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,IVISION OF

INVE.STMENT MANAGEMENT

December 8, 1999

Mr. Craig S. Tyle

General Counsel

Investment Company Institute

1401 H Street, N.W.

Washington, D.C. 20005

EFFECTIVE September 8, 2022, THIS LETTER IS

WITHDRAWN. Please consult the following web page for more

information: https://www.sec.gov/divisions/investment/immodified-withdrawn-staff-statements.

Dear Mr. Tyle:

As a result of recent events, we believe that it would be helpful to some open-end

management investment companes ("mutual fuds" or "fuds") to review their

obligations to price and redeem fud shares during emergency or unusual situations. As

you know, the ability to redeem fud shares is a priar consideration for mutual fud

investors, especially durng emergency or unusual situations. Because all fuds may

experience emergency or unusual situations at some point, we believe that it would be

usefu to review fuds' pricing obligations under the law, and to provide additional

guidance to fuds on their obligations to price and redeem their securities durng these

and other situations.

We discuss below thee issues relating to fuds' responsibilties for pricing

portfolio securities. First, we clarfy that market quotations for portfolio securties are not

readily available when the exchanges or markets on which those securties trade do not

open for trading for the entire day, and that fuds, accordingly, must price those securties

based on their fair value ("fair value price"). Second, we provide additional guidance

regarding the process of fair value pricing, and describe certn factors that fuds should

consider when fai value pricing portfolio securties. Finally, we discuss the obligations

of fud boards of directors ("boards") for fair value pricing securties, and discuss

measures that boards may tae when discharging those responsibilties.

Section 22( e) and Rule 22c-1

The Investment Company Act of 1940 ("1940 Act") requires mutu fuds to

price and redeem their shares at the net asset values ("NA V") next computed after receipt

of redemption requests, and to make prompt payment of redemption proceeds. i

of

redemption.

Section 22( e) of the 1940 Act generally prohibits mutual funds from suspending the right

redemption proceeds for more

and prohibits funds from postponing the payment of

than seven days. Rule 22c-l (b) under the 1940 Act generally requires that a fund's NA V be

Mr. Craig S. Tyle

December 8, 1999

Page 2

Generally, under the 1940 Act, fuds may, but are not required to, suspend redemptions

and postpone payment for redemptions already tendered for any period durng which the

the

Section 22(e) of

New York Stock Exchange ("NYSE") is closed. For puroses of

1940 Act, the staff considers the NYSE to be closed on any day when it does not open for

trading for the entire day. Whether the NYSE could otherwise be considered to be closed

on any given day depends on the paricular facts and circumstances of the situation.

When fuds encounter diffculties in selling or pricing their portfolio securities due to,

among other thngs, market breaks, trading restrictions, internal fud failures, or natual

disasters, Section 22( e) does not permit fuds to suspend redemptions in the absence of

certain determinations by the Commission.2

Availability of Market Quotations

The 1940 Act requires mutual fuds to value their portfolio securties by using the

market value of the securties when market quotations for the securties are "readily

. available.,,3 When market quotations are not readily available, the 1940 Act requires fud

boards to determine, in good faith, the fair value of the securties. These pricing

requirements are critical to ensurng that the prices at which fud shares are purchased

and redeemed are fair, and do not result in dilution of shareholder interests or other har

to shareholders.

4

computed at least once daily, Monday through Friday, at a specific time or times as determined

by the fund's board.

2 Section 22(e) also permits a fund to suspend redemptions in two other situations. First, a

fund may suspend redemptions for any period during which trading on the NYSE is restricted, as

determined by the Commission. Second, a fund may suspend redemptions for any period during

which an emergency exists, as determined by the Commission, as a result of which it is not

reasonably practicable for the fund to (1) liquidate its portolio securities, or (2) fairly determine

the value of its net assets. With respectto exigent circumstances that do not constitute an

"emergency," see generally Investment Company Act ReI. No. 14459 (June 6, 1985) (discussing

instaces in which funds are unable to complete the mechanical process of pricing on days when

pricing would normally be required under Rule 22c-l, and methods that funds may employ to

address those situations).

the 1940 Act defines "value" as: (i) with respect to securities for

which market quotations are readily available, the market value of such securities; and (ii) with

respect to other securities and assets, fair value as determined in good faith by the board. This

definition also is used in Rule 2a-4 under the 1940 Act as the required basis for computing

periodically the current NA V of funds for the purpose of pricing their shares.

