Vedder Price announced today that Wayne M. Aaron has joined the firm as a member of the Investment Services group and Corporate practice area in New York. Mr. Aaron joined from Milbank, where he served as a Partner in the Litigation & Arbitration, Financial Services Regulatory and Technology practices.

An experienced securities regulatory lawyer, Mr. Aaron represents financial services firms, management and other personnel in regulatory and governmental investigations and internal investigations. His varied practice spans financial services advisory matters, broker-dealer regulation and enforcement, government and regulatory investigations, and FinTech.

“Wayne is a terrific addition to our existing broker-dealer and regulatory investigations practices as we look to continue to grow and diversify those practices, including into other complementary areas, such as high frequency trading and FinTech regulatory work,” said Corporate Practice Area Chair Jennifer Durham King. “We look forward to having Wayne on board and to his assistance in growing our financial services and corporate-related practices in New York.”

Mr. Aaron regularly advises securities firms and their employees on complex sales and trading and other regulatory issues affecting the securities markets. He represents clients in examinations and inquiries by, and enforcement proceedings before, the Securities and Exchange Commission and other government regulators and self-regulatory organizations. His practice encompasses a wide-range of regulatory issues currently affecting financial services firms, hedge funds and other institutional investors.

“I’m excited to offer my clients access to Vedder’s resources and platform, and to join a firm with such a collaborative, cross-selling culture,” said Mr. Aaron. “I look forward not only to growing my practice and working with Vedder’s existing clients, but also to working with my new colleagues across many of our practice groups and in New York to deliver best-in-class customer service.”

Mr. Aaron earned his J.D. from Hofstra University School of Law and his B.S. from Tufts University. He began his legal career with Solomon, Zauderer, Ellenhorn, Frischer & Sharp before practicing at Milbank for 17 years.

Global Transportation Finance Shareholders Francis X. Nolan, III (New York) and Ji Woon Kim (Singapore) joined F. Humera Ahmed VP of Legal & Business Development of the Liberian International Ship & Corporate Registry (LISCR), the US-based manager of the Liberian Registry, for a recorded Q&A on ship financing charters.

Watch the video below (or click here to watch on Vimeo) for in depth analysis from Mr. Nolan and Mr. Kim as they provide a history of traditional ship financing and answer questions such as:

• What is a finance charter, and how has this financing structure ben used and grown in shipping in recent years?
• How is a finance charter different from other forms of financings?
• What led to the development and amendment to Liberia’s maritime law to allow lease financing structures to be recorded as mortgages?
• What are the legal elements to consider when recording a finance charter?
• What are the benefits of recording a finance charter with the Liberia registry?
• How is the Liberian laws and regulations for financing charters different from other laws typically found in the shipping sector?

Both Mr. Nolan and Mr. Kim have extensive experience in ship financing and in Liberian Maritime Law. In 2018, Mr. Nolan helped to modernize Liberia’s maritime laws to accommodate the increasing popularity of lease structures for ship financing, amendments that improved conditions for maritime lessors across the globe.

 

Vedder Price is pleased to announce that the firm’s Investment Services Group has received a 2020 Go-To Thought Leadership award from the National Law Review, its second such award in the past three years, in recognition of the Group’s regular securities law thought leadership contributions and outstanding analysis of issues affecting the asset management industry.

Less than 1% of the authors who publish with the National Law Review receive the Go-To Thought Leadership Award. Vedder Price’s Investment Services Group also received the award in 2018, the first year the National Law Review began formal recognition of the unique talents of its contributors.

The driving force behind the Investment Services Group’s prodigious output of thought leadership is the Investment Services Regulatory Update, a monthly newsletter the Group produces to keep clients updated on relevant regulatory matters. Co-edited by Investment Services attorneys John S. Marten, Jacob C. Tiedt and Nathaniel Segal, the newsletter has featured over 60 articles in the past year covering topics including SEC rulemaking, guidance and alerts, as well as important securities litigation matters and asset management industry-related regulatory enforcement actions and settlements.

In addition to the Investment Services Regulatory Update, the Investment Services Group also published numerous independent articles to its Coronavirus Task Force page this year, helping clients keep abreast of a flurry of important regulatory updates and developments in the asset management industry related to the global coronavirus pandemic.

“We would like to thank the National Law Review for this thought leadership award. This recognition reflects our Group’s combined efforts to closely follow and analyze regulatory developments of importance to our clients and peers.” commented John S. Marten, Co-editor of the Investment Services Regulatory Update.

“Our Investment Services Group attorneys regularly collaborate to publish timely pieces on emerging issues,” Co-editor Nathaniel Segal added. “We look forward to continuing Vedder Price’s strong record of thought leadership regarding legal issues facing the asset management industry in the coming year.”

Click here to subscribe to the Investment Services Regulatory Update via email, as well as other important legal updates from Vedder Price. The latest bulletins from Vedder Price’s Investment Services Group can also be viewed on the firm’s website here.

To view the full list of National Law Review 2020 Go-To Thought Leadership award winners, please click here.

Vedder Price announced that Christopher S. Harrison has joined the firm as a Finance & Transactions Partner in the firm’s London office. Mr. Harrison joined from Pillsbury Winthrop Shaw Pittman LLP’s Finance group.

“We are pleased to add another impressive leveraged finance and capital markets attorney to our London office,” said Michael A. Nemeroff, President and CEO of Vedder Price. “Chris brings world-class leveraged finance and capital markets experience for our clients.”

For over 25 years, Mr. Harrison has represented financial institutions, funds and corporate and government entities on complex cross-border leveraged finance and capital market transactions across a wide range of industries, including transportation, energy, telecommunications, media and financial services sectors.

Mr. Harrison has extensive experience with debt and equity products and the structuring of acquisitions, spin offs and disposals from investment grade to distressed assets and has worked extensively with investment funds advising on the effective deployment of capital and activist strategies to drive value. Mr. Harrison has advised various funds and other bondholder groups in restructuring situations, advising on the use of UK/EU insolvency, Companies Act and U.S. Bankruptcy Code procedures, hold outs, consent solicitations and exchange offers to create leverage and enhance negotiated solutions.

