Financial Reporting

SEC Rule 2a-5 Spells Out a Fair-Value Process. Private Funds Can Borrow Its Four Functions

Rule 2a-5 binds registered funds and BDCs, yet fund CFOs and controllers can borrow its four functions to write a Level 3 valuation policy auditors accept.

By 409.AI Team - 2026-10-09

# SEC Rule 2a-5 Spells Out a Fair-Value Process. Private Funds Can Borrow Its Four Functions

If you run finance at a venture or private equity fund, Rule 2a-5 under the Investment Company Act does not apply to you. It binds registered investment companies and business development companies. Yet it is the only US rule that lists, in plain text, what a good-faith fair value process has to contain. Your auditor has read it. So has the examiner who asks to see your valuation policy. Using it as the skeleton for your own policy costs you nothing and answers most of the questions before they are asked.

This article is for the fund CFO, controller or emerging-manager GP who is writing or tightening a valuation policy before year-end. It walks through what the rule requires, what each requirement looks like on a fund with Level 3 positions, and where the rule stops being a useful template.

What the rule is, and who it covers

The SEC adopted Rule 2a-5 (17 CFR 270.2a-5) in December 2020 and it took effect on March 8, 2021. The SEC gave funds an eighteen-month transition, so compliance became mandatory in September 2022. The adopting release (Investment Company Act Release No. 34128) also created a companion recordkeeping rule, Rule 31a-4, and withdrew older SEC fair value guidance (Accounting Series Releases 113 and 118, among others).

The rule defines a "fund" as a registered investment company or a business development company. It defines "fair value" as the value of a portfolio investment for which market quotations are not readily available. Section 2(a)(41) of the Act makes the board responsible for determining that value in good faith. Rule 2a-5 says what good faith looks like in practice, and it lets the board hand the work to a valuation designee, normally the fund's investment adviser.

A private fund is not a "fund" under the rule. But the standard it sets is the closest thing in US regulation to an agreed description of a defensible process. When our readers ask what an auditor wants to see around a Level 3 mark, we point to the structure below. It maps cleanly onto the [fund valuation policy](https://www.409.ai/articles/fund-valuation-policy-asc-820-audit-sec-exam) your auditor and any SEC examiner will ask for first.

The four functions in paragraph (a)

Paragraph (a) names four things a fund's fair value process must address, "taking into account the fund's valuation risks."

1. Assess and manage valuation risks. Identify the places a mark could go wrong, including material conflicts of interest, and manage them. For a private fund the obvious conflict is the adviser's own fee: carry is calculated on marks, and some fee bases move with NAV. We covered the mechanics in our piece on [carried interest accrual under a hypothetical liquidation](https://www.409.ai/articles/carried-interest-accrual-hypothetical-liquidation-fund-marks). A policy that names this conflict and says who reviews marks that move fee or carry numbers is doing function one.

2. Select and consistently apply methodologies. Choose valuation methods suited to each type of investment, apply them consistently, review them periodically, and watch for events that call for a fair value. The word that matters is "consistently." A fund that values a Series B position on the last round price in March and on a revenue multiple in June, with no recorded reason, has a methodology problem even if both numbers are defensible.

3. Test the methodologies. The rule asks the fund to specify how and how often it tests whether its methods are appropriate and accurate. Backtesting is the usual answer: compare marks against subsequent transaction prices, exits and follow-on rounds, and record the variance. If a fund marked a company at 1.4x cost and the next priced round came in at 1.1x, the policy should show that someone looked at the gap and asked what the model missed.

4. Oversee pricing services. Approve, monitor and evaluate any third-party pricing provider, and challenge prices when warranted. Venture funds use few pricing services, but many use an outside valuation firm. The function carries over: the fund decides which firm, reads the report instead of filing it, and can explain what the fund did when it disagreed.

What "readily available" means, and why it matters for Level 3

Paragraph (c) of the rule is short and strict. A market quotation is readily available only when it is a quoted price, unadjusted, in an active market for identical investments that the fund can access on the measurement date. A quotation that is unreliable does not count.

That is the same boundary that separates Level 1 from everything else in ASC 820. If you have ever argued over whether a lightly traded secondary price is Level 2 or Level 3, you were making the same judgment. Our guide to [Level 3 classification and significant unobservable inputs](https://www.409.ai/articles/asc-820-level-3-classification-significant-unobservable-input) covers the accounting side; the rule gives the regulatory vocabulary.

Reporting to the board, and what it teaches an LPAC

When a board assigns fair value to a valuation designee, paragraph (b) of the rule requires the designee to report in writing on a set rhythm.

  • **Quarterly:** the materials the board asks for, plus a summary of material fair value matters from the prior quarter.
  • **Annually:** an assessment of whether the fair value process is adequate and effective, including the results of testing and a look at staffing.
  • **Promptly:** any material matter, such as a significant deficiency, a material weakness or a material error in NAV. The notice is due within the period the board sets and no later than five business days after the designee becomes aware of it.

