
person). See infra section II.E (rescission of staff guidance).
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    While many commenters thought that the proposal's general approach 
of balancing between prescriptive requirements and principles-based 
guidelines was reasonable, others requested modifications.\22\ A number 
of commenters recommended that the Commission recast the proposed rule 
as a non-exclusive safe harbor or provide additional flexibility.\23\ 
Some stated that they believed that fair value in good faith is a 
flexible concept, and thus they believed that fair value determinations 
are not amenable to a single approach, which they believed was 
consistent with the flexible approach taken in ASR 118.\24\
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    \22\ See, e.g., JPMAM Comment Letter; Vanguard Comment Letter; 
Comment Letter of State Street Global Advisors (July 21, 2020) 
(``SSGA Comment Letter''); Comment Letter of Baillie Gifford Funds 
(July 21, 2020) (``Baillie Gifford Comment Letter'').
    \23\ See, e.g., Comment Letter of Arthur E. Johnson, Chairman of 
Independent Trustees, Fidelity Fixed Income and Asset Allocation 
Funds and David M. Thomas, Co-Lead Independent Trustee, Fidelity 
Equity and High Income Funds (June 26, 2020) (``Fidelity Trustees 
Comment Letter''); ICI Comment Letter; Comment Letter of Ronald E. 
Toupin, Board Chair, Guggenheim Funds (July 20, 2020) (``Guggenheim 
Trustees Comment Letter''); Catherine L. Newell, General Counsel and 
Executive Vice President, Dimensional Fund Advisers (July 27, 2020) 
(``Dimensional Comment Letter''); Comment Letter of Dechert LLP 
(July 21, 2020) (``Dechert Comment Letter''); Comment Letter of 
David B. Smith, General Counsel, Mutual Fund Directors Forum (July 
21, 2020) (``MFDF Comment Letter'').
    \24\ See ICI Comment Letter; Fidelity Trustees Comment Letter; 
Guggenheim Trustees Comment Letter; Dimensional Comment Letter; 
Dechert Comment Letter. See also ASR 118 and Letter to Craig S. 
Tyle, General Counsel, Investment Company Institute (Dec. 8, 1999) 
and infra footnote 386 and accompanying text.
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    In light of the developments since the Commission last 
comprehensively addressed fair value determinations for funds, we 
believe that it is important to establish a minimum and consistent 
framework for fair value practices across funds. This framework also 
allows the Commission to articulate appropriate oversight measures, as 
outlined in section II.B below,\25\ that are designed to help address 
valuation risks, including those arising from conflicts of 
interest.\26\ The final rule establishes minimum and baseline standards 
that we believe are inherent in any good faith fair value 
determination, as informed by current industry practice. If we were to 
establish a safe harbor, in contrast, it may give the misleading 
impression that an approach to making fair value determinations that 
does not meet this minimum baseline would satisfy the board's statutory 
obligations.\27\ The final rule does not establish a single approach to 
making such determinations. Instead, it establishes a principles-based 
framework for boards to use in creating their own specific process for 
making fair value determinations, including through designating and 
appropriately overseeing a valuation designee to perform certain 
valuation tasks.\28\ It reflects an appropriate balance between 
providing a board or valuation designee with the flexibility to 
exercise judgment in the valuation process consistent with its good 
faith, paired with an appropriate set of baseline standards. 
Accordingly, we do not think that it is appropriate to recast rule 2a-5 
as a safe harbor. However, we do agree with commenters that additional 
flexibility is appropriate in certain areas and have made a number of 
changes from the proposal in this regard, as discussed below.\29\
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    \25\ Throughout this release, when we refer to ``appropriate'' 
oversight, we mean oversight consistent with the guidance set out 
infra in section II.B.1.
    \26\ As stated in the Proposing Release, we believe that, in 
light of the developments discussed above, to determine the fair 
value of fund investments in good faith requires a certain minimum, 
consistent framework for fair value and standard of baseline 
practices across funds, which would be established by the final 
rule. See Proposing Release, supra footnote 2, at 14-15.
    \27\ We do not believe that establishing a baseline for making 
fair value determinations detracts from, or is at odds with, the 
board's fiduciary duty. Nothing in this rulemaking should be 
construed as abrogating or limiting any of the fiduciary duties that 
boards owe to funds. See, e.g., section 36(a) of the Act; Burks v. 
Lasker, 441 U.S. 471, 484-85 (1970).
    \28\ See also Fidelity Comment Letter (approving of the proposed 
approach of describing the process that must be followed rather than 
the describing with specificity the substantive elements of a proper 
fair value determination); ICI Comment Letter (appreciating that the 
Commission has not prescribed detailed methodological or investment-
specific valuation guidance and instead emphasized process, 
reporting, and oversight).
    \29\ See, e.g., infra section II.B.2.
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    In support of a safe-harbor approach, some commenters raised 
concerns that violations of the proposed rule that may not directly 
impact the value given to an asset, for example a failure to keep 
records for the prescribed period, could

[[Page 751]]

raise doubts about whether a valuation was made consistent with the 
requirements of the Act. These commenters stated that this would be 
true even where the end result of the actual valuation was 
appropriate.\30\ In response to these concerns, as discussed below, we 
are tailoring certain of the proposed reporting requirements and moving 
the proposed recordkeeping requirements out of rule 2a-5 and into a 
separate rule under the Act.\31\ While a board or adviser's failure to 
comply with the final rule's requirements may call into question the 
effectiveness of the fund's fair value process and its compliance 
program, the Commission underscores that the objective of the final 
rule is to ensure that a fund's assets are properly valued. A violation 
of the final rule does not necessarily mean that the actual values 
ascribed to particular fund investments were in fact inappropriate, or, 
for example, that the fund has violated rule 22c-1.
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    \30\ See, e.g., Comment Letter of Stradley Ronon Stevens Young, 
LLP (July 21, 2020) (``Stradley Comment Letter''); Comment Letter of 
Guggenheim Investments (July 21, 2020) (``Guggenheim Comment 
Letter''); Dechert Comment Letter.
    \31\ See infra section II.C.
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A. Fair Value as Determined in Good Faith Under Section 2(a)(41) of the 
Act

    Rule 2a-5 sets forth certain required functions that must be 
performed to determine the fair value of the fund's investments in good 
faith.\32\ As discussed below, we are adopting these required functions 
substantially as proposed, with several changes from the proposal based 
on the comments the Commission received.
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    \32\ As proposed, these requirements will apply to a fund's 
board that is determining fair value or, if the board designates a 
valuation designee to perform any fair value determinations as 
discussed below, to that party.
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1. Periodically Assess and Manage Valuation Risks
    We are adopting, as proposed, the requirement to assess 
periodically any material risks associated with the determination of 
the fair value of the fund's investments, including material conflicts 
of interest, and to manage those identified valuation risks.\33\ Also 
as proposed, the final rule does not identify other specific valuation 
risks that may need to be addressed under this requirement or establish 
a specific re-assessment frequency.
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    \33\ Rule 2a-5(a)(1). Valuation risk includes the risks 
associated with the process of determining whether an investment 
must be fair valued in the first place.
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    Several commenters expressed general support for the valuation risk 
requirement,\34\ with others suggesting certain modifications, 
particularly regarding whether the final rule should prescribe a 
frequency for the proposed periodic re-assessment of the fund's 
material valuation risks.\35\ One commenter opposed the proposed 
requirement entirely, and suggested that the Commission remove 
references to valuation risk from the proposed rule, on the basis that 
identified valuation risks should have no impact on the actual fair 
valuing of particular fund investments, and that this requirement thus 
would unnecessarily complicate the final rule while providing no 
investor protection benefit.\36\
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    \34\ See Comment Letter of Valuation Research Corporation (July 
21, 2020) (``VRC Comment Letter''); Murphy Comment Letter.
    \35\ See, e.g., Comment Letter of Sullivan & Worcester LLP (June 
8, 2020) (``Sullivan Comment Letter'') (suggesting requirement of 
annual re-assessment of valuation risks); Comment Letter of the 
International Valuation Standard Council (July 14, 2020) (``IVSC 
Comment Letter'') (same); but see ABA Comment Letter (stating that 
valuation policies and procedures, including procedures for re-
assessment of valuation risks, would be subject to annual review 
under rule 38a-1, and recommending no minimum frequency in final 
rule).
    \36\ See Franklin Comment Letter. For the same reasons, this 
commenter also suggested that we remove the proposed requirement 
that the adviser periodically report to the board on material 
changes to the assessment and management of valuation risks, 
including conflicts of interest. As discussed in section II.B.2.a 
below, the final rule includes periodic reporting on material 
changes in the assessment and management of valuation risks.
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    After considering these comments, we continue to believe that 
requiring the assessment and management of material valuation risks in 
the final rule will help promote an effective overall process for fair 
valuing fund investments in good faith.\37\ With respect to the 
frequency of the required periodic re-assessment of valuation risks, we 
continue to believe that different frequencies for the re-assessment of 
valuation risks may be appropriate for different funds or risks, and 
have determined not to modify the proposed rule to include a required 
minimum frequency. We also continue to believe, as stated in the 
Proposing Release, that the periodic re-assessment of valuation risk 
generally should take into account changes in fund investments, 
significant changes in a fund's investment strategy or policies, market 
events, and other relevant factors.\38\
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    \37\ The final rule will require, among other things, that the 
board or valuation designee, as applicable, take into account the 
fund's valuation risks in establishing and applying fair value 
methodologies and, where the board has designated the valuation 
designee to perform fair value determinations, periodic reporting on 
material changes in the management and assessment of valuation 
risks, as discussed in section II.B.2.a) below. See rule 2a-5(a)(2).
    \38\ See Proposing Release, supra footnote 2, at section II.A.1.
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    The Proposing Release also included a non-exhaustive list of 
examples of sources or types of valuation risk.\39\ As discussed below, 
we are reiterating this non-exhaustive list here, with several 
modifications to broaden the examples to include additional sources and 
types of risk raised by commenters.
---------------------------------------------------------------------------

    \39\ See id.
---------------------------------------------------------------------------

    We received a number of comments on the list of sources and types 
of valuation risk. One commenter expressed general support for the 
inclusion of this list, including its level of generality in describing 
sources and types of risk.\40\ One commenter, on the other hand, stated 
that this list would cause confusion because funds cannot anticipate 
how the identified sources and types of valuation risk will affect the 
valuation of particular investments.\41\ One commenter stated that the 
text of the final rule should identify specific valuation risks 
(similar to the non-exhaustive list discussed in the Proposing Release) 
that a board or adviser, as applicable, must assess and manage.\42\ 
Other commenters recommended that the Commission identify additional 
sources and types of valuation risks.\43\
---------------------------------------------------------------------------

    \40\ See, e.g., Murphy Comment Letter.
    \41\ See Franklin Comment Letter (questioning whether funds 
should be expected to anticipate ``potential market shocks or 
dislocations'' in fair valuing their investments). See also ABA 
Comment Letter (stating that a board or adviser's assessment of 
valuation risks cannot account for potential future events, such as 
potential market shocks or dislocations that could change the 
assessment or management of valuation risk).
    \42\ See University of Miami Comment Letter.
    \43\ See, e.g., Comment Letter of IHS Markit (July 21, 2020) 
(``IHS Markit Comment Letter'') (stating that additional risks 
include the market structure for the asset); Murphy Comment Letter 
(stating that additional risks include the possibility that an 
adviser or third-party service provider will be unable to operate).
---------------------------------------------------------------------------

    One commenter recommended we clarify that the assessment and 
management of valuation risks other than those identified in the 
Proposing Release can satisfy this requirement.\44\ Similarly, one 
commenter suggested we clarify that some sources or types of valuation 
risk may be considered more or less important than others based on a 
particular fund's investments, the markets in which its investments 
trade, reliance on third-party service providers, and other relevant 
circumstances.\45\
---------------------------------------------------------------------------

    \44\ See Stradley Comment Letter.
    \45\ See ABA Comment Letter.
---------------------------------------------------------------------------

    After considering these comments, we continue to believe that a 
fund's specific

[[Page 752]]

valuation risks depend on the facts and circumstances of the particular 
fund's investments. As such, we believe that the non-exhaustive list of 
examples of sources and types of valuation risk, set forth below, is 
appropriate. As we stated in the Proposing Release, the risks 
identified are not intended to be a comprehensive list of all possible 
sources of valuation risk, but a set of examples that may help inform 
fund boards and valuation designees. We agree that the additional risks 
identified by commenters may also be relevant for certain funds, and 
have broadened the list provided below in several respects to include 
those risks. The final rule, like the proposal, is designed to provide 
a board or valuation designee, as applicable, with the flexibility to 
determine which of the identified sources and types of valuation risk 
are relevant to the fund's investments, as well as to identify other 
risks not listed here. The final rule also provides flexibility to 
determine whether certain sources and types of valuation risk should be 
weighed more heavily than others.
    As such, the following is a non-exhaustive list of sources or types 
of valuation risk:
     The types of investments held or intended to be held by 
the fund \46\ and the characteristics of those investments; \47\
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    \46\ We recognize that in assessing and managing this potential 
source of valuation risk, a board or valuation designee, as 
applicable, may not be able to identify all of the types of 
investments the fund will hold or the specific valuation risks 
related to such investments. This risk assessment and management 
generally should take into account those investments that the fund 
reasonably expects to purchase in the reasonably near term.
    \47\ Investment characteristics would include among other 
things, the size of the investment relative to measures of market 
demand, such as daily trading volume.
---------------------------------------------------------------------------

     Potential market or sector shocks or dislocations and 
other types of disruptions that may affect a valuation designee's or a 
third-party's ability to operate; \48\
---------------------------------------------------------------------------

    \48\ Indicators of potential market or sector shocks or 
dislocations could include a significant change in short-term 
volatility or market liquidity, significant changes in trading 
volume, or a sudden increase in trading suspensions. Additional 
types of disruptions that may affect a valuation designee's or a 
third-party's ability to operate include, for example, a system 
failure or cyberattack.
---------------------------------------------------------------------------

     The extent to which each fair value methodology uses 
unobservable inputs, particularly if such inputs are provided by the 
valuation designee; \49\
---------------------------------------------------------------------------

    \49\ See infra footnotes 354-355 and accompanying text.
---------------------------------------------------------------------------

     The proportion of the fund's investments that are fair 
valued as determined in good faith, and their contribution to the 
fund's returns;
     Reliance on service providers that have more limited 
expertise in relevant asset classes; the use of fair value 
methodologies that rely on inputs from third-party service providers; 
and the extent to which third-party service providers rely on their own 
service providers (so-called ``fourth-party'' risks); and
     The risk that the methods for determining and calculating 
fair value are inappropriate or that such methods are not being applied 
consistently or correctly.
2. Establish and Apply Fair Value Methodologies
    As proposed, the final rule will provide that fair value as 
determined in good faith requires the board or valuation designee, as 
applicable, to establish and apply fair value methodologies. To satisfy 
this requirement, a board or valuation designee, as applicable, must:
    (1) Select and apply appropriate fair value methodologies;
    (2) Periodically review the appropriateness and accuracy of the 
methodologies selected and make any necessary changes or adjustments 
thereto; and
    (3) Monitor for circumstances that may necessitate the use of fair 
value.
    As discussed below, we are adopting these functions substantially 
as proposed, with certain modifications to respond to commenters' 
concerns and suggestions.
(a) Select and Apply Appropriate Fair Value Methodologies
    The final rule will require the board or valuation designee, as 
applicable, to select and apply in a consistent manner an appropriate 
methodology or methodologies \50\ for determining (which includes 
calculating) the fair value of fund investments.\51\ As proposed, to 
satisfy this requirement, the board or valuation designee, as 
applicable, will have to specify the key inputs and assumptions 
specific to each asset class or portfolio holding.\52\ We are, however, 
modifying the requirement to select and apply appropriate methodologies 
in the final rule in two ways to address commenter concerns and 
suggestions. First, the final rule will provide that the selected 
methodologies for fund investments may be changed if different 
methodologies are equally or more representative of the fair value of 
the investments. Second, the final rule will not require the 
specification of methodologies that will apply to new types of 
investments in which the fund intends to invest.
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    \50\ As the Commission stated in the Proposing Release, ASC 
Topic 820 refers to valuation approaches and valuation techniques. 
In practice, many valuation techniques are referred to as methods 
(e.g., discounted cash flow method). As a result, this Adopting 
Release uses the terms ``technique'' and ``method'' interchangeably 
to refer to a specific way of determining fair value and likewise 
uses the terms ``methods'' and ``methodologies'' interchangeably.
    \51\ Proposing Release, supra footnote 2, at n.45 and 
accompanying text. As stated in the Proposing Release, regarding the 
key inputs and assumptions specific to each asset class or portfolio 
holding, it would not be sufficient, for example, to simply state 
that private equity investments are valued using a discounted cash 
flow model, or that options are valued using a Black-Scholes model, 
without providing any additional detail on the specific qualitative 
and quantitative factors to be considered, the sources of the 
methodology's inputs and assumptions, and a description of how the 
calculation is to be performed (which may, but need not necessarily, 
take the form of a formula).
    \52\ See rule 2a-5(a)(2)(i).
---------------------------------------------------------------------------

    We received numerous comments on the proposed requirement that the 
board or adviser, as applicable, select and apply in a consistent 
manner an appropriate methodology or methodologies for determining 
(which includes calculating) the fair value of fund investments. These 
commenters generally requested clarification relating to the proposed 
requirement that a board or adviser, as applicable, select and apply 
fair value methodologies ``in a consistent manner.'' Several commenters 
stated that this proposed requirement suggested that a board or 
adviser, as applicable, generally may select only one methodology per 
asset class, and requested we clarify that this requirement does not 
preclude a board or adviser, as applicable, from selecting different 
methodologies for different securities within the same asset class or 
sub-class.\53\ The final rule clarifies that this requirement is not 
meant to limit a board or valuation designee, as applicable, from using 
an appropriate methodology to fair value an investment, even if other 
investments within the same ``asset class'' are fair valued using a 
different appropriate methodology.
---------------------------------------------------------------------------

    \53\ See, e.g., ICI Comment Letter; Sullivan Comment Letter; 
Murphy Comment Letter; Comment Letter of MFS Investment Management 
(July 21, 2020) (``MFS Comment Letter''); Comment Letter of John 
Hancock Investment Management LLC (July 21, 2020) (``John Hancock 
Comment Letter'').
---------------------------------------------------------------------------

    Similarly, commenters requested we clarify that the requirement to 
select and apply fair value methodologies in a consistent manner does 
not restrict a board's or adviser's ability to change the selected 
methodology for an investment or asset class under appropriate 
circumstances.\54\ We recognize that

[[Page 753]]

there may be circumstances where it is appropriate to change a 
methodology if it would result in a measurement that is equally or more 
representative of fair value.\55\ Accordingly, we have modified the 
final rule to clarify that the requirement to apply fair value 
methodologies in a consistent manner does not preclude the board or 
valuation designee, as applicable, from changing the methodology for an 
investment in such circumstances.\56\ Applying a methodology 
consistently is not meant to lock in place a rigid pre-established 
methodology, but instead to address the risks associated with switching 
methodologies in order to achieve a specific outcome. Accordingly, the 
consistent application of appropriate methodologies allows for a board 
or valuation designee, as applicable, to select and apply a different 
methodology or methodologies for investments in the same asset class, 
or to change the methodology selected for one or more particular 
investments, based on changes to the facts and circumstances related to 
the particular investment if different methodologies are equally or 
more representative of the fair value of the investments.\57\ Any 
change in methodology must be documented under the applicable 
recordkeeping requirements.\58\
---------------------------------------------------------------------------

    \54\ See, e.g., Sullivan Comment Letter; IVSC Comment Letter; 
JPMAM Comment Letter; Comment Letter of Seward & Kissel LLP (July 
20, 2020) (``Seward & Kissel Comment Letter''). For this reason, two 
commenters also suggested that we remove this term from the final 
rule. See Franklin Comment Letter; Comment Letter of Federated 
Hermes, Inc. (July 21, 2020) (``Federated Hermes Comment Letter'').
    \55\ See ASC Topic 820-10-35-25 (requiring consistent 
application of valuation techniques, but providing that a change in 
a valuation technique or its application is appropriate if the 
change results in a measurement that is equally or more 
representative of fair value in the circumstances).
    \56\ See rule 2a-5(a)(2)(i).
    \57\ A change includes using a new methodology or making a 
material adjustment to an existing methodology. See JPMAM Comment 
Letter.
    \58\ See rule 31a-4(a). Furthermore, where the board has 
designated the valuation designee to perform fair value 
determinations, the final rule will require that the valuation 
designee periodically report to the board on material changes to, or 
material deviations from, the fair value methodologies established 
under this requirement. See rule 2a-5(b)(1)(i)(A)(2)(ii).
---------------------------------------------------------------------------

    Commenters questioned our statement in the Proposing Release that 
to be appropriate under rule 2a-5, a methodology used for purposes of 
determining fair value must be consistent with ASC Topic 820,\59\ and 
thus must be derived from one of the principles-based approaches 
described therein.\60\ Some of these commenters suggested that ASC 
Topic 820 is not appropriately tailored to address all of the specific 
circumstances that may arise for a fund that values its assets daily, 
and stated that we should either provide more specific guidance for 
certain funds or investments,\61\ or not limit appropriate 
methodologies to those addressed in ASC Topic 820.\62\
---------------------------------------------------------------------------

    \59\ Currently, ASC Topic 820 refers to valuation approaches, 
including the market approach, income approach, and cost approach, 
as well as valuation techniques and methods as ways in which to 
measure fair value. See supra footnote 50.
    \60\ See, e.g., NYC Bar Comment Letter; Scheidt Comment Letter 
2.
    \61\ See Scheidt Comment Letter 2.
    \62\ See ABA Comment Letter.
---------------------------------------------------------------------------

    We believe that an appropriate methodology must be consistent with 
those used to prepare the fund's financial statements and thus be 
consistent with the principles of the valuation approaches laid out in 
ASC Topic 820. Therefore, if a valuation methodology was used that is 
not consistent with the principles of the valuation approaches laid out 
in ASC Topic 820, we would presume that use of such a methodology would 
be misleading or inaccurate. While the valuation approaches laid out in 
ASC Topic 820 may not directly address every situation that a fund may 
face because the accounting standards are principles-based, we believe 
that taking a valuation approach that is inconsistent with the 
principles outlined in ASC Topic 820 may result in a fund having a 
misleading or inaccurate fair value process because such an approach 
may not be consistent with U.S. GAAP and the fund's financial reporting 
process. Supplemental methodologies for situations not explicitly 
outlined in ASC Topic 820 may be appropriately applied by boards or 
valuation designees provided that the methodologies are not 
inconsistent with the principles outlined in ASC Topic 820. We 
recognize that there is no single methodology for determining the fair 
value of an investment because fair value depends on the facts and 
circumstance of each investment, including the relevant market and 
market participants.\63\ We continue to believe that for any particular 
investment, there may be a range of appropriate values that could 
reasonably be considered to be fair value, and whether a specific value 
should be considered fair value will depend on the facts and 
circumstances of the particular investment. A consistent application of 
the selected methodology or methodologies, with changes to the 
methodology or methodologies where appropriate, together with the other 
provisions of the rules, would promote unbiased determinations of fair 
value within the range.
---------------------------------------------------------------------------

    \63\ This is consistent with what the Commission previously said 
in ASR 118 (``Methods which are in accord with this principle may, 
for example, be based on a multiple of earnings, or a discount from 
market of a similar freely traded security, or yield to maturity 
with respect to debt issues, or a combination of these and other 
methods.''). Consistent with the principles in ASC Topic 820, the 
methodologies selected should maximize the use of relevant 
observable inputs and minimize the use of unobservable inputs.
---------------------------------------------------------------------------

    Commenters suggested we clarify that certain guidance provided in 
the 2014 Money Market Funds Adopting Release relating to the valuation 
of thinly traded securities is being superseded by final rule 2a-5 and 
the related guidance provided herein.\64\ We believe that the guidance 
contained in this section addresses the same concerns discussed in the 
guidance contained in the last paragraph of the section on valuing 
thinly traded securities in the 2014 Money Market Funds Adopting 
Release.\65\ Accordingly, that paragraph is superseded. As a general 
principle, determining fair value requires taking into account market 
conditions existing at the time of the determination. Accordingly, 
appropriate methodologies for funds holding debt securities generally 
should not fair value these securities at par or amortized cost based 
on the expectation that the funds will hold those securities until 
maturity, if the funds could not reasonably expect to receive 
approximately that value upon the measurement date under current market 
conditions. We continue to believe that fair value cannot be based on 
what a buyer might pay at some later time, such as when the market 
ultimately recognizes the security's true value as currently perceived 
by the portfolio manager.\66\ Funds also may not fair value portfolio 
securities at prices not achievable on a current basis on the belief 
that the fund would not currently need to sell those securities. We 
believe the principles established in ASC Topic 820, which provide that 
an investment is valued based on an exit price at the measurement date 
from the perspective of a market participant under current market 
conditions, are consistent with the statements in this paragraph.\67\
---------------------------------------------------------------------------

    \64\ See, e.g., Vanguard Comment Letter.
    \65\ See 2014 Money Market Funds Release, supra footnote 11, at 
last paragraph of section III.D.2.a.
    \66\ See 2014 Money Market Funds Release, supra footnote 11, at 
section III.D.2.a.
    \67\ See ASC 820-10-35-3 and ASC 820-10-20 (``A fair value 
measurement assumes that the asset or liability is exchanged in an 
orderly transaction between market participants to sell the asset or 
transfer the liability at the measurement date under current market 
conditions.''; Fair Value means ``the price that would be received 
to sell an asset or paid to transfer a liability in an orderly 
transaction between market participants at the measurement date''). 
See also ASC Topic 820, at par. 820-10-35-54H (``A reporting 
entity's intention to hold the asset or to settle or otherwise 
fulfill the liability is not relevant when measuring fair value 
because fair value is a market-based measurement, not an entity-
specific measurement.'').

---------------------------------------------------------------------------

[[Page 754]]

    The proposed rule also would have required the board or adviser, as 
applicable, to consider the applicability of the selected fair value 
methodologies to types of fund investments that a fund does not 
currently hold but in which it intends to invest in the future.\68\ 
This requirement was designed to facilitate the effective determination 
of the fair value of these new investments by the board or adviser, as 
applicable. While one commenter suggested that this requirement was 
appropriate as proposed,\69\ other commenters generally opposed this 
requirement as being potentially overly burdensome by requiring boards 
and advisers to establish a predetermined list of methodologies to 
account for all types of new investments in which the fund may 
invest.\70\
---------------------------------------------------------------------------

    \68\ Proposed rule 2a-5(a)(2)(i)(B).
    \69\ See IHS Markit Comment Letter (stating that funds currently 
have processes in place to ensure that a methodology and supporting 
pricing service provider are in place to cover new investments).
    \70\ See, e.g., Sullivan Comment Letter; Seward & Kissel Comment 
Letter; ABA Comment Letter; VRC Comment Letter.
---------------------------------------------------------------------------

    We are persuaded that specifically requiring a predetermination of 
the methodologies that must be applied to hypothetical future 
investments could cause undue burdens to the extent it caused a fund to 
establish methodologies for assets in which a fund ultimately does not 
invest. Moreover, a fund will be required to value all of its 
investments, regardless of whether the fund had pre-determined a 
methodology. We believe that the general requirement under the final 
rule to select and apply in a consistent manner an appropriate 
methodology or methodologies for determining (and calculating) the fair 
value of fund investments,\71\ will require a board or a valuation 
designee, where applicable, to determine which methodology is 
appropriate for a new investment type that a fund has actually 
purchased by the time the investments are valued. Accordingly, we have 
determined to remove from the final rule the proposed specific 
requirement that a board or adviser, as applicable, specify in advance 
the fair value methodologies that will apply to new types of 
investments in which the fund intends to invest.
---------------------------------------------------------------------------

    \71\ See rule 2a-5(a)(1).
---------------------------------------------------------------------------

(b) Periodically Review the Appropriateness and Accuracy of the 
Methodologies Selected
    To establish and apply fair value methodologies appropriately, the 
final rule will require a board or valuation designee to review 
periodically the selected fair value methodologies for appropriateness 
and accuracy, and to make changes or adjustments to the methodologies 
where necessary.\72\ We are adopting this requirement substantially as 
proposed, with one modification, discussed below, to respond to a 
comment we received. In addition, as stated in the Proposing Release, 
the results of back-testing or calibration (as discussed below) or a 
change in circumstances specific to an investment, for example, could 
necessitate adjustments to a fund's fair value methodologies.\73\
---------------------------------------------------------------------------

    \72\ See Proposing Release, supra footnote 2, at n.50 and 
accompanying text.
    \73\ Cf. ASC Topic 820-10-35-25, which provides a non-exhaustive 
list of events that may warrant a change or an adjustment to a 
valuation technique, including where (1) new markets develop, (2) 
new information becomes available, (3) information previously used 
is no longer available, (4) the valuation technique improves, and 
(5) market conditions change. Boards or valuation designees 
generally should seek to account for such occurrences and consider 
specifying alternative sources.
---------------------------------------------------------------------------

    We received one comment on this requirement. The commenter 
generally supported it, but suggested we clarify that ``adjustments'' 
to the selected fair value methodologies under this requirement may 
include a change to new appropriate methodologies.\74\ We agree, and 
have added the word ``change'' to the final rule to clarify that a 
necessary adjustment to the selected methodology under the final rule 
is not limited to modifying an existing methodology for a particular 
investment (for example, adjusting inputs), but also may include 
changing to a new methodology where appropriate.\75\
---------------------------------------------------------------------------

    \74\ See Murphy Comment Letter.
    \75\ See supra section II.A.2.a).
---------------------------------------------------------------------------

(c) Monitor for Circumstances That May Necessitate the Use of Fair 
Value
    As proposed, the final rule will also require the board or 
valuation designee, as applicable, to monitor for circumstances that 
may necessitate the use of fair value as determined in good faith.\76\ 
For example, if a fund invests in securities that trade in foreign 
markets, the board or valuation designee, as applicable, generally 
should identify and monitor for the kinds of significant events that, 
if they occurred after the market closes in the relevant jurisdiction 
but before the fund prices its shares, would materially affect the 
value of the security and therefore may suggest that market quotations 
are not reliable.\77\
---------------------------------------------------------------------------

    \76\ Rule 2a-5(a)(2)(iii).
    \77\ Cf. ASC Topic 820-10-35-41C(b).
---------------------------------------------------------------------------

    One commenter generally requested we clarify that this requirement 
is not meant to require the board or valuation designee, where 
applicable, to identify in advance all of the circumstances that may 
require the use of fair value.\78\ While we agree that the 
circumstances that may necessitate fair value depend on the facts and 
circumstances of the particular fund's investments and that certain of 
these circumstances cannot be established in advance, we also believe 
that monitoring for circumstances that may require the use of fair 
value is an important element of an effective overall process for 
determining fair value in good faith.
---------------------------------------------------------------------------

    \78\ See John Hancock Comment Letter.
---------------------------------------------------------------------------

    The proposed rule also would have required the establishment of 
criteria for determining when market quotations are no longer reliable 
and therefore not readily available.\79\ One commenter viewed this 
proposed requirement as potentially being overly restrictive of boards' 
and advisers' discretion to question the reliability of market 
quotations, and suggested we remove it from the final rule.\80\ Another 
commenter suggested that requiring a board or adviser to identify in 
advance all of the criteria indicating when a market quotation may not 
be reliable would be overly burdensome.\81\
---------------------------------------------------------------------------

    \79\ Proposed rule 2a-5(a)(2)(iv).
    \80\ See Sullivan Comment Letter.
    \81\ See John Hancock Comment Letter.
---------------------------------------------------------------------------

    Although this requirement derived from the Commission's positions 
under the compliance rule,\82\ we have determined to remove it from the 
final rule. We agree with commenters that requiring, in advance, a list 
of specific criteria for determining when market quotations may no 
longer be reliable could limit the board's or valuation designee's 
flexibility to consider the full range of conditions that may affect 
the reliability of market quotations. In addition, we believe that to 
satisfy the requirement to monitor for circumstances that may 
necessitate the use of fair value, discussed above, boards and 
valuation designees would have to take into account the circumstances 
that may cause market quotations to be no longer reliable. The final 
rule, however, will not require

[[Page 755]]

those broader circumstances to be captured in specific criteria.
---------------------------------------------------------------------------

    \82\ See Compliance Programs of Investment Companies and 
Investment Advisers, Investment Company Act Release No. 26299 (Dec. 
17, 2003) [68 FR 74713 (Dec. 24, 2003)] (``Compliance Rules Adopting 
Release'').
---------------------------------------------------------------------------

3. Test Fair Value Methodologies for Appropriateness and Accuracy
    As proposed, the final rule will require the testing of the 
appropriateness and accuracy of the methodologies used to calculate 
fair value.\83\ This requirement is designed to help ensure that the 
selected fair value methodologies are appropriate and that adjustments 
to the methodologies are made where necessary. The final rule, similar 
to the proposal, will require the board or valuation designee, as 
applicable, to identify the testing methods to be used and the minimum 
frequency with which such testing methods are used, but will not 
require particular testing methods or a specific minimum frequency for 
the testing.
---------------------------------------------------------------------------

    \83\ Rule 2a-5(a)(3).
---------------------------------------------------------------------------

    While several commenters supported the proposed requirement,\84\ 
other commenters recommended that we modify or clarify the requirement 
in the final rule. One commenter recommended that we remove from the 
final rule the proposed requirement that the adviser or board identify 
the testing methods to be used and the minimum frequency with which 
such testing methods are used, viewing it as overly prescriptive and 
too limiting of the discretion of the board or adviser, as applicable, 
to determine how testing should be conducted.\85\ Several commenters 
recommended we clarify that parties other than the board or adviser, as 
applicable, such as pricing services, may perform the testing.\86\ One 
commenter asked that we provide a de minimis exception to the proposed 
testing requirement for funds that have a limited amount of fair valued 
investments.\87\ Finally, one commenter recommended that the final rule 
require that methodology testing be performed at least quarterly or 
whenever the fund provides financial statements to investors.\88\
---------------------------------------------------------------------------

    \84\ See, e.g., Baillie Gifford Comment Letter; Capital Group 
Comment Letter; Comment Letter of Invesco Advisers, Inc. (July 21, 
2020) (``Invesco Comment Letter'').
    \85\ See Franklin Comment Letter.
    \86\ See ICI Comment Letter; IHS Markit Comment Letter; Comment 
Letter of New York State Society of Certified Public Accountants 
(Jul. 22, 2020) (``NYSSCPA Comment Letter''). We received several 
comments generally requesting that we clarify that the board or 
adviser, where applicable, may engage third parties to assist with 
fair value determinations. Those comments are addressed below in 
section II.B relating to guidance on assistance of others.
    \87\ See NYSSCPA Comment Letter.
    \88\ See Comment Letter of CFA Institute (July 21, 2020) (``CFA 
Institute Comment Letter'').
---------------------------------------------------------------------------

    After considering these comments, we continue to believe that the 
specific tests to be performed and the frequency with which such tests 
should be performed are matters that depend on the circumstances of 
each fund and thus should be determined by the board or the valuation 
designee, as applicable. We also continue to believe that requiring the 
identification of (1) the testing methods to be used, and (2) the 
minimum frequency of the testing, is appropriate and still provides 
boards and valuation designees with flexibility to perform methodology 
testing based on the particular circumstances of a particular fund.\89\ 
We believe that funds that have even a limited amount of fair valued 
investments should test their methodologies, and therefore are not 
providing a de minimis exception.\90\ Testing can often reveal 
important information about the continuing appropriateness of a 
methodology. We expect the frequency and nature of testing would vary 
depending on the type and amount of investments held by the fund. If a 
specific methodology consistently over-values or under-values one or 
more fund investments as compared to observed transactions, the board 
or valuation designee, as applicable, should investigate the reasons 
for this difference.
---------------------------------------------------------------------------

    \89\ Calibration can assist in assessing whether the fund's 
valuation technique reflects current market conditions, and whether 
any adjustments to the valuation technique are appropriate. 
``Calibration'' for these purposes is the process for monitoring and 
evaluating whether there are material differences between the actual 
price the fund paid to acquire portfolio holdings that received a 
fair value under the Act and the prices calculated for those 
holdings by the fund's fair value methodology at the time of 
acquisition. See Proposing Release, supra footnote 2, at n.57.
    \90\ See NYSSCPA Comment Letter.
---------------------------------------------------------------------------

    Calibration and back-testing are examples of particularly useful 
testing methods to identify trends in certain circumstances, and 
potentially to assist in identifying issues with methodologies applied 
by fund service providers, including poor performance or potential 
conflicts of interest.\91\ Several commenters recommended we clarify 
that this statement is not meant to suggest that calibration and back-
testing are required testing methods, or that the use of appropriate 
testing methods other than calibration and back-testing would not 
satisfy the testing requirement.\92\ While we believe that calibration 
and back-testing are methods that should be used for testing the 
appropriateness and accuracy of funds' fair value methodologies in many 
circumstances, the final rule does not require calibration and back-
testing, nor does it preclude boards or valuation designees, where 
applicable, from using other appropriate testing methods.\93\ We expect 
that as testing methodologies are developed and change over time, new 
and different tools for testing may also become more prominent or 
useful. The final rule provides flexibility to allow funds to use new, 
appropriate testing methods.
---------------------------------------------------------------------------

    \91\ As stated in the Proposing Release, back-testing involves a 
comparison of the fair value ascribed to the fund's investment 
against observed transactions or other market information, such as 
quotes from dealers or data from pricing services. One common form 
of back-testing is ``disposition analysis,'' which compares a fair 
value as determined using a fair value technique with the price 
obtained for the security upon its disposition by the fund. See 
Proposing Release, supra footnote 2, at n.58.
    \92\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc. 
(``July 21, 2020) (``TRC Comment Letter''); SIFMA Comment Letter; 
CFA Institute Comment Letter.
    \93\ We recognize, for example, that back-testing as a testing 
method may be less useful for portfolio holdings that trade 
infrequently. See Proposing Release, supra footnote 2, at n.59 and 
accompanying text.
---------------------------------------------------------------------------

4. Pricing Services
    As proposed, the final rule will provide that determining fair 
value in good faith requires the oversight and evaluation of pricing 
services, where used.\94\ For funds that use pricing services, the 
final rule will require that the board or valuation designee, as 
applicable, establish a process for approving, monitoring, and 
evaluating each pricing service provider. The final rule also will 
require that the board or valuation designee, as applicable, establish 
a process for initiating price challenges as appropriate. Commenters 
generally supported the proposal to require the board or adviser, as 
applicable, to oversee and evaluate pricing services.\95\ One 
commenter, however, stated that this oversight provision is unnecessary 
in the case of pricing services that are not affiliated with the fund's 
adviser.\96\ This commenter stated that pricing services should not be 
distinguished from other third-party fund service providers, which 
advisers oversee to meet their own fiduciary obligations. Another 
commenter questioned the significance

[[Page 756]]

of a pricing service's conflicts of interest, stating that pricing 
services maintain relationships with a wide variety of investment 
advisers, and generally are expected to provide the same valuation 
information with respect to a particular security to all funds.\97\ As 
a result, this commenter asserted that it would be less likely for a 
pricing service to be unduly pressured to provide favorable information 
in a particular scenario or to a particular investment adviser. We 
believe, however, that the conflict is not necessarily one of 
responding to pressure from a particular investment adviser, but, 
rather, a pricing service might generally provide higher or more 
aggressive valuations to retain business.
---------------------------------------------------------------------------

    \94\ Rule 2a-5(a)(4).
    \95\ See, e.g. Comment Letter of Deloitte & Touche LLP (July 15, 
2020) (``Deloitte Comment Letter''); Fidelity Trustees Comment 
Letter; John Hancock Comment Letter; ICI Comment Letter; Comment 
Letter of Council of Institutional Investors (July 20, 2020) 
(``Council of Institutional Investors Comment Letter''); Comment 
Letter of AIMA (July 21, 2020) (``AIMA Comment Letter); Vanguard 
Comment Letter; Invesco Comment Letter; MFS Comment Letter; VRC 
Comment Letter; Guggenheim Comment Letter; TRP Comment Letter; IVSC 
Comment Letter; Comment Letter of Harvest Investments, Ltd. (July 
21, 2020) (``Harvest Comment Letter''); Murphy Comment Letter.
    \96\ Stradley Comment Letter.
    \97\ John Hancock Comment Letter.
---------------------------------------------------------------------------

    We believe, and many commenters agreed, that pricing services play 
an important role in the fair value process by providing information on 
evaluated prices, matrix prices, price opinions, or similar pricing 
estimates or information that can assist in determining the fair value 
of fund investments.\98\ Additionally, we believe that pricing services 
may have conflicts of interest such as maintaining continuing business 
relationships with the valuation designee. Therefore, given the 
widespread reliance on pricing services, the critical role they play in 
the valuation of fund investments, and their potential conflicts of 
interests, regardless of whether they are affiliated with the fund's 
adviser, the final rule will require that pricing services be subject 
to oversight so that the board or valuation designee, as applicable, 
has a reasonable basis to use the pricing information it receives as an 
input in determining fair value in good faith. To oversee pricing 
services effectively, the board or valuation designee, as applicable, 
should establish a process for the approval, monitoring, and evaluation 
of each pricing service provider used.
---------------------------------------------------------------------------

    \98\ See, e.g. Fidelity Trustees Comment Letter; Deloitte 
Comment Letter. See also Capital Group Comment Letter (noting that 
more than 50% of the fund portfolios with non-U.S. equity strategies 
may be subject to non-U.S. price adjustments due to significant U.S. 
market moves, which would require pricing services to provide a 
substantial amount of pricing information).
---------------------------------------------------------------------------

    In a change from the proposal, we are modifying the final rule to 
require funds to establish a process for initiating price challenges as 
appropriate, instead of the proposed approach that would have required 
funds to establish criteria for the circumstances under which price 
challenges would be initiated.\99\ Many commenters stated that 
requiring funds to establish specific criteria, such as objective 
thresholds, for price challenges was too rigid. Commenters were 
concerned that this would result in rote or mechanical price challenges 
that may be unnecessary, while not covering price challenges that may 
be appropriate based on facts and circumstances not readily susceptible 
to being distilled into criteria specified in advance.\100\ Commenters 
stated that the circumstances under which a fund might initiate a price 
challenge are not always objective or based on set criteria given the 
myriad of different, and often fluid, data sources and inputs that 
could lead to challenges.\101\
---------------------------------------------------------------------------

    \99\ See Proposing Release, supra footnote 2, at text following 
n.63 (stating that price challenges are typically initiated when 
pricing information from a pricing service differs materially from 
the board's or adviser's view of the fair value of an investment).
    \100\ See e.g., ICI Comment Letter; JPMAM Comment Letter; John 
Hancock Comment Letter; Dechert Comment Letter; SIFMA AMG Comment 
Letter; TRP Comment Letter; Guggenheim Comment Letter; Comment 
Letter of Jon Hunt and Joseph T. Grause, Trustee and Lead Non-
Interested Trustee, Advisors' Inner Circle Funds Trusts (July 23, 
2020) (``Advisor's Inner Circle Trustees Comment Letter''); Murphy 
Comment Letter.
    \101\ See e.g., Capital Group Comment Letter; John Hancock 
Comment Letter.
---------------------------------------------------------------------------

    After considering comments, we agree that there can be a range of 
circumstances under which a price challenge may be warranted, some of 
which cannot be distilled into specific criteria in advance.\102\ For 
example, such an approach may lead the valuation designee to challenge 
pricing information that is reasonable given market conditions, solely 
because such pricing information meets the pre-established criteria. We 
believe, however, that appropriate oversight of pricing services 
includes a rigorous analysis of the pricing information provided by 
pricing services and any price challenges, where appropriate. 
Therefore, we are amending this requirement to require that funds 
establish a process for initiating price challenges, instead of pre-
established criteria.\103\ Such a process generally should outline the 
circumstances under which a price challenge should be initiated.\104\
---------------------------------------------------------------------------

    \102\ See e.g., ICI Comment Letter; Guggenheim Comment Letter; 
TRP Comment Letter.
    \103\ See e.g. SIFMA AMG Comment Letter.
    \104\ If the board designates a valuation designee to perform 
fair value determinations, the process for initiating price 
challenges established by the valuation designee is required to be 
subject to appropriate board oversight under rule 2a-5. See infra 
text accompanying footnotes 214-218 (noting that a valuation 
designee may have an incentive to value fund assets improperly in 
order to increase fees and that, therefore, as part of the board's 
oversight responsibilities, the board should seek to identify such 
potential conflicts of interest, monitor such conflicts, and take 
reasonable steps to manage such conflicts).
---------------------------------------------------------------------------

    Several commenters urged the Commission to provide additional 
guidance concerning who would qualify as a pricing service under the 
final rule.\105\ Two commenters stated that the term ``pricing 
service'' as used in the Proposing Release is not entirely consistent 
with the definition in the Public Company Accounting Oversight Board 
(PCAOB) standards for auditing fair value measurements.\106\ We are not 
adopting a specific list of criteria for who may qualify as a pricing 
service because we believe that it may become outdated over time and 
that the scope of the term ``pricing service'' is generally understood 
by boards and valuation designees. However, as we stated in the 
Proposing Release, we refer to pricing services as third parties that 
regularly provide funds with information on evaluated prices, matrix 
prices, price opinions, or similar pricing estimates or information to 
assist in determining the fair value of fund investments.\107\ We 
believe that the types of entities that would be pricing services under 
the final rule would include pricing services as defined in the PCAOB 
standards.\108\
---------------------------------------------------------------------------

    \105\ See e.g., Comment Letter of Refinitiv Evaluated Pricing 
Service (July 21, 2020) (``Refinitiv Comment Letter''); Comment 
Letter of ICE Data Pricing & Reference Data, LLC (July 21, 2020) 
(``ICE Data Comment Letter''); Capital Group Comment Letter; AIMA 
Comment Letter; Comment Letter of KPMG (July 20, 2020) (``KPMG 
Comment Letter''); Comment Letter of Duffs and Phelps (July 21, 
2020) (``Duff & Phelps Comment Letter''); Comment Letter of the 
American Society of Appraisers (July 21, 2020) (``ASA Comment 
Letter'').
    \106\ See KPMG Comment Letter; see also Duff & Phelps Comment 
Letter.
    \107\ See Proposing Release, supra footnote 2, at text 
accompanying n.60.
    \108\ See PCAOB AS 2501.
---------------------------------------------------------------------------

    Some commenters suggested we also include a specific requirement 
for a fund's board or adviser, as applicable, to periodically review 
the selection of pricing services and to evaluate other pricing 
services.\109\ Two commenters, in contrast, stated that such a 
requirement would be unnecessary because the compliance rule already 
requires periodic reviews of service providers, including fund pricing 
services.\110\ We believe that a specific requirement to review the 
selection of pricing services is unnecessary in light of the reporting 
requirements of rule 2a-5, discussed

[[Page 757]]

below.\111\ We think that the board or the valuation designee should, 
as part of their annual review of the adequacy and effectiveness of the 
fair value process, consider the adequacy and effectiveness of the 
pricing services used given the important role that information 
provided by pricing services can play in the fair value process.
---------------------------------------------------------------------------