“Chris’s broad finance practice and solid client base are a perfect fit for Vedder and exactly what we need to enhance our finance capabilities and support corporate private equity in London,” said Derek Watson, Administrative Partner of the London office. “The addition of Chris on the heels of Trevor Wood a few months ago shows the firm’s commitment to the strategic growth of our London corporate practice and I am very much looking forward to working with him.”

“Vedder’s platform allows me to deliver best-in-class service to my clients and I’m thrilled to play a part in expanding our capabilities as this team continues to grow,” said Mr. Harrison. ”I look forward to working with my talented new colleagues in London and across all our offices.”

Mr. Harrison earned his LL.B. from the University of Bristol. He is admitted to practice in England and Wales.

On December 3, 2020, the U.S. Securities and Exchange Commission adopted new Rule 2a-5 under the Investment Company Act of 1940 (the “1940 Act”) providing a new framework for fund valuation practices and clarity on how fund boards may satisfy their statutory obligation to determine the fair value of fund investments. In particular, new Rule 2a-5:

• permits fund boards to designate the fund’s investment adviser (or, for internally managed funds, a fund officer) as the party that performs determinations of fair values of fund investments (in this capacity, the “valuation designee”), subject to board oversight, without any requirement that boards subsequently ratify any fair values so determined by the valuation designee;
• establishes a principles-based framework for determining fair values of fund investments that incorporates the assessment and management of material valuation risks, the establishment, application and testing of fair valuation methodologies, and enhanced oversight of pricing services ¹;
• requires periodic reporting by the valuation designee to facilitate board oversight; and
• formally defines when market quotations are “readily available” for purposes of the 1940 Act.

In addition, the SEC issued significant new guidance concerning various aspects of Rule 2a-5, including, among other things, examples of specific sources of valuation risk. The SEC also set forth its expectations regarding fund directors’ oversight responsibilities with respect to valuation matters, which are discussed in Section IV. A. below. Finally, the SEC also adopted new Rule 31a-4, which establishes certain recordkeeping requirements associated with fair value determinations under Rule 2a-5.
Rule 2a-5 applies to all investment companies registered under the 1940 Act, including investment companies structured as unit investment trusts, and business development companies. While Rule 2a-5 and the related recordkeeping requirements of Rule 31a-4 will become effective 60 days from publication in the Federal Register (anticipated in early 2021), compliance with the new rules will not be required until 18 months after the effective date.

I. Background, Regulatory Approach and Differences from the Proposed Rule

Under the 1940 Act, securities held by a fund for which market quotations are “readily available” are to be valued at current market value, and securities for which market quotations are not readily available are to be valued at fair value as determined in good faith by the fund’s board. The SEC last comprehensively addressed valuation almost 50 years ago¹. Since then, the growing complexity of funds’ investments, expansion of the fund industry and regulatory developments in accounting and compliance have altered the way funds and their boards approach the fair valuation of fund investments.

In response to the need for a modernized valuation framework, the SEC proposed Rule 2a-5 in April 2020. Following public comment, the SEC adopted final Rule 2a-5 in December 2020 with certain modifications. Key differences between the proposed and final forms of Rule 2a-5 are as follows:

• Final Rule 2a-5 excludes certain prescriptive elements of the proposed rule and provides more flexibility to boards or their valuation designees to exercise judgment in the valuation process. ²
• Final Rule 2a-5 provides that the board may “designate,” rather than “assign,” the performance of fair valuation determinations to a valuation designee. This change was intended by the SEC to underscore that the valuation designee performs valuation determinations on the board’s behalf and subject to board oversight.
• Other notable changes from the proposed rule include: (i) a requirement that a board’s valuation designee be the fund’s primary adviser (i.e., not a fund’s sub-adviser) ³; (ii) certain modifications to the required reporting by a valuation designee to the fund’s board; (iii) certain changes to the requirements for selecting and applying fair value methodologies; and (iv) a clarification that the newly adopted definition of “readily available” market quotations applies in all contexts under the 1940 Act, including with respect to cross trades under Rule 17a-7.
• Finally, in a change from the proposal, final Rule 31a-4 does not require that detailed records be kept relating to specific methodologies and inputs used by pricing services in making fair valuation determinations.

II. Designation of Performance of Fair Value Determinations

Under Rule 2a-5, a fund’s board, or a committee thereof, may retain responsibility for determining the fair value in good faith of fund investments for which market quotations are not readily available, or the board may designate the performance of fair value determinations for some or all fund investments to the fund’s primary investment adviser (or, in the case of an internally managed fund, a fund officer). The board may not designate this responsibility to sub-advisers or other service providers.

If the board appoints a valuation designee to make fair value determinations in reliance on Rule 2a-5, the board is not required to subsequently ratify any fair value determinations so made. However, if a valuation designee is appointed, certain additional requirements concerning board oversight and board reporting apply. Details concerning these requirements are set forth below in Section IV.

III. Determining Fair Value in Good Faith

Rule 2a-5 provides that determining fair value in good faith, consistent with the standards of the 1940 Act, requires a fund’s board or its valuation designee to (i) periodically assess and manage valuation risks, (ii) establish, apply and periodically test fair valuation methodologies and (iii) evaluate and oversee pricing services.

A. Periodically Assess and Manage Valuation Risks. A fund’s board or its valuation designee must assess periodically any material risks associated with the determination of the fair value of fund investments, including material conflicts of interest, and manage those identified valuation risks.

