Valuation for Compliance Personnel:
Strategies and Steps
By Peter J. Anderson and Deborah G. Heilizer1
Introduction
Peter J. Anderson is a partner in the Atlanta,
GA office of Sutherland, Asbill and Brennan.
He has practiced in the securities regulatory
and enforcement arena for almost 30 years
representing brokerage firms, broker-dealers
and individual brokers before the Securities
and Exchange Commission, all self-regulatory
organizations, and state securities regulators
and attorneys general in investigations relating to supervision, suitability, sales practices
and insider trading.
Deborah G. Heilizer is a partner in the Washington, DC office of Sutherland, Asbill and
Brennan, and is a member of the firm’s Litigation Group. She provides representation in a
wide range of securities matters with emphasis
on accounting and financial issues, regulatory
enforcement and litigation involving the SEC,
self-regulatory organizations and private
litigants. Deb also advises broker-dealers, investment advisers and financial institutions on
state and federal regulatory matters, disclosure
issues and compliance matters.
Portfolio valuation, and more specifically, the fair valuation of portfolio securities, has recently received more attention than during any
other period since the inception of the original fair value accounting guidance nearly four decades ago. It has commanded lengthy
Securities and Exchange Commission roundtables,2 resulted in civil
and criminal enforcement actions, and appeared in new Financial
Accounting Standards Board (“FASB”) guidance. While recognized
as important, “because advisory clients need to know the fair value of
their holdings”3 fair value accounting has also been blamed as “one
of the biggest culprits” of the current economic crisis.4 Regardless of
the merits of fair value accounting, its application will likely plague
legal, compliance and financial personnel for a variety of institutions
for years to come.5
The SEC Staff has been emphasizing a number of fair valuation themes in recent presentations. These include the regulators’
desire that (1) decisions regarding the fair valuation of a security
be documented in sufficient detail that the original source of the
information can be identified and tested; (2) firms understand
and manage what the regulators perceive as independence issues
with respect to internally generated fair value prices; and (3) firms
examine and document their procedures for fair valuation.
The Basic Tenets of Fair Valuation:
Accounting Series Releases 113 and 118;
Statement of Financial Accounting Standards 157
The requirement to fair value securities stems from the Investment Company Act’s requirement that certain entities, including
open-end investment companies (open-end funds) buy and sell
shares at net asset value,6 a calculation that requires that securities
and assets for which market quotations are not readily available
be fairly valued in good faith by a fund’s board of directors. For
©
2009; Sutherland, Asbill & Brennan, LLP
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open-end funds, this process must be done daily;
for closed-end investment companies (closed-end
funds) the process must be done periodically,
although many closed-end funds calculate NAV
weekly or even more frequently. Entities other
than mutual funds may also be required to fairly
value securities.
Nearly four decades ago, the SEC issued its first
accounting guidance on fair value. Accounting
Series Releases (“ASR”) 113, together with ASR
118 (issued the following year), set out the basic
principles for determining fair value, which are
still followed today. In essence, ASR 113 and
118 require fund boards to have an appropriate
valuation process that is consistently applied (although no particular process or single standard is
mandated). The goal of fair valuation is to arrive
at a price, that is, “the amount which the owner
might reasonably expect to receive for them upon
their current sale.”7 A fair value determination
may be made from information about the specific
security itself, or by reference to other, observable market information, such as a discount
from market of a similar, freely trading security,
or yield to maturity with respect to debt issues,
or a combination of information specific to the
security, information about other securities, and
information about market forces.
The SEC has long reported to be considering
more definitive guidance with respect to fair valuation, but its pronouncements have been limited.
The more recent guidance, albeit limited, has
come from the Financial Accounting Standards
Board—first, as a result of the issuance of Statement of Financial Accounting Standards (“FAS”)
157, and later in the recent amendments contained
in FAS 157-3.
