[Federal Register Volume 86, Number 3 (Wednesday, January 6, 2021)]
[Rules and Regulations]
[Pages 748-808]
[FR Doc No: 2020-26971]

Vol. 86

Wednesday,

No. 3

January 6, 2021

Part III

Securities and Exchange Commission

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17 CFR Parts 210 and 270

Good Faith Determinations of Fair Value; Final Rule

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

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210 and 270

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

Good Faith Determinations of Fair Value

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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

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

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

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

Table of Contents

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

I. Introduction

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

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

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

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

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

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

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

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

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

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

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

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

valuation risks depend on the facts and circumstances of the particular
fund's investments. As such, we believe that the non-exhaustive list of
examples of sources and types of valuation risk, set forth below, is
appropriate. As we stated in the Proposing Release, the risks
identified are not intended to be a comprehensive list of all possible
sources of valuation risk, but a set of examples that may help inform
fund boards and valuation designees. We agree that the additional risks
identified by commenters may also be relevant for certain funds, and
have broadened the list provided below in several respects to include
those risks. The final rule, like the proposal, is designed to provide
a board or valuation designee, as applicable, with the flexibility to
determine which of the identified sources and types of valuation risk
are relevant to the fund's investments, as well as to identify other
risks not listed here. The final rule also provides flexibility to
determine whether certain sources and types of valuation risk should be
weighed more heavily than others.
    As such, the following is a non-exhaustive list of sources or types
of valuation risk:
     The types of investments held or intended to be held by
the fund \46\ and the characteristics of those investments; \47\
---------------------------------------------------------------------------

    \46\ We recognize that in assessing and managing this potential
source of valuation risk, a board or valuation designee, as
applicable, may not be able to identify all of the types of
investments the fund will hold or the specific valuation risks
related to such investments. This risk assessment and management
generally should take into account those investments that the fund
reasonably expects to purchase in the reasonably near term.
    \47\ Investment characteristics would include among other
things, the size of the investment relative to measures of market
demand, such as daily trading volume.
---------------------------------------------------------------------------

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

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

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

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

     The proportion of the fund's investments that are fair
valued as determined in good faith, and their contribution to the
fund's returns;
     Reliance on service providers that have more limited
expertise in relevant asset classes; the use of fair value
methodologies that rely on inputs from third-party service providers;
and the extent to which third-party service providers rely on their own
service providers (so-called ``fourth-party'' risks); and
     The risk that the methods for determining and calculating
fair value are inappropriate or that such methods are not being applied
consistently or correctly.
2. Establish and Apply Fair Value Methodologies
    As proposed, the final rule will provide that fair value as
determined in good faith requires the board or valuation designee, as
applicable, to establish and apply fair value methodologies. To satisfy
this requirement, a board or valuation designee, as applicable, must:
    (1) Select and apply appropriate fair value methodologies;
    (2) Periodically review the appropriateness and accuracy of the
methodologies selected and make any necessary changes or adjustments
thereto; and
    (3) Monitor for circumstances that may necessitate the use of fair
value.
    As discussed below, we are adopting these functions substantially
as proposed, with certain modifications to respond to commenters'
concerns and suggestions.
(a) Select and Apply Appropriate Fair Value Methodologies
    The final rule will require the board or valuation designee, as
applicable, to select and apply in a consistent manner an appropriate
methodology or methodologies \50\ for determining (which includes
calculating) the fair value of fund investments.\51\ As proposed, to
satisfy this requirement, the board or valuation designee, as
applicable, will have to specify the key inputs and assumptions
specific to each asset class or portfolio holding.\52\ We are, however,
modifying the requirement to select and apply appropriate methodologies
in the final rule in two ways to address commenter concerns and
suggestions. First, the final rule will provide that the selected
methodologies for fund investments may be changed if different
methodologies are equally or more representative of the fair value of
the investments. Second, the final rule will not require the
specification of methodologies that will apply to new types of
investments in which the fund intends to invest.
---------------------------------------------------------------------------