    \109\ See Council of Institutional Investors Comment Letter; VRC 
Comment Letter; IHS Markit Comment Letter.
    \110\ ICE Data Comment Letter; see also Refinitiv Comment 
Letter; Murphy Comment Letter. We disagree with these commenters. 
See Compliance Rules Adopting Release, supra footnote 82, at n.28 
(stating that the term ``service provider'' as used in the 
Compliance Rules Adopting Release does not include pricing 
services).
    \111\ See infra section II.B.2.
---------------------------------------------------------------------------

    In addition, several commenters stated that the oversight of 
pricing services requirements under rule 2a-5 may not be consistent 
with previous guidance regarding the use of pricing services in the 
2014 Money Market Fund Release, particularly regarding the role of the 
board of directors.\112\ Some of these commenters urged us to rescind 
that guidance and holistically address oversight of pricing services in 
this Adopting Release.\113\
---------------------------------------------------------------------------

    \112\ See MFDF Comment Letter; Fidelity Trustees Comment Letter; 
Comment Letter of Independent Directors Council (July 16, 2020) 
(``IDC Comment Letter''); NYC Bar Comment Letter; ABA Comment 
Letter; American Funds Trustees Comment Letter.
    \113\ ABA Comment Letter; IDC Comment Letter; Fidelity Trustees 
Comment Letter. See also Advisor's Inner Circle Trustees Comment 
Letter (stating its belief that the list of factors set out in the 
Proposing Release exceeds what is reasonably necessary to oversee 
pricing services, and offering, as an example, that review of a 
pricing service's valuation methods or techniques, inputs and 
assumptions is inconsistent with the role of an overseer of pricing 
services). The specific factors with which the commenter had 
concerns were also included in the guidance in the 2014 Money Market 
Fund Release. We disagree with the commenter because we believe that 
a review of a pricing service's valuation methods or techniques, 
inputs, and assumptions is a necessary factor of effective oversight 
by the valuation designee or the board, as applicable.
---------------------------------------------------------------------------

    We believe that the requirements of the final rule and the guidance 
provided in this section effectively address the concerns with 
oversight of pricing services discussed as part of the fair value 
guidance in the 2014 Money Market Fund Release. We state below our 
views on how oversight and selection of pricing services may be 
effectively conducted, which is largely consistent with our previous 
guidance from the 2014 Money Market Fund Release guidance but reflects 
the process established in rule 2a-5 allowing the board to designate 
the valuation designee to perform fair value determinations.\114\ The 
guidance below also includes certain additional factors that were 
included in the Proposing Release.\115\ Our views stated below 
supersede the guidance the Commission expressed in the 2014 Money 
Market Fund Release regarding the use of pricing services, and so we 
are rescinding that guidance.\116\
---------------------------------------------------------------------------

    \114\ See Proposing Release, supra footnote 2, at text following 
n.154 (requesting comment on whether the Commission should rescind 
any other valuation guidance in light of the proposal).
    \115\ See Proposing Release, supra footnote 2, at text 
accompanying nn.62-63.
    \116\ This rescission is limited to section III.D.2.b of the 
2014 Money Market Fund Release entitled ``Use of Pricing Services.'' 
The guidance in that release on the use of amortized cost valuation 
remains valid. See also supra footnotes 64-67 and accompanying text 
(discussing the rescission of certain guidance we provided in the 
2014 Money Market Fund Release regarding thinly traded securities).
---------------------------------------------------------------------------

    We believe that under the final rule, before deciding to use a 
pricing service, the fund's board or valuation designee, as applicable, 
generally should take into consideration factors such as: (i) The 
qualifications, experience, and history of the pricing service; (ii) 
the valuation methods or techniques, inputs, and assumptions \117\ used 
by the pricing service for different classes of holdings, and how they 
are affected (if at all) as market conditions change; \118\ (iii) the 
quality of the pricing information provided by the service and the 
extent to which the service determines its pricing information as close 
as possible to the time as of which the fund calculates its net asset 
value; \119\ (iv) the pricing service's process for considering price 
challenges, including how the pricing service incorporates information 
received from price challenges into its pricing information; (v) the 
pricing service's actual and potential conflicts of interest and the 
steps the pricing service takes to mitigate such conflicts; \120\ and 
(vi) the testing processes used by the pricing service.\121\ In 
addition, the fund's board or valuation designee, as applicable, should 
generally consider the appropriateness of using pricing information 
provided by a pricing service in determining the fair values of the 
fund's investments where, for example, the fund's board or valuation 
designee, as applicable, does not have a good faith basis for believing 
that the pricing service's pricing methodologies produce prices that 
reflect fair value.\122\
---------------------------------------------------------------------------

    \117\ In considering a pricing service's valuation methods or 
techniques, inputs, and assumptions, the fair value policies and 
procedures generally should address whether the pricing service is 
relying on inputs or assumptions provided by the valuation designee 
or its affiliates. See Proposing Release, supra footnote 2, at n.62. 
See also infra section II.B.3.
    \118\ Guidance in the 2014 Money Market Fund Release contained a 
similar position. See, e.g., 2014 Money Market Fund Release, supra 
footnote 11, at text accompanying n.899.
    \119\ Id.
    \120\ See supra footnote 97 and accompanying text (discussing 
the conflicts of interests of pricing services).
    \121\ Factors (iv) through (vi) were included in the Proposing 
Release. See Proposing Release, supra footnote 2, at text 
accompanying nn.62-63.
    \122\ The 2014 Money Market Fund Release contained a similar 
position. See, e.g., 2014 Money Market Fund Release, supra footnote 
11, at text accompanying n.899.
---------------------------------------------------------------------------

5. Fair Value Policies and Procedures
    The final rule does not include the provision in the proposal that 
would have separately required the fund to adopt written policies and 
procedures reasonably designed to achieve compliance with the 
requirements of rule 2a-5.\123\ While commenters generally supported 
this requirement,\124\ other commenters argued that policies and 
procedures required by the proposed rule are already required by the 
compliance rule and urged the Commission to clarify the interaction 
between fund obligations under the compliance rule and the policies and 
procedures required under the proposed rule.\125\
---------------------------------------------------------------------------

    \123\ Proposed rule 2a-5(a)(5).
    \124\ See, e.g., Comment Letter of IDC Comment Letter (July 21, 
2020) (``IAA Comment Letter''); Murphy Comment Letter; ICI Comment 
Letter; Invesco Comment Letter; AIMA Comment Letter; IVSC Comment 
Letter; Comment Letter of the Small Business Investor Alliance (July 
21, 2020) (``SBIA Comment Letter''); ICE Data Comment Letter; 
Fidelity Comment Letter; Comment Letter of Richard Cavanagh and 
Karen Robards, Independent Co-Chairs of the Boards of Directors/
Trustees of the Funds in the BlackRock Fixed-Income Complex (July 
17, 2020) (``BlackRock Trustees Comment Letter''); ABA Comment 
Letter; Vanguard Comment Letter.
    \125\ See, e.g., Seward & Kissel Comment Letter; ABA Comment 
Letter; Fidelity Comment Letter; NYC Bar Comment Letter. See also 
Stradley Comment Letter and Advisor's Inner Circle Trustees Comment 
Letter (noting that the proposed policies and procedures required 
under rule 2a-5 were duplicative and would be unnecessarily 
burdensome to boards).
---------------------------------------------------------------------------

    Rule 38a-1 requires a fund's board, including a majority of its 
independent directors, to approve the fund's policies and procedures, 
and those of each adviser and other specified service providers, based 
upon a finding by the board that the policies and procedures are 
reasonably designed to prevent violation of the Federal securities 
laws.\126\ We agree that, after our adoption of rules 2a-5 and 31a-4, 
the compliance rule by its terms will require the adoption and 
implementation of written policies and procedures reasonably designed 
to prevent violations of the requirements of rules 2a-5 and 31a-4 
(``fair value policies and procedures'').\127\ Accordingly, final rule 
2a-5 does not include a separate policies and procedures requirement.
---------------------------------------------------------------------------

    \126\ 17 CFR 270.38a-1(a)(2). See also Compliance Rules Adopting 
Release, supra footnote 82.
    \127\ See, e.g., Seward & Kissel Comment Letter; ABA Comment 
Letter; Fidelity Comment Letter; Advisor's Inner Circle Trustees 
Comment Letter; NYC Bar Comment Letter. See Compliance Rules 
Adopting Release, supra footnote 82, at nn.39-47.
---------------------------------------------------------------------------

    While the adopting release for the compliance rule included a 
discussion

[[Page 758]]

of certain policies and procedures for determination of fair value that 
a fund should adopt, this discussion occurred prior to our adoption of 
rule 2a-5.\128\ Rule 2a-5 creates a new framework for fair value 
determinations. As we stated in the Proposing Release, the requirements 
of rule 2a-5 and guidance in this release will supersede the Compliance 
Rules Adopting Release's discussion of policies and procedures for the 
pricing of portfolio securities and fund shares.\129\ Accordingly, to 
comply with the compliance rule, each fund must adopt and implement 
fair value policies and procedures that are reasonably designed to 
prevent violations of new rules 2a-5 and 31a-4's requirements. Because 
rules 2a-5 and 31a-4 are new rules under the Act with new fair value 
determination requirements, and given the intrinsic relationship of the 
rules to the board's own statutory functions relating to valuation, the 
fair value policies and procedures must be approved by the board 
pursuant to rule 38a-1 and may not be considered material amendments to 
existing fair value policies and procedures.\130\
---------------------------------------------------------------------------

    \128\ See Compliance Rules Adopting Release, supra footnote 82, 
at nn.39-47.
    \129\ See Proposing Release, supra footnote 2 at n.69.
    \130\ Additionally, as discussed below, rule 2a-5 continues to 
contain certain board reporting requirements specifically tailored 
to the requirements of the final rule. While the compliance rule 
separately requires the fund's chief compliance officer (``CCO'') to 
provide an annual report to the fund's board that addresses the 
operation of these policies and procedures, including any material 
changes to these policies and procedures, rule 2a-5's reporting 
requirements address a different set of concerns. See rule 38a-
1(a)(4)(iii)(A). See also Compliance Rules Adopting Release, supra 
footnote 82.
---------------------------------------------------------------------------

    Where the board determines the fair value of investments, the fund 
will adopt and implement the fair value policies and procedures under 
the compliance rule.\131\ Similarly, where the board designates the 
adviser as valuation designee to perform fair value determinations 
under rule 2a-5(b), as discussed in section II.B, the adviser will 
adopt and implement the fair value policies and procedures under the 
compliance rule. As with a fund adopting fair value policies and 
procedures, the adviser's fair value policies and procedures must be 
approved by the board pursuant to rule 38a-1 and may not be considered 
material amendments to existing fair value policies and procedures. 
This approach clarifies, as some commenters requested, that the board 
can fulfill its responsibilities under the compliance rule if the 
adviser adopts fair value policies and procedures without the need for 
the fund to adopt duplicative policies separately.\132\ Additionally, 
we believe that this approach helps to ensure that fair value policies 
and procedures include an appropriate amount of detail, while 
preserving a certain level of flexibility for the board or adviser, as 
applicable, to tailor the fair value policies and procedures to the 
unique facts and circumstances of the fund.\133\
---------------------------------------------------------------------------

    \131\ For an internally-managed fund, the fair value policies 
and procedures will be adopted by the fund regardless of whether the 
board determines the fair value of investments itself or designates 
an officer of the fund to perform fair value determinations.
    \132\ See Advisor's Inner Circle Trustees Comment Letter 
(requesting that the Commission clarify that a board can fulfill its 
responsibilities under rule 38a-1 by approving the adviser's fair 
value policies as reasonably designed to prevent violation of the 
Federal securities laws, without the investment company's having to 
``adopt'' its own or the adviser's policies); NYC Bar Comment 
Letter. Furthermore, as we stated in the Proposing Release, for 
UITs, the fund's principal underwriter or depositor conducts the 
functions assigned to management company boards under rule 38a-1. 
Rule 38a-1(b). This would not be affected by the final rule.
    \133\ See, e.g., SBIA Comment Letter; University of Miami 
Comment Letter; MFS Comment Letter; Vanguard Comment Letter; ABA 
Comment Letter; BlackRock Trustees Comment Letter (arguing that rule 
2a-5 should give fund boards flexibility in developing fair value 
policies and procedures). But see IVSC Comment Letter (urging the 
Commission to consider requiring additional prescriptive elements 
that should be included in fair value policies and procedures).
---------------------------------------------------------------------------

B. Performance of Fair Value Determinations

    Largely as proposed, under the final rule, a board may choose to 
determine fair value in good faith for any or all fund investments by 
carrying out all of the functions required in paragraph (a) of the 
final rule, including, among other things, selecting and applying 
valuation methodologies.\134\ A board could also designate the 
performance of fair value determinations relating to any or all fund 
investments to a valuation designee, subject to the board's oversight. 
The final rule will require the valuation designee to make certain 
reports to the board, specify responsibilities regarding fair value 
determinations, and reasonably segregate portfolio management from fair 
value determinations.\135\ The trustee or depositor will generally 
perform the fair value functions in paragraph (a) of the final rule for 
UITs, which do not have a board or adviser.\136\ These provisions are 
designed to provide boards, valuation designees, and other parties 
involved with a consistent approach to the allocation of fair value 
functions that recognizes the important role that valuation designees 
can play in the fair value process, while also preserving a crucial 
role for boards to fulfill their obligations under section 2(a)(41) of 
the Act by meeting the requirements of the final rule.\137\
---------------------------------------------------------------------------

    \134\ In this circumstance, the fund would need to adopt and 
implement policies and procedures under rule 38a-1 to address 
valuation issues and keep records consistent with the requirements 
of the rules. See rules 2a-5(b), 31a-4, and 38a-1(a)(1).
    \135\ Rule 2a-5(b).
    \136\ Rule 2a-5(d). See also infra footnotes 178 through 180 and 
accompanying text (discussing the limited circumstance under which 
other parties may perform the requirements of paragraph (a) of the 
final rule for UITs).
    \137\ Proposing Release, supra footnote 2, at 32.
---------------------------------------------------------------------------

Designate or Assign
    Section 2(a)(41) requires that the board determine fair value for 
securities that do not have readily available market quotations. The 
final rule provides that the board may ``designate'' the performance of 
these fair value determinations to a valuation designee. This is a 
change from the proposal that would have provided that the board may 
``assign'' such task to an adviser. Some commenters questioned the use 
of the phrase ``assign'' in the proposed rule, stating that it was 
unique in the rules adopted under the Act. These commenters stated that 
the scope of an assignment was unclear.\138\ One such commenter 
observed that other terms, such as ``designate,'' are used in other 
Commission rules and connote choosing a party for a particular 
purpose.\139\ After considering comments, we believe that a board 
``designating'' a valuation designee to perform fair value 
determinations better describes the relationship between the board and 
valuation designee under the final rule--that is, one where the 
valuation designee performs the fair value determinations for the fund 
on the board's behalf subject to appropriate oversight by the fund's 
board. Some commenters believed that the term ``assign'' could suggest 
that the board has completely delegated the entire valuation function 
and related obligations to the adviser.\140\ We do not intend this 
result. Accordingly, the final rule uses the term ``designate'' instead 
of ``assign.''
---------------------------------------------------------------------------

    \138\ See ABA Comment Letter; MFDF Comment Letter; Stradley 
Comment Letter; Dechert Comment Letter (stating that ``assign'' 
applies to rights and interests, not responsibilities).
    \139\ See ABA Comment Letter (noting that this term is used in 
rule 38a-1).
    \140\ See Stradley Comment Letter (stating that ``assign'' seems 
broader than ``delegate''); ABA Comment Letter.
---------------------------------------------------------------------------

Who May Be Designated
    In a change from the proposal, which would have permitted boards to 
assign only to an adviser of the fund, the final rule will permit 
boards to designate the

[[Page 759]]

fund's adviser to perform fair value determinations or, if the fund is 
internally managed, an officer of the fund.\141\ Many commenters 
recommended that we expand the types of entities that could perform 
fair value determinations on behalf of the board beyond the fund's 
adviser. Commenters suggested that we permit any affiliate of the 
adviser; \142\ fund administrators and affiliates; \143\ committees 
composed of a blend of personnel or officers of the fund, adviser, or 
administrator; \144\ pricing services; \145\ accounting firms; \146\ or 
any party the board has determined has sufficient expertise and 
capacity to conduct the fair value determinations.\147\ Some also 
recommended that we permit officers of internally managed funds to 
conduct this activity because these funds do not have advisers.\148\
---------------------------------------------------------------------------

    \141\ Rule 2a-5(b).
    \142\ See Sullivan Comment Letter; ICI Comment Letter; Seward & 
Kissel Comment Letter; Comment Letter of Russell Investment 
Management, LLC (July 20, 2020) (``Russell Comment Letter''); 
Dechert Comment Letter.
    \143\ See ICI Comment Letter; IDC Comment Letter; Seward & 
Kissel Comment Letter; Murphy Comment Letter (suggesting this would 
address ``turnkey'' fund situations where the adviser typically only 
provides investment advice but the administrator performs other 
functions such as valuation); John Hancock Comment Letter 
(suggesting affiliated administrators); Advisor's Inner Circle 
Trustees Comment Letter; Dechert Comment Letter; see also John 
Hancock Comment Letter (stating that if the administrator is an 
affiliate of the adviser, the board can exercise oversight through 
its relationship with the adviser and that staff guidance provides 
some further protections); Advisor's Inner Circle Trustees Comment 
Letter (recommending permitting reporting by non-advisers, such as 
fund administrators and pricing services).
    \144\ See ICI Comment Letter; Seward & Kissel Comment Letter.
    \145\ See CFA Institute Comment Letter; Dimensional Comment 
Letter. But see ICE Data Comment Letter (recommending that pricing 
services not be permitted to be assigned).
    \146\ See CFA Institute Comment Letter. But see ICE Data Comment 
Letter (recommending that accounting firms not be permitted to be 
assigned).
    \147\ See Murphy Comment Letter; VRC Comment Letter; Advisor's 
Inner Circle Trustees Comment Letter.
    \148\ See Sullivan Comment Letter; Deloitte Comment Letter; 
Seward & Kissel Comment Letter; SBIA Comment Letter; NYC Bar Comment 
Letter; see also Dechert Comment Letter; Franklin Comment Letter 
(recommending permitting officers generally).
---------------------------------------------------------------------------

    These commenters suggested that an expanded list of permissible 
entities would more accurately reflect current organizational 
structures and practices, would make it easier for smaller funds to 
comply with rule 2a-5, and would facilitate boards that would prefer 
non-advisers that may have fewer conflicts of interest.\149\ Some 
commenters believed it was unnecessary for the party performing fair 
value determinations to be a fiduciary of the fund.\150\ In contrast, 
others suggested that a fiduciary relationship is important.\151\
---------------------------------------------------------------------------

    \149\ See ICI Comment Letter; IDC Comment Letter; Russell 
Comment Letter; Seward & Kissel Comment Letter (stating that 
advisers could raise their fees in response to the proposed rule, 
resulting in higher costs for funds if they can only assign to 
advisers).
    \150\ See Seward & Kissel Comment Letter; Russell Comment 
Letter; see also Harvest Comment Letter (stating that fiduciary 
duties or registration status should not matter and that the board 
should only assign to third parties based upon experience, 
expertise, accuracy, and documentation and be fully vetted).
    \151\ See generally IHS Market Comment Letter (recommending that 
we agree that pricing services are acting as fiduciaries when 
involved in the valuation process). We did not propose to require 
pricing services to act as fiduciaries as part of this rulemaking, 
and do not believe that it is appropriate to make such a mandate as 
part of this adoption.
---------------------------------------------------------------------------

    We generally decline to expand permissible designees beyond the 
adviser in the final rule because we believe that it is critical for 
the entity actually performing the fair value determinations to owe a 
fiduciary duty to the fund and be subject to direct board oversight 
whenever possible.\152\ While these other parties may not have the same 
conflicts as an adviser, they also generally have other conflicts that 
could influence their fair value determinations. For example, pricing 
services may have an interest in maintaining continuing business 
relationships with the adviser or fund, which could present conflicts 
\153\ and in such cases, unlike advisers,\154\ their performance of 
fair value determinations may not be subject to the same fiduciary 
obligations owed to the fund.\155\ We believe that having fiduciary 
obligations to the fund will help ensure that the party performing fair 
value determinations acts in the fund's best interest and, as 
appropriate, eliminates, mitigates, or discloses conflicts.\156\ 
Further, we believe that it is important for the valuation designee to 
have a direct relationship with the fund's board and have comprehensive 
and direct knowledge of the fund.\157\ This is true of the fund's 
adviser, whose advisory contract is subject to substantive board 
oversight pursuant to the Act,\158\ or, in the case of internally-
managed funds, officers of the fund. To the extent that other parties 
provide services that are essential for fair value determinations, the 
board or valuation designee can seek their assistance as discussed 
below.
---------------------------------------------------------------------------

    \152\ See, e.g., Proposing Release, supra footnote 2, at 106.
    \153\ See also supra section II.A.4 (discussing these 
conflicts).
    \154\ See infra footnote 219 and accompanying text.
    \155\ See also infra footnotes 184-186 and accompanying text.
    \156\ See, e.g., Commission Interpretation Regarding Standard of 
Conduct for Investment Advisers, Investment Advisers Act Release No. 
5248 (Jun. 5, 2019) [84 FR 33669 (July 12, 2019)] (``Commission 
Fiduciary Interpretation'').
    \157\ See, e.g., supra sections II.A.1 and II.A.2.
    \158\ See section 15(c) of the Act.
---------------------------------------------------------------------------

    We recognize, as commenters stated, that internally managed funds 
have no adviser. Instead they rely on certain officers of the fund to 
perform the broad range of tasks that advisers to externally managed 
funds otherwise perform.\159\ These officers also have fiduciary 
duties,\160\ and as employees of the fund are subject to oversight by 
the fund's board of directors. We believe that internally managed funds 
should not be excluded from this provision of the final rule solely 
because they have no adviser. Thus, in a change from the proposal, the 
final rule also permits such a fund's board to designate an officer or 
officers of the fund to perform the fair value determinations if the 
fund does not have an adviser.\161\
---------------------------------------------------------------------------

    \159\ To the extent that the officers tasked with performing 
these duties have additional conflicts, such as by being compensated 
with fund shares, boards should consider those conflicts and any 
other conflicts prior to permitting this delegation. See infra 
section II.B.1.
    \160\ See, e.g., Zirn v. VLI Corp., 621 A.2d 773 (Del. 1993); 
Guth v. Loft, Inc., 23 Del. Ch. 255, 5 A.2d 503, 510 (1939). See 
also SBIA Comment Letter (arguing that officers of internally 
managed funds should be permitted to perform fair value 
determinations because officers of such funds generally have 
fiduciary and similar duties to the fund and its equity holders).
    \161\ Rule 2a-5(e)(4). Because these officers are ``valuation 
designees'' under the final rule, they will be required to perform 
all the functions rule 2a-5 will require of valuation designees, 
including the mandatory board reporting.
---------------------------------------------------------------------------

    In the Proposing Release, we stated that the proposed rule would 
permit boards to assign either to the fund's primary adviser or one or 
more sub-advisers.\162\ While some commenters generally supported the 
flexibility this interpretation would afford,\163\ others opposed or 
had concerns about it, arguing that sub-advisers do not currently 
perform this task and permitting them to do so could significantly 
increase costs.\164\ Some did not object to the flexibility but stated 
that having sub-advisers involved in valuation was inconsistent with 
some current practices, with some questioning if this would be an 
appropriate role for a sub-adviser.\165\ A number of commenters raised 
concerns about how permitting assignment to

[[Page 760]]

sub-advisers would work in practice, for example, how to resolve 
conflicting fair value determinations,\166\ and requested that we 
provide guidance on how to reconcile in such circumstances.\167\
---------------------------------------------------------------------------

    \162\ Proposing Release, supra footnote 2, at 33-34.
    \163\ See, e.g., TRP Comment Letter; IAA Comment Letter; CFA 
Institute Comment Letter; Vanguard Comment Letter.
    \164\ See MFS Comment Letter; Seward & Kissel Comment Letter.
    \165\ See Capital Group Comment Letter; IAA Comment Letter; 
SIFMA AMG Comment Letter; see also TRP Comment Letter (noting it 
could increase costs to assign to a sub-adviser).
    \166\ See Seward & Kissel Comment Letter; SIFMA AMG Comment 
Letter.
    \167\ See Capital Group Comment Letter; CFA Institute Comment 
Letter; MFS Comment Letter; IAA Comment Letter; see also SIFMA AMG 
Comment Letter.
---------------------------------------------------------------------------

    The final rule will not permit boards to designate the performance 
of fair value determinations to fund sub-advisers.\168\ However, 
consistent with the guidance below, boards or their valuation designee 
can seek the assistance of sub-advisers as they see appropriate. We 
proposed allowing designation to sub-advisers as a method to provide 
additional flexibility to boards. After considering the increased 
complexity identified by commenters that this flexibility may create, 
and commenters' assertions that sub-advisers typically do not currently 
serve in this role,\169\ we have determined that any benefits provided 
by this additional flexibility would not be justified by the additional 
challenges it may create. We also are concerned that allowing 
designation to sub-advisers may create complicated reconciliation and 
oversight issues for boards, advisers, and sub-advisers. However, we 
welcome engagement with respect to the role of sub-advisers in the fair 
value determination process.
---------------------------------------------------------------------------

    \168\ Rule 2a-5(e)(4) (defining ``valuation designee'' as, among 
other things, an adviser other than a sub-adviser).
    \169\ See MFS Comment Letter; Seward & Kissel Comment Letter.
---------------------------------------------------------------------------

    The proposed rule would have permitted only the UIT's trustees to 
perform fair value determinations.\170\ Commenters stated that the 
final rule should permit the parties specified as evaluators in the 
UIT's trust indenture or similar document, including the depositor and 
other entities, to perform fair value determinations under rule 2a-5. 
These commenters argued that these evaluators are the entities with 
relevant expertise in valuation matters and this change would make rule 
2a-5 more consistent with current practice.\171\ Others asked that we 
not apply the final rule's requirements to existing UITs given their 
trust indentures are currently drafted to permit entities other than 
trustees to value the UITs' investments.\172\ One commenter stated that 
the cost to implement the proposed rule could be significant for UITs 
due to the change in practice.\173\
---------------------------------------------------------------------------

    \170\ Proposed rule 2a-5(d).
    \171\ See ICI Comment Letter; Comment Letter of Chapman and 
Cutler LLP (July 20, 2020) (``Chapman Comment Letter''); Comment 
Letter of Advisers Asset Management, Inc. (July 20, 2020) (``AAM 
Comment Letter''); Comment Letter of First Trust Portfolios L.P. 
(July 21, 2020) (``First Trust Comment Letter''); Comment Letter of 
Hennion & Walsh, Inc. (July 20, 2020) (``Hennion & Walsh Comment 
Letter''); Invesco Comment Letter; Comment Letter of the Bank of New 
York Mellon (July 20, 2020) (``BNY Mellon Comment Letter''); see 
also Seward & Kissel Comment Letter (suggesting permitting UIT 
trustees to assign to any assignee).
    \172\ See Chapman Comment Letter; AAM Comment Letter; First 
Trust Comment Letter.
    \173\ See BNY Mellon Comment Letter. Some commenters also asked 
that we clarify that the oversight elements of paragraph (b) do not 
apply to UITs. See Chapman Comment Letter; AAM Comment Letter; First 
Trust Comment Letter; Hennion & Walsh Comment Letter; BNY Mellon 
Comment Letter. Because paragraph (b) only applies when a board 
designates the performance of fair value determinations to a 
valuation designee, which a UIT will not have, we agree that it is 
inapplicable to UITs.
---------------------------------------------------------------------------

    In other contexts under the Investment Company Act, the Commission 
has provided for a UIT's depositor to conduct activities that the board 
of directors would otherwise conduct, given that a UIT has neither a 
board of directors nor an adviser.\174\ UIT depositors are subject to 
liability under section 36(a) of the Act for breach of fiduciary 
duty.\175\ We agree, in light of these comments, that UITs should not 
be limited to trustees to perform their fair value determinations. As 
we understand that the trustee traditionally has not performed fair 
value determinations, and we have recognized in the past that 
depositors generally serve the most equivalent function to an adviser 
for UITs,\176\ the final rule will permit either the fund's depositor 
or trustee to perform the fair value determinations required under rule 
2a-5.\177\ To the extent that the assistance of other parties (such as 
evaluators) is necessary, trustees or depositors can seek that 
assistance consistent with the guidance below regarding obtaining the 
assistance of others.
---------------------------------------------------------------------------

    \174\ See, e.g., 17 CFR 270.17j-1(c)(1)(iii) (``rule 17j-1'') 
and 38a-1(b).
    \175\ See section 36 of the Act; see also Memorandum on the 
Regulation of Unit Investment Trusts from the Division of Investment 
Management to the Securities and Exchange Commission, Fed. Sec. L. 
Rep. (CCH) 84,328 (Sep. 22, 1988).
    \176\ See, e.g., items 25 through 31 of Form N-8B-2 (requiring 
information regarding depositors that is similar to that required of 
an adviser to a management company in item 10 of Form N-1A).
    \177\ Rule 2a-5(d).
---------------------------------------------------------------------------

    In recognition of commenters' statements that there would be 
significant costs for pre-existing UITs to change who engages in the 
fair value determination as they might need to amend their trust 
indenture (and potentially obtain a unit holder vote approving the 
change) we are grandfathering existing UITs under limited 
circumstances. Thus, the final rule will now require trustees or 
depositors to perform fair value determinations if the UIT's date of 
initial deposit (which would include a rollover) of portfolio 
securities occurred after the effective date of rule 2a-5. If the 
initial deposit of securities into the UIT took place prior to the 
effective date of the final rule, to the extent that an entity other 
than the UIT's trustee or depositor has been designated in the trust 
indenture to perform fair value determinations, that previously 
designated entity may perform such fair value determinations pursuant 
to paragraph (a) of the final rule.\178\ We believe that this approach 
should be acceptable, even though the party making fair value 
determinations under this provision may not be subject to the same 
fiduciary duties, as this outcome reflects a balancing of the costs and 
risks, informed by the unmanaged and fixed nature of these UITs, and 
because of the limited nature of this relief.\179\ Further, we believe 
that the number of these funds that will be able to utilize an entity 
other than a depositor or trustee will be small and decrease over 
time.\180\ We are also concerned that it would be unlikely that pre-
existing UITs could comply with the final rule absent this provision 
given the statutory requirement that UITs be organized under a trust 
indenture, contract of custodianship or agency, or similar instrument 
(the terms of which, in these limited cases, provide for an evaluator 
other than the trustee or depositor). Further, we believe that this 
approach should address commenter concerns about disrupting existing 
UIT fair value determination designees and the associated potential 
costly changes which could affect investors if the costs are passed on 
to them.
---------------------------------------------------------------------------

    \178\ To be clear, this exception from the requirement to 
utilize a depositor or trustee for fair value determinations will 
not continue to be available when a pre-existing UIT is rolled over 
to a new UIT after the termination date of the pre-existing UIT. In 
such a case, when the rollover occurs, the new UIT will be required 
to designate either the depositor or trustee to perform fair value 
determinations consistent with the final rule. In addition, if a 
pre-existing UIT has a trustee or depositor already designated to 
perform the fair value determination, then that entity would be the 
entity responsible for performing the fair value determination 
requirements under the final rule.
    \179\ See generally Fund of Funds Arrangements, Investment 
Company Release No. 34045 (Oct. 17, 2020) [85 FR 73924 (Nov. 19, 
2020)] (``FOF Adopting Release'') at 92.
    \180\ We believe that the universe of UITs relying on this 
exception will be small. See infra footnote 550 and accompanying 
text. Further, as we have noted previously, many existing UITs have 
a limited term, sometimes of approximately 12 to 18 months. FOF 
Adopting Release, supra footnote 179, at n.332 and accompanying 
text.

---------------------------------------------------------------------------

[[Page 761]]

    As proposed, the final rule defines ``board'' both as the full 
board or a designated committee thereof composed of a majority of 
directors who are not interested persons of the fund.\181\ We received 
limited comments on this aspect of the proposal. One commenter, 
however, suggested that the fund should be required to develop policies 
and procedures for when the whole board, rather than a committee, would 
be required to be involved.\182\ Conversely, another stated that 
because state law permits fund boards to empower specific committees to 
act on behalf of the entire board, rule 2a-5 was sufficient as 
proposed.\183\ We believe that no such changes are necessary to this 
provision because it is important that boards be able to utilize 
specialized committees, particularly on matters as detailed and 
important as valuation. Should a fund choose to develop policies and 
procedures regarding when a matter is more appropriate for the full 
board, it can do so, but it will not be required under the final rule.
---------------------------------------------------------------------------

    \181\ Rule 2a-5(e)(3).
    \182\ See IVSC Comment Letter.
    \183\ See Murphy Comment Letter.
---------------------------------------------------------------------------

    One commenter wanted clarification that the fund's adviser could 
perform fair value determinations on the board's behalf regardless of 
whether it is acting pursuant to an advisory contract, administrative 
contract, or similar agreement.\184\ Another asked that we clarify when 
a pricing service that is a Commission-registered adviser would be 
considered an ``investment adviser'' for purposes of the final 
rule.\185\ The final rule, consistent with the proposal, provides that 
where the valuation designee is an adviser, it must be an ``adviser of 
the fund.'' This would not include other service providers, whether or 
not they are registered as advisers, or acting under a contract with 
the fund, unless they are actually serving as the adviser of the fund 
as defined under the Investment Company Act because they may not have a 
comprehensive and direct knowledge of the fund, a direct relationship 
with the board, or the same fiduciary duties to the fund in other 
cases.\186\ As discussed above, it also would not include a sub-adviser 
to the fund.
---------------------------------------------------------------------------

    \184\ See John Hancock Comment Letter.
    \185\ See ICE Data Comment Letter.
    \186\ See section 2(a)(20) (defining investment adviser of an 
investment company). See also supra footnotes 152-156 and 
accompanying text (explaining why we are generally not permitting 
parties other than the adviser to be valuation designees under the 
final rule).
---------------------------------------------------------------------------

Guidance on Obtaining the Assistance of Others
    Some commenters also asked that we clarify that the adviser or the 
fund board could engage third parties to assist with certain functions 
of the fair value determination process, such as performing back-
testing, fund accounting, or shareholder reporting, other than making 
the actual determinations themselves.\187\ Others urged us to state 
that advisers assigned to perform fair value determinations under the 
proposed rule could, in turn, assign their responsibilities to other 
third parties.\188\
---------------------------------------------------------------------------

    \187\ See Sullivan Comment Letter; Fidelity Comment Letter; NYC 
Bar Comment Letter (asserting fund boards must be able to rely upon 
fund auditors and counsel); Dechert Comment Letter.
    \188\ See Russell Comment Letter.
---------------------------------------------------------------------------

    We believe that whether the board or the valuation designee makes 
fair value determinations under the final rule, it may of course obtain 
assistance from others in fulfilling its duties. It may, for example, 
seek assistance from pricing services, fund administrators, sub-
advisers, accountants, or counsel.\189\ That assistance can take 
different forms, and may include services such as performing back-
testing as specified by the valuation designee and performing 
calculations required by the valuation method selected by the board or 
valuation designee. The board or the valuation designee, using this 
assistance, must of course also perform its responsibilities under the 
Act, the final rule, and other applicable rules under the Act. However, 
in seeking the assistance of others, the entity or officer designated 
to perform the fair value determination remains responsible for that 
determination and may not designate or assign that responsibility to 
the third party for the same reasons we are not permitting the board to 
designate performance of this task to a party other than the valuation 
designee.\190\
---------------------------------------------------------------------------

    \189\ For example, some commenters suggested that the 
administrator may be better positioned to perform the fair value 
determinations under rule 2a-5 than an adviser. See Sullivan Comment 
Letter. For the reasons discussed above, we determined generally to 
limit the valuation designee to the fund's adviser. See supra 
footnotes 152-158 and accompanying text.
    \190\ See supra footnotes 152-158 and accompanying text.
---------------------------------------------------------------------------

1. Board Oversight
    The final rule, consistent with the proposal, specifically requires 
a board to oversee the valuation designee if the board has designated 
the performance of fair value determinations to the valuation 
designee.\191\ In the proposal, we provided guidance on our 
expectations related to this board oversight.\192\ A number of 
commenters supported this guidance,\193\ with one commenter stating 
that the discussion properly reflects the general roles of boards and 
advisers under both current practices of properly functioning boards as 
well as Federal and state law.\194\ However, other commenters 
questioned parts of the guidance or asked that we provide further 
guidance on certain issues.
---------------------------------------------------------------------------

    \191\ Rule 2a-5(b).
    \192\ Proposing Release, supra footnote 2, at nn.84-94 and 
accompanying text.
    \193\ See Council of Institutional Investors Comment Letter; 
Fidelity Comment Letter; VRC Comment Letter; Invesco Comment Letter; 
CFA Institute Comment Letter; Comment Letter of Better Markets (July 
21, 2020) (``Better Markets Comment Letter''); see also IDC Comment 
Letter (agreeing with the lack of specificity of ``oversight'' in 
the proposed rule). One of these commenters recommended that we 
require that boards have the requisite experience, knowledge, and 
sufficient lack of conflicts to fulfill their obligations. Better 
Markets Comment Letter. Another suggested that directors be required 
to have ``valuation literacy.'' CFA Institute Comment Letter. The 
commenter did not clarify what is meant by ``valuation literacy'' 
and we do not believe that an affirmative requirement is necessary. 
However, the board's statutory obligation for determining fair value 
in good faith, as well its oversight obligation with respect to any 
valuation designee under new rule 2a-5, generally warrants 
consideration of the appropriateness of director qualifications, 
such as with respect to accounting and valuation matters, when funds 
and boards are identifying potential board candidates. The 
Commission understands that board members are often selected to 
provide a variety of specialized knowledge and experience, including 
in accounting and valuation.
    \194\ See Fidelity Comment Letter; see also ICI Comment Letter 
(stating that the proposal correctly distinguished oversight from 
design and administration).
---------------------------------------------------------------------------

    Some of these commenters argued that board oversight of the 
valuation process should be the same as the oversight of other 
functions, such as liquidity risk.\195\ While we agree that boards 
should provide oversight in those contexts as well, we believe that we 
should provide specific guidance with respect to board oversight in the 
context of making fair value determinations. We believe that specific 
guidance is appropriate because section 2(a)(41) is one of the few 
provisions of the Act that specifically imposes a requirement on fund 
boards, requiring boards to determine fair value in good faith. 
Therefore, this guidance supports our view that a board may still 
satisfy its statutory obligation to determine fair

[[Page 762]]

value even though it has designated another entity to perform the fair 
value determinations under the final rule, subject to appropriate 
oversight.\196\
---------------------------------------------------------------------------

    \195\ See MFDF Comment Letter; ABA Comment Letter (requesting 
the Commission to reiterate, as it had in the adopting release for 
17 CFR 270.22e-4 (``rule 22e-4''), that the board role under this 
rule is substantially similar to its roles and responsibilities in 
other contexts under the Act and that providing a different standard 
of care for board action would not be appropriate); Advisor's Inner 
Circle Trustees Comment Letter; see also NYC Bar Comment Letter.
    \196\ See section 1(b) of the Act (``it is hereby declared that 
the national public interest and the interest of investors are 
adversely affected . . . when investment companies, in computing 
their earnings and the asset value of their outstanding securities . 
. . are not subjected to adequate independent scrutiny'').
---------------------------------------------------------------------------

    A number of commenters questioned the guidance stating that boards 
must be active in their oversight role by probing reports written by 
advisers and being inquisitive,\197\ but other commenters agreed that 
board oversight cannot be a passive activity.\198\ We believe that 
boards are not providing appropriate oversight if they simply rely on 
information presented to them without actively probing it, asking 
questions, and seeking relevant information, particularly when there 
are red flags or other indications of problems. Some commenters asked 
us to state that the board does not have an independent duty to seek to 
discover conflicts of interest but can reasonably rely upon the 
adviser's identification of these conflicts,\199\ but one stated we 
should clarify that the board has an affirmative duty to do so.\200\ 
Another stated that the board should be able to rely upon the adviser 
much the same way that it can reasonably rely upon others, such as fund 
CCOs, administrators, and counsel.\201\ As discussed below in the 
guidance on board oversight, we are reiterating our belief, stated in 
the Proposing Release, that boards should seek to identify potential 
conflicts of interest as part of their oversight duties under the final 
rule. Boards must work with valuation designees, which also have a duty 
to disclose their conflicts,\202\ to address or manage these conflicts 
to the board's satisfaction.
---------------------------------------------------------------------------

    \197\ See IDC Comment Letter; ABA Comment Letter; Stradley 
Comment Letter; Capital Group Comment Letter; Advisor's Inner Circle 
Trustees Comment Letter; see also NYC Bar Comment Letter (stating 
that oversight should consist of reviewing reports and determining 
corrective action); Dechert Comment Letter; American Funds Trustees 
Comment Letter. Cf. Proposing Release, supra footnote 2, at nn.89-94 
and accompanying text.
    \198\ See Fidelity Comment Letter; Invesco Comment Letter; CFA 
Institute Comment Letter; Better Markets Comment Letter.
    \199\ See Sullivan Comment Letter; ABA Comment Letter.
    \200\ See CFA Institute Comment Letter.
    \201\ See IDC Comment Letter; Stradley Comment Letter.
    \202\ See, e.g., Commission Fiduciary Interpretation, supra 
footnote 156, at n.24.
---------------------------------------------------------------------------

    Although several commenters asked us to confirm that boards may 
provide oversight of the performance of fair value determinations 
consistent solely with the business judgment rule under state law, we 
decline to do so.\203\ Instead, we are providing guidance that we 
believe should be more useful to directors than the more generalized 
principles of the business judgment rule, as this new guidance 
specifically relates to directors' oversight responsibilities under 
section 2(a)(41) of the Act and the final rule.
---------------------------------------------------------------------------

    \203\ See ABA Comment Letter; Stradley Comment Letter.
---------------------------------------------------------------------------

    Finally, several commenters recommended that we adopt additional 
oversight requirements, such as third-party reviews, attestations, or 
certifications by the adviser,\204\ or that we require the board to 
make specific findings.\205\ Others argued that additional requirements 
were unnecessary due to state law duties applicable to boards or 
because the expense was not justified by the regulatory benefits.\206\ 
Several commenters also asked that we clarify whether directors are 
expected to ratify fair value determinations made by the adviser under 
rule 2a-5.\207\ We are not adding specific oversight requirements in 
the final rule beyond those that were proposed. We believe that the 
oversight requirements of boards under the final rule, discussed below, 
taken together with the directors' fiduciary duties, are reasonably 
designed to establish a minimum set of requirements for addressing the 
conflict of interest and other concerns associated with permitting a 
valuation designee to make fair value determinations. As such, we 
believe that additional requirements like those suggested by these 
commenters may be duplicative or involve burdens that are not justified 
by their potential benefits. The final rule does not require boards to 
ratify fair value determinations made by the valuation designee, as we 
believe it is not a necessary component of active oversight.
---------------------------------------------------------------------------

    \204\ See IVSC Comment Letter; CFA Institute Comment Letter; see 
also ABA Comment Letter (recommending a certification by the adviser 
similar to that required in rule 17j-1); Council of Institutional 
Investors Comment Letter (supporting an attestation requirement).
    \205\ See ICE Data Comment Letter; Murphy Comment Letter.
    \206\ See Murphy Comment Letter; Comment Letter of Timothy 
Keehan, Vice President & Senior Counsel, American Bankers 
Association (``American Bankers Association Comment Letter'').
    \207\ See ABA Comment Letter.
---------------------------------------------------------------------------

Guidance on Board Oversight
    We reiterate the guidance on board oversight of the fair value 
determination process from the Proposing Release.\208\ When the board 
designates the performance of fair value determinations to the 
valuation designee, the final rule will require the board to satisfy 
its statutory obligation with respect to these determinations through 
the framework of rule 2a-5, including overseeing the valuation 
designee. Boards should approach their oversight of the performance of 
fair value determinations by the valuation designee of the fund with a 
skeptical and objective view that takes account of the fund's 
particular valuation risks, including with respect to conflicts, the 
appropriateness of the fair value determination process, and the skill 
and resources devoted to it.\209\ Further, in our view appropriate 
oversight cannot be a passive activity. Directors should ask questions 
and seek relevant information.
---------------------------------------------------------------------------

    \208\ Proposing Release, supra footnote 2, at nn.84-94 and 
accompanying text.
    \209\ See generally Investment Company Governance, Investment 
Company Act Release No. 26520 (July 27, 2004) [69 FR 46378 (Aug. 2, 
2004)] (``Governance Release'').
---------------------------------------------------------------------------

    The board should view oversight as an iterative process and seek to 
identify potential issues and opportunities to improve the fund's fair 
value processes.\210\ The final rule will require the valuation 
designee to report to the board with respect to matters related to the 
valuation designee's fair value process, in part to ensure that the 
board has sufficient information to conduct this oversight.\211\ Boards 
should also request follow-up information when appropriate and take 
reasonable steps to see that matters identified are addressed.\212\
---------------------------------------------------------------------------

    \210\ Cf. Derivatives Adopting Release, supra footnote 6 (noting 
that ``the use of the word `iterative' is not intended to imply that 
the board is responsible for the day-to-day management of the fund's 
derivatives risk, but is instead intended to clarify that the 
board's oversight role requires regular engagement with the 
derivatives risk management program rather than a one-time 
assessment'').
    \211\ Rule 2a-5(b)(1).
    \212\ See also Governance Release, supra footnote 209 
(independent directors should ``bring to the boardroom `a high 
degree of rigor and skeptical objectivity to the evaluation of 
management and its plans and proposals,' particularly when 
evaluating conflicts of interest'').
---------------------------------------------------------------------------

    We expect that boards engaged in this process would use the 
appropriate level of scrutiny based on the fund's valuation risk, 
including the extent to which the fair value of the fund's investments 
depend on subjective inputs. For example, a board's scrutiny would 
likely be different if a fund invests in publicly traded foreign 
companies than if the fund invests in private early stage companies. As 
the level of subjectivity increases and the inputs and assumptions used 
to determine fair value move away from more objective measures, we 
expect that

[[Page 763]]

the board's level of scrutiny would increase correspondingly.\213\
---------------------------------------------------------------------------

    \213\ For a discussion of valuation risks generally, see supra 
section II.A.1.
---------------------------------------------------------------------------

    We also believe that, consistent with their obligations under the 
Act and as fiduciaries, boards should seek to identify potential 
conflicts of interest, monitor such conflicts, and take reasonable 
steps to manage such conflicts.\214\ In so doing, the board should 
serve as a meaningful check on the conflicts of interest of the 
valuation designee and other service providers involved in the 
determination of fair values.\215\ In particular, the fund's adviser 
may have an incentive to value fund assets improperly in order to 
increase fees, improve or smooth reported returns, or comply with the 
fund's investment policies and restrictions.\216\ Other service 
providers, such as pricing services or broker-dealers providing 
opinions on prices, may have incentives (such as maintaining continuing 
business relationships with the valuation designee) \217\ or may 
otherwise be subject to pressures to provide pricing estimates that are 
favorable to the valuation designee.\218\ In overseeing the valuation 
designee's process for making fair value determinations, the board 
should understand the role of, and inquire about conflicts of interest 
regarding, any other service providers used by the valuation designee 
as part of the process, and satisfy itself that any conflicts are being 
appropriately managed.
---------------------------------------------------------------------------

