Thursday, April 23, 2020
In recent years, investment funds have shifted more assets to private market securities. This can make it much more difficult to figure out how much a particular investment is worth. The SEC has proposed a new rule for valuing these sorts of investments. Comments on it will be due on July 21, 2020.
Investment Companies have to tell investors how much their stake in the fund is worth. Investments in public companies are often easy to value. The investment fund simply takes the market price of the security and uses that figure for valuation. It can become more complicated if you take into account fundamental value, the size of the position, or the ability to sell it all at a particular price. For securities without readily available market prices, the Investment Company Act calls for "using the fair value of that security, as determined in good faith by the fund’s board."
Yet how should an investment company board go about valuing its assets? The new rule would put a framework in place for that process to create more consistency.
The proposal made me think of an article by Utah's Jeff Schwartz. He looked at how one mutual fund valued its investments in venture capital funds. What he saw made him realize that we need "new rules governing how mutual funds value their startup investments, which tie changes to objective evidence, and new disclosure requirements that would shed light on the rationale for valuation changes and provide mutual-fund investors with notice that startups are in their portfolios and that these investments pose certain risks." Hopefully the SEC's final rule will be informed by this work.