    \50\ As the Commission stated in the Proposing Release, ASC
Topic 820 refers to valuation approaches and valuation techniques.
In practice, many valuation techniques are referred to as methods
(e.g., discounted cash flow method). As a result, this Adopting
Release uses the terms ``technique'' and ``method'' interchangeably
to refer to a specific way of determining fair value and likewise
uses the terms ``methods'' and ``methodologies'' interchangeably.
    \51\ Proposing Release, supra footnote 2, at n.45 and
accompanying text. As stated in the Proposing Release, regarding the
key inputs and assumptions specific to each asset class or portfolio
holding, it would not be sufficient, for example, to simply state
that private equity investments are valued using a discounted cash
flow model, or that options are valued using a Black-Scholes model,
without providing any additional detail on the specific qualitative
and quantitative factors to be considered, the sources of the
methodology's inputs and assumptions, and a description of how the
calculation is to be performed (which may, but need not necessarily,
take the form of a formula).
    \52\ See rule 2a-5(a)(2)(i).
---------------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

    While the adopting release for the compliance rule included a
discussion

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

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

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

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

B. Performance of Fair Value Determinations

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

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

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

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

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

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

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

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

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

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

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

    We recognize, as commenters stated, that internally managed funds
have no adviser. Instead they rely on certain officers of the fund to
perform the broad range of tasks that advisers to externally managed
funds otherwise perform.\159\ These officers also have fiduciary
duties,\160\ and as employees of the fund are subject to oversight by
the fund's board of directors. We believe that internally managed funds
should not be excluded from this provision of the final rule solely
because they have no adviser. Thus, in a change from the proposal, the
final rule also permits such a fund's board to designate an officer or
officers of the fund to perform the fair value determinations if the
fund does not have an adviser.\161\
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    \159\ To the extent that the officers tasked with performing
these duties have additional conflicts, such as by being compensated
with fund shares, boards should consider those conflicts and any
other conflicts prior to permitting this delegation. See infra
section II.B.1.
    \160\ See, e.g., Zirn v. VLI Corp., 621 A.2d 773 (Del. 1993);
Guth v. Loft, Inc., 23 Del. Ch. 255, 5 A.2d 503, 510 (1939). See
also SBIA Comment Letter (arguing that officers of internally
managed funds should be permitted to perform fair value
determinations because officers of such funds generally have
fiduciary and similar duties to the fund and its equity holders).
    \161\ Rule 2a-5(e)(4). Because these officers are ``valuation
designees'' under the final rule, they will be required to perform
all the functions rule 2a-5 will require of valuation designees,
including the mandatory board reporting.
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    In the Proposing Release, we stated that the proposed rule would
permit boards to assign either to the fund's primary adviser or one or
more sub-advisers.\162\ While some commenters generally supported the
flexibility this interpretation would afford,\163\ others opposed or
had concerns about it, arguing that sub-advisers do not currently
perform this task and permitting them to do so could significantly
increase costs.\164\ Some did not object to the flexibility but stated
that having sub-advisers involved in valuation was inconsistent with
some current practices, with some questioning if this would be an
appropriate role for a sub-adviser.\165\ A number of commenters raised
concerns about how permitting assignment to