• How to Assess Valuation Risk. The SEC states in the adopting release that a fund’s specific valuation risks depends on the facts and circumstances of the particular fund’s investments. Rule 2a-5 provides flexibility to determine whether certain sources and types of valuation risk should be weighed more heavily than others.
• Types of Valuation Risks. The adopting release includes a non-exhaustive list of the types or sources of valuation risk, including:
  •  the types and characteristics of investments held or intended to be held by the fund;
     potential market or sector shocks or dislocations and other types of disruptions that may affect the ability of a valuation designee or other third party to operate;
     the extent to which a fair value methodology uses unobservable inputs, in particular if such inputs are provided by the valuation designee;
     the proportion of the fund’s investments that are fair valued and the contribution of those investments 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 those third-party service providers rely on their own service providers (known as “fourth-party” risks); and
    the risk that methodologies for determining and calculating fair value may be inappropriate or that those methodologies may be applied inconsistently or incorrectly.
• Frequency of Periodic Reassessment. Rule 2a-5 does not prescribe a minimum frequency for the reassessment of valuation risk. However, according to the adopting release, periodic reassessment of valuation risk generally should take into account: (i) changes in fund investments, (ii) significant changes in a fund’s investment strategies or policies, (iii) market events and (iv) any other relevant factors.

B. Establish and Apply Fair Value Methodologies. Under Rule 2a-5, a fund’s board or its valuation designee must establish and apply fair value methodologies. To satisfy this requirement, a board or its valuation designee, as applicable, must:

• Select and Apply Appropriate Fair Value Methodologies. A fund’s board or its valuation designee must select and apply, in a consistent manner, appropriate methodologies for determining (which includes calculating) the fair value of fund investments. This includes specifying the key inputs and assumptions specific to each asset class or portfolio holding.

• Rule 2a-5 provides fund boards or their valuation designees flexibility in applying selected methodologies. In particular, the rule permits selected methodologies to be changed or adjusted if different methodologies are at least equally representative of the fair value of the investments and does not prohibit the use of different methodologies for investments within the same asset class. The SEC stated in the adopting release that determination of a fair value is dependent on the facts and circumstances of a particular investment and that there is no single methodology for determining the fair value of an investment; rather, there may be a range of appropriate values that could reasonably be considered to be the fair value. In addition, in a change from the proposed rule, final Rule 2a-5 does not require funds to preemptively determine valuation methodologies for investments in which a fund may, but does not currently, invest.⁴
• Periodically Review Appropriateness and Accuracy of Selected Fair Value Methodologies. A fund's board or its valuation designee must review periodically the selected fair value methodologies for appropriateness and accuracy, and make changes or adjustments to the methodologies as needed.
• Monitor for Circumstances that May Necessitate the Use of Fair Value. In a change from the proposed rule, final Rule 2a-5 does not require a board or its valuation designee to establish criteria for determining when market quotations are no longer reliable and therefore are not readily available. However, a fund's board or its valuation designee must monitor for circumstances that may necessitate the use of fair value. The adopting release cites as an example securities that trade in foreign markets, which should be monitored for significant events after market close that may impact valuation.

C. Testing of Fair Value Methodologies. Rule 2a-5 requires periodic testing of the appropriateness and accuracy of the methodologies used to calculate fair value.

• Methods and Frequency. To satisfy the testing requirement a board or its valuation designee must identify appropriate testing methods and provide for a minimum frequency of testing. Rule 2a-5 does not specify any particular testing methods to be used or a minimum frequency for conducting tests; rather, these will vary depending on a fund’s particular circumstances and will be determined by the board or its valuation designee.
• Calibration and Back-Testing. In the adopting release, the SEC stated that 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.” The SEC noted that these methods should be used in many instances to test the appropriateness and accuracy of fair value methodologies. However, Rule 2a-5 neither requires the use of these testing methodologies nor precludes the use of other appropriate methodologies.

D. Oversight of Pricing Services. Under Rule 2a-5, determining fair value in good faith also requires the oversight of any pricing services, including establishing a process for approving, monitoring and evaluating pricing services.

• Oversight of Pricing Services. The SEC did not adopt a specific requirement to review the selection of pricing services; however, in the adopting release the SEC notes that in cases in which a fund’s board has appointed a valuation designee, the valuation designee should, as part of the annual report to the board on the adequacy and effectiveness of the fair valuation process, consider the adequacy and effectiveness of any pricing services used. The process for initiating price challenges established by the valuation designee is also subject to appropriate board oversight.
• Guidance on Selection of Pricing Services. In the adopting release for Rule 2a-5, the SEC states that a board or its valuation designee generally should take into consideration the following factors when selecting a pricing service:
  • the qualifications, experience and history of the pricing service;
    the valuation methodologies or techniques, inputs and assumptions used by the pricing service for different investments and how they may be affected as market conditions change;
    the quality of the pricing information provided by the pricing service and the extent to which the pricing service makes pricing determinations as close as possible to the time at which the fund calculates its net asset value;
    the pricing service’s process for addressing price challenges, including how the pricing service incorporates information received through price challenges into its pricing information;
    the pricing service’s actual and potential conflicts of interest and steps taken to mitigate those conflicts; and
    the pricing service’s testing processes.

In addition, in the adopting release, the SEC stated that a fund’s board or its valuation designee generally should take into account the appropriateness of using information from a pricing service in determining the fair values of a fund’s investments under circumstances in which, for example, the board or valuation designee lacks a good faith basis for believing that the pricing service’s methodologies produce prices that reflect fair value.

• Process for Initiating Price Challenges. Under Rule 2a-5, a fund’s board or its valuation designee must establish a process for initiating price challenges, representing a change from the proposed rule, which would have required the establishment of criteria for initiating price challenges. In the adopting release, the SEC notes that there may be a range of circumstances under which initiating a price challenge may be appropriate, and that pre-established criteria likely would not be able to account for all such circumstances.