FAS 157: (1) describes fair value; (2) establishes a framework for measuring fair value; and
(3) expands disclosure about fair value. Under
FAS 157, fair value is “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.”8 It sets up
a hierarchy of “inputs” or types of information
to be considered in arriving at fair value. Quoted
prices in active markets (Level 1 inputs) are
considered the most reliable basis for valuation
and are to be used when available. Alternative
pricing methods, such as matrix pricing, quotes
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for identical assets in inactive markets or similar
assets in active markets, are examples of Level 2
inputs. Unobservable inputs, or Level 3 inputs,
are those based upon the reporting entity’s own
assessment of the assumptions that market participants would use to value an asset.
In the wake of the recent credit market meltdown, FASB clarified FAS 157 by issuing FAS
157-3, which allows limited additional flexibility
in fair valuation. Examples include permitting
management to use estimates of value based
upon future expected cash flows in certain circumstances, emphasizing that broker quotes may
not necessarily be determinative of fair value,
and stressing the role of management judgment,
particularly in disorderly markets.
Compliance Efforts
Compliance staff, however, should not equate
the recent relative flexibility with any easing
of the standards to which regulators hold the
valuation process. In light of the recent market
turmoil, the SEC examination staff has been
insisting that the fair value process remain rigorous, robust, and transparent.
Following is a list of questions that the compliance professional may wish to ask concerning
his or her own company’s fair valuation process
when third party prices are not available. Some
of these questions were drawn from a recent
presentation by John Walsh of the Offi ce of
Compliance, Inspections and Examinations at
the National Society of Compliance Personnel.
These questions were not intended as guidance
or opinions of law, but as starting points for
compliance personnel to consider vis-à-vis their
firm’s operations.9
1. Has the firm turned to a modeling tool
provided by a vendor or consultant?
If so, do the pricing staff or the reviewers
understand how the tool works or view it
as a black box?
In recent years, there has been an increasing use
of service providers or consultants that provide
prices for structured or other products. Retention of an outside pricing consultant can ease any
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conflict of interest that could arise when an entity
states the fair values of its own securities.10 However, retention of an outside pricing consultant
may not be sufficient to shield management from
regulatory scrutiny. The Director of the Office of
Compliance Examinations and Inspections has
stated that “[f ]or those assets valued by using a
broker’s quote or a price from a pricing service—
you should be sure that you understand whether
the quote or price is based on actual transactions,
reflects the willingness of the broker to trade at
that price, or is based on a model or another
methodology.”11 Other questions management
might consider asking are:
whether the pricing service uses quoted prices
from an active market, or observable inputs,
whether the pricing service’s assumptions about
the relevant market reflect a market available
to the firm.12
Thus, compliance personnel may wish to ascertain whether there is some visibility into, and
understanding of, a vendor’s methodology through
presentations, periodic reports, documented conversations, or other means.
Has the vendor been checked for conflicts?
One of the purposes of using a third-party vendor
in the fair value process can be to bring a modicum of objectivity and independence to a process
that often must rely on good faith judgments.
However, the objectivity and independence of
third-party pricing services may be questionable. The SEC and the DOJ recently instituted
civil and criminal charges against four financial
services workers, alleging a scheme to overvalue
a commodities derivatives trading portfolio.13
The complaint asserts that a trader agreed with a
third-party brokerage firm (of which he was the
largest client) that the brokerage firm would send
back to the trader’s firm the same quotes that the
trader had received. What the case against the
trader and others demonstrates is that a third
party may not in and of itself be a guaranty of
objectivity or independence. Thus, compliance
personnel may wish to ask whether there are
factors that would impede the vendor’s exercise
of independent judgment. Such factors could
include a substantial business relationship, like
that at issue in the above recent case involving
the trader. Alternatively, compliance personnel
may wish to review whether the pricing service
relies on input from a fund or reporting entity’s
own management, which SEC Staff has indicated
could result in stale prices, among other things.14
Other inquiries might include whether there are
any conflicts that arise from the vendor’s other
relationships, such as an affiliation with the seller
of the products at issue.
2. Has the firm’s internal model or matrix
been tested or validated in some way?
Matrix pricing is a “technique relying on extrapolation used to value normal institutional size
trading units of debt securities without relying
exclusively on quoted prices.” Instead of exclusive
reliance on quoted prices, a matrix incorporates
“[f ]actors such as the issue’s coupon or stated
interest rate, maturity, rating, and quoted prices
of similar issues [which] are considered in developing the issue’s current market yield.”15 Thus,
matrix prices may be inferred from securities
viewed as comparable in terms of factors such as
ratings, interest rate, and due date.
