SEC Division of Investment Management staff letter: Chief Financial Officer

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON. D.C. 20549

,IVISION OF

INVESTMENT MANAGEMENT
November 1, 1994
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De Chief Financia Offcer: lA..allttbUtty !~I'l r 1J~_ri~ t-. jr TtW'""'l T r 'l . ~ The accountig sta of the Division of Investment Mangement has prepar ths letter to assist investment company registrats and their independent public accountats in addressing cert accountig-related matters. These comments reresent the views of the sta of the

Division of Investment Management and ar not necessay those of the Securities and Excbange Commission (the "Commission"). The comments addrssed in this letter apply to filgs made by registere investment companes, includig reorts to shareholders. Ths letter should be read in conjunction with simar letters issued by the Division's Offce of Disclosure and Review and Offce of Insurace Products. Accountin For Certin Transctions with Aff'ilates Increasingly dunng the past yea, afilatesl have compensated funds for losses on cert of

their investment holdigs. The contnbutions generay tae one of two fonus - a dit

contnbution by the afate to the fund to offset the effect of a reed loss on a portolio investment ("diect contnbution") or the purchase by the afilte of securities from the fund at prices in excess of the securities' currnt market value ("afilte purchase"). In both cases, the accountig for the loss on the investment and the resultig payment should be reflected in a fund's fmancial statements as a rea loss and a correspndig contribution to capita.

Cash (or other assets) recived from an afilte as a dit contnbution should be reflected by

the fund in its fmancia statements in the statement of changes in net assets immedately afer the capita share trsactions setion and in the fmacia highlghts table imedtely following the "distributions" section. . Notes to the fmancial statements and fmancia highlghts table should describe these contnbutions. In addition, footnotes to the tota return disclosure in the
table should quantif the effect of the capita contnbution in a maner simar to disclosure for
2 the effect of volunta waivers of fees and expenses.

The term "affliate" as used in this context is as defied by the Commssion's Regulation S-X Item 6~2(a) (17 CPR §2lO.6~2(a)). Ths comment doe not address situtions involving non-affiliate. The accunting for such non-affated tractions should be reviewed on a cae-by-ce basis.

2 In addition to the genera gudace in Statement of Financial Accounting Stadads No. 57, Relaed Part Disclosure, specific reuirements are set fort in Pargrph 5.29 of the Audit and Accounting Guide, Audits of Investment Collanes, AICP A, 1993.

Afted purchases at a price in exces of the currnt maret value3 do not reuce the loss tht would otherwis have occur if the investment had ben sold to an unate person. The amount by which the payment exces the currnt market value of the investments purchas is considere a contnbution to caita, and the accountig should be the sae as that for dit

contnbutions.
Funds"'shöuldconsider the. non..ficia statement diclosur implications surrundig the

contnbution and the relate accoun$g trtment, includig the Mangement's Discussion of Fun Pêiforme requir by Item 5A of Form N-IA. The nartive disclosure should be consistent with the relate fiancia statement disclosure referr to above. Valuation of Certin Portfolio Invesents In recent yeas, investment companes have made increasing use of cert instrments that,

under some market conditions, may require valuation by the companes' boards of ditors.

The Commssion's Accounng Series Releases (ARs) 113 an 118 provide guidace in the valuation, accuntig and auditig of these investments. Ths guidace requires clealy defmed policies and procedures to be established by an investment company's board of diectors and any deviation from these policies and procedures to be disclosed in the fiancia statements or

notes thereto. These policies and procedures should encompass al appropriate factors relevant to the valuation of investments for which market quotations ar not rediy avaiable.

In determg whether market quotations ar rediy avaible, Section 404.03.b.ii of the Codication of Financial Reprtg Policies reiterates the guidace in ASR 118, which states that "quotations for a security should be obtaed from more than one broker-deaer....1f the valdity of the quotations appes to be questionable, or if the number of quotations indicates

that there is a thi market in the security, further consideration should be given to whether

market quotations are rediy avaible." Where it is determed that market quotations are

readiy avaible, the certing accountat should indepndently veri al the quotations used

by the company at the balce sheet date. With respect to valuation of non-exchange-traded

investments by a certg accountat, independent verication should be inteipreted as reliance on quotations recived from a source independent of the source used by the client. The guidace in ASRs 113 and 118 also applies to investments for which there are few market makers or broker-deaers4 providing market quotations. The sta believes, where there areJew market makers or broker-deaers providig market quotations (as in the case of structured notes), the independent verication guidace set forth above requirs the independent public

accountat to seek verication from a market maker or broker-deaer different from that used by the company. In the case of only one market maker or broker-deaer providig a market quotation, the independent public accountat should employ altemativevaluation procedures that provide an accurate and reasonable valuation. Unless facts indicate otherwise, the staff views purchases of fud investments by affiates under the circumstaces described in ths lettr as being at a price in excess of maket value. Ths lettr is not intended to expres any views on the implications of any tractions describe under section 17 of the

Investment Company Act of 1940.
The term "maket maer" and "broker-deaer" as used in this context have the sae meag as those in ASRs 113 and 118. 2 -, , . ~ ./-:'.., ~J 4

Audied Balance Shee for New Series
Although the sta has interpreted Section 14(a)(2) of the Investment Company Act of 1940 (the "Act") generay to permt a new series of a fund to make a public offerig of seurities without having at least $100,00 of net wort, a fund registrig a new series may sell one or more

shars of the series to a single shaholder, usuay afte with the fund. In such caes, regardless of the amount invest by the inti shaholder or shaholders prior to the

effecveness of the registrtion, an audite balce shee is reuir in the regitrtion statement in accrdace with Item 25, Schedule A of the Securities Act of 1933. Ths reuirment also applies to those companes distnbutig inurace proucts which ar alowed an exemption under Rules 6e-2(b)(6), 6e-3(T(b)(6) and 14a-2 under the Act which, despite the exemption,

decide to see the insurace products' company with inti capita.

Securities With Zero Value
Schedule 12-12 of Regulation S-X contemplates the listig of each security a fund owns in the

schedule of investments. A fund tht owns securities considered to be worthless should
contiue to list those securities in its schedule of investments indicatig a zero value. Only afer the fund has classifed the security as a wortess security for federa income ta purposes should any security be removed from the listig. Omittg securities from the schedule prior to the determination of worthlessness for ta purposes may be misleadig to investors inter￾ested in evaluatig the fund's investments.

Ths letter contas inormation of importce to the company's indepndent public

accountat; therefore, we encourae these items to be discussed with them. Any questions on the contents of this letter or related matters ca be addrssed to me, Anthony S. Evangelista or James F. Volk, Assistat Chief Accountats, at (202) 942-0590.

Very truly yours, ~~.¿¿J-~
Lawrence A. Friend
Chief Accountat
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