Section 2(a)(41)(B) of

4 For example, if

fund shares are overpriced, redeeming shareholders wil receive a

windfall at the expense of shareholders that remain in the fund, and purchasing shareholders wil

pay too much for the shares. Similarly, sales of shares in a fund that has undervalued its portolio

would also have dilutive effects. See Investment Trusts and Investment Companies: Hearings on

Mr. Craig S. Tyle

December 8, 1999

Page 3

When the exchange or market on which a securty is traded does not open for

trading for an entire trading day, and no other market prices are available, we believe that

market quotations for that securty are no longer "readily available." In such instances,

fuds holding securties traded on the closed exchange or market must fair value price

those securties.s For example, following September's earhquake in Taiwan, the Taiwan

Stock Exchange ("TSE") was closed for a number of days. We believe that under these

circumstances, market prices for securities traded on the TSE were not "readily available"

and that fuds holding such securties were required to use fair value prices in

determinng NA V.6 In anticipation of circumstaces such as these, fuds should consider

adopting procedures that are designed to alert the board and fud management to

conditions that may necessitate fair value pricing of portfolio securities.

Fair Value Pricing

In recent years, commentators have suggested that we should provide additional

or fuher guidance regarding pricing issues and the factors that fud boards should

evaluate when fair value pricing a fud's portfolio securities. These suggestions were

primarly directed at ASR Nos. 113 and 118, which were issued by the Commssion at a

time when financial markets were less diverse and fuds had fewer investment

alternatives.7 Although we recognize the limited scope of these ASRs, we also note that

they were not intended to provide comprehensive guidance to fuds on how to address all

pricing issues, nor were they specifically addressed to emergency or unusual situations.

the Senate Committee on Baning and Currency, 76th Cong.,

3d Sess. 136-38,289 (1940); Accounting Series Release ("ASR") No. 219 (May 31, 1977).

Thus, pricing of fund portolio securities based upon their current values is necessary to ensure

fairness among all fund shareholders.

S. 3580 Before a Subcommittee of

5

We note that, in these circumstaces, the determination that market quotations are no

longer "readily available" does not preclude a fund's board from concluding that the most recent

closing market price represents fair value. We believe that the most recent closing market prices

generally should be considered, along with other appropriate factors, when determining the fair

value of securities for which current market quotations are not readily available.

6 In situations such as the Taiwan earhquake, funds should pay particular attention to

whether all issuers are affected by significant events similarly. For example, in the event of a

natural disaster, funds that hold securities of affected issuers should, to the extent possible, make

efforts to determine whether a paricular issuer has been affected by that event differently from

the damage inflicted generally.

7

ì

)

ASR No. 113, Financial Reporting Codification (CCH) § 404.04 (Oct. 21, 1969); ASR

No. 118, Financial Reporting Codification (CCH) § 404.03 (Dec. 23, 1970).

Mr. Craig S. Tyle

Decem ber 8, 1999

Page 4

ASR Nos. 113 and 118 were intended to provide general ilustrative guidance on certain

continue to represent the views of

the

valuation issues, and we believe that they

Commission.

.. 8

The Commission has stated that, as a general principle, the fair value of a

portfolio securty is the price which the fud might reasonably expect to receive upon its

curent sale.9 Ascertnig fair value requires a determination of the amount that an

ar's-length buyer, under the circumstances, would curently pay for the security. Fair

value canot be based on what a buyer might pay at some later time, such as when the

market ultimately recognzes the securty's tre value as curently perceived by the

portolio manager. 10 Funds also may not fair value price portfolio securties at prices

which are not achievable on a curent basis on the belief that the fud would not curently

1 1 Thus, bond or similar fuds generally may not fair value

need to sell those securties.

price portfolio securities at par based on the expectation that the fuds will hold those

securities until matuty,12 ifthe fuds could not receive par value upon the curent sale of

h .. 13

t ose securties.

See,~, Pamassus Investments, Initial Dec. No. 13 1 (Sept. 3, 1998), initial dee.final

(Oct. 8, 1998) (administrative law judge ("ALJ") finding, among other things, that the fund's

directors failed to act in accordance with guidance provided in ASR Nos. 113 and 118 and failed

to satisfy their good faith obligations when fair value pricing portolio securities).

9

See ASR Nos. 113 and 118, supra note 7; ASR No. 219, supra note 4.

io See Pamassus, supra note 8 (ALJ finding that a board's valuation of a portfolio security

based upon what the security would be worth upon the sale of the company as a going concern,

when no such offers were forthcoming, was not determined in good faith).

11 When investors redeem fund shares, they are entitled to obtain their proportionate

the fund's portolio securities at the time that the transaction is effected.

Similarly, when investors buy fund shares, they should not pay any more (or less) than the value

of those shares at that time. See also note 4, supra.

amount ofthe value of

12 See ASR No. 219, supra note 4. In ASR No. 219, the Commission stated that it would

not object if boards of certin funds determined, in good faith, that the fair value of their portolio

debt securities with remaining maturities of 60 days or less was equal to their amortized cost,

unless an impairment to the creditworthiness of the issùers or other factors vitiated the accuracy

of such amortized cost valuations.