E. Fair Valuation Policies and Procedures. Rule 2a-5 does not include proposed provisions that would have required a fund to adopt separate written policies and procedures reasonably designed to achieve compliance with the requirements of the rule. Instead, Rule 38a-1 by its terms requires the adoption and implementation of written policies and procedures reasonably designed to prevent violations of the requirements of Rule 2a-5. When a board retains responsibility to make fair value determinations, the fund must adopt and implement new procedures under Rule 38a-1 to address Rules 2a-5 and 31a-4. However, when a board designates a valuation designee to make those determinations, the valuation designee must adopt and implement such policies and procedures, and the fund need not separately adopt its own duplicative policies and procedures. In either case, policies and procedures adopted by either the fund or the valuation designee to address Rules 2a-5 and 31a-4 are considered “new” procedures under Rule 38a-1, rather than amendments to existing procedures, and must be approved by the fund’s board.

IV. Additional Requirements if a Valuation Designee Is Used

Under Rule 2a-5, if a fund’s board appoints a valuation designee to make fair value determinations for a fund, the following additional guidance related to board oversight and requirements for board reporting will apply.

A. Board Oversight. In the adopting release for Rule 2a-5, the SEC provided the following guidance to fund directors regarding the SEC’s expectations for board oversight of the valuation process assigned to a valuation designee:

• Skeptical and Objective Oversight. Boards should approach their oversight of fair value determinations assigned to a valuation designee with a skeptical and objective view that takes into account a fund’s particular valuation risks, including with respect to conflicts of interest, the appropriateness of the fair value determination process and the skill and resources devoted to it.
• Active Oversight. Effective board oversight cannot be a passive activity. Directors should ask questions and seek relevant information, particularly when there are red flags or other indications of problems. Oversight should be an iterative process that seeks to identify potential issues and opportunities to improve the fund’s fair value processes. Boards should request follow-up information when appropriate and take reasonable steps to see that matters identified are addressed.
• Scrutiny of Subjective Inputs. Board scrutiny of the valuation process should be appropriately calibrated to a fund’s valuation risks, including the extent to which fair value determinations depend on subjective inputs. As the level of subjectivity of inputs and assumptions increases, the level of board scrutiny should increase correspondingly.
• Management of Conflicts of Interest. It is incumbent upon boards—consistent with their obligations under the 1940 Act and as fiduciaries—to seek to identify conflicts of interest, monitor such conflicts and take reasonable steps to manage such conflicts. Boards should serve as a meaningful check on the conflicts of interest of the valuation designee and other service providers involved in the fair valuation process. Boards are advised to critically review the information provided to them, particularly with regard to the valuation designee's reporting on its own conflicts of interest.
• Periodic Reviews of the Valuation Designee’s Processes. Boards should probe the appropriateness of the valuation designee’s fair value processes, including the adequacy of resources supporting fair value functions, such as financial, technology, compliance and personnel resources and expertise as well as the reasonableness of the valuation designee's reliance on other service providers in this respect.
• Nature of Board Reporting. Boards should consider the type, content and frequency of the reports they receive. Boards should request and review such information as may be necessary to be informed of the valuation designee’s fair valuation processes.

B. Board Reporting. The valuation designee must report to the board about its performance of responsibilities under Rule 2a-5, including certain periodic reports and prompt notification and reporting on matters that materially affect the fair value of fund investments.

• Quarterly Reporting. Rule 2a-5 requires the valuation designee, at least quarterly, to provide the board with a written summary or description of material fair value matters that occurred in the prior quarter, including:
  • any material changes in how the valuation designee assesses and manages valuation risks, including any material changes in conflicts of interest involving the valuation designee or any other relevant service provider;
    any material changes to, or material deviations from, the fair value methodologies established pursuant to Rule 2a-5;
    any material changes to the valuation designee’s process for selecting and overseeing pricing services and any material events related to the valuation designee’s oversight of pricing services; and
    any other reports or materials requested by the board related to determining fair values of fund investments or the valuation designee’s process for determining fair values.
• Annual Reporting. The valuation designee must provide at least annually a written assessment of the adequacy and effectiveness of the valuation designee’s process for determining the fair value of the fund’s investments. At a minimum, this report must include:
  • a summary of the results of testing of fair valuation methodologies; and
    an assessment of adequacy of resources allocated to the fair value process, including any material changes to the roles or functions of persons responsible for determining fair values.
  • The annual reporting requirements represent a change from the proposed rule, which would have required reporting on these items on a quarterly basis. In a further change, Rule 2a-5 does not require reporting on the results of all valuation testing, but instead only requires a summary.
• Prompt Board Notification and Reporting. The valuation designee must provide written notification to the board of the occurrence of matters that materially affect the fair value of fund investments no later than five business days after the valuation designee becomes aware of the material matter. In a change from the proposed rule, Rule 2a-5 will also provide a valuation designee 20 business days from becoming aware of a valuation matter to determine whether the matter is material. The proposed rule would have provided valuation designees with three business days.
• Guidance on Material Matters. In the adopting release, the SEC noted that material matters requiring prompt reporting would generally be those matters about which the board would reasonably need to know to exercise appropriate oversight of the valuation designee’s process for determining fair values. Examples that the SEC provided include a significant deficiency or material weakness in the design or effectiveness of the valuation
  designee’s fair value determination process or material errors in the calculation of net asset value, as well as appropriate follow-up reports on these matters.
• Form of Board Reporting. The valuation designee’s reports must include information reasonably necessary for the board to evaluate the matters covered in the reports. In the adopting release, the SEC suggested that boards work with valuation designees to determine the scope and format of information that would be most useful to the board in its conduct of oversight, subject to the minimum content requirements discussed above. These reports may take the form of narrative summaries, graphical representations, statistical analyses, dashboards or exceptions-based reporting, among other methods. The SEC agreed that “boards should have latitude to implement a flexible reporting mechanism that is tailored to their fund, recognizes judgment in exercising oversight, and minimizes rote reporting.”

C. Specification of Functions. The fair valuation policies and procedures adopted to comply with Rule 2a-5 should specify the titles of the persons responsible for determining the fair value of the designated investments and should specify the particular functions for which the identified persons are responsible, including those with duties associated with price challenges and with the authority to override a price.

