Sign up today and take advantage of member-only content — the kind of timely, cutting edge industry insight that only Money Management Executive can deliver.
  • Exclusive Online Only Content
  • Free Daily Email News Alerts
  • Asset Management Blogs

Certain Funds Are at Risk for Fair Value Accounting Treatment


The Investment Company Act of 1940 requires that funds use fair value pricing' when the market quotation for a security is not readily available. Of course, that doesn't affect the vast majority of securities in mutual funds because their market prices are widely available.

However, if there is a thin market in a security or sales have been infrequent, or if the security in question is traded on a foreign market that has different standards and is in a different time zone, prices may not be pure. Consequently, funds that are affected are usually those with high risk. It affects bond funds that hold illiquid bonds, funds with very small equities, and global and international funds.

In 1999, funds sought guidelines on fair value pricing procedures because of concerns about Y2K as well as the Asian markets crisis that had occurred two years earlier.

"In 1999, and even a little before that, we got a lot of questions about fair valuation," said Evan Geldzahler, special counsel in the SEC's division of investment management. "We hadn't really said much since 1970 on fair valuation and we looked into it and had a study done."

That study examined 15 investment companies and their response to the 1997 Asian markets crisis. What the Commission found was that only two of them, Fidelity and T. Rowe Price, had used fair value pricing, and eight out of the 15 did not even have fair value procedures in place. The SEC wrote a preliminary letter to clarify what its policies were, but there were a lot of questions about it and the fund community asked further guidance leading to the 2001 letter, according to Capone.

In the middle of all this came several high-profile enforcement actions. The most notable case was when Heartland Advisors allegedly adopted fair value pricing procedures for two of its junk bond funds. That resulted in one-day drops in the NAVs of 44% and 70% and elicited class action suits and SEC sanctions. While those price valuations were separate from the SEC's recent focus on foreign markets, they have proved significant because they brought the issue abruptly in front of investors, Capone said.

And while the current emphasis has been on foreign markets, the attention is likely to shift eventually to how funds that hold illiquid bonds should monitor those prices, Capone said.