    \214\ See, e.g., Governance Release, supra footnote 209 (``. . . 
state law duties of loyalty and care . . . oblige directors to act 
in the best interest of the fund when considering important matters 
the Act entrusts to them, such as approval of an advisory contract 
and the advisory fee.'').
    \215\ See, e.g., id. (``. . . . the Act and our rules rely 
heavily on fund boards of directors to manage the conflicts of 
interest that advisers have with funds they manage.''). See also 
Division of Investment Management, SEC, Protecting Investors: A Half 
Century of Investment Company Regulation, 252 (1992) (``the 
[Investment Company] Act . . . imposes requirements that assume the 
standard equipment of a corporate democracy: a board of directors . 
. . whose function is to oversee the operations of the investment 
company and police conflicts of interest . . . [W]e believe that 
independent directors perform best when required to exercise their 
judgment in conflict of interest situations'').
    \216\ See, e.g., In re Piper Capital Management, et al., 
Investment Company Act Release No. 26167 (Aug. 26, 2003) (Commission 
opinion). For discussion of the conflicts of the fund's portfolio 
manager, see infra section II.B.3. Further, officers of internally 
managed funds may have other conflicts that boards should consider. 
See supra footnote 159.
    \217\ See supra footnote 97 and accompanying text.
    \218\ Cf. In re Morgan Asset Management, Investment Company Act 
Release No. 29704 (June 22, 2011) (settlement) (``In re Morgan Asset 
Management'') at 7 (broker-dealer ``induced to provide interim price 
confirmations that were lower than the values at which the Funds 
were valuing certain bonds, but higher than the initial 
confirmations that the [broker-dealer] had intended to provide''). 
See also supra footnote 154 and accompanying text.
---------------------------------------------------------------------------

    Boards should probe the appropriateness of the valuation designee's 
fair value processes. In particular, boards should periodically review 
the financial resources, technology, staff, and expertise of the 
valuation designee, and the reasonableness of the valuation designee's 
reliance on other fund service providers, relating to valuation.\219\ 
In addition, boards should consider the valuation designee's compliance 
capabilities that support the fund's fair value processes, and the 
oversight and financial resources available for the fair value process.
---------------------------------------------------------------------------

    \219\ See In re Morgan Asset Management, supra footnote 218 
(``the Valuation Committee left pricing decisions to lower level 
employees in Fund Accounting who did not have the training or 
qualifications to make fair value pricing determinations'').
---------------------------------------------------------------------------

    Boards should also consider the type, content, and frequency of the 
reports they receive. The final rule will require reporting to the 
board (both periodically and promptly) regarding many aspects of the 
valuation designee's fair value determination process as a means of 
facilitating the board's oversight as discussed below. While a board 
can reasonably rely on the information provided to it in summaries and 
other materials provided by the valuation designee and other service 
providers in conducting appropriate oversight, it is incumbent on the 
board to request and review such information as may be necessary to be 
informed of the valuation designee's process for determining the fair 
value of fund investments.\220\ Further, if the board becomes aware of 
material matters (whether the board identifies the matter itself or the 
fund's CCO, valuation designee, or another party identifies the issue), 
we believe that in fulfilling its oversight duty the board must inquire 
about such matters and take reasonable steps to see that they are 
addressed.
---------------------------------------------------------------------------

    \220\ In the Proposing Release, we had characterized the board's 
role as requiring that it be ``fully informed'' of the adviser's 
process. Two commenters questioned what that means in this context. 
See Deloitte Comment Letter and ABA Comment Letter. Our intent was 
to make sure that the board was not solely relying upon the 
information provided to it by the valuation designee, but was 
thoughtful and sought additional information when needed. However, 
we did not intend to imply that the board should be actively 
managing the process. We have therefore deleted the word ``fully'' 
in this release to avoid that implication.
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2. Board Reporting
    As modified in response to comments received, the final rule will 
require a valuation designee that the board has designated to perform 
fair value determinations to report to the board regarding its 
performance of that responsibility, including certain periodic reports 
and prompt notification and reporting on matters that materially affect 
the fair value of investments whose fair value is determined by the 
valuation designee.\221\ These requirements are intended to assist 
boards in their oversight responsibility under the final rule and to 
help ensure that boards receive the amount and type of information to 
oversee the valuation designee appropriately by familiarizing directors 
with the salient features of, and developments in, the valuation 
designee's process.\222\ These are minimum requirements and boards may 
find, depending on the facts and circumstances, that additional 
information is necessary or appropriate in order to discharge their 
oversight responsibilities appropriately.
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    \221\ Rule 2a-5(b)(1).
    \222\ See also Proposing Release, supra footnote 2, at 41-42.
---------------------------------------------------------------------------

(a) Periodic Reporting
    The final rule will require the valuation designee to make both 
annual and quarterly written reports to the board.\223\ Specifically:
---------------------------------------------------------------------------

    \223\ Rule 2a-5(b)(1)(i).
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     Quarterly Reports. The valuation designee must provide at 
least quarterly, in writing, (1) any reports or materials requested by 
the board related to the fair value of designated investments or the 
valuation designee's process for fair valuing fund investments and (2) 
a summary or description of material fair value matters that occurred 
in the prior quarter. This summary or description must include (1) any 
material changes in the assessment and management of valuation risks, 
including any material changes in conflicts of interest of the 
valuation designee (and any other service provider), (2) any material 
changes to, or material deviations from, the fair value 
methodologies,\224\ and (3) any material changes to the valuation 
designee's process for selecting and overseeing pricing services, as 
well as any material events related to the valuation designee's 
oversight of pricing services.\225\
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    \224\ Valuation designees can utilize this report to notify the 
board of changes to methodologies that are equally or more 
representative of fair value of the investments. See supra section 
II.A.2.a.
    \225\ Rule 2a-5(b)(1)(i)(A).
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     Annual Reports. The valuation designee must provide at 
least annually,

[[Page 764]]

in writing, an assessment of the adequacy and effectiveness of the 
valuation designee's process for determining the fair value of the 
designated portfolio of investments. At a minimum, this annual report 
must include a summary of the results of the testing of fair value 
methodologies required under the final rule and an assessment of the 
adequacy of resources allocated to the process for determining the fair 
value of designated investments, including any material changes to the 
roles or functions of the persons responsible for determining fair 
value.\226\
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    \226\ Rule 2a-5(b)(1)(i)(B).
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    After considering comments, we have made certain changes to the 
proposed periodic reporting requirements designed to enhance 
flexibility of reporting to better match boards' needs and to minimize 
the chance that boards receive reporting that is too detailed or 
repetitive to facilitate appropriate oversight. The proposed rule would 
have required quarterly reporting on a variety of valuation 
matters.\227\ Commenters raised concerns regarding these proposed 
reporting requirements. Some stated that, while some reporting is 
necessary, the proposed reporting requirements were overly prescriptive 
and would not result in appropriate board oversight in practice.\228\ 
Commenters also generally believed that we should give greater 
deference to boards to use their business judgment to request the 
information and the frequency of reports that they see as 
necessary.\229\ Some of these commenters supported a program where the 
adviser would make quarterly reports on material changes to aspects of, 
or deviations from, the program, with a broader annual report covering 
the overall design and implementation of the program.\230\ Others 
recommended that we permit the board to set reporting standards.\231\
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    \227\ Proposed rule 2a-5(b)(1)(i).
    \228\ See, e.g., ICI Comment Letter; SSGA Comment Letter; TRP 
Comment Letter; Guggenheim Comment Letter; Vanguard Comment Letter. 
See also JPMAM Comment Letter.
    \229\ See, e.g., Fidelity Trustees Comment Letter; BlackRock 
Trustees Comment Letter; Murphy Comment Letter; Fidelity Comment 
Letter (asserting the proposed reporting mechanism would lead to 
reporting designed to fulfill a regulatory requirement rather than 
assist with board oversight).
    \230\ See, e.g., Sullivan Comment Letter; JPMAM Comment Letter; 
ICI Comment Letter; IDC Comment Letter; ABA Comment Letter; Murphy 
Comment Letter. See also Federated Hermes Comment Letter; Baillie 
Gifford Comment Letter (recommending that, to the extent that 
quarterly reporting is retained, it be permitted to focus on 
material changes or exceptions and allow summary dashboards). See 
also generally BlackRock Trustees Comment Letter (detailing their 
current reporting mechanism of annual reports on the overall 
framework, quarterly valuation reports with the information the 
board wants, and monthly reports concerning NAV accuracy and pricing 
errors).
    \231\ See, e.g., BlackRock Trustees Comment Letter; MFDF Comment 
Letter; SSGA Comment Letter; Fidelity Comment Letter; Dechert 
Comment Letter; Advisor's Inner Circle Trustees Comment Letter; see 
also American Funds Trustees Comment Letter (stating that they rely 
upon the oversight of the compliance process under rule 38a-1 to 
perform oversight); SIFMA AMG Comment Letter (urging flexible 
reporting depending upon the type of inputs).
---------------------------------------------------------------------------

    The proposed rule would have included a number of specific items to 
be included in the quarterly assessment to boards. Specifically, the 
proposed rule would have required the quarterly report to include: (1) 
A summary or description of the assessment and management of material 
valuation risks (including material conflicts of interest), (2) 
material changes to, or material deviations from, established fair 
value methodologies, (3) testing results, (4) adequacy of resources 
allocated to fair value determinations, (5) material changes to the 
adviser's process for selecting and overseeing pricing services 
(including changes in service providers and price overrides), as well 
as (6) any other materials requested by the board. A number of 
commenters objected to many of these specific items being reported on a 
quarterly basis, asserting that the cost to produce them on a quarterly 
basis would exceed the costs the Commission assumed \232\ and the 
requirements could result in over-reporting to satisfy regulatory 
obligations or liability concerns rather than to facilitate 
oversight.\233\ Commenters also asserted that many of the reporting 
items, and particularly valuation risks and adequacy of resources, 
would not change frequently enough to justify quarterly reporting.\234\ 
Many of these commenters suggested that we instead require advisers to 
report some or all of these items on an annual basis,\235\ or remove 
some of them altogether, particularly reporting on specific price 
overrides, to provide more relevant information and to reduce burdens 
on boards.\236\
---------------------------------------------------------------------------

    \232\ See Sullivan Comment Letter; TRP Comment Letter; SIFMA AMG 
Comment Letter; American Trustees Comment Letter.
    \233\ See TRP Comment Letter; Fidelity Comment Letter; Dechert 
Comment Letter; SIFMA AMG Comment Letter; see also Capital Group 
Comment Letter.
    \234\ See, e.g., Fidelity Trustees Comment Letter; JPMAM Comment 
Letter; IDC Comment Letter; BlackRock Trustees Comment Letter; 
Murphy Comment Letter; TRP Comment Letter; Guggenheim Comment 
Letter; SIFMA AMG Comment Letter; NYSSCPA Comment Letter; see also 
ICI Comment Letter (recommending removing adequacy of resources 
reporting); Baillie Gifford Comment Letter (recommending removing 
adequacy of resources reporting). But see ABA Comment Letter 
(recommending that we further require a narrative description of 
testing results); VRC Comment Letter (suggesting requiring the 
reporting of specific information on each individual portfolio 
holding for securities with a higher perceived risk profile).
    \235\ See, e.g., Sullivan Comment Letter; JPMAM Comment Letter; 
ICI Comment Letter; ABA Comment Letter; TRP Comment Letter. See also 
Federated Hermes Comment Letter; Advisor's Inner Circle Trustees 
Comment Letter; IHS Market Comment Letter (stating that it had 
observed best practices for reporting on pricing services to be 
board or committee approval of the provider itself and at least 
annual review of performance based upon back testing).
    \236\ See, e.g., Sullivan Comment Letter; Fidelity Trustees 
Comment Letter; Murphy Comment Letter; Fidelity Comment Letter; see 
also IAA Comment Letter (stating that significant increases in price 
challenges or overrides should not be considered a material 
valuation risk due to their routine nature); American Fund Trustee 
Comment Letter.
---------------------------------------------------------------------------

    We agree that boards should have latitude to implement a flexible 
reporting mechanism that is tailored to their fund, recognizes judgment 
in exercising oversight, and minimizes rote reporting. That said, we 
believe that appropriate oversight, facilitated by a certain minimum 
level of reporting, is necessary in order for the designation process 
to be consistent with the Act.\237\ As a result, we are making tailored 
changes to the proposed periodic reporting regime in the final rule 
designed to enable boards to receive the information they want and need 
to conduct appropriate oversight. We believe that the changes we are 
adopting today will allow reporting to address the specific 
circumstances of each fund, and reporting should be tailored to address 
the fund's holdings, valuation methodologies, and inputs, as urged by 
some commenters.\238\
---------------------------------------------------------------------------

    \237\ See section 1(b)(5) of the Act and supra footnote 196 and 
accompanying text discussing the need for independent oversight of 
the valuation process.
    \238\ See, e.g., SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Specifically, we have made adjustments to the overall proposed 
periodic reporting requirements. The final rule will require that the 
valuation designee report its assessment of the adequacy and 
effectiveness of the valuation designee's process for determining the 
fair value of designated investments, testing results, and adequacy of 
allocated resources at least annually rather than quarterly as 
proposed. In lieu of quarterly assessments of the entire fair value 
process, the final rule will instead require quarterly reports to 
address issues about which the board requests information, as well as 
information about material changes or events that occurred during the 
period.\239\ These

[[Page 765]]

revisions are consistent with the suggestions from commenters noted 
above that we require annual overall reporting with quarterly updates 
regarding material changes. We believe that the changes in the final 
rule establish the necessary minimum reporting needed for appropriate 
oversight. Further, by expressly recognizing boards' authority to 
require any additional reports they want on a quarterly basis, the 
final rule seeks to empower boards to tailor periodic reporting to suit 
the needs of their fund, as recommended by commenters.
---------------------------------------------------------------------------

    \239\ Material fair value matters that occurred in the prior 
quarter related to the items reported on annually, such as 
significant changes to testing results or material reductions in the 
resources provided for the determination process, would, however, 
still be reported as part of the quarterly material change report.
---------------------------------------------------------------------------

    We have also made adjustments, in response to comments, from the 
proposal regarding the specific items that will be required to be part 
of periodic reports. In lieu of a discussion of the assessment and 
management of material valuation risks as part of the valuation 
designee's assessment, the final rule will instead require that the 
quarterly report identify material changes, including the 
identification of any material changes in the assessment or management 
of these risks that occurred during the quarter. We agree with 
commenters that this reporting could become rote if it does not change 
and have focused it upon material changes as a result.\240\
---------------------------------------------------------------------------

    \240\ However, boards may wish to consider periodically 
requesting a report assessing all material valuation risks (not just 
changes) faced by the fund, so that they remain apprised of the 
fund's overall valuation risk landscape.
---------------------------------------------------------------------------

    Some commenters suggested that the proposed rule, as worded, would 
have required the adviser to report every test result, service provider 
change, or price override to the board, which we did not intend.\241\ 
We agree that these items may have provided a level of detail that may 
not be necessary. Therefore, we clarified that the annual assessment 
can contain a summary of testing results and removed a requirement to 
report service provider changes or price overrides. Lastly, we agree 
with commenters that the reporting of the summary of testing results 
and assessment of the adequacy of allocated resources is not needed 
quarterly because they are unlikely to change on a quarterly basis. 
Consistent with the overall change to an annual assessment, the final 
rule will require these results to be reported annually. However, based 
upon the summaries that they receive, boards can seek more information 
from the valuation designee if necessary to conduct appropriate 
oversight.\242\
---------------------------------------------------------------------------

    \241\ See, e.g., Sullivan Comment Letter; Fidelity Trustees 
Comment Letter; Murphy Comment Letter; Fidelity Comment Letter; see 
also IAA Comment Letter (stating that significant increases in price 
challenges or overrides should not be considered a material 
valuation risk due to their routine nature); American Fund Trustee 
Comment Letter.
    \242\ See supra section II.B.1. See also rule 2a-
5(b)(1)(i)(A)(1).
---------------------------------------------------------------------------

    Some commenters requested more clarification as to what constitutes 
``material'' in the context of the final rule's reporting 
requirements,\243\ suggesting that we create a ``material valuation 
matter'' standard that would be reported similar to serious compliance 
matters under the compliance rule,\244\ that we permit the board to 
define materiality,\245\ or use different terminology altogether to 
avoid confusion with accounting or auditing standards.\246\ We believe 
that material matters in this context would generally be those matters 
about which the board would reasonably need to know in order to 
exercise appropriate oversight of the valuation designee's fair value 
determination process.\247\ For example, material matters include 
significant deficiencies or material weaknesses in internal control 
over financial reporting related to fair value determinations that have 
been identified and generally would include those items that ``could 
have materially affected'' the fair value of the fund's investments as 
proposed.\248\ We believe that material matters also include other 
issues, such as a change to a pricing service affiliated with the 
valuation designee or material changes to or deviations from 
methodologies, including changes to critical inputs or 
assumptions.\249\ As another example, with regards to material changes 
to the selection or oversight of pricing services, a pattern of price 
challenges or overrides over time that raise concerns with the overall 
valuation process may be material. The valuation designee should 
identify material issues, and the board should follow-up as necessary 
for its oversight.
---------------------------------------------------------------------------

    \243\ See ABA Comment Letter; MFDF Comment Letter; SIFMA AMG 
Comment Letter (stating that the industry will likely look to the 
serious compliance issues standard from rule 38a-1 for guidance); 
AIMA Comment Letter (with regard to prompt reporting); Deloitte 
Comment Letter; see also University of Miami Comment Letter 
(suggesting that differences in what constitutes materiality could 
lead to delays in prompt reporting); MFS Comment Letter (the prompt 
reporting requirement is unnecessary because of the similarity of 
materiality in this rule with serious compliance matters under rule 
38a-1).
    \244\ See Stradley Comment Letter; Dechert Comment Letter.
    \245\ See Vanguard Comment Letter.
    \246\ See Duff & Phelps Comment Letter.
    \247\ This standard is similar to that of ``material compliance 
matter'' found in rule 38a-1. See rule 38a-1(e)(2).
    \248\ To align the material matters that would be reported with 
Commission rules and auditing standards better, we are eliminating 
the term ``could have materially affected'' from the final rule and 
instead are using the term material matter alone. Material matters 
under the final rule would generally include, for example, material 
weaknesses and significant deficiencies as defined in 17 CFR 210.1-
02(a)(4) that are related to fair value determinations. Some 
commenters questioned the relevance of financial reporting concepts 
when reporting regarding fair value determinations. See ABA Comment 
Letter; TRP Comment Letter (regarding prompt, but not periodic, 
reporting). We believe that these issues can be significant as the 
lack of sufficient controls over financial reporting could have 
significant implications in the fund's fair value determinations. 
See also TRP Comment Letter (supporting a system of annual reporting 
for many items but quarterly reporting for significant deficiencies 
and material weaknesses in internal controls over financial 
reporting in lieu of prompt reporting on these items).
    \249\ See Proposing Release, supra footnote 2, at n.104 and 
accompanying text.
---------------------------------------------------------------------------

    The final rule will require the valuation designee's reports to 
include such information as may be reasonably necessary for the board 
to evaluate the matters covered in the reports.\250\ Based upon that 
information, the board can determine whether to ask additional 
questions or request additional information, as appropriate. For 
example, if a valuation designee reports that there is a new material 
conflict of interest, the valuation designee should provide, and the 
board should seek,\251\ additional information as necessary for the 
board to evaluate the potential impact of the conflict on the adequacy 
and effectiveness of the valuation designee's determinations of fair 
value. As another example, where a valuation designee has materially 
changed a fair value methodology, the report could summarize the 
relevant market conditions or other circumstances leading to the 
decision to apply an alternate methodology and the alternate fair value 
methodology used.
---------------------------------------------------------------------------

    \250\ Rule 2a-5(b)(1).
    \251\ See supra section II.B.1 (``Further, in our view effective 
oversight cannot be a passive activity. Directors should ask 
questions and seek relevant information.'').
---------------------------------------------------------------------------

    Some commenters were concerned that this requirement will result in 
advisers providing extraneous or out-of-context information, such as 
back-testing results, to the board.\252\ The specific content of the 
periodic or prompt reports and supplemental information under the final 
rule is left to the board and valuation designees. These reports can 
take the form of narrative summaries, graphical representations, 
statistical analyses, dashboards, or exceptions-based

[[Page 766]]

reporting, among other methods.\253\ Boards should work with valuation 
designees to determine what information and the format of such 
information is most useful to the board.
---------------------------------------------------------------------------

    \252\ See, e.g., Capital Group Comment Letter; TRP Comment 
Letter. But see CFA Institute Comment Letter (arguing that the 
results of testing methods such as calibration/back-testing can 
assist in identifying issues with methodologies, including poor 
performance or conflicts of interest).
    \253\ See ABA Comment Letter (recommending we require the 
production of narrative summaries of testing results).
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    In the Proposing Release, we provided a list of specific items that 
a board could review and consider, if relevant. These included a number 
of data-driven reporting items like reports regarding portfolio 
holdings whose price has changed outside of pre-determined ranges over 
time, reports regarding stale prices, and analyzing trends in the 
number of the fund's portfolio holdings that received a fair 
value.\254\
---------------------------------------------------------------------------

    \254\ See Proposing Release, supra footnote 2, at 46-47.
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    A number of commenters objected to this list, suggesting that 
boards and advisers would see these items as mandatory, leading to 
advisers providing unwanted data to boards in an abundance of 
caution.\255\ The items we identified in the Proposing Release were 
intended to provide a list of examples of the types of information that 
a board could request to facilitate data-driven reviews of the fair 
value process if the board found such information helpful. We continue 
to believe that boards should request, and valuation designees should 
provide, such relevant trend dashboards and other analytical tools that 
the board believes it needs in order to perform appropriate 
oversight.\256\ However, the final rule will not require the production 
of any particular data or data tool unless the board requests it. We 
also continue to believe that the types of potential reporting items 
included in the proposal may be helpful for some boards. They are not 
mandatory, however. Boards should use their judgment in determining 
what types of optional reporting they wish to receive beyond the 
required reporting contained in the final rule.
---------------------------------------------------------------------------

    \255\ See Fidelity Trustees Comment Letter; ICI Comment Letter; 
IDC Comment Letter; ABA Comment Letter (further suggesting that it 
should be incumbent upon the adviser, similar to the requirements of 
section 15(c) or 17 CFR 270.12b-1, to provide this type of 
information, rather than upon the board to request it); MFDF Comment 
Letter; Fidelity Comment Letter; Vanguard Comment Letter; Capital 
Group Comment Letter; SIFMA AMG Comment Letter; see also Federated 
Hermes Comment Letter.
    \256\ See, e.g., Capital Group Comment Letter (stating that 
reporting of trends, outliers, and similar analysis of price 
overrides and challenges would be more helpful for board oversight 
than requiring all price overrides or challenges to be reported).
---------------------------------------------------------------------------

(b) Prompt Board Notification and Reporting
    With modifications made to address comments received on this aspect 
of the proposal, the final rule will require the valuation designee to 
provide a written notification of the occurrence of matters that 
materially affect the fair value of the designated portfolio of 
investments (defined as ``material matters'') within a time period 
determined by the board, but in no event later than five business days 
after the valuation designee becomes aware of the material matter.\257\ 
Material matters in this instance include, as examples, a significant 
deficiency or material weakness in the design or effectiveness of the 
valuation designee's fair value determination process or of material 
errors in the calculation of net asset value.\258\ The valuation 
designee must also provide such timely follow-on reports as the board 
may reasonably determine are appropriate.\259\ This process is designed 
to ensure that the valuation designee notifies the board of certain 
issues that may require its immediate attention in a timely manner, but 
also empower boards to seek the appropriate level of follow-up 
reporting that they need to exercise appropriate oversight.
---------------------------------------------------------------------------

    \257\ The proposed rule would have required prompt reporting 
regarding matters associated with the adviser's process that had 
this effect. The purpose of this requirement is to inform boards 
quickly of issues associated with fair value determinations that may 
require their immediate attention. See Proposing Release, supra 
footnote 2, at 49. We have updated the text of rule 2a-5 to clarify 
that this reporting is not limited to issues relating to the 
valuation designee's process.
    \258\ Rule 2a-5(b)(1)(ii). See also supra footnotes 243 through 
249 and accompanying text (discussing ``materiality'') and infra 
footnote 272 through 274 and accompanying text (discussing price 
errors).
    \259\ Rule 2a-5(b)(1)(ii). The notifications or reports, like 
the periodic reports discussed above, must also include such 
information as may be reasonably necessary for the board to evaluate 
the matter covered in the report. See rule 2a-5(b)(1) and supra 
footnotes 243-256 and accompanying text. This information need not 
be voluminous, particularly the prompt notification. If boards want 
more information, however, they should seek it out.
---------------------------------------------------------------------------

    The proposal included a reporting requirement that would have 
required prompt reporting on matters that could have materially 
affected the fair value of the designated portfolio of 
investments.\260\ Commenters argued that this requirement could be 
interpreted broadly and would result in excessive reporting, 
particularly in relation to the requirement to report material changes 
in valuation risks.\261\ They also suggested it could involve the board 
in the day-to-day process of determining investments' fair values 
despite the designation of that function to the adviser,\262\ and could 
open the valuation program to post-facto questioning by third parties, 
particularly the proposed requirement to promptly report matters that 
``could have'' impacted valuations.\263\
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    \260\ Proposed rule 2a-5(b)(1)(ii). The proposed rule identified 
significant deficiencies or material weaknesses in the design or 
implementation of the adviser's fair value determination process or 
material changes in the fund's valuation risks, but not material 
errors in the calculation of net asset value, as examples of these 
material matters. Id. See also Proposing Release, supra footnote 2, 
at n.115 and accompanying text. Also, in the Proposing Release, we 
provided guidance that advisers could take an additional three days 
to determine the materiality of the issue at hand. Id. at 49-50.
    \261\ See, e.g., ICI Comment Letter; IAA Comment Letter (stating 
that a significant increase in price challenges should not be 
considered a material valuation risk); see also Federated Hermes 
Comment Letter.
    \262\ See, e.g., Fidelity Trustees Comment Letter; ICI Comment 
Letter; IDC Comment Letter; BlackRock Trustees Comment Letter; ABA 
Comment Letter; Fidelity Comment Letter.
    \263\ See, e.g., Fidelity Trustees Comment Letter; JPMAM Comment 
Letter; ICI Comment Letter; IDC Comment Letter; Murphy Comment 
Letter; see also Federated Hermes Comment Letter. See also supra 
footnote 248 and accompanying text (discussing the final rule's 
treatment of matters that the valuation designee or fund's auditors 
have determined ``could have'' materially affected fair value).
---------------------------------------------------------------------------

    Some suggested alternatives, such as the adviser making a prompt 
notification within the prescribed period and then subsequently 
providing a report to the board following an assessment of the issue as 
soon as reasonably practicable.\264\ Others suggested that the specific 
items required to be promptly reported, such as significant 
deficiencies or material weaknesses in the design or implementation of 
the adviser's fair value determination process or material changes to 
the fund's current valuation risks, be clarified or made in the 
periodic reports instead.\265\ Some suggested that the prompt reporting 
requirement be eliminated altogether,\266\ or that the final rule 
should allow boards or advisers to set reporting parameters.\267\
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    \264\ See JPMAM Comment Letter; Murphy Comment Letter; John 
Hancock Comment Letter.
    \265\ See, e.g., ICI Comment Letter; TRP Comment Letter; 
Vanguard Comment Letter (regarding a significant increase in price 
challenges as a material change to the fund's current valuation 
risk); Capital Group Comment Letter; see also Federated Hermes 
Comment Letter.
    \266\ See ICI Comment Letter; IDC Comment Letter; BlackRock 
Trustees Comment Letter; MFDF Comment Letter; AIMA Comment Letter; 
see also Federated Hermes Comment Letter.
    \267\ See, e.g., Fidelity Comment Letter; Stradley Comment 
Letter; NYC Bar Comment Letter; Guggenheim Comment Letter; Vanguard 
Comment Letter; see also Duff & Phelps Comment Letter.
---------------------------------------------------------------------------

    The purpose of this requirement is to ensure that boards receive 
timely information that demands their immediate attention. We believe 
that it is critical for appropriate oversight under the final rule that 
the board be

[[Page 767]]

kept informed of material changes or events in a timely manner, rather 
than waiting until the next periodic report. However, we also agree 
that boards should be receiving information tailored to this purpose. 
As a result, in a modification from the proposal, the final rule will 
require that the valuation designee provide a prompt written 
notification of the material matter,\268\ with such follow-on reporting 
as the board may determine \269\ appropriate.\270\ Examples of material 
matters that would need to be reported under this provision include 
significant deficiencies or material weaknesses in the design or 
effectiveness of the valuation designee's fair value determination 
process \271\ as well as material errors in the calculation of net 
asset value.\272\ Some commenters had suggested that we set an NAV 
error threshold, similar to that generally utilized in the industry at 
$0.01 a share or 0.5% of the NAV, as the threshold for prompt 
reporting.\273\ While we decline to establish that specific standard as 
what constitutes a ``material error in the calculation of net asset 
value'' for purposes of the final rule, we agree that relying upon that 
standard would not be unreasonable.\274\
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    \268\ Some commenters suggested that the prompt reporting 
element in particular should be oral rather than in writing. See 
JPMAM Comment Letter; John Hancock Comment Letter; SIFMA AMG Comment 
Letter; AIMA Comment Letter; MFS Comment Letter. We believe that it 
is important to ensure that records are kept of these notifications 
and thus the notification must be in writing. Rule 2a-5(b)(1). 
However, the final rule does not prescribe the information that must 
be included in the written notification, and advisers may, if 
appropriate, provide a brief written notification (e.g., in an 
email) of the issue and follow up with supplemental information.
    \269\ Consistent with the guidance above regarding board 
oversight, the board can utilize this follow-up reporting process to 
inquire about the matter raised in the notification and take 
reasonable steps to see that matters identified in the notification 
are addressed. See supra footnote 212 and accompanying text.
    \270\ The notifications and reports that will be required under 
this provision are records that will need to be maintained pursuant 
to new rule 31a-4. See rule 31a-4(b)(1); see also infra section 
II.C. Further, to the extent that the board does seek follow-on 
reporting, appropriate records of that report will need to be 
maintained, consistent with the requirement to maintain appropriate 
documentation to support fair value determinations. See rule 31a-
4(a). If such reporting occurs as part of the valuation designee's 
periodic reports required under the final rule, a separate record 
will not need to be maintained.
    \271\ We have changed this requirement from the proposed 
``implementation'' to ``effectiveness'' to clarify the intent of 
this provision and better align it with auditing concepts of 
internal control. This specific example was, as proposed, based upon 
these auditing concepts. See Proposing Release, supra footnote 2, at 
n.115. This change should help address comments that the proposed 
rule was insufficiently clear as to when this report is needed as it 
will now be tied to the auditing concepts with which funds and 
valuation designees are already familiar. See supra footnote 261 and 
accompanying text.
    \272\ Rule 2a-5(b)(1)(ii). Some commenters had recommended this 
as a reporting item and we agree that valuation designees should 
promptly notify boards of this issue. See Advisor's Inner Circle 
Trustees Comment Letter. See generally BlackRock Trustees Comment 
Letter; ABA Comment Letter (arguing that ``material'' in the 
reporting context should be considered synonymous with material NAV 
errors); Murphy Comment Letter (recommending this as a quarterly 
reporting item); TRP Comment Letter (recommending this as a 
quarterly reporting item); Vanguard Comment Letter (suggesting that 
``material'' for prompt reporting purposes could be based upon an 
NAV error threshold test).
    \273\ See ABA Comment Letter; Vanguard Comment Letter.
    \274\ See also supra footnotes 243 through 249 and accompanying 
text (discussing materiality).
---------------------------------------------------------------------------

    Commenters also had concerns about the proposed three-business-day 
time period for making these reports, arguing that it was insufficient 
time to provide a meaningful report to the board.\275\ Some suggested 
that we either remove or extend the specified reporting period.\276\ We 
believe that it is important to specify some time period for these 
reports so that the board receives timely information within an 
appropriate window of time, but we agree with commenters that three 
business days may be insufficient time to prepare the necessary 
communication. As a result, we are extending the period to five 
business days to give valuation designees sufficient time to coordinate 
and prepare communications for the board regarding a material matter 
that meets the standard for prompt notification.\277\ In light of the 
changes discussed above, we are not extending the period beyond five 
business days as we believe it is important that boards receive 
information about material matters as promptly as practicable. However, 
the final rule also empowers boards to require that valuation designees 
make this notification within a shorter time frame should boards 
determine that more timely notification or reporting is necessary for 
their oversight of these matters.
---------------------------------------------------------------------------

    \275\ See, e.g., Sullivan Comment Letter; JPMAM Comment Letter; 
MFDF Comment Letter; Fidelity Comment Letter; TRP Comment Letter 
(recommending we incorporate the concept of ``reasonable diligence'' 
from certain ``Dear CFO'' staff letters relating to tax 
liabilities); John Hancock Comment Letter (stating that this is 
particularly difficult timing when an adviser would need to consult 
with a sub-adviser); see also ABA Comment Letter (stating that three 
days was arbitrary); Duff & Phelps Comment Letter (stating that 
additional time may be necessary); Federated Hermes Comment Letter; 
American Funds Trustees Comment Letter; MFS Comment Letter; 
Advisor's Inner Circle Trustees Comment Letter. But see NYC Bar 
Comment Letter (stating that three days was sufficient if the 
adviser is simply informing the board of an error in implementation 
or risk of material effects on the valuation of the fund's 
portfolio): University of Miami Comment Letter.
    \276\ See, e.g., Sullivan Comment Letter; ICI Comment Letter; 
IAA Comment Letter; AIMA Comment Letter; NYSSCPA Comment Letter; ABA 
Comment Letter (recommending ten days).
    \277\ As discussed in more detail below, the final rule does not 
require valuation designees to complete their materiality assessment 
within this five-day window. See infra footnote 280 and accompanying 
text. As a result, once materiality has been determined, valuation 
designees must notify the board within five business days.
---------------------------------------------------------------------------

    Under this revised requirement, a valuation designee must promptly 
notify the board of material matters related to valuation controls or 
errors that either the valuation designee has identified itself or that 
the valuation designee has been notified of by an independent third 
party, including the fund's auditor. We believe that the valuation 
designee should promptly determine the materiality of matters it 
identifies consistent with its fiduciary duties and then notify the 
board within the five business day period after determining that the 
matter is material. In cases where the materiality of a matter is 
immediately apparent, the designee would report the material matter to 
the board within the five business day period.\278\ If, after 20 
business days of becoming aware of the relevant valuation matter, the 
designee has not been able to determine the matter's materiality, we 
would expect the designee to then notify the board of its ongoing 
evaluation of the matter within the five-business-day prompt reporting 
period.\279\ A valuation designee should act promptly in seeking to 
determine the materiality of a matter, and not take the 20 business 
days as a matter of course, in order to enable the board to provide 
effective oversight. This is a change from the proposal, where we would 
have required materiality determinations to be made within three 
business days.\280\
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    \278\ If the materiality of the event is not in question, such 
as when an independent third party (for example an auditor), 
notifies the valuation designee of a material matter and that 
notification includes a conclusion as to the impact of the material 
matter upon the fund's portfolio or the fund's control deficiencies' 
severity, then the five business day notification period is 
triggered immediately.
    \279\ We believe that taking longer than 20 business days to 
determine materiality, or at least begin the five business day 
period to notify the board if materiality cannot be determined that 
quickly, would be excessive and thus not consistent with the 
promptness contemplated by the reporting requirement.
    \280\ The proposed rule would have provided three business days 
to report to the board on these matters, and the Proposing Release 
clarified that an adviser would have been permitted to take an 
additional three business days to verify and make a final 
determination of the matter's materiality prior to reporting to the 
board. Proposing Release, supra footnote 2, at 50-51.
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    In combination, these changes should clarify and focus the prompt 
reporting

[[Page 768]]

and provide boards and valuation designees with more flexibility. As 
adopted, the final rule also should be better suited for the ongoing 
dialogue between boards and valuation designees that commenters 
stressed as important when the board is exercising oversight,\281\ in 
that it gives boards discretion to get in-depth analysis they may need 
to provide appropriate oversight rather than mandating a quickly 
produced formal report. We also believe that these modifications make 
clear that the board's role under rule 2a-5, where the board has 
designated the valuation designee to perform fair value determinations, 
is one of oversight and that the final rule's prompt reporting 
requirements will help boards to effectively perform this function.
---------------------------------------------------------------------------

    \281\ See, e.g., BlackRock Trustees Comment Letter; MFS Comment 
Letter.
---------------------------------------------------------------------------

    Some commenters recommended that we permit a designated board 
member, such as an independent board member, to receive the prompt 
report.\282\ We believe that the reports should be made to the board 
members that are tasked with carrying out appropriate oversight over 
valuations, which can be a committee. Therefore, the final rule, 
consistent with the proposal, permits reporting to either the full 
board or a designated committee of such board composed of a majority of 
directors who are not interested persons of the fund.\283\
---------------------------------------------------------------------------

    \282\ See Murphy Comment Letter (stating that such an approach 
would be helpful with small fund boards); Fidelity Comment Letter; 
AIMA Comment Letter.
    \283\ Rule 2a-5(e)(3) (``board'' defined as either fund's entire 
board of directors or designated committee of such board composed of 
majority of directors who are not interested persons of the fund).
---------------------------------------------------------------------------

3. Specification of Functions
    We are adopting the specification of functions requirement largely 
as proposed. Under the final rule, if the board designates the 
performance of fair value determinations to a valuation designee, rule 
2a-5 will require the valuation designee to specify the titles of the 
persons responsible for determining the fair value of the designated 
investments, including by specifying the particular functions for which 
the persons identified are responsible.\284\ Consistent with this 
requirement, the specific personnel with duties associated with price 
challenges should be identified, including those with the authority to 
override a price, along with the roles and responsibilities of such 
persons, and the valuation designee is required to establish a process 
for the review of price overrides.\285\ Finally, the final rule 
requires the valuation designee reasonably to segregate fair value 
determinations from the portfolio management of the fund such that the 
portfolio manager may not determine, or effectively determine by 
exerting substantial influence on, the fair values ascribed to 
portfolio investments.\286\
---------------------------------------------------------------------------

    \284\ Rule 2a-5(b)(2). To comply with this requirement, the fair 
value policies and procedures adopted under rule 38a-1 generally 
should specify the titles of the persons responsible for determining 
the fair value of the designated investments and should specify the 
particular functions for which persons with the identified titles 
are responsible. Similarly, if the valuation designee uses a 
valuation committee or similar body to assist in the process of 
determining fair value, the fair value policies and procedures 
should generally describe the composition and role of the committee, 
or reference any related committee governance documents as 
appropriate. See Proposing Release, supra footnote 2, at text 
following n.117.
    \285\ See also rule 2a-5(a)(4) (requiring the oversight of 
pricing services).
    \286\ Rule 2a-5(b)(2). The valuation designee of an internally 
managed fund would also be required to reasonably segregate fair 
value determinations from the portfolio management of the fund.
---------------------------------------------------------------------------

    Commenters generally supported these provisions.\287\ One 
commenter, however, stated that the proposed rule lacked clarity as to 
which individuals are required to be identified and stated that 
``little appears to be gained by the mechanical exercise'' of naming 
individuals and their titles, which may be generic, and identifying 
with specificity their roles in the valuation function.\288\ We 
disagree with the commenter because these provisions cannot be 
satisfied by simply listing the generic titles of those involved in 
valuation. As we stated in the Proposing Release, we believe, and other 
commenters agreed, that it is important for funds clearly to identify, 
in their fair value policies and procedures, the titles of persons, and 
a description of their roles and responsibilities, who make fair value 
determinations to enhance accountability and provide clear lines of 
responsibility.\289\ We believe requiring the identification of the 
titles of the responsible individuals and a description of their roles 
will facilitate an effective fair value process and promote 
accountability.\290\
---------------------------------------------------------------------------

    \287\ See, e.g., AIMA Comment Letter; ICI Comment Letter; ABA 
Comment Letter; Fidelity Comment Letter; Dechert Comment Letter.
    \288\ See Sullivan Comment Letter.
    \289\ See Proposing Release, supra footnote 2, at n.118 and 
accompanying text. See also, generally, AIMA Comment Letter; ICI 
Comment Letter; ABA Comment Letter; Fidelity Comment Letter; Dechert 
Comment Letter. See supra section II.A.5.
    \290\ See, e.g., AIMA Comment Letter.
---------------------------------------------------------------------------

    Additionally, commenters generally supported the proposed 
requirement that the adviser reasonably segregate fair value 
determinations from the portfolio management of the fund.\291\ These 
commenters agreed with our assertions in the Proposing Release that a 
significant source of potential adviser conflicts of interest in the 
fair value determination process is the level and kinds of input that 
fund portfolio managers or persons in related functions have in the 
design or modification of fair value methodologies, or in the 
calculation of specific fair values.\292\ Three commenters stated that 
portfolio managers have ``insurmountable'' conflicts of interest 
because they are often compensated based on the returns of the 
fund.\293\ These commenters urged the Commission to prohibit portfolio 
managers from participating in the process of fair value determinations 
in any way. Other commenters, however, stated that in many 
circumstances, the fund's portfolio manager may be the most 
knowledgeable person at an adviser regarding a fund's portfolio 
holdings and it is appropriate for him or her to provide input into the 
process for determining the fair value of fund investments.\294\ Two 
commenters also stated the segregation requirement may create 
challenges for smaller managers due to their limited resources and 
personnel, but recognized the importance of appropriately mitigating 
portfolio managers' biases or conflicts of interest.\295\ One commenter 
stated that,

[[Page 769]]

by requiring a fund reasonably to segregate portfolio management from 
the process of making fair value determinations in the text of rule 2a-
5, the condition could be read to prohibit any involvement of fund 
portfolio management in any part of the process of making fair value 
determinations.\296\
---------------------------------------------------------------------------

    \291\ SBIA Comment Letter; AIMA Comment Letter; IVSC Comment 
Letter; Duff & Phelps Comment Letter; Stradley Comment Letter; 
Vanguard Comment Letter; MFS Comment Letter; Fidelity Comment 
Letter; American Bankers Association Comment Letter; Dechert Comment 
Letter. See Proposing Release, supra footnote 2, at text 
accompanying n.122.
    \292\ Id. See also Investment Company Institute Independent 
Directors Council, Fair Valuation Series: The Role of the Board at 
10 (2006) (``IDC Role of the Board''), available at http://www.ici.org/pdf/06_fair_valuation_board.pdf (noting that portfolio 
managers can be important sources of information about the value of 
securities, but there may be conflict of interest concerns when 
portfolio managers select fair values that boost a fund's 
performance, particularly when the compensation of the portfolio 
manager is based on the fund's performance).
    \293\ Better Markets Comment Letter; CFA Institute Comment 
Letter; University of Miami Comment Letter.
    \294\ SBIA Comment Letter; AIMA Comment Letter; IVSC Comment 
Letter; Stradley Comment Letter; Vanguard Comment Letter; MFS 
Comment Letter; Fidelity Comment Letter; American Bankers 
Association Comment Letter; Dechert Comment Letter. One commenter 
further argued that the Commission should mandate the involvement of 
portfolio managers in the valuation process because they have ``the 
most relevant investment specific information pertaining to an 
investment.'' Duff & Phelps Comment Letter.
    \295\ Duff & Phelps Comment Letter; American Bankers Association 
Comment Letter (suggesting that, in certain situations where 
segregation may be burdensome, the Commission should allow 
alternative processes for managing conflicts, including establishing 
reconciliation procedures that are designed to protect against 
improper valuation of fund investments).
    \296\ Dechert Comment Letter.
---------------------------------------------------------------------------

    We continue to believe that our proposed approach strikes the 
appropriate balance. The final rule will not prohibit portfolio 
managers from participating in the process of fair value determinations 
because of the unique insights that portfolio management may have 
regarding the value of fund holdings. Keeping the functions reasonably 
segregated in the context of fair value determinations should help 
mitigate the possibility that a portfolio manager's competing 
incentives diminish the effectiveness of fair value determinations. 
However, in a change from the proposal, the final rule would remove the 
phrase ``process of'' from this subsection of rule 2a-5. This change is 
meant to clarify that the segregation requirement would not prevent 
portfolio managers from providing inputs that are used in the process 
for determining fair value, as raised by one commenter.\297\ However, 
in a change from the proposal, the final rule clarifies that, to 
satisfy the reasonable segregation requirement, the portfolio manager 
may not determine, or effectively determine by exerting substantial 
influence on, the fair values ultimately ascribed to portfolio 
investments.\298\ A portfolio manager determining the fair value of 
fund investments would not be consistent with the reasonable 
segregation of functions required by the final rule.
---------------------------------------------------------------------------

    \297\ Dechert Comment Letter. See also Proposing Release, supra 
footnote 2, at text following n.122 (stating that the reasonable 
segregation requirement is not meant to indicate that portfolio 
management must necessarily be subject to a communications 
``firewall'').
    \298\ An example of effectively determining by exerting 
substantial influence would be if the fair values ascribed to 
portfolio investments are based solely on information provided by 
the portfolio manager,
---------------------------------------------------------------------------

    As discussed in the Proposing Release, this requirement is designed 
to address concerns regarding a portfolio manager's conflicts of 
interest while recognizing the important perspective and insight 
regarding the value of fund holdings that portfolio management 
personnel can provide.\299\ Reasonable segregation of functions 
facilitates these important checks and balances, and funds could 
institute this requirement through a variety of methods, such as 
independent reporting chains, oversight arrangements, or separate 
monitoring systems and personnel.\300\ We recognize that this 
requirement may create certain challenges for smaller advisers and 
internally managed funds due to their limited numbers of personnel, but 
we believe that this requirement is necessary to manage potential 
conflicts of interest. Additionally, to alleviate some of these 
challenges, the final rule's reasonable segregation approach is 
designed to allow funds to structure their fair value determination 
process and portfolio management functions in ways that are tailored to 
each fund's facts and circumstances, including the size and resources 
of a particular fund. However, the final rule clarifies that a fund 
should limit the extent of influence portfolio managers may have on 
administration of the fair value process. If portfolio managers provide 
a significant amount of input on the fair value of an investment, the 
segregation process should be appropriately rigorous and robust to 
mitigate any potential conflicts of interest. For example, in such a 
circumstance, the valuation designee could, as part of its reasonable 
segregation process, seek to provide independent voices as a check on 
any potential conflicts of interest to the extent appropriate.\301\
---------------------------------------------------------------------------

    \299\ See Proposing Release, supra footnote 2, at text following 
n.122.
    \300\ See American Bankers Association Comment Letter.
    \301\ See Proposing Release, supra footnote 2, at n.122. See 
also supra footnote 189 (noting that an evaluation designee, once 
designated by the board, could seek to obtain the assistance from 
other parties such as the fund administrator).
---------------------------------------------------------------------------