13 Unlike mutual funds, closed-end management investment companies ("closed-end

funds") are not obligated to redeem fund shares at NA V. Nonetheless, closed-end fund boards

are required to fair value price portfolio securities in good faith and in accordance with the same

principles that apply to mutual funds. Under Section 30(e) ofthe 1940 Act, closed-end funds

must report their NA Vs to fund shareholders semi-annually. They also typically report their

NA Vs in newspapers weekly. In addition, closed-end funds that periodically repurchase their

Mr. Craig S. Tyle

December 8, 1999

Page 5

This is not to say that fair value pricing is an inelastic concept. Indeed, ASR Nos.

113 and 118 recognize that no single standard exists for determining fair value in good

faith. Instead, the Commission adopted a more flexible standard which requires fud

directors to "satisfy themselves that all appropriate factors relevant to the value of

securities for which market quotations are not readily available have been considered and

to determe the method of ariving at the fair value of each such securty." ASR No. 118

fuer states that "directors should take into account all indications of value available to

them in determinig the 'fair value' assigned to a paricular securty" (emphasis added).

Whether a factor is "appropriate," and whether a paricular indication of

value is

available, depends upon the paricular facts and circumstances of the situation. Thus,

durg emergency situtions, fud boards should evaluate as many relevant factors as

they are able to under the circumstances.

ASR Nos. 113 and 118 suggest that fudamental analytical information is among

the most important factors for fud boards to evaluate when fair value pricing portfolio

securties. Whle we believe that an analysis of the value of the investment itself

continues to be of priar importance in determining fair value, we also believe that in

many situtions fud boards may need to incorporate other, external sources of

information in their fair value determinations. Information derived from world financial

markets and various financial products, which can assist in establishing the value of

portolio securities or can provide indications as to the value of securties comparable to

those in the portfolio, may be usefu for fair value pricing in certain circumstances.

The following list of factors that fud boards may need to consider, if relevant,

when fair value pricing portolio securties is merely ilustrative, and is not intended to

any other factors. The factors include: the value of

preclude a board's consideration of

other financial instrents, including derivative securities, traded on other markets or

among dealers; trading volumes on markets, exchanges, or among dealers; values of

baskets of securties traded on other markets, exchanges, or among dealers; changes in

interest rates; observations from financial institutions; governent (domestic or foreign)

actions or pronouncements; and other news events. With respect to securties traded on

foreign markets, the factors also might include the value of foreign securties traded on

other foreign markets, ADR trading, closed-end fud trading, foreign curency exchange

shares in reliance on Rule 23c-3 under the 1940 Act are required to compute NAVin connection

with each repurchase offer. The failure to report accurate NA Vs may result in the market being

misled and investors buying and selling fund shares at market prices that are based, in par, on

inaccurate NA V s. In addition, an adviser's receipt of advisory fees that are based on inflated

NA V s may raise issues under, among other things, Sections 15( c) and 36(b) of the 1940 Act, and

Section 206 of the Investment Advisers Act of 1940.

Mr. Craig S. Tyle

December 8, 1999

Page 6

. . h WEBS 14 .

activity, and the trading prices of financial products that are tied to baskets of foreign

securties, suc as .

We believe that a fud board, when fair value pricing portfolio securties in an

emergency or other unusual sitution, should evaluate the natue and duration of the event

and the forces inuencing the operation of the financial markets.. The board also should

evaluate factors relating to the event that precipitated the problem, whether the event is

the event are isolated or whether they afect entire

likely to recur, whether the effects of

markets, countres, or regions. We believe that, at a minimum, fud boards should

consider how factors, such as those listed above, or other, similar factors, to the extent

relevant, may assist in fair value pricing portfolio securties.

The Board's "Good Faith" Responsibilities

The development of

world financial markets and the proliferation of

new financial

products have both simplified and complicated a board's responsibilities when fair value

pricing portfolio securties. Access to information regarding global financial markets, as.

well as instantaeous communcations, are continually raising the amount of curent and

accurate information in the marketplace. New markets and products, such as those

discussed above, provide alternative pricing indicators and benchmarks, which can ease

these new sources of

information also have

the task of

fair value pricing. Conversely,

increased significantly the number of factors that a mutual fud board may need to

evaluate when fair value pricing portfolio securities. This, in tu, provides additional

challenges to fud directors, who may have to consider numerous alternatives when

makng complex decisions under tight time constraints. is

We also recognize that different fud boards, or fuds in the same complex with

different boards, when fair value pricing identical securties, could reasonably arive at

14 We understand that in connection with the extreme volatilty that occurred in world

financial markets in October 1997, certain funds used a variety of indicators and benchmarks to

fair value price their Asian portolio securities, including news items, the bids on baskets of

securities, ADR trading, closed-end fund trading, and futures on the securities indices of certain

countres.