sub-advisers would work in practice, for example, how to resolve
conflicting fair value determinations,\166\ and requested that we
provide guidance on how to reconcile in such circumstances.\167\
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    \162\ Proposing Release, supra footnote 2, at 33-34.
    \163\ See, e.g., TRP Comment Letter; IAA Comment Letter; CFA
Institute Comment Letter; Vanguard Comment Letter.
    \164\ See MFS Comment Letter; Seward & Kissel Comment Letter.
    \165\ See Capital Group Comment Letter; IAA Comment Letter;
SIFMA AMG Comment Letter; see also TRP Comment Letter (noting it
could increase costs to assign to a sub-adviser).
    \166\ See Seward & Kissel Comment Letter; SIFMA AMG Comment
Letter.
    \167\ See Capital Group Comment Letter; CFA Institute Comment
Letter; MFS Comment Letter; IAA Comment Letter; see also SIFMA AMG
Comment Letter.
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    The final rule will not permit boards to designate the performance
of fair value determinations to fund sub-advisers.\168\ However,
consistent with the guidance below, boards or their valuation designee
can seek the assistance of sub-advisers as they see appropriate. We
proposed allowing designation to sub-advisers as a method to provide
additional flexibility to boards. After considering the increased
complexity identified by commenters that this flexibility may create,
and commenters' assertions that sub-advisers typically do not currently
serve in this role,\169\ we have determined that any benefits provided
by this additional flexibility would not be justified by the additional
challenges it may create. We also are concerned that allowing
designation to sub-advisers may create complicated reconciliation and
oversight issues for boards, advisers, and sub-advisers. However, we
welcome engagement with respect to the role of sub-advisers in the fair
value determination process.
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    \168\ Rule 2a-5(e)(4) (defining ``valuation designee'' as, among
other things, an adviser other than a sub-adviser).
    \169\ See MFS Comment Letter; Seward & Kissel Comment Letter.
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    The proposed rule would have permitted only the UIT's trustees to
perform fair value determinations.\170\ Commenters stated that the
final rule should permit the parties specified as evaluators in the
UIT's trust indenture or similar document, including the depositor and
other entities, to perform fair value determinations under rule 2a-5.
These commenters argued that these evaluators are the entities with
relevant expertise in valuation matters and this change would make rule
2a-5 more consistent with current practice.\171\ Others asked that we
not apply the final rule's requirements to existing UITs given their
trust indentures are currently drafted to permit entities other than
trustees to value the UITs' investments.\172\ One commenter stated that
the cost to implement the proposed rule could be significant for UITs
due to the change in practice.\173\
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    \170\ Proposed rule 2a-5(d).
    \171\ See ICI Comment Letter; Comment Letter of Chapman and
Cutler LLP (July 20, 2020) (``Chapman Comment Letter''); Comment
Letter of Advisers Asset Management, Inc. (July 20, 2020) (``AAM
Comment Letter''); Comment Letter of First Trust Portfolios L.P.
(July 21, 2020) (``First Trust Comment Letter''); Comment Letter of
Hennion & Walsh, Inc. (July 20, 2020) (``Hennion & Walsh Comment
Letter''); Invesco Comment Letter; Comment Letter of the Bank of New
York Mellon (July 20, 2020) (``BNY Mellon Comment Letter''); see
also Seward & Kissel Comment Letter (suggesting permitting UIT
trustees to assign to any assignee).
    \172\ See Chapman Comment Letter; AAM Comment Letter; First
Trust Comment Letter.
    \173\ See BNY Mellon Comment Letter. Some commenters also asked
that we clarify that the oversight elements of paragraph (b) do not
apply to UITs. See Chapman Comment Letter; AAM Comment Letter; First
Trust Comment Letter; Hennion & Walsh Comment Letter; BNY Mellon
Comment Letter. Because paragraph (b) only applies when a board
designates the performance of fair value determinations to a
valuation designee, which a UIT will not have, we agree that it is
inapplicable to UITs.
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    In other contexts under the Investment Company Act, the Commission
has provided for a UIT's depositor to conduct activities that the board
of directors would otherwise conduct, given that a UIT has neither a
board of directors nor an adviser.\174\ UIT depositors are subject to
liability under section 36(a) of the Act for breach of fiduciary
duty.\175\ We agree, in light of these comments, that UITs should not
be limited to trustees to perform their fair value determinations. As
we understand that the trustee traditionally has not performed fair
value determinations, and we have recognized in the past that
depositors generally serve the most equivalent function to an adviser
for UITs,\176\ the final rule will permit either the fund's depositor
or trustee to perform the fair value determinations required under rule
2a-5.\177\ To the extent that the assistance of other parties (such as
evaluators) is necessary, trustees or depositors can seek that
assistance consistent with the guidance below regarding obtaining the
assistance of others.
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    \174\ See, e.g., 17 CFR 270.17j-1(c)(1)(iii) (``rule 17j-1'')
and 38a-1(b).
    \175\ See section 36 of the Act; see also Memorandum on the
Regulation of Unit Investment Trusts from the Division of Investment
Management to the Securities and Exchange Commission, Fed. Sec. L.
Rep. (CCH) 84,328 (Sep. 22, 1988).
    \176\ See, e.g., items 25 through 31 of Form N-8B-2 (requiring
information regarding depositors that is similar to that required of
an adviser to a management company in item 10 of Form N-1A).
    \177\ Rule 2a-5(d).
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    In recognition of commenters' statements that there would be
significant costs for pre-existing UITs to change who engages in the
fair value determination as they might need to amend their trust
indenture (and potentially obtain a unit holder vote approving the
change) we are grandfathering existing UITs under limited
circumstances. Thus, the final rule will now require trustees or
depositors to perform fair value determinations if the UIT's date of
initial deposit (which would include a rollover) of portfolio
securities occurred after the effective date of rule 2a-5. If the
initial deposit of securities into the UIT took place prior to the
effective date of the final rule, to the extent that an entity other
than the UIT's trustee or depositor has been designated in the trust
indenture to perform fair value determinations, that previously
designated entity may perform such fair value determinations pursuant
to paragraph (a) of the final rule.\178\ We believe that this approach
should be acceptable, even though the party making fair value
determinations under this provision may not be subject to the same
fiduciary duties, as this outcome reflects a balancing of the costs and
risks, informed by the unmanaged and fixed nature of these UITs, and
because of the limited nature of this relief.\179\ Further, we believe
that the number of these funds that will be able to utilize an entity
other than a depositor or trustee will be small and decrease over
time.\180\ We are also concerned that it would be unlikely that pre-
existing UITs could comply with the final rule absent this provision
given the statutory requirement that UITs be organized under a trust
indenture, contract of custodianship or agency, or similar instrument
(the terms of which, in these limited cases, provide for an evaluator
other than the trustee or depositor). Further, we believe that this
approach should address commenter concerns about disrupting existing
UIT fair value determination designees and the associated potential
costly changes which could affect investors if the costs are passed on
to them.
---------------------------------------------------------------------------