C. Recordkeeping

    We are adopting new rule 31a-4 that applies to both registered 
investment companies and business development companies \302\ to 
contain the recordkeeping requirements associated with the final 
rule.\303\ Rule 31a-4 will require, substantially as proposed as part 
of rule 2a-5, funds or their advisers to maintain appropriate 
documentation to support fair value determinations.\304\ In addition, 
rule 31a-4 provides that, in cases where the board has designated the 
performance of fair value determinations to a valuation designee, the 
reports and other information provided to the board must include a 
specified list of the investments or investment types for which the 
valuation designee has been designated.\305\ These records will, in a 
change from the proposal,\306\ generally be required to be maintained 
for six years, the first two in an easily accessible place.\307\ In 
another change from the proposal, rule 31a-4 will require funds or 
their advisers to maintain appropriate documentation to support fair 
value determinations, rather than requiring a fund or adviser to keep 
records of the specific methodologies applied and assumptions and 
inputs that form the basis of the fair value determination in all 
cases. Lastly, as proposed, the fund will be required to maintain these 
records unless the board has designated the performance of fair value 
determinations to the fund's investment adviser. In that case, the 
investment adviser will maintain the records.\308\
---------------------------------------------------------------------------

    \302\ See section 64 of the Act (generally applying section 31 
of the Act to business development companies to the same extent as 
if they were registered closed-end investment companies).
    \303\ Except as discussed in more detail below, the provisions 
of this rule are the same as the recordkeeping requirements proposed 
to be part of rule 2a-5. See proposed rule 2a-5(a)(6) and (b)(3).
    \304\ Rule 31a-4(a).
    \305\ Rule 31a-4(b).
    \306\ We proposed a five-year retention period for these 
records. See proposed rule 2a-5(a)(6) and (b)(3). Other than the 
list of designated investments, this retention period will, as 
proposed, begin when the determination is made for documentation to 
support fair value determinations and from the end of the relevant 
fiscal year for valuation designee reports. Rule 31a-4(a) and (b). 
Cf. Murphy Comment Letter (questioning the beginning of the 
retention period) and infra footnote 307 and accompanying text 
(discussing the retention period for the list of designated 
investments).
    \307\ The list of designated investments will be required to be 
kept for a period beginning with the designation and ending at least 
six years after the end of the fiscal year in which the designation 
was terminated, in an easily accessible place until two years after 
such termination, instead of the proposed period of five years 
beginning at the end of the fiscal year in which the investments or 
investment types were assigned to the adviser, the first two years 
in an easily accessible place. See rule 31a-4(b)(2) and proposed 
rule 2a-5(b)(3)(ii). We had requested comment on, among other 
things, whether the proposed holding periods were sufficient to 
evidence compliance with the proposed rule. See Proposing Release, 
supra footnote 2, at 57. While we did not receive any specific 
comments on this point, we are concerned that in cases where a 
valuation designee's appointment lasts longer than five or six 
years, third parties, including Commission staff, will not have 
access to this information.
    \308\ Rule 31a-4(c).
---------------------------------------------------------------------------

    Comments on the recordkeeping aspects of the proposal were mixed, 
with some commenters broadly agreeing with them,\309\ and others 
stating that the proposed requirements would add significant additional 
costs.\310\

[[Page 770]]

Specifically, these commenters stated that the proposed requirement to 
maintain documentation to support fair value determinations, including 
information regarding the specific methodologies applied and the 
assumptions and inputs considered when making fair value 
determinations, would result in the adviser needing to obtain and 
retain significant amounts of data that it would not otherwise obtain 
and retain when it utilizes a pricing service, and could hamper 
flexibility in making fair value determinations.\311\
---------------------------------------------------------------------------

    \309\ See IVSC Comment Letter; Council of Institutional 
Investors Comment Letter; CFA Institute Comment Letter. Some 
commenters approved of the proposed recordkeeping requirements, but 
only for records created by the fund or adviser, not records of a 
pricing service. See Fidelity Comment Letter; TRP Comment Letter; 
Vanguard Comment Letter.
    \310\ See, e.g., ICI Comment Letter; Fidelity Comment Letter; 
Vanguard Comment Letter; Guggenheim Comment Letter (asserting that 
funds or advisers would need to hire additional personnel to comply 
with the rule as proposed); and Guggenheim Trustees Comment Letter. 
But see Comment Letter of Elena Davidson (July 20, 2020) (``Davidson 
Comment Letter'') (suggesting that the Commission provided ample 
reason to believe that the costs of compliance would be on the 
smaller side).
    \311\ See, e.g., ICI Comment Letter; IDC Comment Letter; SSGA 
Comment Letter; Sullivan Comment Letter; ICE Data Comment Letter 
(stating that pricing services would need to increase fees to 
compensate for the demands for records under the proposed regime).
---------------------------------------------------------------------------

    One commenter suggested that the proposed recordkeeping 
requirements were more appropriate as a rule under section 31 of the 
Act, stating that this would both help centralize investment company 
recordkeeping provisions and would also ensure that a failure to keep 
the required records would not lead to a board being found to have not 
fair valued in good faith.\312\ We agree, and are therefore moving 
these amended recordkeeping requirements to a new rule under section 
31. Another suggested that these requirements are duplicative with the 
existing recordkeeping rules adopted under section 31 of the Act.\313\ 
While some records currently required to be maintained pursuant to the 
rules adopted under section 31 of the Act may be the appropriate 
documentation to support fair value determinations in some 
circumstances,\314\ they may not always be sufficient to meet that 
standard. Thus, we do not believe that rule 31a-4's recordkeeping 
requirements are duplicative of the existing rules adopted under 
section 31.\315\
---------------------------------------------------------------------------

    \312\ Murphy Comment Letter.
    \313\ NYC Bar Comment Letter.
    \314\ Schedules evidencing and supporting each computation of 
net asset value as required under 17 CFR 270.31a-2(a)(2) (``rule 
31a-2'') are examples of records that could also be considered 
appropriate documentation to support fair value determinations.
    \315\ Also, the reports to the board and specified list of 
designated investments that will be required to be maintained under 
rule 31a-4 are not clearly required as part of the existing section 
31 rules. See also Compliance Rules Adopting Release, supra footnote 
82, at n.94 (adopting a similar requirement for rule 38a-1 for 
similar reasons).
---------------------------------------------------------------------------

    A number of commenters also recommended that we tie the 
recordkeeping requirements to the three-tier fair value hierarchy 
within U.S. GAAP \316\ or otherwise not require obtaining or 
maintaining detailed records regarding the level 2 categorized fair 
value measurements of securities for which funds use pricing 
services.\317\ These commenters stated that, because the fund or 
adviser would not have access to the appropriate level of information 
on the pricing service's specific inputs considered or assumptions 
applied in each particular case, the proposed requirement would be a 
significant departure from industry practice. Instead, these commenters 
asked that we only require detailed recordkeeping to support fair value 
determinations for those investments for which the fund or valuation 
designee establishes or applies its own methodologies.\318\ A number of 
commenters suggested that we provide additional guidance regarding 
exactly what records fit within the rule's requirements.\319\ One 
commenter requested that the Commission confirm that the view that 
funds and advisers must maintain documentation sufficient for a third 
party to verify the fair value determination is not intended to mandate 
documentation detailed enough to fully recreate it.\320\
---------------------------------------------------------------------------

    \316\ ASC Topic 820 categorizes inputs to valuation techniques 
used to measure fair value into three levels. The fair value 
hierarchy gives the highest priority to quoted, observable inputs 
(level 1) and the lowest priority to unobservable inputs (level 3). 
See infra section II.D.
    \317\ See TRP Comment Letter; Franklin Comment Letter; MFS 
Comment Letter; Fidelity Comment Letter; John Hancock Comment 
Letter; see also Vanguard Comment Letter (stating that the prosed 
requirements differ from industry practice); SIFMA AMG Comment 
Letter.
    \318\ See ICI Comment Letter (noting this approach is similar to 
that in rule 22e-4); IDC Comment Letter; SSGA Comment Letter; 
Fidelity Comment Letter; TRP Comment Letter; Franklin Comment 
Letter; Vanguard Comment Letter; Capital Group Comment Letter; SIFMA 
AMG Comment Letter; Dechert Comment Letter; ICE Data Comment Letter; 
Dimensional Comment Letter.
    \319\ See Harvest Comment Letter; Guggenheim Comment Letter.
    \320\ Guggenheim Comment Letter.
---------------------------------------------------------------------------

    We believe that the requirement to maintain appropriate 
documentation to support fair value determinations should include 
documentation that would be sufficient for a third party, such as the 
Commission's staff, not involved in the preparation of the fair value 
determinations to verify, but not fully recreate, the fair value 
determination, as further described below.\321\ We understand that 
advisory personnel currently produce working papers supporting fair 
value determinations that include, for example, copies of internally 
developed valuation models, including inputs and assumptions used 
therein and relevant supporting documentation.\322\ These records that 
valuation designees currently create in the ordinary course of 
performing fair value determinations are examples of the types of 
records that we consider to be ``appropriate documentation to support 
fair value determinations.''
---------------------------------------------------------------------------

    \321\ See Proposing Release, supra footnote 2, at n.74 and 
accompanying text.
    \322\ See, e.g., infra section III.B.2.h.
---------------------------------------------------------------------------

    In a change from the proposal, we are not requiring detailed 
records relating to the specific methodologies a pricing service 
applied and the assumptions and inputs a pricing service considered 
when providing each piece of pricing information as we are persuaded 
that such a requirement would be impractical. Rather, we believe 
appropriate documentation to support a fair value determination that 
takes into account inputs from pricing services consists of the records 
related to the fund or valuation designee's initial due diligence 
investigation prior to selecting a pricing service and records from its 
ongoing monitoring and oversight of the pricing services.\323\ As 
discussed above, for example, this diligence should consider the 
valuation methods or techniques, inputs, and assumptions used by the 
pricing service for different classes of holdings, and how they are 
affected as market conditions change, among other matters.\324\ Other 
appropriate documentation also includes work papers created by the 
valuation designee while overseeing pricing services or testing fair 
value methodologies, such as those documenting the valuation designee's 
monitoring and conducting of price challenges, stale price analysis, 
and testing such as calibration or back-testing.\325\ The fund or 
adviser will not be required to maintain the internal records of the 
pricing service or the specific inputs the pricing service used for 
each piece of pricing information it provides to the fund.
---------------------------------------------------------------------------

    \323\ We expect that the type of documentation discussed in this 
paragraph would be the type of documentation that would be 
sufficient for a third party to verify the fair value determination 
as discussed in the text accompanying n.321.
    \324\ See also supra section II.A.4 regarding various matters a 
board or valuation designee should consider in approving, 
monitoring, and evaluating pricing services.
    \325\ Stale price analysis can include an evaluation of whether 
a price quote that may be used to support a fair value price is 
sufficiently timely to be useful.
---------------------------------------------------------------------------

    We also believe that different types of records will be appropriate 
depending on the security or fair value

[[Page 771]]

methodology used. For example, the documentation to support the fair 
value determination of an investment valued with level 3 inputs would 
typically require different and more extensive documentation \326\ than 
an investment that was valued only with level 2 inputs. We expect that 
the records kept may vary based on a variety of factors, including the 
subjectivity of the inputs used in determining fair value (e.g., level 
2 or level 3).
---------------------------------------------------------------------------

    \326\ Examples of the records that may be needed for level 3 
inputs include documentation supporting the inputs, assumptions, and 
calculation methodology used in determining fair value, for example 
selected financial models, financial reporting information, income 
or growth projections, or public company comparable data.
---------------------------------------------------------------------------

    Under rule 31a-4, and consistent with proposed rule 2a-5, an 
adviser designated to perform fair value determinations will be 
required to maintain the relevant records.\327\ While commenters 
disagreed about whether the fund or adviser should keep these 
records,\328\ we continue to believe the adviser should maintain them 
when it is the valuation designee. As one commenter suggested,\329\ the 
adviser would need to keep valuation records anyway. The reporting 
requirement should give boards the access to the documentation they 
deem necessary without mandating that the fund also directly hold these 
duplicative records.\330\
---------------------------------------------------------------------------

    \327\ Rule 31a-4(c).
    \328\ Compare CFA Institute Comment Letter; Council of 
Institutional Investors Comment Letter; and VRC Comment Letter with 
Murphy Comment Letter and Sullivan Comment Letter.
    \329\ See Sullivan Comment Letter.
    \330\ For internally managed funds that have delegated the 
performance of fair value determinations to an officer or officers 
of the fund, the fund will need to preserve these records. See rule 
31a-4(c). Also, we would expect that, in the event of a change in 
advisers, the fund will take appropriate action to ensure that the 
records are transferred. Cf. Murphy Comment Letter.
---------------------------------------------------------------------------

    We are not expanding the records to be maintained under the rule as 
suggested by some commenters.\331\ We believe that further 
recordkeeping requirements are not necessary because, as discussed 
above, we believe that the records required under rule 31a-4 should be 
sufficient to meet the purpose of the recordkeeping requirements, which 
is to assist third party oversight. We are also adopting as proposed 
the requirement to maintain records of the reports and other 
information provided to the board in accordance with rule 2a-5(b)(1) so 
that we and our staff will have access to them. Also, because we are 
not adopting the proposed requirement to establish fair value policies 
and procedures in light of the existing requirements of rule 38a-1, the 
final rule will not contain the proposed requirement to maintain copies 
of fair value policies and procedures, as policies and procedures 
adopted under rule 38a-1 have their own existing recordkeeping 
requirements.\332\
---------------------------------------------------------------------------

    \331\ See IVSC Comment Letter (suggesting that the Commission 
require keeping records relating to the background details of 
valuation professionals); MFS Comment Letter (stating that the 
recordkeeping requirements should reflect the relevant details of 
prompt board reports by maintaining a log or meeting minutes).
    \332\ Rule 38a-1(d)(1). See supra section II.A.5. But see 
Fidelity Comment Letter (stating that it would be appropriate to 
have a separate policies and procedures record retention requirement 
in rule 2a-5 and that the interplay between the rules was 
sufficiently explained in the Proposing Release).
---------------------------------------------------------------------------

    Under the final rule, funds and advisers will be generally required 
to maintain these records for a total of six, rather than the proposed 
five, years.\333\ We had proposed a five year period to align with the 
retention period of rule 38a-1. In light of the commenters noting the 
relationship between certain records required to be maintained under 
rule 31a-2 and rule 31a-4, we believe that aligning the retention 
period with rule 31a-2, regarding schedules evidencing and supporting 
each computation of net asset value, is more appropriate.
---------------------------------------------------------------------------

    \333\ See Duff & Phelps Comment Letter (recommending that the 
retention period mirror fund documents and ``statutory 
requirements,'' stating that six or seven years is common). But see 
CFA Institute Comment Letter (agreeing with a five-year retention 
period).
---------------------------------------------------------------------------

D. Readily Available Market Quotations

    We are adopting the definition of readily available market 
quotations as proposed. The board's role in the valuation of a 
portfolio holding for purposes of fair value depends on whether or not 
market quotations are readily available for such a holding.\334\ Under 
section 2(a)(41) of the Investment Company Act, if a market quotation 
is readily available for a portfolio security, it must be valued at the 
market value. Conversely, if market quotations are ``not readily 
available,'' a portfolio security value must be fair valued as 
determined in good faith by the board (or the valuation designee under 
the final rule).\335\
---------------------------------------------------------------------------

    \334\ Section 2(a)(41) requires the use of market values only 
for securities for which market quotations are readily available. 
Non-security holdings must always be fair valued regardless of 
whether readily available market quotations exist for that holding. 
See also infra footnote 338.
    \335\ Section 2(a)(41). Neither the Investment Company Act nor 
the rules thereunder currently define ``readily available.''
---------------------------------------------------------------------------

    The final rule will provide that a market quotation is readily 
available for purposes of section 2(a)(41) of the Investment Company 
Act with respect to a security only when that ``quotation is a quoted 
price (unadjusted) in active markets for identical investments that the 
fund can access at the measurement date, provided that a quotation will 
not be readily available if it is not reliable.'' \336\ This definition 
is consistent with the definition of a level 1 input in the fair value 
hierarchy outlined in U.S. GAAP. Thus, under the final definition, a 
security will be considered to have readily available market quotations 
if its value is determined solely by reference to these level 1 inputs. 
Fair value, as defined in the Act and further defined in rule 2a-
5,\337\ therefore must be used in all other circumstances.\338\
---------------------------------------------------------------------------

    \336\ Rule 2a-5(c). ASC Topic 820 defines level 1 inputs as 
``[q]uoted prices (unadjusted) in active markets for identical 
assets . . . that the reporting entity can access at the measurement 
date.'' ASC Topic 820-10-20 (emphasis added). In ASR 113, the 
Commission interpreted ``readily available market quotations'' to 
refer ``to reports of current public quotations for securities 
similar in all respects to the securities in question.'' Despite the 
respective references to ``securities similar in all respects'' in 
the Commission's prior guidance and ``identical assets'' in ASC 
Topic 820, we view these respective definitions as being 
substantively the same. See also Proposing Release, supra footnote 
2, at n.129 and accompanying text.
    \337\ We decline, as suggested by one commenter, to clarify that 
the final rule's definition of readily available market quotations 
only applies to determinations made pursuant to rule 2a-5. See 
Seward & Kissel Comment Letter. As discussed below, we believe that 
this definition is appropriate for all contexts under the Investment 
Company Act and its rules. See infra footnotes 359 through 364 and 
accompanying text.
    \338\ Rule 2a-5(e)(2). See also supra section II.A.2. One 
commenter recommended that certain assets that are not considered 
securities under the Act but have readily available market 
quotations should be valued at market value rather than fair valued. 
See Comment Letter of Practus, LLP (July 21, 2020) (``Practus 
Comment Letter''). The Act requires boards to determine fair value 
for all assets other than securities regardless of the existence of 
readily available market quotations. See section 2(a)(41). However, 
as we noted in the Proposing Release, U.S. GAAP requires funds to 
maximize the use of relevant observable inputs and minimize the use 
of unobservable inputs in valuing any asset. See Proposing Release, 
supra footnote 2, at 59. As a result, we believe that application of 
U.S. GAAP would generally provide for consideration of this 
information in determining fair value.
---------------------------------------------------------------------------

    Some commenters that addressed our proposed definition of readily 
available market quotations generally supported it.\339\ However, some 
commenters asked

[[Page 772]]

that we treat all securities that are valued using level 2 inputs in 
the U.S. GAAP hierarchy, including evaluated prices, as also having 
readily available market quotations under our definition.\340\ We 
believe that the best conceptual analogue for readily available market 
quotations are securities whose values are determined solely by 
reference to level 1 inputs, as we proposed. We also believe that this 
approach is consistent with many funds' practices today.\341\ We 
believe that level 2 inputs under the U.S. GAAP hierarchy are not 
consistent with the concept of readily available market quotations 
under the Act and therefore our final definition. Securities valued 
using level 2 inputs include securities that are not traded on an 
active market, and/or are valued using inputs other than quoted prices 
for the specific security (such as credit spreads).\342\ Accordingly, 
we do not believe that securities valued with level 2 inputs are 
consistent with the definition of readily available market quotations.
---------------------------------------------------------------------------

    \339\ AIMA Comment Letter; Better Markets Comment Letter; ICI 
Comment Letter; Murphy Comment Letter; Stradley Comment Letter; Duff 
& Phelps Comment Letter. Other commenters asked that we go further, 
and depart from the binary approach laid out in the Act and instead 
mirror the approach established in U.S. GAAP that treats all values 
as fair values, but establishes a three-tier hierarchy of inputs 
that are used in making fair value determinations. Fidelity Comment 
Letter; TRP Comment Letter; Capital Group Comment Letter; Baillie 
Gifford Comment Letter. We have not modified the final rule as they 
suggested because the Investment Company Act provides a binary 
framework in section 2(a)(41) under which a security either has 
readily available market quotations or must be fair valued.
    \340\ See Guggenheim Comment Letter (suggesting that not 
including bonds, which usually have level 2 inputs, would face a 
significant burden under this definition); IAA Comment Letter 
(stating that fund boards may treat some securities with level 2 
inputs as having readily available market quotations); ICE Data 
Comment Letter. But see, e.g., ICI Comment Letter (agreeing with the 
proposed definition).
    \341\ See, e.g., ICI Comment Letter.
    \342\ ASC Topic 820-10-35-48.
---------------------------------------------------------------------------

    As we stated in the proposal, under the final rule, evaluated 
prices are not readily available market quotations as they are not 
based upon unadjusted quoted prices from active markets for identical 
investments.\343\ In addition, for the same reason, ``indications of 
interest'' and ``accommodation quotes,'' would also not be ``readily 
available market quotations'' for the purposes of rule 2a-5(c).\344\
---------------------------------------------------------------------------

    \343\ See Proposing Release, supra footnote 2, at nn.133-134 and 
accompanying text; see also 2014 Money Market Fund Release, supra 
footnote 11, at text accompanying n.895.
    \344\ See Investment Company Liquidity Risk Management Programs, 
Investment Company Act Release No. 32315 (Oct. 13, 2016) [81 FR 
82142 (Nov. 18, 2016)], at nn.800-801 and accompanying text.
---------------------------------------------------------------------------

    Two commenters asked whether certain pooled investment vehicle 
securities, such as those of funds that publish their NAV daily and 
issue and redeem shares at that NAV (such as mutual funds), or that are 
valued using their NAV as a practical expedient (such as many private 
fund shares),\345\ would qualify as having readily available market 
quotations.\346\ We understand that, under ASC Topic 820, an investment 
in a mutual fund or similar structure that has a readily determinable 
fair value per share that is determined and published and is the basis 
for current transactions,\347\ such as a daily NAV for mutual fund 
shares, is generally considered to have observable level 1 inputs under 
U.S. GAAP.\348\ Accordingly, we agree with the commenter and believe 
that such investments are generally consistent with the definition of 
having readily available market quotations under the final rule.
---------------------------------------------------------------------------

    \345\ See ASC 820-10-35-59 through 35-62 in 820, a topic called 
``Measuring the Fair Value of Investment in Certain Entities That 
Calculate Net Asset Value per Share (or Its Equivalent) (``A 
reporting entity is permitted, as a practical expedient, to estimate 
the fair value of an investment within the scope of paragraphs 820-
10-15-4 through 15-5 using the net asset value per share (or its 
equivalent, such as member units or an ownership interest in 
partners' capital to which a proportionate share of net assets is 
attributed) of the investment, if the net asset value per share of 
the investment (or its equivalent) is calculated in a manner 
consistent with the measurement principles of Topic 946 as of the 
reporting entity's measurement date.'').
    \346\ See ICI Comment Letter (recommending that mutual funds and 
other pooled investment vehicles with daily NAVs be considered to 
have readily available market quotations); CFA Institute Comment 
Letter (recommending that we not consider private funds that utilize 
NAV as a practical expedient as having readily available market 
quotations).
    \347\ See definition of readily determinable fair value, item c. 
with ASC 820-10-20. One commenter sought clarification as to whether 
the proposed definition was seeking to incorporate the concept of 
``readily determinable'' fair value from U.S. GAAP as well. American 
Bankers Association Comment Letter. ``Readily determinable'' fair 
value is not utilized to value all securities but for certain 
limited purposes under U.S. GAAP. Specifically the concept is 
similar but narrower in that it only applies with respect to equity 
securities. While readily determinable is a similar concept to 
``readily available market quotations'' in that it utilizes similar 
concepts (e.g., it references prices or quotations of securities 
exchanges), it is not what we are utilizing for this definition.
    \348\ Investments in mutual fund shares are not valued using NAV 
as a ``practical expedient.'' See ASC 820-10-35-54B. See also ICI 
Comment Letter.
---------------------------------------------------------------------------

    Conversely, securities that are valued using NAV as a practical 
expedient, like certain private funds, do not require disclosure of the 
level of input associated with them under the U.S. GAAP fair value 
hierarchy.\349\ We understand that the fair value of those investments 
for which use of NAV as a practical expedient is permitted under U.S. 
GAAP may generally require less effort and resources than other 
securities without readily available market quotations because fair 
value measurement utilizing such a fund's NAV involves less 
subjectivity and more objective measures. Nevertheless, we believe that 
these securities generally do not have readily available market 
quotations under the final definition because their value is not based 
on unadjusted quoted prices.\350\
---------------------------------------------------------------------------

    \349\ See Proposing Release, supra footnote 2, at n.213. See 
also ASC 820-10-65-7.
    \350\ As under our proposal, for purposes of our economic 
analysis we assume that such securities had no readily available 
market quotations, and would be thus fair valued under the final 
rule. See Proposing Release, supra footnote 2, at n.213.
---------------------------------------------------------------------------

    One commenter stated that securities exchanges such as NASDAQ or 
the NYSE often adjust prices to establish a closing price or address 
technical issues. This commenter asked that we clarify that by 
``unadjusted'' we did not mean to disqualify securities adjusted by 
exchanges in this way.\351\ We agree. The word unadjusted in the final 
definition refers to adjustments in market prices made by the fund or 
valuation designee, not adjustments made by the exchange on which the 
security is listed.
---------------------------------------------------------------------------

    \351\ Practus Comment Letter.
---------------------------------------------------------------------------

    Consistent with the requirements for preparing fund financial 
statements,\352\ we will presume a fair value methodology not 
determined in accordance with U.S. GAAP to be misleading or inaccurate 
and thus not an appropriate methodology under the final rule.\353\ U.S. 
GAAP requires the maximization of the use of relevant observable inputs 
and minimization of the use of unobservable inputs. However, under U.S. 
GAAP there are circumstances where otherwise relevant observable inputs 
become unreliable.\354\ Consistent with this, we will generally presume 
that a quote would be unreliable under final rule 2a-5(c) where it 
would require adjustment under U.S. GAAP or where U.S. GAAP would 
require consideration of additional inputs in determining the value of 
the security. For example, under the final rule funds would, consistent 
with U.S. GAAP, use previous closing prices for securities that 
principally trade on a closed foreign market to calculate the value of 
that security, except when an event has occurred since the time the 
value was established that is likely to have resulted in a change in 
such value.\355\ In such circumstances, the quote would be

[[Page 773]]

unreliable and the fund would need to fair value the security.
---------------------------------------------------------------------------

    \352\ See 17 CFR 210.4-01(a)(1).
    \353\ When referencing ASC Topic 820 throughout this release, we 
intend to reference the accounting topic on Fair Value Measurements 
within U.S. GAAP and the principles therein.
    \354\ See Proposing Release, supra footnote 2, at n.131 and 
accompanying text and ASC Topic 820-10-35-41C (outlining 
circumstances when a reporting entity shall make an adjustment to a 
Level 1 input).
    \355\ See ASC Topic 820-10-35-41C at b; see also supra footnote 
77 and accompanying text. One commenter suggested that these 
adjustments are not required, which is inconsistent with our 
understanding of ASC Topic 820-10-35-36B and 35-41C. See NYC Bar 
Comment Letter.
---------------------------------------------------------------------------

    A number of commenters raised concerns that the proposed definition 
of readily available market quotations may affect current practices on 
cross trades under 17 CFR 270.17a-7 (``rule 17a-7'').\356\ For a fund 
to engage in a cross trade under rule 17a-7, the security first must 
have a ``readily available market quotation'' and then the transaction 
must meet the other conditions of that rule.\357\ These commenters 
stated that funds and their affiliates regularly engage in cross trades 
of certain fixed-income securities that they believed would not qualify 
as having readily available market quotations under the proposed 
definition, and asked that we clarify that the proposed definition was 
not meant to disrupt current cross-trading practices.\358\
---------------------------------------------------------------------------

    \356\ See, e.g., ICI Comment Letter; Capital Group Comment 
Letter.
    \357\ See rule 17a-7.
    \358\ See, e.g., ICI Comment Letter; Murphy Comment Letter. One 
commenter noted that they agreed with the Fixed Income Market 
Structure Advisory Committee recommendation on reform of rule 17a-7. 
See https://www.sec.gov/spotlight/fixed-income-advisory-committee/preliminary-recommendation-re17a-7.pdf.
---------------------------------------------------------------------------

    The definition of readily available market quotations that we are 
adopting will apply in all contexts under the Investment Company Act 
and the rules thereunder, including rule 17a-7.\359\ In the adopting 
release for rule 17a-7, the Commission stated that ``[t]he phrase 
`which market quotations are readily available' also is found in 
section 2(a)(41) of the Act and rule 2a-4 and is intended to have the 
same meaning ascribed to it in those other provisions.'' \360\ Further, 
the Commission has previously suggested that active secondary markets 
are an important indicator of readily available market quotations.\361\ 
We continue to believe it is important to have a consistent definition 
of the term in all contexts, including in rule 17a-7, where it serves 
to ensure that there is an independent basis for determining the value 
of securities.
---------------------------------------------------------------------------

    \359\ See, e.g., Exemption of Certain Purchase or Sale 
Transactions Between a Registered Investment Company and Certain 
Affiliated Persons Thereof, Investment Company Act Release No. 11136 
(Apr. 21, 1980) [45 FR 29067 (May 1, 1980)] (``17a-7 Proposing 
Release''), at 12-13; Exemption of Certain Purchase or Sale 
Transactions Between a Registered Investment Company and Certain 
Affiliated Persons Thereof, Investment Company Act Release No. 11676 
(Mar. 10, 1981) [46 FR 17011 (Mar. 17, 1981)] (``17a-7 Adopting 
Release'') at 10 (``If the rule were expanded to include securities 
for which market quotations are not readily available, the 
independent basis for determining the value of securities would be 
eliminated.'').
    \360\ See 17a-7 Proposing Release, supra footnote 359, at n.16.
    \361\ 17a-7 Adopting Release supra footnote 359, at 7 (noting 
the importance of active secondary markets to provide an independent 
basis for cross-trade pricing).
---------------------------------------------------------------------------

    We recognize that whenever we define a term, to the extent market 
participants are currently engaged in practices that are not consistent 
with that definition, they will need to conform their practices. As a 
result, certain securities that had been previously viewed as having 
readily available market quotations and being available to cross trade 
under rule 17a-7 may not meet our new definition and thus would not be 
available for such trades.\362\ We also understand that many cross 
trades today are done taking into consideration certain letters by our 
staff that address, among other things, the application of the term 
readily available market quotations in the context of certain 
transactions under rule 17a-7.\363\ The staff is reviewing these 
letters to determine whether these letters, or portions thereof, should 
be withdrawn. Separately, consideration of potential revisions to rule 
17a-7 is on the rulemaking agenda.\364\ We welcome input from the 
public as we undertake our consideration of rule 17a-7.
---------------------------------------------------------------------------

    \362\ We discuss in the economic analysis section below the 
impact that the adoption of this definition may have on such fund 
cross trading practices. See infra section III.D.5
    \363\ See, e.g., United Municipal Bond Fund, SEC Staff No-Action 
Letter (Jan. 27, 1995) and Federated Municipal Funds, SEC Staff No-
Action Letter (Nov. 20, 2006).
    \364\ See Spring 2020 Securities and Exchange Commission 
Regulatory Actions, available at https://www.reginfo.gov/public/do/eAgendaMain?operation=OPERATION_GET_AGENCY_RULE_LIST&currentPub=true&agencyCode=&showStage=active&agencyCd=3235&csrf_token=1A4EE40E5F597FA80ECBE64464FA72F1716FCD8F60FDF1D26B9A8644E274D25057FE57666F0C582CC5575C6CC8DC0DCE11D3.
---------------------------------------------------------------------------

E. Rescission of Prior Commission Releases

    As proposed, we are rescinding ASR 113 and ASR 118 in their 
entirety. We believe that rescission is appropriate because the 
guidance included in ASR 113 and ASR 118 is superseded or made 
redundant by the adoption of rule 2a-5 and by the requirements under 
the current accounting and auditing standards.\365\
---------------------------------------------------------------------------

    \365\ See Proposing Release, supra footnote 2 at n.150.
---------------------------------------------------------------------------

    Commenters generally supported the rescission of ASR 113 and ASR 
118.\366\ These commenters agreed with our assertion in the Proposing 
Release that the guidance within the ASRs is not inconsistent with 
current accounting standards, but they are not considered essential or 
additive to the existing accounting standard framework.\367\ One 
commenter stated that at a minimum the Commission should retain ASR 
118's interpretive guidance that permits fund boards to appoint persons 
to assist them in making fair value determinations, and to make actual 
calculations pursuant to the board's discretion.\368\ Some commenters 
opposed rescinding ASRs 113 and 118, stating that certain specific fair 
value matters are not covered in the relevant accounting standards and 
that certain content within those releases should be reissued or 
restated by the Commission.\369\ Other commenters disagreed, generally 
stating that valuation matters are addressed in the principles and 
framework of ASC Topic 820 and the concepts that are necessary to 
retain are now either included in the relevant accounting standards or 
were included in the rule as proposed.\370\
---------------------------------------------------------------------------

    \366\ See ICI Comment Letter; Comment Letter of 
PricewaterhouseCoopers LLP (July 21, 2020) (``PWC Comment Letter''); 
KPMG Comment Letter; ABA Comment Letter; Comment Letter of Ernst & 
Young LLP (July 20, 2020) (``E&Y Comment Letter''); Council of 
Institutional Investors Comment Letter; MFDF Comment Letter, Duff & 
Phelps Comment Letter; Invesco Comment Letter; Federated Hermes; 
Comment Letter of Charles E. Andrews, et al. (July 21, 2020) 
(``Capital Group Directors Comment Letter''); Capital Group Comment 
Letter.
    \367\ See ICI Comment Letter.
    \368\ See Scheidt Comment Letter 2.
    \369\ See Scheidt Comment Letter 1; Scheidt Comment Letter 2; 
NYC Bar Comment Letter and Vanguard Comment Letters that highlight 
reaffirming certain concepts from ASR 118 and the 1999 Letter to ICI 
(there can be differences in valuation depending on fund 
structures).
    \370\ See Duff & Phelps Comment Letter; ICI Comment Letter; KPMG 
Comment Letter; E&Y Comment Letter; PWC Comment Letter.
---------------------------------------------------------------------------

    One commenter argued that we should retain the ASRs, as it believed 
that the ASRs addressed certain fund specific issues, such as those 
related to the valuation of ``odd lots'' it believed were not addressed 
in U.S. GAAP.\371\ Others specifically disagreed with this point, and 
argued that the principles of ASC Topic 820 and related U.S. GAAP 
standards address such ``odd lot'' cases.\372\ We agree that the odd 
lot valuation practices, such as those that occurred in the cases 
referenced by the commenter (e.g., a fund with an investment, held in 
an odd-lot quantity, valued at a round-lot price when the entity has no 
ability to access the round-lot market to exit such investment at the 
measurement date) do not reflect an appropriate methodology consistent 
with the principles of ASC Topic 820 and the existing U.S. GAAP 
framework.
---------------------------------------------------------------------------

    \371\ See Scheidt Comment Letter 1 (discussing previous SEC 
enforcement actions regarding odd-lots, including Pacific Investment 
Management Company LLC, Investment Company Act Release No. 4577 
(Dec. 1, 2016) and Semper Capital Management, LP, Investment 
Advisers Act Release No. 5489 (Apr. 28, 2020)).
    \372\ See, e.g., ICI Comment Letter.

---------------------------------------------------------------------------

[[Page 774]]

    With respect to the comments concerning odd lot valuation 
practices, the rescission of the ASRs will not change the Commission's 
ability to bring similar enforcement cases in the future. The cases 
were brought under several legal bases, including section 34(b) of the 
Act and 17 CFR 270.22c-1, because the funds made misstatements related 
to their performance and sold shares at a price other than their 
current net asset values. Although the guidance in the ASRs has been 
cited in prior cases, these cases were brought under independent legal 
bases as stated above, and valuing odd lots at a price that a fund 
cannot access on the measurement date will continue to be inconsistent 
with these requirements and ASC Topic 820 after the rescission of the 
ASRs.\373\
---------------------------------------------------------------------------

    \373\ ASC Topic 820 requires that the reporting entity have 
access to the principal or most advantageous market used to measure 
fair value (see ASC 820-10-35-6A), and so a reporting entity may not 
use round lot pricing if it is not able to access the round lot 
market at the measurement date.
---------------------------------------------------------------------------

    Among other things, ASC Topic 820 provides a principles-based 
framework for valuing all investments. The accounting standards are not 
designed to describe specific fair value measurement fact patterns; we 
disagree with certain commenters that certain fund specific valuation 
issues are not addressed in U.S. GAAP and continue to believe that the 
principles in ASC Topic 820 provide a framework appropriate to utilize 
for all fair value measurements.\374\ In light of this, and in 
connection with the adoption of rule 2a-5, the specific incremental 
guidance included in the ASRs is no longer necessary.
---------------------------------------------------------------------------

    \374\ See Scheidt Comment Letter 1.
---------------------------------------------------------------------------

    Furthermore, as discussed in the proposing release, the guidance in 
ASR 118 states that auditors of funds should verify all quotations for 
securities with readily available market quotations, implicating the 
auditor's requirement to test the valuation assertion for all 
securities when auditing a fund's financial statements.\375\ We 
believe, and commenters agreed, that rescinding the auditing guidance 
included in ASR 118 would allow fund auditors to apply only PCAOB 
standards, which would permit sampling and other techniques to verify 
the value of a fund's investments, and believe that such a change is 
appropriate. \376\ While this will provide the auditors with greater 
flexibility in carrying out their audit procedures, a fund board or 
valuation designee could request that its auditor continue current 
practice to verify 100% of the values of the fund's investments if it 
determines that this approach is preferable.\377\ Therefore, after 
review of the comments received and for the reasons noted above, ASR 
113 and ASR 118 are rescinded in their entirety upon the compliance 
date of the final rule.\378\
---------------------------------------------------------------------------

    \375\ See Proposing Release, supra footnote 2, at n.149
    \376\ See PWC Comment Letter; KPMG Comment Letter; E&Y Comment 
Letter; Deloitte Comment Letter; ICI Comment Letter; IDC Comment 
Letter; NYSSCPA Comment Letter. See also Proposing Release, supra 
footnote 2, at n.149, stating that the statutory requirement in 
section 30(g) of the Investment Company Act, which requires the 
independent public accountant to verify securities owned, implicates 
the auditors requirement to test the existence assertion of all 
securities. The statutory requirement under section 30(g) remains 
distinct from the rescinded valuation guidance in ASR 118 and the 
auditing standards established by the PCAOB concerning accounting 
estimates, including fair value.
    \377\ See ICI Comment Letter.
    \378\ See infra footnote 391 and accompanying text (stating that 
a fund may voluntarily comply with the final rule in advance of the 
compliance date).
---------------------------------------------------------------------------

F. Existing Commission Guidance, Staff No-Action Letters, and Other 
Staff Guidance

    In addition to our rescission of ASR 113 and ASR 118, certain 
Commission guidance, staff letters and other staff guidance addressing 
a board's determination of fair value and other matters covered by the 
rules will be withdrawn or rescinded in connection with this adoption. 
Upon the compliance date of these rules, some staff letters and other 
Commission and staff guidance, or portions thereof, will be moot, 
superseded, or otherwise inconsistent with the rules and, therefore, 
will be withdrawn or rescinded.
    Commenters generally agreed that certain existing Commission and 
staff guidance should be withdrawn as part of the adoption of rule 2a-
5.\379\ While many commenters agreed with the scope of the guidance we 
identified for withdrawal in the proposal, others suggested that 
additional guidance be withdrawn or rescinded, such as the guidance on 
overseeing pricing services contained in the 2014 Money Market Fund 
Release.\380\ As discussed in section II.A.4 above (relating to pricing 
services), the guidance on oversight of pricing services contained in 
the 2014 Money Market Fund Release is superseded by the guidance on 
pricing service oversight contained in this release.\381\ Additionally, 
as discussed in the fair value methodologies section above, we are 
rescinding and restating certain guidance the Commission provided in 
the 2014 Money Market Fund Release regarding the valuation of thinly 
traded securities.\382\ As proposed, however, we are not modifying or 
supplementing the Commission's prior guidance regarding the use of the 
amortized cost method because the Commission continues to believe that 
our prior guidance, as discussed in the 2014 Money Market Fund Release, 
remains relevant, adequate, and appropriate.\383\ Finally, two 
commenters \384\ asked that one staff no-action letter be retained 
regarding the meaning of ``good faith,'' which characterizes ``good 
faith'' as ``a flexible concept that can accommodate many different 
considerations.'' \385\ Retaining the staff letters as recommended by 
these commenters is unnecessary because the framework set out in U.S. 
GAAP along with the guidance provided in the fair value methodologies 
section of this release supports this flexible meaning of good 
faith.\386\
---------------------------------------------------------------------------

    \379\ See, e.g., ICI Comment Letter; IDC Comment Letter; ABA 
Comment Letter; MFDF Comment Letter; Capital Group Comment Letter; 
Invesco Comment Letter.
    \380\ ABA Comment Letter; MFDF Comment Letter; Fidelity Trustees 
Comment Letter; IDC Comment Letter; NYC Bar Comment Letter; American 
Funds Trustees Comment Letter; Council of Institutional Investors 
Comment Letter.
    \381\ See supra section II.A.4.
    \382\ See supra section II.A.2.
    \383\ See supra footnote 116 (noting that the guidance in the 
2014 Money Market Fund Release on the use of amortized cost 
valuation remains valid).
    \384\ ICI Comment Letter; Federated Hermes Comment Letter. See 
also SIFMA AMG Comment Letter.
    \385\ See Investment Company Institute, SEC Staff No-Action 
Letter (Dec. 8, 1999).
    \386\ See supra section II.A.2. For example, under U.S. GAAP, 
investments generally have a range of acceptable values. 
Accordingly, different funds, based on the various factors and 
market conditions considered could reasonably come to different 
conclusions on the price of a particular investment.
---------------------------------------------------------------------------

    Upon the compliance date of the rules, certain Commission guidance 
as well as all the staff letters and other staff guidance listed below 
will be withdrawn. Some commenters also asked that we confirm that, to 
the extent staff guidance not identified in the proposal conflicts with 
the requirements of the rules, such guidance is superseded.\387\ To the 
extent any staff guidance is inconsistent or conflicts with the 
requirements of the rules, even if not specifically identified below, 
that guidance is superseded.
---------------------------------------------------------------------------

    \387\ ABA Comment Letter.

[[Page 775]]



----------------------------------------------------------------------------------------------------------------
                     Name                              Date                             Topic
----------------------------------------------------------------------------------------------------------------
Paul Revere Investors, Inc...................  Feb. 21, 1973......  Delegation to a board valuation committee.
The Putnam Growth Fund and Putnam              Jan. 23, 1981......  Fair value of portfolio securities which
 International Equities Fund, Inc.                                   trade on a closed foreign exchange.
Form N-7 for Registration of Unit Investment   Mar. 17, 1987......  Fair value for UITs to be determined by the
 Trusts under the Securities Act of 1933 and                         trustee or its appointed person.
 the Investment Company Act of 1940,
 Investment Company Act Release No. 15612,
 Appendix B, Guide 2.
Investment Company Institute.................  Dec. 8, 1999.......  Fair value generally.
Investment Company Institute.................  Apr. 30, 2001......  Fair value generally.
Last paragraph of Section III.D.2.(a) and the  July 23, 2014......  Guidance regarding the fair value of thinly
 entirety of Section III.D.2.(b) of the 2014                         traded securities and use of pricing
 Money Market Fund Release.                                          services.
Valuation Guidance Frequently Asked Questions  2014...............  Fund directors' responsibilities when
 (FAQ 1 only).                                                       determining whether an evaluated price
                                                                     provided by a pricing service, or some
                                                                     other price, constitutes fair value.
----------------------------------------------------------------------------------------------------------------

G. Transition Period

    The Commission is adopting an eighteen month transition period 
beginning from the effective date of the rules to provide sufficient 
time for funds and valuation designees to prepare to come into 
compliance with rules 2a-5 and 31a-4.\388\ Some commenters urged the 
Commission to provide more time beyond the one-year transition period 
we discussed in the Proposing Release, suggesting an extended time 
period of eighteen months for compliance in light of the aspects of the 
proposed rule that they believed may require funds to change certain of 
their practices.\389\ We appreciate these concerns, and accordingly, 
the compliance date will be eighteen months following the effective 
date of the rules. We will rescind ASRs 113 and 118 on the compliance 
date, and the other identified guidance will also be withdrawn. 
Additionally, we agree with one commenter that urged the Commission to 
provide funds with the option of complying with the rules prior to the 
compliance date.\390\ Once the rules become effective, a fund may 
voluntarily comply with the rules in advance of the compliance date. To 
promote regulatory consistency, however, any fund that elects to rely 
on rules 2a-5 and 31a-4 prior to the compliance date may rely only on 
rules 2a-5 and 31a-4, and not also consider Commission and staff 
letters and other guidance that will be withdrawn or rescinded on the 
compliance date in determining fair value in good faith for purposes of 
section 2(a)(41) of the Act and rule 2a-4 thereunder.\391\
---------------------------------------------------------------------------

    \388\ The compliance date will require boards and valuation 
designees to implement the new rules as of that date regardless of 
their fiscal year end or financial reporting period.
    \389\ See, e.g., ICI Comment Letter; Dechert Comment Letter; IDC 
Comment Letter; Invesco Comment Letter.
    \390\ See ABA Comment Letter.
    \391\ As evidence of the date of early compliance, the records 
to be kept under rule 2a-5 would also need to begin being maintained 
as of that date.
---------------------------------------------------------------------------

H. Other Matters

    Pursuant to the Congressional Review Act,\392\ the Office of 
Information and Regulatory Affairs has designated these rules, 
collectively, as a ``major rule,'' as defined by 5 U.S.C. 804(2). If 
any of the provisions of these rules, or the application thereof to any 
person or circumstance, is held to be invalid, such invalidity shall 
not affect other provisions or application of such provisions to other 
persons or circumstances that can be given effect without the invalid 
provision or application.
---------------------------------------------------------------------------

    \392\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

III. Economic Analysis

A. Introduction

    Rule 2a-5 provides requirements for determining fair value in good 
faith for purposes of section 2(a)(41) of the Act and rule 2a-4 
thereunder. The Commission is adopting rule 2a-5 for the reasons 
provided above in section II. The final rule provides that 
determination of fair value in good faith requires assessing and 
managing material risks associated with fair value determinations; 
selecting, applying, and testing fair value methodologies; and 
evaluating any pricing services used.\393\ The Commission is also 
adopting rule 31a-4, which includes the recordkeeping requirements 
associated with rule 2a-5.
---------------------------------------------------------------------------

    \393\ See rule 2a-5(a). Additionally, upon the adoption of rule 
2a-5, rule 38a-1 will require the adoption and implementation of 
written policies and procedures reasonably designed to prevent 
violations of the requirements of rule 2a-5.
---------------------------------------------------------------------------

    Rule 2a-5 permits a fund's board of directors to designate certain 
parties to perform such fair value determinations in good faith, who 
will then carry out these functions for some or all of the fund's 
investments. This designation will be subject to board oversight and 
certain reporting and other requirements designed to facilitate the 
board's ability to oversee effectively this party's fair value 
determinations.\394\ These requirements of the final rule directly 
address conflicts of interest and other risks posed when fair value 
determinations are performed by persons other than the board. It also 
provides a mechanism for coordinating the requirements of the Act with 
U.S. accounting standards. Lastly, rule 2a-5 defines when market 
quotations are readily available for purposes of section 2(a)(41) of 
the Act.\395\
---------------------------------------------------------------------------

    \394\ See rule 2a-5(b).
    \395\ See rule 2a-5(c).
---------------------------------------------------------------------------

    We are sensitive to the economic effects that may result from the 
rules, including the benefits, costs, and the effects on efficiency, 
competition, and capital formation.\396\ Section 2(c) of the Investment 
Company Act requires us, when engaging in rulemaking that requires us 
to consider or determine whether an action is consistent with the 
public interest, to also consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition, and 
capital formation.
---------------------------------------------------------------------------

    \396\ Our analysis of the final rule takes into account the 
rescission of ASR 113 and ASR 118 as well as the withdrawal and 
rescission of certain staff letters and Commission and staff 
guidance addressing a board's determination of fair value and other 
matters covered by rule 2a-5. See supra sections II.E and II.F.
---------------------------------------------------------------------------

    We discuss potential effects of the rules as well as possible 
alternatives to the rules in more detail below. Where possible, we have 
attempted to quantify the costs, benefits, and effects on efficiency, 
competition, and capital formation expected to result from the rules. 
In some cases, however, we are unable to quantify the economic effects 
because we lack the information necessary to provide a reliable 
estimate. Where we are unable to quantify the economic effects of the 
rules, we provide a qualitative assessment of the potential effects.

