Determination of an NAV Error When the Net Asset Value Reported on the Financial Statements Differs From Published Values

Posted by admin on Jul 10, 2013 4:31:00 PM

For starters, the regulatory provisions relating to net asset value (“NAV”) can be found in the rules adopted under the Investment Company Act of 1940, in particular, Rules 2A-4 and 22c-1. A few notable excerpts from these two rules are as follows:

Changes in the holdings of portfolio securities, as well as the number of outstanding shares of the registered company, shall be reflected no later than in the first calculation on the first business day following the trade date. (Rule 2A-4)

Items otherwise required by paragraphs (a)(4) and (6) of this section need not be so reflected if cumulatively, when netted, they do not amount to as much as once cent per outstanding share. (Rule 2A-4) (One could reasonably conclude this to be a de minimus provision for computing NAV)

Portfolio securities with respect to which market quotations are readily available shall be valued at current market value, and other securities and assets shall be valued at fair value as determined in good faith by the board of directors of the registered company (Rule 2A-4)

The current net asset value shall be computed no less frequently than once daily, with certain exceptions for holidays , etc. (Rule 22c-1)

To summarize above, when computing the daily NAV, transaction should be reflected on a trade date +1 basis. Any items that would impact the NAV by $.01 should be included in the calculation, fair valued securities should be estimated in good faith, and the NAV should be computed at least once daily. Noticeably absent is any reference to any subsequent events considerations, which is logical due to the no less frequently than daily requirement.

Contrast the above rules for computing NAV with the FASB Codification Rules for preparing GAAP financial statements for investment companies. Noticeable excerpts from the FASB codification for investment companies are as follows:

An entity should recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including estimates ( fair value is an estimate) inherent in the process of preparing financial statements (ASC 855-10-25-1)

Security transactions should be recorded on the trade date. (ASC 946-320-25-1)

Due to these contrasting rules, it is quite possible, and even somewhat likely, that the daily reported NAV will be different that than the Financial Statement NAV. The question at hand is whether or not a different financial statement NAV is indicative of an error in the computation of the daily NAV. If the different NAV is due to different requirements for how each are to be computed (trade date accounting and the consideration of subsequent events), then the answer is clearly no. However, if the different NAV is due to an adjustment to reflect information that was available at the time the daily NAV was determined, but not considered until the financial statements were prepared, it will likely be considered a NAV error, and the impact of that error on the fund and the shareholder transactions should be analyzed and resolved.

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