• Use of Committees. If the valuation designee uses a valuation committee or similar body to assist in the process of determining fair value, the fair value policies and procedures generally would describe the composition and role of the committee, or reference any related committee governance documents as appropriate.
• Reasonable Segregation from Portfolio Management. Rule 2a-5 requires the valuation designee to reasonably segregate fair value determinations from portfolio management. Under Rule 2a-5, to satisfy the reasonable segregation requirement, a portfolio manager may not determine, or effectively determine “by exerting substantial influence,” fair valuations. The valuation designee should tailor the segregation of functions to the valuation designee’s particular facts and circumstances, taking into account the valuation designee’s size and resources.

D. Guidance on Obtaining the Assistance of Others. In response to requests from commenters, the SEC clarified that a valuation designee may obtain assistance from others, such as pricing services, fund administrators, sub-advisers, accountants or counsel in fulfilling fair value duties, such as back-testing and calculations required by the valuation methodology selected by the valuation designee. However, in the adopting release, the SEC emphasized that a valuation designee would remain responsible for making fair value determinations and may not designate or assign that responsibility to a third party.

V. Recordkeeping

Along with Rule 2a-5, the SEC also adopted new Rule 31a-4 to establish certain recordkeeping requirements associated with the fair value activities conducted in reliance on Rule 2a-5. Records are generally required to be maintained for six years, the first two in an easily accessible place, either by the fund or the valuation designee.

A. Records Required to Be Maintained. Rule 31a-4 requires that funds or the valuation designee maintain: (i) appropriate documentation to support fair value determinations; (ii) reports to the fund’s board required under Rule 2a-5; and (iii) a specified list of the investments or investment types whose fair value determination has been designated to the valuation designee.

B. Guidance regarding Appropriate Documentation to Support Fair Value Determinations. In a change from the proposed rule, final Rule 2a-5 does not require detailed records relating to specific methodologies and inputs used in making a fair valuation determination. The SEC indicated that appropriate documentation “should include documentation that would be sufficient for a third party, such as the SEC staff, not involved in the preparation of the fair value determinations, to verify, but not fully recreate, the fair value determination.” The SEC acknowledged that different types of records may be appropriate depending on the security, methodology or subjectivity of inputs used.

• The SEC provided the following examples of documentation that may be appropriate to support fair valuation determinations in certain instances:
  • schedules evidencing and supporting each computation of net asset value as required under Rule 31a-2;
    copies of internally developed valuation models, including inputs and assumptions and supporting documentation;
    work papers documenting price challenges, stale price analyses and testing, such as calibration or back-testing; and
    with respect to a fair valuation provided by a pricing service, records related to the initial due diligence and ongoing monitoring and oversight of the pricing service.

VI. “Readily Available” Market Quotations

Under the 1940 Act, a fair value determination must be made when a market quotation for an investment is not “readily available.” Rule 2a-5 provides that “a market quotation is readily available only when that quotation is a quoted price (unadjusted) in active markets for identical investments that the fund can access at the measurement date, provided that a quotation will not be readily available if it is not reliable.” ⁵

A. Guidance on “Readily Available” Market Quotations. The adopting release provided the following guidance as to whether certain prices would be considered to meet the definition outlined in Rule 2a-5:

• Exchange Adjusted Prices. The adopting release clarifies that an “unadjusted” price includes prices for securities that are adjusted by the exchange on which the security is listed.
• Evaluated Prices. Evaluated prices, indications of interest and accommodation quotes would not be considered “readily available” market quotations for purposes of Rule 2a-5.
• Net Asset Values of Certain Pooled Investment Vehicles. Securities of pooled investment vehicles that publish their net asset values daily and issue and redeem shares at that net asset value (such as mutual funds) are generally consistent with the definition of having “readily available” market quotations under Rule 2a-5.

B. Definition of Readily Available Market Quotations and Cross Trades under Rule 17a-7. The definition of readily available market quotations adopted in Rule 2a-5 applies in all contexts under the 1940 Act, including with respect to cross trades under Rule 17a-7. The SEC acknowledged that certain securities that previously had been viewed as having readily available market quotations may not meet the new definition and thus would not be available for cross trades. The SEC also noted that many cross trades are done in reliance on certain no-action letters issued by the SEC staff and cited certain letters that allow for cross trades in municipal securities when transaction prices are provided by an independent pricing service. The adopting release states that the staff is reviewing these letters to determine whether they should be withdrawn.

VII. Rescission of Current SEC Guidance

With the adoption of Rule 2a-5, the SEC rescinded Accounting Series Release 113, issued in 1969, and Accounting Series Release 118, issued in 1970, in which the SEC provided guidance on, among other things, the role of a fund’s board in making fair value determinations, as well as on certain related accounting and auditing matters. In addition, guidance contained in the adopting release for Rule 2a-5 supersedes certain guidance in the SEC’s 2014 Money Market Fund Release regarding the oversight of pricing services and the valuation of thinly traded securities ⁶. However, other portions of the Money Market Fund Release remain in effect ⁷. Furthermore, certain other SEC staff letters and other staff guidance related to the fair value process are withdrawn or rescinded.

VIII. Implementation and Transition Period

Rule 2a-5 and the related recordkeeping requirements of Rule 31a-4 will become effective 60 days from publication in the Federal Register (anticipated in early 2021). However, compliance with the new rules will not be required until 18 months after the effective date. Once the rules become effective, funds may voluntarily comply in advance of the compliance date; however, funds doing so must rely only on the new rules in connection with fair value determinations and may not also consider SEC staff letters or other guidance that will be rescinded at the end of the 18-month transition period.

The adopting release is available here.

____________________________________

1 See Securities and Exchange Commission Codification of Financial Reporting Policies, Statement Regarding “Restricted Securities,” Investment Company Act Release No. 5847 (Oct. 21, 1969); Investment Companies, Investment Company Act Release No. 6295 (Dec. 23, 1970).