15 One factor placing time pressure on fuds to quickly determine NA V is the brief period

between the time that most U.S. funds price their securities and the deadline for reporting NA V

information to the NASDAQ in order to ensure that the NA Vs are reported in the

next day's

newspapers. Although we recognize the importce of publishing this information in

newspapers, this concern is secondary to ensuring that the fund's NAVis accurate. Moreover,

the availability of other systems for delivering NA V information, including internet web sites and

automated telephone operating systems, provides funds with alternative methods for

disseminating current NA V s.

Mr. Craig S. Tyle

December 8, 1999

Page 7

prices that were not the same, consistent with the boards' obligation to fair value price in

good faith.16 We believe that "good faith" is a flexible concept that can accommodate

many different considerations, including the incorporation of a variety of sources of

information. Finally, we believe that the specific actions that a mutual fud board must

take in order to satisfy its good faith obligation under Section 2( a)( 41) of the 1940 Act

wil var, dependig on the natue of the paricular fud, the context in which the board

must fair value price, and, importantly, the pricing procedures adopted by the board.

Some commentators have suggested that, in light of the changes in securties and

markets, mutual fud boards are il-equipped to fair value price portfolio securties and

that the obligations placed on boards by the 1940 Act are unworkable. Mutual fud

boards, however, typically are only indirectly involved in the day-to-day pricing of a

fud's portfolio securities. Most boards fulfill their obligations by reviewing and

approving pricing methodologies, which may be formulated by the board, but more

typically are recommended and applied by fud management. In reviewing and

approving pricing procedures, boards should determine whether those methodologies and

procedures are reasonably likely to result in the valuation of securties at prices which the fuds could expect to receive upon their curent sale. Mutual fuds also may use a

number of other technques to minmize the burdens of fair value pricing on their

directors. For example, a number of fuds delegate certain respónsibilities for fair value

pricing decisions to a valuation committee. Such committees generally assist the board in

developing methodologies by which fair values are to be calculated, and implement the

board-approved methodologies on a day-to-day basis or as frequently as necessar.

A mutual fud board can tae significant steps toward satisfying its good faith

obligations prior to an emergency or unusual situation. We believe that, in general, the

degree of involvement required of a board during emergencies wil depend heavily on the

comprehensiveness of the pricing procedures adopted for the fud and the degree of

discretion vested in fud management. If, for example, a board has approved

comprehensive procedures which provide methodologies for how fud management

should fair value price portfolio securties, including procedures which would be

appropriate for that paricular emergency situation, a board would need to have

comparatively little involvement in the valuation process in order to satisfy its good faith

obligation. Ths necessitates, of course, that the board periodically review the

appropriateness of the methods used to fair value price portfolio securities and the quality

of the prices obtained through these procedures, and that it make changes when

appropriate.

16

We generally believe, however, that a board could not arrive at different fair valuations

for identical securities held by two or more funds that the board oversees, consistent with its good

faith obligation.

Mr. Craig S. Tyle

December 8, 1999

Page 8

When the board has vested a comparatively greater amount of discretion in fud

management, or when pricing procedures are relatively vague, we believe that the board's

involvement must be greater and more immediate. In these instances, a fud board may

be required to evaluate how emergency conditions are affecting the fud's pricing

mechansms, whether the pricing procedures are appropriate, what inquiries fud

management is makg, and what factors management is considering when makg

valuation recommendations. Depending on the paricular circumstances, the board may

need to evaluate how paricular portfolio securties are being priced, or, when the fud

has limited or no fair value pricing procedures, authorize the specific pricing

methodology used.

In any event, given that the fud's board retains oversight responsibilty for the

the fud's assets, the board should receive periodic reports from fud

the valuation process and that focus on issues

management that discuss the fuctioning of

valuation of

and valuation problems that have arsen.

*

*

*

*

*

This letter addresses certai selected pricing issues and is not intended to provide

comprehensive guidance on ths subject. Nothing in this letter is intended to alter the

guidance in ASR Nos. 113 or 118, or the general requirement that fuds must use market

values to value their portfolio securties when market quotations are readily available.

We will consider whether to provide additional guidance on pricing issues in the

futue. We would appreciate your sharg ths letter with your members. If you have any

questions, please contact me, Mercer Bullard, or Evan Geldzahler, at (202) 942-0660.

~~

Very trly yours,

I?ougit)S:heidt

Associate Director and

Chief Counsel