44. Should the rule require assigned advisers to reasonably
segregate the process of making fair value determinations from the
portfolio management of the fund? Would this pose any difficulty for
particular types of entities, for example funds managed by small
advisers?
    45. Is there a better way to prevent conflicts between a portfolio
manager's incentives and a fund's interest, for example, in
determination of investment values that do not result in dilution of
purchasing or redeeming investors? Should we provide any additional
clarification regarding the proposed reasonable segregation
requirement? If so, what changes should we make? Should we add or
change any specific requirements? For example, should we prohibit
portfolio management from having any involvement in the fair value
process or should we generally prohibit their involvement outside of
certain situations beyond making fair value determinations? If so, what
level of involvement should we permit? Further, should we exempt
smaller advisers from this requirement or clarify that this is a key
risk and thus, where feasible, such personnel should be segregated,
without making segregation an explicit regulatory requirement? Are
there effective steps, other than segregation, that funds currently use
to manage the potential conflicts of portfolio management personnel
that the rule should require instead of segregation? If so, what are
they and why should they be required instead?
4. Records of Assignment
    Under the proposed rule, in addition to the records that would need
to be kept as part of a good faith determination of fair value
generally, a fund must also keep records related to the fair value
determinations assigned to the adviser. Specifically, the fund would be
required to: (1) Keep copies of the reports and other information
provided to the board required by the rule and (2) a specified list of
the investments or investment types whose fair value determinations
have been assigned to the adviser pursuant to the requirements of the
proposed rule.\123\ In each case, these records would be required to be
kept for at least five years after the end of the fiscal year in which
the documents were provided to the board or the investments or
investment types were assigned to the adviser, the first two years in
an easily accessible place.\124\
---------------------------------------------------------------------------

    \123\ Proposed rule 2a-5(b)(3).
    \124\ Proposed rule 2a-5(b)(3).
---------------------------------------------------------------------------

    As discussed above, funds must create and retain certain
documentation, including the reports that advisers make to the fund
board.\125\ Further, we believe that a clear identification of the
investments or investment types that the board has assigned to the
adviser would facilitate the board's oversight of the adviser's fair
value determinations.\126\ These proposed recordkeeping requirements
are designed to achieve these objectives and to facilitate compliance,
and related regulatory oversight, with the proposed rule.
---------------------------------------------------------------------------

    \125\ See supra section II.A.6.
    \126\ Proposed rule 2a-5(b)(3).
---------------------------------------------------------------------------

    We request comment on these proposed additional recordkeeping
requirements.
    46. Are there any additional types of records that we should
require the fund to maintain in connection with the assignment process?
Why or why not?
    47. Should we apply any or all of the proposed recordkeeping
requirements of this section to the adviser, rather than the fund? If
so, which requirements?
    48. Are the holding periods sufficient to evidence compliance? Why
or why not? Should they be different (e.g., six years)?

C. Readily Available Market Quotations

    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. Under section 2(a)(41) of the
Investment Company Act, if a market quotation is readily available for
a portfolio holding, it must be valued at the market value. Conversely,
if market quotations are ``not readily available,'' the holding's value
must be fair value as determined in good faith by the board.\127\
---------------------------------------------------------------------------

    \127\ Section 2(a)(41).
---------------------------------------------------------------------------

    Neither the Investment Company Act nor the rules thereunder
currently define ``readily available.'' However, we understand that
industry practice has developed to incorporate many of the concepts of
ASC Topic 820 when evaluating whether market quotations are readily
available.\128\
---------------------------------------------------------------------------

    \128\ We acknowledge that specific references and principles in
U.S. GAAP may change over time. 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.
---------------------------------------------------------------------------

    The proposed rule would provide that a market quotation is readily
available for purposes of section 2(a)(41) of the Investment Company
Act with respect to an investment 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.\129\ Fair value, as
defined in the Act, therefore must be used in all other
circumstances.\130\ As discussed previously, we believe that for a fair
value methodology to be appropriate under the proposed rule, it must be
determined in accordance with U.S. GAAP. As mentioned above, U.S. GAAP
requires funds to maximize the use of relevant observable inputs and
minimize the use of unobservable inputs. However, under U.S. GAAP there
are circumstances where otherwise relevant observable inputs become
unreliable.\131\ Consistent with this, a quote would be considered
unreliable under proposed rule 2a-5(c) in the same circumstances 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 current U.S. GAAP, funds looking to
the proposed rule would 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.\132\ In

such circumstances, the fund would need to fair value the security.
---------------------------------------------------------------------------

    \129\ Proposed 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.
    \130\ Proposed rule 2a-5(e)(2). See also supra section II.A.2.
    \131\ See ASC Topic 820-10-35-41C (outlining circumstances when
a reporting entity shall make an adjustment to a Level 1 input).
    \132\ See id. at b.
---------------------------------------------------------------------------

    As we have stated previously, evaluated prices are not, by
themselves, readily available market quotations.\133\ In addition,
``indications of interest'' and ``accommodation quotes,'' for example,
would not be ``readily available market quotations'' for the purposes
of proposed rule 2a-5.\134\
---------------------------------------------------------------------------

    \133\ See 2014 Money Market Fund Release supra footnote 14, at
text accompanying n.895.
    \134\ See Liquidity Risk Management Release, supra footnote 3,
at nn.800-801 and accompanying text.
---------------------------------------------------------------------------

    We request comment on our proposed definition of when market
quotations are readily available for purposes of section 2(a)(41) and
rule 2a-4.
    49. Is the proposed definition of when market quotations are
readily available under the Investment Company Act appropriate? Should
we look elsewhere than or in addition to ASC Topic 820?
    50. How should we address investments in pooled vehicles, such as
registered investment companies, that are valued at NAV, not at a
market price? Do funds currently treat such investments as securities
that are fair valued? What would be the burdens on boards of funds that
invest substantially in such vehicles (e.g., funds of funds)? To the
extent that a board assigned the determination of fair values of such
investments to a fund's adviser, would the adviser's use of NAV involve
the conflicts of interest or other concerns underlying paragraph (b) of
the proposed rule?
    51. Would this provision cause any compliance issues with other
elements of the proposed rule, ASC Topic 820, or any other provision of
the federal securities laws?
    52. This definition is designed to track concepts in U.S. GAAP.
Should we instead expressly refer to U.S. GAAP in the rule text to
ensure that consistency with U.S GAAP in case of changes over time? For
example, should the rule instead provide that ``market quotations are
readily available for purposes of section 2(a)(41) of the Act with
respect to an investment only when the investment's value is determined
under generally accepted accounting principles of the United States
based solely on quoted, unadjusted prices in active markets for
identical investments that the fund can access at the measurement
date?''
    53. Should the Commission define readily available market
quotations via rulemaking as proposed, or should we instead provide
interpretive guidance?
    54. Do practitioners understand what it means in this context for
the fund to have access to identical investments at the measurement
date? Should some other standard be used, such as ``readily access'' or
``reasonably access''?

D. Rescission of Prior Commission Releases

    In ASR 113 and ASR 118, the Commission provided specific guidance
for funds regarding the ``inclusion'' (or recognition), ``valuation''
(or measurement), and disclosure of investment securities.\135\ Since
the Commission issued that guidance, we believe that developments in
the FASB accounting standards have modernized the approach to
accounting topics addressed in ASR 113 and ASR 118. Further, as noted
above, market and fund investment practices have evolved
considerably.\136\ As a result, the fund-specific accounting guidance
for recognition, measurement, and disclosure provided in those
statements may no longer be necessary.
---------------------------------------------------------------------------

    \135\ See ASR 113 (``1. The Problems of Valuation'' and ``2. The
Problems of Portfolio Management''); ASR 118. ASR 118 refers to the
concepts of ``inclusion'' and ``valuation'' of securities in the
portfolio, which we believe are equivalent to the U.S. GAAP concepts
of recognition and measurement, respectively.
    \136\ See supra section I.
---------------------------------------------------------------------------

    Several examples illustrate how FASB accounting standards have
addressed the topics covered in the ASRs. First, ASR 118 provides
guidance related to the ``inclusion,'' or recognition, of securities in
a portfolio. Today, U.S. GAAP provides authoritative standards
applicable to the recognition of investments by investment companies
for financial reporting purposes.\137\ For example, ASC Topic 946:
Financial Services--Investment Companies (``ASC Topic 946'') requires
that an investment company recognize security purchases and sales as of
the date on which the investment company agrees to purchase or sell the
investment.\138\ It also provides that securities acquired in private
placements and tender offers are required to be recognized as of the
date the investment company obtained legal rights and obligations
relating to the transferred securities.\139\
---------------------------------------------------------------------------

    \137\ Rule 2a-4(a)(2) under the Investment Company Act provides
that, for purposes of calculating the NAV of a redeemable security,
``changes in holdings of portfolio securities shall be reflected no
later than in the first calculation on the first business day
following the trade date.'' The ``first business day following the
trade date'' is commonly referred to as T+1. We believe that our
proposed rescission of ASR 113 and ASR 118 is consistent with the
provisions of rule 2a-4.
    \138\ See ASC 946-320-25-1.
    \139\ See ASC 946-320-25-2.
---------------------------------------------------------------------------

    In addition, ASRs 113 and 118 provide guidance related to the
valuation and disclosure of securities for financial reporting
purposes. Again, U.S. GAAP provides authoritative standards applicable
to the measurement of fund investments and related disclosures for
financial reporting purposes. For example, ASC Topic 946 requires that
investment companies measure investments in debt and equity securities,
as well as other investments, at fair value.\140\ ASC Topic 820, in
turn, defines ``fair value'' as ``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.'' \141\ ASC Topic
820 also provides a framework for measuring fair value as well as
principles for financial statement disclosures.\142\
---------------------------------------------------------------------------

    \140\ See ASC 946-320-35-1 and ASC 946-325-35-1.
    \141\ As noted above, the term ``fair value'' is used in
sections II.A and II.B as defined in ASC Topic 820. See supra
footnote 13.
    \142\ ASC Topic 820 defines fair value at ASC 820-10-20. See
also ASC Topic 820-10-50.
---------------------------------------------------------------------------