The question above implies a concern that without testing or validation of the prices generated by
the matrix, it may be impossible to demonstrate
that the model results in fair values. Regulators
may prefer that compliance personnel be able
to demonstrate how they know that the matrix
actually works, which may require employing an
appropriate test. Although the guidance does not
mandate that any particular test be employed for
matrix prices, compliance personnel may wish to
consider back testing actual matrix priced securities, or, if possible, follow actual sales of securities
for which the quoted prices are used as a matrix
input to determine the proximity of quoted to
actual sale prices.
Does the matrix use current information?
Or does it use information from aged trades?
While this question can be seen as an application
of the “do you understand how it works” question
above, it also underscores the SEC’s concern that
pricing remain fresh, particularly in an illiquid
market. Nearly four decades ago, in ASR 118,
the SEC stated that one of the general factors
to be used in fair valuation is “an evaluation of
the forces which influence the market in which
these securities are purchased and sold.”16 If the
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underlying data in a volatile (and illiquid) market is dated, regulators may question whether
the inferred prices may be dated as well. Again,
resolving this question may require compliance
personnel to query the matrix service provider
regarding inputs into the model.
3. Are you using test trades? If so, on which
side of the market are you?
This question asks compliance personnel to
consider whether prices obtained from actual
purchases or sales entered into in order to obtain a
current price are truly representative of fair value.
Answering this question may require compliance
personnel to examine whether the transaction
mirrors the firm’s typical transactions.
If the firm is only buying, what inferences can
you make about selling the portfolio?
FASB has indicated that “[c]onceptually, entry
prices and exit prices are different.”17 In fact, according to FASB, “[e]ntities do not necessarily
sell assets at the prices paid to acquire them.18 As
a result, the price the firm pays may not be an accurate predictor of the price that the firm would
receive if it were to sell a position. The effect of
buy or sell bias, if any, on pricing may be particularly significant in times of exaggerated spreads.
Compliance personnel thus may wish to evaluate
whether test trades are being done in such a way
and in such a market, that they are truly predictive
of the value that would be realized upon exiting the
entire position held in the portfolio, as opposed to
a small piece in a particular transaction.
4. Are your valuations aggregated or
averaged before being reviewed?
Reviewing and testing prices can be a tedious
and time consuming task. Averaging for purposes of review is a shortcut that might have
some utility, but may carry risks, because each
mark is less transparent.
Can aggressive marks be hidden by using averages?
When marks, or prices are aggregated, more aggressive or outlier marks can be obscured. It is possible
that aggregating marks could cause compliance
officers to overlook trends in marks, or information that some of the marks may not be verifiable
in accordance with procedures.
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The risks of aggregation burst into the news
earlier this year with the revelation that a junior
trader at Société Générale Bank had entered into
allegedly unauthorized transactions that caused
approximately $7.7 billion in losses.19 A derivatives trader on the Bank’s Delta One desk, where
positions were supposed to be perfectly hedged,
instead allegedly offset huge directional bets on
the market by engaging in a number of transactions that were designed to appear as hedging or
cancelling transactions, but were not.20 Because
the transactions were allegedly being netted,
they may have received less scrutiny than they
would have otherwise. Thus, if a firm’s procedures
require a reviewer to examine netted transactions or prices, consideration might be given to
developing an individual transaction or price
test protocol.21
5. How good is your internal information
management?
Market stresses may stress internal valuation
systems and the oversight of those systems. In
order to ensure that valuation methodology
and output respond appropriately to fast-paced
market changes, regulators have recently been
emphasizing the process for arriving at valuations.
Examination staff recommended as an example of
a “strong control practice” that “[f ]irms maintain
an internal data warehouse that serves as the internal repository for security position information,
including periodic valuations, in order to ensure
consistency amongst various inventory trading
accounts and collateral valuations.”22 As market
information about the valuations of particular
securities becomes scarce, it may become more
important that relevant information be shared
among responsible personnel.