[[Page 776]]

B. Economic Baseline

1. Current Regulatory Framework
    To understand the effects of the rules, we compare the requirements 
of the rules to the current regulatory framework and current industry 
practices. As discussed in greater detail in section II above, the 
regulatory framework regarding fair value determinations and the role 
of the board of directors in the determination of fair value is set 
forth in the Investment Company Act and the rules thereunder. The 
Commission has also expressed its views on the role of the board 
regarding fair value under the Investment Company Act in several 
releases, including ASR 113 and ASR 118, the 2014 Money Market Fund 
Release, and the Compliance Rules Adopting Release.\397\
---------------------------------------------------------------------------

    \397\ See supra footnotes 1, 2, and 4. See also supra section I 
(discussing other aspects of funds' regulatory framework that are 
related to boards' fair value role (e.g., ASC Topic 820)).
---------------------------------------------------------------------------

    Section 2(a)(41) of the Investment Company Act defines the value of 
assets for which market quotations are not readily available as fair 
value as determined by the board of directors in good faith. Under the 
Investment Company Act, whenever market quotations are readily 
available for a security, these market quotations must be used to value 
that security.\398\ Whenever market quotations are not readily 
available for a fund security or if the investment is not a security, 
the fund must value that investment using its fair value as determined 
by the board in good faith.
---------------------------------------------------------------------------

    \398\ See section 2(a)(41) and rule 2a-4.
---------------------------------------------------------------------------

    As discussed in the Proposing Release, the Commission stated in ASR 
113 and ASR 118 that the board need not itself perform each of the 
specific tasks required to calculate fair value in order to perform its 
role under section 2(a)(41).\399\ However, ASR 113 and ASR 118 stated 
that the board should choose the methods used to arrive at fair value 
and continuously review the appropriateness of such methods.\400\ In 
addition, the Commission stated that boards should consider all 
appropriate factors relevant to the fair value of fund investments for 
which market quotations are not readily available.\401\ Finally, the 
Commission stated that whenever technical assistance is requested from 
individuals who are not directors, the findings of such individuals 
must be carefully reviewed by the directors in order to satisfy 
themselves that the resulting valuations are fair.\402\
---------------------------------------------------------------------------

    \399\ See Proposing Release, supra footnote 2, at n.14.
    \400\ Id.
    \401\ See Proposing Release, supra footnote 2, at n.15.
    \402\ See Proposing Release, supra footnote 2, at n.16; ASR 118.
---------------------------------------------------------------------------

    The 2014 Money Market Fund Release stated that funds ``may consider 
evaluated prices from third-party pricing services, which may take into 
account these inputs as well as prices quoted from dealers that make 
markets in these instruments and financial models.'' \403\ The 2014 
Money Market Fund Release also stated that ``evaluated prices provided 
by pricing services are not, by themselves, `readily available' market 
quotations or fair values `as determined in good faith by the board of 
directors' as required under the Investment Company Act.'' \404\ In 
addition, the Commission discussed in that release the factors that the 
fund's board of directors may want to consider ``[b]efore deciding to 
use evaluated prices from a pricing service to assist it in determining 
the fair values of a fund's portfolio securities.'' \405\
---------------------------------------------------------------------------

    \403\ 2014 Money Market Fund Release, supra footnote 11, at 
47813.
    \404\ Id. at 47814.
    \405\ Id.
---------------------------------------------------------------------------

    Finally, for a fund to engage in a cross trade under rule 17a-7, 
the security first must have a ``readily available market quotation'' 
and then the transaction must meet the other conditions of rule 17a-7. 
Currently, funds and their affiliates rely on rule 17a-7 and consider 
related staff no-action letters when engaging in cross trades of 
certain fixed-income securities. Funds' reliance on rule 17a-7 and 
funds' practices in consideration of related staff no-action letters 
form part of our baseline for the economic analysis of the final 
rules.\406\
---------------------------------------------------------------------------

    \406\ See supra section II.D.
---------------------------------------------------------------------------

2. Current Practices
    Our understanding of current fair value practices is based on fund 
disclosures, staff discussions with industry representatives, staff's 
experience, review of relevant industry publications and academic 
papers, and commenters' letters.\407\ We expect that funds' policies 
and procedures generally reflect their fair value practices.\408\ We 
discuss below our understanding of current practices but acknowledge 
that practices may vary across funds and through time.\409\
---------------------------------------------------------------------------

    \407\ See, e.g., IDC Role of the Board, supra footnote 215; K&L 
Gates, Mutual Fund Valuation and Liquidity Procedures (2013), 
available at https://files.klgates.com/files/upload/dc_im_07-valuation.pdf (``2013 K&L Report''); Arthur Delibert, Mutual Fund 
Pricing and Fair Valuation, K&L Gates 2016 Investment Management 
Conference; (2016), available at https://files.klgates.com/files/upload/2016im_dc_conference_presentations_sessioniv.pdf; Mutual Fund 
Directors Forum, Practical Guidance for Fund Directors on Valuation 
Oversight (June 2012), available at https://www.mfdf.org/docs/default-source/default-document-library/publications/white-papers/practical-guidance-for-fund-directors-on-valuation-oversight.pdf?sfvrsn=68e27dc6_2 (``MFDF Valuation Report''); supra 
footnote 10 and accompanying discussion. See also ABA Comment 
Letter; Advisors' Inner Circle Comment Letter; AIMA Comment Letter; 
American Bankers Association Comment Letter; American Funds Comment 
Letter; Better Markets Comment Letter; Dechert Comment Letter; Duff 
& Phelps Comment Letter; Fidelity Comment Letter; Fidelity Comment 
Letter; Fidelity Trustees Comment Letter; Franklin Comment Letter; 
IAA Comment Letter; ICI Comment Letter; IDC Comment Letter; Invesco 
Comment Letter; IVSC Comment Letter; MFS Comment Letter; Murphy 
Comment Letter; New York City Bar Association Comment Letter; SIFMA 
AMG Comment Letter; TRC Comment Letter; VRC Comment Letter.
    \408\ See, e.g., IDC Role of the Board, supra footnote 215, at 
6-7. See also AIMA Comment Letter; Fidelity Trustees Comment Letter; 
ICI Comment Letter; Invesco Comment Letter; SIFMA AMG Comment 
Letter.
    \409\ See supra footnote 8 and accompanying discussion, and 
section II; see also infra footnotes 407 and 408.
---------------------------------------------------------------------------

(a) Fair Value Calculation
    Most fund boards or UIT trustees do not play a day-to-day role in 
the pricing of fund investments.\410\ Typically, an adviser to a fund 
or other service providers perform the actual day-to-day fair value 
calculations.\411\ Commenters stated that sub-advisers play a role or 
assist in the fair value determination process.\412\ In addition to 
performing day-to-day calculations, advisers also typically develop (or 
assist the board in developing) the fund's fair value 
methodologies.\413\ Commenters generally validated this view of boards' 
oversight role and advisers' roles in day-

[[Page 777]]

to-day fair value calculations.\414\ We understand that for UITs, which 
do not have a board of directors or an adviser, it is generally the 
evaluator designated in the UIT's trust indenture, which is often the 
UIT's depositor, that conducts the valuation activities equivalent to 
fund boards.\415\ This evaluator may also seek assistance from service 
providers (such as pricing services) to perform the actual day-to-day 
fair value calculation. As discussed above,\416\ pricing services 
provide advisers, funds, and depositors with information such as 
evaluated prices, matrix prices, price opinions, or other information 
for a wide range of investments, including fixed-income securities 
(e.g., corporate and municipal bonds), securitized assets, and bank 
loans, that are used as prices or as inputs to the fair value 
determination process, as many commenters acknowledged.\417\
---------------------------------------------------------------------------

    \410\ See, e.g., Investment Company Institute, Independent 
Directors Council, & ICI Mutual Insurance Company, An Introduction 
to Fair Valuation (Spring 2005), at 7, available at https://www.icimutual.com/system/files/Fair%20Valuation%20Series%20An%20Introduction%20to%20Fair%20Valuation.pdf (``ICI Fair Valuation Report''). Nevertheless, ``[t]here may be 
circumstances at a particular fund group that leads a board and 
adviser to determine that it is desirable for an independent 
director to be involved in day-to-day decision-making, whether as 
part of the adviser's valuation committee or by reviewing and 
ratifying the committee's decisions daily.'' See MFDF Valuation 
Report, supra footnote 407, at 9.
    \411\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
4. In addition, officers of internally managed funds may also 
perform this function in lieu of an adviser. See Sullivan Comment 
Letter; Deloitte Comment Letter; Seward & Kissel Comment Letter; 
SBIA Comment Letter; Franklin Comment Letter; NYC Bar Comment 
Letter; Dechert Comment Letter; see also supra section II.B.
    \412\ See, e.g., IAA Comment Letter, (stating that ``while sub-
advisers currently may provide input and support to the primary 
adviser on pricing and the fair value process, ultimately fund 
boards rely on the primary adviser, not the sub-adviser, to conduct 
the day-to-day valuation work.'')
    \413\ See, e.g., 2013 K&L Report, supra footnote 407, at 14; 
MFDF Valuation Report, supra footnote 407, at 11.
    \414\ See, e.g., ABA Comment Letter; Advisors' Inner Circle 
Comment Letter; AIMA Comment Letter; BNY Mellon Comment Letter; 
Dechert Comment Letter; Scheidt Comment Letter 2; Fidelity Comment 
Letter; First Trust Comment Letter; IAA Comment Letter; ICI Comment 
Letter; Invesco Comment Letter; JPMAM Comment Letter; Murphy Comment 
Letter; NYC Bar Comment Letter; Seward & Kissel Comment Letter.
    \415\ See ICI Comment Letter; Chapman Comment Letter; AAM 
Comment Letter; First Trust Comment Letter; Hennion & Walsh Comment 
Letter; Invesco Comment Letter; BNY Mellon Comment Letter.
    \416\ See supra section II.A.4 and infra section III.B.2.c).
    \417\ See ABA Comment Letter; Advisors' Inner Circle Comment 
Letter; AIMA Comment Letter; American Bankers Association Comment 
Letter; American Funds Comment Letter; Baillie Gifford Comment 
Letter; Capital Group Comment Letter; Dechert Comment Letter; 
Deloitte Comment Letter; Dimensional Comment Letter; Duff & Phelps 
Comment Letter; Fidelity Comment Letter; Fidelity Trustees Comment 
Letter; First Trust Comment Letter; Franklin Comment Letter; 
Guggenheim Comment Letter; Guggenheim Trustees Comment Letter; ICE 
Data Comment Letter; ICI Comment Letter; IDC Comment Letter; IHS 
Markit Comment Letter; Invesco Comment Letter; IVSC Comment Letter; 
JPMAM Comment Letter; John Hancock Comment Letter; MFDF Comment 
Letter; Murphy Comment Letter; NYC Bar Comment Letter; NYSSCPA 
Comment Letter; Refinitiv Comment Letter; SSGA Comment Letter; 
Stradley Comment Letter; Sullivan Comment Letter; TRC Comment 
Letter; VRC Comment Letter.
---------------------------------------------------------------------------

(b) Fair Value Practices--Assess and Manage Risks \418\
---------------------------------------------------------------------------

    \418\ See supra section II.A.1.
---------------------------------------------------------------------------

    It is our understanding that boards, advisers, and UIT evaluators 
currently play an important role in identifying and managing valuation 
risks,\419\ and many commenters confirmed this understanding.\420\ 
Examples of valuation risks that funds often address include changes in 
market liquidity, reliance on a single source for pricing data, 
reliability of data obtained from pricing services for investments that 
are not traded on exchanges, reliability of data provided by credit 
rating agencies, use of internal information provided by portfolio 
managers to estimate fair values, use of internally developed models to 
value investments, extensive use of matrix pricing, the process 
surrounding the adviser's price overrides, timely identification of 
material events, and valuation risks arising from new investments.\421\
---------------------------------------------------------------------------

    \419\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
6-8; Paul Kraft et al., Fair Valuation Pricing Survey, 17th Edition, 
Executive Summary, DELOITTE INSIGHTS (2019), at 10, available at 
https://www2.deloitte.com/us/en/insights/industry/financial-
services/fair-valuation-pricing-
survey.html#:~:text=The%2017th%20annual%20Deloitte%20Fair,use%20of%20
technology%2C%20internal%20controls (``Deloitte Survey''). We lack 
information on how the Deloitte survey sample was constructed or how 
the survey data was collected, so we cannot speak to the 
representativeness of the sample or the unbiasedness of the survey 
responses. Nevertheless, the results of the survey are largely 
consistent with Commission staff's experience and in line with 
practices as described in prior Commission staff's letters. See, 
e.g., staff letters, supra section II.F.
    \420\ See, e.g., ABA Comment Letter; AIMA Comment Letter; 
American Bankers Association Comment Letter; American Fund Trustees 
Comment Letter; Baillie Gifford Comment Letter; CFA Institute 
Comment Letter; Duff & Phelps Comment Letter; Fidelity Comment 
Letter; Fidelity Trustees Comment Letter; Guggenheim Comment Letter; 
Harvest Comment Letter; IHS Markit Comment Letter; Invesco Comment 
Letter; IVSC Comment Letter; JPMAM Comment Letter; John Hancock 
Comment Letter; MFDF Comment Letter; Murphy Comment Letter; NYC Bar 
Comment Letter; Stradley Comment Letter; Sullivan Comment Letter; 
Vanguard Comment Letter; VRC Comment Letter.
    \421\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
6-8.
---------------------------------------------------------------------------

    Many of these risks are operational in nature, such as model risk, 
which includes the risk of loss caused by using inaccurate models 
(methodologies) to make decisions such as determinations of fair 
value.\422\ To the extent that valuation is less informed by liquid 
markets and price discovery mechanisms and is more informed by models, 
the risk of biased valuations rises. Model risk includes misspecified 
models, biased information provided by those with conflicts of 
interest, use of inappropriate inputs and assumptions, and incorrect 
implementation.
---------------------------------------------------------------------------

    \422\ See, e.g., Clifford Rossi, How to Reduce Model Risks: 4 
Basic Principles, GLOB. ASS'N OF RISK PROF'L; https://www.garp.org/#!/risk-intelligence/all/all/a1Z1W000003PzmhUAC; SR 11-7: Guidance 
on Model Risk Management, BD. OF GOVERNORS OF THE FED. RESERVE SYS., 
https://www.federalreserve.gov/supervisionreg/srletters/sr1107.htm; 
and Model Risk Management Guidance, FED. HOUSING FIN. AGENCY, 
https://www.fhfa.gov/SupervisionRegulation/AdvisoryBulletins/Pages/AB-2013-07-Model-Risk-Management-Guidance.aspx.
---------------------------------------------------------------------------

    Funds' valuation practices generally focus on mitigating potential 
conflicts of interest of the adviser as well as conflicts of interest 
of other parties that assist the board with fair value determinations 
(e.g., portfolio managers).\423\ Some advisers currently have in place 
processes to address potential conflicts of interest when portfolio 
management personnel provides input regarding valuation for a 
fund.\424\ UIT depositors may have weaker conflicts of interest in 
valuation processes because such depositors are generally compensated 
based on the number of units, rather than the trust's net assets.\425\
---------------------------------------------------------------------------

    \423\ According to a Deloitte survey, ``22 percent of survey 
participants noted that their boards seek to identify areas in the 
valuation process where there might be a conflict of interest and 
provide oversight relative to these conflicts.'' See Deloitte 
Survey, supra footnote 419, at 10. The cited statistic does not 
imply that the remaining funds do not have policies in place to 
manage conflicts of interest of advisers but it means that any such 
policies may not be valuation specific.
    \424\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
9.
    \425\ See, e.g., Chapman Comment Letter; ICI Comment Letter.
---------------------------------------------------------------------------

    Valuation risks can change with changes in market conditions, 
changes in fund investments, changes in inputs and assumptions, and 
changes in methodologies or models. Hence, funds may periodically 
review any previously identified valuation risks.\426\ Some boards meet 
with the fund's chief risk officer or members of the risk committee on 
a periodic basis to discuss the valuation of the portfolio investments 
as part of the assessment and management of previously identified 
risks.\427\
---------------------------------------------------------------------------

    \426\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
8.
    \427\ According to a Deloitte Survey, 34% of survey participants 
reported that the board or one of its subcommittees met with the 
chief risk officer or members of the risk committee to discuss 
valuation matters. See Deloitte Survey, supra footnote 419, at 10.
---------------------------------------------------------------------------

    Many commenters noted that assessing and managing valuation risks 
is a part of current practice,\428\ with one commenter noting the 
necessity of considering valuation risk in the context of determining 
whether a given fair value methodology would be appropriate.\429\
---------------------------------------------------------------------------

    \428\ See supra section II.A.1 and section III.B.2.b).
    \429\ See Vanguard Comment Letter.
---------------------------------------------------------------------------

(c) Fair Value Practices--Establish Fair Value Methodologies \430\
---------------------------------------------------------------------------

    \430\ See supra section II.A.2.
---------------------------------------------------------------------------

    Funds with investments that are fair valued currently have in place 
written policies and procedures that describe the methodologies used 
when calculating fair values.\431\ Commenters confirmed our 
understanding of this

[[Page 778]]

practice.\432\ UITs may provide for the methodology in which the assets 
shall be valued by the evaluator within the UIT's trust indenture.\433\
---------------------------------------------------------------------------

    \431\ See, e.g., IDC Role of the Board, supra footnote 215, at 
6-7; MFDF Valuation Report, supra footnote 407, at 5; rule 38a-1.
    \432\ See, e.g., ABA Comment Letter; Advisors' Inner Circle 
Comment Letter; AIMA Comment Letter; Capital Group Comment Letter; 
Chapman Comment Letter; Dechert Comment Letter; Dimensional Comment 
Letter; Duff & Phelps Comment Letter; First Trust Comment Letter; 
Franklin Comment Letter; Guggenheim Comment Letter; Guggenheim 
Trustees Comment Letter; Harvest Comment Letter; IAA Comment Letter; 
ICE Data Comment Letter; ICI Comment Letter; IDC Comment Letter; IHS 
Markit Comment Letter; Invesco Comment Letter; University of Miami 
Comment Letter; IVSC Comment Letter; JPMAM Comment Letter; John 
Hancock Comment Letter; Murphy Comment Letter; NYC Bar Comment 
Letter; Refinitiv Comment Letter; Russell Investments Comment 
Letter; Scheidt Comment Letter 2; SSGA Comment Letter; Stradley 
Comment Letter; Sullivan Comment Letter; VRC Comment Letter.
    \433\ See ICI Comment Letter; Chapman Comment Letter; AAM 
Comment Letter; First Trust Comment Letter; Hennion & Walsh Comment 
Letter; Invesco Comment Letter; BNY Mellon Comment Letter.
---------------------------------------------------------------------------

    The methodologies provided in policies and procedures or trust 
indentures can require multiple data sources and entail various 
assumptions.\434\ Methodologies often establish a suggested ranking of 
the pricing sources that an adviser should use when valuing 
investments, and different rankings can be established for different 
types of investments.\435\ Many funds and advisers periodically review 
the appropriateness and accuracy of the methodologies used in valuing 
investments and make any necessary adjustments.\436\ Further, funds and 
advisers generally monitor the circumstances that may necessitate the 
use of fair values.\437\ For example, many funds establish triggering 
mechanisms in their policies and procedures to monitor circumstances 
that require the use of fair value methodologies, and third-party 
pricing services may be used to identify those triggering events.\438\ 
As discussed above, pricing services also play an important role in the 
fair value determination process and, as such, help to establish fair 
value methodologies that are reviewed by funds and advisers.\439\
---------------------------------------------------------------------------

    \434\ See, e.g., AIMA Comment Letter; ASA Comment Letter; CFA 
Institute Comment Letter; Dechert Comment Letter; Duff & Phelps 
Comment Letter; Harvest Comment Letter; ICI Comment Letter; Invesco 
Comment Letter; MFS Comment Letter; Murphy Comment Letter; NYC Bar 
Comment Letter; SIFMA AMG Comment Letter; Chapman Comment Letter.
    \435\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
5.
    \436\ According to the Deloitte survey, 72% of survey 
participants performed periodic reviews of valuation models relating 
to private equity investments to determine the appropriateness and 
accuracy relative to the investment being valued, and 56% of 
participants reported that the valuation models used for private 
equity investments are explicitly subject to internal control 
policies and procedures. According to the same survey, 63% of survey 
participants made a change or revision to their valuation policies 
over the last year. See Deloitte Survey, supra footnote 419, at 9 
and 14.
    \437\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
5.
    \438\ See, e.g., IDC Role of the Board, supra footnote 215, at 
6-7 and 10-11; MFDF Valuation Report, supra footnote 407, at 5.
    \439\ See supra section II.A.4.
---------------------------------------------------------------------------

    We understand that fund boards, advisers, and UIT depositors and 
evaluators have generally established fair value methodologies for 
their investments that lack readily available market quotations, which 
are generally applied consistently in accordance with policies and 
procedures or trust indentures as described above.\440\ Similarly, many 
commenters stated that pricing services establish their own 
methodologies,\441\ subject to the due diligence of the board or 
adviser,\442\ and one commenter stated that pricing services recommend 
methodologies.\443\
---------------------------------------------------------------------------

    \440\ See, e.g., AAM Comment Letter; BNY Mellon Comment Letter; 
Chapman Comment Letter; First Trust Comment Letter; Hennion & Walsh 
Comment Letter; ICI Comment Letter; Invesco Comment Letter.
    \441\ See, e.g., ABA Comment Letter; American Bankers 
Association Comment Letter; Dechert Comment Letter; Dimensional 
Comment Letter; Guggenheim Comment Letter; IAA Comment Letter; ICE 
Data Comment Letter; ICI Comment Letter; IDC Comment Letter; John 
Hancock Comment Letter; Refinitiv Comment Letter; Russell 
Investments Comment Letter; SSGA Comment Letter; Sullivan Comment 
Letter.
    \442\ See, e.g., ABA Comment Letter; Dechert Comment Letter; IAA 
Comment Letter; ICE Data Comment Letter; IDC Comment Letter; John 
Hancock Comment Letter; Russell Investments Comment Letter; SSGA 
Comment Letter;
    \443\ See NYC Bar Comment Letter.
---------------------------------------------------------------------------

(d) Fair Value Practices--Test Fair Value Methodologies \444\
---------------------------------------------------------------------------

    \444\ See supra section II.A.3.
---------------------------------------------------------------------------

    We understand that funds or pricing services generally test the 
appropriateness and accuracy of internally selected methodologies used 
to value investments.\445\ Funds may utilize methods such as back-
testing to review the appropriateness and accuracy of the methodologies 
used.\446\ We understand that many funds use systems to identify 
security valuations that may require additional attention, such as 
security prices that have not changed over a period of time and price 
changes beyond a certain threshold.\447\ Many commenters confirmed our 
understanding that testing fair value methodologies is common 
practice.\448\
---------------------------------------------------------------------------

    \445\ See infra section III.B.2.f).
    \446\ See, e.g., ICI Fair Valuation Report, supra footnote 410, 
at 17-18.
    \447\ See, e.g., IDC Role of the Board, supra footnote 215, at 
6-7.
    \448\ See, e.g., ABA Comment Letter; Advisors' Inner Circle 
Comment Letter; AIMA Comment Letter; American Funds Comment Letter; 
Capital Group Comment Letter; Dimensional Comment Letter; Duff & 
Phelps Comment Letter; Fidelity Comment Letter; Franklin Comment 
Letter; Guggenheim Comment Letter; Harvest Comment Letter; ICI 
Comment Letter; IHS Markit Comment Letter; Invesco Comment Letter; 
University of Miami Comment Letter; JPMAM Comment Letter; John 
Hancock Comment Letter; MFDF Comment Letter; Murphy Comment Letter; 
NYC Bar Comment Letter; NYSSCPA Comment Letter; Refinitiv Comment 
Letter; Stradley Comment Letter; Sullivan Comment Letter; TRC 
Comment Letter.
---------------------------------------------------------------------------

(e) Fair Value Practices--Identify Responsibilities
    As discussed above, a fund's adviser often plays an important and 
valuable role in carrying out the day-to-day work of determining fair 
values, while the board reviews periodic reports from the adviser 
regarding the fair value of fund investments and fair value practices 
(e.g., methodologies, testing, etc.).\449\ UITs, which lack a board of 
directors, generally describe who is responsible for valuation duties 
in the UIT's trust indenture, with the depositor or evaluator generally 
performing fair value determinations, sometimes with the assistance of 
other parties such as evaluators.\450\ As discussed above \451\ and as 
acknowledged by many commenters,\452\ pricing services provide advisers 
and funds with information such as evaluated prices, matrix prices, 
price opinions, or other information that is used as prices or as 
inputs to the fair value determination process. Some boards create 
separate valuation committees with clearly established

[[Page 779]]

functions that help the board provide oversight of the advisers' 
valuation practices.\453\ If used, the structure of the valuation 
committees can differ across funds. Finally, fund policies and 
procedures may include ``escalation procedures'' that describe the 
circumstances under which certain adviser personnel or board members 
should be notified when fair value issues arise that are not addressed 
in existing fair value policies and procedures.\454\
---------------------------------------------------------------------------

    \449\ See supra section II.B and section II.B.3.
    \450\ See supra section II.B, footnotes 171-173 and accompanying 
discussion. See also AAM Comment Letter; BNY Mellon Comment Letter; 
Chapman Comment Letter; First Trust Comment Letter; Hennion & Walsh 
Comment Letter; Invesco Comment Letter; MFS Comment Letter; Seward & 
Kissel Comment Letter.
    \451\ See supra section II.A.4, section III.B.2.a), and section 
III.B.2.c).
    \452\ See ABA Comment Letter; Advisors' Inner Circle Comment 
Letter; AIMA Comment Letter; American Bankers Association Comment 
Letter; American Funds Comment Letter; Baillie Gifford Comment 
Letter; Capital Group Comment Letter; Dechert Comment Letter; 
Deloitte Comment Letter; Dimensional Comment Letter; Duff & Phelps 
Comment Letter; Fidelity Comment Letter; Fidelity Trustees Comment 
Letter; First Trust Comment Letter; Franklin Comment Letter; 
Guggenheim Comment Letter; Guggenheim Trustees Comment Letter; ICE 
Data Comment Letter; ICI Comment Letter; IDC Comment Letter; IHS 
Markit Comment Letter; Invesco Comment Letter; IVSC Comment Letter; 
JPMAM Comment Letter; John Hancock Comment Letter; MFDF Comment 
Letter; Murphy Comment Letter; NYC Bar Comment Letter; NYSSCPA 
Comment Letter; Refinitiv Comment Letter; SSGA Comment Letter; 
Stradley Comment Letter; Sullivan Comment Letter; TRC Comment Letter 
VRC Comment Letter.
    \453\ See, e.g., IDC Role of the Board, supra footnote 215, at 
8-10.
    \454\ Id. at 7.
---------------------------------------------------------------------------

    The commenters who weighed in on this aspect confirmed our 
understanding of these practices.\455\ Commenters stated that advisers 
currently have the ``means to ensure that portfolio managers do not 
exert undue influence on the fair value process'' \456\ and that other 
practices such as ``establish[ing] [a] `middle office' that facilitates 
the establishment of [fair value]'' determinations mitigates ``undue 
influence'' from portfolio managers.\457\ Another commenter described 
segregating duties by ``delegating the calculation, determination, and 
production of the NAV to a suitably independent, competent and 
experienced third-party valuation service provider'' and that ``[i]f 
the investment manager is responsible for determining the NAV, and/or 
acts as the fund governing body, robust controls over conflicts of 
interest should be established.'' \458\ The same commenter also 
described appointing an investment manager valuation committee to 
mitigate conflicts of interest and ensuring that a broker or dealer 
that provides inputs to fair value ``is free of relationships with the 
fund through which the investment manager can directly or indirectly 
control or influence the broker or dealer.'' \459\ Other commenters 
underscored the importance of segregating duties and described 
practices to mitigate the risk from conflicts of interest in the 
valuation process.\460\
---------------------------------------------------------------------------

    \455\ See, e.g., AIMA Comment Letter; ABA Comment Letter; Murphy 
Comment Letter; MFS Comment Letter.
    \456\ ICI Commenter Letter; see also Seward & Kissel Comment 
Letter;
    \457\ See VRC Comment Letter.
    \458\ See AIMA Comment Letter.
    \459\ Id.
    \460\ See, e.g., ABA Comment Letter; Fidelity Comment Letter; 
IVSC Comment Letter; Murphy Comment Letter.
---------------------------------------------------------------------------

(f) Fair Value Practices--Evaluate Pricing Services \461\
---------------------------------------------------------------------------

    \461\ See supra section II.A.4.
---------------------------------------------------------------------------

    We understand that, under existing practice, fund boards, advisers, 
and UIT depositors frequently use third-party pricing service providers 
to assist in determining fair values.\462\ Before engaging a pricing 
service, boards may review background information on the vendor, such 
as the vendor's operations and internal testing procedures, emergency 
business continuity plans, and methodologies and information used to 
form its recommended valuations.\463\ Boards may develop an 
understanding of the circumstances in which third-party pricing 
services would provide assistance in the valuation of fund 
investments.\464\ In reviewing the performance of these pricing 
services, boards also may seek input from the fund's adviser or the 
pricing service itself, including probing whether the adviser performed 
adequate due diligence when selecting the service.\465\ In particular, 
boards may consider whether the adviser tests prices received from 
pricing services against subsequent sales or open prices, whether the 
pricing services are periodically reviewed, and to what extent the 
pricing service considers adviser input. Funds may establish procedures 
for ongoing monitoring of the pricing services--including the pricing 
service's presentations to the board, the adviser's due diligence, and 
on-site visits to the pricing service--to determine whether the pricing 
service continues to have competence in valuing particular investments 
and maintains an adequate control environment.\466\ Further, boards may 
seek to understand the circumstances under which the adviser may 
challenge or override the prices obtained from the pricing service 
provider.\467\ Many commenters confirmed our understanding of common 
practices in the evaluation of pricing services.\468\ While some 
commenters stated that some advisers (e.g., small advisers) lack the 
resources or staffing to perform due diligence of pricing services, 
back-testing of methodologies, analysis of pricing challenge efficacy, 
and back-testing of fair value determinations,\469\ most commenters 
stated that funds routinely rely on advisers to conduct due diligence 
on pricing services.\470\
---------------------------------------------------------------------------

    \462\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
10; IDC Role of the Board, supra footnote 215, at 10-11.
    \463\ See, e.g., IDC Role of the Board, supra footnote 215, at 
11.
    \464\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
10.
    \465\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
11.
    \466\ Id.
    \467\ Id. at 10-11.
    \468\ See, e.g., ABA Comment Letter; Advisors' Inner Circle 
Comment Letter; AIMA Comment Letter; Capital Group Comment Letter; 
Dechert Comment Letter; Deloitte Comment Letter; Dimensional Comment 
Letter; Duff & Phelps Comment Letter; Fidelity Comment Letter; 
Fidelity Trustees Comment Letter; First Trust Comment Letter; 
Guggenheim Comment Letter; Harvest Comment Letter; ICE Data Comment 
Letter; ICI Comment Letter; IDC Comment Letter; IHS Markit Comment 
Letter; Invesco Comment Letter; University of Miami Comment Letter; 
IVSC Comment Letter; JPMAM Comment Letter; John Hancock Comment 
Letter; KPMG Comment Letter; MFDF Comment Letter; Murphy Comment 
Letter; NYC Bar Comment Letter; Practus Comment Letter; Refinitiv 
Comment Letter; Stradley Comment Letter; Sullivan Comment Letter; 
TRC Comment Letter; Vanguard Comment Letter; VRC Comment Letter.
    \469\ See, e.g., MFS Comment Letter; Sullivan Comment Letter.
    \470\ See, e.g., ABA Comment Letter; Advisors' Inner Circle 
Comment Letter; American Funds Comment Letter; Capital Group Comment 
Letter; Dimensional Comment Letter; First Trust Comment Letter; 
Guggenheim Comment Letter; ICE Data Comment Letter; ICI Comment 
Letter; IDC Comment Letter; Invesco Comment Letter; John Hancock 
Comment Letter; Refinitiv Comment Letter; Russell Investments 
Comment Letter; TRC Comment Letter.
---------------------------------------------------------------------------

(g) Board Reporting \471\
---------------------------------------------------------------------------

    \471\ See supra section II.B.1.
---------------------------------------------------------------------------

    Many commenters confirmed our understanding of current practices of 
board reporting.\472\ On a periodic basis, as part of their current 
fair value oversight, boards may review reports from the adviser 
regarding the fair value of fund investments \473\ and fair value 
methodologies, but rely on the adviser for the day-to-day calculation 
of fair values.\474\ Many boards review fair value determinations based 
on information provided in quarterly reports, but some boards review 
the determinations in more or less frequent reporting depending on the 
type of fund investments and the market conditions.\475\ Boards also 
may have ad-hoc discussions on valuation matters outside of their 
regular meetings.\476\ In some circumstances, board members may play an 
active role in shaping the type of information contained in and the 
format of valuation reports given to the

[[Page 780]]

board.\477\ The content of reports boards receive depends on the type 
of fund and fund investments.\478\ The type of general information that 
boards may receive includes a summary of back-testing data and an 
analysis of the impact of fair values on the fund's NAV.\479\ The 
reports also may include more specific information about fund 
investments that are more difficult to value, such as the fair values 
assigned to each investment, the size of the holding, the effect of the 
fair value on the fund's NAV, and the rationale for the decision to 
fair value.\480\ Some board reports may also include security-specific 
information in cases where advisers override prices provided by pricing 
services.\481\ Finally, some funds also include in board reports the 
minutes of, or summary memoranda and other written documentation from, 
valuation committee meetings held during the prior period.\482\
---------------------------------------------------------------------------

    \472\ See, e.g., ABA Comment Letter; Advisors' Inner Circle 
Comment Letter; AIMA Comment Letter; American Funds Comment Letter; 
Capital Group Comment Letter; Dechert Comment Letter; Fidelity 
Comment Letter; Fidelity Trustees Comment Letter; Guggenheim Comment 
Letter; IAA Comment Letter; IDC Comment Letter; MFS Comment Letter; 
Murphy Comment Letter; SIFMA AMG Comment Letter; Vanguard Comment 
Letter.
    \473\ See, e.g., IDC Role of the Board, supra footnote 215, at 
12-13.
    \474\ See, e.g., MFDF Valuation Report, supra footnote 407, at 2 
as well as supra section III.B.2.e).
    \475\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
10. See also Deloitte Survey, supra footnote 419, at 10 (stating 
that 26% of the participants mentioned that the board held a 
valuation discussion in the prior 12 months with management outside 
of a regularly scheduled meeting to address a valuation matter or 
question).
    \476\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
14.
    \477\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
14.
    \478\ Id.
    \479\ See, e.g., IDC Role of the Board, supra footnote 215, at 
12.
    \480\ Id. at 12-13.
    \481\ Id. at 13. See also Deloitte Survey, supra footnote 419, 
at 10 (noting that 74% of the participants in the 2019 survey 
reported that their boards receive price challenge information as 
part of the valuation reports).
    \482\ See, e.g., IDC Role of the Board, supra footnote 215, at 
13.
---------------------------------------------------------------------------

    Valuation reports may vary depending on the volume and complexity 
of fair value determinations.\483\ For example, some boards require a 
case-by-case review of each asset that received fair value, whereas 
other boards require the adviser to provide a sample report on an asset 
that was assigned a fair value to illustrate the methodology that is 
used by the adviser.\484\
---------------------------------------------------------------------------

    \483\ See, e.g., MFDF Valuation Report, supra footnote 407, at 
14.
    \484\ Id.
---------------------------------------------------------------------------

(h) Recordkeeping \485\
---------------------------------------------------------------------------

    \485\ See supra section II.C.
---------------------------------------------------------------------------

    It is our understanding that funds and advisers currently retain 
records related to fair value determinations. These records generally 
include identifying information for each portfolio investment, data 
used for pricing, and any other information related to price 
determinations and fund valuation policies and procedures. Commenters 
generally confirmed our understanding of common practices in 
recordkeeping.\486\ We recognize that some fund boards may not apply 
these same recordkeeping practices for some investments, including, for 
example, those for which the board relies on pricing services for fund 
investments using level 2 inputs for fair value determinations.\487\ 
Furthermore, commenters described common recordkeeping practices such 
as maintaining specific methodologies, inputs, and assumptions for 
investments fair valued with level 3 inputs and conducting due 
diligence of pricing services' methodologies and testing for 
investments fair valued with level 2 inputs; \488\ maintaining records 
of methodologies and other detailed inputs and assumptions for cases 
when a fund, board, or adviser establishes and applies its own 
methodologies; \489\ maintaining only prices from a pricing service 
(e.g., evaluated prices for securities fair valued with level 2 inputs) 
that were actually used as an input by the adviser; \490\ and not 
maintaining records for investments for which the funds rely on pricing 
services to calculate fair value for assets valued with level 2 
inputs.\491\
---------------------------------------------------------------------------

    \486\ See, e.g., Advisors' Inner Circle Comment Letter; AIMA 
Comment Letter; Baillie Gifford Comment Letter; Duff & Phelps 
Comment Letter; Fidelity Comment Letter; Franklin Comment Letter; 
Guggenheim Comment Letter; Guggenheim Trustees Comment Letter; ICE 
Data Comment Letter; ICI Comment Letter; IDC Comment Letter; Invesco 
Comment Letter; University of Miami Comment Letter; JPMAM Comment 
Letter; John Hancock Comment Letter; MFS Comment Letter; NYC Bar 
Comment Letter; SIFMA AMG Comment Letter; SSGA Comment Letter; 
Stradley Comment Letter; Sullivan Comment Letter; TRC Comment 
Letter; Vanguard Comment Letter; VRC Comment Letter.
    \487\ See, e.g., American Bankers Association Comment Letter; 
Baillie Gifford Comment Letter; Capital Group Comment Letter; ICE 
Data Comment Letter; John Hancock Comment Letter; SSGA Comment 
Letter; TRC Comment Letter; Vanguard Comment Letter.
    \488\ See, e.g., Vanguard Comment Letter.
    \489\ See, e.g., IDC Comment Letter.
    \490\ See, e.g., SSGA Comment Letter.
    \491\ See, e.g., Franklin Comment Letter; Baillie Gifford 
Comment Letter.
---------------------------------------------------------------------------

(i) Cross Trades \492\
---------------------------------------------------------------------------

    \492\ See supra section II.C.
---------------------------------------------------------------------------

    It is our understanding that some funds currently rely on rule 17a-
7 and consider staff no-action letters when engaging in cross trades in 
investments, including fixed-income securities.\493\ Commenters 
confirmed our understanding of the common practice of cross 
trades.\494\ Furthermore, some commenters noted that some funds may 
currently cross trade certain assets that rely on level 2 inputs.\495\
---------------------------------------------------------------------------

    \493\ See supra footnotes 356, 357, and 358 and accompanying 
discussion.
    \494\ See, e.g., ABA Comment Letter; Capital Group Comment 
Letter; Dechert Comment Letter; Dimensional Comment Letter; ICE Data 
Comment Letter; ICI Comment Letter; Murphy Comment Letter; NYC Bar 
Comment Letter; Stradley Comment Letter; Sullivan Comment Letter; 
TRC Comment Letter.
    \495\ See supra section II.D.
---------------------------------------------------------------------------

3. Affected Parties
    Rules 2a-5 and 31a-4 potentially affect all registered investment 
companies and BDCs (because their fund investments must be fair valued 
under the Act), those funds' boards of directors, advisers, and 
investors. The rules also affect funds that engage in cross trades. 
Table 1 below presents descriptive statistics for the funds that could 
be affected by the rules. As of September 11, 2020, there were 14,010 
registered investment companies: (i) 12,680 open-end funds; (ii) 664 
closed-end funds; (iii) 661 UITs; and (iv) 14 variable annuity separate 
accounts

[[Page 781]]

registered as management companies.\496\ As of the same date, (i) open-
end funds held total net assets of $27,112 billion; (ii) closed-end 
funds held total net assets of $308 billion; (iii) UITs held total net 
assets of $2,113 billion; and (iv) variable annuity separate accounts 
registered as management companies held total net assets of $226 
billion. As of September 2020, there were 97 BDCs with $62 billion in 
total net assets.\497\ Not all funds hold investments that must be fair 
valued under the Act, and not all funds engage in cross trades. In 
addition, for those funds that hold investments that must be fair 
valued under the Act or that engage in cross trades, the extent of 
those investments and activities varies. Hence, the rules affect only a 
subset of the funds listed in Table 1 below.
---------------------------------------------------------------------------

    \496\ We estimate the number of registered investment companies 
by reviewing the most recent filings of Forms N-CEN filed with the 
Commission as of September 2020. Open-end funds are series of trusts 
registered on Form N-1A. Closed-end funds are trusts registered on 
Form N-2. UITs are variable annuity separate accounts organized as 
UITs registered on Form N-4, variable life insurance separate 
accounts organized as UITs registered on Form N-6, or series, or 
classes of series, of trusts registered on Form N-8B-2. Separate 
accounts registered as management companies are trusts registered on 
Form N-3.
    \497\ Estimates of the number of BDCs and their net assets are 
based on a staff analysis of Form 10-K and Form 10-Q filings as of 
September 2020, which are the most recent available filings. Our 
estimates include BDCs that may be delinquent or have filed 
extensions for their filings, and they exclude eight wholly owned 
subsidiaries of other BDCs and feeder BDCs in master-feeder 
structures.

                Table 1--Descriptive Statistics for Funds
------------------------------------------------------------------------
                                                        Total net assets
                                     Number of funds     (in billion $)
                                                  (1)                (2)
------------------------------------------------------------------------
Open-end funds....................             12,680             27,112
Closed-end funds..................                664                308
UITs..............................                661              2,113
Management company separate                        14                226
 accounts.........................
BDCs \1\..........................                 97                 62
                                   -------------------------------------
    Total.........................             14,116             29,821
------------------------------------------------------------------------
Note 1. Out of 97 BDCs reporting on Form N-CEN, nine were reported as
  being internally managed.
Sources: Form 10-K; Form 10-Q; Form N-CEN.

    To understand the extent of current boards' involvement in the 
valuation of funds' investments and the extent to which the rules could 
affect funds' operations (including for funds that engage in cross 
trades), we examine funds' investments under the U.S. GAAP fair value 
hierarchy.\498\ For purposes of this economic analysis, we treat 
investments that are valued using level 1 inputs as investments for 
which readily available market quotations are available, and 
investments valued using level 2 and 3 inputs as investments that must 
be fair valued in good faith under the Act's definition of value.\499\ 
We therefore expect that funds that hold more investments that are 
valued using level 2 and level 3 inputs will be more affected by the 
rules than funds with no or fewer such investments. In particular, as 
commenters noted, some funds currently treat some investments valued 
with level 2 inputs as having readily available market quotations and 
perform determinations of fair value in good faith on other investments 
valued with level 2 inputs.\500\
---------------------------------------------------------------------------

    \498\ According to ASC Topic 820, assets and liabilities are 
classified as using level 1, level 2, or level 3 inputs. Level 1 
inputs are ``quoted prices (unadjusted) in active markets for 
identical assets or liabilities that the reporting entity can assess 
at the measurement date.'' Level 2 inputs are ``inputs other than 
quoted prices included within level 1 that are observable for the 
asset or liability, either directly or indirectly.'' Level 3 inputs 
are ``unobservable inputs for the asset and liability.'' See ASC 
Topic 820, supra footnote 1.
    \499\ See rule 2a-5(c). See also supra section II.D.
    \500\ See, e.g., Capital Group Comment Letter; IAA Comment 
Letter.
---------------------------------------------------------------------------

    Table 2 provides descriptive statistics on funds' investments 
measured based on level 1, 2, and 3 inputs using Form N-PORT data as of 
September 2020.\501\ As Table 2 shows, there are 13,101 funds with 
$24,417 billion in net assets that filed Form N-PORT.\502\ About 62% of 
fund assets are valued using level 1 inputs. Nevertheless, the average 
percentage of investments valued using level 1 inputs varies depending 
on the type of fund, ranging from 26% for closed-end funds to 99% for 
ETFs registered as UITs. About 34% of fund assets are valued using 
level 2 inputs, which also varies depending on the type of fund. Only a 
small percentage of fund assets are valued using level 3 inputs.\503\
---------------------------------------------------------------------------

    \501\ UITs (other than the ETFs registered as UITs) and BDCs do 
not file Form N-PORT, and thus are excluded from Table 2. We 
estimate the statistics in Table 2 by reviewing the most recent 
filings of Forms N-PORT filed with the Commission as of September 
2020. The average ratio of securities by fair value hierarchy (i.e., 
Columns 3 to 6 in Table 2) is retrieved from Item C.8 of Form N-
PORT. Our analysis excludes funds with non-positive net assets and 
funds with total assets less than net assets because these 
observations are likely data errors. The Average Level 1, Level 2, 
and Level 3 Inputs is the average ratio of level 1, level 2, or 
level 3 long positions divided by the fund's total gross assets 
across all funds within each fund category. Open-end funds are 
series of trusts registered on Form N-1A. Closed-end funds are 
trusts registered on Form N-2. ETFs registered as UITs are series, 
or classes of series, of trusts registered on Form S-6. Separate 
accounts registered as management companies are trusts registered on 
Form N-3. The last row in Table 2 represents the sum of the previous 
rows within the same column for Columns 1 and 2, and it represents 
the asset-weighted average of the previous rows within the same 
column for columns 3 to 6.
    \502\ The numbers of open-end funds, closed-end funds, and 
separate accounts registered as management companies that filed Form 
N-PORT reported in Table 2 differ from those that filed Form N-CEN 
reported in Table 1 due to differing reporting requirements and the 
frequency of reporting. Total net assets in Form N-CEN also may be 
different from total net assets in Form N-PORT because Form N-CEN 
reports average net assets estimated over the reporting period while 
Form N-PORT reports point-in-time net assets as of the reporting 
date.
    \503\ Investments that are valued at NAV, and thus do not have a 
level associated with them, are classified as ``N/A'' in Form N-
PORT. These investments have no level under the U.S. GAAP fair value 
hierarchy and for purposes of this analysis we assume they are 
securities for which there are no readily available market 
quotations. Nevertheless, the valuation of those investments 
arguably requires less effort than the valuation of investments 
valued using level 2 and 3 inputs because funds' NAVs are easily 
obtainable. About 1% of the fund assets are classified as ``N/A'' 
investments. For open-end funds, approximately 1% of ``N/A'' 
investments are classified as private fund investments and 
approximately 85% are classified as registered fund investments; for 
closed-end funds, approximately 68% are classified as private fund 
investments and approximately 23% are classified as registered fund 
investments. The sum of the average using level 1, 2, 3, and ``N/A'' 
within each fund category may not sum up to 100% due to rounding 
error.