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

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

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

    One commenter wanted clarification that the fund's adviser could
perform fair value determinations on the board's behalf regardless of
whether it is acting pursuant to an advisory contract, administrative
contract, or similar agreement.\184\ Another asked that we clarify when
a pricing service that is a Commission-registered adviser would be
considered an ``investment adviser'' for purposes of the final
rule.\185\ The final rule, consistent with the proposal, provides that
where the valuation designee is an adviser, it must be an ``adviser of
the fund.'' This would not include other service providers, whether or
not they are registered as advisers, or acting under a contract with
the fund, unless they are actually serving as the adviser of the fund
as defined under the Investment Company Act because they may not have a
comprehensive and direct knowledge of the fund, a direct relationship
with the board, or the same fiduciary duties to the fund in other
cases.\186\ As discussed above, it also would not include a sub-adviser
to the fund.
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    \184\ See John Hancock Comment Letter.
    \185\ See ICE Data Comment Letter.
    \186\ See section 2(a)(20) (defining investment adviser of an
investment company). See also supra footnotes 152-156 and
accompanying text (explaining why we are generally not permitting
parties other than the adviser to be valuation designees under the
final rule).
---------------------------------------------------------------------------

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

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

    We believe that whether the board or the valuation designee makes
fair value determinations under the final rule, it may of course obtain
assistance from others in fulfilling its duties. It may, for example,
seek assistance from pricing services, fund administrators, sub-
advisers, accountants, or counsel.\189\ That assistance can take
different forms, and may include services such as performing back-
testing as specified by the valuation designee and performing
calculations required by the valuation method selected by the board or
valuation designee. The board or the valuation designee, using this
assistance, must of course also perform its responsibilities under the
Act, the final rule, and other applicable rules under the Act. However,
in seeking the assistance of others, the entity or officer designated
to perform the fair value determination remains responsible for that
determination and may not designate or assign that responsibility to
the third party for the same reasons we are not permitting the board to
designate performance of this task to a party other than the valuation
designee.\190\
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    \189\ For example, some commenters suggested that the
administrator may be better positioned to perform the fair value
determinations under rule 2a-5 than an adviser. See Sullivan Comment
Letter. For the reasons discussed above, we determined generally to
limit the valuation designee to the fund's adviser. See supra
footnotes 152-158 and accompanying text.
    \190\ See supra footnotes 152-158 and accompanying text.
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1. Board Oversight
    The final rule, consistent with the proposal, specifically requires
a board to oversee the valuation designee if the board has designated
the performance of fair value determinations to the valuation
designee.\191\ In the proposal, we provided guidance on our
expectations related to this board oversight.\192\ A number of
commenters supported this guidance,\193\ with one commenter stating
that the discussion properly reflects the general roles of boards and
advisers under both current practices of properly functioning boards as
well as Federal and state law.\194\ However, other commenters