If different people come to different values
(for example, one value for collateral
and a different value for an asset under
management), does each group know about the
price assigned to the security of the other group?
SEC Staff recognizes that the boards of different
funds, or funds in the same complex with different boards, could reasonably arrive at different
fair values for identical securities.23 The Staff of
the SEC, however, to date has not taken a position on whether it is ever possible for a regulated
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entity, such as a broker-dealer, to have different
prices for assets serving as collateral, and those,
for example, held in an affiliated fund’s portfolio. In fact, SEC Staff did note in its July 2008
Compliance Alert24 that “[a]t some firms, only
the limited number of securities that were both
held as collateral and held in inventory were
subject to review by the product control group”
(independent verifiers).25 At other firms, SEC
Staff noted, “subprime securities held as collateral were [valued] solely by proprietary traders
and/or outside pricing services, with no oversight by the product control group.” According
to the Staff, a lack of communication between
the two groups with valuation responsibility
could lead to different or inconsistent values
being assigned, without analysis of the apparent discrepancies. 26 One compliance “fix” for
this issue might be to have procedures in place
that centralize the flow of pricing information
to a central, independent group. Compliance
personnel thus may wish to consider “mapping”
where in their organization valuation decisions
are made, to ensure that they filter up to a centralized, independent group that has visibility
into all of the fair valuations.
6. What role do traders have in pricing?
This question has become a central focus of regulators. Their assumption appears to be that traders
have a vested interest in maintaining a positive
bias in pricing because of payment arrangements
typical in the industry (e.g., compensation based
on assets under management). The regulators thus
have a pronounced preference for: (1) what they
term to be “verification by independent personnel
of the valuations assigned by trading personnel;”27
and (2) an understanding of whether and how the
trader or portfolio manager influences the pricing
process, either directly with those who value positions, or through interactions with third-party
pricing services.28
Has the firm relied on traders because they are the
only ones who seem to understand the product?
Regulators want the valuation process to be
verifiable; that is, they believe a robust valuation
process can exist only if the underlying pricing
judgments are transparent and are understood
in comparison to external events. Regulators are
likely to contend that ceding to a trader the sole
or predominant authority to set prices creates a
“black box” that is antithetical to transparency,
fraught with potential conflicts of interest and
prone to material errors.
Predictably, a “black box” junction in a regulated
industry can lead to compliance issues. Perhaps the
most famous example involves Nick Leeson and
Barings Bank. During the 1980s, Nick Leeson, the
son of a plasterer,29 joined Barings Bank. By 1993,
Leeson was a star of the Bank’s Singapore branch,
responsible for about 10 percent of the Bank’s earn-
[F]air value accounting has … been
blamed as “one of the biggest culprits” of
the current economic crisis.
ings for the year.30 After an audit in 1995, however,
it was discovered that Leeson had been using an
error account to take huge bets on the Nikkei. The
market moved against Leeson, resulting in losses
near the value of the Bank’s assets. Eventually, Barings collapsed, and Leeson served several years in a
Singapore prison.
While it may seem that hiding losses in an
internal account has little, if anything, in common with pricing securities, regulators have long
cautioned against a lack of separation of functions. The SEC has brought a number of actions
against funds and portfolio managers arising from
marks those managers provided. For example, in
Van Kampen American Capital Asset Management,
Inc.,31 the SEC brought administrative proceedings against an investment adviser for failure to
supervise a portfolio manager’s mispricing of
certain derivative securities. According to the
SEC, the adviser used inflated prices provided
by the portfolio manager. The SEC chided the
adviser, among other things, for giving the portfolio manager “too much control over the pricing
process with little or no oversight by anyone in a
supervisory capacity” and for not “independently
verify[ing] the daily prices provided to American
Capital’s accounting department with the pricing
source or any secondary sources.”32
The SEC has also brought a number of other
actions in which the involvement of a portfolio
manager in the pricing process was criticized.
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These include the Mitchell Hutchins matter,33
and the Western Asset Management matter. 34
In both of these instances, it was suggested
that the adviser did not fully comprehend the
portfolio manager’s actual involvement in the
pricing process.