    The Commission historically has recognized FASB pronouncements as
authoritative for financial reporting purposes in the absence of any
contrary Commission determination.\143\ In Financial Reporting Release
No. 70,\144\ the Commission stated its determination that the FASB and
its parent organization, the Financial Accounting Foundation, satisfied
the criteria in section 19(b) of the Securities Act and, accordingly,
FASB financial accounting and reporting standards are recognized as
``generally accepted'' under the federal securities laws.\145\ As a
result, registrants are required to comply with those standards for
recognition, measurement and disclosure in preparing financial
statements filed with the Commission, unless the Commission provides
otherwise.\146\ Accordingly, we believe ASR 113 and ASR 118 are not
necessary to clarify fund obligations with respect to these accounting
topics. We further believe that, because the guidance contained in ASR
113 and ASR 118, on the one hand, and U.S. GAAP, on the other, require
funds to reach similar results with respect to the recognition,
measurement, and disclosure of fund portfolio holdings, such guidance
is not necessary to supplement the requirements of U.S. GAAP. We
believe that the measurement concepts under

ASC Topic 820 are consistent with the Investment Company Act and the
Commission's prior statements that fair value is the amount that an
owner of a portfolio holding might reasonably expect to receive upon
its ``current sale.'' \147\ As a result, we propose to rescind the
Commission's prior guidance in ASR 113 and ASR 118.\148\ Additionally,
in light of the Sarbanes-Oxley Act giving the PCAOB the authority to
establish or adopt professional standards for auditors, subsequent to
the release of the Commission guidance in ASR 118, we no longer believe
that it is necessary to retain the specific requirement in ASR 118 for
an independent accountant of a fund to verify all quotations for
securities with readily available market quotations at the balance
sheet date. Accordingly, we are proposing to rescind ASR 118, including
this specific requirement.\149\
---------------------------------------------------------------------------

    \143\ See Rule 4-01(a)(1) of Regulation S-X [17 CFR 210.4-
01(a)(1)]. See also ASR 150 (Dec. 20, 1973) and ASR 4 (Apr. 25,
1938).
    \144\ Policy Statement: Reaffirming the Status of the FASB as a
Designated Private-Sector Standard Setter, Investment Company Act
Release No. 26028 (Apr. 25, 2003) [68 FR 23333 (May 1, 2003)] (``FR-
70'').
    \145\ 15 U.S.C 77s(b).
    \146\ See FR-70, supra footnote 144; rule 4-01(a)(1) of
Regulation S-X.
    \147\ In ASR 118 the Commission stated that, as a general
principle, fair value of a security would be the amount that a fund
might reasonably expect to receive for the security upon its current
sale. (The ``current sale'' standard also is referred to as the
``exit price'' standard.) In U.S. GAAP, ASC Topic 820 defines fair
value as the price that would be received to sell an asset or paid
to transfer a liability between market participants at the
measurement date under current market conditions (an exit price).
    \148\ We also are proposing to make conforming amendments to 17
CFR 210.6-03 (rule 6-03 of Regulation S-X).
    \149\ The proposed rescission would eliminate the Commission's
auditing guidance to verify all quotations of securities with
readily available market quotations at the balance sheet date,
implicating the auditor's requirement to test the valuation
assertion for all securities. This proposal does not impact the
statutory requirement in section 30(g) of the Investment Company
Act, which requires the independent public accountant to verify
securities owned, either by actual examinations, or by receipt of a
certificate from the custodian, which implicates the auditor's
requirement to test the existence assertion for all securities. The
statutory requirement under section 30(g) of the Investment Company
Act remains distinct from the requirements in auditing standards
established by the PCAOB.
---------------------------------------------------------------------------

    In addition to the discussions in ASR 113 and ASR 118 regarding
accounting, auditing, and the role of the board in determining fair
value, these releases also discuss other matters. Because we believe
that many of these statements would be superseded by the rule we are
proposing here, or have also been superseded by subsequent requirements
under U.S. GAAP, we propose to rescind ASR 113 and ASR 118 in their
entirety.\150\ We continue to believe that the improper valuation of
fund investments that materially affects the NAV of the shares being
offered or, in the case of an open-end fund, redeemed, could violate
the anti-fraud provisions of the federal securities laws.\151\
---------------------------------------------------------------------------

    \150\ The discussion of liquidity in ASR 113 under the heading
``2. The Problems of Portfolio Management'' has been rendered moot
by the adoption of rule 22e-4 on liquidity risk management programs.
The discussion in ASR 113 under the heading ``3. The Problem of
Disclosure'' has been rendered obsolete by the repeal of Form N-8B-1
and the adoption of our current disclosure forms. See, e.g.,
Investment Company Registration and Report Forms and Reporting
Requirements, Revision of Forms, Reports and Regulations, Investment
Company Act Release No. 10378 (Aug. 28, 1978) (``Forms N-1 and N-2 .
. . replace Form N-8B-1''); Registration Form Used by Open-End
Management Investment Companies; Guidelines, Investment Company Act
Release No. 13436 (Aug. 22, 1983) (Form N-1A replaces Form N-1);
Form N-1A; Form N-2.
    \151\ See also ASR 113.
---------------------------------------------------------------------------

    We do not propose to modify the Commission's prior guidance
regarding the use of the amortized cost method because the Commission
recently considered this topic in the 2014 Money Market Fund Release,
and we do not believe that further guidance in this area is required at
this time.\152\
---------------------------------------------------------------------------

    \152\ See 2014 Money Market Fund Release supra footnote 14. See
also Accounting Series Release No. 219, Valuation of Debt
Instruments by Money Market Funds and Certain Other Open-End
Investment Companies, (May 31, 1977) (stating that, under certain
circumstances, funds may determine the fair value of debt securities
that mature in 60 days or fewer by using the amortized cost method).
---------------------------------------------------------------------------

    55. Do commenters agree that all of the guidance provided in ASR
113 and ASR 118 has been rendered unnecessary by subsequent
developments, including developments in the fund industry, subsequent
Commission statements, rulemakings, and developments related to U.S.
GAAP, and the requirements of the proposed rule, if adopted? Is there
any guidance contained in either of ASR 113 and ASR 118, accounting or
otherwise, that commenters believe it is necessary or desirable to
retain?
    56. To the extent prior guidance has not already been incorporated
into U.S. GAAP, is there any prior guidance that should be recommended
for incorporation into U.S. GAAP by the FASB?
    57. We have previously stated that fair value is what ``the owner
might reasonably expect to receive . . . upon [a] current sale.'' \153\
Are the concepts of ``current sale'' in ASR 118 and ``exit price'' in
U.S. GAAP identical? If not, what are the differences between the two
standards and how should we address such gap?
---------------------------------------------------------------------------

    \153\ ASR 118.
---------------------------------------------------------------------------

    58. The proposal does not address the views the Commission has
expressed related to the use of amortized cost in valuing portfolio
securities with maturity dates of 60 days or less.\154\ Is there other
valuation guidance that the proposal should address? Do funds or
advisers look to any other guidance on valuation that would be relevant
for the Commission to address?
---------------------------------------------------------------------------

    \154\ See 2014 Money Market Fund Release, supra footnote 14.
These views were codified in the ``Codification of Financial
Reporting Policies'' at section 404.05.c.
---------------------------------------------------------------------------

    59. Our proposal to rescind ASR 118 would eliminate the
Commission's statement in that release regarding verification by an
independent accountant of all quotations for securities with readily
available market quotations at the balance sheet date. Should we
maintain that position regarding independent verification of quotations
for all securities for which market quotations are available? What are
the benefits or costs associated with independent verification of
quotations for all portfolio investments?
    60. Is there any other Commission valuation rule (such as rule
6.02(b) of Regulation S-X) or guidance that we should consider
rescinding or amending in light of the proposal? If so, why?

E. Existing Staff No-Action Letters, Other Staff Guidance, and Proposed
Transition Period

    In addition to the proposal to rescind ASR 113 and ASR 118, certain
staff letters and other staff guidance addressing a board's
determination of fair value and other matters covered by proposed rule
2a-5 would be withdrawn or rescinded in connection with any adoption of
this proposal. Upon the adoption of any final rule, some letters and
other guidance, or portions thereof, would be moot, superseded, or
otherwise inconsistent with the final rule and, therefore, would be
withdrawn or rescinded. If commenters believe that additional letters
or other guidance, or portions thereof, should be withdrawn or
rescinded, they should identify the letter or guidance, state why it is
relevant to the proposed rule, how it or any specific portion thereof
should be treated, and the reason therefor. Based on the proposed rule,
staff letters and guidance that would be withdrawn or rescinded would
include, but would not necessarily be limited to, all of the staff
letters and other staff guidance listed below.

------------------------------------------------------------------------
             Name                      Date                Topic
------------------------------------------------------------------------
Paul Revere Investors, Inc....  Feb. 21, 1973....  Delegation to a board
                                                    valuation committee.
The Putnam Growth Fund and      Jan. 23, 1981....  Fair value of
 Putnam International Equities                      portfolio securities
 Fund, Inc..                                        which trade on a
                                                    closed foreign
                                                    exchange.
Form N-7 for Registration of    Mar. 17, 1987....  Fair value for UITs
 Unit Investment Trusts under                       to be determined by
 the Securities Act of 1933                         the trustee or its
 and the Investment Company                         appointed person.
 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.
Valuation Guidance Frequently   2014.............  Fund directors'
 Asked Questions (FAQ 1 only).                      responsibilities
                                                    when determining
                                                    whether an evaluated
                                                    price provided by a
                                                    pricing service, or
                                                    some other price,
                                                    constitutes fair
                                                    value.
------------------------------------------------------------------------

    We also are proposing a one-year transition period to provide time
for funds and their advisers to prepare to come into compliance with
proposed rule 2a-5. Accordingly, we propose that the effective date of
any adoption of this proposal would be one year following the
publication of the final rule in the Federal Register. We propose to
rescind ASR 113 and 118 at that time, and the identified guidance would
be withdrawn.
    We request comment on the proposed rescissions and transition
period.
    61. Are there any other staff letters or guidance pieces that
should be rescinded or withdrawn should proposed rule 2a-5 be adopted?
    62. Alternatively, should the Commission codify any staff letters
or other staff guidance pieces, for example, FAQ 2 in the 2014
Valuation Guidance Frequently Asked Questions? If so, commenters should
identify the positions and explain why commenters believe they should
be codified.
    63. Do commenters agree that a one-year transition period to
provide time for funds and their advisers to prepare to come into
compliance with proposed rule 2a-5 is appropriate? Should the period be
shorter or longer?
    64. Should the transition period be the same for all funds that
would be subject to proposed rule 2a-5, as proposed? Alternatively,
should we adopt tiered transition periods for smaller entities? For
example, should we provide an additional six months in the transition
period for smaller entities (or some other shorter or longer period)?
    65. Instead of a fixed transition period of one year, should we tie
the transition period to the fiscal year end of funds? For example,
should the transition period instead start for each fund at the
beginning of its fiscal year end after the one-year period following
adoption of any rule?