[[Page 782]]



                                    Table 2--Descriptive Statistics for Funds by ASC Topic 820 Fair Value Hierarchy1
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             Total net     Average level   Average level   Average level   Average ``N/
                                                             Number of      assets (in       1 inputs        2 inputs        3 inputs       A'' inputs
                                                               funds        billion $)       (percent)       (percent)       (percent)       (percent)
                                                                     (1)             (2)             (3)             (4)             (5)             (6)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Open-end funds..........................................          12,387          23,475              62              35             0.2               1
Registered closed-end funds.............................             696             305              26              53               6              12
ETFs registered as UITs.................................               5             423              99               0               0               0
Management company separate accounts....................              13             212              75              26               0               0
                                                         -----------------------------------------------------------------------------------------------
    Total/Average.......................................          13,101          24,415              62              34               0               1
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note 1: Out of the 12,387 open-end funds, two reported being internally managed with net assets of $7 billion. Out of the 696 registered closed-end
  funds, 12 reported being internally managed with net assets of $18 billion. No ETFs registered as UITs or management company separate accounts
  reported being internally managed. Approximately 19.5% of assets of open-end funds were foreign holdings; less than 1% of assets of closed-end funds,
  ETFs registered as UITs, and management company separate accounts were foreign holdings.
Source: Form N-PORT.

    As of September 2020, there were 1,518 advisers that reported 
providing portfolio management for investment companies or BDCs with 
regulatory assets under management of $61.6 trillion, of which $33.6 
trillion was attributable to investment company and BDC clients.\504\ 
Among the open-end funds reported in Table 2, approximately 2% reported 
not engaging a pricing service. Among the closed-end funds reported in 
Table 2, approximately 12% reported not engaging a pricing service. No 
ETF registered as a UIT reported engaging a pricing service, and all 
management company separate accounts reported engaging a pricing 
service. As of December 2019, there were 59.7 million U.S. households 
and 103.9 million individuals owning U.S. registered investment 
companies that could be affected by the rules.\505\ Untabulated 
analysis shows that 29% of the funds report having 100% of their 
investments valued using level 1 inputs.\506\ Based on this, we 
estimate that approximately 9,804 funds may be affected by the rules, 
of which 9,335 are not UITs.\507\ However, foreign holdings made up 
approximately (1) 20% of assets of open-end funds; (2) 24% of assets of 
closed-end funds; (3) 23% of assets of ETFs registered as UITs; and (4) 
3% of assets of management company separate accounts. Overall, 
approximately 20% of assets were foreign holdings. Thus, to the extent 
that funds determined that these foreign holdings had readily available 
market quotations (i.e., are reported falling in level 1 in the fair 
value hierarchy), the 29% estimate of funds unaffected by the rules may 
be overstated. Furthermore, approximately 28% of funds reported relying 
on 17a-7 for cross trades, but we cannot determine to what extent 
reliance on 17a-7 is limited to investments meeting the definition 
under the final rule of having readily available market quotations.
---------------------------------------------------------------------------

    \504\ Based on Form ADV Items 5.G.(3), 5.F.2.(c), 5.D.(d)(3), 
and 5.D.(e)(3) of Part 1A of Forms ADV filed with the Commission as 
of September 2020.
    \505\ Investment Company Institute, Investment Company Fact 
Book: A Review of Trends and Activities in the Investment Company 
Industry, 60th Edition (2020), available at https://www.ici.org/pdf/2020_factbook.pdf, (last accessed on Sept. 4, 2020).
    \506\ 29% = (3,810 open-end funds with investments valued using 
only level 1 inputs that filed Form N-PORT + 45 closed-end funds 
with investments valued using only level 1 inputs that filed Form N-
PORT + 5 ETFs registered as UITs with investments valued using only 
level 1 inputs that filed Form N-PORT + 3 variable annuity separate 
accounts registered as management companies with investments valued 
using only level 1 inputs that filed Form N-PORT)/13,101 funds that 
filed Form N-PORT. See supra footnote 502.
    \507\ 9,804 funds = 13,101 funds that filed Form N-PORT from 
Table 2--3,863 funds that hold investments valued using only level 1 
inputs and filed Form N-PORT + 97 BDCs from Table 1 above + 469 
affected UITs. 469 = 661 UITs that filed Form N-CEN * (1--29% of 
funds that only report securities valued using level 1 inputs based 
on N-PORT data). This calculation assumes that the distribution of 
investments valued using level 1 inputs for registered investment 
companies that filed Form N-PORT is similar to the distribution of 
investments valued using level 1 inputs for UITs that filed Form N-
CEN. This calculation also assumes that all 97 BDCs in our sample 
hold a non-zero amount of investments valued using level 2 and level 
3 inputs. This assumption is made because BDCs are required to 
invest at least 70% of their assets in private or public U.S. firms 
with market values of less than $250 million, and these investments 
usually are securities valued using level 2 or level 3 inputs. See 
15 U.S.C. 80a-54(a).
---------------------------------------------------------------------------

C. General Economic Considerations

1. Investment Adviser Role in Fair Value Determinations
    Unbiased valuation of fund investments is important because it 
affects the prices at which fund shares are purchased or redeemed by 
shareholders. Similarly, to the extent that valuation reflects what 
would be obtained in a current arm's length transaction, such valuation 
could also provide fund managers and investors a more accurate picture 
of the funds' volatility.\508\ This could help fund managers better 
tailor their portfolios to specific risk-reward profiles or benchmarks 
and ensure that their portfolios comply with the fund's risk appetite 
statement. Likewise, investors could better evaluate how a given fund 
fits their risk appetite and ability to bear risk. Valuation of fund 
investments is also important because it can affect funds' fee and 
performance calculations, and also can affect funds' compliance with 
regulatory requirements. Finally, properly valuing a fund's investments 
is a critical component of the accounting and financial reporting for 
investment companies.\509\
---------------------------------------------------------------------------

    \508\ See Comment Letter of Will Gornall and Ilya Strebulaev 
(May 19, 2020) (describing the difficulty of valuation and 
consequences of low quality valuations, including mismeasurement of 
risk and returns, which in turn leads to overly smoothed valuations, 
inflated risk-adjusted performance measures, misallocation of 
capital, and, ultimately, economic inefficiency).
    \509\ See supra section II for more discussion on the importance 
of unbiased valuation of fund investments.
---------------------------------------------------------------------------

    As explained above, we understand that boards typically rely on 
fund advisers to perform the day-to-day calculation of fair value 
determinations for fund investments that do not have readily available 
market quotations.\510\ Because a board's role is focused on oversight 
rather than day-to-day involvement in fund activities such as 
valuation, this is appropriate to ensure that boards are not engaging 
in duties that distract them from oversight and governance of the fund 
and its fair value process. Furthermore, a board's members are unlikely 
to have the necessary experience, knowledge, skills,

[[Page 783]]

or resources to carry out the day-to-day calculation of fair value 
determination.
---------------------------------------------------------------------------

    \510\ See supra section II.B.1 and footnote 201 as well as 
section III.B.2.
---------------------------------------------------------------------------

    Fund advisers' interests may conflict with the interest of 
shareholders,\511\ an issue that many commenters echoed.\512\ In 
particular, advisers have incentives to inflate fund asset values (or 
deflate fund liability values) because they typically receive a 
management fee that is calculated as a percentage of the value of net 
assets under management.\513\ Relatedly, advisers have incentives to 
inflate fund asset values because investors tend to invest more in 
funds with good recent performance, which would increase assets under 
management and ultimately increase advisers' compensation.\514\ 
Advisers also have incentives to mismeasure fund investments in a way 
that would smooth reported fund performance over time to lower the 
funds' perceived risk.\515\ Finally, advisers may mismeasure values of 
fund investments as a result of expending less effort than the effort 
required to ensure more accurate and unbiased valuations.\516\ Any such 
mismeasurement likely will be more pronounced for investors of funds 
whose shares are not publicly traded (e.g., open-end funds (other than 
ETFs), UITs, and some BDCs) because there is no secondary market for 
the shares of those funds, and fund investors can transact only at a 
price based on NAV, which is determined by the fund's fair value 
determinations.
---------------------------------------------------------------------------

    \511\ Some academic literature suggests that fund fair values 
are not always measured in an accurate and unbiased way. See, e.g., 
Vikas Agarwal et al., Private Company Valuations by Mutual Funds 
(Working Paper, Aug. 2019), available at https://ssrn.com/abstract=3066449; Rahul Bhargava, Ann Bose, & David A. Dubofsky, 
Exploiting International Stock Market Correlations with Open-End 
International Mutual Funds, 25 J. BUS. FIN. & ACCT. 765 (1998); 
Scott Cederburg & Neal Stoughton, Discretionary NAVs (Working Paper, 
Nov. 2019), available at https://www.wu.ac.at/fileadmin/wu/d/i/finance/BBS-Papers/SS2019/20190515_STOUGHTON.pdf; John M. R. 
Chalmers, Roger M. Edelen, & Gregory B. Kadlec, On the Perils of 
Financial Intermediaries Setting Security Prices: The Mutual Fund 
Wild Card Option, 56 J. FIN. 2209 (2001); Nandini Chandar & Robert 
Bricker, Incentives, Discretion, and Asset Valuation in Closed-End 
Mutual Funds, 40 J. ACCT. RES. 1037 (2002) (``Chandar and Bricker 
2002''); Jaewon Choi, Mathias Kronlund, & Ji Yeol Jimmy Oh, Sitting 
Bucks: Zero Returns in Fixed Income Funds (Working Paper, Aug. 
2020), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3244862; Gjergji Cici, Scott Gibson, & John 
J. Merrick Jr., Missing the marks? Dispersion in corporate bond 
valuations across mutual funds, 101 J. Fin. Econ. 206 (2011) (``Cici 
et al. 2011''); Vladimir Atanasov, John J. Merrick Jr., & Philipp 
Schuster, Mismarking Fraud in Mutual Funds (Working Paper, Apr. 
2019), available at http://www.fmaconferences.org/Glasgow/Papers/Fraud_in_OpenEndMutualFunds_2018_1126.pdf. As noted above, officers 
of internally managed funds that perform these functions in lieu of 
an adviser may face conflicts that are different from those of 
advisers. See supra footnote 159.
    \512\ See, e.g., AAM Comment Letter; ABA Comment Letter; AIMA 
Comment Letter; American Bankers Association Comment Letter; 
American Funds Trustees Comment Letter; Better Markets Comment 
Letter; BlackRock Trustees Comment Letter; CFA Institute Comment 
Letter; Chapman Comment Letter; Dechert Comment Letter; Duff & 
Phelps Comment Letter; Fidelity Comment Letter; Fidelity Trustees 
Comment Letter; First Trust Comment Letter; Franklin Comment Letter; 
Guggenheim Comment Letter; Hennion & Walsh Comment Letter; ICE Data 
Comment Letter; IDC Comment Letter; IHS Markit Comment Letter; 
University of Miami Comment Letter; IVSC Comment Letter; John 
Hancock Comment Letter; MFS Comment Letter; Murphy Comment Letter; 
NYC Bar Comment Letter; Scheidt Comment Letter 2; Seward & Kissel 
Comment Letter; SIFMA AMG Comment Letter; TRC Comment Letter; VRC 
Comment Letter.
    \513\ See, e.g., Joseph Golec, Regulation and the Rise in Asset-
Based Mutual Fund Management Fees, 26 J. FIN. RES. 19 (2003) for 
evidence on the percentage of mutual funds that use asset-based 
management fees. In addition to explicit contracts that link 
advisers' compensation to fund size, there may be implicit contracts 
that provide incentives to advisers to mismeasure fund investments. 
For example, advisers may mismeasure fund investments to meet or 
beat certain benchmarks. See, e.g., Chandar and Bricker 2002.
    \514\ See, e.g., Judith Chevalier & Glenn Ellison, Risk Taking 
by Mutual Funds as a Response to Incentives, 105 J. POL. ECON. 1167 
(1997); Erik R. Sirri & Peter Tufano, Costly Search and Mutual Fund 
Flows, 53 J. FIN. 1589 (1998). Portfolio managers also have 
incentives to inflate fund asset values and thus increase fund 
performance because fund performance is positively related to the 
portfolio managers' compensation and negatively related to the 
probability that a portfolio manager will be terminated. See, e.g., 
Judith Chevalier & Glenn Ellison, Career Concerns of Mutual Fund 
Managers, 114 Q.J. ECON. 389 (1999); Linlin Ma, Yuehua Tang, & Juan-
Pedro Gomez, Portfolio Manager Compensation in the U.S. Mutual Fund 
Industry, 74 J. FIN. 587 (2018).
    \515\ See, e.g., Cici et al. 2011.
    \516\ Advisers may have incentives to underinvest in effort (or 
``shirk'') because they do not internalize the benefits accruing to 
the fund board of directors and fund investors from the expenditure 
of effort to estimate accurate and unbiased fair values. See, e.g., 
David Brown & Shaun Davies, Moral Hazard in Active Asset Management, 
125 J. FIN. ECON. 311 (2017) (``Brown and Davies 2017'').
---------------------------------------------------------------------------

    The degree of such conflicts of interest may vary across 
funds,\517\ depending on the extent to which funds or their advisers 
rely on pricing services for fair value determinations,\518\ the types 
of assets being subjected to fair value determinations \519\ (e.g., 
there may be a tension between expertise that an adviser may provide 
for particularly complex assets or alternative investments and the 
consequent lack of independence), and the manner in which an adviser or 
depositor is compensated. In particular, advisers' incentives to 
misreport fund investments may be more pronounced for funds that face 
higher competition to attract new investors and for actively managed 
funds that face higher demands from investors to beat certain 
benchmarks. Relatedly, advisers' incentives to underinvest in effort 
may be higher for funds whose performance is more difficult to measure 
and evaluate, and thus advisers' performance is also more difficult to 
measure and evaluate (e.g., funds that hold complex investments).\520\ 
Conflicts of interest may be lower for parties whose compensation is 
not based on the value of assets, as is the case with depositors or 
evaluators of some UITs. Officers of internally managed funds who make 
determinations of fair value may also be subject to conflicts of 
interest to the extent that their compensation is related to the value 
of assets. Boards of directors currently serve as a check on the 
conflicts of interest of the adviser, officers of the fund, and the 
other service providers involved in the calculations of fair 
values.\521\ BDCs face similar conflicts of interest, which likewise 
should be managed by their boards. The final rule retains the important 
safeguard of board oversight of fair value determinations, while making 
more efficient use of boards' time and expertise and recognizing the 
important role of valuation designees in the fair value determination 
process.
---------------------------------------------------------------------------

    \517\ See, e.g., AAM Comment Letter; Chapman Comment Letter; 
First Trust Comment Letter; Hennion & Walsh Comment Letter on the 
notion that UITs pose a lower level of concern in regard to such 
conflicts of interest.
    \518\ Pricing services may mitigate conflicts of interest by, 
for example, contributing to a clearer segregation between fair 
value determinations and portfolio management. On the other hand, 
pricing services also may be incentivized to provide higher or more 
aggressive valuations generally to retain business. See, also, e.g., 
AIMA Comment Letter; American Bankers Association Comment Letter; 
Dechert Comment Letter; Fidelity Trustees Comment Letter; Guggenheim 
Comment Letter; ICE Data Comment Letter; IHS Markit Comment Letter; 
John Hancock Comment Letter; Murphy Comment Letter; VRC Comment 
Letter.
    \519\ See, e.g., AIMA Comment Letter; American Bankers 
Association Comment Letter; American Funds Comment Letter; Fidelity 
Comment Letter; Guggenheim Comment Letter; SIFMA AMG Comment Letter; 
TRC Comment Letter.
    \520\ See, e.g., Brown and Davies 2017.
    \521\ See supra footnote 423.
---------------------------------------------------------------------------

2. Board Considerations When Designating Fair Value Determinations
    Under the final rule, boards may designate the performance of fair 
value determinations for investments of the fund to a valuation 
designee.\522\ It is our understanding that funds' advisers or officers 
of internally managed funds already perform or assist the board with 
respect to many of those functions subject to the board's oversight. 
When deciding whether to designate a party to perform fair value 
determinations for the fund, we anticipate that a board will

[[Page 784]]

consider certain trade-offs. In particular, fund boards' decisions to 
oversee valuation designees' fair value determinations instead of 
determining fair value themselves may depend on the number, amount, or 
allocation of investments that must be fair valued, the nature and 
complexity of the valuation of those investments, the type of fund, the 
valuation designee's willingness to assume additional fair value 
responsibilities, and the fund's current practices. Boards' decisions 
may also depend on the resources of the valuation designee.\523\ Boards 
of funds that hold more investments that must be fair valued and 
harder-to-value investments may be more likely to designate a valuation 
designee to perform these fair value determinations and to oversee the 
process of determining fair value by the valuation designee because 
valuation designees may be better suited to value those types of 
investments. A board's decision may also depend on the type of fund. 
For example, a board of an open-end fund that must calculate NAVs on a 
daily basis may be more likely to designate the performance of fair 
value determinations (on which the fund's NAV is based) to a valuation 
designee than the board of a fund that calculates value less regularly. 
As another example, the board of a BDC may choose to determine fair 
value itself through its officers due to specialized expertise retained 
internally.
---------------------------------------------------------------------------

    \522\ See rule 2a-5(b).
    \523\ See supra footnote 295 and accompanying discussion.
---------------------------------------------------------------------------

    The decision to oversee valuation designees' fair value 
determinations may also depend on valuation designees' willingness to 
assume the designated responsibilities. Such willingness may depend on 
the valuation designee's valuation expertise and experience, whether 
the valuation designee has available resources to satisfy new 
obligations, and the extent to which the valuation designee could be 
compensated for those increased responsibilities, including by passing 
through to the fund and its investors any higher costs. Finally, a 
board's decision to designate responsibilities under the final rule may 
depend on the expected costs of compliance, which ultimately depend on 
how different the fund's current practices and policies and procedures 
are from the requirements of the final rule.
    We lack comprehensive information on funds' current fair value 
practices and do not have visibility into boards' decision-making 
processes when seeking assistance with fair value determinations from 
valuation designees.\524\ Further, boards' decision-making processes 
with respect to seeking assistance with fair value determinations from 
valuation designees is complex. Hence, we are unable to estimate 
precisely the number of fund boards that will designate 
responsibilities to a valuation designee under the final rule instead 
of the boards making fair value determinations in good faith 
themselves. Nevertheless, we believe the vast majority of boards will 
designate these responsibilities to a valuation designee \525\ because 
the valuation designee has valuation experience and expertise, is 
involved with the fund's operations on a daily basis and, thus, may be 
better suited than the board to deal with fair value matters that arise 
on a daily basis. We believe this is true regardless of whether the 
board designates an adviser or an officer of the fund to perform the 
valuation responsibilities. Further, valuation designees already 
provide significant assistance with the fair value determinations to 
the board of directors and so funds that designate a valuation designee 
to perform fair value determinations under the final rule should not 
need to modify their operations significantly to comply with the final 
rule. For the purpose of our economic analysis, we assume all funds 
with some investments that need to be fair valued under the final rule 
are affected parties.
---------------------------------------------------------------------------

    \524\ The industry reports cited in section II above only 
provide qualitative information on certain aspects of funds' current 
practices. See also supra footnote 419 for a discussion of 
limitations of the Deloitte survey data. Funds have discretion in 
the type of disclosures they provide regarding their fair value 
determinations. As discussed throughout section III.B.2, commenters 
provided descriptions of current practice.
    \525\ Commenters agreed with this view. See, e.g., IDC Comment 
Letter.
---------------------------------------------------------------------------

3. General Discussion of Benefits and Costs of Good Faith 
Determinations of Fair Value
    Overall, the requirements of the final rule provide a framework for 
appropriate oversight of determinations of fair value in good faith. As 
such, the final rule helps the board oversee the fund and helps to 
promote, for example, the mitigation of conflicts of interest of those 
involved in the fair value process and in the management of investments 
and the management of the fund for the benefit of the fund's 
shareholders. Another benefit arising from appropriate oversight of the 
fair value process is that fair value determinations will be more 
likely to reflect a price that could be obtained in arm's length 
transactions with less bias. This will contribute to better measurement 
of the risk and return profile of individual investments and their 
contribution to the risk and return profile of the fund, which will 
help promote the management of the fund in accordance with its 
investment objectives; ensure the accuracy of asset-based and 
performance-based fee calculations; and affect the accuracy of 
disclosures of fund fees, performance, NAV, and portfolio holdings.
    Similarly, as less biased fair value determinations help to ensure 
that a fund's value more accurately reflects the value that a current 
arm's length transaction would produce when purchasing or selling fund 
shares, as well as in cross trades, the final rule aims to provide 
investors their pro rata share of the fund's assets. Thus, proper 
valuation promotes the purchase and sale of fund shares at fair prices, 
and helps to avoid dilution of shareholder interests. Furthermore, 
investors may have stronger assurance that they can rely on valuations 
to express the risk and return profile of a fund, making investors' 
decisions better informed. Thus, investors may be better able to 
evaluate a fund and consider whether a fund fits into their investment 
goals in terms of returns and risk (e.g., ability and willingness to 
bear risk). Improper valuation can cause investors to pay fees that are 
too high or to base their investment decisions on inaccurate 
information.
    Finally, as described in the proposal, the increased specificity of 
the rules could reduce compliance costs for some funds that may expend 
less effort and time to design policies and procedures, reporting, and 
recordkeeping than trying to determine appropriate compliance under the 
statute alone. For funds whose current practices are more burdensome 
than the requirements of the rules, this increased specificity also 
could reduce compliance costs to the extent that funds might be less 
likely to put in place overly burdensome and unnecessary policies and 
procedures, reporting, and recordkeeping to comply with the statute. 
Relatedly, the rules and rescission of existing no-action letters and 
guidance may increase certainty because funds will follow a single rule 
rather than following various no-action letters and guidance when 
determining fair values, which could ultimately reduce compliance 
costs. Conversely, to the extent that the specificity of the 
requirements of the rules prompts some funds or advisers to devote 
greater resources to ensure compliance with their fair value 
obligations, the requirements of the rules may impose greater costs on 
such funds and advisers. Changes in costs of compliance for funds or 
advisers

[[Page 785]]

ultimately could affect fund investors to the extent that any changes 
in costs would be passed down to them in the form of changed fund 
operating expenses.
    In the next section, we discuss the benefits and costs; in a 
subsequent section, we discuss effects on efficiency, competition, and 
capital formation.

D. Benefits and Costs

1. Fair Value as Determined in Good Faith Under Section 2(a)(41) of the 
Act
    Rule 2a-5 sets forth certain required functions that must be 
performed to determine the fair value of the fund's investments in good 
faith. As discussed above,\526\ we are adopting these required 
functions substantially as proposed, with several changes from the 
proposal based on the comments the Commission received. These required 
functions constitute an important part of the framework that the final 
rule establishes and thus contribute to the benefits described in 
section III.C.3 To the extent that a function required by the final 
rule is in line with a fund's current practice, the additional costs 
and benefits described below are likely to be limited with respect to 
the fund.
---------------------------------------------------------------------------

    \526\ See supra section II.A.
---------------------------------------------------------------------------

(a) Periodically Assess and Manage Valuation Risks
    The final rule will require the periodic assessment of any material 
risks associated with the determination of the fair value of the fund's 
investments, including material conflicts of interest, and management 
of those identified valuation risks. The final rule does not specify 
which risks are to be assessed or the frequency of reassessments.\527\ 
As discussed above, many funds or their advisers already periodically 
assess and manage their valuation risks.\528\ Some fund boards may not, 
however, assess such risks for all investments, including, for example, 
those with level 2 inputs.\529\
---------------------------------------------------------------------------

    \527\ See supra section II.A.1.
    \528\ See supra section III.B.2.b).
    \529\ See, e.g., Capital Group Comment Letter; IAA Comment 
Letter.
---------------------------------------------------------------------------

    To the extent that funds or valuation designees do not currently 
assess and manage valuation risks, the final rule will impose both one-
time costs to develop or augment practices that conform to the 
requirements of the final rule as well as ongoing costs associated with 
implementing those practices. Likewise, to the extent that funds 
experience additional costs associated with developing or augmenting 
practices to conform with the requirements of the final rule to assess 
and manage valuation risks, these costs may be less burdensome for 
larger funds that could spread any such costs across a larger amount of 
assets under management. The final rule will, however, provide 
investors the benefit of assurances that mechanisms are in place to 
identify, assess, and manage valuation risks. To the extent that funds 
or valuation designees already assess and manage valuation risks in a 
manner consistent with rule 2a-5, the final rule will not impose any 
additional ongoing costs or present any additional ongoing benefits; 
such funds or valuation designees may have a one-time cost associated 
with reviewing the requirements of the final rule and ensuring that 
their practices conform to the requirements.
(b) Establish and Apply Fair Value Methodologies
(1) Select and Apply Appropriate Fair Value Methodologies
    The final rule will require funds or valuation designees to select 
and apply in a consistent manner appropriate fair value methodologies 
for determining (which includes calculating) the fair value of fund 
investments.\530\ The final rule permits methodologies to be changed 
(so long as the different methodology is equally or more representative 
of the fair value of fund investments) \531\ and does not require funds 
or valuation designees to specify methodologies that will apply to 
anticipated or intended investments. As a matter of course in 
performing fair value determinations, we understand that funds or 
valuation designees currently establish and apply fair value 
methodologies.\532\ Some fund boards may not, however, consistently use 
these methodologies for all investments.
---------------------------------------------------------------------------

    \530\ See supra section II.A.2.
    \531\ See supra footnote 57 and accompanying discussion in 
section II.A.2.a).
    \532\ See supra section III.B.2.
---------------------------------------------------------------------------

    To the extent that funds currently deviate from the requirements of 
the final rule to select and apply in a consistent manner fair value 
methodologies, the final rule will impose additional costs on funds or 
valuation designees. For example, a fund currently may make fair value 
determinations for certain securities, but not clearly select and apply 
the fair value methodology used to do so; under the final rule, the 
fund would have to clearly select and apply that methodology in a 
consistent manner. We recognize that there will be costs for funds that 
do not currently select and apply fair value methodologies in a 
consistent manner for all fund investments without readily available 
market quotations as defined in the final rule. These costs include 
one-time costs to evaluate the requirements of the final rule and make 
changes to practices as well as ongoing additional costs due to 
implementing these changes on an ongoing basis (e.g., determining fair 
value in good faith for assets that rely on level 2 inputs). Likewise, 
to the extent that funds experience additional costs associated with 
developing or augmenting practices to conform to the requirements of 
the final rule to select and apply fair value methodologies in a 
consistent manner, these costs may be less burdensome for larger funds 
that could spread any such costs across a larger amount of assets under 
management.
(2) Periodically Review Appropriateness and Accuracy of Selected 
Methodologies
    The final rule will require the periodic review of the 
appropriateness and accuracy of the valuation methodologies selected. 
The final rule will also require that funds make changes or adjustments 
to existing methodologies where necessary. As discussed above, many 
funds already incorporate such reviews into their current 
practices.\533\ However, some fund boards may not conduct these 
periodic reviews for all methodologies. To the extent that funds 
already periodically engage in such reviews that are currently 
consistent with the final rule, the final rule will not impose any 
additional ongoing costs or present any additional ongoing benefits; 
such funds will have a one-time cost associated with reviewing the 
requirements of the final rule and ensuring that their practices 
conform to the requirements. However, for funds that do not currently 
conduct such reviews, the final rule will impose both one-time costs to 
create practices that conform to the requirements of the final rule as 
well as ongoing costs arising from these new reviews, but will provide 
the benefit of promoting appropriate methodologies and improving the 
governance for such funds.
---------------------------------------------------------------------------

    \533\ See supra section III.B.2.c).
---------------------------------------------------------------------------

(3) Monitor for Circumstances That May Necessitate the Use of Fair 
Value
    The final rule will require that funds or valuation designees 
monitor for circumstances that may necessitate use of fair value.\534\ 
As discussed above, this monitoring is common in practice,\535\

[[Page 786]]

though some fund boards may not monitor for such circumstances with 
respect to all fund investments.\536\ To the extent that funds already 
engage in such monitoring, the final rule will not impose any 
additional ongoing costs or present any additional ongoing benefits; 
such funds may have a one-time cost associated with reviewing the 
requirements of the final rule and ensuring that their practices 
conform to the requirements. However, for funds that did not previously 
conduct such monitoring, the final rule will impose both one-time costs 
to create practices that conform to the requirements of the final rule 
as well as ongoing costs of monitoring, but will provide the benefit of 
ensuring that investments for which market quotations become unreliable 
will have fair value determined for them. Likewise, to the extent that 
funds bear additional costs associated with developing or augmenting 
practices to conform to the requirements of the final rule to monitor 
for circumstances that may necessitate the use of fair value, these 
costs may be less burdensome for larger funds that could spread any 
such costs across a larger amount of assets under management.
---------------------------------------------------------------------------

    \534\ See supra section II.A.2.c).
    \535\ See supra section III.B.2.c).
    \536\ See, e.g., ABA Comment Letter; IAA Comment Letter; Scheidt 
Comment Letter 1 (stating that ``funds are required to adopt 
policies and procedures that require monitoring for circumstances 
that may necessitate the use of fair value prices'' under the 
compliance rule); SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

(c) Test Fair Value Methodologies for Appropriateness and Accuracy
    The final rule will require that the board or valuation designee, 
as applicable, test the appropriateness and accuracy of the fair value 
methodologies that have been selected, including by identifying testing 
methods to be used and determining the minimum frequency with which 
such testing methods are used.\537\ As discussed above, this practice 
is common.\538\ Some funds may not, however, currently conduct this 
type of testing or apply these testing methods as the final rule 
requires with respect to all fund investments. To the extent that funds 
already engage in such testing, the final rule will not impose any 
additional ongoing costs or present any additional ongoing benefits; 
such funds may have a one-time cost associated with reviewing the 
requirements of the final rule and ensuring that their practices 
conform to the requirements. However, for funds that did not previously 
conduct such testing or conducted testing in a manner that differs from 
the requirements of the final rule, the final rule will impose both 
one-time costs to create practices that conform to the requirements of 
the final rule as well as ongoing costs associated with testing of fair 
value methodologies. Likewise, to the extent that funds bear additional 
costs associated with developing or augmenting practices to conform to 
the requirements of the final rule to test fair value methodologies for 
appropriateness and accuracy, these costs may be less burdensome for 
larger funds that could spread any such costs across a larger amount of 
assets under management.
---------------------------------------------------------------------------

    \537\ See supra section II.A.3.
    \538\ See supra section III.B.2.d).
---------------------------------------------------------------------------

    One commenter noted specifically that ``requirements around back 
testing, calibration, transparency and evaluation of inputs may require 
valuation designees to develop additional data science capabilities to 
analyze valuation data and perform necessary testing.'' \539\ We 
recognize that, to the extent that the board or valuation designee, as 
applicable, determines that tests for which the board or valuation 
designee does not currently have capabilities should be performed, 
there will be costs attendant to the development or acquisition of 
these capabilities. However, these costs may be mitigated for a number 
of reasons. First, not all boards or valuation designees, as 
applicable, will need to perform such tests. For example, as noted 
above, while we continue to believe that calibration and back-testing 
can be particularly useful testing methods, the final rule does not 
require that calibration and back-testing be performed, nor does it 
preclude boards or valuation designees, where applicable, from using 
other appropriate testing methods on fair value methodologies.\540\ 
Second, experience in back-testing, calibration, and evaluation of 
inputs is common in the industry.\541\ Relatedly, special data science 
capabilities are not required for standard testing techniques that have 
been common for decades. As such, there is unlikely to be a need to 
develop additional capabilities for all funds.
---------------------------------------------------------------------------

    \539\ See SIFMA AMG Comment Letter.
    \540\ See supra section II.A.2.b) and section II.A.3.
    \541\ See supra section III.B.2.d).
---------------------------------------------------------------------------

(d) Pricing Services
    The final rule provides that determining fair value in good faith 
requires the oversight and evaluation of pricing services, where used. 
The final rule will require that, where funds or valuation designees 
engage a pricing service, the fund or valuation designee establish a 
process for approvals, monitoring, and evaluation of each pricing 
service.\542\ Funds or valuation designees, as applicable, must 
establish a process for price challenges. As discussed above, it is 
common practice for funds or valuation designees to evaluate and 
monitor pricing services and to challenge prices from pricing 
services.\543\ The Commission has previously stated that technical 
assistance by non-directors must be carefully reviewed by the 
directors.\544\ Valuation designees (including, for example, small 
advisers) may not, however, currently have the exact processes for 
monitoring and evaluating pricing services prescribed by the final 
rule.
---------------------------------------------------------------------------

    \542\ See supra section II.A.4.
    \543\ See supra section III.B.2.f).
    \544\ See Proposing Release, supra footnote 2, at n.16; ASR 118.
---------------------------------------------------------------------------

    To the extent that funds already have a process for the approval, 
monitoring, and evaluation of pricing services in the precise manner 
prescribed by the final rule, the final rule will not impose any 
additional ongoing costs or present any additional ongoing benefits; 
such funds may have a one-time cost associated with reviewing the 
requirements of the final rule and ensuring that their processes 
conform to the requirements. Likewise, to the extent that funds bear 
additional costs associated with developing or augmenting practices to 
conform to the requirements of the final rule to oversee and evaluate 
pricing services, these costs may be less burdensome for larger funds 
that could spread any such costs across a larger amount of assets under 
management.
    The requirement to establish a process for price challenges will 
impose some burdens on some funds or valuation designees. To the extent 
that funds already have processes for price challenges, the final rule 
will not impose any additional ongoing costs or present any additional 
ongoing benefits; such funds will have a one-time cost associated with 
reviewing the requirements of the final rule and ensuring that their 
practices conform to the requirements. However, for funds that did not 
previously establish such processes, the final rule will impose both 
one-time costs to create practices that conform to the requirements of 
the final rule as well as ongoing costs, such as implementation of 
these processes. The final rule will also provide the benefit of 
oversight of price challenges that should mitigate conflicts of 
interest between shareholders and valuation designees to the extent 
that such conflicts exist. For example, the final rule should mitigate 
conflicts of interest where valuation designees may

[[Page 787]]

otherwise engage in price challenges that distort determinations of 
fair value in order to increase their compensation or make their 
performance appear to be better than it otherwise would.
(e) Fair Value Policies and Procedures
    In connection with the final rule, and as discussed above, to 
comply with the compliance rule, each fund must adopt and implement 
written policies and procedures that are reasonably designed to prevent 
violations of the final rule. To comply with the compliance rule, these 
fair value policies and procedures must be tailored to the final rule's 
requirements. \545\ A fund may rely on an adviser's policies, which 
should eliminate duplication and mitigate costs. In a change from the 
proposed rule, the final rule does not have an explicit requirement to 
adopt written policies and procedures as this is already required by 
the compliance rule. As discussed above, funds must adopt and implement 
written policies and procedures for fair value determinations under the 
compliance rule, so all funds must maintain written fair value policies 
and procedures.\546\ To the extent that funds already maintain written 
fair value policies and procedures that are aligned with reasonably 
preventing violations of the requirements of the final rule, the final 
rule will not impose any additional ongoing costs or present any 
additional ongoing benefits; such funds will have a one-time cost 
associated with reviewing the requirements of the final rule and 
conforming their policies and procedures accordingly. Likewise, to the 
extent that funds bear additional costs associated with changes to 
policies and procedures to conform to the requirements of the final 
rule, these costs may be less burdensome for larger funds that could 
spread any such costs across a larger amount of assets under 
management.
---------------------------------------------------------------------------

    \545\ See supra section II.A.5.
    \546\ See supra section III.B.2.
---------------------------------------------------------------------------

2. Performance of Fair Value Determinations
    As discussed above,\547\ the final rule will permit the board to 
carry out all of the fair value functions required in paragraph (a) of 
the final rule or to designate the fund's adviser or an officer or 
officers of the fund to perform fair value determinations relating to 
any or all fund investments, subject to the board's appropriate 
oversight. Boards may only designate to these valuation designees, 
though the trustee or depositor will perform the fair value functions 
in paragraph (a) of the final rule for UITs, which do not have a board 
or adviser.
---------------------------------------------------------------------------

    \547\ See supra section II.B.
---------------------------------------------------------------------------

    A number of commenters suggested that the costs of rule 2a-5 as 
proposed would be significant for UITs, particularly for pre-existing 
ones,\548\ as valuations for UITs are generally performed by parties 
other than trustees. We believe that the universe of existing UITs that 
will be relying upon this provision will be small, as we believe that 
(1) the insurance company (acting as depositor) generally provides 
valuation services for separate accounts formed as UITs, (2) similarly, 
ETF UITs typically utilize the trustee for valuation services, and 
generally hold investments that have readily available market 
quotations, and (3) other UITs often already use a trustee or depositor 
to perform valuation and, to the extent otherwise, generally have a 
short, fixed-term existence.
---------------------------------------------------------------------------

    \548\ See, e.g., AAM Comment Letter; Chapman Comment Letter; 
First Trust Comment Letter; Hennion & Walsh Comment Letter.
---------------------------------------------------------------------------

    As discussed above, funds commonly engage advisers to assist them 
in performing fair value determinations, and the Commission has stated 
that the board need not itself perform each of the specific tasks 
required to calculate fair value in order to perform its role under 
section 2(a)(41).\549\ To the extent that funds' practices conform 
precisely to what is required under the final rule, the final rule will 
not impose any additional ongoing costs or present any additional 
ongoing benefits; such funds may have a one-time cost associated with 
reviewing the requirements of the final rule and ensuring that their 
practices conform to the requirements. However, for boards that did not 
previously engage valuation designees to assist in performing fair 
value determinations, the final rule permits a board to leverage the 
expertise of valuation designees with deeper and more specialized 
experience to conduct fair value determinations. Doing so will come 
with a cost, but will also come with the benefit of permitting the 
fund's board to focus on providing appropriate oversight under the 
final rule.
---------------------------------------------------------------------------

    \549\ See supra section III.B.2.a).
---------------------------------------------------------------------------

    Explicitly allowing boards to designate a valuation designee to 
perform fair value determinations allows boards to allocate the fair 
value responsibilities to that party, and thus could free board 
resources tied to valuation and redirect them to oversight or other 
matters in which board action may be more valuable.\550\ The final rule 
will have larger effects on any boards that choose, under the final 
rule, to designate a valuation designee.
---------------------------------------------------------------------------

    \550\ While this benefit will accrue to internally managed funds 
that will now similarly be permitted to designate to an officer or 
officer of the fund, it will not accrue to UITs because they do not 
have boards that may designate. Under the final rule the trustees or 
depositors of UITs (or other entities designated in the 
documentation of existing UITs) will carry out the requirements of 
the final rule. See final rule 2a-5(d). However, see, e.g., Capital 
Group Comment Letter and American Funds Comment Letter, in which 
commenters characterized the proposed rule as prescriptive, 
requiring boards to be involved ``in the weeds'' and distracted by 
``voluminous reports'' rather than freeing up board resources and 
effectively focusing the board on oversight. Changes to the rules 
reduce the prescriptiveness compared to the proposed rule. See supra 
section II.B.2.
---------------------------------------------------------------------------

    For a fund whose board designates the fund's adviser to perform 
fair value determinations, one-time costs associated with reviewing the 
final rule to ensure that practices conform to requirements of the 
final rule may be borne by the adviser, the fund, or both, depending on 
the fund's governing documentation or advisory agreements, and could be 
ultimately passed through to the fund's shareholders in the form of 
higher management fees or other expenses in the future.\551\ For funds 
whose boards determine the fair values themselves, these costs will be 
borne by the fund, and those one-time costs, if any, could be 
ultimately passed through to the fund's shareholders in the form of 
higher operating expenses.
---------------------------------------------------------------------------

    \551\ See Capital Group Comment Letter; Guggenheim Trustees 
Comment Letter.
---------------------------------------------------------------------------

    Relatedly, to the extent that an adviser to the fund is designated 
to perform fair value determinations that it is not currently 
performing, depending on the fund's governing documentation or advisory 
agreements, such an adviser or the fund may incur ongoing costs to 
satisfy its new fair value obligations. Similarly, to the extent that 
an officer of the fund performs the fair value determinations, the fund 
itself could directly incur higher ongoing costs, if any higher costs 
occur, though it would also benefit from improved governance of the 
fair value process. Those costs and benefits will be attributable to 
adopting and implementing assessment and testing practices, 
methodologies, reporting, and recordkeeping to ensure compliance with 
the rules' requirements. The magnitude of those costs and benefits will 
depend on how funds' or their advisers' current practices compare to 
the requirements of the rules. To the extent that advisers currently 
engage in the fair value process as permitted by the final rule and in 
accordance with its requirements (and thus currently incorporate the 
costs of doing so in their compensation), additional ongoing costs 
(including the extent to which any costs are passed on

[[Page 788]]

to fund investors) and benefits are likely to be limited.
    Similarly, to the extent that an officer of the fund currently 
performs fair value determinations in accordance with the requirements 
of the final rule and is already compensated for such duties and 
responsibilities, such an officer is unlikely to demand higher wages. A 
valuation designee designated by the board to perform fair value 
determinations relating to any or all fund investments will, as 
discussed above, also be subject to appropriate oversight, including 
through board reporting.\552\
---------------------------------------------------------------------------

    \552\ See supra section II.B. See also supra footnote 141 
(discussing the change to permit designation to officers of 
internally managed funds).
---------------------------------------------------------------------------

    We discuss the costs and benefits of this oversight and reporting 
below. The elements of oversight and reporting constitute an important 
part of the framework that the final rule establishes and thus 
contribute to the benefits described in section III.C.3. To the extent 
that a requirement of the final rule is in line with a fund's current 
practice, additional costs and benefits are likely to be limited with 
respect to the fund.
(a) Board Oversight
    As discussed above, the final rule, similar to the proposed rule, 
will require a board to oversee any valuation designee designated to 
perform fair value determinations.\553\ Also, as discussed above, it is 
a common practice that boards provide oversight of valuation designees 
engaged to perform fair value determinations.\554\ Because boards 
already provide oversight of valuation designees engaged to perform 
fair value determinations, the final rule is not likely to impose any 
additional ongoing costs or present any additional ongoing benefits; 
such funds will have a one-time cost associated with reviewing the 
requirements of the final rule and ensuring that their practices 
conform to the requirements. There may, however, be some boards that, 
in exercising their oversight obligations, currently undertake to 
perform more tasks than will be required by the final rule, including, 
for example, the ratification of specific fund fair values daily or 
periodically. To the extent that these boards choose to cease these 
practices, this could result in a reduction in benefits that are 
associated with a board undertaking these additional duties as well as 
a reduction in any associated costs. Such a change in oversight 
practice may reduce the costs of boards' resources spent on such day-
to-day involvement and provide the benefit of directing those resources 
to more productive and critical areas of board oversight of the fair 
value process or to other oversight obligations that the board has with 
respect to the fund.
---------------------------------------------------------------------------

    \553\ See supra section II.B.1.
    \554\ See supra section III.B.2.
---------------------------------------------------------------------------

    To the extent that certain funds' fair value practices currently 
are less thorough than those required under the final rule the final 
rule could decrease the likelihood that fund investments are 
inappropriately fair valued.\555\ This is because, for these funds, the 
final rule should create a more robust valuation framework to address 
conflicts of interest of the valuation designee, which could result in 
less biased determinations of asset valuations. Nevertheless, the final 
rule's effect on mitigating conflicts of interest and on the accuracy 
of fair value determinations may be limited, as it is our understanding 
that many funds currently have in place fair value practices that are 
similar to the requirements of the final rule and that boards oversee 
the valuation designee's assistance with fair value calculations, 
including the role of pricing services in the fair value process.\556\
---------------------------------------------------------------------------

    \555\ See supra section III.C.1 for a discussion related to 
advisers' conflicts of interest.
    \556\ See supra section III.B.2. These costs and benefits are 
similar for internally managed funds seeking to designate to an 
officer or officers under the final rule.
---------------------------------------------------------------------------

    In addition, under the final rule, if the fund is a UIT, the fund's 
trustee or depositor must carry out the fair value determinations.\557\ 
Hence, UITs will not bear any costs associated with oversight and 
reporting. We expect the effects of all other aspects of the final rule 
to be similar for UITs and other funds.
---------------------------------------------------------------------------

    \557\ See final rule 2a-5(d).
---------------------------------------------------------------------------

    We believe that funds' incremental ongoing costs associated with 
this aspect of the final rule will be limited to the extent that boards 
or funds currently engage in appropriate oversight of a valuation 
designee's assistance with fair value calculations and that boards 
currently review periodic and ad-hoc reports related to fair value 
determinations prepared by the fund's valuation designee in a manner 
and to an extent consistent with the requirements of the final 
rule.\558\ Commenters stated that boards lack the expertise and 
resources to perform fair value determinations in good faith \559\ and 
that few boards perform this function themselves.\560\ Hence, we 
believe that incremental ongoing costs on boards and fund investors 
compared to the ongoing costs under current practices will be limited 
to the extent that boards are already performing appropriate oversight 
in a manner and to an extent consistent with the final rule.\561\ We 
acknowledge, however, that to the extent boards' current oversight of 
valuation designees' fair value calculations and boards' current 
practices with respect to review of valuation reports are inconsistent 
with appropriate oversight as discussed above,\562\ funds may bear 
higher additional ongoing costs to comply with the final rule.
---------------------------------------------------------------------------

    \558\ As discussed above, the final rule has been made less 
prescriptive than the proposed rule, thus narrowing the gap between 
practice and the requirements.
    \559\ See, e.g., ABA Comment Letter; JPMAM Comment Letter; NYC 
Bar Comment Letter.
    \560\ See, e.g., ABA Comment Letter; Baillie Gifford Comment 
Letter; Fidelity Comment Letter; IAA Comment Letter; MFS Comment 
Letter.
    \561\ We do not believe that the final rule will result in cost 
savings associated with boards' involvement in the determination of 
fair values because we believe that boards will reallocate time and 
attention to overseeing the valuation designee's fair value 
determinations or other activities unrelated to fair valuing fund 
investments.
    \562\ See supra section II.B.
---------------------------------------------------------------------------