The SEC has also sanctioned advisers, however,
for not appropriately collecting and evaluating
information held by a fund’s portfolio manager.
In In the Matter of Heartland Advisors, Inc.,35 an
investment adviser/broker-dealer was alleged to
have mispriced certain bonds priced by an outside
vendor. According to the SEC, the adviser did
not take into account information the portfolio
managers had indicated that certain independently
priced bonds had gone into default, which was not
reflected in the third-party pricing. The adviser,
among others, was alleged to have negligently
mispriced the bonds.
The SEC enforcement actions, when read as
a group, might leave a compliance person feeling like a tightrope walker inching through the
valuation process. Balance, SEC Staff guidance
communications can serve to detect and prevent
inappropriate influence by portfolio management
personnel over the valuation process and would
substantiate the independence of a third-party
pricing service.”36 As discussed further below, ideally, regulators and outside auditors might like to
see prices following conversations with traders or
others to be memorialized contemporaneously in
some fashion. For prices derived from some sort of
modeling, compliance personnel may wish to collect and retain printouts of the model output.
A fair value determination may be made
from information about the specific
security itself, or by reference to other,
observable market information, such
as a discount from market of a similar,
freely trading security, or yield to
maturity with respect to debt issues, or
a combination of information specific
to the security, information about
other securities, and information about
market forces.
8. Do you have enough pricing staff?
suggests, can be bridged by: (1) an understanding of the process; (2) a review of pertinent
communications; and (3) documentation that is
auditable. OCIE Staff has observed that: “some
high yield funds with effective valuation procedures required documentation and review of
communications between portfolio management
personnel and pricing services. The review of such
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7. Have you tapped internal analytical
or quantitative skills?
Many financial services entities have a number
of affiliated entities. Investment advisers may
be corporate kin to fixed income trading desks,
hedge funds, or derivative trading operations. As
with Question 5, above, the regulators would like
compliance personnel to tap all in-house expertise
capable of having information relevant to the pricing of positions. To achieve such a goal, compliance
personnel would need to have an understanding of
the various and often disparate business units that
make up a financial services enterprise.
The recent market turmoil has caused many firms
to devote additional resources to the fair value
process. Deloitte reports in its annual Fair Value
Pricing Survey that over 46 percent of survey
participants “stated that they have at least two
full time resources focused on fair valuation, as
compared to 29 percent last year.”37 Clearly, the
SEC wants to see sufficient resources in this area.
In a recent speech, Chairman Christopher Cox
asserted that companies should be “sustaining
their support for compliance during this market
turmoil, and beyond it as well.”38 He cautioned
CCOs that “[y]ou have to be assertive in making
it known there must be no tolerance for cutting
corners or skirting the law, particularly in disclosures and valuation.”39
A corollary question would be—is your staff
sufficiently experienced? When markets are in
disarray, and valuation personnel turn to models
or matrices, rather than broker quotes or other
third-party pricing based on recent sales,40 those
personnel may be called upon to perform new
or additional evaluations. Not surprisingly, the
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“level of experience and sophistication of the
personnel who are involved in pricing” will be
looked at by examination staff.41 Of particular
interest to the staff is personnel’s facility and experience with modeled prices.42 Current models
are complicated, and may require time to understand. The time involved in obtaining fresh
or current market information under today’s
chaotic conditions may increase. Valuing a sizable portfolio of structured products today may
require different types of expertise than those
required a short time ago. Th e SEC staff has
recommended that firms should ensure that “[t]
he product control group is adequately staffed
and includes members that have the experience,
knowledge and capability of assessing the valuation of the securities they are charged to review.”43
Compliance personnel, working in conjunction
with senior management, therefore, may wish to
periodically check the “fit” of the staff to the business. Documented training regarding financial
instruments may be useful in demonstrating to
regulators that staff has the requisite familiarity
with the instruments at issue.
9. Are you using dealer quotes?
Regulators have become increasingly skeptical
of the provenance and integrity of dealer quotes.
Dealer quotes, however, may be a primary source
of information about current market values. Compliance personnel may therefore wish to consider
building procedures around the use of such quotes
that facilitate and test their reliability.