III. Economic Analysis

A. Introduction

    The proposed rule would 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 would involve assessing and
managing material risks associated with fair value determinations;
selecting, applying, and testing fair value methodologies; evaluating
any pricing services used; adopting and implementing certain written
policies and procedures; and maintaining certain records.\155\ The
proposed rule would permit a fund's board of directors to assign the
fair value determination relating to any or all fund investments to an
investment adviser of the fund, which would carry out all of the
functions required under the rule, subject to board oversight and
certain reporting, recordkeeping, and other requirements designed to
facilitate the board's ability to effectively oversee the adviser's
fair value determinations.\156\ Finally, the proposed rule would define
when market quotations are readily available for purposes of section
2(a)(41) of the Act.\157\ We are sensitive to the economic effects that
may result from the proposed rule, including the benefits, costs, and
the effects on efficiency, competition, and capital formation.\158\
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.
---------------------------------------------------------------------------

    \155\ See proposed rule 2a-5(a).
    \156\ See proposed rule 2a-5(b).
    \157\ See proposed rule 2a-5(c).
    \158\ Our analysis of the proposed rule takes into account the
rescission of ASR 113 and ASR 118 as well as the withdrawal and
rescission of certain staff letters and other guidance addressing a
board's determination of fair value and other matters covered by
proposed rule 2a-5 (see Sections II.D. and II.E. above).
---------------------------------------------------------------------------

    The proposed rule would provide a consistent framework for boards
to comply with their obligations under section 2(a)(41) of the
Investment Company Act and would permit boards to assign fair value
determinations to an investment adviser, which would carry out all of
the functions required under the proposed rule, subject to oversight
and other conditions. Permitting a fund's board to assign fair value
determinations to an investment adviser recognizes the developments
discussed in Section I above, including the increased complexity of
many fund portfolios and the in-depth expertise needed to accurately
fair value such complex investments. The proposed rule also recognizes
the important role that fund investment advisers now play and the
expertise they provide in the fair value determination process given
market and regulatory developments over the past fifty years.
Permitting a fund's board to assign fair value determinations to the
adviser would allow the board to focus its time and attention on other
matters related to the fund, such as the oversight of the investment
adviser. This could lead to a more efficient use of boards' resources
and therefore improve funds' governance for the benefit of fund
investors. The proposed rule would impose one-time costs to funds to
review the proposed rule's requirements and modify their fair value
practices, policies and procedures, reporting, and recordkeeping to
comply with the proposed rule. Further, to the extent that fair value
determinations would be assigned to a fund's investment adviser, the
investment adviser may have to incur ongoing costs to satisfy the new
fair value obligations. The investment adviser ultimately may pass
through some of these ongoing costs to funds and their investors.
    We discuss the potential effects of the proposed rule as well as
possible alternatives to the proposed rule 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 proposed rule. 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 proposed rule, we
provide a qualitative assessment of the potential effects and encourage
commenters to provide data and information that would help quantify the
benefits, costs, and the potential impacts of the proposed rule on
efficiency, competition, and capital formation.

B. Economic Baseline

1. Current Regulatory Framework
    To understand the effects of the proposed rule, we compare the
proposed rule's requirements to the current regulatory framework and
current industry practices. As discussed in greater detail in Section I
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.\159\
---------------------------------------------------------------------------

    \159\ See supra footnotes 1, 12, 14, and 26. See also Section I
for a discussion of other aspects of funds' regulatory framework
that are related to boards' fair value role (e.g., the Sarbanes-
Oxley Act and 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. As
discussed above, the Commission acknowledged 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). 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.\160\ In addition, the
Commission stated that boards should consider all appropriate factors
relevant to the fair value of securities for which market quotations
are not readily available.\161\ 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.\162\ 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.'' \163\ 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.'' \164\ In addition, the Commission
discussed in that release the factors that the fund's board of
directors may want to consider ``before deciding to use evaluated
prices from a pricing service to assist it in determining the fair
values of a fund's portfolio securities.'' \165\
---------------------------------------------------------------------------

    \160\ See supra footnote 14.
    \161\ See supra footnote 15.
    \162\ ASR 118 supra footnote 16.
    \163\ 2014 Money Market Fund Release, supra footnote 14.
    \164\ Id.
    \165\ Id.
---------------------------------------------------------------------------

    Finally, the Compliance Rules Adopting Release stated the
Commission's view that rule 38a-1 requires compliance policies and
procedures with respect to fair value.\166\
---------------------------------------------------------------------------

    \166\ Compliance Rules Adopting Release, supra footnote 26, at
74718.
---------------------------------------------------------------------------

2. Current Practices

    Our understanding of boards' current fair value practices is based
on fund disclosures, staff discussions with industry representatives,
staff's experience, and review of relevant industry publications and
academic papers.\167\ We expect that fund's policies and procedures
generally reflect their fair value practices.\168\ We discuss below our
understanding of current practices but acknowledge that practices may
vary across funds and through time. We lack detailed data on the fair
value practices of each individual fund and fund board, but, based on
available inputs, we preliminarily believe that many of the
requirements of the proposed rule are generally similar to current
practice. We request data and other information on current fund
practices in Section III.E below.\169\
---------------------------------------------------------------------------

    \167\ See, e.g., Investment Company Institute, Independent
Directors Council, ICI Mutual Insurance Company, The Role of the
Board, Spring 2005 (``ICI and IDC Report''); K&L Gates, Mutual Fund
Valuation and Liquidity Procedures, 2013 (``K&L Report''); K&L
Gates, Mutual Fund Pricing and Fair Valuation, 2016; MFDF Valuation
Report, see supra footnote 97.
    \168\ See, e.g., ICI and IDC Report, supra footnote 167, at 6-7.
    \169\ Funds have discretion in the type of disclosures they
provide regarding their fair value determinations. Our review of N-
1A, 485APOS, 485BPOS, N-2, and POS 8C Forms filed with the
Commission between January 1, 2019 and December 31, 2019 showed that
only 13% of the open-end funds and closed-end funds disclose
information related to board's fair value practices, out of which
37% explicitly state that the investment adviser assists the board
in the fair value determinations. Nevertheless, the results of our
review should be interpreted with caution because funds' disclosures
of fair value practices are unstructured and results may be
sensitive to the algorithm used to identify those disclosures.
---------------------------------------------------------------------------

    Fair Value Calculation. Most fund boards do not play a day-to-day
role in the pricing of fund investments.\170\ Typically, an investment
adviser to the fund or other service providers perform the actual day-
to-day fair value calculations.\171\ In addition to performing day-to-
day calculations, investment advisers also typically assist the board
in developing the fund's fair value methodologies.\172\
---------------------------------------------------------------------------

    \170\ See, e.g., Investment Company Institute, Independent
Directors Council, ICI Mutual Insurance Company, An Introduction to
Fair Valuation, Spring 2005 (``ICI Fair Valuation Report''), at 7.
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 97, at 9.
    \171\ See, e.g., MFDF Valuation Report, supra footnote 97, at 4.
    \172\ See, e.g., K&L Report, supra footnote 167, at 14; MFDF
Valuation Report, supra footnote 97, at 11.
---------------------------------------------------------------------------

    Fair Value Practices--Assess and manage risks. It is our
understanding that boards play an important role in identifying and
managing the fund's valuation risks.\173\ 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 securities 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 securities, 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.\174\ Funds' valuation practices generally focus on
mitigating potential conflicts of interest of the investment adviser as
well as conflicts of interest of other parties that assist the board
with fair value determinations (e.g., portfolio managers).\175\ In
particular, some investment advisers currently have in place processes
to address potential conflicts of interest when portfolio management
personnel provides input regarding valuation for a fund.\176\
---------------------------------------------------------------------------

    \173\ See, e.g., MFDF Valuation Report, supra footnote 97, at 6-
8; Deloitte Insights, 2019. Fair valuation pricing survey, 17th
edition, executive summary (``Deloitte Survey''), at 10. We lack
information on how the Deloitte survey sample was constructed or how
the survey data was collected and 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 the Commission staff's experience and in line with
practices as described in prior Commission staff's letters. See,
e.g., staff letters in Section II.E.
    \174\ See, e.g., MFDF Valuation Report, supra footnote 97, at 6-
8.
    \175\ 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 173, at 10. The cited statistic does not
imply that the remaining funds do not have policies in place to
manage conflicts of interest of investment advisers but it means
that any such policies may not be valuation specific.
    \176\ See, e.g., MFDF Valuation Report, supra footnote 97, at 9.
---------------------------------------------------------------------------

    Valuation risks can change with changes in market conditions and
changes in fund investments. Hence, funds may periodically review any
previously-identified valuation risks.\177\ 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 securities as
part of the assessment and management of previously identified
risks.\178\
---------------------------------------------------------------------------

    \177\ See, e.g., MFDF Valuation Report, supra footnote 97, at 8.
    \178\ 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 173, at 10.
---------------------------------------------------------------------------

    Fair Value Practices--Establish fair value methodologies. Further,
it is our understanding that funds that invest in securities that are
fair valued have in place written policies and procedures that detail
the methodologies used when calculating fair values.\179\ The
methodologies often establish a suggested ranking of the pricing
sources that an adviser should use when valuing securities, and
different rankings can be established for different types of
securities.\180\ Many funds periodically review the appropriateness and
accuracy of the methodologies used in valuing securities and make any
necessary adjustments.\181\ Further, funds generally monitor the
circumstances that may necessitate the use of fair values.\182\ 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.\183\
---------------------------------------------------------------------------

    \179\ See, e.g., ICI and IDC Report, supra footnote 167, at 6-7;
MFDF Valuation Report, supra footnote 97, at 5.
    \180\ See, e.g., MFDF Valuation Report, supra footnote 97, at 5.
    \181\ 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 173, p. 9
and 14.
    \182\ See, e.g., MFDF Valuation Report, supra footnote 97, at 5.
    \183\ See, e.g., ICI and IDC Report, supra footnote 167, at 6-7
and 10-11; MFDF Valuation Report, supra footnote 97, at 5.
---------------------------------------------------------------------------