(b) Board Reporting
    The final rule will require the valuation designee to provide 
periodic reports and prompt notification of matters that materially 
affect the fair value of the designated portfolio of investments.\563\ 
For funds whose boards will designate valuation designees to perform 
fair value determinations, the final rule could impose additional 
ongoing costs associated with boards' appropriate oversight of the 
valuation designee's fair value determinations and review of board 
reports. Some commenters suggested the ongoing costs of reporting would 
be high, due in part to ``substantially more information'' being 
provided to boards prompted by the proposed rule, and would provide 
little or no benefit.\564\ In response to these commenters, the final 
rule contains certain changes to the proposed board reporting 
requirements designed to, among other things, reduce the chance that 
boards receive reporting that is too detailed or repetitive.\565\ We 
discuss the costs and benefits of these periodic and prompt reporting 
requirements below.
---------------------------------------------------------------------------

    \563\ See supra section II.B.2.
    \564\ See, e.g., American Funds Comment Letter; Capital Group 
Letter; Dechert Comment Letter; Guggenheim Comment Letter; ICI 
Comment Letter; SIFMA AMG Comment Letter.
    \565\ See supra text accompanying footnote 229.
---------------------------------------------------------------------------

(1) Periodic Reporting
    The final rule, like the proposed rule, will require that certain 
reporting be provided to the board on a quarterly basis and certain 
reporting on an annual

[[Page 789]]

basis.\566\ As discussed above, periodic reporting to boards on matters 
of fair value determination is common practice.\567\ Currently, the 
board may not receive quarterly or annual reports, and may receive more 
or less frequent reporting depending on the type of fund investments 
and the market conditions.
---------------------------------------------------------------------------

    \566\ See supra section II.B.2.a).
    \567\ See supra section III.B.2.g).
---------------------------------------------------------------------------

    Funds will have a one-time cost associated with reviewing the 
requirements of the final rule and ensuring that their practices 
conform to the requirements. To the extent that boards do not receive 
periodic reporting that conforms to the requirements of the final rule, 
the final rule will impose additional ongoing costs to valuation 
designees, such as providing additional reports or more frequent 
reports as required by the final rule or reports of different 
information. Similarly, the boards of these entities will incur ongoing 
costs related to reviewing such reports. The final rule's requirement 
to assess the adequacy and effectiveness on an annual basis will, for 
example, to the extent that a valuation designee does not do so on an 
annual basis, increase a valuation designee's costs as well as the 
board's costs of reviewing such reports. Further, the final rule's 
requirement that quarterly reports include material changes in 
assessment or management of valuation risks will, to the extent that a 
valuation designee does not report material changes in assessment or 
management of valuation risks or does not do so on a quarterly basis, 
increase a valuation designee's costs as well as the board's costs of 
reviewing such reports. The final rule's requirement for a summary of 
testing results and assessment of adequacy of resources on an annual 
basis will, to the extent that a valuation designee does not report 
testing results or an assessment of adequacy of resources or does not 
do so on an annual basis, increase their costs as well as the board's 
costs of reviewing such reports. In addition, to the extent that these 
reporting requirements increase the volume of information that boards 
must review, board members may seek higher fees or may devote less time 
to other issues, which may impact the general effectiveness of the 
board. Furthermore, to the extent that the board consults outside 
counsel or other experts, such as accountants, with respect to such 
reporting, there may be additional external expenses incurred. These 
costs could be passed on to investors. However, to the extent that the 
requirement of the final rule for periodic reporting aligns with a 
fund's current practice, this requirement of the final rule may impose 
additional costs or contribute additional benefits of improved board 
oversight of the fair value process.
    Certain funds might put in place reporting procedures to comply 
with the final rule that are more costly than those funds' current 
practices, while other funds might set up reporting as a result of the 
final rule that will result in lower ongoing costs than the costs of 
current practice. We acknowledge that funds whose reporting is less 
costly than that required under the final rule will bear additional 
ongoing costs under the final rule.
(2) Prompt Board Notification
    The final rule will require the valuation designee to provide a 
written notification of the occurrence of material matters, including 
significant deficiencies or material weaknesses in the design or 
effectiveness of the valuation designee's fair value determination 
process or material errors in the calculation of net asset value. This 
notification must take place within a time period determined by the 
board, but in no event later than five business days after the 
valuation designee becomes aware of the material matter. The valuation 
designee must also provide such timely follow-on reports as the board 
may reasonably determine are appropriate. As discussed above, it is 
common practice to require that certain matters be reported promptly to 
the board, though the content and frequency of current ad hoc reporting 
to boards may vary depending on the type of fund and fund investments.
    To the extent that funds do not already provide boards with prompt 
reporting on matters as required in the final rule, the final rule will 
impose additional ongoing costs such as preparing reports more quickly 
or more often than waiting for routine reporting. Specifically, the 
final rule requires written notification of the occurrence of material 
matters in no event later than five business days after the valuation 
designee becomes aware. This will impose costs on valuation designees, 
including costs of diverting or expending additional resources, to meet 
the required timeline. In addition, the final rule's definition of 
material matters may include matters for which some boards do not 
currently receive reports, which could impose additional burdens on 
valuation designees producing additional reports and on boards' time 
and attention and related external costs. The requirement to provide 
such timely follow-on reports as the board may reasonably determine are 
appropriate may impose similar costs to the extent boards do not 
receive such reporting already. Also, funds and valuation designees may 
have a one-time cost associated with reviewing the requirements of the 
final rule and conforming their practices to the requirements.
    Overall, as discussed previously, the changes to the reporting 
requirements of the final rule reduce the burden and cost of required 
prompt board reporting under the final rule compared to the 
requirements of the proposed rule. Valuation designees will have 
relatively reduced reporting burdens and the relatively reduced 
reporting to the board will permit the board to more effectively and 
more efficiently focus on its oversight role.
(c) Specification of Functions and Reasonable Segregation From 
Portfolio Management
    The final rule, like the proposed rule, will require that the 
valuation designee (a) specify the titles of the persons responsible 
for determining the fair value of designated investments, including by 
specifying the particular functions for which they are responsible, and 
(b) reasonably segregate portfolio management from fair value 
determinations.\568\ As discussed above, similar practices are common 
among advisers performing fair value determinations.\569\
---------------------------------------------------------------------------

    \568\ See supra section II.B.3.
    \569\ See supra section III.B.2.e).
---------------------------------------------------------------------------

    To the extent that funds do not already specify functions as 
required in the final rule, the final rule will impose additional 
ongoing costs, such as reviewing and specifying functions in accordance 
with the final rule. Specifically, the requirement to specify the 
titles of the persons responsible for determining the fair value of the 
designated investments, including by particular function and as related 
to price challenges, may impose costs, including those related to 
identifying clearly those responsible for price challenges to the 
extent funds do not do so already. In addition, the final rule's 
requirement for the valuation designee to segregate fair value 
determinations from the portfolio management of the fund reasonably 
will impose costs to the extent that such reasonable segregation 
results in a decrease in quality or quantity of information provided by 
portfolio managers or an increase in staffing to ensure compliance with 
the final rule. Costs will vary, based in part on whether a fund 
establishes new processes to institute this requirement, which could 
include independent

[[Page 790]]

reporting chains, oversight arrangements, or separate monitoring 
systems and personnel. All funds subject to this requirement may have a 
one-time cost associated with reviewing the requirements of the final 
rule and ensuring that their practices conform to the requirements.
    Whenever the fund's adviser is designated to perform fair value 
determinations, the requirement to segregate fair value determinations 
from portfolio management reasonably may be more costly for smaller 
advisers, and smaller internally managed funds, with limited resources 
and personnel, than for larger ones. The reason is that smaller 
advisers, and smaller internally managed funds, may lack the staff and 
resources to segregate portfolio management personnel from those making 
fair value determinations reasonably as efficiently as larger advisers, 
and internally managed funds, or may only be able to meet this 
requirement by hiring additional personnel. As such, the reasonable 
segregation requirement of the final rule allows a fund to make 
decisions about tradeoffs it faces (e.g., costs, benefits, risks) in 
the context of the specific facts and circumstances of the fund.
    Finally, to the extent that the board designates the valuation 
designees to perform the fair value determinations relating to any or 
all of fund investments, the final rule will provide the valuation 
designee--which has conflicting interests--a greater permissible role 
in fair value determinations relative to current practices.\570\ 
Nevertheless, we believe that any impact from such conflicts may be 
mitigated because the final rule contains explicit requirements related 
to the identification, assessment, and management of any material 
conflicts of interest of the valuation designee as well as the 
requirement to reasonably segregate the valuation designee's fair value 
determinations from portfolio management, and most funds currently have 
in place policies to manage conflicts of interest of valuation 
designees that may not be valuation specific.
---------------------------------------------------------------------------

    \570\ See supra section II.B.3 for a discussion related to 
advisers' conflicts of interest.
---------------------------------------------------------------------------

    One commenter stated that the proposed rule lacked clarity as to 
which individuals are required to be identified and stated that 
``little appears to be gained by the mechanical exercise'' of naming 
individuals and their titles, which may be generic, and identifying 
with specificity their roles in the valuation function.\571\ As 
discussed more extensively above, we disagree with the commenter 
because this requirement in the final rule cannot be satisfied by 
simply listing the generic titles of those involved in valuation.\572\ 
As a result, this requirement may result in costs, as described above, 
but also benefits resulting from the improved oversight and 
accountability which would not be provided by listing generic titles.
---------------------------------------------------------------------------

    \571\ See Sullivan Comment Letter.
    \572\ See supra footnote 288 and accompanying discussion.
---------------------------------------------------------------------------

3. Recordkeeping
    Rule 31a-4 will require that a fund or designated adviser maintain 
appropriate documentation to support fair value determinations.\573\ As 
discussed above, maintenance of such documentation is a common 
practice.\574\ Some funds may not, however, maintain these records for 
all investments. For example, a fund may not maintain records for which 
the board relies on pricing services and investments with level 2 
inputs as required under rule 31a-4.\575\
---------------------------------------------------------------------------

    \573\ See supra section II.C.
    \574\ See supra section III.B.2.h).
    \575\ See supra section III.B.2.h).
---------------------------------------------------------------------------

    Some commenters stated that the recordkeeping requirements 
associated with rule 2a-5 as proposed would represent a significant 
change from current practice and would entail additional costs.\576\ 
Funds will have a one-time cost associated with reviewing the 
requirements of rule 31a-4 and ensuring that their practices conform to 
the requirements. To the extent that funds do not already maintain 
documentation to support fair value determinations that conforms to 
rule 31a-4, it will impose additional ongoing costs, including costs 
associated with updating documentation as practices change and evolve 
and maintaining records for six years. Certain funds or advisers might 
put in place recordkeeping practices to comply with rule 31a-4 that are 
more costly than the funds' or advisers' current practices, while other 
funds or advisers might set up recordkeeping practices as a result of 
rule 31a-4 that will result in lower ongoing costs than the costs of 
current practice. We continue to believe that funds' or advisers' 
incremental ongoing costs associated with rule 31a-4 will, however, be 
limited to the extent that, as discussed in section II.C above, funds 
or advisers currently have in place recordkeeping practices associated 
with fair value determinations that are similar to rule 31a-4's 
requirements.\577\
---------------------------------------------------------------------------

    \576\ See, e.g., Baillie Gifford Comment Letter; Capital Group 
Comment Letter; ICE Data Comment Letter; ICI Comment Letter; MFS 
Comment Letter; SSGA Comment Letter; TRC Comment Letter; Vanguard 
Comment Letter. See also supra footnotes 310 and 311 and 
accompanying discussion.
    \577\ As discussed above, the final rule has been made less 
prescriptive than the proposed rule, thus narrowing the gap between 
practice and the requirements.
---------------------------------------------------------------------------

    Some commenters suggested that the time and resources required in 
order to comply with the recordkeeping requirements would be higher 
than stated in the proposal, but without providing estimates.\578\ 
While recordkeeping costs may be higher than estimated for some funds, 
to the extent that a fund's current recordkeeping practices are similar 
to the requirements of rule 31a-4, a fund will incur minimal additional 
ongoing costs. Likewise, to the extent that a fund's recordkeeping 
practices fail to meet the requirements of rule 31a-4, a fund will 
incur higher ongoing costs.
---------------------------------------------------------------------------

    \578\ See John Hancock Comment Letter; SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

    Maintaining certain documentation to support fair value 
determinations is an important element of the oversight framework that 
rule 2a-5 establishes and thus contributes to the benefits described in 
section III.C.3.\579\ To the extent that rule 31a-4's requirements are 
in line with a fund's current practice, additional costs and benefits 
are likely to be limited.
---------------------------------------------------------------------------

    \579\ See supra section III.C.3.
---------------------------------------------------------------------------

4. Readily Available Market Quotations
    The final rule defines a market quotation as readily available only 
when that ``quotation is a quoted price (unadjusted) in active markets 
for identical investments that the fund can access at the measurement 
date, provided that a quotation will not be readily available if it is 
not reliable.'' This definition will apply in all contexts under the 
Investment Company Act and the rules thereunder, including rule 17a-
7.\580\
---------------------------------------------------------------------------

    \580\ See supra section II.D.
---------------------------------------------------------------------------

    To the extent that funds currently consider some or all investments 
valued with level 2 inputs as investments with readily available market 
quotations, funds will incur costs related to fair valuing these 
investments. Specifically, if a fund currently treats certain 
investments valued with level 2 inputs as having readily available 
market quotations,\581\ the fund will likely experience additional 
costs associated with the application of fair value practices and 
requirements of the final rule to those investments, as discussed 
above. For example, if such a fund currently views a level 2 input or 
the product of level 2 inputs for some

[[Page 791]]

securities as readily available market quotations, the fund will need 
to subject those securities to the fair value process. Depending on the 
fund's practices, this may merely mean documenting the due diligence it 
already performs; however, if the fund does not perform due diligence, 
then it will have to establish procedures to do so and document such 
due diligence. These costs could be passed on to investors. To the 
extent that the final rule reflects current industry practice (e.g., 
properly fair valuing such securities and board reporting), there will 
be fewer, if any, additional costs or benefits arising from the 
definition in the final rule. As mentioned above, funds will incur one-
time costs of reviewing the final rule and ensuring that practices 
conform to the final rule.\582\
---------------------------------------------------------------------------

    \581\ See, e.g., Capital Group Comment Letter; IAA Comment 
Letter.
    \582\ See supra section III.D.2.b) and section III.D.3.
---------------------------------------------------------------------------

    The final rule's definition of readily available market quotations 
may also impose costs on funds that currently cross trade securities 
not captured by the definition. The application of this definition may 
result in funds that had previously viewed certain securities as having 
readily available market quotations, and thus eligible for cross trades 
under rule 17a-7, to re-evaluate practices for trading those securities 
or change their practices for trading those securities. This re-
evaluation will impose costs on those funds and may result in those 
funds having a more restricted set of securities being available for 
cross trades than they had previously viewed as being available for 
cross trades.
    Depending on the reasons for trading, cross trading may impact fund 
investors both positively and negatively. First, cross trading allows 
both trading funds to avoid commissions or other transaction costs that 
would otherwise be borne in a market transaction. Second, cross trading 
can allow a fund facing liquidity constraints to avoid depressed or 
fire-sale prices when it is selling an asset for which market prices 
would otherwise be depressed. However, since these transactions are not 
market transactions and can be affected by conflicts of interest, rule 
17a-7 requires securities to have readily available market quotations 
to serve as an independent basis, and the ``prices'' at which cross 
trades execute are set internally based on the requirements of rule 
17a-7.The final rule, by defining readily available market quotations, 
further mitigates the risk that one fund will ``subsidize'' another 
fund through cross trading of assets with more subjective values.\583\
---------------------------------------------------------------------------

    \583\ See Alexander Eisele, Tamara Nefedova, Gianpaolo Parise, & 
Kim Peijnenburg, Trading out of sight: An analysis of cross-trading 
in mutual fund families, 135 J. Fin. Econ. 359 (2020) (``Eisele et 
al. 2020''), which provides evidence of strategic reallocation of 
performance among sibling funds; and Gerald Abdesaken, Conflicts of 
interest in multi-fund management, 20 J. Asset Mgmt. 54 (2019) 
(``Abdesaken 2019''), which provides evidence of conflicts of 
interest among asset managers that simultaneously manage multiple 
mutual funds.
---------------------------------------------------------------------------

    Funds may also bear the cost of going to market for trades that 
otherwise would have been implemented via a cross trade if the 
securities in question lack readily available market quotations. Such 
costs include transaction costs (such as bid-ask spreads or 
commissions) and search costs for hard-to-find securities. Based on the 
estimates presented in Table 2, approximately 33% of fund assets are 
fair valued with level 2 or level 3 inputs. However, we lack detailed 
data on funds' engagement in cross trading in such securities to 
estimate what fraction of this subset will be affected by the 
definition of readily available market quotation.\584\ Likewise, we 
lack detailed data to estimate the transactions and other costs that a 
fund might incur if forced to go to the market for transactions that 
otherwise would have been executed with a cross trade. The final rule 
will have a larger effect on funds for which a larger percentage of 
their investments does not have readily available market quotations 
because those funds will be required to determine the fair value of a 
larger percentage of their investments.
---------------------------------------------------------------------------

    \584\ Approximately 28% of funds reported relying on 17a-7 for 
cross trades, but we cannot determine to what extent reliance on 
17a-7 is limited to investments meeting the definition under the 
final rule of having readily available market quotations. See supra 
section III.B.3.
---------------------------------------------------------------------------

    As discussed above, commenters were concerned about requirements in 
the proposed rule to maintain records of specific methodologies, 
assumptions, and inputs for determining fair values, in particular for 
investments valued with level 2 inputs.\585\ Commenters stated that the 
definition of readily available market quotations would effectively 
prompt funds to treat all investments valued with level 2 inputs as not 
having readily available market quotations.\586\ Many suggested, in 
particular, that applying the proposed recordkeeping provisions to 
investments valued with level 2 inputs is not necessary and would 
impose additional costs.\587\ To the extent that some funds currently 
treat some investments relying on level 2 inputs as having readily 
available market quotations, those funds will face higher costs 
associated with determining the fair value of those investments in good 
faith as required by the final rule. These costs could include 
compliance costs (e.g., updating procedures for fair value 
determinations) or devoting greater resources to conduct due diligence 
of pricing services. As discussed above,\588\ commenters described 
varying recordkeeping practices for investments relying on level 2 
inputs, including documenting the due diligence and oversight of 
pricing services and maintaining prices received from a pricing 
service. To the extent that a fund's practices with respect to 
investments relying on level 2 inputs conform to the final rules, a 
fund will face few, if any, additional ongoing costs.
---------------------------------------------------------------------------

    \585\ See supra section II.C.
    \586\ See, e.g., AIMA Comment Letter; American Bankers 
Association Comment Letter; American Funds Comment Letter; Baillie 
Gifford Comment Letter; Capital Group Comment Letter; Dechert 
Comment Letter; Guggenheim Comment Letter; IAA Comment Letter; ICE 
Data Comment Letter; ICI Comment Letter; IDC Comment Letter; SIFMA 
AMG Comment Letter; SSGA Comment Letter; TRC Comment Letter; 
Vanguard Comment Letter.
    \587\ See, e.g., Capital Group Comment Letter; SIFMA AMG Comment 
Letter.
    \588\ See supra section II.C and section III.B.2.h).
---------------------------------------------------------------------------

    One commenter also stated that ``challenges associated with the 
proposed rule's definition of `readily available market quotations' '' 
could discourage purchases of certain investments, particularly for 
smaller firms.\589\ Another commenter expressed a similar concern about 
the definition and the costs of the proposed rule's requirements for 
establishing methodologies, inputs, and assumptions for prices provided 
by pricing services.\590\ As discussed above, we agree that there will 
be additional costs for funds that currently treat investments that 
rely on level 2 inputs as having readily available market quotations. 
While there is a potential risk that initial purchases of certain 
investments may be discouraged, the commenter's concern with the 
``rigidity of the proposed rule,'' which required the specification of 
methodologies that would apply to new types of investments in which the 
fund intended to invest, is mitigated by changes to rule 2a-5, which 
does not include this requirement. Similarly, the other commenter's 
concern with the proposed rule's requirement to establish 
methodologies, inputs, and assumptions for prices provided by pricing 
services is mitigated by changes to the final rule, which allows the 
due diligence process

[[Page 792]]

for pricing services to fulfill this requirement.
---------------------------------------------------------------------------

    \589\ See Guggenheim Comment Letter.
    \590\ See Dechert Comment Letter.
---------------------------------------------------------------------------

5. Rescission of Prior Commission Releases and Guidance
    The final rule, like the proposed rule, rescinds certain Commission 
releases and guidance, including ASR 113, ASR 118, and prior guidance 
on the oversight of pricing services contained in the 2014 Money Market 
Fund Release.\591\ To the extent that funds' interpretations of such 
Commission releases and guidance have led to funds' adoption of 
practices that do not conform to the requirements of the final rule, 
the final rule will impose additional initial and ongoing costs, but 
come with additional ongoing benefits. Furthermore, as described in the 
Proposing Release, some parts of the Commission releases and guidance 
have been superseded or made obsolete.\592\ Similarly, one commenter 
stated that rescinding ASR 113 and ASR 118 will avoid potentially 
contradictory requirements \593\ and other commenters stated that U.S. 
GAAP and related accounting rules play an informative role in the 
valuation process.\594\ Because U.S. GAAP standards are commonly 
understood and used in the industry in financial reporting, both the 
additional one-time and ongoing costs of conforming to these standards 
and the final rule, rather than relying on Commission releases and 
guidance, should be limited. Finally, we believe that rescinding the 
auditing guidance included in ASR 118 will have little or no impact on 
funds or valuation designees because a fund board or valuation designee 
could request that its auditor continue current practice to verify 100% 
of the values of the fund's investments if it determines that this 
approach is preferable.
---------------------------------------------------------------------------

    \591\ See supra section II.E.
    \592\ See Proposing Release, supra footnote 2, at n.150 and 
accompanying discussion.
    \593\ See KPMG Comment Letter.
    \594\ See ABA Comment Letter; E&Y Comment Letter.
---------------------------------------------------------------------------

    The final rule provides a minimum, consistent framework for fair 
value and standard of baseline practices across funds to help ensure 
that boards fulfill their oversight roles appropriately, and these will 
encourage funds to adopt best practices to support more rigorous fair 
value determinations. The rescission of prior Commission releases and 
guidance obviates a fund's need to analyze and interpret those releases 
and guidance, thus reducing compliance costs.\595\ As discussed above, 
some commenters opposed rescission of ASR 113 and ASR 118 stating that 
certain specific fair values are not covered in the relevant accounting 
standards and that certain content within those releases should be 
reissued or restated by the Commission, but we continue to believe that 
in light of the existing framework in U.S. GAAP, and upon adoption of 
rule 2a-5 in this document, these specific valuation matters do not 
require the specific incremental guidance included in the ASRs.\596\ 
Lower costs of compliance for funds resulting from relying on the final 
rule rather than various guidance ultimately could benefit fund 
investors to the extent that any cost savings would be passed down to 
them in the form of lower fund operating expenses.
---------------------------------------------------------------------------

    \595\ Academic literature provides evidence consistent with the 
idea that uncertainty has negative effects on investment and growth. 
See, e.g., Nicholas Bloom, Stephen Bond, & John Van Reenen, 
Uncertainty and Investment Dynamics, 74 Rev. Econ. Stud. 391 (2007); 
Nicholas Bloom, The Impact of Uncertainty Shocks, 77 Econometrica 
623 (2009); Scott R. Baker, Nicholas Bloom, & Steven J. Davis, 
Measuring Economic Policy Uncertainty, 131 Q.J. Econ. 1593 (2016).
    \596\ See supra section II.E.
---------------------------------------------------------------------------

6. Cost Estimates
    Rules 2a-5 and 31a-4 will affect all funds with investments that do 
not have readily available market quotations, their boards of 
directors, the advisers of most funds, and the depositors or trustees 
of UITs, though not all of those funds will have to materially change 
their practices to comply with the final rule. The effects of these 
rules depend on the extent to which funds' current practices differ 
from their requirements. Our staff estimates that the one-time 
incremental costs necessary to ensure compliance with these rules range 
from $100,000 to $600,000 per fund, depending on the current fair value 
practices of the fund.\597\ These estimated costs are attributable to 
the following activities: (i) Reviewing the rules' requirements; (ii) 
developing new (or modifying existing) fair value policies and 
procedures,\598\ reporting,\599\ recordkeeping,\600\ valuation risk 
assessment,\601\ fair value methodology,\602\ testing,\603\ and pricing 
service oversight \604\ practices to align with the requirements of the 
rules; (iii) implementing those policies and procedures, reporting, 
recordkeeping, valuation risk assessment, fair value methodology, 
testing, and pricing oversight practices and integrating them into the 
rest of the funds' activities; (iv) preparing new training materials 
and administering training sessions for staff in affected areas; and 
(v) independent board members consulting their independent counsel on 
whether the valuation designee should be designated to perform fair 
value determinations and how to set up appropriate policies and 
procedures, reporting, and recordkeeping requirements.
---------------------------------------------------------------------------

    \597\ The one-time cost estimates used in the economic analysis 
may differ from the cost estimates in section IV below because (i) 
the cost estimates in the economic analysis capture all costs 
associated with the final rule, while the cost estimates in section 
IV capture only costs related to information collection burdens and 
(ii) the cost estimates in the economic analysis capture incremental 
costs associated with the final rule, while the cost estimates in 
section IV capture total costs. Hence, the cost estimates in section 
IV below serve as an upper bound of costs related to information 
collection burdens for funds that do not have in place currently any 
practices that are similar to the final rule's requirements.
    \598\ The final rule does not specify a requirement for policies 
and procedures beyond that in the compliance rule, but the final 
rule may affect the content of policies and procedures required for 
documentation of fair value determinations under the compliance 
rule. See supra section II.A.5, section III.B.2, and section 
I.A.1.e.
    \599\ See supra section II.B.2, section III.B.2.g), and section 
III.D.2.b).
    \600\ See supra section II.C, section III.B.2.h), and section 
III.D.3.
    \601\ See supra section II.A.1, section III.B.2.b), and section 
III.D.1.a).
    \602\ See supra section II.A.2, section III.B.2.c), and section 
III.D.1.b).
    \603\ See supra section II.A.3, section III.B.2.d), and section 
I.A.1.c.
    \604\ See supra section II.A.4, section III.B.2.f), and section 
I.A.1.d.
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    Many commenters agreed that the requirements of the proposed rule 
would impose such costs \605\ and some commenters stated that our 
estimates understated the costs described in the proposed rule.\606\ 
However, such commenters did not provide specific estimates or data to 
inform more accurate cost estimates. As described above, the 
requirements of these rules will be less prescriptive and burdensome 
than the requirements of the proposed rule. Nonetheless, our estimates 
have not changed because these estimates are for the one-time costs 
described here. Such costs are unlikely to vary as a result of the 
differences between the requirements of the proposed rule and those of 
rules 2a-5 and 31a-4 as adopted. We expect that the one-time 
incremental cost necessary to ensure compliance with the rules depends 
on each fund's current fair

[[Page 793]]

value practices and the amount and valuation complexity of fund 
investments that must be fair valued. In particular, the one-time costs 
will be closer to the lower end of the range for funds whose current 
practices are more similar to the requirements of the rules and funds 
with fewer and easier-to-value fund investments. Further, the one-time 
costs will be closer to the lower end of the range for funds that 
belong to fund complexes because certain aspects of the one-time costs 
are fixed costs that could be spread across multiple funds in the case 
of fund complexes.
---------------------------------------------------------------------------

    \605\ See, e.g., Dechert Comment Letter; Guggenheim Trustees 
Comment Letter; ICI Comment Letter; IDC Comment Letter; Invesco 
Comment Letter; John Hancock Comment Letter; NYSSCPA Comment Letter; 
Scheidt Comment Letter 2; Stradley Comment Letter.
    \606\ See, e.g., Guggenheim Comment Letter; ICI Comment Letter; 
John Hancock Comment Letter.
---------------------------------------------------------------------------

    As discussed above, we estimate that 9,804 funds will be affected 
by the rules, and thus incur one-time costs associated with the 
rules.\607\ We estimate that 70% of one-time costs are attributable to 
funds reviewing and updating their current practices and related 
policies and procedures to comply with the final rule's requirements; 
15% of one-time costs are attributable to funds reviewing and updating 
current recordkeeping processes to align with rule 31a-4's 
requirements; and the remaining 15% of one-time costs are attributable 
to funds reviewing and updating the current board reporting processes 
to comply with the final rule's requirements. Hence, we estimate the 
aggregate one-time costs of the final rule to range between $980.4 
million and $5.9 billion.\608\
---------------------------------------------------------------------------

    \607\ See supra footnote 509.
    \608\ $980.4 million = 9,804 affected funds x $100,000. $5.9 
billion = 9,804 affected funds x $600,000. See supra footnote 509.
---------------------------------------------------------------------------

    Section IV below presents estimates of ``collection of 
information''-related burdens \609\ associated with rule 2a-5's board 
reporting and rule 31a-4's recordkeeping requirements and with the 
requirement, to comply with rule 38a-1 after our adoption of rule 2a-5, 
to adopt and implement written policies and procedures reasonably 
designed to prevent violations of the requirements of rule 2a-5. Our 
estimates of one-time costs in the economic analysis above subsume the 
estimates of initial burdens in section IV, as the former cover costs 
associated with a broader set of activities, as described above, that 
do not all relate to the collection of information. In addition, some 
funds with investments valued using non-level 1 inputs may incur 
ongoing costs, in addition to the one-time costs described above, 
associated with the rules' requirements. However, we believe that the 
level of ongoing costs associated with the requirements of the rules 
are generally similar to that associated with existing practices of 
funds with investments valued without readily available market 
quotations. As a result, the estimate of ongoing industry burdens of 
$504,973,451 per year \610\ in section IV represents an upper bound on 
the incremental ongoing costs for funds affected by the rules.
---------------------------------------------------------------------------

    \609\ See infra footnote 637 and associated text.
    \610\ The ongoing burden associated with board reporting is 
based on 20 hours x $368 (senior programmer) + 1.5 hours x $4,770 
(combined rate for 4 directors) + 0.44 hours x $368 (compliance 
attorney) + an external burden of $3,180 = $17,859 for each affected 
fund, implying a total ongoing industry burden of $17,859 x 9,335 
affected funds = $166,709,616. See infra section IV.B. The ongoing 
burden associated with recordkeeping is based on 35 hours x $63 
(general clerk) + 35 hours x $96 (senior computer operator) + 35 
hours x $368 (compliance attorney) = $18,445 for each affected fund, 
implying a total ongoing industry burden of $18,445 x 9,335 affected 
funds = $172,184,075. See infra section IV.B. The ongoing burden 
associated with rule 38a-1 is based on 5 hours x $329 (senior 
manager) + 5 hours x $466 (assistant general counsel) + 2 hours x 
$530 (chief compliance officer) + 1 hour x $365 (compliance 
attorney) + 2 hours x $4,770 (Board of Directors as a whole), 
implying a total ongoing industry burden of $16,940 x 9,804 affected 
funds = $166,079,760. See infra section IV.B. Therefore, the total 
ongoing industry burden associated with the final rule is 
$166,709,616 + $172,184,075 + $166,079,760 = $504,973,451.
---------------------------------------------------------------------------

7. Other Cost Considerations and Comments on Costs
    Many commenters stated that costs would likely be higher than we 
estimated in the Proposing Release without quantifying those higher 
costs. In addition, some commenters presented a number of other costs--
also without quantification--that were not included in our estimates in 
the Proposing Release. For example, one commenter stated that the 
proposed reporting requirements could even lead to increased self-
imposed costs becoming industry standards.\611\ As discussed above, to 
the extent that funds' reporting practices already conform to the 
requirements of the final rule, additional costs will be limited. 
Likewise, we believe it is unlikely that funds will engage in 
additional reporting that is not necessary for compliance with the 
final rule. A few commenters suggested the proposed rule would result 
in increased liability of funds, boards, and advisers in fulfilling 
their fair value responsibilities.\612\ It is possible funds, boards, 
and advisers may incur liability in connection with their fair value 
responsibilities under the final rule, but they already may incur 
liability in this regard under the law.
---------------------------------------------------------------------------

    \611\ See Dechert Comment Letter.
    \612\ See ICI Comment Letter; American Funds Trustees Comment 
Letter; Capital Group Comment Letter; SIFMA AMG Comment Letter.
---------------------------------------------------------------------------

E. Effects on Efficiency, Competition, and Capital Formation

    Rules 2a-5 and 31a-4 may also have effects on efficiency, 
competition, and capital formation. Under the final rule, boards may 
designate a valuation designee to perform fair value determinations and 
may oversee the valuation designee's fair value determinations instead 
of determining fair value themselves, which could free board resources 
tied to valuation and redirect them to oversight or other matters. As a 
result, to the extent that boards currently determine fair value of 
investments themselves, the final rule could lead to more efficient use 
of boards' resources and therefore improve funds' governance of 
determinations of fair value in good faith for the benefit of 
investors.\613\ Conversely, to the extent that fund boards do not 
currently determine fair value themselves and instead rely on an 
adviser to compute fair value in line with the requirements of the 
final rule, such boards are not likely to benefit from more efficient 
use of their resources. The final rule also could improve the 
efficiency of fund operations because it will explicitly allow boards 
more flexibility to oversee the valuation designees' fair value 
determination, whether the fund boards currently make fair value 
determinations themselves or not.
---------------------------------------------------------------------------

    \613\ As discussed above, some commenters disagreed that this 
would free up board resources. See, e.g., Russell Comment Letter; 
Fidelity Comment Letter; MFS Comment Letter; John Hancock Comment 
Letter. The final rule does not impose requirements on the board 
that go beyond its present obligations, but does impose various 
specific requirements that are not currently expressly required. 
However, the final rule does provide an express mechanism such that 
a board is permitted to designate a valuation designee to perform 
actual determinations of fair value on a daily basis, thus avoiding 
a board's involvement in the day-to-day activities of fair value 
determination, while maintaining its critical oversight role.
---------------------------------------------------------------------------

    As discussed above, for UITs, a UIT's trustee or depositor must 
conduct fair value determinations under the final rule.\614\ To the 
extent that the assistance of other parties (such as evaluators) is 
necessary, trustees or depositors can seek that assistance consistent 
with the guidance above regarding obtaining the assistance of others. 
Thus, for UITs, the final rule explicitly places the responsibility on 
a UIT's trustee or depositor, as specified in the trust indenture of 
the UIT, to fulfill the requirements of the final rule to ensure 
appropriate oversight of the fair value determination process.
---------------------------------------------------------------------------

    \614\ See section II.B. See also footnotes 174, 176, and 177 and 
accompanying discussion.
---------------------------------------------------------------------------

    As discussed above, the final rule mandates oversight of a 
valuation

[[Page 794]]

designee, which could ultimately improve the efficiency and reduce the 
bias of funds' valuations. Similarly, the requirements for UITs to 
provide oversight of the fair value determination process could improve 
the efficiency and reduce the bias of UITs' valuations. The final rule 
could improve the efficiency of valuations because it may create a more 
rigorous valuation framework and could help mitigate any conflicts of 
interest of the valuation designees or, in the case of UITs, the 
trustee or depositor, which ultimately could result in less biased 
valuations. A potential increase in asset valuation efficiency could 
improve boards' monitoring of funds' and of valuation designees' 
performance and could benefit capital formation because less biased 
valuations permit the allocation of resources to more efficient use. As 
mentioned by a commenter, ``[b]etter standards improve the transparency 
and stability of financial markets, contribute to the growth of 
stronger economies and lead to improved confidence for investors and 
users of valuation services.'' \615\ Similarly, another commenter noted 
that ``more accurate and neutral information'' could lead to positive 
economic consequences and improved decision-making.\616\ Nevertheless, 
we believe that any such effects likely will be limited to the extent 
that funds currently have in place fair value practices that are 
generally similar to the requirements of the rules and that boards 
oversee the valuation designee's and any pricing service's role in fair 
value calculations. Similarly, we believe that any such effects likely 
will be small to the extent that UITs currently have in place fair 
value practices that are generally similar to the requirements of the 
final rule and that UITs' trustee or depositor oversees the fair value 
process and any pricing service's role in fair value calculations.
---------------------------------------------------------------------------

    \615\ See IVSC Comment Letter.
    \616\ See Davidson Comment Letter.
---------------------------------------------------------------------------

    As discussed above, the final rule includes a definition of readily 
available market quotations and this definition may affect the ability 
of funds to cross trade certain investments.\617\ Any such reduction in 
cross trades may have some implications for efficiency, competition, 
and capital formation. Any reduction in the extent of cross trades, to 
the extent that such trades are executed in the market, may affect 
market efficiency by contributing to price discovery for such 
investments that otherwise would not have gone to market. In this 
regard, transactions that are brought to market rather than being 
transacted internally will contribute to an increase in more efficient 
capital allocation and foster capital formation by subjecting more 
investments to price discovery.
---------------------------------------------------------------------------

    \617\ See supra section III.D.4.
---------------------------------------------------------------------------

    One commenter stated that the requirements of the proposed rule for 
all investments without readily available market quotations could 
discourage the purchase of certain securities, particularly for smaller 
and mid-sized firms and could ``impair the ability of such firms to 
offer funds that invest in fixed income securities, resulting in fewer 
investment options for mutual fund investors.'' \618\ To the extent 
that the final rule increases compliance burdens with respect to 
securities valued with level 2 or level 3 inputs, the final rule could 
provide incremental disincentives to purchase these securities, 
particularly by smaller and mid-sized funds. To the extent that these 
disincentives affect smaller and mid-sized funds more than other funds, 
the requirements of the final rule may affect the competitive landscape 
(e.g., by resulting in fewer investment options for investors). 
However, it is our understanding that the requirements of the final 
rule align with current practice of fair value determinations of 
investments without readily available market quotations.
---------------------------------------------------------------------------

    \618\ See Guggenheim Comment Letter. The commenter's concern was 
focused on investments that rely on prices provided by pricing 
services, particularly those which ``frequently use Level 2 
inputs.''
---------------------------------------------------------------------------

    Overall, we do not believe that the rules will have any material 
effects on competition because the effects of the rules likely will be 
limited to the extent that the rules are similar to current practices. 
Even though costs could be more burdensome for smaller fund complexes, 
we believe that these costs will not significantly affect competition 
in the fund industry because few funds will incur costs at the higher 
end of the cost range estimate (i.e., between $100,000 and $600,000). 
Furthermore, the extent to which the costs of the requirements of the 
final rule are relatively more burdensome for a fund is likely to be 
correlated to the fund's current lack of appropriate oversight of the 
fair value process. As the requirements of the final rule establish a 
framework for appropriate oversight of the fair value process, this may 
improve the competitive landscape in the fund industry. Any decrease in 
the ability of certain funds' engagement in cross trades due to the 
definition of readily available market quotations and the requirement 
to fair value all investments that are valued using level 2 inputs 
should affect all such funds and not result in any change in the 
competitive landscape in this regard; at most it would level the 
playing field among funds and thus contribute to a fairer competitive 
landscape. Thus, we continue to believe that the rules will not 
negatively affect competition in the fund industry, though it may have 
unfavorable effects on funds and valuation designees currently lacking 
an effective framework for appropriate oversight of their fair value 
processes.
    In addition, the requirement of the final rule reasonably to 
segregate fair value determinations from portfolio management likely 
will more significantly affect those smaller valuation designees or 
funds that lack the staff and resources necessary to effect such 
segregation as efficiently as larger advisers or larger funds. For 
example, such funds or valuation designees that lack the staff or 
resources to effect such segregation may hire additional personnel to 
ensure (or to assure a board) that they can reasonably segregate the 
fair value process from portfolio management. Similarly, the 
requirement to segregate determinations of fair value from portfolio 
management may present a barrier to entry to smaller advisers. This 
barrier may be realized through boards' unwillingness to hire advisers 
that cannot ensure such segregation to the boards' satisfaction. To the 
extent that boards may be unwilling to hire advisers who cannot 
reasonably segregate these functions, small advisers without the 
resources to provide such segregation will face a competitive 
disadvantage. Nevertheless, we do not believe that this requirement of 
the final rule will have a material effect on competition in the fund 
adviser industry because many smaller advisers to funds and internally 
managed funds currently have in place processes to address the 
potential conflicts of interest whenever portfolio management personnel 
provide input to valuation. To the extent that boards currently 
consider such risks and the need to segregate such functions in their 
selection of advisers--including small advisers--as we understand is 
current practice, the requirement is unlikely to affect competition in 
the fund adviser industry.
    Another commenter suggested that one of the valuation risk factors 
discussed above--``reliance on service providers that have more limited 
expertise in relevant asset classes''--could ``deter competition in the 
market for pricing services.'' \619\ We do not believe evaluation of 
valuation risks will prevent funds from engaging a pricing service with 
limited experience,

[[Page 795]]

but rather funds will assess the risks associated with such an 
engagement and manage them accordingly (for example, through more 
frequent backtesting of such pricing service's valuation information 
until it gains more experience).
---------------------------------------------------------------------------

    \619\ See IHS Markit Comment Letter.
---------------------------------------------------------------------------

    As described above, the requirements of rule 2a-5 are similar to 
current practices \620\ and establish a certain minimum, consistent 
framework for determinations of fair value in good faith under the 
final rule.\621\ Likewise, rule 31a-4 is based upon current practices 
and is designed to help implement this framework. Rule 2a-5's framework 
includes elements providing for effective oversight. Effective 
corporate governance is a key piece of investor protection \622\ at the 
same that it can provide for increased efficiency, competition, and 
capital formation. Boards practicing good governance can mitigate the 
agency problem that exists between the ``agents'' (e.g., advisers) and 
the ``principals'' (e.g., funds). In the area of fair value 
determinations in good faith, governance can reduce the information 
asymmetry that exists between fund advisers or portfolio managers and 
investors.
---------------------------------------------------------------------------

    \620\ See supra section III.B.2.
    \621\ See supra section III.C.3 and sections III.D.1 to III.D.4.
    \622\ See, e.g., Rafael La Porta, Florencio Lopez-de-Silanes, 
Andrei Schleifer, & Robert Vishny, Investor Protection and Corporate 
Governance, 58 J. Fin. Econ. 3 (2000).
---------------------------------------------------------------------------

    As described above,\623\ we expect that the requirements of the 
rules will contribute to less biased valuations, which has benefits for 
fund managers and investors alike. Fund managers are better able to 
manage their portfolios to tailor their portfolios to specific risk-
reward profiles or benchmarks as described in their investment policy 
statement \624\ and to ensure that their portfolios comply with the 
fund's risk appetite statement. However, advisers may have an incentive 
to ``improperly value fund assets in order to increase fees, improve or 
smooth returns, or comply with the fund's investment policies and 
restrictions,'' \625\ and fund boards are ``uniquely positioned to 
engage in oversight of the affiliated service provider generally and 
with respect to the conflicts of interest potentially arising in 
connection with the fair valuation process.'' \626\ Improper and biased 
valuations may also distort other behavior.\627\ The requirements of 
the final rule are designed to mitigate any such distortions.
---------------------------------------------------------------------------

    \623\ See supra footnote 510 and accompanying discussion.
    \624\ See Elements of an Investment Policy Statement for 
Institutional Investors, CFA Institute (2010).
    \625\ See Proposing Release, supra footnote 2, at n.911 and 
accompanying text.
    \626\ Russell Comment Letter; see also Better Markets Comment 
Letter; CFA Institute Comment Letter; SIFMA AMG Comment Letter.
    \627\ See, e.g., CFA Institute Comment Letter; Fidelity Comment 
Letter; JPMAM Comment Letter; MFS Comment Letter; SIFMA AMG Comment 
Letter; Stradley Comment Letter.
---------------------------------------------------------------------------

    Properly valuing a fund's investments is also a critical component 
of the accounting and financial reporting for investment companies. 
Appropriate and unbiased valuations should thus provide investors with 
greater confidence in the accuracy of the value of fund investments, 
the performance of funds, and the level of risk of fund investments. 
This should allow investors to evaluate more effectively how a given 
fund fits their investment objectives, risk appetite, and ability to 
bear risk.
    Taken together, appropriate and unbiased valuation fosters price 
discovery. Price discovery, in turn, ensures that investments and 
resources are directed to their most efficient use, both by investors 
and funds themselves. Efficiency and improved accounting and financial 
reporting resulting from appropriate and unbiased valuation should 
promote capital formation by increasing the quality and reliability of 
information in capital markets.\628\ Similarly, appropriate and 
unbiased valuation induces greater competition as the performance of 
funds and their advisers becomes more reliably assessable. While 
appropriate and unbiased valuation contribute to investor protection, 
efficiency, competition, and capital formation, the extent to which the 
requirements of the rules will increase these contributions may be 
limited by the extent to which funds' current practices are similar to 
the rules. As discussed above, the costs of the rules will likewise be 
limited to the extent to which funds' current practices are similar to 
the rules.
---------------------------------------------------------------------------

    \628\ See, e.g., Andrea Polo, Fair Value and Corporate 
Governance, 6 Corp. Ownership & Control 382 (2008).
---------------------------------------------------------------------------

F. Reasonable Alternatives

1. Designation to Officers of Internally Managed Fund Not Permitted
    We considered not permitting internally managed funds to designate 
officers to perform the fair value functions required by the final 
rule, but allowing such funds to seek individual exemptive applications 
to allow designation of their officers. This would give the Commission 
the opportunity to design protections that are more tailored to the 
kinds and magnitude of conflicts involved in internally managed funds 
and the kinds of assets in which those funds invest. We believe, 
however, that the costs to these funds involved in applying for 
individual exemptive relief could be passed on to investors in these 
funds. Furthermore, officers of internally managed funds do, in fact, 
have a fiduciary duty, and play a similar or the same role as other 
valuation designees. Thus, treating officers of internally managed 
funds differently or preferentially would be inconsistent with the goal 
of ensuring appropriate oversight and governance of the fair value 
process (regardless of the parties involved) that the final rule seeks. 
Further, we believe that the final rule's oversight and other 
requirements provide minimum and baseline standards that we believe 
should be part of any good faith fair value determination for 
internally managed funds. We do not believe that individually-granted 
exemptive relief would provide funds or their shareholders 
substantially more protections in the fair value process, as compared 
to those included in the final rule, to justify the costs of requiring 
exemptive applications. For these reasons, we are not adopting this 
alternative.
2. Safe Harbor
    Some commenters suggested that the proposed rule be formulated as a 
safe harbor.\629\ These commenters perceived the proposed rule as 
prescriptive and indicated that such rules are more appropriate for a 
safe harbor. Commenters argued that for those not availing themselves 
of the safe harbor, practices would evolve and adapt in response to 
market developments and permit heterogeneity of practices that are 
appropriate for the idiosyncrasies of market participants. However, for 
those funds that choose not to use the safe harbor, the guidelines 
would be less clear, and perhaps only as clear the current regulatory 
framework. Any lack of certainty would likely entail higher compliance 
costs and possible investor protection costs. Funds not relying on the 
safe harbor would likely have to divert more resources to ensuring 
compliance and may fall short of

