THE
WALL STREET JOURNAL.
Markets
Regulators Look Into Mutual Funds’ Procedures for Valuing Startups
SEC increases focus on private-company valuations as part of
regular fund-firm reviews
In September, Fidelity marked down the estimated value of its
stake in Snapchat. PHOTO: LUCAS JACKSON/REUTERS |
By
Kirsten Grind
Updated Nov. 17, 2015 7:17
p.m. ET
Federal securities
regulators are looking more closely at whether U.S. mutual funds have
proper procedures in place to accurately price shares of private
technology companies amid signs the tech boom is wavering, according
to people familiar with the matter.
The Securities and
Exchange Commission in recent months has been asking more questions of
large fund firms about how they value startups and whether their
process ensures an accurate estimate of a company’s worth, the people
said.
The SEC conducts
occasional checkups of mutual funds in which they examine things such
as the proportion of funds’ holdings that are in hard-to-sell
securities, which include shares of private companies. The amount of
hard-to-sell shares is an indicator of how easily a mutual-fund
investor would be able to get his or her money back. Some SEC
examiners have shifted more of their focus in those regular reviews to
possible shortcomings in the startup-valuation process, the people
said.
Startup shares are “not
traded on an exchange, so a market quote is not readily available,”
said Jay Baris, a partner and chair of the law firm Morrison &
Foerster’s investment-management practice. “The question is, how do
you put a fair value on it when you’re looking at squishy data?”
Accurate pricing of
securities is fundamental to the mutual-fund business, and millions of
investors rely on precise valuations to figure out how much their
holdings are worth. Fidelity Investments,
T. Rowe Price Group Inc.
and
BlackRock Inc.
are among
the biggest money managers investing in private tech companies.
The scrutiny comes as
big money managers have been loading up on shares of private companies
over the past several years, investing in hot startups such as Uber
Technologies Inc., Dropbox Inc. and Airbnb Inc. Five of the biggest
fund firms participated in funding rounds worth a combined $8.3
billion this year as of Sept. 30, up from $1 billion for the full year
of 2011, according to data from venture-capital research firm CB
Insights.
Shares of those startups
have landed in some of the most popular mutual funds available to
small investors, including the $111 billion Fidelity Contrafund and
the $15.7 billion T. Rowe Price New Horizons fund.
But mutual-fund firms
are struggling to value the startups and frequently report different
prices for the same company,
The Wall Street Journal reported in a
front-page article last month.
According to a Journal
analysis of data provided by fund-research firm
Morningstar Inc.
of
startups worth at least $1 billion, there were 12 instances over the
past two years in which the same company was valued differently by
more than one mutual fund on the same date.
In the quarter
ended June 30, for example, Fidelity said car-sharing service Uber was
worth $33.32 a share,
Hartford Financial Services Group
said it was $35.67 a share and BlackRock valued the company at $40.02
a share. Spokesmen for Fidelity and BlackRock have said that they
employ rigorous valuation processes for pricing private holdings. A
spokeswoman for Hartford has declined to comment.
Mutual-fund firms use
different processes and procedures for valuing startup companies,
unlike typical securities that track an index, The Journal has
reported. Sometimes funds place a price on a startup based on its
most-recent funding valuation, and other times they base the price on
similar publicly traded companies or other market movements.
Often the process is
made more complicated because the fund companies aren’t all receiving
the same information from the startup, money managers have told The
Journal.
Fund companies don’t
disclose the process they go through for valuing the startup shares,
generally citing competitive reasons.
There is growing concern
in the technology sector that private shares have become too bloated,
and that some recent technology IPOs have been priced at less than the
latest private valuation of the companies. In September,
Fidelity marked down the estimated value of
its stake in Snapchat, the chat startup, by 25%,
according to a monthly report from Fidelity.
A spokesman for Fidelity
declined to comment on the change.
The SEC hasn’t directed
its examiners to focus on mutual-fund firms’ pricing of private
companies, said the people familiar with the matter. The scrutiny is
not being handled in the agency’s enforcement division, which brings
civil cases against companies and individuals.
The SEC has said that as
part of its examination priorities for investment firms for 2015, it
would look more closely at “alternative” investments whose returns
don’t track the stock market and have experienced “rapid and
significant growth,” according to a public regulatory document
outlining the priorities. In particular, the agency said it would look
closely at liquidity and valuation policies.
In their latest reviews,
SEC examiners have focused on the steps fund companies are taking to
make sure the values are appropriate, the people said.
Examiners, who are
questioning fund managers as well as independent board members of fund
companies, are asking about the procedures and tools funds are using
to land at the prices they are placing on the startups. Often that
includes looking through documents and manuals outlining the processes
that fund companies have in place, these people said.
Mutual funds’
investments in holdings that are hard to sell—so-called illiquid
securities—have increasingly become a focus for the SEC. By
regulation, a fund is only allowed to hold 15% of its assets in
hard-to-sell securities, a category that includes private-company
shares.
“Liquidity is a prime
concern and is now at the top of [the SEC’s] list and right behind
that is valuation,” Morrison & Foerster’s Mr. Baris said.
Corrections &
Amplifications
Fidelity Investments in
September marked down the value of its stake in Snapchat by 25%. A
previous version of this article misstated that Fidelity lowered its
valuation of the company by 25%.
Write to
Kirsten Grind at
kirsten.grind@wsj.com
|