Deloitte Report: Mutual Fund Directors on Alert Over Fair Valuation Oversight After Morgan Keegan Case

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Sep 23, 2013, 10:00 ET

NEW YORK, Sept. 23, 2013 /PRNewswire/ -- The U.S. Securities and Exchange Commission's enforcement action against the former directors of the Morgan Keegan Funds has mutual fund companies stepping up their focus on fair value pricing, particularly at the board level, according to Deloitte, based on a new survey.

"The SEC certainly has the industry's attention," said Elizabeth Krentzman, the leader of Deloitte's mutual fund practice and a principal with Deloitte & Touche LLP. "Events over the last year have cast a significant spotlight on fund valuation efforts. The Morgan Keegan case, which came after other SEC enforcement actions, was more than a warning shot. It was the strongest signal yet that the SEC has fund directors firmly in its sights and will hold them responsible for fair valuation decisions."

According to Deloitte's eleventh annual fair value pricing survey, SEC enforcement actions were the most talked about topic among board members outside of regularly scheduled meetings. As the report observes, discussions – both in and outside of regular board meetings – have given directors "opportunities to assess whether they needed to change elements such as the timing and frequency of their oversight, the type and extent of materials being reviewed, and the level of delegation provided to others." Indeed, 54 percent of the mutual funds surveyed said they have changed the types of valuation materials provided to the board, and 57 percent have changed the level of detail in this area.

More broadly, more than three out of four mutual fund firms (78 percent) indicated they changed their valuation policies and procedures over the last year.

Deloitte's survey focuses on the policies, procedures and processes of mutual funds for fair value pricing of fund investments. Each business day, a mutual fund must determine the value of each portfolio security it holds to set what is known as a "net asset value per share." This calculation is subsequently used to process purchases, redemptions and exchanges by shareholders.

Among other findings:

According to the survey, the second-most-popular subject of board member discussions between meetings was trading halts, which can be a trigger for funds to fair value their investments under certain circumstances. "With technology challenges continuing to plague the exchanges, these issues may continue to demand attention from both fund directors and management," said Rajan Chari, a partner with Deloitte & Touche LLP and co-author of the survey.
Beyond future SEC action in the valuation arena, the mutual fund firms surveyed believe that pricing vendor oversight, managing the external audit process, derivative valuations, and board reporting and oversight will be the most pressing valuation challenges over the next one to two years.
Risk management remains an integral part of the "valuation alchemy" for many fund groups, as about half (51 percent) of survey participants indicated that they had identified valuation risks for one or more specific investment types as part of their annual compliance reviews under rule 38a-1 or formal risk assessment process.
Nearly six out of seven (84 percent) reported that their fund's chief compliance officer (CCO) has a full-time presence at board meetings when valuation matters were discussed, an increase from the 2012 survey. CCOs were also more actively involved in identifying risks associated with the valuation of asset classes. Adviser compliance personnel saw their full-time participation at such meetings increase (at 58 percent in 2013 against 49 percent last year).
More than a third of fund managers (38 percent) said they have conducted an analysis over the past year to identify ways to improve the efficiency of valuation processes and to reduce redundancies.

"Fair valuation isn't a static process," said Chari. "Constant refinement, as well as the tailoring of policies and procedures to each firm's investment setting, is pushing the industry towards common practices in certain areas, even as others remain in flux. Just over the last three years, we have seen some fair value approaches being embraced on an industry-wide basis. We may also see some of today's emerging practices become more established in the near future."

Deloitte's 11th Annual Fair Value Pricing Survey aggregates the views of 96 mutual fund firms, the survey's highest-ever tally of respondents. Respondents hold more than $10 trillion in assets under management. The population of survey participants represents a diverse mix of mutual fund firms encompassing various sizes, asset classes and geographies. The survey took place between June and August 2013.

About Deloitte's Investment Management Services Practice
Deloitte's investment management services practice works with each of the top 30 global asset managers and serves as the corporate and/or mutual fund auditor for 23 of the top 50 U.S. mutual fund complexes. The practice has a strong reputation built through its work with a roster of blue-chip clients, many of whom it has served for more than 30 years.

As used in this document, "Deloitte" means Deloitte LLP and its subsidiaries. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

SOURCE Deloitte