    Fair Value Practices--Test fair value methodologies. We understand
that funds generally test the appropriateness and accuracy of the
internally selected methodologies used to value securities. Funds may
utilize methods such as back-testing to review the appropriateness and
accuracy of the methodologies used.\184\ 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 changes in prices beyond a certain threshold.\185\
---------------------------------------------------------------------------

    \184\ See, e.g., ICI Fair Valuation Report, supra footnote 170,
at 17-18.
    \185\ See, e.g., ICI and IDC Report, supra footnote 167, at 6-
78.
---------------------------------------------------------------------------

    Fair Value Practices--Identify responsibilities. Based on our
understanding of current industry practices, we believe that funds
generally allocate fair value functions,\186\ which may be reflected in
a written charter or the fund's valuation policies and procedures.\187\
As discussed above, an investment adviser to the fund assists the board
with the day-to-day fair-value process. This allocation of valuation
functions can help boards understand and monitor the level of
involvement of portfolio managers in the valuation process. Portfolio
managers can provide valuable inputs to the valuation of fund
securities, but they are subject to conflicts of interest. Some boards
create separate valuation committees with clearly established functions
that help the board provide oversight of the investment advisers'
valuation practices.\188\ 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 investment adviser personnel or board
members should be notified when fair value issues arise that are not
addressed in existing fair value policies and procedures.\189\
---------------------------------------------------------------------------

    \186\ See generally MFDF Valuation Report, supra footnote 97, at
9; ICI and IDC Report, supra footnote 167, at 8-10.
    \187\ See, e.g., ICI and IDC Report, supra footnote 167, at 10.
    \188\ See, e.g., ICI and IDC Report, supra footnote 167, at 8-
10.
    \189\ See, e.g., ICI and IDC Report, supra footnote 167, at 7.
---------------------------------------------------------------------------

    Fair Value Practices--Evaluate Pricing Services. We understand that
funds frequently use third-party pricing service providers to assist in
determining fair values.\190\ 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.\191\ Boards may develop an understanding of the
circumstances in which third-party pricing services would provide
assistance in securities valuation.\192\ 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
investment adviser performed adequate due diligence when selecting the
service.\193\ 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 pricing service's presentations to the board,
investment 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 securities and maintains an adequate
control

environment.\194\ Further, boards may seek to understand the
circumstances under which the adviser may override the prices obtained
by the pricing service provider.\195\
---------------------------------------------------------------------------

    \190\ See, e.g., MFDF Valuation Report, supra footnote 97, at
10; ICI and IDC Report, supra footnote 167, at 10-11.
    \191\ See, e.g., ICI and IDC Report, supra footnote 167, at 11.
    \192\ See, e.g., MFDF Valuation Report, supra footnote 97, at
10.
    \193\ See, e.g., MFDF Valuation Report, supra footnote 97, at
11.
    \194\ See, e.g., MFDF Valuation Report, supra footnote 97, at
11.
    \195\ See, e.g., MFDF Valuation Report, supra footnote 97, at
10-11.
---------------------------------------------------------------------------

    Board Reporting. As part of their current fair value practices,
boards may review on a periodic basis reports regarding the fair value
of fund securities.\196\ Many boards review fair value determinations
quarterly but some boards review the determinations more or less
frequently depending on the type of fund securities and the market
conditions.\197\ Boards also may have ad-hoc discussions on valuation
matters outside of their regular meetings.\198\ Boards may consider the
information they want in valuation reports, and, in some circumstances,
a board member may play an active role in shaping the content of the
valuation reports given to the board.\199\ The content of reports the
boards receive depends on the type of fund and fund investments.\200\
The type of general information that the boards may receive include a
summary of back-testing data and an analysis of the impact of fair
values on the fund's NAV.\201\ The reports also may include more
specific information about securities that are more difficult to value,
such as the fair values assigned to each security, 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.\202\ Some board reports may
also include security-specific information in cases where investment
advisers override prices provided by pricing services.\203\ 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.\204\
---------------------------------------------------------------------------

    \196\ See, e.g., ICI and IDC Report, supra footnote 167, at 12-
13.
    \197\ See, e.g., MFDF Valuation Report, supra footnote 97, at
10. See also Deloitte Survey, supra footnote 173, 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.
    \198\ See, e.g., MFDF Valuation Report, supra footnote 97, at
14.
    \199\ See, e.g., MFDF Valuation Report, supra footnote 97, at
14.
    \200\ See, e.g., MFDF Valuation Report, supra footnote 97, at
14.
    \201\ See, e.g., ICI and IDC Report, supra footnote 167, at 12.
    \202\ See, e.g., ICI and IDC Report, supra footnote 167, at 12-
13.
    \203\ See, e.g., ICI and IDC Report, supra footnote 167, at 13.
See also Deloitte Survey, supra footnote 173, 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.
    \204\ See, e.g., ICI and IDC Report, supra footnote 167, at 13.
---------------------------------------------------------------------------

    Valuation reports may vary depending on the volume and complexity
of fair value determinations.\205\ 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 report on an asset that
was assigned a fair value and this report is intended to provide a
sample of the methodology that is used by the investment adviser.\206\
---------------------------------------------------------------------------

    \205\ See, e.g., MFDF Valuation Report, supra footnote 97, at
14.
    \206\ See, e.g., MFDF Valuation Report, supra footnote 97, at
14.
---------------------------------------------------------------------------

    Recordkeeping. It is our understanding that most funds currently
retain records related to fair value determinations as required by
section 31 and the rules thereunder of the Investment Company Act.
These records generally include identifying information for each
portfolio security, data used for pricing, and any other information
related to price determinations and fund valuation policies and
procedures.
3. Affected Parties
    The proposed rule would affect all funds that invest in securities
that must be fair valued under the Act, those funds' boards of
directors, investment advisers, and investors. Table 1 below presents
descriptive statistics for the funds that could be affected by the
proposed rule. As of January 2020, there were 13,733 registered
investment companies: (i) 12,379 open-end funds; (ii) 666 closed-end
funds; (iii) 674 UITs; and (iv) 14 variable annuity separate accounts
registered as management companies.\207\ As of the same date, (i) open-
end funds held total net assets of $28,184 billion; (ii) closed-end
funds held total net assets of $301 billion; (iii) UITs held total net
assets of $1,883 billion; and (iv) variable annuity separate accounts
registered as management companies held total net assets of $234
billion. As of September 2019, there were 98 BDCs with $64 billion in
total net assets.\208\ Not all funds hold investments that must be fair
valued under the Act. In addition, for those funds that hold
investments that must be fair valued under the Act, the extent of those
investments varies. Hence, the proposed rule would affect only a subset
of the funds listed in Table 1 below.
---------------------------------------------------------------------------

    \207\ We estimate the number of registered investment companies
by reviewing the most recent filings of Forms N-CEN filed with the
Commission as of January 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.
    \208\ 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 2019, 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 8 wholly-owned
subsidiaries of other BDCs and feeder BDCs in master-feeder
structures.

                Table 1--Descriptive Statistics for Funds
------------------------------------------------------------------------
                                                        Total net assets
                                          Number of      (in billion $)
                                         funds  (1)           (2)
------------------------------------------------------------------------
Open-end funds.......................          12,379             28,184
Closed-end funds.....................             666                301
UITs.................................             674              1,883
Management company separate accounts.              14                234
BDCs.................................              98                 64
                                      ----------------------------------
    Total............................          13,831             30,666
------------------------------------------------------------------------
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 proposed
rule would affect funds' operations, we examine funds' investments
under the U.S. GAAP fair value hierarchy.\209\ For purposes of this
economic analysis, we treat investments that are valued using Level 1
inputs as investments for which readily available market quotations
would be available, and investments valued using Level 2 and 3 inputs
as investments that would be fair valued in good faith by the fund's
board of directors.\210\ We therefore expect that funds that hold more
securities that are measured using Level 2 and 3 inputs would be more
affected by the proposed rule than funds that do not invest in these
kinds of securities or hold fewer of them.
---------------------------------------------------------------------------

    \209\ According to ASC 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
Financial Accounting Standards Board, Fair Value Measurement (Topic
820).
    \210\ See proposed rule 2a-5(c). See also supra Section II.C.
---------------------------------------------------------------------------

    Table 2 provides descriptive statistics on funds' investments in
securities measured based on Levels 1, 2, and 3 inputs using Form N-
PORT data as of January 2020.\211\ As Table 2 shows, there are 11,436
funds with $24,338 billion in net assets that filed Form N-PORT.\212\
About 63% of fund assets are valued using Level 1 inputs. Nevertheless,
the average percentage of securities valued using Level 1 inputs varies
with the type of fund, ranging from 26% for closed-end funds to 99% for
ETFs registered as UITs. About 33% of fund assets are valued using
Level 2 inputs, and this percentage varies with the type of fund. Only
a small percentage of fund assets are valued using Level 3 inputs.\213\
---------------------------------------------------------------------------

    \211\ 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
January 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.
    \212\ The number of open-end funds, closed-end funds, ETFs
registered as UITs, and separate accounts registered as management
companies that filed Form N-PORT (i.e., 11,436 in Table 2) is
smaller than the number of open-end funds, closed-end funds, ETFs
registered as UITs, and separate accounts registered as management
companies that filed Form N-CEN (i.e., 13,067 in Table 1) because,
as of the N-PORT data collection date, N-PORT only covered large
fund groups. Large fund groups are funds that together with other
investment companies in the same ``group of related investment
companies'' have net assets of $1 billion or more as of the end of
the most recent fiscal year of the fund. Filing Form N-PORT will
begin in April 2020 for small fund groups. See Amendments to the
Timing Requirements for Filing Reports on Form N-PORT, Interim Final
Rule, Release No. IC-33384; File No. S7-02-19. Nevertheless, large
fund groups represent 84% of all open-end funds, closed-end funds,
ETFs registered as UITs, and separate accounts registered as
management companies in terms of total net assets (84% = $24,338
billion total net assets in Table 2/$29,093 billion total net assets
for open-end funds, closed-end funds, ETFs registered as UITs, and
variable annuity separate accounts registered as management
companies in Table 1).
    Total net assets in Form N-CEN also may be different than 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.
    \213\ Securities 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 securities arguably
requires less effort than the valuation of securities valued using
Level 2 and 3 inputs because funds' NAVs are easily obtainable.
About 1% of the fund assets are classified as ``N/A'' securities.
    The sum of the average using Level 1, 2, 3, and ``N/A'' within
each fund category may not sum up to one hundred percent due to
rounding error.
---------------------------------------------------------------------------