The five-day clock is easy to misread. The adopting release says the designee does not have to finish its materiality assessment inside five days, but it should assess promptly. If, after twenty business days, the designee still cannot say whether a matter is material, the SEC expects it to tell the board that the evaluation is ongoing, and that notice must go out within the five-business-day window. If an independent third party, such as the auditor, tells the designee a matter is material and says what it does to the portfolio, the five days start at once.

A private fund has no board in this sense, but it has an advisory committee, an investment committee or a CFO who answers to the GP. The rhythm transfers. A quarterly valuation memo, an annual look at whether the process worked, and a written escalation path with a deadline are the three things most private-fund policies lack.

An illustration: a $200M venture fund

Illustrative only. Suppose a fund holds 30 portfolio companies, 26 of them private and carried at Level 3. Its policy today says "investments are valued at fair value in accordance with ASC 820 by the General Partner."

Rewritten around the four functions, the same policy would say:

  • **Risks and conflicts.** Marks that change the carry accrual by more than a stated amount go to a second reviewer who does not sit on the deal team.
  • **Methods.** Each position has a primary method recorded at first mark (recent round, calibrated back-solve, market multiple), and a change of method is documented with the reason and the date.
  • **Testing.** After each exit or priced follow-on, the team compares the last mark with the realized price and logs the variance. Once a year, the log is summarized for the investment committee.
  • **Outside providers.** The valuation firm is engaged by the CFO, reports to the CFO, and any mark that differs from the firm's range is explained in the memo.

Nothing in that list is exotic. Each item is something the fund probably does informally. The change is that it is written down, owned by a named role, and dated, which is what an auditor reviewing management's process under AU-C 540 wants to find.

Segregation: the line most small managers cross

The rule requires the designee to reasonably segregate fair value determinations from portfolio management, so that a portfolio manager may not determine, or effectively determine through substantial influence, the value of a holding. It also asks the designee to identify the job titles of the people responsible for fair value.

Emerging managers with three partners cannot always build a separate valuation department. The release does not ask for impossible structures; it asks that the person who sourced the deal and sits on the board cannot also be the one who sets the mark without a check. A second reviewer, an outside valuation provider or a valuation committee with a non-deal-team member each address it. Write down which one you use. For the staff's September 2026 view on calibrating private asset marks, see [our note on the SEC staff statement and NAV](https://www.409.ai/articles/sec-staff-statement-private-asset-fair-value-calibration-nav).

Records

Rule 31a-4 requires funds, or their advisers when the board has designated them, to keep the documentation that supports fair value determinations, along with the board's designation and the designee's reports. The retention period is six years, the first two in an easily accessible place. The adopting release dropped an earlier requirement to record every methodology, assumption and input in all cases, and replaced it with "appropriate documentation" to support each determination.

Six years is a reasonable default for a private fund even though the rule does not bind you. Fund audits are repeated, LP disputes arise late, and the year-end valuation memo is the document you will want when someone asks in year four why a position was written down.

Where the template stops

Rule 2a-5 was written for registered funds and BDCs that report to a board of directors. Three things do not carry over without adaptation:

  • **Board oversight.** A private fund's governance runs through the LPA and the LPAC. Decide what goes to whom, and when.
  • **Pricing services.** Most Level 3 venture positions have none. Function four becomes an oversight rule for outside valuation advisers.
  • **Registered-fund conflict rules.** The Investment Company Act has its own affiliated-transaction regime. Do not import it by reflex.

For custody-rule funds, the audit calendar adds its own pressure on timing; see our piece on the [120-day audit deadline and year-end marks](https://www.409.ai/articles/custody-rule-120-day-audit-deadline-fund-year-end-marks). The valuation memo has to be done well before the auditor starts.

What to do this quarter

Take your current valuation policy and hold it against four questions. Does it name the risks and conflicts in your marks, and who reviews them? Does it say how each type of position is valued and how a change of method is recorded? Does it say how you test marks after the fact, and how often? Does it say who engages and oversees outside valuation help? Wherever the answer is "by custom," write the sentence.

Then add a calendar: quarterly memo, annual process review, and a written escalation window. If you want an independent valuation of the Level 3 positions behind those marks, [409.AI's ASC 820 valuation service](https://www.409.ai/products/asc-820) is built for fund finance teams at exactly this point in the quarter.

*Sources: 17 CFR 270.2a-5 ([Cornell LII](https://www.law.cornell.edu/cfr/text/17/270.2a-5)); SEC, Good Faith Determinations of Fair Value, Release No. IC-34128 ([sec.gov](https://www.sec.gov/rules/final/2020/ic-34128.pdf)).*

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