The SEC is concerned that while dealer quotes
may originate with third parties, they may follow,
or result from, communications with trading or
portfolio management personnel, and thus, in
a sense, be circular. At a recent conference, the
Director of the Office of Compliance Inspections
and Examinations cautioned that “[i]f you work
for a broker-dealer that provides quotes or for
an investment adviser or other user of broker
quotes – be particularly alert to and look for the
possibility of ‘accommodation quotes’—which
don’t reflect prices at which the security could
actually be sold. At worst, this could be fraudulent conduct.” 44 As discussed above, the SEC
instituted a civil action, and the Department
of Justice brought criminal charges, against a
commodities derivatives trader and others, for
allegedly “u-turning” quotes; that is, providing
quotes to a third-party dealer who then funneled
those same quotes back to the firm as purportedly
independent prices.45
How are dealer quotes used?
According to SEC Staff, in order to incorporate
dealer quotes into an effective valuation system,
responsible personnel should understand the
source of the quotes and the role they play in the
valuation process. As with third-party pricing
services, regulators now wish to see that valuation
personnel understand the quoting firm’s methodology for arriving at quotes.46 As the OCIE
Director recently cautioned, “[f ]or those assets
valued by using a broker’s quote or a price from
a pricing service – you should be sure that you
understand whether the quote or price is based
on actual transactions, reflects the willingness of
the broker to trade at that price, or is based on a
model or another methodology.”47
Understanding the source of a dealer quote
may assist management with determining how
dealer quotes are to be used in a valuation system,
e.g., whether the quotes actually determine the
internal value of the security, or are simply one
piece of information to be considered. It may
also lead management to analyze the impact of
quotes on value and the other pieces of information to be utilized in arriving at a value. The
regulators will want to see a clear, consistent and
well-documented set of procedures describing
how the quotes are to be used by the portfolio’s
valuation personnel.
How have you tested for validity?
With respect to dealer quotes, regulators want to
know whether the resulting valuations “seem to
reflect prices at which the security could actually be
sold.”48 That means that it may not be sufficient to
rely solely on a dealer quote, and there may be a need
to verify or back test the quotes in some fashion. If
possible, a firm could consider obtaining multiple
quotes as a validation method. Alternatively, a firm
could obtain quotes for comparable securities.
Finally, a firm could track subsequent sales of the
securities for which dealer quotes were obtained to
understand whether the quotes received were reasonably related to the sales price, particularly if the
quotes were in reasonable proximity to the sales.
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10. Are you documenting your decisions?
Fair valuation requires a good faith process, rather
than a specific result. However, establishing that
a firm followed a particular procedure in a particular instance, often years after a security was
valued, can require excruciating attention to the
documentation that supports the valuation of the
securities. The content of that documentation is
not described. However, adequate documentation
has assumed a central role in recent speeches and
industry presentations.
Will a second or third level reviewer understand
how and why the value was reached?
This question articulates a standard that the SEC
may implicitly impose for all fair value determinations. Examiners want to be able to reconstruct the
factors in the decision-making that led to the fair
value determination for any security on any given
day. That means they want to be able to understand why a particular dealer quote was followed
on a given day, but not followed at another time;
why a third-party price was believed to be reliable
during one period, and why it was thought to be
stale during another. In short, the reasons for the
pricing should be documented in this view. To the
extent that there are reasons prices did not change
over a particular period, ideally these should be
documented as well.
The methodology for valuing securities should
also be recorded. If the methodology positions
change as a result of the board’s “continuous[ ] review [of ] the appropriateness of the method used,”49
the new process should be documented, so that it
can be tested appropriately.
Creating an inventory of routine pricing documentation, therefore, may require the compliance
officer to map out all of the possible inputs that
go into a valuation, and provide clear procedures
for the creation and retention of those documents.
For example, if conversations with a pricing vendor
may affect the decision whether to change a price,
it might be helpful to document those conversations. If the valuation personnel believe that market
conditions render prices impervious to all but the
largest changes, it may be prudent to note that
belief as well.