    Finally, untabulated analysis shows that 28% of the funds only
report securities valued using Level 1 inputs.\214\ Consequently, we
estimate that approximately 9,986 funds could be affected by the
proposal, of which 9,501 are not UITs.\215\ Nevertheless, even though
the proposed rule would be relevant for all funds with investments
valued using non-Level 1 inputs, not all of those funds would have to
materially change their practices under the proposed rule. As discussed
in more detail below, the effects of the proposed rule would depend on
the extent to which funds' current practices differ from the
requirements of the proposed rule.
---------------------------------------------------------------------------

    \214\ 28% = (3,209 open-end funds with securities valued using
only Level 1 inputs that filed Form N-PORT + 29 closed-end funds
with securities valued using only Level 1 inputs that filed Form N-
PORT + 5 ETFs registered as UITs with securities valued using only
Level 1 inputs that filed Form N-PORT + 3 variable annuity separate
accounts registered as management companies with securities valued
using only Level 1 inputs that filed Form N-PORT)/11,436 funds that
filed Form N-PORT. See supra footnote 211.
    \215\ 9,986 funds = 13,733 registered investment companies that
filed Form N-CEN from Table 1 above-3,845 registered investment
companies that filed Form N-CEN and are estimated to hold securities
valued using only Level 1 inputs + 98 BDCs from Table 1 above. 3,845
= 28% * 13,733 registered investment companies that filed Form N-CEN
from Table 1 above. See supra footnote 214 for the estimation of the
28%.
    This calculation assumes that the distribution of securities
valued using Level 1 inputs for registered investment companies that
filed Form N-PORT is similar to the distribution of securities
valued using Level 1 inputs for registered investment companies that
filed Form N-CEN. This calculation also assumes that all 98 BDCs in
our sample hold a non-zero amount of securities valued using Level 2
and Level 3 inputs 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).
    Under the proposed rule 2a-5(d), if the fund is a unit
investment trust, the fund's trustee must carry out the requirements
related to fair value determinations. Hence, UITs would not bear
one-time costs associated with oversight and reporting (see proposed
rule 2a-5(b)) because the trustees of UITs would perform all fair
value determinations. 9,501 = 9,986 affected fundsx485 affected
UITs. 485 = 674 UITs that filed Form N-CEN - (1x28% of funds that
only report securities valued using Level 1 inputs).

                                        Table 2--Descriptive Statistics for Funds by ASC 820 Fair Value Hierarchy
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             Total net
                                                             Number of      assets  (in    Average level   Average level   Average level   Average ``N/
                                                               funds        billion $)       1 Inputs        2 Inputs        3 Inputs       A'' Inputs
                                                                     (1)             (2)             (3)             (4)             (5)             (6)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Open-end funds..........................................          10,841          23,429             63%             33%            0.2%              1%
Closed-end funds........................................             577             303             26%             60%              4%              9%
ETFs registered as UITs.................................               5             389             99%              0%              0%              0%

Management company separate accounts....................              13             217             73%             26%              0%              0%
                                                         -----------------------------------------------------------------------------------------------
        Total/Average...................................          11,436          24,338             63%             33%              0%              1%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Form N-PORT

    As of January 2020, there were 1,921 investment advisers that
provide portfolio management services to funds and these investment
advisers managed assets equal to $28,517 billion.\216\
---------------------------------------------------------------------------

    \216\ Based on Item 5.D. of Forms ADV filed with the Commission
as of January 2020.
---------------------------------------------------------------------------

    Finally, as of December 2018, there were 57.2 million U.S.
households and 101.6 million individuals owning U.S. registered
investment companies that could be affected by the proposed rule.\217\
---------------------------------------------------------------------------

    \217\ Investment Company Institute, 2019 Fact Book: A Review of
Trends and Activities in the Investment Company Industry, available
at https://www.ici.org/pdf/2019_factbook.pdf, accessed on December
5, 2019.
---------------------------------------------------------------------------

C. Benefits and Costs and Effects on Efficiency, Competition, and
Capital Formation of Proposed Rule

1. General Economic Considerations
    Unbiased and accurate valuation of fund investments is important
because it affects the prices at which fund securities are purchased or
sold in the secondary market and also affects the prices at which fund
securities are purchased or redeemed in the primary market. The
valuation of fund securities 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.\218\
---------------------------------------------------------------------------

    \218\ See Section I above for more discussion on the importance
of accurate and unbiased valuation of fund securities.
---------------------------------------------------------------------------

    Under the Investment Company Act, whenever market quotations are
readily available, these market quotations must be used to determine
fund asset values.\219\ Whenever market quotations are not readily
available, the value must be the fair value of fund holdings as
determined by the board in good faith. This fair value determination
can involve the use of complex methodologies, multiple data sources,
and various assumptions. Today, we understand that, typically, boards
determine the methodologies used to fair value fund investments, but
rely on the adviser for the day-to-day calculation of fair values.\220\
---------------------------------------------------------------------------

    \219\ See section 2(a)(41) and rule 2a-4.
    \220\ See, e.g., MFDF Valuation Report, supra footnote 97, at 2.
---------------------------------------------------------------------------

    Nevertheless, fund investment advisers have conflicts of interest,
which could bias the fair value process.\221\ In particular, investment
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 assets under
management.\222\ Relatedly, investment advisers have incentives to
inflate fund asset values because investors tend to invest more in
funds that performed well in recent periods, which would increase
assets under management and ultimately increase investment advisers'
compensation.\223\ Investment advisers also have incentives to
mismeasure fund investments in a way that would result in smooth
reported fund performance over time to lower the funds' perceived
risk.\224\ Finally, investment advisers may mismeasure fund investments
as a result of expending less effort to value assets than the effort
required to ensure accurate and unbiased valuations.\225\
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    \221\ 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, 2019) available at https://ssrn.com/abstract=3066449; Rahul Bhargava et al., 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, 2019) available at
https://www.wu.ac.at/fileadmin/wu/d/i/finance/BBS-Papers/SS2019/20190515_STOUGHTON.pdf; John M. R. Chalmers et al., 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 et al., Sitting Bucks: Zero Returns in Fixed
Income Funds, (Working Paper, 2019) available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3244862; Cici et al.
2011, supra footnote 7; Vladimir Atanasov et al., Mismarking Fraud
in Mutual Funds, (Working Paper, 2019) available at http://www.fmaconferences.org/Glasgow/Papers/Fraud_in_OpenEndMutualFunds_2018_1126.pdf.
    \222\ 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 investment
advisers' compensation to fund size, there may be implicit contracts
that provide incentives to investment advisers to mismeasure fund
investments. For example, investment advisers may mismeasure fund
investments to meet or beat certain benchmarks. See, e.g., Chandar
and Bricker 2002, supra footnote 221.
    \223\ 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. 53, 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 et al., Portfolio Manager Compensation in the U.S. Mutual Fund
Industry, 74 J. Fin. 587 (2018).
    \224\ See, e.g., Cici et al. 2011, supra footnote 7.
    \225\ Investment 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 asset
management, 125 J. Fin. Econ. 311 (``Brown and Davies 2017'').
---------------------------------------------------------------------------

    The degree of conflicts of interest may vary across funds. In
particular, investment 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, investment advisers' incentives to underinvest in effort may
be higher for funds whose performance is more difficult to measure and
evaluate, and thus investment advisers' performance is also more
difficult to measure and evaluate (e.g., funds that hold complex
investments).\226\ Boards of directors currently serve as a check on
the conflicts of interest of the adviser

and the other service providers involved in the calculations of fair
values.\227\
---------------------------------------------------------------------------

    \226\ See, e.g., Brown and Davies 2017, supra footnote 225.
    \227\ See supra footnote 175.
---------------------------------------------------------------------------

    As discussed in Section I above, since ASR 113 and 118 were first
issued roughly fifty years ago, funds' investment practices have
changed, the regulatory framework under which funds operate has
evolved, and there have been significant advances in technology and
communication. The proposed rule would provide an updated framework for
valuation under the Investment Company Act that is more suitable to
current market realities. The proposed 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 fund investment advisers in the fair value
determination process.
    The proposed rule differs from the current regulatory framework and
funds' current practices in the following ways. First, under the
current regulatory framework, funds have flexibility to determine their
fair value policies and procedures, reporting, and recordkeeping
requirements. The proposed rule would differ from the current
regulatory framework because it would mandate more specific fair value
practices, policies and procedures, reporting, and recordkeeping
requirements and those requirements would be explicitly imposed on
funds and performed by boards or advisers.\228\ In particular, the
proposed rule would prescribe more specific elements that fair value
policies and procedures adopted under the rule must address as compared
to the current framework under rule 38a-1.\229\ For example, in
addition to the fair value policies and procedures that are required
pursuant to rule 38a-1, the proposed rule would require the written
policies and procedures to be reasonably designed to address, in the
context of methodologies, the selection and application of a
methodology in a consistent manner, the specification of which
methodologies apply to new types of fund investments in which a fund
intends to invest, and testing of the appropriateness and accuracy of
the selected methodology, including identifying the testing methods and
minimum frequency of testing.\230\ In addition, unlike under proposed
rule 2a-5, there is currently no requirement regarding the frequency
and content of periodic valuation reports and the promptness and
content of ad hoc valuation reports the board receives. The proposed
rule would require quarterly periodic reporting as well as prompt
reporting no later than three business days after the adviser becomes
aware of certain matters relevant to fair value. Also, the proposed
rule specifies the matters that the adviser must, at a minimum, cover
in its periodic reporting to the board. Finally, rule 38a-1 requires
the maintenance of records related to the fund's compliance policies
and procedures for five years.\231\ The proposed rule would apply the
same retention period, but it would require the maintenance of records
that are specific to fair value determinations.\232\ Further, the
proposed rule would require the adviser to maintain copies of the
reports and other information provided to the board under the rule
whenever the board assigns the determination of fair value to an
investment adviser to the fund.
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    \228\ See proposed rule 2a-5(a) and (b).
    \229\ Compare proposed rule 2a-5(a)(1)-(5) with Compliance Rules
Adopting Release, supra footnote 26. See also supra footnote 28 and
accompanying text.
    \230\ See proposed rule 2a-5(a)(2), (3), and (5).
    \231\ See rule 38a-1(d). See also supra footnote 72.
    \232\ See proposed rule 2a-5(a)(6) and (b)(3).
---------------------------------------------------------------------------