2 In this regard, the SEC declined to adopt the “safe harbor” approach suggested by some commenters and instead established a minimum and baseline standard to fair value investments in good faith. The SEC also declined to confirm that boards may provide oversight of the performance of fair value determinations consistent solely with the business judgment rule under state law.
3 For funds that are internally managed, an officer of the fund may serve as valuation designee.

⁴ To be appropriate under Rule 2a-5, and in accordance with current accounting standards, a methodology that is used to determine the fair value of a fund’s investments must be consistent with FASB Accounting Standard Codification Topic 820: Fair Value Measurement (“ASC Topic 820”), and thus derived from the market approach, the income approach or the cost approach. 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. Furthermore, in describing the particular fair value methodologies to be used, the SEC states that it would not be sufficient simply to 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).
⁵ The adopting release notes that the definition outlined in Rule 2a-5 is consistent with the definition of a Level 1 input in the fair value hierarchy outlined in U.S. GAAP. Thus, under the final definition, a security will be considered to have readily available market quotations if its value is determined solely by reference to these Level 1 inputs.
⁶ Money Market Fund Reform; Amendments to Form PF, Investment Company Act Release No. 31166 (July 23, 2014).
7 See Investment Company Act Release No. 34128 (Dec. 3, 2020) at § II.D.-E.

On December 27, 2020, as part of a larger government funding bill, President Donald J. Trump signed into law the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Act”). The Act, among other things, restarts the Paycheck Protection Program (“PPP”), as administered by the Small Business Administration (“SBA”), provides borrowers with greater flexibility in using PPP loan proceeds and expands the types of expenses eligible for loan forgiveness. The following is a summary of these provisions; however, please note that the SBA is required to issue implementing regulations by January 6, 2020 and we expect further guidance on the Act’s provisions at that time.

General

What is the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act?

In general, the Act appropriates $325 billion to the PPP and other programs, including (a) $284.45 billion committed to providing eligible borrowers with the opportunity to obtain a second round of PPP loan funding (“PPP Second Round”), (b) $20 billion committed for the Economic Injury Disaster Loan (“EIDL”) advance program; (c) $3.5 billion committed for the Section 7(a) debt relief program; (d) $2 billion committed for SBA lending enhancements; and (e) $15 billion committed for grants for shuttered live venues, theaters, museums and zoos.

Existing PPP Loans

Does the Act expand the types of expenses that are eligible for forgiveness?

Yes. While borrowers are still required to spend at least 60% of their PPP loan proceeds on eligible “payroll costs” in order to be eligible for full forgiveness, the Act expands the permissible use of PPP loan proceeds for which borrowers may receive forgiveness to the following:

• Additional Group Insurance Expenditures (Payroll Costs) – The Act redefines “payroll costs” to specifically include group insurance payments made on group life, disability, vision and dental insurance.
• Covered Supplier Cost Expenditures – Expenditures made (a) to a supplier of goods for goods that are essential to the borrower’s operations at the time the expenditure is made and (b) pursuant to a contract, order or purchase order in effect at any time before the PPP loan is disbursed, provided that for perishable goods such expenditure need not be tied to a contract or purchase order that existed prior to the PPP loan.
• Covered Worker Protection Expenditure – Expenditures that are made to facilitate the adaptation of the business activities of a borrower to comply with requirements established or guidance issued by the Department of Health and Human Services, the Centers for Disease Control, the Occupational Safety and Health Administration or a state or local government, subsequent to March 1, 2020. These expenditures may include the purchase, maintenance or renovation of drive-through windows, air filtration systems, physical barriers (sneeze guards), expanded indoor or outdoor operating space, onsite or offsite health screening and other expenditures as necessary. Expenditures on real estate and other intangible property are not covered under this category.
• Covered Operations Expenditure – Expenditures for any business software or cloud computing service that facilitates business operations, product or service delivery, the processing, payment, or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses.
• Covered Property Damage Cost – Expenditures related to property damage and vandalism or looting due to public disturbances that occurred during 2020 that were not covered by insurance or other compensation.

How does the Act otherwise impact a borrower’s ability to obtain full forgiveness?

• Applicable Covered Period – A borrower may elect, at its option, to choose a “covered period” ending at any time between 8-weeks and 24-weeks after loan origination. Regardless of the chosen covered period, each borrower must use the full amount of the PPP loan proceeds on eligible expenses during its chosen covered period to be eligible for full loan forgiveness.
• Simplified Forgiveness Process for PPP Loans up to $150,000 – The Act provides for a simplified loan forgiveness process for PPP loans of up to $150,000. Specifically, applicable borrowers will be eligible for loan forgiveness if the borrower signs and submits a one page certification to the lender (a) describing the number of employees the borrower was able to retain because of the PPP loan, the estimated amount spent on eligible payroll costs and total PPP loan value and (b) attesting that it accurately provided the required certification and complied with applicable PPP requirements. The form of the above described certification is expected to be available by January 20, 2021.
• Economic Injury Disaster Loans Advances – Borrowers that received both a PPP loan and an EIDL advance will no longer be required to subtract the EIDL advance from their PPP forgiveness calculation.

If a borrower has already received a forgiveness determination from the SBA, may the borrower refile its loan forgiveness application to take advantage of the expanded provisions governing forgivable uses of PPP loan proceeds? No. The Act provides that its provisions expanding expenses eligible for loan forgiveness will not apply to a borrower that “received forgiveness before the date of enactment” of the Act. Please note that although the Act is not explicit on this point, it appears, based on the foregoing language of the Act, that if a borrower only received a portion of its requested loan forgiveness prior to enactment of the Act, such borrower would not be able to claim the additional covered expenses described above as forgivable expenses. In addition, the Act does not specifically address whether a borrower that has filed its loan forgiveness application and is awaiting a forgiveness determination by the SBA may re-file its application to take advantage of the expanded provisions concerning expenses eligible for loan forgiveness.