Conclusion
Current market conditions have led regulators to
emphasize three principal attributes of a robust
fair valuation system: (1) independence, (2)
consistency; and (3) transparency. The output
of the fair valuation system, regulators believe,
should be documented sufficiently so that a
reviewer will be able to understand what was
done and why.
ENDNOTES
1
2
3
4
5
34
Mr. Anderson and Ms. Heilizer are partners in
the Securities Enforcement and Regulation
group of Sutherland Asbill and Brennan.
SEC Roundtable on Mark-to-Market Accounting, (October 29, 2008, November 21,
2008.)
Speech by Lori A. Richards, Focus Areas in SEC
Examinations of Investment Advisers: The Top 10
(March 20, 2008) available at http://www.sec.
gov/news/speech/2008/spch032008lar.htm.
See Prepared Remarks by William M. Isaac, for
SEC Roundtable on Mark-to-Market Accounting, Securities and Exchange Commission, at 5
(October 29, 2008).
Chairman Christopher Cox recently discussed
fair value accounting in remarks before the
AICPA national conference on current SEC
and PCAOB developments. The December
8 remarks available at http://www.sec.gov/
news/speech/2008/spch120808cc.htm. It has
also recently been reported that FASB’s guidance for pension plans will require additional
fair value disclosure. Compliance Week, Ac-
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counting and Auditing Update, Pension Guidance Will Call for More Fair-Value Disclosure
(November 11, 2008).
Investment Company Act of 1940, Section 11,
15 U.S.C. § 80a-11.
ASR 118.
FAS 157, par. 5.
The discussion following each question is the
authors’ attempt to explore the question, and
should not be attributed to Mr. Walsh.
See Presentation by Lori A. Richards, Director,
Office of Compliance Inspections and Examinations, IA Compliance Best Practices Summit
2008 (March 20, 2008) (“This [controls over
valuation] is an important area because
advisory clients need to know the fair value
of their holdings, and they can be harmed
if the adviser overcharges its advisory fee
based on overvalued holdings.”) available
at http://www.sec.gov/news/speech/2008/
spch032008lar.htm.
See Speech by Lori A. Richards, Director, Office
of Compliance Inspections and Examinations,
12
13
Compliance Through Crisis: Focus Areas for
SEC Examiners and Compliance Professionals,
National Society of Compliance Professionals
(October 21, 2008) available at http://www.
sec.gov/news/speech/2008/spch102108lar.
htm.
Public Company Accounting Oversight Board
(“PCAOB”), Staff Audit Practice Alert No. 2,
Matters Related to Auditing Fair Value Measurements of Financial Instruments and the
Use of Specialists, at 8 (December 10, 2007),
available as a link from http://www.pcaob.
org/Standards/Staff_Questions_and_Answers/index.aspx; Fair Value Pricing Survey
Results, at 2 (September 15, 2008) (The
PCAOB practice alert provides insight to
management’s responsibilities in developing
valuations) available as an attachment to
http://www.deloitte.com/dtt/press_release
/0%2C1014%2Ccid%25253D223649%2C
00.html.
See SEC v. Lee, 08-CIV-9961 (GDB)(SDNY).
(complaint available at http://www.sec.gov/
P R A C T I C A L C O M P L I A N C E & R I S K M A N A G E M E N T F O R T H E S E C U R I T I E S I N D U S T RY
Portfolio Valuation for Compliance Personnel
litigation/complaints/2008/comp20811.
pdf) and the Press Release of the United
States Attorney, Southern District of New
York (November 18, 2008), available at
http://www.usdoj.gov/usao/nys/pressreleases/November08/cassidyleeindictmentpr.pdf for a description of the criminal
charges.
14
Compliance Alert (July 2008), available at
http://www.sec.gov/about/offices/ocie/complialert0708.htm.
15
AICPA Audit and Accounting Guide, Investment
Companies, 451 (with conforming changes as
of May 1, 2007).
16
ASR 118.
17
FAS 157, par. 16.
18
Id.
19
Katrin Bennhold, Société Générale blames
managers, International Herald Tribune (May
22, 2008).
20
Associated Press, Kerviel’s assistant handed
preliminary charges, International Herald
Tribune
(August 4, 2008).
