On April 12, 2016, the Investment Company Institute (ICI) issued a memorandum to member firms regarding fund policies and procedures for valuing portfolio assets and pricing, issuing and redeeming fund shares, as well as related disclosure, in light of unanticipated events on securities trading venues. The ICI memo states that unanticipated disruptions in the functions of securities exchanges or other trading venues raise various legal and operational considerations for open-end funds, including issues such as trade execution, valuation of portfolio assets, pricing of fund shares and processing transactions in fund shares. Citing the midday suspension of trading on the New York Stock Exchange (NYSE) on July 8, 2015, the ICI notes that, in that case, the NYSE resumed trading before the 4:00 pm (Eastern Time) market close and therefore, funds were able to price their shares in accordance with standard operating procedures and policies. Nonetheless, the memo explains, many fund complexes have been evaluating relevant policies, procedures and disclosure in anticipation of future potential trading venue disruptions. In this connection, the ICI identifies several matters that member firms may wish to consider as they conduct such evaluations.
Valuation Policies and Procedures: Noting that funds often look primarily to a security’s closing price on its primary listing market or exchange in valuing that security, the memo advises funds to review their current valuation policies to determine whether they provide for the use of additional sources of pricing data or information when prices from the primary listing market are unavailable, or are earlier and less representative of current market value. In this regard, the ICI notes that in the event of an unexpected close of the primary listing market, a security may continue to trade in one or more other markets, and the price as reflected in those other trading venues may be more reflective of the security’s value than an earlier price from the primary listing market (which had closed unexpectedly).
Consideration of a Fund’s Time for Pricing Fund Shares and Accepting Orders: The ICI recommends that funds take into account valuation and operational factors in adopting policies with respect to when and how often fund shares will be priced. For instance, the memo notes that funds may consider the capabilities of service providers such as pricing vendors (e.g., whether they can provide reliable values for securities at unanticipated times of the day) and intermediaries (e.g., whether they can apply an unanticipated fund cut-off time and sort purchase and redemption orders accordingly). On this matter, the memo explains that Rule 22c-1 under the Investment Company Act provides funds with flexibility regarding when and how often they must price their shares and, as a result, fund policies vary with respect to the time when they price fund shares and stop accepting purchase and redemption orders (the “cut-off time”). Some funds stipulate a fixed cut-off time (e.g., 4:00 pm Eastern Time); others stipulate that their cut-off time will coincide with the close of trading on the NYSE. The ICI explains that this difference in policies may yield different results in the event that trading is suspended on the NYSE and “closed” as of a time that is not 4:00 pm Eastern Time.
Enhancing Fund Policies and Related Disclosure: Whichever general option a fund adopts, funds should consider ways of elaborating on Rule 22c-1 policies and related disclosure to describe steps to be taken in response to unanticipated market events. The objectives, according to the ICI, should be to improve funds’ ability to accommodate these events while still providing shareholders a clear sense of likely outcomes from the application of these policies. For instance, a fund preferring to tie its daily cut-off time to that of the NYSE might specify that the relevant time would be the time as of which the NYSE determines official closing prices. Thus, in the event that the NYSE were to close early unexpectedly but determine prices for its securities at a later time, this later time would control for purposes of the fund’s cut-off time.
In addition to the foregoing, the memo advises that the fund board should review and approve any material changes to the fund’s valuation policies and procedures regarding when the fund will price its shares. The ICI also recommends that a fund effectively communicate to its intermediaries any changes to the fund’s policies and procedures or its cut-off time to ensure prompt and proper application of the fund’s new policies and the proper cut-off time when sorting purchase and redemption orders following an unanticipated exchange event. Finally, as to disclosure, the memo states that a fund must provide shareholders with disclosure about its procedures for valuing portfolio assets and pricing, issuing and redeeming fund shares in its prospectus and SAI. Therefore, any changes to such policies and procedures may require conforming changes to the fund’s prospectus and SAI.