    Second, we understand that funds' current practices regarding their
fair value policies and procedures, reporting, and recordkeeping are
generally consistent with the requirements of the proposed rule.
Nevertheless, there is variation in funds' fair value practices, and
the practices of certain funds may be more or less extensive and
thorough than the requirements of the proposed rule. Consequently, the
proposed rule would impose uniform minimum requirements on all affected
funds related to their fair value policies and procedures, reporting,
and recordkeeping.
    Third, under the current regulatory framework, boards choose the
methodologies used to determine the fair value of the funds'
investments, continuously review the appropriateness of such methods,
consider all appropriate factors relevant to the fair value of
securities for which market quotations are not readily available, and
carefully review the findings of individuals that are not directors
whenever technical assistance is requested from those individuals.\233\
In addition, it is our understanding that some boards currently ratify
all or some of the fair value calculations of an investment adviser to
the fund. Under the proposed rule, boards may assign a fair value
determination to an investment adviser of the fund, who would carry out
all of those functions.\234\ It is our understanding that funds'
investment advisers already assist the board with respect to many of
those functions subject to the board's oversight.
---------------------------------------------------------------------------

    \233\ See supra Section III.B.1.
    \234\ See proposed rule 2a-5(b).
---------------------------------------------------------------------------

    Under the proposed rule, fund boards would have discretion to
assign the fair value determination to an investment adviser to the
fund, who would carry out all of the functions that would be required
under the rule. When deciding whether to assign fair value
determinations to an investment adviser to the fund, a board would
consider certain trade-offs. In particular, fund boards' decisions to
oversee investment advisers' fair value determinations instead of
determining fair value themselves would depend on the amount of
investments that must be fair valued, the nature and complexity of the
valuation of those investments, the type of fund, the investment
adviser's willingness to assume additional fair value responsibilities,
and the fund's current practices. Boards of funds that hold more
securities that must be fair valued and harder-to-value securities may
be more likely to assign these fair value determinations to an adviser
and oversee the process of determining fair value by the assigned
adviser because investment advisers may be better suited to value
certain investments. It 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 assign to an investment adviser the
determination of fair values (on which fund's NAV is based) than the
board of a fund that calculates value less regularly. The decision to
oversee investment advisers' fair value determinations would also
depend on investment advisers' willingness to assume the assigned
responsibilities. Such willingness would depend on investment advisers'
valuation expertise and experience, whether the investment advisers
have available resources to satisfy their new obligations, and the
extent to which the investment advisers could pass through to the fund
and its investors any higher costs associated with the increased
responsibilities. Finally, a board's decision to assign
responsibilities under the proposed rule would depend on the expected
costs of compliance, which would ultimately depend on how different
funds' current practices and policies and procedures are from the
requirements of the proposed rule.
    We lack detailed and representative information on funds' current
fair value practices and we do not have visibility into boards'
decision-making processes when seeking the investment advisers'
assistance with fair value

determinations.\235\ Further, boards' decision-making processes with
respect to seeking the investment advisers' assistance with fair value
determinations is complex. Hence, we are unable to accurately estimate
the number of fund boards that would assign responsibilities to an
adviser under the proposed rule instead of the boards making fair value
determinations in good faith themselves. Nevertheless, we believe that
most boards would assign these responsibilities to an investment
adviser to the fund because the investment adviser has valuation
experience and expertise and 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. Further, advisers
already provide significant assistance with the fair value
determinations to the board of directors and so funds would not be
required to significantly modify their operations if they choose to
assign fair value determinations to an investment adviser to the fund
under the proposed rule. As a result, for the purpose of our economic
analysis, we assume that all funds that have some securities that would
need to be fair valued would be affected parties.
---------------------------------------------------------------------------

    \235\ The industry reports cited in Section III.B.2 above only
provide qualitative information on certain aspects of funds' current
practices. See also supra footnote 173 for a discussion of
limitations of the Deloitte survey data. Finally, funds have
discretion in the type of disclosures they provide regarding their
fair value determinations. See supra footnote 169.
---------------------------------------------------------------------------

    We expect that the effects of the proposed rule could differ across
funds. In particular, under the proposed rule, if the fund is a unit
investment trust, the fund's trustee must carry out the fair value
determinations.\236\ Hence, UITs would not bear any costs associated
with oversight and reporting. We expect the effects of all other
aspects of the rule to be similar for UITs and other funds. Further,
the proposed rule would have larger effects on funds that currently do
not utilize advisers in the fair value process but would choose under
the proposed rule to assign the fair value determination of fund
investments to an investment adviser to the fund. In addition, the
proposed rule would also have a larger effect on funds for which a
larger percentage of their investments do not have readily available
market quotations because those funds would be required to determine
the fair value of a larger percentage of their investments in
compliance with the rule. The proposed rule would also have larger
effects on funds whose current fair value policies and procedures,
reporting, and recordkeeping requirements differ more from the proposed
rule's requirements. The proposed rule could have a larger effect on
smaller funds because of economies of scale in the adoption and
implementation of the proposed rule's requirements. In particular, as
discussed in detail in Section III.C.3 below, there are certain fixed
costs associated with the implementation of the proposed rule's
requirements, such as testing and preparing methodologies, policies and
procedures, and training materials, and those fixed costs would be less
burdensome for larger funds, who could spread those costs across a
larger amount of assets under management. Finally, whenever the fair
value determinations would be assigned to the fund's investment
adviser, the requirement to reasonably segregate the investment
adviser's process of making fair value determinations from the
portfolio management could be more costly for smaller investment
advisers than for larger ones. The reason is that smaller investment
advisers could lack the staff and resources to segregate portfolio
management personnel from those making fair value determinations as
efficiently as larger advisers or might only be able to meet this
requirement by hiring additional personnel.
---------------------------------------------------------------------------

    \236\ See proposed rule 2a-5(d).
---------------------------------------------------------------------------

    We discuss the benefits and costs of the proposed rule as well as
the effects on efficiency, competition, and capital formation in detail
below.
2. Benefits
    The proposed rule would mandate specific fair value functions,
including written policies and procedures, reporting, and recordkeeping
that funds would have to have in place to comply with the statute, and
would define which securities are considered to have readily available
market quotations under section 2(a)(41) of the Act. This increased
specificity could reduce compliance costs in that funds may expend less
effort and time to design policies and procedures, reporting, and
recordkeeping under the proposed rule than trying to determine
appropriate compliance under the statute alone.\237\ For funds whose
current practices are more burdensome than the proposed rule's
requirements, 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.\238\ Relatedly, the
proposed rule and the rescission of existing no-action letters and
guidance would increase certainty because funds would follow a single
rule rather than following various no-action letters and guidance when
determining fair values, which could ultimately reduce compliance
costs.\239\ Lower costs of compliance for funds 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.
---------------------------------------------------------------------------

    \237\ Any such benefits could be at least partially limited by
the fact that mandating specific fair value functions for all funds
could lead to the adoption of fair value functions that are
appropriate for most but not all funds.
    \238\ Nevertheless, we acknowledge that because the proposed
rule is principles based, the possibility still exists that some
funds may put in place additional policies and procedures,
reporting, and recordkeeping that are not required by the proposed
rule.
    \239\ Academic literature provides evidence consistent with the
idea that uncertainty has negative effects on investment and growth.
See, e.g., Nicholas Bloom et al., Uncertainty and Investment
Dynamics, 74 Rev. Econ. Stud. 391 (2007); Nicholas Bloom, The Impact
of Uncertainty Shocks, 77 Econometrica, 623 (2009); Scott R. Baker
et al., Measuring Economic Policy Uncertainty, 131 Q. J. Econ. 1593
(2016).
---------------------------------------------------------------------------

    In addition, the proposed rule would benefit funds and their
investors because it would allow boards to allocate more fair value
responsibilities to an investment adviser to the fund, 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.\240\ In
particular, for funds whose boards of directors would assign the fair
value determinations to an investment adviser to the fund, the boards
would no longer be required to choose the methodologies used to
determine the fair value of the funds' investments, continuously review
the appropriateness of such methods, consider all appropriate factors
relevant to the fair value of securities for which market quotations
are not readily available, and carefully review the findings of
individuals that are not directors whenever technical assistance is
requested from those individuals. We lack detailed data on boards'
current practices and so we are unable to estimate these cost savings
but we request comment on this point in Section III.E. below.\241\
---------------------------------------------------------------------------

    \240\ This benefit would not accrue to UITs because under the
proposed rule the trustees of UITs would carry out the requirements
of the proposed rule. See proposed rule 2a-5(d).
    \241\ See supra footnote 235.
---------------------------------------------------------------------------

    Finally, the proposed rule would require all funds to adopt
specific policies and procedures related to fair value determinations.
In addition, whenever the board assigns the fair value determination
relating to a fund investment to an investment adviser, the

proposed rule would require the board's effective oversight of the
investment adviser's conflicts of interest related to fair value
determinations. To the extent that certain funds' fair value policies
and procedures currently are less thorough than the policies and
procedures of the proposed rule and certain boards' oversight of the
investment advisers' conflicts of interest is less effective than under
the proposed rule, the proposed rule could decrease the likelihood that
fund investments would be inaccurately fair valued.\242\ This is
because the proposed rule could create a more robust valuation
framework and could help to address any conflicts of interest of the
investment adviser, which could result in more accurate and unbiased
asset prices. Any such effects likely would be more pronounced for
investors of funds that are not publicly traded (e.g., open-end funds
and BDCs) because there is no secondary market for the shares of those
funds and fund investors can only trade at NAV, which is determined by
the fund's fair value determinations. Nevertheless, this may not have a
significant effect because it is our understanding that many funds
currently have in place fair value practices that are similar to the
proposed rule's requirements and boards oversee the investment
adviser's assistance with fair value calculations.
---------------------------------------------------------------------------

    \242\ See supra Section III.C.1. for a discussion related to
investment advisers' conflicts of interest.
---------------------------------------------------------------------------