21
Interestingly, Kerviel also reportedly refused
to take regular vacations, which allegedly violated bank policy and may have facilitated his
ability to escape detection. James B. Stewart,
The Omen, The New Yorker, 54, 58 (October
20, 2008).
22
Compliance Alert, July 2008, available at
http://www.sec.gov/about/offices/ocie/complialert0708.htm.
23
Division of Investment Management, December 1999 Letter to the ICI Regarding Valuation
Issues (December 9, 1999)(available at http://
www.sec.gov/divisions/investment/guidance/
tyle120899.htm.
24
Available at http://www.sec.gov/about/of-
25
26
27
28
29
30
31
32
33
34
35
36
37
38
fices/ocie/complialert0708htm.
Id.
Id.
Id.
Id. It bears repeating that the regulators
continue to emphasize that it is the Board’s
responsibility to implement an appropriate
fair value process, including the oversight of
relevant communications. Id.
Business: The Economy--How Leeson Broke
the Bank, BBC News, ( June 22, 1999).
Available at http://news.bbc.co.uk/2/hi/
business/375259.stm.
The Top 25 Crimes of the Century, Time, available
at http://www.time.com/time/2007/crimes/18.
html; Business: The Economy--How Leeson Broke
the Bank, BBC News, (June 22, 1999).
Investment Advisers Act Rel. No. 1525 (September 29, 1995).
Id.
In the Matter of Mitchell Hutchins Asset Management, Inc., Investment Advisers Act Rel.
No. 1654 (September 2, 1997).
In the Matter of Western Asset Management Co.
and Legg Mason Fund Adviser, Inc., Investment
Advisers Act Rel. No. 1980 (September 28,
2001).
Investment Advisers Act Rel. No. 2698 (January
25, 2008).
Compliance Alert, July 2008, available at
http://www.sec.gov/about/offices/ocie/complialert0708.htm.
Fair Value Pricing Survey Results, at 4 (September
15, 2008) available as an attachment to http://
www.deloitte.com/dtt/press_release/0%2C101
4%2Ccid%25253D223649%2C00.html
Speech by SEC Chairman Christopher Cox:
Address to the 2008 CCOutreach National
Seminar (November 13, 2008), available at
39
40
41
42
43
44
45
46
47
48
49
http://www.sec.gov/news/speech/2008/
spch111308cc.htm.
Id. (emphasis added).
Deloitte reports in its annual survey of fair
value pricing that “there is a clear trend in
using pricing vendors as the primary source
in valuing derivatives that are not traded
on an exchange.” Fair Value Pricing Survey
Results, at 6.
Speech by Lori A. Richards (March 20, 2008).
Compliance Alert, July 2008, available at
http://www.sec.gov/about/offices/ocie/complialert0708.htm.
Id.
Presentation by Lori Richards, Director, Office
of Compliance Inspections and Examinations,
Compliance Through Crisis: Focus Ares for
SEC Examiners and Compliance Personnel,
National Society of Compliance Professionals
(October 21, 2008).
See Litigation Rel. No. 20811 (November 18,
2008); SEC v. Lee, et. al, Civil Action No. 08CIV-9961 (GBD)(SDNY); Press Release, United
States Attorney, Southern District of New York
(November 18, 2008).
Deloitte reports in its annual Fair Value Survey that 79 percent of respondents indicated
that they were asking brokers questions with
respect to domestic fixed income securities.
Fair Value Pricing Survey at 5.
Presentation by Lori Richards, Director, Office
of Compliance Inspections and Examinations,
Compliance Through Crisis: Focus Areas for
SEC Examiners and Compliance Personnel,
National Society of Compliance Professionals
(October 21, 2008).
Presentation by Lori Richards (March 20,
2008).
ASR 118.
This article is reprinted with permission from Practical Compliance and Risk Management for
the Securities Industry, a professional journal published by Wolters Kluwer Financial Services, Inc.
For more information on this journal or to order a subscription to Practical Compliance and
Risk Management for the Securities Industry, go to onlinestore.cch.com and
search keywords “practical compliance”
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