PPP Second Round Loans

What borrowers are eligible to obtain a PPP Second Round loan? In order to be eligible for a PPP Second Round loan, a borrower must be “a business concern, nonprofit organization, housing cooperative, veterans organization, [t]ribal business concern, eligible self-employed individual, sole proprietor, independent contractor, or small agricultural cooperative” and be able to demonstrate the following:

• it has no more than 300 employees; and
• it has suffered a 25% or more reduction in gross revenues between comparable quarters in 2019 and 2020.

A borrower may either be a first time PPP borrower or have previously received a PPP loan. Importantly, on the Act’s face, it is unclear whether a borrower may avail itself of (a) the SBA’s alternative employee-based and revenue-based size standards corresponding to a borrower’s primary industry (i.e., the NAICS industry classification) or (b) the SBA’s alternative maximum tangible net worth and net income standards for purposes of determining its eligibility under the PPP Second Round.

Does the Act expand PPP Second Round loan eligibility to certain entity types? Yes. New entities that are eligible to participate in the PPP Second Round include certain Section 501(c)(6) nonprofits, including trade organizations and chambers of commerce, and nonprofits and government instrumentalities that engage in destination or tourism marketing (defined as “destination marketing organizations”) with (a) 300 or fewer employees, (b) that do not receive more than 15% of their revenue from lobbying (capped at $1 million during the most recent tax year prior to February 15, 2020) and, (c) if engaged in lobbying activities, that do not engage in lobbying activities which comprise 15% or more of total business activities. In addition, certain local newspapers, television, and radio stations, which were largely ineligible to participate in the first round of the PPP by their affiliation with other stations, are also eligible to participate.

Are certain entity types ineligible to participate in the PPP Second Round? Yes. The Act renders the below types of persons and entities ineligible to participate in the PPP Second Round.

• Those entity types that are generally prohibited from participating in the SBA’s 7(a) lending programs listed at 13 C.F.R. 120.110, which includes, among other things, financial businesses primarily engaged in lending;
• Publicly traded companies, provided that businesses that are owned or controlled by publicly traded companies may still be eligible.
• Any business primarily engaged in political or lobbying activities;
• Any business (a) organized under the laws of the People’s Republic of China or the Special Administrative Region of Hong Kong or (b) that has a person who is a resident of the People’s Republic of China on its board of directors; and
• Any person required to register as a foreign agent under the Foreign Agents Registration Act of 1938.

Is a borrower that returned all or part of its first round PPP loan eligible to reapply for a PPP Second Round loan? Yes. The Act provides that a borrower that returned all or part of its first round PPP loan may reapply for the maximum amount applicable under the Act.

Is a borrower that is in bankruptcy eligible for a PPP Second Round loan? Yes, under certain circumstances. Pursuant to the Act, a procedure is established for certain bankruptcies, including Chapter 11 bankruptcies, whereby a debtor in possession, or a trustee of a debtor, may request the Bankruptcy Court’s permission to obtain a PPP Second Round loan. The PPP Second Round loan will be “treated as a debt to the extent the loan is not forgiven” and will have super-priority equal to “administrative expenses.”

Are borrowers still required to apply the affiliation rules in determining whether the borrower is eligible to participate in the PPP Second Round? Yes. The Act explicitly provides that the affiliation rules are applicable. However, the Act maintains existing expansions in eligibility for businesses assigned a North American Industry Classification System (“NAICS”) Code 72 (Accommodation and Food Services).

What is the maximum loan amount a borrower is eligible for under the PPP Second Round? Under the PPP Second Round, a borrower will be eligible to obtain a loan amount equal to the lesser of (a) 2.5x its average monthly payroll costs, as measured during either (i) the one year period before the date the PPP Second Round loan is disbursed or (ii) calendar year 2019, or (b) $2 million. In addition, for a borrower assigned a NAICS Code of 72 (Accommodation and Food Services), the borrower will be eligible to receive a PPP Second Round loan in an amount equal to the lesser of (a) 3.5x its average monthly payroll costs or (b) $2 million. 

Lender Provisions – Existing PPP Loans and PPP Second Round Loans

Did the Act set aside a portion of the appropriated funds for specific types of financial institutions? Yes. Of the approximately $284.5 billion appropriated to the PPP Second Round, (a) $15 billion will be allocated for guaranteeing PPP loans made by community banks and credit unions with less than $10 billion in consolidated assets, and (b) $15 billion will be allocated for guaranteeing loans made by community development financial institutions and minority depository institutions.

Does the Act provide for greater protections for PPP lenders? Yes. The Act provides that the SBA will hold a PPP lender harmless, provided it has acted in good faith and adhered to federal, state and local laws. These provisions are summarized below.

• Reliance – PPP lenders may rely on certifications and documentation submitted by a borrower, provided that (a) the certification and documentation satisfies the applicable PPP laws and regulations and (b) the borrower attests it has accurately provided the certification or documentation to the lender in accordance with applicable PPP laws and regulations.
• No Enforcement Actions – The SBA will not take an enforcement action or assess a penalty against a PPP lender, provided the lender (a) has acted in good faith and (b) complied with applicable federal, state and local requirements.

What PPP lenders are eligible to participate in the PPP Second Round? All lenders previously approved to originate PPP loans may participate in the PPP Second Round pursuant to existing PPP requirements.

What are the loan processing fees for PPP Second Round loans? The loan fees that PPP lenders will be entitled to are noted below.

• $50,000 or less – PPP lenders will be entitled to the lesser of either (a) 50% of the PPP loan amount disbursed or (b) $2,500.
• More than $50,000, and up to $350,000 – PPP lenders will be entitled to 5% of the PPP loan amount disbursed.
• More than $350,000 – PPP lenders will be entitled to 3% of the PPP loan amount disbursed. 