[[Page 796]]

providing appropriate oversight and governance of the fair value 
process as compared to the final rule. Recasting rule 2a-5 as a safe 
harbor would not provide a minimum baseline framework, as boards that 
chose not to avail themselves of the safe harbor might take an approach 
to the process of making fair value determinations that does not result 
in investors receiving as rigorous valuations as under the final rule. 
Valuation is a core responsibility of the board under the Act and 
critical for investor protection. Consequently, we believe not defining 
minimum and baseline standards could harm investors if funds took 
approaches that lacked consistency or certain aspects of these basic 
standards.
---------------------------------------------------------------------------

    \629\ See supra section II; see also American Bankers 
Association Comment Letter; American Funds Trustees Comment Letter; 
Dechert Comment Letter; Fidelity Trustees Comment Letter; Guggenheim 
Comment Letter; ICI Comment Letter; Stradley Comment Letter; 
Vanguard Comment Letter; Comment Letter of Mark Loughridge, Lead 
Independent Director, Board of Trustees of the Vanguard Funds (July 
21, 2020).
---------------------------------------------------------------------------

3. Three-Tiered Approach
    Some commenters suggested that instead of a binary approach where 
securities that are valued based on level 2 and level 3 inputs are 
subject to fair value determinations, we instead adopt a three-tier 
approach similar to U.S. GAAP's level 1, level 2, and level 3 input 
classifications and have rules 2a-5 and 31a-4 further distinguish the 
fair value determination process between securities in level 2 or 
between level 2 and level 3.\630\ We are not adopting this alternative 
because, as discussed previously, we believe that the Act establishes a 
binary framework with securities either being valued based on their 
readily available market quotations, or for all other investments, 
being fair valued in good faith. However, the final rule establishes a 
framework that allows boards or valuation designees to tailor their 
fair value determination process to the investments held by the fund, 
and allows for a variety of different methodologies to be applied. As 
described above, the requirements of rule 31a-4 for investments fair 
valued with level 2 inputs does allow for different levels of 
recordkeeping that correspond with the risk and nature of the 
investments that are being fair valued. The recordkeeping and reporting 
requirements of rules 2a-5 and 31a-4 are designed to be flexible, and 
thus funds may distinguish between level 2 and level 3 securities as 
part of their recordkeeping and reporting processes. Accordingly, we 
believe that the final rule permits boards and valuation designees 
sufficient flexibility to design their fair value determination process 
as appropriate for the investments held by the fund.
---------------------------------------------------------------------------

    \630\ See, e.g., SSGA Comment Letter.
---------------------------------------------------------------------------

4. More Principles-Based Approach
    The final rule mandates the performance of certain prescribed 
functions to determine the fair value of fund investments in good 
faith. As suggested by many commenters, we considered an alternative 
with a more principles-based approach that would not specify the types 
of fair value functions that must be performed, but instead would only 
state that funds should have in place practices, policies and 
procedures, reporting, and recordkeeping that would allow fair values 
to be determined in good faith by the board of directors or the 
valuation designee. For example, funds would have greater discretion to 
apply more or less rigorous valuation requirements on fair value 
determinations of investments that rely on level 2 inputs, including 
treating certain such investments as having readily available market 
quotations, depending on what the fund deemed to be appropriate.\631\
---------------------------------------------------------------------------

    \631\ See supra section III.B.2.c) and section III.F.3.
---------------------------------------------------------------------------

    The benefits of such an approach would be that funds would have 
more flexibility in what their policies and procedures, reporting, and 
recordkeeping cover. To the extent this alternative would reduce 
certainty for funds, it could increase compliance costs to the 
detriment of fund investors. Further, a less prescriptive approach 
would not adequately ensure that the board provides sufficient 
oversight over the valuation designee's fair value determinations.\632\ 
In addition, if certain funds within a fund complex were to use the 
additional flexibility afforded by a more principles-based approach to 
set up practices, policies and procedures, reporting, and recordkeeping 
arrangements that are different from one another, such flexibility 
could increase the cost of board oversight. This could occur because a 
board that is shared across funds within a fund complex may not be able 
to apply a similar framework across the various funds it oversees or 
because a board believes that the principles-based requirements could 
be satisfied with respect to a particular fund only using different 
practices, policies and procedures, reporting, and recordkeeping 
arrangements. However, such flexibility would provide funds and boards 
themselves the option to evaluate the tradeoffs among, for example, 
non-uniform arrangements across funds, more tailored and effective 
reporting, corresponding increased costs of board oversight, and 
corresponding increased costs of compliance. Thus each fund could make 
a choice that is more aligned with its goals and constraints, including 
regulatory constraints, than under a less principles-based arrangement.
---------------------------------------------------------------------------

    \632\ We acknowledge that under the final rule, funds could face 
some uncertainty regarding how to comply with the final rule's 
requirements. Nevertheless, we believe that a more principles-based 
approach than the final rule would increase further any uncertainty 
regarding how to comply with the requirements of section 2(a)(41) of 
the Act without any additional benefit of ensuring appropriate 
oversight of the fair value process.
---------------------------------------------------------------------------

    A more principles-based approach would not mandate a minimum, 
consistent framework for fair value and standard of baseline practices 
across funds, which we believe is inherent in any good faith fair value 
determination process. For these reasons, we are not adopting this 
alternative.
5. Designation of the Performance of Fair Value Determinations to 
Service Providers Other Than Advisers, Officers, Trustees, or 
Depositors
    Under the final rule, the board may designate the adviser of the 
fund, or an officer or officers of an internally managed fund, to 
perform fair value determinations. For UITs, trustees or depositors of 
a UIT or other entities appointed by existing UITs will perform fair 
value determinations. The valuation designee carries out all of the 
functions required under the final rule. As an alternative, we 
considered allowing the board to designate sub-advisers or service 
providers other than the adviser or an officer or officers, and 
providing for parties other than trustees or depositors of a UIT, such 
as a pricing service, to perform fair value determinations. Such an 
approach would provide additional flexibility to the board. As noted by 
commenters, pricing service providers currently provide evaluated 
prices extensively to funds, many of which use these prices as fair 
values for the purposes of the Act.\633\ This could also help in a 
situation where the adviser's conflicts and a pricing service's 
comparative expertise make designation of the adviser less desirable 
and designation of the pricing service more beneficial. Likewise, the 
board might also choose to designate to a party such as a pricing 
service because the board assesses that the conflicts of interest with 
the pricing service are less extensive, less problematic, or more 
feasibly managed than those with an adviser or officers of the fund.
---------------------------------------------------------------------------

    \633\ See supra footnote 417 and accompanying discussion.
---------------------------------------------------------------------------

    Nevertheless, such an approach potentially could limit a board's 
ability to oversee effectively the service provider that performs the 
fair value

[[Page 797]]

determinations to the extent that the board does not have the same 
level of visibility, access to information, and control over the 
actions of service providers other than the valuation designee as 
provided in the final rule. Further, even though service providers may 
have a contractual obligation to perform valuation services for the 
fund, those service providers may not owe the same fiduciary duty to 
the fund that an adviser would, and thus their obligation to serve the 
fund's best interests may be more limited than the adviser's. We also 
believe, as discussed above, that it is important for the valuation 
designee to have a direct relationship with the fund's board and have 
comprehensive and direct knowledge of the fund.\634\ Although the final 
rule allows some persons besides advisers to perform fair value 
determinations (e.g., officers of internally managed funds and trustees 
and depositors of UITs) who also generally have a fiduciary duty, we 
believe that retaining responsibility with a more closely associated 
person is more likely to increase accountability than a third-party 
service provider. Hence, such an alternative approach could compromise 
the integrity of the fair values by increasing the likelihood of 
conflicts with the adviser.
---------------------------------------------------------------------------

    \634\ See supra footnotes 157-158 and accompanying text.
---------------------------------------------------------------------------

    While some pricing services are also registered investment 
advisers, such pricing services would not necessarily owe the same 
fiduciary duties to a fund if they are not the investment adviser for 
the fund, and may have conflicts of interest that are more difficult to 
mitigate to the extent that the role of fair value determination and 
portfolio management are integrated. Further, in cases where a single 
pricing service cannot perform fair value determinations for all 
assets, the process and oversight could become extremely burdensome for 
funds and their boards. Finally, nothing in the final rule prevents 
other service providers, such as pricing services, from continuing to 
provide significant input and assistance, much as they do today, on 
fair value determinations. However, retaining direct responsibility 
with an adviser or more closely affiliated designee is more likely to 
increase accountability and oversight over these other service 
providers.
6. Not Permit Boards To Designate a Valuation Designee
    As discussed in more detail above, unlike the current regulatory 
framework, the final rule permits fund boards to designate the 
performance of fair value determinations to a valuation designee. In 
addition, relative to the current regulatory framework, rules 2a-5 and 
31a-4 will mandate more specific fair value practices, reporting, and 
recordkeeping. As an alternative to these rule, we considered not 
permitting fund boards to designate a valuation designee to perform 
fair value determinations for the fund but instead only requiring funds 
to adopt the practices, reporting, and recordkeeping as described in 
the final rule. We also considered requiring boards periodically to 
ratify the fair value determinations calculated by the fund's valuation 
designee using a methodology determined by the board. Such an approach 
could prescribe minimum requirements with respect to valuation 
practices, reporting, and recordkeeping. Nevertheless, such an approach 
would not allow funds the flexibility to leverage the fair value 
expertise of the valuation designee and assign a role to the fund's 
board that is more in line with the board's experience and expertise. 
Consequently, we believe that such an approach would not result in more 
efficient use of boards' time and more efficient fund operations, and 
would not result in improvements in fund governance, nor would it 
ultimately benefit fund investors.

IV. Paperwork Reduction Act

A. Introduction

    Certain provisions of rules 2a-5 and 31a-4 contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\635\ We are submitting the collections 
of information to the Office of Management and Budget (``OMB'') for 
review in accordance with the PRA.\636\ The title for the existing 
collection of information is ``Investment Company Act Rule 38a-1, 17 
CFR 270.38a-1, Compliance procedures and practices of registered 
investment companies'' (OMB Control No. 3235-0586). We are also 
submitting a new collection of information for rules 2a-5 and 31a-4. 
The titles for the new collections of information will be ``Rule 2a-5 
under the Investment Company Act of 1940, Fair Value'' and ``Rule 31a-4 
under the Investment Company Act of 1940, Records of Fair Value 
Determinations.'' An agency may not conduct or sponsor, and a person is 
not required to respond to, a collection of information unless it 
displays a currently valid control number.
---------------------------------------------------------------------------

    \635\ 44 U.S.C. 3501 through 3520.
    \636\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
---------------------------------------------------------------------------

    We discuss below the collection of information burdens associated 
with new rules 2a-5, 31a-4, and their impact on the burdens of rule 
38a-1.\637\ Rule 2a-5 will provide requirements for determining fair 
value in good faith for purposes of section 2(a)(41) and rule 2a-4 
thereunder and rule 31a-4 will provide the recordkeeping requirements 
associated with this rule.
---------------------------------------------------------------------------

    \637\ The Commission's estimates of the relevant wage rates in 
the tables below are based on salary information for the securities 
industry compiled by the Securities Industry and Financial Markets 
Association's Office Salaries in the Securities Industry 2013. The 
estimated wage figures are modified by Commission staff to account 
for an 1,800-hour work-year and inflation, and multiplied by 5.35 
for professional staff and 2.93 for clerical staff to account for 
bonuses, firm size, employee benefits, overhead, and adjusted to 
account for the effects of inflation. See Securities Industry and 
Financial Markets Association, Report on Management & Professional 
Earnings in the Securities Industry 2013 (``SIFMA Report'').
---------------------------------------------------------------------------

B. Rule 2a-5

    Rule 2a-5 will provide requirements for determining fair value in 
good faith for purposes of section 2(a)(41) and rule 2a-4 thereunder. 
This determination will involve assessing and managing material risks 
associated with fair value determinations; selecting, applying, and 
testing fair value methodologies; and evaluating any pricing services 
used. The final rule will permit a fund's board of directors to 
designate the performance of fair value determinations relating to any 
or all fund investments to a valuation designee, which will carry out 
all of these requirements, subject to board oversight and certain 
reporting and other requirements designed to facilitate the board's 
ability effectively to oversee the valuation designee's fair value 
determinations. As relevant here, the final rule will require, if the 
board designates performance of fair value determinations to a 
valuation designee, that the valuation designee report to the board in 
both periodic and as needed reports on a per-fund basis.\638\
---------------------------------------------------------------------------

    \638\ Rule 2a-5(b).
---------------------------------------------------------------------------

    The respondents to rule 2a-5 will be registered investment 
companies and BDCs.\639\ We estimate that 9,804 funds will be affected 
by rule 2a-5, of which 9,335 are not UITs.\640\ Compliance with rule 
2a-5 will be mandatory for any fund that will need to determine fair 
value under the Act. To the extent that records will be required to be 
created and maintained under the final rule are provided to the 
Commission in connection with examinations or investigations, such 
information will be

[[Page 798]]

kept confidential subject to the provisions of applicable law.
---------------------------------------------------------------------------

    \639\ See Rule 2a-5(e)(1) (defining ``fund'').
    \640\ See supra footnotes 508-509 and accompanying text.
---------------------------------------------------------------------------

    Table 3 below summarizes the PRA initial and ongoing burden 
estimates associated with the board reporting requirements under the 
final rule, as well as the proposed burden estimates. Some commenters 
argued that the burden estimates as proposed for this requirement were 
too low, arguing in particular that the cost to produce the items that 
would have been required on a quarterly basis as part of the proposed 
periodic reporting requirements would be in excess of what we had 
assumed due to burdens of both creating these reports and of reviewing 
them on the part of the board.\641\ While we have clarified that 
certain reporting that commenters thought was suggested in the proposed 
rule will not be required in the final rule and made other changes to 
address these concerns,\642\ we are nonetheless increasing our 
estimates for the final rule in consideration of these comments. We 
also have corrected certain estimates, specifically to include an 
initial burden as we believe the final rule will impose some start-up 
burdens and to update the wage rates for relevant personnel. We have 
also updated the estimated number of respondents based upon updated 
data.\643\ Lastly, we increased the estimated amount of external cost 
burden to include costs relating to both legal and accounting services 
as the proposed estimate only estimated external costs relating to 
legal expenses.
---------------------------------------------------------------------------

    \641\ See Sullivan Comment Letter; TRP Comment Letter; SIFMA AMG 
Comment Letter; American Trustees Comment Letter; see also Capital 
Group Comment Letter; Guggenheim Trustees Comment Letter.
    \642\ See supra section II.B.2.
    \643\ See supra footnotes 508-509 and accompanying text.
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[[Page 799]]

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[[Page 800]]


BILLING CODE 8011-01-C

C. Rule 31a-4

    Rule 31a-4 contains the recordkeeping requirements associated with 
rule 2a-5. Specifically, registered investment companies and BDCs, or 
their advisers, will be required to maintain appropriate documentation 
to support fair value determinations made pursuant to rule 2a-5.\644\ 
Further, if the board of the fund designates performance of fair value 
determinations to a valuation designee under the final rule, the fund 
or adviser will need to maintain certain additional records relating to 
that designation.\645\ The respondents to rule 31a-4 will be registered 
investment companies and BDCs.\646\ We estimate that 9,804 funds will 
be affected by rule 31a-4.\647\ Compliance with rule 31a-4 will be 
mandatory for any fund that will need to determine fair value under the 
Act. To the extent that records that will be required to be created and 
maintained under this rule are provided to the Commission in connection 
with examinations or investigations, such information will be kept 
confidential subject to the provisions of applicable law.
---------------------------------------------------------------------------

    \644\ Rule 31a-4(a).
    \645\ Rule 31a-4(b).
    \646\ See Rule 2a-5(e)(1) (defining ``fund'').
    \647\ See supra footnotes 508-509 and accompanying text.
---------------------------------------------------------------------------

    Table 4 below summarizes the PRA initial and ongoing burden 
estimates associated with the rule, as well as the proposed burden 
estimates. Some commenters argued that the burden estimates as proposed 
for this requirement were too low.\648\ Specifically, these commenters 
stated that the proposed requirement to maintain documentation to 
support fair value determinations, including information regarding the 
specific methodologies applied and the assumptions and inputs 
considered when making fair value determinations, would result in the 
valuation designee needing to obtain significant amounts of data that 
it would not otherwise obtain and retain it when it utilizes a pricing 
service,\649\ and would require funds or valuation designees to hire 
additional personnel to be able to comply.\650\ While we have clarified 
that certain recordkeeping that commenters thought was suggested in the 
proposed rule will not be required in rule 31a-4 as adopted and made 
other changes to address these concerns,\651\ we are nonetheless 
significantly increasing our estimates for this rule in consideration 
of these comments. We have also updated the estimated number of 
respondents based upon updated data.\652\ We also further revised 
certain estimates, specifically to include the likely involvement of a 
compliance attorney in the formulation of policies and procedures 
relating to this requirement and to update the wage rates for relevant 
personnel.
---------------------------------------------------------------------------

    \648\ See, e.g., ICI Comment Letter; Fidelity Comment Letter; 
Vanguard Comment Letter; Guggenheim Comment Letter; Guggenheim 
Trustees Comment Letter. But see Davidson Comment Letter (suggesting 
that the Commission provided ample reason to believe that the costs 
of compliance would be on the smaller side).
    \649\ See, e.g., ICI Comment Letter; IDC Comment Letter; SSGA 
Comment Letter; Fidelity Comment Letter; TRP Comment Letter; John 
Hancock Comment Letter; ICE Data Comment Letter (noting that pricing 
services would need to increase fees to compensate for the demands 
for records under the proposed regime).
    \650\ See Guggenheim Trustees Letter; Guggenheim Comment Letter.
    \651\ See supra section II.C.
    \652\ See supra footnotes 508-509 and accompanying text.
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BILLING CODE 8011-01-P

[[Page 801]]

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[[Page 802]]


[GRAPHIC] [TIFF OMITTED] TR06JA21.003

BILLING CODE 8011-01-C

D. Rule 38a-1

    As discussed above, after our adoption of rules 2a-5 and 31a-4, 
rule 38a-1 will require the adoption and implementation of written 
policies and procedures reasonably designed to prevent violations of 
the requirements of the rules.\653\ To comply with rule 38a-1, these 
policies and procedures must be tailored to rules 2a-5 and 31a-4's 
requirements to ensure that a board or valuation designee, as 
applicable, determines the fair value of fund investments in compliance 
with the rules. In our most recent PRA submission for rule 38a-1, we 
estimated for rule 38a-1 a total hour burden of 235,720 hours, at a 
time cost of $86,784,720, and no external burdens.\654\
---------------------------------------------------------------------------

    \653\ See supra section II.A.5.
    \654\ This estimate is based on the last time the rule's 
information collection was submitted for PRA renewal in 2020.
---------------------------------------------------------------------------

    The table below summarizes the PRA initial and ongoing burden 
estimates associated with the new fair value policies and procedures.
BILLING CODE 4011-01-P

[[Page 803]]

[GRAPHIC] [TIFF OMITTED] TR06JA21.004

BILLING CODE 4011-01-C

V. Final Regulatory Flexibility Analysis

    The Commission has prepared the following Final Regulatory 
Flexibility Analysis (``FRFA'') in accordance with section 604 of the 
Regulatory Flexibility Act (``RFA'').\655\ It relates to new rules 2a-5 
and 31a-4. An Initial Regulatory Flexibility Analysis (``IRFA'') was 
prepared in accordance with the RFA and included in the Proposing 
Release.\656\
---------------------------------------------------------------------------

    \655\ 5 U.S.C. 604.
    \656\ See Proposing Release, supra footnote 2, at section V.

---------------------------------------------------------------------------

[[Page 804]]

A. Need for the Rules

    The Commission is adopting new rule 2a-5 in order to address 
practices and the role of the board of directors with respect to the 
fair value of the investments of the fund. The Commission is also 
adopting rule 31a-4 to address the recordkeeping requirements 
associated with rule 2a-5. Under section 2(a)(41), the board must 
determine in good faith the fair value of fund assets for which no 
market quotations are readily available. Rule 2a-5 is designed to 
specify how a board or valuation designee, as applicable, must make 
good faith determinations of fair value as well as when the board can 
designate the performance of these determinations to a valuation 
designee, while still ensuring that fund investments are valued in a 
way consistent with the Investment Company Act.\657\
---------------------------------------------------------------------------

    \657\ Under the final rule, the valuation designee must be a 
fund's adviser or, if the fund is internally managed, an officer of 
the fund. The trustee or depositor of a UIT (or in the case of 
existing UITs another entity designated to do so in the UIT's 
documentation), which does not have a board, will perform fair value 
determinations.
---------------------------------------------------------------------------

    Rule 2a-5 will provide requirements for determining fair value in 
good faith for purposes of section 2(a)(41) of the Act and rule 2a-4 
thereunder. This determination will be required to involve: Assessing 
and managing material risks associated with fair value determinations; 
selecting, applying, and testing fair value methodologies; evaluating 
any pricing services used; and maintaining certain records required by 
rule 31a-4.\658\ The rules will permit a fund's board of directors to 
designate the performance of these requirements to a valuation designee 
for some or all of the fund's investments, subject to board oversight 
and certain reporting, recordkeeping, and other requirements designed 
to facilitate the board's ability effectively to oversee the valuation 
designee's fair value determinations.\659\ Rule 2a-5 will also define 
when market quotations are readily available under section 2(a)(41) of 
the Act. Lastly, rule 2a-5 will have the trustee or depositor of a UIT 
(or in the case of existing UITs another entity designated to do so in 
the UIT's documentation) carry out the requirements of the rules. The 
requirements of rule 2a-5 associated with the fair value as determined 
in good faith and readily available market quotations are designed to 
create a minimum, consistent framework for fair value and standard of 
baseline practices across funds, and reflects our understanding of 
current market practices.\660\ The requirements of rule 2a-5 associated 
with the designation of the performance of responsibilities to a 
valuation designee are designed to ensure that the board effectively 
oversees such valuation designee, including receiving sufficient 
information to do so.\661\ The recordkeeping requirements of rule 31a-4 
are designed to help ensure compliance with the other 
requirements.\662\
---------------------------------------------------------------------------

    \658\ As a result of the adoption of rule 2a-5, under rule 38a-1 
funds or the adviser must adopt and implement policies and 
procedures reasonably designed to comply with rule 2a-5.
    \659\ For internally managed funds, the board may designate an 
officer or officers of the fund to perform fair value 
determinations.
    \660\ See supra sections I, II.A, and II.D.
    \661\ See supra section II.B.
    \662\ See supra sections II.A.5 II.C.
---------------------------------------------------------------------------

    All of these requirements are discussed in detail in section II of 
this release. The costs and burdens of these requirements on small 
funds are discussed below as well as above in our Economic Analysis and 
Paperwork Reduction Act Analysis, which discuss the applicable costs 
and burdens on all funds.\663\
---------------------------------------------------------------------------

    \663\ See supra section III and IV. These sections also discuss 
the professional skills that we believe compliance with the rules 
will entail.
---------------------------------------------------------------------------

B. Significant Issues Raised by Public Comments

    In the Proposing Release, we requested comment on every aspect of 
the IRFA, including the number of small entities that would be affected 
by the proposed rule, the existence or nature of the potential impact 
of the proposal on small entities discussed in the analysis, and how to 
quantify the impact of the proposed rule. We also requested comment on 
the proposed compliance burdens and the effect these burdens would have 
on smaller entities.
    Although we did not receive comments specifically addressing the 
IRFA, some commenters noted the impact of certain aspects of proposed 
rule 2a-5 on smaller funds. For example, one commenter suggested that 
we allow funds to assign fair value determinations to entities other 
than the adviser, such as the fund's administrator, to make it easier 
for smaller funds to comply with the proposed rule.\664\ Another 
commenter argued that we should adopt a more principles-based approach 
that would be less burdensome on smaller funds.\665\ Additionally, a 
few commenters stated that the proposed quarterly reporting requirement 
would be unnecessarily burdensome, including for smaller funds, because 
many of the valuation issues described in the Proposing Release are 
unlikely to change on a quarterly basis.\666\ Furthermore, with regard 
to the requirement that certain valuation issues be reported promptly 
to the fund's board, one commenter suggested that we allow one of the 
independent directors on the board to receive these reports to make the 
requirement less burdensome for small funds.\667\ Finally, one 
commenter suggested that the recordkeeping requirements of the proposed 
rule 2a-5 was duplicative with the section 31 rules.\668\ After 
considering the comments we received, we are adopting the rules, with 
certain modifications from the proposal intended to address many of the 
challenges commenters identified.
---------------------------------------------------------------------------

    \664\ IDC Comment Letter.
    \665\ ABA Comment Letter.
    \666\ Sullivan Comment Letter. See also ICI Comment Letter.
    \667\ Murphy Comment Letter.
    \668\ NYC Bar Comment Letter.
---------------------------------------------------------------------------

    As discussed above, we believe that it is important to establish a 
minimum and consistent framework for fair value practices across funds, 
including for small funds.\669\ Therefore, rule 2a-5 establishes 
requirements for engaging in fair value determinations that are broadly 
applicable to all funds, including small funds, and that we believe 
should be part of any good faith fair value determination. However, we 
have made certain modifications to the requirements of the proposed 
rule to enhance flexibility and ease certain unnecessary burdens. For 
example, we have made certain changes to the proposed quarterly 
reporting requirements designed to enhance flexibility of reporting to 
match boards' needs better and to minimize the chance that boards 
receive reporting that is too detailed or repetitive to facilitate 
appropriate oversight.\670\ Additionally, in a change from the 
proposal, which would have permitted boards to assign only to an 
adviser of the fund, rule 2a-5 will permit boards to designate the 
fund's adviser to perform fair value determinations or, if the fund is 
internally managed, an officer of the fund. Furthermore, rule 2a-5 
clarifies, in response to commenters,\671\ that the board or the 
valuation designee can seek the assistance of other parties that 
provide services that are essential for fair value determination, such 
as a pricing service or the fund

[[Page 805]]

administrator, among others. Finally, new rule 31a-4 contains the 
recordkeeping requirements associated with rule 2a-5. We believe that 
these modifications will make it less burdensome for small funds to 
comply with the rules, while still maintaining the integrity of the 
fair value process across all funds.
---------------------------------------------------------------------------

    \669\ See supra text accompanying footnote 13.
    \670\ See supra section II.B.2 (noting that the final rule will 
require a quarterly summary or description of material fair value 
matters that occurred in the prior quarter while the annual report 
will include an assessment of the adequacy and effectiveness of the 
valuation designee's process for determining the fair value of 
designated investments).
    \671\ Sullivan Comment Letter.
---------------------------------------------------------------------------

C. Small Entities Subject to the Rule

    For purposes of Commission rulemaking in connection with the 
Regulatory Flexibility Act, an investment company is a small entity if, 
together with other investment companies in the same group of related 
investment companies, it has net assets of $50 million or less as of 
the end of its most recent fiscal year (a ``small fund'').\672\ 
Commission staff estimates that, as of June 2020, approximately 40 
registered open-end mutual funds,\673\ 8 registered ETFs, 26 registered 
closed-end funds,\674\ 2 UITs, and 12 BDCs \675\ (collectively, 88 
funds) are small entities.\676\
---------------------------------------------------------------------------

    \672\ See 17 CFR 270.0-10(a) [rule 0-10(a) under the Investment 
Company Act].
    \673\ None of these registered open-end funds are internally 
managed.
    \674\ 7 of these registered closed-end funds are internally 
managed.
    \675\ 3 of these BDCs are internally managed.
    \676\ This estimate is derived an analysis of data obtained from 
Morningstar Direct as well as data reported to the Commission for 
the period ending June 2020.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The rules will require fair value determinations under the Act to 
be made according to a specific process for affected funds, including 
those that are small entities. This process will include a requirement 
to maintain certain records to support fair value determinations.\677\ 
The rules will permit fund boards to designate the valuation designee 
to perform fair value determinations if the valuation designee, in 
addition to the above, makes certain reports to the fund's board 
regarding the fair value process in writing. Funds will also be 
required to keep certain additional records in such circumstances. We 
therefore believe that there are two principal reporting, 
recordkeeping, or other compliance requirements associated with the 
rules: (1) Recordkeeping requirements and (2) board reporting 
requirements.
---------------------------------------------------------------------------

    \677\ As discussed above, after our adoption of rule 2a-5, 
pursuant to rule 38a-1 funds should adopt and implement written fair 
value policies and procedures reasonably designed to prevent 
violations of rule 2a-5. See supra section II.A.5.
---------------------------------------------------------------------------

1. Recordkeeping
    The recordkeeping requirements of rule 31a-4 are designed to help 
ensure compliance with rule 2a-5's requirements and aid in oversight. 
Rule 31a-4 will require the fund to keep appropriate documentation to 
support fair value determinations for at least six years from the time 
the determination was made, the first two years in an easily accessible 
place.\678\ Further, should the board designate the valuation designee 
to perform fair value determinations, the fund must keep, in addition 
to the records above, copies of the reports and other information 
provided to the board for at least six years after the end of the 
fiscal year in which the documents were made, the first two years in an 
easily accessible place and a specified list of the investments or 
investment types whose fair value determination has been designated to 
the valuation designee, in each case for at least six years after the 
end of the fiscal year in which the determinations were provided to the 
board or the investments or investment types were designated to the 
valuation designee, the first two years in an accessible place.\679\
---------------------------------------------------------------------------

    \678\ Rule 31a-4(a). Rule 38a-1 also will require funds to keep 
a copy of the fair value policies and procedures that are in effect, 
or were in effect at any time within the past five years, in an 
easily accessible place.
    \679\ Rule 31a-4(b).
---------------------------------------------------------------------------

    These requirements will impose burdens on all funds, including 
those that are small entities. The specifics of these burdens are 
discussed in the Economic Analysis and Paperwork Reduction Act sections 
above.\680\ There are different factors that would affect whether a 
smaller fund incurs costs relating to this requirement that are on the 
higher or lower end of the estimated range. For example, we would 
expect that smaller funds--and more specifically, smaller funds that 
are not part of a fund complex--may not have recordkeeping systems that 
meet all the elements that are required under this rule. Also, while 
larger funds or funds that are part of a large fund complex may incur 
higher costs related to these requirements in absolute terms relative 
to a smaller fund or a fund that is part of a smaller fund complex, a 
smaller fund may find it more costly, per dollar managed, to comply 
with the requirements because it will not be able to benefit from a 
larger fund complex's economies of scale.\681\
---------------------------------------------------------------------------

    \680\ See supra section III.C.3. This section and section IV 
also discuss the professional skills that we believe compliance with 
this aspect of the proposal would entail.
    \681\ See supra section III.E.
---------------------------------------------------------------------------

2. Board Reporting
    The requirement for board reporting by the valuation designee is 
designed to ensure that the board can exercise sufficient oversight 
over the fair value process. The final rule will require two general 
types of reports, periodic reports and prompt reports. Periodic reports 
rule will require the valuation designee to make both annual and 
quarterly written reports to the board. The quarterly reports must 
include any specific reports or materials boards request related to the 
fair value of designated investments or the valuation designee's 
process for fair valuing fund investments. In addition, the final rule 
requires a quarterly summary or description of material fair value 
matters that occurred in the prior quarter, including some specific 
summaries and descriptions. The final rule will also require an annual 
assessment of the adequacy and effectiveness of the valuation 
designee's process for determining the fair value of designated 
investments. The prompt reporting requirement will require the 
valuation designee to provide a written notification of the occurrence 
of matters associated with the valuation designee's process that 
materially affect the fair value of the designated portfolio of 
investments (defined as ``material matters'') within a time period 
determined by the board, but in no event later than five business days 
after the valuation designee becomes aware of the material matter. 
Material matters in this instance include an assessment of a 
significant deficiency or material weakness in the design or 
effectiveness of the valuation designee's fair value determination 
process or of material errors in the calculation of net asset value. 
The valuation designee must also provide such timely follow-on reports 
as the board may reasonably determine appropriate.\682\
---------------------------------------------------------------------------

    \682\ See supra section II.B.2.
---------------------------------------------------------------------------

    These requirements will impose burdens on all funds, including 
those that are small entities. The specifics of these burdens are 
discussed in the Economic Analysis and Paperwork Reduction Act sections 
above.\683\ There are different factors that will affect whether a 
smaller fund incurs costs related to this requirement that are on the 
higher or lower end of the estimated range. For example, smaller 
funds--and more specifically, smaller funds that are not part of a fund 
complex--may not have an advisory agreement that has a reporting 
mechanism that meets all the elements that will be required under the

[[Page 806]]

final rule. Also, while larger funds or funds that are part of a large 
fund complex may incur higher costs, via increased advisory fees for 
valuation designees to take on this responsibility on behalf of such 
funds, related to this requirement in absolute terms relative to a 
smaller fund or a fund that is part of a smaller fund complex, a 
smaller fund may find it more costly, per dollar managed, to comply 
with the final requirement because it will not be able to benefit from 
a larger fund complex's economies of scale.\684\
---------------------------------------------------------------------------

    \683\ See supra section III.C.3 and section IV.
    \684\ See supra section III.C.1.
---------------------------------------------------------------------------

E. Agency Action To Minimize Effect on Small Entities

    The RFA directs the Commission to consider significant alternatives 
that would accomplish our stated objective, while minimizing any 
significant economic impact on small entities. We considered the 
following alternatives for small entities in relation to our proposal: 
(1) Exempting funds that are small entities from the proposed 
reporting, recordkeeping, and other compliance requirements, to account 
for resources available to small entities; (2) establishing different 
reporting, recordkeeping, and other compliance requirements or 
frequency, to account for resources available to small entities; (3) 
clarifying, consolidating, or simplifying the requirements under the 
proposal for small entities; and (4) using performance rather than 
design standards.
    We do not believe that exempting small funds from the provisions in 
the rules would permit us to achieve our stated objectives, principally 
to protect investors from improper valuations. Further, the board 
reporting and additional recordkeeping provisions of the rules only 
affect fund boards that designate a valuation designee to perform fair 
value determinations, and, therefore, the rules will require funds to 
comply with these specific requirements only if the boards designated 
responsibilities to a valuation designee. However, we expect that most 
funds holding securities that must be fair valued will do so. 
Therefore, if a board to a small entity does not do this and instead 
performs its statutory function directly, then the small entity would 
not be subject to these provisions of the rules.
    We estimate that 72% of all funds will be subject to the rules in 
making fair value determinations.\685\ This estimate indicates that 
some funds, including some small funds, will be unaffected by the 
rules. However, for small funds that are affected by the rules, 
providing an exemption for them could subject investors in small funds 
to a higher degree of risk than investors in large funds that will be 
required to comply with the elements of the rules.
---------------------------------------------------------------------------

    \685\ See supra footnote 508 and accompanying text.
---------------------------------------------------------------------------

    As discussed throughout this release, we believe that the rules 
will result in investor protection benefits, and these benefits should 
apply to investors in smaller funds as well as investors in larger 
funds. We therefore do not believe it would be appropriate to exempt 
small funds from the rules' requirements, or to establish different 
requirements applicable to funds of different sizes under these 
provisions to account for resources available to small entities. We 
believe that all of the elements of the rules should work together to 
produce the anticipated investor protection benefits, and therefore do 
not believe it is appropriate to except smaller funds because we 
believe this would limit the benefits to investors in such funds.
    We also do not believe that it would be appropriate to subject 
small funds to different reporting, recordkeeping, and other compliance 
requirements or frequency. Similar to the concerns discussed above, if 
the rules included different requirements for small funds, it could 
raise investor protection concerns for investors in small funds in that 
small funds face the same conflicts of interest that can lead to 
mispricing and otherwise harm investors that larger funds do.
    We do not believe that clarifying, consolidating, or simplifying 
the requirements under the rules for small funds, beyond that already 
adopted for all funds, would permit us to achieve our stated 
objectives. Again, this approach would raise investor protection 
concerns for investors in small funds. We believe, as outlined above in 
the discussion of the rules and the guidance contained in this release, 
that the requirements of the rules are, to some extent, current 
industry practice under existing rules, with some changes from current 
practice. As a result, we think that the rules could result in a 
reduction in the current burdens experienced by small entities to the 
extent that they are subject to the rules.
    The costs associated with rules 2a-5 and 31a-4 will vary depending 
on a fund's particular circumstances, and thus the rules could result 
in different burdens on funds' resources. In particular, we expect that 
a fund that does not have reporting or recordkeeping practices similar 
to those that will required by the rules would need to modify those 
practices. Thus, to the extent a fund that is a small entity already 
has a fair value process that is consistent with the requirements of 
the rules, we believe it will incur relatively low costs to comply with 
it. However, we believe that it is appropriate to correlate the costs 
associated with the rules with the fund's actual fair value process, 
and not necessarily with the fund's size in light of our investor 
protection objectives.
    Finally, with respect to the use of performance rather than design 
standards, the rules generally use design standards for all funds 
subject to the rules, regardless of size. We believe that providing 
funds with the flexibility permitted in the rules with respect to 
designing specific fair value process is appropriate because of the 
fact-specific nature of making fair value determinations.

VI. Update to Codification of Financial Reporting Policies

    The Commission amends the ``Codification of Financial Reporting 
Policies'' announced in Financial Reporting Release No. 1 (April 15, 
1982) [47 FR 21028 (May 17, 1982]) as follows:
    1. By removing and reserving Section 404.03.
    2. By removing and reserving Section 404.04.
    3. By amending Section 404.05.c.2. as follows:
    a. By removing the last paragraph under the subject heading ``Fair 
Value for Thinly Traded Securities.''
    b. By removing the subject heading ``Use of Pricing Services'' and 
the paragraphs included below that subject heading.
    The Codification is a separate publication of the Commission. It 
will not be published in the Federal Register or Code of Federal 
Regulations. For more information on the Codification of Financial 
Reporting Policies, contact the Commission's Public Reference Room at 
(202) 551-5450.

Statutory Authority

    The Commission is adopting rules 2a-5 and 31a-4 under the authority 
set forth in sections 2(a), 6(c), 31(a), 31(c), 38(a), 59, and 64(a) of 
the Investment Company Act of 1940 [15 U.S.C. 80a-2(a), 80a-6(c), 80a-
30(a), 80a-31(c), 80a-37(a), 80a-58, and 80a-63(a)].

List of Subjects

17 CFR Part 210

    Accountants, Accounting, Banks, Banking, Employee benefit plans, 
Holding companies, Insurance companies, Investment companies, Oil and 
gas exploration, Reporting and

[[Page 807]]

recordkeeping requirements, Securities, Utilities.

17 CFR Part 270

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Rule Amendments

    For the reasons set out in the preamble, we are amending title 17, 
chapter II of the Code of Federal Regulation as follows:

PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL 
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 
1934, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 
1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975

0
1. The authority citation for part 210 continues to read as follows:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77aa(25), 77aa(26), 77nn(25), 77nn(26), 78c, 78j-1, 78l, 78m, 78n, 
78o(d), 78q, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-20, 80a-29, 80a-30, 
80a-31, 80a-37(a), 80b-3, 80b-11, 7202 and 7262, and sec. 102(c), 
Pub. L. 112-106, 126 Stat. 310 (2012), unless otherwise noted.


0
2. Amend Sec.  210.6-03 by revising paragraph (d) to read as follows:


Sec.  210.6-03   Special rules of general application to registered 
investment companies and business development companies.

* * * * *
    (d) Valuation of investments. The balance sheets of registered 
investment companies, other than issuers of face-amount certificates, 
and business development companies, shall reflect all investments at 
value, with the aggregate cost of each category of investment reported 
under Sec.  210.6-04 subsection 1, 2, 3, and 9 or the aggregate cost of 
each category of investment reported under Sec.  210.6-05 subsection 1 
shown parenthetically. State in a note the methods used in determining 
the value of investments. As required by section 28(b) of the 
Investment Company Act of 1940 (15 U.S.C. 80a-28(b)), qualified assets 
of face-amount certificate companies shall be valued in accordance with 
certain provisions of the Code of the District of Columbia.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
3. The general authority citation for part 270 continues to read as 
follows:

    Authority:  15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39, 
and Pub. L. 111-203, sec. 939A, 124 Stat. 1376 (2010), unless 
otherwise noted.
* * * * *

0
4. Add Sec.  270.2a-5 to read as follows:


Sec.  270.2a-5   Fair value determination and readily available market 
quotations.

    (a) Fair value determination. For purposes of section 2(a)(41) of 
the Act (15 U.S.C. 80a-2(a)(41)) and Sec.  270.2a-4, determining fair 
value in good faith with respect to a fund requires:
    (1) Assess and manage risks. Periodically assessing any material 
risks associated with the determination of the fair value of fund 
investments (``valuation risks''), including material conflicts of 
interest, and managing those identified valuation risks;
    (2) Establish and apply fair value methodologies. Performing each 
of the following, taking into account the fund's valuation risks:
    (i) Selecting and applying in a consistent manner an appropriate 
methodology or methodologies for determining (and calculating) the fair 
value of fund investments, provided that a selected methodology may be 
changed if a different methodology is equally or more representative of 
the fair value of fund investments, including specifying the key inputs 
and assumptions specific to each asset class or portfolio holding;
    (ii) Periodically reviewing the appropriateness and accuracy of the 
methodologies selected and making any necessary changes or adjustments 
thereto; and
    (iii) Monitoring for circumstances that may necessitate the use of 
fair value;
    (3) Test fair value methodologies. Testing the appropriateness and 
accuracy of the fair value methodologies that have been selected, 
including identifying the testing methods to be used and the minimum 
frequency with which such testing methods are to be used; and
    (4) Evaluate pricing services. Overseeing pricing service 
providers, if used, including establishing the process for approving, 
monitoring, and evaluating each pricing service provider and initiating 
price challenges as appropriate.
    (b) Performance of fair value determinations. The board of the fund 
must determine fair value in good faith for any or all fund investments 
by carrying out the functions required in paragraph (a) of this 
section. The board may choose to designate the valuation designee to 
perform the fair value determination relating to any or all fund 
investments, which shall carry out all of the functions required in 
paragraph (a) of this section, subject to the requirements of this 
paragraph (b).
    (1) Oversight and reporting. The board oversees the valuation 
designee, and the valuation designee reports to the fund's board, in 
writing, including such information as may be reasonably necessary for 
the board to evaluate the matters covered in the report, as follows:
    (i) Periodic reporting. (A) At least quarterly:
    (1) Any reports or materials requested by the board related to the 
fair value of designated investments or the valuation designee's 
process for fair valuing fund investments; and
    (2) A summary or description of material fair value matters that 
occurred in the prior quarter, including:
    (i) Any material changes in the assessment and management of 
valuation risks required under paragraph (a)(1) of this section, 
including any material changes in conflicts of interest of the 
valuation designee (and any other service provider);
    (ii) Any material changes to, or material deviations from, the fair 
value methodologies established under paragraph (a)(2) of this section; 
and
    (iii) Any material changes to the valuation designee's process for 
selecting and overseeing pricing services, as well as any material 
events related to the valuation designee's oversight of pricing 
services; and
    (B) At least annually, an assessment of the adequacy and 
effectiveness of the valuation designee's process for determining the 
fair value of the designated portfolio of investments, including, at a 
minimum:
    (1) A summary of the results of the testing of fair value 
methodologies required under paragraph (a)(3) of this section; and
    (2) An assessment of the adequacy of resources allocated to the 
process for determining the fair value of designated investments, 
including any material changes to the roles or functions of the persons 
responsible for determining fair value under paragraph (b)(2) of this 
section; and
    (ii) Prompt board notification and reporting. The valuation 
designee notifies the board of the occurrence of matters that 
materially affect the fair value of the designated portfolio of 
investments, including a significant deficiency or material weakness in 
the design or effectiveness of the valuation designee's fair value 
determination process, or material errors in the calculation of net 
asset value, (any such matter or error, a ``material matter'') within a 
time period determined by the

[[Page 808]]

board (but in no event later than five business days after the 
valuation designee becomes aware of the material matter), with such 
timely follow-on reporting as the board may determine appropriate; and
    (2) Specify responsibilities. The valuation designee specifies the 
titles of the persons responsible for determining the fair value of the 
designated investments, including by specifying the particular 
functions for which they are responsible, and reasonably segregates 
fair value determinations from the portfolio management of the fund 
such that the portfolio manager(s) may not determine, or effectively 
determine by exerting substantial influence on, the fair values 
ascribed to portfolio investments.
    (c) Readily available market quotations. For purposes of section 
2(a)(41) of the Act (15 U.S.C. 80a-2(a)(41)), a market quotation is 
readily available only when that quotation is a quoted price 
(unadjusted) in active markets for identical investments that the fund 
can access at the measurement date, provided that a quotation will not 
be readily available if it is not reliable.
    (d) Unit investment trusts. If the fund is a unit investment trust, 
and the initial deposit of portfolio securities into the unit 
investment trust occurs after March 8, 2021, the fund's trustee or 
depositor must carry out the requirements of paragraph (a) of this 
section. If the initial deposit of portfolio securities into the unit 
investment trust occurred before March 8, 2021, and an entity other 
than the fund's trustee or depositor has been designated to carry out 
the fair value determination, that entity must carry out the 
requirements of paragraph (a) of this section.
    (e) Definitions. For purposes of this section:
    (1) Fund means a registered investment company or business 
development company.
    (2) Fair value means the value of a portfolio investment for which 
market quotations are not readily available under paragraph (c) of this 
section.
    (3) Board means either the fund's entire board of directors or a 
designated committee of such board composed of a majority of directors 
who are not interested persons of the fund.
    (4) Valuation designee means the investment adviser, other than a 
sub-adviser, of a fund or, if the fund does not have an investment 
adviser, an officer or officers of the fund.

0
5. Add Sec.  270.31a-4 to read as follows:


Sec.  270.31a-4   Records to be maintained and preserved by registered 
investment companies relating to fair value determinations.

    (a) Appropriate documentation. Every registered investment company 
shall maintain appropriate documentation to support fair value 
determinations made pursuant to Sec.  270.2a-5 for at least six years 
from the time that the determination was made, the first two years in 
an easily accessible place.
    (b) Records when designating. If the board of a registered 
investment company has designated performance of fair value 
determinations to a valuation designee under Sec.  270.2a-5(b), in 
addition to the records required in paragraph (a) of this section, the 
registered investment company must maintain copies of:
    (1) The reports and other information provided to the board as 
required under Sec.  270.2a-5(b)(1) for at least six years after the 
end of the fiscal year in which the documents were provided to the 
board, the first two years in an easily accessible place; and
    (2) A specified list of the investments or investment types whose 
fair value determination has been designated to the valuation designee 
to perform pursuant to Sec.  270.2a-5(b) for a period beginning with 
the designation and ending at least six years after the end of the 
fiscal year in which the designation was terminated, in an easily 
accessible place until two years after such termination.
    (c) Party to maintain. If the board of a registered investment 
company has designated performance of fair value determinations to its 
investment adviser under Sec.  270.2a-5(b), such investment adviser 
shall maintain the records required by this section. If the investment 
adviser is not so designated, the fund shall maintain such records.

    By the Commission.

    Dated: December 3, 2020.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2020-26971 Filed 1-5-21; 8:45 am]
BILLING CODE 8011-01-P