3. Costs
    The proposed rule would impose one-time costs on funds and their
investors.\243\ We expect that funds would incur one-time costs to
review the proposed rule's requirements and modify, as necessary, their
fair value practices, policies and procedures, and recordkeeping to
comply with the proposed rule. Funds whose boards would assign the fair
value determinations to the investment adviser would also incur one-
time costs to review the proposed rule's requirements and modify their
oversight and reporting procedures to comply with the rule. Even though
we understand that most funds currently have in place practices related
to fair value determinations, those practices differ across funds and
also may differ from the proposed rule's requirements. In particular,
the types of policies and procedures that funds have in place related
to fair value determinations, the frequency and content of periodic
board reporting, the promptness and content of ad hoc board reporting,
and the extent and duration of recordkeeping may differ under the
proposed rule compared to current practices.
---------------------------------------------------------------------------

    \243\ The proposed rule requires funds to evaluate any pricing
services that assist funds with the fair value determinations. See
proposed rule 2a-5(a)(4). To the extent that the proposed rule's
requirements related to pricing services differ from funds' current
practices, the proposed rule could have second-order effects on
pricing services' operations because pricing services could adjust
their operations to cater to their clients' new demands. Because we
believe that funds' current practices are generally similar to the
proposed rule's requirements related to the evaluation of pricing
services, we believe that the proposed rule would not have
significant effects on pricing services.
---------------------------------------------------------------------------

    Our staff estimates that the one-time incremental costs necessary
to ensure compliance with the proposed rule would range from $100,000
to $600,000 per fund, depending on the current fair value practices of
the fund.\244\ These estimated costs are attributable to the following
activities: (i) Reviewing the proposed rule's requirements; (ii)
developing new (or modifying existing) policies and procedures,
reporting, and recordkeeping requirements to align with the
requirements of the proposed rule; (iii) integrating and implementing
those policies and procedures, reporting, and recordkeeping
requirements to 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 fair value determinations should be
assigned to the fund's investment adviser and how to set up appropriate
policies and procedures, reporting, and recordkeeping requirements. We
expect that the one-time incremental cost necessary to ensure
compliance with the proposed rule would depend on the fund's current
fair value practices and the amount and valuation complexity of fund
investments that must be fair valued. In particular, the one-time costs
would be closer to the lower end of the range for funds whose current
practices are more similar to the requirements of the proposed rule and
funds with fewer and easier-to-value fund investments. Further, the
one-time costs would 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.
---------------------------------------------------------------------------

    \244\ 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 proposed 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 proposed 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 proposed
rule's requirements.
---------------------------------------------------------------------------

    As discussed above, out of the 13,831 funds, we estimate that 9,986
would be affected the proposed rule, and thus incur the one-time costs
associated with the proposed rule.\245\ We estimate that 70% of the
one-time costs would be attributable to funds reviewing and updating
the current practices and related policies and procedures to comply
with the proposed rule's requirements; 15% of those costs would be
attributable to funds reviewing and updating current recordkeeping
processes to align with the proposed rule's requirements; and the
remaining 15% of those costs would be attributable to funds reviewing
and updating the current board reporting processes to comply with the
proposed rule's requirements. Hence, we estimate the aggregate one-time
costs of the proposed rule to range between $991.3 million and $5.9
billion.\246\
---------------------------------------------------------------------------

    \245\ See supra footnote 215.
    \246\ 991.3 million = (485 UITs that would be affected by the
proposed rule x $100,000 minimum one-time costs of the proposed rule
x 85%) + (9,501 open-end funds, closed-end funds, variable annuity
separate accounts, and BDCs that would be affected by the proposed
rule x $100,000 minimum one-time costs of the proposed rule). 85% =
70% of the one-time costs attributable to reviewing fair value
practices and policies and procedures + 15% of the one-time costs
attributable to reviewing recordkeeping practices. See supra
footnote 215.
     5.9 billion = (485 UITs that would be affected by the proposed
rule x $600,000 maximum one-time costs of the proposed rule x 85%) +
(9,501 open-end funds, closed-end funds, variable annuity separate
accounts, and BDCs that would be affected by the proposed rule x
$600,000 maximum one-time costs of the proposed rule).
---------------------------------------------------------------------------

    For funds whose boards would assign the fair value determinations
to the funds' investment advisers, those one-time costs would be borne
by the investment adviser, and could be ultimately passed through to
the fund shareholders in the form of higher management fees. For funds
whose boards determine the fair values themselves, those one-time costs
could be ultimately passed through to the fund shareholders in the form
of higher operating expenses. We expect that the vast majority of the
boards would assign fair value determinations relating to an investment
adviser to the fund, and so the majority of the one-time costs would be
borne by the fund's investment adviser, and ultimately could be passed
through to the fund shareholders in the form of higher management fees.
    The proposed rule also could impose ongoing costs on all funds that
hold securities without readily available market quotations because
those funds

would be required to comply with the proposed rule's policies and
procedures, reporting, and recordkeeping requirements. Nevertheless, we
believe that funds' incremental ongoing costs associated with this
aspect of the proposed rule would be limited to the extent that, as
discussed in Section III.B.2. above, funds currently have in place
practices, policies and procedures, reporting, and recordkeeping
associated with fair value determinations that are similar to the
proposed rule's requirements. Certain funds might put in place policies
and procedures, reporting, and recordkeeping to comply with the
proposed rule that are more costly than the funds' current practices,
while other funds might set up policies and procedures, reporting, and
recordkeeping as a result of the proposed rule that would result in
lower ongoing costs than the costs of current practice. We acknowledge
that funds whose practices, policies and procedures, reporting, and
recordkeeping are less costly than the proposed rule's requirements
would bear additional ongoing costs under the proposed rule. We lack
detailed data on funds' fair value practices, policies and procedures,
reporting, and recordkeeping, and so we are unable to estimate the net
incremental ongoing costs of the proposed rule on funds, but we request
comment on this topic in Section III.E. below.\247\
---------------------------------------------------------------------------

    \247\ See supra footnote 235.
---------------------------------------------------------------------------

    The proposed rule also would mandate more detailed and specific
policies and procedures, reporting, and recordkeeping than the current
regulatory framework, which could decrease funds' flexibility to design
policies and procedures, reporting, and recordkeeping that better meet
their preferences. Consequently, funds could bear costs to implement
practices (e.g., quarterly periodic reporting) that are incompatible
with the way they would approach these matters absent rule 2a-5. Any
such costs could be borne ultimately by fund investors in the form of
higher operating expenses.
    For funds whose boards would assign the fair value determinations
to the funds' investment advisers, the proposed rule could impose
additional ongoing costs associated with boards' oversight of the
investment adviser's fair value determinations and review of board
reports. Nevertheless, we believe that funds' incremental ongoing costs
associated with this aspect of the proposed rule would be limited to
the extent that boards or funds currently have in place policies to
ensure appropriate oversight of an investment adviser's assistance with
fair value calculations and boards currently review periodic and ad-hoc
reports related to fair value determinations prepared by the fund's
investment adviser. Hence, we do not believe that this aspect of the
proposed rule would impose any significant incremental ongoing costs on
boards and fund investors compared to the ongoing costs under current
practices.\248\ We acknowledge, however, that to the extent boards'
current oversight of investment advisers' fair value calculations and
boards' current practices with respect to review of valuation reports
is inconsistent with the proposed rule's requirements, funds would bear
ongoing costs to comply with the proposed rule.
---------------------------------------------------------------------------

    \248\ We do not believe that the proposed rule would result in
cost savings associated with boards' involvement in the
determination of fair values because we believe that boards would
reallocate time and attention to overseeing the adviser's fair value
determinations or other activities unrelated to fair valuing fund
investments.
---------------------------------------------------------------------------

    Relatedly, to the extent that fair value determinations would be
assigned to an investment adviser to the fund, such investment advisers
would incur ongoing costs to satisfy their new fair value obligations.
Those costs would be attributable to adopting and implementing policies
and procedures, reporting, and recordkeeping to ensure compliance with
the proposed rule's requirements. The magnitude of those costs would
depend on how investment advisers' current practices compare to the
requirements of the proposed rule. Investment advisers could demand
higher fees as a compensation for the increased valuation
responsibilities. Depending on the level of competition in the fund
investment adviser industry, those higher fees could be passed on to
fund investors in the form of higher fund fees. We lack data to
estimate any cost increases and the pass-through rate of those cost
increases to fund investors but we request comment on this issue in
Section III.E. below.
    Finally, to the extent that the board would assign the fair value
determinations relating to any or all of fund investments to the
investment adviser, the proposed rule would provide the adviser--which
has conflicting interests--a greater role in fair value determinations
relative to current practices.\249\ Nevertheless, we believe that any
impact from such conflicts would be limited because the proposed rule
contains explicit requirements related to the identification,
assessment, and management of any material conflicts of interest of the
investment adviser, including the requirement to reasonably segregate
the investment adviser's process of making fair value determinations
from the portfolio management, and funds currently have in place
policies to manage conflicts of interest of investment advisers that
may not be valuation specific.
---------------------------------------------------------------------------

    \249\ See supra Section III.C.1. for a discussion related to
investment advisers' conflicts of interest.
---------------------------------------------------------------------------

4. Effects on Efficiency, Competition, and Capital Formation
    Under the proposed rule, boards may assign fair value
determinations to an investment adviser and oversee the investment
adviser'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, the proposed
rule could lead to more efficient use of boards' resources and
therefore improve funds' governance for the benefit of fund investors.
The proposed rule also could improve the efficiency of fund operations
because it would allow boards more flexibility to oversee the
investment advisers' fair value determinations instead of determining
fair values themselves.
    As discussed above, the proposed rule would mandate specific fair
value policies and procedures and effective oversight of an assigned
investment adviser, which could ultimately improve the efficiency of
funds' asset prices. The proposed rule could improve the efficiency of
asset prices because it could create a more robust valuation framework
and it could help mitigate any conflicts of interest of the investment
adviser, which ultimately could result in more accurate and unbiased
asset prices. A potential increase in asset price efficiency could
improve boards' monitoring of funds' and investment advisers'
performance and could benefit capital formation because more accurate
and unbiased prices permit the allocation of resources to their most
efficient use. Nevertheless, we believe that any such effects likely
would be small because many funds currently have in place fair value
practices that are generally similar to the proposed rule's
requirements and boards oversee the investment adviser's assistance
with fair value calculations.
    We do not believe that the proposed rule would have any material
effects on competition because the effects of the rule likely would be
small in light of the proposed rule's similarities to current
practices. In particular, as discussed in Section III.C.3. above, the
main costs arising from the proposed rule are the one-time costs to
comply with the rule.