When are a borrower’s agent fees required to be paid? It depends. If a borrower has “knowingly retained an agent,” then applicable agent fees will be paid by the borrower and may not be paid out of the PPP loan proceeds. A lender is only required to pay agent fees where the lender has “directly” contracted with the agent.

PPP Audits

Does the Act provide for greater clarity on how the SBA will audit existing PPP loans and PPP Second Round loans? While the Act itself does not provide for greater clarity, the Act requires the SBA to issue its forgiveness audit plan, policies and procedures to Congress by February 10, 2021. This guidance should provide greater transparency with respect to how and when the SBA will audit PPP loans.

Section 7(a) Loan Programs

How does the Act impact ordinary Section 7(a) business loans? The Act also provides for certain enhancements to existing Section 7(a) business loans. As a means of ensuring the SBA has adequate tools to address the needs of small businesses during the pandemic, the Act temporarily enhances the terms of the 7(a) loan program by (a) increasing the loan guarantee to 90% until October 1, 2021 and (b) reducing or eliminating borrower and lender fees until September 30, 2021.

Separately, until October 1, 2021, the Act temporarily increases the loan guarantee for Section 7(a) express loans in an amount less than $350,000 to 75%, while keeping the current 50% guarantee for loans larger than $350,000.

Shuttered Venue Operators

What types of venue operators are eligible to receive a grant under the Act? In general, a business is eligible to receive a grant under the Act if it is a “live venue operator or promoter, theatrical producer, or live performing arts organization operator, a relevant museum operator, a motion picture theatre operator, or a talent representative” that was both (a) fully operational on February 29, 2020 and (b) that demonstrates a 25% reduction from the gross earned revenue during the same quarter in 2019 (or 2020, as applicable). Certain venue operators are not eligible to participate (e.g., venue operators owned by public companies, offering performances of a prurient sexual nature, receiving more than 10% of gross revenue from federal funding).
We note that, as of the date of the grant, the business must be open or intend to reopen.

What is the amount of grants that may be made to a venue operator? Initial grants may be in an amount equal to 45% of gross earned revenue in 2019. A venue operator may qualify for a second grant equal to 50% of the amount of the first grant, but the total amount of grants may not exceed $10 million.

In what priority will grants be awarded? For a 14-day period, the SBA will award priority grants to the venue operators that have seen at least a 90% decline in revenue comparing the period between April 1, 2020 and December 31, 2020 against the comparable period in 2019. Immediately thereafter, for another 14-day period, the SBA will then award second priority grants to venue operators that have seen at least a 70% decline in revenue. After both priority grants have been satisfied, all other venue operators may then apply. We note that the Act reserves $3 billion for venue operators that do not qualify under the priority grant provisions.

Is a grant recipient restricted in how it uses the grant funds? Yes. A recipient must use the grant funds for the following expenses which were incurred between March 1, 2020 and December 31, 2021: payroll costs; and certain rental obligations, utility payments, mortgage obligations, worker protection costs, payments to certain independent contractors and ordinary/necessary expenses.

PPP Tax Considerations

Did the Act render expenses paid with the proceeds of a forgiven PPP loan deductible? Yes. In a reversal of the Department of Treasury’s and Internal Revenue Service’s prior guidance, the Act provides that no deduction for business expenses funded with the proceeds of a forgiven PPP loan may be denied by reason of the exclusion of the loan forgiveness from gross income.

Did the Act extend payroll tax deferral periods? Yes. In prior guidance, the Internal Revenue Service permitted employers to defer withholding of the employee’s share of social security payroll taxes from September 1, 2020 through December 31, 2020 and to withhold and deposit the applicable taxes ratably between January 1, 2021 and April 30, 2021. The Act extends the withholding and depositing deadline to December 31, 2021.

Did the Act extend the Employee Retention Tax Credit? Yes, the Act extends the Employee Retention Tax Credit (“ERTC”) through June 30, 2021. In addition, for calendar quarters beginning after December 31, 2020, the ERTC was expanded by (a) increasing the amount of the tax credit from 50% to 70% of “qualified wages” paid to an employee up to $10,000 per calendar quarter and (b) expanding a business’ eligibility by reducing the threshold for the decline in gross receipts to qualify as an “eligible employer” from 50% to 20%. Further, the Act allows employers that obtained PPP loans to claim the ERTC on eligible wages not used to support PPP loan forgiveness.

Please join James W. Morrissey and Mark C. Svalina of Vedder Price’s Financial Institutions group for an educational webinar on the newly enacted stimulus bill.

Signed into law on December 27, 2020, as part of a larger government funding bill, the stimulus bill:

• restarts the Paycheck Protection Program (“PPP”) and provides borrowers with greater flexibility under the PPP; and
• implements various other bank-specific provisions.  

Our webinar discussion will help financial institutions understand the provisions and implications of both the second round of PPP and other relevant provisions in the general stimulus package. We hope you will join us!

To help us better answer your questions, we strongly encourage you to submit confidential questions for the panelists on the registration page or to send your questions directly to Mark C. Svalina at msvalina@vedderprice.com. Any question not answered during the event will be answered individually, via email, upon the webinar’s completion.

Please join Vedder Price attorneys Joseph M. Mannon and Robert M. Crea, as well as co-panelist Julie Dixon, Founder and CEO of Titan Regulation, for a webinar panel discussion about the new Marketing Rule recently adopted by the U.S. Securities and Exchange Commission.

The new Marketing Rule represents a significant change to how investment advisers can market themselves and their products, including how advisers to private funds such as private equity, venture capital and hedge funds can present their performance information.

During this webinar participants will gain knowledge regarding:

• What qualifies as an “advertisement” under the new Marketing Rule
• Compliance requirements for using testimonials and endorsements in an advertisement
• How advisers may use third-party ratings in an advertisement
• The new Marketing Rule’s provisions regarding the use of performance advertising
• General prohibitions under the new Marketing Rule