Even though these costs could be more burdensome for smaller fund
complexes, we believe that these costs would not affect competition in
the fund industry, especially when considering that these are one-time
costs that can be amortized over a number of years and because we
believe that only few funds would incur costs at the higher end of the
cost range estimate (i.e., between $100,000 and $600,000).
Consequently, we believe that the proposed rule would not affect
competition in the fund industry.
    In addition, the proposed rule's requirement to reasonably
segregate the investment adviser's process of making fair value
determinations from the portfolio management likely would more
significantly affect those smaller investment advisers that lack the
staff and resources necessary to effect such segregation as efficiently
as larger advisers and would otherwise need to hire additional
personnel. Nevertheless, we do not believe that this requirement of the
proposed rule would have a material effect on competition in the fund
investment adviser industry because many smaller investment advisers to
funds currently have in place processes to address the potential
conflicts of interest whenever portfolio management personnel provides
input to valuation.

D. Reasonable Alternatives

1. More Principles-Based Approach
    The proposed rule mandates the performance of certain prescribed
functions to determine the fair value of fund investments in good
faith. As an alternative to the proposed rule, we considered 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 policies and procedures, reporting, and
recordkeeping that would allow fair values to be determined in good
faith by the board of directors or the investment adviser. The benefits
of such an approach would be that funds would have more flexibility to
tailor their policies and procedures, reporting, and recordkeeping to
their valuation needs. Nevertheless, under such an approach funds could
be less certain on how to comply with the proposed rule. To the extent
this alternative would reduce certainty for funds, it could increase
compliance costs to the detriment of fund investors, and it would not
adequately ensure that the board provides sufficient oversight over the
investment adviser's fair value determinations.\250\ In addition, if
certain funds within a fund complex would use the additional
flexibility afforded by a more principles-based approach to set up
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 would not be able to apply a
similar framework across the various funds it oversees. Further, a more
principles-based approach would not mandate a minimum prescribed set of
fair value policies and procedures, reporting, and recordkeeping,
unlike the proposed rule that would provide a consistent framework for
funds to apply. Consequently, not all funds necessarily would put in
place adequate policies and procedures, reporting, and recordkeeping to
achieve accurate and unbiased fair value determinations.
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    \250\ We acknowledge that under the proposed rule, funds could
face some uncertainty regarding how to comply with the proposed
rule's requirements. Nevertheless, we believe that a more
principles-based approach than the proposed rule would increase
further any uncertainty regarding how to comply with the proposed
rule's requirements.
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2. Assignment of Responsibilities to Service Providers Other Than
Investment Advisers
    Under the proposed rule, the board may assign the fair value
determinations to an investment adviser to the fund, which would carry
out all of the functions required under the rule. As an alternative, we
considered allowing the board to assign the fair value determinations
to service providers other than the investment adviser, such as a
pricing service provider. Such an approach would provide additional
flexibility to the board to assign the fair value determinations to
appropriate persons. As a result, this alternative could free up board
resources tied to the determination of fair value and redirect them to
oversight, in situations where an adviser was unwilling or unable to
accept the responsibility to determine the fair value of fund
investments and another third party was available to accept the
assignment. Nevertheless, such an approach potentially could limit a
board's ability to effectively oversee the service provider that
performs the fair value determinations because the board does not have
the same level of visibility, access to information, and control over
the actions of service providers other than the investment adviser.
Further, even though service providers may have a contractual
obligation to perform valuation services for the fund, those service
providers, unlike an adviser to a fund, may not owe a fiduciary duty to
the fund, and thus their obligation to serve the fund's and its
shareholders' best interests is limited. Hence, such an alternative
approach could compromise the integrity of the fair values.
3. Not Permit Boards To Assign Fair Value Determinations to an
Investment Adviser
    As discussed in more detail above, unlike the current regulatory
framework, the proposed rule would permit fund boards to assign the
fair value determinations to an investment adviser. In addition,
relative to the current regulatory framework, the proposed rule would
mandate more specific fair value policies and procedures, reporting,
and recordkeeping. As an alternative to the proposed rule, we
considered not permitting fund boards to assign the fair value
determinations to an investment adviser to the fund but instead only
requiring funds to adopt the policies and procedures, reporting, and
recordkeeping as described in the proposed rule. We also considered
requiring boards periodically to ratify the fair value determinations
calculated by the fund's adviser using the methodology determined by
the board. Such an approach could prescribe minimum requirements with
respect to valuation policies and procedures, reporting, and
recordkeeping. Nevertheless, such an approach would not allow funds the
flexibility to leverage the fair value expertise of the investment
adviser and assign a role to the fund's board that is more in line with
the board's experience and expertise. Relatedly, 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, which would ultimately benefit fund investors.

E. Request for Comment

    We request comment on all aspects of our economic analysis,
including the potential costs and benefits of the proposed rule and
alternatives thereto, and whether the proposed rule, if adopted, would
promote efficiency, competition, and capital formation. Commenters are
requested to provide empirical data, estimation methodologies, and
other factual support for their views, in particular, on costs and
benefits estimates. In addition, we request comment on the following:
    58. Is our understanding regarding boards' current fair value
practices

correct? If not, please describe boards' current fair value practices.
In particular, how do boards determine the fair values of fund
investments in good faith? What type of assistance do boards receive
with respect to fair value determinations? Who assists the board with
the fair value determinations? To what extent and under what
circumstances does information from pricing services assist the board
with fair value determinations? What kinds of services do pricing
services provide? What percentage of fund boards receive assistance
with the fair value determinations? Does this percentage differ with
the type of fund or with the type of fund investments? What types of
fair value practices and policies and procedures do funds have in
place? What types of reports related to valuation do fund boards
currently receive and how frequently do they receive these reports?
What types of records related to valuation do funds retain? For how
long do they retain these records? Do these practices differ with the
type of fund or with the type of fund investments?
    59. Is our assumption correct that the vast majority of current and
prospective fund boards would assign fair value determinations to an
investment adviser under the proposed rule? If not, what percentage of
current and prospective funds would assign the fair value
determinations to an investment adviser to the fund? Do these
percentages vary with the type of fund or with the type of fund
investments? What factors would boards consider when deciding whether
to assign the fair value determinations to an investment adviser to the
fund?
    60. What percentage of fund independent board members have
valuation experience and expertise? Please provide data on the
percentage of fund independent board members that have valuation
experience and expertise by fund type.
    61. Are there any entities affected by the proposed rule that are
not discussed in the economic analysis? In which ways would those
entities be affected by the proposed rule? Please provide an estimate
of the number and size of those affected entities and of the nature and
magnitude of the effect. Is our assessment correct that the effects of
the proposed rule on UITs would be similar to the effects of the
proposed rule on other funds, except for the fact that UITs would not
bear any costs associated with oversight and reporting and their
trustees would not receive any of the benefits associated with
assigning fair value determinations to an investment adviser? Is our
understanding correct that the proposed rule would not have significant
effects on pricing services? If not, please describe any effects the
proposed rule would have on pricing services.
    62. Do UITs' exposures to investments that use Level 1, 2, and 3
inputs differ from the exposure of other registered investment
companies? What percentage of UITs hold investments that use Level 1,
2, and 3 inputs respectively?
    63. In which ways do funds' current practices differ from the
policies and procedures, reporting, and recordkeeping and other
activities mandated by the proposed rule? Is our understanding correct
that current funds' practices are largely similar to the policies and
procedures, reporting, and recordkeeping and other requirements of the
proposed rule?
    64. Are there any costs and benefits of the proposed rule that are
not discussed in the economic analysis? If so, please describe the
types of costs and benefits and provide a dollar estimate of these
costs and benefits.
    65. Please provide any estimates of the board time and other
savings arising from the assignment of fair value determinations to an
investment adviser to the fund under the proposed rule. What is the
source of these savings? How would the board utilize any savings as the
result of the assignment of the fair value determinations to an
investment adviser to the fund under the proposed rule? Would the
boards engage in additional activities at meetings or would the boards
instead spend less time on fund matters? Please provide dollar
estimates (mean, median, standard deviation, minimum, and maximum) of
these savings? Would these savings differ by fund? If yes, in which
way?
    66. Please provide a list of activities that would give rise to
one-time costs for funds under the proposed rule. Also please provide
dollar estimates (mean, median, standard deviation, minimum, and
maximum) of the one-time costs that funds would incur. Would these
costs differ by fund? If yes, in which ways? What percentage of these
costs would be borne by the board and what percentage by an investment
adviser to the fund? What percentage of these costs would be passed on
to fund investors in the form of higher operating expenses or higher
management fees?
    67. Is our understanding correct that the incremental ongoing
operating costs for funds would be minimal under the proposed rule? If
not, please provide an estimate of the number of funds that would bear
ongoing costs under the proposed rule. Also, please describe the
activities that would give rise to ongoing costs for funds under the
proposed rule, and an estimate of the costs associated with each
activity. Would these costs differ by fund? If yes, in which ways?
Which of these costs would be borne by the board and which by the
investment adviser to the fund? What percentage of these costs would be
passed down to fund investors in the form of higher operating expenses
or higher management fees?
    68. Would the proposed rule increase the fees of investment
advisers or trustees of UITs? If yes, why and how? Please provide an
estimate of the increase in the investment advisers' or trustees' fees.
    69. What would be the effects of the proposed rule, including any
effects on efficiency, competition, and capital formation? Would the
proposed rule be beneficial or detrimental to funds and their
investors? Would the proposed rule affect competition in the fund
industry? If yes, why? Would the proposed rule affect the efficiency of
the prices of fund investments? If so, in which way?
    70. Would a more principles-based approach relative to the proposed
rule be preferable? If yes, why? If we did adopt such an approach, what
safeguards would be necessary to ensure that fair value determinations
are not influenced by conflicts of interest?
    71. Would it be preferable to allow the board to assign the fair
value determinations to service providers other than the investment
adviser, such as a pricing service provider? If yes, why?
    72. Would it be preferable to not permit boards to assign fair
value determinations to an investment adviser to the fund but only
mandate fair value policies and procedures, reporting, and
recordkeeping requirements that are similar to the proposed rule's
requirements? If yes, why?

IV. Paperwork Reduction Act Analysis

A. Introduction

    Proposed rule 2a-5 would result in new ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\251\ The title for the new collection
of information would be ``Rule 2a-5 under the Investment Company Act of
1940, Fair Value.'' The Commission is submitting these collections of
information to the Office of Management and Budget (``OMB'') for review
in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. 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.
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    \251\ 44 U.S.C. 3501-3520.